10-Q 1 f10q073105.txt FORM 10Q FOR QUARTER ENDED 7/31/05 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) [ X ] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For quarterly period ended JULY 31, 2005 or [ ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 Commission file number 1-8551 Hovnanian Enterprises, Inc. (Exact Name of Registrant as Specified in Its Charter) Delaware 22-1851059 (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.) l0 Highway 35, P.O. Box 500, Red Bank, NJ 07701 (Address of Principal Executive Offices) (Zip Code) 732-747-7800 (Registrant's Telephone Number, Including Area Code) Same (Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report) Indicate by check mark whether the registrant: (l) has filed all reports required to be filed by Section l3 or l5(d) of the Securities Exchange Act of l934 during the preceding l2 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [ X ] No [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [ X ] No [ ] Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [ X ] Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. 47,054,474 shares of Class A Common Stock and 14,680,163 shares of Class B Common Stock were outstanding as of August 31, 2005. HOVNANIAN ENTERPRISES, INC. FORM 10-Q INDEX PAGE NUMBER PART I. Financial Information Item l. Financial Statements: Condensed Consolidated Balance Sheets as of July 31, 2005 (unaudited) and October 31, 2004 3 Condensed Consolidated Statements of Income for the three and nine months ended July 31, 2005 and 2004 (unaudited) 5 Condensed Consolidated Statement of Stockholders' Equity for the nine months ended July 31, 2005 (unaudited) 6 Condensed Consolidated Statements of Cash Flows for the nine months ended July 31, 2005 and 2004 (unaudited) 7 Notes to Condensed Consolidated Financial Statements (unaudited) 8 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 24 Item 3. Quantitative and Qualitative Disclosures About Market Risk 43 Item 4. Controls and Procedures 44 PART II. Other Information Item 1. Legal Proceedings 45 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 46 Item 6. Exhibits 47 Signatures 49 HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (In Thousands Except Share Amounts)
July 31, October 31, ASSETS 2005 2004 ----------- ----------- (unaudited) Homebuilding: Cash and cash equivalents.................... $ 43,985 $ 65,013 ----------- ----------- Inventories - At the lower of cost or fair value: Sold and unsold homes and lots under development.............................. 2,278,418 1,785,706 ----------- ----------- Land and land options held for future development or sale...................... 448,296 436,184 ----------- ----------- Consolidated Inventory Not Owned: Specific performance options............. 5,705 11,926 Variable interest entities............... 134,196 201,669 Other options............................ 120,920 31,824 ----------- ----------- Total Consolidated Inventory Not Owned.. 260,821 245,419 ----------- ----------- Total Inventories........................ 2,987,535 2,467,309 ----------- ----------- Investments in and advances to unconsolidated joint ventures............................. 160,655 42,441 ----------- ----------- Receivables, deposits, and notes ............ 63,670 55,152 ----------- ----------- Property, plant, and equipment - net......... 77,837 44,137 ----------- ----------- Prepaid expenses and other assets............ 121,594 93,616 ----------- ----------- Goodwill..................................... 32,658 32,658 ----------- ----------- Definite life intangibles.................... 120,136 125,492 ----------- ----------- Total Homebuilding....................... 3,608,070 2,925,818 ----------- ----------- Financial Services: Cash and cash equivalents.................... 11,514 13,011 Mortgage loans held for sale................. 182,084 209,193 Other assets................................. 4,714 8,245 ----------- ----------- Total Financial Services................. 198,312 230,449 ----------- ----------- Income Taxes Receivable - Including Deferred Tax Benefits................................. 47,701 - ----------- ----------- Total Assets................................... $ 3,854,083 $ 3,156,267 =========== =========== See notes to condensed consolidated financial statements (unaudited).
HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (In Thousands Except Share Amounts)
July 31, October 31, LIABILITIES AND STOCKHOLDERS' EQUITY 2005 2004 ----------- ----------- (unaudited) Homebuilding: Nonrecourse land mortgages....................... $ 31,221 $ 25,687 Accounts payable and other liabilities........... 380,920 329,621 Customers' deposits.............................. 112,893 80,131 Nonrecourse mortgages secured by operating Properties..................................... 24,495 24,951 Liabilities from inventory not owned............. 132,309 68,160 ----------- ----------- Total Homebuilding........................... 681,838 528,550 ----------- ----------- Financial Services: Accounts payable and other liabilities........... 6,868 6,080 Mortgage warehouse line of credit................ 167,174 188,417 ----------- ----------- Total Financial Services..................... 174,042 194,497 ----------- ----------- Notes Payable: Revolving credit agreement....................... 43,050 115,000 Senior notes..................................... 803,207 602,737 Senior subordinated notes........................ 400,000 300,000 Accrued interest................................. 12,841 15,522 ----------- ----------- Total Notes Payable.......................... 1,259,098 1,033,259 ----------- ----------- Income Taxes Payable............................... - 48,999 ----------- ----------- Total Liabilities............................ 2,114,978 1,805,305 ----------- ----------- Minority interest from inventory not owned......... 109,125 155,096 ----------- ----------- Minority interest from consolidated joint ventures. 1,206 3,472 ----------- ----------- Stockholders' Equity: Preferred Stock,$.01 par value-authorized 100,000 shares; liquidation preference of $25,000 per share, issued 5,600 shares at July 31, 2005 and zero shares at October 31, 2004............ - - Common Stock,Class A,$.01 par value-authorized 200,000,000 shares; issued 57,906,182 shares at July 31, 2005 and 56,797,313 shares at October 31, 2004 (including 10,795,656 shares at July 31, 2005 and 10,395,656 shares at October 31, 2004 held in Treasury).............. 579 568 Common Stock,Class B,$.01 par value (convertible to Class A at time of sale) authorized 30,000,000 shares; issued 15,372,561 shares at July 31, 2005 and 15,376,972 shares at October 31, 2004 (including 691,748 shares at July 31, 2005 and October 31, 2004 held in Treasury)....................................... 154 154 Paid in Capital................................... 350,085 199,643 Retained Earnings................................. 1,357,575 1,053,863 Deferred Compensation............................. (7,474) (11,784) Treasury Stock - at cost.......................... (72,145) (50,050) ----------- ----------- Total Stockholders' Equity.................... 1,628,774 1,192,394 ----------- ----------- Total Liabilities and Stockholders' Equity..........$ 3,854,083 $ 3,156,267 =========== =========== See notes to condensed consolidated financial statements (unaudited).
HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF INCOME (In Thousands Except Per Share Data) (Unaudited)
Three Months Ended Nine Months Ended July 31, July 31, ----------------------- ----------------------- 2005 2004 2005 2004 ----------- ---------- ----------- ---------- Revenues: Homebuilding: Sale of homes...................... $ 1,289,373 $1,044,610 $ 3,495,014 $2,702,826 Land sales and other revenues...... 4,820 2,756 32,747 8,549 ----------- ---------- ----------- ---------- Total Homebuilding............... 1,294,193 1,047,366 3,527,761 2,711,375 Financial Services................... 18,533 13,683 48,995 41,926 ----------- ---------- ----------- ---------- Total Revenues................... 1,312,726 1,061,049 3,576,756 2,753,301 ----------- ---------- ----------- ---------- Expenses: Homebuilding: Cost of sales, excluding interest.. 940,202 778,216 2,588,285 2,016,257 Cost of sales interest............. 19,257 13,369 47,089 39,159 ----------- ---------- ----------- ---------- Total Cost of Sales.............. 959,459 791,585 2,635,374 2,055,416 ----------- ---------- ----------- ---------- Selling, general and administrative 116,388 82,548 319,680 234,853 Inventory impairment loss.......... 1,354 1,438 3,352 2,230 ----------- ---------- ----------- ---------- Total Homebuilding............... 1,077,201 875,571 2,958,406 2,292,499 Financial Services................... 12,296 8,637 33,683 25,334 Corporate General and Administrative. 18,884 13,011 49,678 42,229 Other Interest....................... 4,224 4,356 13,317 14,605 Expenses Related To Extinguishment Of Debt............................ - 8,663 - 9,597 Other Operations..................... 7,356 3,361 10,575 9,107 Intangible Amortization.............. 11,781 9,716 32,255 19,115 ----------- ---------- ----------- ---------- Total Expenses................... 1,131,742 923,315 3,097,914 2,412,486 ----------- ---------- ----------- ---------- Income from unconsolidated joint ventures........................... 13,907 2,282 22,482 4,053 ----------- ---------- ----------- ---------- Income Before Income Taxes............. 194,891 140,016 501,324 344,868 ----------- ---------- ----------- ---------- State and Federal Income Taxes: State................................ 10,535 7,761 26,299 20,417 Federal.............................. 68,262 45,517 171,313 109,530 ----------- ---------- ----------- ---------- Total Taxes........................ 78,797 53,278 197,612 129,947 ----------- ---------- ----------- ---------- Net Income............................. $ 116,094 $ 86,738 $ 303,712 $ 214,921 =========== ========== =========== ========== Per Share Data: Basic: Income per common share.............. $ 1.85 $ 1.40 $ 4.87 $ 3.47 Weighted average number of common shares outstanding................. 62,754 62,001 62,412 61,887 Assuming dilution: Income per common share.............. $ 1.76 $ 1.33 $ 4.63 $ 3.30 Weighted average number of common shares outstanding................ 65,796 65,115 65,574 65,158 See notes to condensed consolidated financial statements (unaudited).
HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (Dollars In Thousands) (Unaudited) A Common Stock B Common Stock Preferred Stock ------------------- ------------------- ------------------------ Shares Shares Shares Issued and Issued and Issued and Paid-In Retained Deferred Treasury Outstanding Amount Outstanding Amount Outstanding Amount Capital Earnings Comp. Stock Total ----------- ------ ----------- ------ ----------- -------- -------- ---------- -------- --------- ---------- Balance, October 31, 2004.......... 46,401,657 $ 568 14,685,224 $ 154 $199,643 $1,053,863 $(11,784)$(50,050) $1,192,394 Issuance of Preferred Stock........... 5,600 135,720 135,720 Sale of common stock under employee stock option plan 880,628 9 17,884 17,893 Net Stock Bonus issuances........ 223,830 2 (2,469) 899 (1,568) Net Restricted Stock granted.......... (693) 659 (34) Amortization of Restricted Stock.. 2,752 2,752 Conversion of Class B to Class A common stock...... 4,411 (4,411) Treasury Stock Purchases......... (400,000) (22,095) (22,095) Net Income.......... 303,712 303,712 ----------- ------ ----------- ------ ----------- -------- -------- ---------- -------- --------- ---------- Balance, July 31, , 2005............ 47,110,526 $ 579 14,680,813 $ 154 5,600 $ - $350,085 $1,357,575 $ (7,474)$(72,145) $1,628,774 =========== ====== =========== ====== =========== ======== ======== ========== ======== ========= ========== See notes to condensed consolidated financial statements (unaudited).
HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (In Thousands - unaudited)
Nine Months Ended July 31, ------------------------ 2005 2004 ----------- ----------- Cash Flows From Operating Activities: Net Income.......................................... $ 303,712 $ 214,921 Adjustments to reconcile net income to net cash (used in) operating activities: Depreciation.................................... 5,912 4,606 Intangible amortization......................... 32,255 19,115 Amortization of deferred compensation........... 1,150 506 Gain on sale and retirement of property and assets.................................... (3,479) (238) Income from unconsolidated joint ventures....... 22,482 4,053 Expenses related to extinguishment of debt...... - 9,597 Deferred income taxes........................... (14,287) (14,426) Impairment losses............................... 3,352 2,230 Decrease (increase) in assets: Mortgage notes receivable..................... 27,357 73,548 Receivables, prepaids and other assets........ (19,572) (27,232) Inventories................................... (434,634) (658,351) (Decrease) increase in liabilities: State and Federal income taxes................ (67,204) (5,817) Customers' deposits........................... 25,252 29,215 Interest and other accrued liabilities........ 8,124 12,602 Post development completion costs............. 1,017 (2,929) Accounts payable.............................. 12,312 32,575 ----------- ----------- Net cash (used in) operating activities..... (96,251) (306,025) ----------- ----------- Cash Flows From Investing Activities: Net proceeds from sale of property and assets....... 8,040 721 Purchase of property, equipment and other fixed assets and acquisitions of homebuilding companies......................................... (131,872) (56,634) Net investments of capital in unconsolidated affiliates........................................ (140,619) (27,871) ----------- ----------- Net cash (used in) investing activities..... (264,451) (83,784) ----------- ----------- Cash Flows From Financing Activities: Proceeds from mortgages and notes................... 1,379,997 2,674,035 Proceeds from senior debt........................... 200,000 365,000 Proceeds from senior subordinated debt.............. 100,000 Principal payments on mortgages and notes........... (1,458,129) (2,599,739) Principal payments on senior debt................... - (156,844) Purchase of treasury stock.......................... (22,095) (3,022) Proceeds from sale of stock and employee stock plan. 138,404 1,142 ----------- ----------- Net cash provided by financing activities.... 338,177 280,572 ----------- ----------- Net (Decrease) In Cash........... ....................... (22,525) (109,237) Cash and Cash Equivalents Balance, Beginning Of Period........................................... 78,024 128,221 ----------- ----------- Cash and Cash Equivalents Balance, End Of Period...... $ 55,499 $ 18,984 =========== =========== Supplemental Disclosures of Cash Flow Cash paid during the year for: Interest......................................... $ 63,975 $ 56,795 =========== =========== Income taxes..................................... $ 279,686 $ 150,016 =========== =========== Supplemental disclosures of noncash operating activities: Consolidated Inventory Not Owned: Specific performance options..................... $ 5,415 $ 21,798 Variable interest entities....................... 121,989 181,265 Other options.................................... 118,405 29,382 ----------- ----------- Total Inventory Not Owned.......................... $ 245,809 $ 232,445 =========== =========== See notes to condensed consolidated financial statements (unaudited).
HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED 1. The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. In the opinion of management, all adjustments for interim periods presented have been made, which include only normal recurring accruals and deferrals necessary for a fair presentation of our consolidated financial position, results of operations, and changes in cash flows. The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates and these differences could have a significant impact on the financial statements. Results for interim periods are not necessarily indicative of the results which might be expected for a full year. The balance sheet at October 31, 2004 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In March 2004, our Board of Directors authorized a 2-for-1 stock split in the form of a 100% stock dividend of Class A and Class B Common Stock payable to stockholders of record on March 19, 2004. The additional shares were distributed on March 26, 2004. All share and per share amounts (except par value) have been retroactively adjusted to reflect the stock split. There was no net effect on total stockholders' equity as a result of the stock split. Certain prior year amounts have been reclassified to conform to the current year presentation. 2. Stock-Based Compensation Plans - SFAS No. 123 "Accounting for Stock-Based Compensation" ("SFAS 123") established a fair value based method of accounting for stock-based compensation plans, including stock options and non-vested stock. Under SFAS 123, registrants may elect to continue accounting for stock-based compensation plans under APB Opinion No. 25 "Accounting for Stock Issued to Employees" ("APB 25"), but are required to provide pro forma net income and earnings per share information "as if" the fair value approach had been adopted. We continue to account for our stock-based compensation plans under APB 25. Under APB 25, no compensation expense is recognized when the exercise price of our employee stock options equals the market price of the underlying stock on the date of grant. However, for non-vested stock awards, compensation expense equal to the market price of the stock on the date of grant is recognized ratably over the vesting period. In December 2002, the Financial Accounting Standards Board ("FASB") issued SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure" ("SFAS 148"). SFAS 148 amends SFAS 123 to provide alternative methods of transition for an entity that voluntarily adopts the fair value recognition method of recording stock-based compensation expense. SFAS 148 also amends the disclosure provisions of SFAS 123 and APB Opinion No. 28, "Interim Financial Reporting", to require disclosure in the summary of significant accounting policies of the effects of an entity's accounting policy with respect to stock-based compensation on reported net income and earnings per share in annual and interim financial statements. For purposes of pro forma disclosures, the estimated fair value of the options using Black-Scholes is amortized to expense over the options' vesting period. Our pro forma information follows (dollars in thousands except for earnings per share information): Three Months Ended Nine Months Ended July 31, July 31, ------------------ ------------------ 2005 2004 2005 2004 -------- -------- -------- -------- Net income as reported.......... $116,094 $ 86,738 $303,712 $214,921 Deduct: total stock-based employee compensation expense determined using Black-Scholes fair value based method for all awards... 1,689 1,244 4,531 3,175 -------- -------- -------- -------- Pro forma net income............ $114,405 $ 85,494 $299,181 $211,746 ======== ======== ======== ======== Pro forma basic earnings per share $ 1.82 $ 1.38 $ 4.79 $ 3.42 ======== ======== ======== ======== Basic earnings per share as reported...................... $ 1.85 $ 1.40 $ 4.87 $ 3.47 ======== ======== ======== ======== Pro forma diluted earnings per share......................... $ 1.74 $ 1.31 $ 4.56 $ 3.25 ======== ======== ======== ======== Diluted earnings per share as reported...................... $ 1.76 $ 1.33 $ 4.63 $ 3.30 ======== ======== ======== ======== Pro forma information regarding net income and earnings per share is calculated as if we had accounted for our stock-based compensation under the fair value method of SFAS 123. The fair value for options is established at the date of grant using a Black-Scholes option pricing model with the following weighted average assumptions for July 31, 2005 and 2004: risk-free interest rate of 4.2% for both periods; dividend yield of zero; volatility factor of the expected market price of our common stock of 0.47 and 0.43, respectively; and a weighted average expected life of the option of 4.9 and 5.2 years, respectively. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options, which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because our employee stock options have characteristics significantly different from traded options, and changes in the subjective input assumptions can materially affect the fair value estimate, management believes the existing models do not necessarily provide a reliable measure of the fair value of its employee stock options. In December 2004, the FASB issued SFAS No. 123 (Revised 2004) "Share Based Payment" ("SFAS 123R"), which is a revision of SFAS 123 and supersedes APB 25 and SFAS 148. This statement requires that the cost resulting from all share-based payment transactions be recognized in an entity's financial statements. This statement establishes fair value as the measurement objective in accounting for share-based payment arrangements and requires all entities to apply a fair value based measurement method in accounting for share-based payment transactions with employees except for equity instruments held by employee share ownership plans. SFAS 123R applies to all awards granted after the required effective date (the beginning of the first annual reporting period that begins after June 15, 2005) and to awards modified, repurchased, or cancelled after that date. As of the required effective date, all public entities that used the fair value based method for either recognition or disclosure under Statement 123 will apply SFAS 123R using a modified version of prospective application. Under that transition method, compensation cost is recognized on or after the required effective date for the portion of outstanding awards for which the requisite service has not yet been rendered, based on the grant-date fair value of those awards calculated under Statement 123 for either recognition or pro forma disclosures. For periods before the required effective date, those entities may elect to apply a modified version of the retrospective application under which financial statements for prior periods are adjusted on a basis consistent with the pro forma disclosures required for those periods by Statement 123. As a result, beginning in our fiscal first quarter of 2006, we will adopt SFAS 123R and begin reflecting the stock option expense determined under fair value based methods in our income statement rather than as pro forma disclosure in the notes to the financial statements. We expect the impact of the adoption of SFAS 123R to be a reduction of first quarter fiscal 2006 net income of approximately $1.7 million assuming modified prospective application. 3. Interest costs incurred, expensed and capitalized were: Three Months Ended Nine Months Ended July 31, July 31, ------------------ ------------------ 2005 2004 2005 2004 -------- -------- -------- -------- (Dollars in Thousands) Interest Capitalized at Beginning of Period........ $ 44,488 $ 32,585 $ 37,465 $ 24,833 Interest Incurred(1)(2)...... 27,991 21,426 71,939 65,217 Cost of Sales Interest Expensed (2)............... (19,257) (13,369) (47,089) (39,159) Other Interest Expensed...... (4,224) (4,356) (13,317) (14,605) -------- -------- -------- -------- Interest Capitalized at End of Period.............. $ 48,998 $ 36,286 $ 48,998 $ 36,286 ======== ======== ======== ======== (1) Data does not include interest incurred by our mortgage and finance subsidiaries. (2) Includes interest on borrowings for construction, land and land development costs which are charged to interest expense when homes are delivered or when land is not under active development. 4. Accumulated depreciation at July 31, 2005 and October 31, 2004 amounted to $34.6 million and $31.7 million, respectively, for our homebuilding and senior rental residential assets. 5. In accordance with Financial Accounting Standards No. 144 ("SFAS 144") "Accounting for the Impairment of or Disposal of Long Lived Assets", we record impairment losses on inventories related to communities under development when events and circumstances indicate that they may be impaired and the undiscounted cash flows estimated to be generated by those assets are less than their carrying amounts. In addition, from time to time, we will write off certain residential land options including approval and engineering costs for land management decided not to purchase. We wrote off such costs in the amount of $1.4 million during both the three months ended July 31, 2005 and 2004, respectively, and $3.4 million and $2.2 million during the nine months ended July 31, 2005 and 2004, respectively. Residential inventory impairment losses and option write-offs are reported in the Condensed Consolidated Statements of Income as "Homebuilding-Inventory impairment loss". 6. We provide a warranty accrual for repair costs over $1,000 to homes, community amenities, and land development infrastructure. We accrue for warranty costs as part of cost of sales at the time each home is closed and title and possession have been transferred to the homebuyer. In addition, we accrue warranty costs under our $5 million per occurrence general liability insurance deductible for 2005 (deductible was $150 thousand per occurrence for homes built between fiscal 2001 and fiscal 2004) as part of selling, general and administrative costs. Warranty accruals are based upon historical experience. Additions and charges incurred in the warranty accrual and general liability accrual for the three and nine months ended July 31, 2005 and 2004 are as follows: Three Months Ended Nine Months Ended July 31, July 31, -------- -------- -------- -------- 2005 2004 2005 2004 -------- -------- -------- -------- (Dollars in Thousands) Balance, beginning of period..... $81,122 $47,186 $64,922 $39,532 Additions........................ 15,329 10,869 41,246 27,476 Charges incurred................. (8,841) (4,697) (18,558) (13,650) -------- -------- -------- -------- Balance, end of period.......... $87,610 $53,358 $87,610 $53,358 ======== ======== ======== ======== 7. We are subject to extensive and complex regulations that affect the development and home building, sales and customer financing processes, including zoning, density, building standards and mortgage financing; and we are involved in litigation arising in the ordinary course of business, none of which is expected to have a material adverse effect on our financial position or results of operations. In addition, in March 2005, we received two requests for information pursuant to Section 308 of the Clean Water Act from Region 3 of the Environmental Protection Agency ("EPA") requesting information about storm water discharge practices in connection with completed, ongoing and planned homebuilding projects by subsidiaries in the states and district that comprise EPA Region 3. We also received a notice of violations for one project in Pennsylvania and requests for sampling plan implementation in two projects in Pennsylvania. The amount requested by the EPA to settle the asserted violations at the one project was not material. We have provided the information requested. To the extent that the information provided were to lead the EPA to assert violations of state and/or federal regulatory requirements and request injunctive relief and/or civil penalties, we will defend and attempt to resolve such asserted violations. Our sales and customer financing processes are subject to the jurisdiction of the U. S. Department of Housing and Urban Development ("HUD"). In connection with the Real Estate Settlement Procedures Act, HUD has recently inquired about our process of referring business to our affiliated mortgage company and has separately requested documents related to customer financing. We have responded to HUD's inquiries. At this time, we cannot predict the outcome of the EPA's or HUD's reviews or estimate the costs that may be involved in resolving such matters. 8. As of July 31, 2005 and October 31, 2004, respectively, we are obligated under various performance letters of credit amounting to $305.4 million and $180.6 million. 9. Our amended and restated unsecured Revolving Credit Agreement ("Agreement") with a group of banks provides a revolving credit line of $1.2 billion through July 2009. The facility contains an accordion feature under which the aggregate commitment can be increased to $1.3 billion subject to the availability of additional commitments. Interest is payable monthly at various rates based on a margin ranging from 1.00% to 1.95% per annum, depending on our Consolidated Leverage Ratio, as defined in the Agreement, plus, at the Company's option, either (1) a base rate determined by reference to the higher of (a) PNC Bank, National Association's prime rate and (b) the federal funds rate plus 1/2% or (2) a LIBOR-based rate for a one, two, three, or six month interest period as selected by the Company. In addition, we pay a fee ranging from 0.20% to 0.30% per annum on the unused portion of the revolving credit line depending on its Leverage Ratio and the average percentage unused portion of the revolving credit line. Each of our significant subsidiaries, except for various subsidiaries formerly engaged in the issuance of collateralized mortgage obligations, a subsidiary formerly engaged in homebuilding activity in Poland, our financial services subsidiaries, joint ventures, and certain other subsidiaries, is a guarantor under the Agreement. As of July 31, 2005, the outstanding balance under the Agreement was $43.1 million and as of October 31, 2004, the outstanding balance under the previous facility was $115.0 million. Our amended secured mortgage loan warehouse agreement with a group of banks, which is a short-term borrowing facility, provides up to $250 million through April 2006. Interest is payable monthly at the Eurodollar Rate plus 1.25%. The loan is repaid when we sell the underlying mortgage loans to permanent investors. As of July 31, 2005, borrowings under this agreement were $167.2 million and as of October 31, 2004 the outstanding balance under the previous facility was $188.4 million. 10. On November 30, 2004, we issued $200 million of 6 1/4% Senior Notes due 2015 and $100 million of 6% Senior Subordinated Notes due 2010. The net proceeds of the issuance were used to repay the outstanding balance on our revolving credit facility as of November 30, 2004 and for general corporate purposes. At July 31, 2005, we had $805.3 million of outstanding senior notes ($803.2 million, net of discount), comprised of $140.3 million 10 1/2% Senior Notes due 2007, $100 million 8% Senior Notes due 2012, $215 million 6 1/2% Senior Notes due 2014, $150 million 6 3/8% Senior Notes due 2014, and $200 million 6 1/4% Senior Notes due 2015. At July 31, 2005, we had $400 million of outstanding senior subordinated notes, comprised of $150 million 8 7/8% Senior Subordinated Notes due 2012, $150 million 7 3/4% Senior Subordinated Notes due 2013, and $100 million 6% Senior Subordinated Notes due 2010. As a subsequent event to our July 31, 2005 Consolidated Balance Sheet, on August 8, 2005, we issued $300 million 6 1/4% Senior Notes due 2016. The notes are redeemable in whole or in part at our option at 100% of their principal amount plus the payment of a make-whole amount defined in the offering memorandum. The net proceeds of the issuance were used to repay the outstanding balance under our revolving credit facility as of August 8, 2005, and for general corporate purposes, including acquisitions. Under the terms of the indentures governing our debt securities, we have the right to make certain redemptions and depending on market conditions, may do so from time to time. 11. Per Share Calculations - Basic earnings per common share is computed using the weighted average number of shares outstanding. Diluted earnings per common share is computed using the weighted average number of shares outstanding adjusted for the incremental shares attributed to non- vested stock and outstanding options to purchase common stock, of approximately 3.0 million and 3.1 million for the three months ended July 31, 2005 and 2004, respectively, and approximately 3.2 million and 3.3 million for the nine months ended July 31, 2005 and 2004, respectively. 12. On July 12, 2005, we issued 5,600 shares of 7.625% Series A Preferred Stock, with a liquidation preference of $25,000 per share. Dividends on the Series A Preferred Stock are not cumulative and will be paid at an annual rate of 7.625%. The Series A Preferred Stock is not convertible into the Company's common stock and is redeemable in whole or in part at our option at the liquidation preference of the shares beginning on the fifth anniversary of their issuance. The Series A Preferred Stock is traded as depositary shares, with each depositary share representing 1/1000th of a share of Series A Preferred Stock. The depositary shares are listed on the Nasdaq National Market under the symbol "HOVNP". The net proceeds from the offering of $136 million, reflected in Paid in Capital in the Condensed Consolidated Balance Sheet, were used for the partial repayment of the outstanding balance under our revolving credit facility as of July 12, 2005. 13. Variable Interest Entities - In January 2003, the Financial Accounting Standards Board ("FASB") issued Interpretation No. 46, "Consolidation of Variable Interest Entities" ("FIN 46"). A Variable Interest Entity ("VIE") is created when (i) the equity investment at risk is not sufficient to permit the entity to finance its activities without additional subordinated financial support from other parties or (ii) equity holders either (a) lack direct or indirect ability to make decisions about the entity, (b) are not obligated to absorb expected losses of the entity or (c) do not have the right to receive expected residual returns of the entity if they occur. If an entity is deemed to be a VIE, pursuant to FIN 46, an enterprise that absorbs a majority of the expected losses of the VIE is considered the primary beneficiary and must consolidate the VIE. FIN 46 was effective immediately for VIEs created after January 31, 2003. Pursuant to FASB revision to FIN 46 ("FIN 46R"), issued in December 2003, we were not required to apply the provisions of FIN 46 to an interest held in a variable interest entity or potential variable interest entity until our quarter ended April 30, 2004 for VIEs created before February 1, 2003. In accordance with FIN 46R, we have fully implemented FIN 46 as of April 30, 2004. Based on the provisions of FIN 46, we have concluded that whenever we option land or lots from an entity and pay a non-refundable deposit, a VIE is created under condition (ii) (b) and (c) of the previous paragraph. We are deemed to have provided subordinated financial support, which refers to variable interests that will absorb some or all of an entity's expected theoretical losses if they occur. For each VIE created with a significant nonrefundable option fee, we compute expected losses and residual returns based on the probability of future cash flows as outlined in FIN 46. If we are deemed to be the primary beneficiary of the VIE we consolidate it on our balance sheet. The fair value of the VIEs inventory is reported as "Consolidated Inventory Not Owned - Variable interest entities". Management believes FIN 46 was not clearly thought out for application in the homebuilding industry for land and lot options. Under FIN 46, we can have an option and put down a small deposit as a percentage of the purchase price and still have to consolidate the entity. Our exposure to loss as a result of our involvement with the VIE is only the deposit, not it's total assets consolidated on the balance sheet. In certain cases, we will have to place inventory the VIE has optioned to other developers on our balance sheet. In addition, if the VIE has creditors, its debt will be placed on our balance sheet even though the creditors have no recourse against us. Based on these observations we believe consolidating VIEs based on land and lot option deposits does not reflect the economic realities or risks of owning and developing land. At July 31, 2005, all VIEs we were required to consolidate were a result of our options to purchase land or lots from the selling entities. We paid cash or issued letters of credit deposits to these twenty-one VIEs totaling $19.3 million. Our option deposits represent our maximum exposure to loss. The fair value of the property owned by these VIEs was $134.2 million. Because we could not get the remainder of the selling entities to provide us with any financial information, the fair value of the optioned property less our cash deposits and liabilities from inventory not owned, which totaled $109.1 million, was reported on the balance sheet as "Minority interest from inventory not owned". Creditors of these VIEs have no recourse against us. We will continue to control land and lots using options. Not all our deposits are with VIEs. Including the deposits with the twenty-one VIEs above, at July 31, 2005, we have total cash and letters of credit deposits amounting to approximately $330.9 million to purchase land lots with a total purchase price of $4.5 billion. The maximum exposure to loss is limited to the deposits although some deposits are refundable at our request or refundable if certain conditions are not met. 14. Investments in Unconsolidated Homebuilding and Land Development Joint Ventures - We enter into homebuilding and land development joint ventures from time to time as a means of accessing lot positions, expanding our market opportunities, establishing strategic alliances, managing our risk profile and leveraging our capital base. Our homebuilding joint ventures are generally entered into with third party investors to develop land and construct homes that are sold directly to third party homebuyers. Our land development joint ventures include those entered into with developers and other homebuilders, as well as financial investors, to develop finished lots for sale to the joint venture's members or other third parties. During the nine months ended July 31, 2005, we entered into four new homebuilding joint ventures. As of July 31, 2005, we have investments in seven homebuilding joint ventures and eight land development joint ventures. The tables set forth below summarize the combined financial information related to our unconsolidated homebuilding and land development joint ventures that are accounted for under the equity method. July 31, October 31, 2005 2004 ----------- ----------- (Dollars in Thousands) Assets: Cash $ 25,170 $ 30,519 Inventories 765,409 176,360 Other assets 160,759 5,477 ----------- ----------- Total assets $ 951,338 $ 212,356 =========== =========== Liabilities and Equity: Accounts payable and other liabilities $ 174,487 $ 27,938 Notes payable 345,429 82,742 Equity 431,422 101,676 ----------- ----------- Total liabilities and equity $ 951,338 $ 212,356 =========== =========== Our share of equity related to these unconsolidated joint ventures, shown separately in our Condensed Consolidated Balance Sheets, was approximately $153.9 million and $40.8 million at July 31, 2005 and October 31, 2004, respectively. Additionally, as of July 31, 2005 and October 31, 2004, we had advances outstanding of approximately $6.8 million and $1.6 million to these unconsolidated joint ventures, which were included in the accounts payable and other liabilities balances in the table above. Three Months Ended Nine Months Ended July 31, July 31, -------------------- -------------------- 2005 2004 2005 2004 --------- --------- --------- --------- (Dollars in Thousands) Revenues $ 209,941 $ 15,656 $ 352,831 $ 30,025 Cost of sales and expenses (183,830) (11,214) (309,686) (23,571) --------- --------- --------- --------- Net income $ 26,111 $ 4,442 $ 43,145 $ 6,454 ========= ========= ========= ========= Net income from unconsolidated joint ventures is shown on the face of the Condensed Consolidated Statements of Income and reflects our proportionate share of the income of these unconsolidated homebuilding and land development joint ventures. Our ownership interests in the joint ventures range from 20% to 50%. Typically, our unconsolidated joint ventures obtain separate project specific mortgage financing for each venture. Generally, the amount of such financing is limited to no more than 50% of the joint venture's total assets, and such financing is obtained on a non-recourse basis, with guarantees from us limited only to performance and environmental indemnification. In some instances, the joint venture entity is considered a variable interest entity (VIE) under FIN 46 due to the returns being limited to the equity holders; however, in these instances, we are not the primary beneficiary, therefore we do not consolidate these entities. 15. Recent Accounting Pronouncements - In December 2004, the FASB issued SFAS No. 123 (Revised 2004) "Share Based Payment" ("SFAS 123R"), which is a revision of SFAS 123 and supersedes APB 25 and SFAS 148. This statement requires that the cost resulting from all share-based payment transactions be recognized in an entity's financial statements. This statement establishes fair value as the measurement objective in accounting for share-based payment arrangements and requires all entities to apply a fair value based measurement method in accounting for share- based payment transactions with employees except for equity instruments held by employee share ownership plans. See Note 2 for a further description of SFAS 123R and its expected impact on our first quarter fiscal 2006 net income. In March 2005, the Securities and Exchange Commission released SEC Staff Accounting Bulletin ("SAB") No. 107, "Share-Based Payment". SAB No. 107 provides the SEC staff position regarding the application of SFAS No. 123R. SAB No. 107 contains interpretive guidance related to the interaction between SFAS No. 123R and certain SEC rules and regulations, as well as provides the staff's views regarding the valuation of share- based payment arrangements for public companies. SAB No. 107 also highlights the importance of disclosures made related to the accounting for share-based payment transactions. We are currently evaluating SAB No. 107 and will be incorporating it as part of our adoption of SFAS No. 123R. In December 2004, the FASB issued Staff Position 109-1 ("FSP 109- 1"), Application of FASB Statement No. 109 ("FASB No. 109"), "Accounting for Income Taxes", to the Tax Deduction on Qualified Production Activities Provided by the American Jobs Creation Act of 2004. FSP 109-1 clarifies guidance that applies to the new deduction for qualified domestic production activities. When fully phased-in, the deduction will be up to 9% of the lesser of "qualified production activities income" or taxable income. FSP 109-1 clarifies that the deduction should be accounted for as a special deduction under FASB No. 109 and will reduce tax expense in the period or periods that the amounts are deductible on the tax return. Any tax benefits resulting from the new deduction will be effective for our fiscal year ending October 31, 2006. We are in the process of assessing the impact, if any, the new deduction will have on our financial statements. In June 2005, the Emerging Issues Task Force ("EITF") released Issue No. 04-5 "Determining Whether a General Partner, or the General Partners as a Group, Controls a Limited Partnership or Similar Entity When the Limited Partners Have Certain Rights" ("EITF 04-5"). EITF 04-5 creates a framework for evaluating whether a general partner or a group of general partners controls a limited partnership and therefore should consolidate the partnership. EITF 04-5 states that the presumption of general partner control would be overcome only when the limited partners have certain specific rights as outlined in EITF 04-5. EITF 04-5 is effective immediately for all newly formed limited partnerships and for existing limited partnership agreements that are modified. For general partners in all other limited partnerships, EITF 04-5 is effective no later than the beginning of the first reporting period in fiscal years beginning after December 15, 2005. Implementation of EITF 04-5 is not expected to have a material impact on the Company's results of operations or financial position. 16. Intangible Assets - Except for goodwill, the intangible assets recorded on our balance sheet are definite life intangibles, which include tradenames, architectural designs, distribution processes, and contractual agreements. We no longer amortize goodwill, but instead assess it periodically for impairment. We are amortizing the definite life intangibles over their expected useful life, ranging from three to seven years. 17. Acquisitions - On March 1, 2005, we acquired for cash the assets of Cambridge Homes, a privately held Orlando homebuilder and provider of related financial services, headquartered in Altamonte Springs, Florida. The acquisition provides us with a presence in the greater Orlando market, which is the 9th largest housing market in the U.S., based on 2003 new home starts. Cambridge Homes designs, markets and sells both single family homes and attached townhomes and focuses on first-time, move up and luxury homebuyers. Cambridge Homes also provides mortgage financing, as well as title and settlement services to its homebuyers. The Cambridge Homes acquisition was accounted for as a purchase, with the results of its operations included in our consolidated financial statements as of the date of the acquisition. On March 2, 2005, we acquired the operations of Town & Country Homes, a privately held homebuilder and land developer headquartered in Lombard, Illinois, which occurred concurrently with our entering into a joint venture agreement with affiliates of Blackstone Real Estate Advisors in New York to own and develop Town & Country's existing residential communities. The joint venture is being accounted for under the equity method. Town & Country Homes operations beyond the existing owned and optioned communities, as of the acquisition date, are wholly owned and included in our consolidated financial statements. The Town & Country acquisition provides us with a strong initial position in the greater Chicago market, which is the 6th largest housing market in the U.S., based on 2003 new home starts. This acquisition also expands our operations into the Florida markets of West Palm Beach, Boca Raton and Fort Lauderdale and bolsters our current presence in Minneapolis/St. Paul, which is the 10th largest housing market in the U.S., based on 2003 new home starts. Town & Country designs, markets and sells a diversified product portfolio in each of its markets, including single family homes and attached townhomes, as well as mid-rise condominiums in Florida. Town & Country serves a broad customer base including first-time, move-up and luxury homebuyers. During August 2005, we acquired substantially all of the assets of First Home Builders of Florida and Oster Homes. See the subsequent events note for further information. 18. Hovnanian Enterprises, Inc., the parent company (the "Parent"), is the issuer of publicly traded common stock and preferred stock. One of its wholly owned subsidiaries, K. Hovnanian Enterprises, Inc. (the "Subsidiary Issuer"), acts as a finance entity that as of July 31, 2005 had issued and outstanding approximately $400 million of Senior Subordinated Notes, $805.3 million face value of Senior Notes, and $43.1 million drawn on a Revolving Credit Agreement. The Senior Subordinated Notes, Senior Notes and the Revolving Credit Agreement are fully and unconditionally guaranteed by the Parent. In addition to the Parent, each of the wholly owned subsidiaries of the Parent other than the Subsidiary Issuer (collectively, the "Guarantor Subsidiaries"), with the exception of various subsidiaries formerly engaged in the issuance of collateralized mortgage obligations, our mortgage lending subsidiaries, a subsidiary formerly engaged in homebuilding activity in Poland, our title insurance subsidiaries, joint ventures, and certain other subsidiaries (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, and the Revolving Credit Agreement. In lieu of providing separate audited financial statements for the Guarantor Subsidiaries we have included the accompanying condensed consolidating financial statements. Management does not believe that separate financial statements of the Guarantor Subsidiaries are material to investors. Therefore, separate financial statements and other disclosures concerning the Guarantor Subsidiaries are not presented. The following condensed consolidating financial information presents the results of operations, financial position, and cash flows of (i) the Parent, (ii) the Subsidiary Issuer, (iii) the Guarantor Subsidiaries, (iv) the Non-guarantor Subsidiaries, and (v) the eliminations to arrive at the information for Hovnanian Enterprises, Inc. on a consolidated basis. HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED CONDENSED CONSOLIDATING BALANCE SHEET JULY 31, 2005 (Dollars in Thousands)
Guarantor Non- Subsidiary Subsid- Guarantor Elimin- Consol- Parent Issuer iaries Subsidiaries ations idated ---------- ---------- ------------ ------------ ----------- ---------- ASSETS Homebuilding..................... $ 1,347 $ 78,401 $ 3,328,886 $ 199,436 $ $3,608,070 Financial Services................. (314) 198,626 198,312 Income Taxes Receivable (Payable).. 3,420 45,107 (826) 47,701 Investments in and amounts due to and from consolidated subsidiaries.................... 1,624,007 1,358,573 (1,576,781) (168,218)(1,237,581) ---------- ---------- ------------ ------------ ----------- ---------- Total Assets..................... $1,628,774 $1,436,974 $ 1,796,898 $ 229,018 $(1,237,581)$3,854,083 ========== ========== ============ ============ =========== ========== LIABILITIES AND STOCKHOLDERS' EQUITY Homebuilding................... $ $ $ 678,701 $ 3,137 $ $ 681,838 Financial Services............. (138) 174,180 174,042 Notes Payable................... 1,257,880 (23,277) 24,495 1,259,098 Minority Interest................ 109,125 1,206 110,331 Stockholders' Equity............. 1,628,774 179,094 1,032,487 26,000 (1,237,581) 1,628,774 ---------- ---------- ------------ ------------ ----------- ---------- Total Liabilities and Stockholders' Equity......................... $1,628,774 $1,436,974 $ 1,796,898 $ 229,018 $(1,237,581)$3,854,083 ========== ========== ============ ============ =========== ==========
HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS CONDENSED CONSOLIDATING BALANCE SHEET OCTOBER 31, 2004 (Dollars in Thousands)
Guarantor Non- Subsidiary Subsid- Guarantor Elimin- Consol- Parent Issuer iaries Subsidiaries ations idated ---------- ---------- ------------ ------------ ---------- ---------- Assets Homebuilding......................$ (99) $ 51,441 $ 2,804,800 $ 69,676 $ $2,925,818 Financial Services................ 149 230,300 230,449 Investments in and amounts due to and from consolidated subsidiaries.................... 1,262,169 1,037,671 (1,319,839) (41,423) (938,578) ---------- ---------- ------------ ------------ ----------- --------- Total Assets......................$1,262,070 $1,089,112 $ 1,485,110 $ 258,553 $ (938,578) $3,156,267 ========== ========== ============ ============ =========== ========== Liabilities Homebuilding......................$ $ 149 $ 526,278 $ 2,123 $ $ 528,550 Financial Services................. (1) 194,498 194,497 Notes Payable...................... 1,032,259 (28,324) 29,324 1,033,259 Income Taxes Payable (Receivables). 69,676 1,961 (23,579) 941 48,999 Minority Interest.................. 155,096 3,472 158,568 Stockholders' Equity...............1,192,394 54,743 855,640 28,195 (938,578) 1,192,394 ---------- ----------- ------------ ------------ ----------- ---------- Total Liabilities and Stockholders' Equity......................... $1,262,070 $ 1,089,112 $ 1,485,110 $ 258,553 $ (938,578) $3,156,267 ========== =========== ============ ============ =========== ==========
HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS THREE MONTHS ENDED JULY 31, 2005 (Dollars in Thousands)
Guarantor Non- Subsidiary Subsid- Guarantor Elimin- Consol- Parent Issuer iaries Subsidiaries ations idated -------- ---------- ---------- ------------ ---------- ---------- Revenues: Homebuilding....................$ $ 60 $1,293,968 $ 165 $ $1,294,193 Financial Services............... 1,009 17,524 18,533 Intercompany Charges............. 53,685 54,559 (108,244) Equity In Pretax Income of Consolidated Subsidiaries...... 194,891 (194,891) -------- ---------- ---------- ------------ ---------- ---------- Total Revenues................ 194,891 53,745 1,349,536 17,689 (303,135) 1,312,726 -------- ---------- ---------- ------------ ---------- ---------- Expenses: Homebuilding..................... (814) 1,136,550 881 (17,171) 1,119,446 Financial Services............... 315 12,895 (914) 12,296 -------- ---------- ---------- ------------ ---------- ---------- Total Expenses................. (814) 1,136,865 13,776 (18,085) 1,131,742 -------- ---------- ---------- ------------ ---------- ---------- Income from Unconsolidated Joint Ventures................... 13,907 13,907 Income (Loss) Before Income Taxes. 194,891 54,559 226,578 3,913 (285,050) 194,891 State and Federal Income Taxes..... 78,797 31,571 129,114 3,078 (163,763) 78,797 -------- ---------- ---------- ------------ ---------- ---------- Net Income (Loss).................$ 116,094 $ 22,988 $ 97,464 $ 835 $ (121,287)$ 116,094 ======== ========== ========== ============ ========== ==========
HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS THREE MONTHS ENDED JULY 31, 2004 (Dollars in Thousands)
Guarantor Non- Subsidiary Subsid- Guarantor Elimin- Consol- Parent Issuer iaries Subsidiaries ations idated ------- ---------- ---------- ------------ ---------- ---------- Revenues: Homebuilding....................$ $ 21 $1,042,389 $ 4,956 $ $1,047,366 Financial Services............... 1,499 12,184 13,683 Intercompany Charges............. 25,315 31,898 (57,213) Equity In Pretax Income of Consolidated Subsidiaries......140,016 (140,016) ------- ---------- ---------- ------------ ---------- ---------- Total Revenues................ 140,016 25,336 1,075,786 17,140 (197,229) 1,061,049 ------- ---------- ---------- ------------ ---------- ---------- Expenses: Homebuilding..................... 8,431 937,908 3,925 (35,586) 914,678 Financial Services............... 788 8,422 (573) 8,637 ------- ---------- ---------- ------------ ---------- ---------- Total Expenses................. 8,431 939,696 12,347 (36,159) 923,315 ------- ---------- ---------- ------------ ---------- ---------- Income From Unconsolidated Joint Ventures......................... 2,282 2,282 Income (Loss) Before Income Taxes. 140,016 16,905 139,372 4,793 (161,070) 140,016 State and Federal Income Taxes..... 53,278 7,112 53,133 403 (60,648) 53,278 ------- ---------- ---------- ------------ ---------- ---------- Net Income (Loss).................$ 86,738 $ 9,793 $ 86,239 $ 4,390 $ (100,422)$ 86,738 ======= ========== ========== ============ ========== ==========
HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS NINE MONTHS ENDED JULY 31, 2005 (Dollars in Thousands)
Guarantor Non- Subsidiary Subsid- Guarantor Elimin- Consol- Parent Issuer iaries Subsidiaries ations idated ------- ---------- ---------- ------------ ---------- ---------- Revenues: Homebuilding....................$ $ 161 $3,526,539 $ 1,061 $ $3,527,761 Financial Services............... 3,983 45,012 48,995 Intercompany Charges............. 154,345 156,408 (310,753) Equity In Pretax Income of Consolidated Subsidiaries......501,324 (501,324) ------- ---------- ---------- ------------ ---------- ---------- Total Revenues................ 501,324 154,506 3,686,930 46,073 (812,077) 3,576,756 ------- ---------- ---------- ------------ ---------- ---------- Expenses: Homebuilding..................... (1,902) 3,133,308 2,909 (70,084) 3,064,231 Financial Services............... 2,087 34,388 (2,792) 33,683 ------- ---------- ---------- ------------ ---------- ---------- Total Expenses................. (1,902) 3,135,395 37,297 (72,876) 3,097,914 ------- ---------- ---------- ------------ ---------- ---------- Income from Unconsolidated Joint Ventures........................ 22,482 22,482 Income (Loss) Before Income Taxes. 501,324 156,408 574,017 8,776 (739,201) 501,324 State and Federal Income Taxes.....197,612 54,743 221,741 4,384 (280,868) 197,612 ------- ---------- ---------- ------------ ---------- ---------- Net Income (Loss).................$303,712 $ 101,665 $ 352,276 $ 4,392 $ (458,333)$ 303,712 ======= ========== ========== ============ ========== ==========
HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS NINE MONTHS ENDED JULY 31, 2004 (Dollars in Thousands)
Guarantor Non- Subsidiary Subsid- Guarantor Elimin- Consol- Parent Issuer iaries Subsidiaries ations idated ------- ---------- ---------- ------------ ---------- ---------- Revenues: Homebuilding....................$ $ 207 $2,690,081 $ 21,170 $ (83)$2,711,375 Financial Services............... 3,615 38,311 41,926 Intercompany Charges............. 60,123 95,338 (155,461) Equity In Pretax Income of Consolidated Subsidiaries......344,868 (344,868) ------- ---------- ---------- ------------ ---------- ---------- Total Revenues................ 344,868 60,330 2,789,034 59,481 (500,412) 2,753,301 ------- ---------- ---------- ------------ ---------- ---------- Expenses: Homebuilding..................... 8,859 2,469,407 16,898 (108,012) 2,387,152 Financial Services............... 1,853 25,953 (2,472) 25,334 ------- ---------- ---------- ------------ ---------- ---------- Total Expenses................. 8,859 2,471,260 42,851 (110,484) 2,412,486 ------- ---------- ---------- ------------ ---------- ---------- Income From Unconsolidated Joint Ventures......................... 4,053 4,053 Income (Loss) Before Income Taxes..344,868 51,471 321,827 16,630 (389,928) 344,868 State and Federal Income Taxes.....129,947 17,971 122,666 5,081 (145,718) 129,947 ------- ---------- ---------- ------------ ---------- ---------- Net Income (Loss).................$214,921 $ 33,500 $ 199,161 $ 11,549 $ (244,210)$ 214,921 ======== ========== ========== ============ =========== ==========
HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS NINE MONTHS ENDED JULY 31, 2005 (Dollars in Thousands)
Guarantor Non- Subsidiary Subsid- Guarantor Elimin- Consol- Parent Issuer iaries Subsidiaries ations idated -------- --------- ---------- ------------ ---------- ---------- Cash Flows From Operating Activities: Net Income........................$ 303,712 $ 101,665 $ 352,276 $ 4,392 $(458,333) $ 303,712 Adjustments to reconcile net income to net cash provided by (used in) operating activities... (58,182) 361,828 (1,050,904) (111,038) 458,333 (399,963) -------- --------- ---------- ------------ ---------- ---------- Net Cash Provided By (Used In) Operating Activities........... 245,530 463,493 (698,628) (106,646) (96,251) Net Cash (Used In) Investing Activities............... (264,369) (82) (264,451) Net Cash Provided By (Used In) Financing Activities............... 116,309 228,049 15,304 (21,485) 338,177 Intercompany Investing and Financing Activities - Net...................(361,838) (667,602) 902,645 126,795 -------- --------- ---------- ------------ ---------- ---------- Net Increase (Decrease) In Cash...... 1 23,940 (45,048) (1,418) (22,525) Balance, Beginning of Period......... 15 29,369 35,441 13,199 78,024 -------- --------- ---------- ------------ ---------- ---------- Cash and Cash Equivalents Balance, End of Period.....................$ 16 $ 53,309 $ (9,607) $ 11,781 $ $ 55,499 ======== ========= ========== ============ ========== ==========
HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS NINE MONTHS ENDED JULY 31, 2004 (Dollars in Thousands)
Guarantor Non- Subsidiary Subsid- Guarantor Elimin- Consol- Parent Issuer iaries Subsidiaries ations idated -------- --------- ---------- ------------ ---------- ---------- Cash Flows From Operating Activities: Net Income........................$ 214,921 $ 33,500 $ 199,161 $ 11,549 $ (244,210)$ 214,921 Adjustments to reconcile net income to net cash provided by (used in) operating activities... 46,568 (7,558) (851,671) 47,505 244,210 (520,946) -------- --------- ---------- ------------ ---------- ---------- Net Cash Provided By (Used In) Operating Activities........... 261,489 25,942 (652,510) 59,054 (306,025) Net Cash (Used In) Investing Activities............... (20,909) (62,600) (275) (83,784) Net Cash Provided By (Used In) Financing Activities............... (1,493) 315,000 (10,903) (22,032) 280,572 Intercompany Investing and Financing Activities - Net...................(239,087) (469,933) 737,895 (28,875) -------- --------- ---------- ------------ ---------- ---------- Net Increase (Decrease) In Cash...... (128,991) 11,882 7,872 (109,237) Balance, Beginning of Period......... 15 135,846 (14,372) 6,732 128,221 -------- --------- ---------- ------------ ---------- ---------- Cash and Cash Equivalents Balance, End of Period.....................$ 15 $ 6,855 $ (2,490)$ 14,604 $ $ 18,984 ======== ========= ========== ============ ========== ==========
19. Subsequent Events - On August 8, 2005, we issued $300 million 6 1/4% Senior Notes due 2016. The notes are redeemable in whole or in part at our option at 100% of their principal amount plus the payment of a make-whole amount defined in the offering memorandum. The net proceeds of the issuance were used to repay the outstanding balance under our revolving credit facility as of August 8, 2005, and for general corporate purposes, including acquisitions. On August 8, 2005 we acquired substantially all of the assets of First Home Builders of Florida, a privately held homebuilder and provider of related financial services headquartered in Cape Coral, Florida. First Home Builders is a leading builder in Western Florida and ranked 1st in the greater Fort Myers-Cape Coral market and 51st nationally based on 2004 permit activity as tracked by Builder Magazine. Thus, the acquisition provides Hovnanian with the number one market position in the high growth Fort Myers-Cape Coral market, which is the 18th largest housing market in the U.S. as ranked by Builder Magazine based on 2004 permits. First Home Builders of Florida designs, markets and sells single family homes, with a focus on the first-time home buying segment. The company also provides mortgage financing, title and settlement services to its homebuyers. In 2004, First Home Builders delivered 1,819 homes with revenues of $308 million. As of July 31, 2005, First Home Builders had 4,048 homes in contract backlog with a sales value of $888 million. On August 3, 2005, we acquired substantially all of the homebuilding assets of Oster Homes, a privately held Ohio homebuilder, headquartered in Lorain, Ohio. The acquisition provides Hovnanian with a complementary presence to its Ohio "build-on-your-own-lot" homebuilding operations. Oster Homes builds in Lorain County in Northeast Ohio, just west of Cleveland. Lorain is part of the greater Cleveland MSA, which is the 50th largest housing market in the U. S., based on 2004 new home starts. Oster Homes designs, markets and sells single family homes, with a focus on first-time and move up homebuyers. Additionally, Oster Homes utilizes a design center to market extensive pre-prices options and upgrades. In its 2004 fiscal year, Oster Homes delivered 247 homes with revenue of $56 million. As of August 3, 2005, Oster Homes currently has approximately 105 homes in contract backlog, with a sales value of $25 million, and owns or controls approximately 3,000 lots throughout the greater Cleveland area. Oster Homes ranked as the 4th largest builder in the Cleveland MSA in 2004 by Builder Magazine. Both of these acquisitions will be accounted for as purchases with the results of their operations included in our consolidated financial statements as of the dates of the acquisitions. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS CRITICAL ACCOUNTING POLICIES Management believes that the following critical accounting policies affect its more significant judgments and estimates used in the preparation of its consolidated financial statements: Business Combinations - When we make an acquisition of another company, we use the purchase method of accounting in accordance with the Statement of Financial Accounting Standards (SFAS) No. 141 "Business Combinations". Under SFAS No. 141, we record as our cost the estimated fair value of the acquired assets less liabilities assumed. Any difference between the cost of an acquired company and the sum of the fair values of tangible and intangible assets less liabilities is recorded as goodwill. The reported income of an acquired company includes the operations of the acquired company from the date of acquisition. Income Recognition from Home and Land Sales - Income from home and land sales is recorded when title is conveyed to the buyer, adequate cash payment has been received and there is no continued involvement. Income Recognition from Mortgage Loans - Profits and losses relating to the sale of mortgage loans are recognized when legal control passes to the buyer of the mortgage and the sales price is collected. Inventories - Inventories and long-lived assets held for sale are recorded at the lower of cost or fair value less selling costs. Fair value is defined as the amount at which an asset could be bought or sold in a current transaction between willing parties, that is, other than in a forced or liquidation sale. Construction costs are accumulated during the period of construction and charged to cost of sales under specific identification methods. Land, land development, and common facility costs are allocated based on buildable acres to product types within each community, then charged to cost of sales equally based upon the number of homes to be constructed in each product type. For inventories of communities under development, a loss is recorded when events and circumstances indicate impairment and the undiscounted future cash flows generated are less than the related carrying amounts. The impairment loss is based on discounted future cash flows generated from expected revenue, less cost to complete including interest, and selling costs. Insurance Deductible Reserves - For fiscal 2005, our deductible is $500,000 per occurrence for worker's compensation and $5 million per occurrence for general liability insurance. Reserves have been established based upon actuarial analysis of estimated losses incurred during 2005 and 2004. Interest - Costs related to properties under development are capitalized during the land development and home construction period and expensed along with the associated cost of sales as the related inventories are sold. Costs related to properties not under development are charged to interest expense. Land Options - Costs are capitalized when incurred and either included as part of the purchase price when the land is acquired or charged to operations when we determine we will not exercise the option. In accordance with Financial Accounting Standards Board ("FASB") Interpretation No. 46 ("FIN 46") "Consolidation of Variable Interest Entities", an interpretation of Accounting Research Bulletin No. 51, SFAS No. 49 "Accounting for Product Financing Arrangements" ("SFAS 49"), SFAS No. 98 "Accounting for Leases" ("SFAS 98"), and Emerging Issues Task Force ("EITF") No. 97-10 "The Effects of Lessee Involvement in Asset Construction" ("EITF 97-10"), we record on the Condensed Consolidated Balance Sheet specific performance options, options with variable interest entities, and other options under "Consolidated Inventory Not Owned" with the offset to "Liabilities from inventory not owned", "Minority interest from inventory not owned", and "Minority interest from consolidated joint ventures". Unconsolidated Homebuilding and Land Development Joint Ventures - Investments in unconsolidated homebuilding and land development joint ventures are accounted for under the equity method of accounting. Under the equity method, we recognize our proportionate share of earnings and losses earned by the joint venture upon the delivery of lots or homes to third parties. Our ownership interests in our unconsolidated joint ventures range from 20% to 50%. In some instances, the joint venture entity is considered a variable interest entity (VIE) under FIN 46 due to the returns being limited to the equity holders; however, in these instances, we are not the primary beneficiary, therefore we do not consolidate these entities. Intangible Assets - Except for goodwill, the intangible assets recorded on our balance sheet are definite life intangibles, which include tradenames, architectural designs, distribution processes, and contractual agreements. We no longer amortize goodwill, but instead assess it periodically for impairment. We are amortizing the definite life intangibles over their expected useful life, ranging from three to seven years. Post Development Completion and Warranty Costs - In those instances where a development is substantially completed and sold and we have additional construction work to be incurred, an estimated liability is provided to cover the cost of such work. In addition, our warranty accrual includes estimated costs for construction work that is unforeseen, but estimable based on past history, at the time of closing. Both of these liabilities are recorded in "accounts payable and other liabilities" in the Condensed Consolidated Balance Sheets. CAPITAL RESOURCES AND LIQUIDITY Our operations consist primarily of residential housing development and sales in our Northeast Region (New Jersey, Southern New York State, Pennsylvania, Ohio, Michigan, Illinois and Minnesota), our Southeast Region (Washington D. C., Delaware, Maryland, Virginia, West Virginia, North Carolina, South Carolina, and Florida), our Southwest Region (Texas and Arizona), and our West Region (California). In addition, we provide financial services to our homebuilding customers. Our cash uses during the nine months ended July 31, 2005 were for operating expenses, increases in housing inventories, construction, income taxes, interest, acquisitions, and repayments of our revolving credit facility. We provided for our cash requirements from housing and land sales, the revolving credit facility, the issuance of $200 million of Senior Notes and $100 million of 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 July 3, 2001, our Board of Directors authorized a stock repurchase program to purchase up to 4 million shares of Class A Common Stock. As of July 31, 2005, 2.3 million shares of Class A Common Stock have been purchased under this program. In addition in 2003, we retired at no cost 1.5 million shares that were held by a seller of a previous acquisition. On March 5, 2004, our Board of Directors authorized a 2-for- 1 stock split in the form of a 100% stock dividend. All share information reflects this stock dividend. On July 12, 2005, we issued 5,600 shares of 7.625% Series A Preferred Stock, with a liquidation preference of $25,000 per share. Dividends on the Series A Preferred Stock are not cumulative and will be paid at an annual rate of 7.625%. The Series A Preferred Stock is not convertible into the Company's common stock and is redeemable in whole or in part at our option at the liquidation preference of the shares beginning on the fifth anniversary of their issuance. The Series A Preferred Stock is traded as depositary shares, with each depositary share representing 1/1000th of a share of Series A Preferred Stock. The depositary shares are listed on the Nasdaq National Market under the symbol "HOVNP". The net proceeds from the offering of $136 million, reflected in Paid in Capital in the Condensed Consolidated Balance Sheet, were used for the partial repayment of the outstanding balance under our revolving credit facility as of July 12, 2005. Our homebuilding bank borrowings are made pursuant to an amended and restated unsecured revolving credit agreement (the "Agreement") effective June 17, 2005, that provides a revolving credit line and letter of credit line of $1.2 billion through July 2009. The facility contains an accordion feature under which the aggregate commitment can be increased to $1.3 billion subject to the availability of additional commitments. Interest is payable monthly at various rates based on a margin ranging from 1.00% to 1.95% per annum, depending on our Consolidated Leverage Ratio, as defined in the Agreement, plus, at the Company's option, either (1) a base rate determined by reference to the higher of (a) PNC Bank, National Association's prime rate and (b) the federal funds rate plus 1/2% or (2) a LIBOR-based rate for a one, two, three or six month interest period as selected by the Company. In addition, we pay a fee ranging from 0.20% to 0.30% per annum on the unused portion of the revolving credit line depending on its Leverage Ratio and the average percentage unused portion of the revolving credit line. At July 31, 2005, there was $43.1 million drawn under this Agreement and we had approximately $44.0 million of homebuilding cash. At July 31, 2005, we had issued $305.4 million of letters of credit which reduces cash available under the Agreement. We believe that we will be able either to extend the Agreement beyond July 2008 or negotiate a replacement facility, but there can be no assurance of such extension or replacement facility. We currently are in compliance and intend to maintain compliance with the covenants under the Agreement. We and each of our significant subsidiaries, except for various subsidiaries formerly engaged in the issuance of collateralized mortgage obligations, a subsidiary formerly engaged in homebuilding activity in Poland, our financial services subsidiaries, joint ventures, and certain other subsidiaries, is a guarantor under the Agreement. At July 31, 2005, we had $805.3 million of outstanding senior notes ($803.2 million, net of discount), comprised of $140.3 million 10 1/2% Senior Notes due 2007, $100 million 8% Senior Notes due 2012, $215 million 6 1/2% Senior Notes due 2014, $150 million 6 3/8% Senior Notes due 2014, and $200 million 6 1/4% Senior Notes due 2015. At July 31, 2005, we had $400 million of outstanding senior subordinated notes, comprised of $150 million 8 7/8% Senior Subordinated Notes due 2012, $150 million 7 3/4% Senior Subordinated Notes due 2013, and $100 million 6% Senior Subordinated Notes due 2010. We and each of our wholly owned subsidiaries, except for K. Hovnanian Enterprises, Inc., the issuer of the senior and senior subordinated notes, and various subsidiaries formerly engaged in the issuance of collateralized mortgage obligations, our mortgage lending subsidiaries, a subsidiary engaged in homebuilding activity in Poland, our title insurance subsidiaries, and joint ventures, is a guarantor of the senior notes and senior subordinated notes. Our mortgage banking subsidiary's warehouse agreement was amended on April 26, 2005. Pursuant to the agreement, we may borrow up to $250 million. The agreement expires in April 2006 and interest is payable monthly at the Eurodollar Rate plus 1.25%. We believe that we will be able either to extend this agreement beyond April 2006 or negotiate a replacement facility, but there can be no assurance of such extension or replacement facility. As of July 31, 2005, the aggregate principal amount of all borrowings under this agreement was $167.2 million. Total inventory increased $504.8 million during the nine months ended July 31, 2005. This increase excluded the increase in consolidated inventory not owned of $15.4 million consisting of specific performance options, options with variable interest entities, and other options that were added to our balance sheet in accordance with SFAS 49, SFAS 98, and EITF 97-10, and variable interest entities in accordance with FIN 46. See "Notes to Condensed Consolidated Financial Statements" - Note 13 for additional information on FIN 46. Excluding the impact of $91.7 million from our acquisitions, total inventory in our Northeast Region increased $177.3 million, the Southeast Region increased $180.0 million, the Southwest Region increased $89.3 million, and our West Region decreased $33.5 million; however, if you exclude the impact of property that was owned at October 31, 2004, but is now under option and included in "Consolidated Inventory Not Owned - Other options", our West Region increased $50.0 million. The increase in inventory was primarily the result of future planned organic growth in our existing markets. Substantially all homes under construction or completed and included in inventory at July 31, 2005 are expected to be closed during the next twelve months. Most inventory completed or under development is partially financed through our line of credit and senior and senior subordinated indebtedness. We usually option property for development prior to acquisition. By optioning property, we are only subject to the loss of the cost of the option and predevelopment costs if we choose not to exercise the option. As a result, our commitment for major land acquisitions is reduced. The following table summarizes the number of buildable homes included in our total residential real estate. The July 31, 2005 and October 31, 2004 numbers exclude real estate owned and options in locations where we have ceased development. Active Proposed Grand Active Communities Developable Total Communities Homes Homes Homes ----------- --------- ------------ --------- July 31, 2005: Northeast Region.. 35 9,085 21,287 30,372 Southeast Region.. 142 13,624 24,821 38,445 Southwest Region.. 97 12,488 7,628 20,116 West Region....... 49 9,330 8,807 18,137 ----------- --------- ------------ --------- 323 44,527 62,543 107,070 =========== ========= ============ ========= Owned.......... 22,920 4,665 27,585 Optioned....... 21,607 57,878 79,485 --------- ------------ --------- Total........ 44,527 62,543 107,070 ========= ============ ========= Active Proposed Grand Active Communities Developable Total Communities Homes Homes Homes ----------- --------- ------------ ---------- October 31, 2004: Northeast Region.. 28 7,163 21,160 28,323 Southeast Region.. 113 12,124 19,697 31,821 Southwest Region.. 85 10,859 9,205 20,064 West Region....... 49 11,277 8,455 19,732 ----------- ----------- ---------- ----------- 275 41,423 58,517 99,940 =========== =========== ========== =========== Owned.......... 20,713 6,024 26,737 Optioned....... 20,710 52,493 73,203 ----------- ---------- ----------- Total........ 41,423 58,517 99,940 =========== ========== =========== The following table summarizes our started or completed unsold homes and models. The increase in total started or completed unsold homes compared to the prior year is due to the increase in mid-rise and high- rise buildings for which we count all units started when vertical construction begins. July 31, October 31, 2005 2004 ----------------------- ----------------------- Unsold Unsold Homes Models Total Homes Models Total ------ ------ ----- ------ ------ ----- Northeast Region.... 252 23 275 77 39 116 Southeast Region.... 390 53 443 222 35 257 Southwest Region.... 864 68 932 683 78 761 West Region......... 256 161 417 329 160 489 ------ ------ ----- ------ ------ ----- Total 1,762 305 2,067 1,311 312 1,623 ====== ====== ===== ====== ====== ===== Receivables, deposits, and notes increased $8.5 million to $63.7 million at July 31, 2005. The increase was primarily due to an increase in refundable deposits with municipalities as we begin development of new communities and the timing of cash received from homes that closed at the end of July 2005. Receivables from home sales amounted to $19.1 million and $17.6 million at July 31, 2005 and October 31, 2004, respectively. Prepaid expenses and other assets are as follows: July 31, October 31, Dollar 2005 2004 Change ---------- ----------- --------- Prepaid insurance.................... $ 4,490 $ - $ 4,490 Prepaid project costs................ 60,134 48,695 11,439 Senior residential rental properties. 8,549 8,830 (281) Other prepaids....................... 18,983 16,632 2,351 Other assets......................... 29,438 19,459 9,979 ----------- ----------- --------- $ 121,594 $ 93,616 $ 27,978 =========== =========== ========= Prepaid insurance increased due to a payment of a full year of insurance costs during the first quarter of every year. These costs are amortized monthly on a straight line basis. Prepaid project costs increased due to new communities. Prepaid project costs consist of community specific expenditures that are used over the life of the community. Such prepaids are expensed as homes are delivered. Other prepaids mainly increased as a result of prepaid bond fees from our November 2004 offering of $100 million and $200 million senior notes. The increase in other assets is attributable to the Executive Deferred Compensation Plan, due to increased profit sharing contributions for Senior Management, and GMAC model costs which increased as a result of final settlements for models in the program. Investments in joint ventures increased as we entered into four new homebuilding joint ventures during the nine months ended July 31, 2005. As of July 31, 2005, we have investments in seven homebuilding joint ventures and eight land and land development joint ventures. Other than performance guarantees and environmental indemnifications, no other guarantees associated with unconsolidated joint ventures have been given. At July 31, 2005, we had $32.7 million of goodwill. This amount resulted from company acquisitions prior to fiscal 2003. Definite life intangibles decreased $5.4 million to $120.1 million at July 31, 2005. The decrease was the result of amortization during the nine months of $32.2 million, offset by the Cambridge Homes acquisition and contingent payments related to past acquisitions. For any acquisition, professionals are hired to appraise all acquired intangibles. See "- Critical Accounting Policies - Intangible Assets" above for additional information on intangibles. For tax purposes all our intangibles, except those resulting from an acquisition classified as a tax free exchange, are being amortized over 15 years. Accounts payable and other liabilities are as follows: July 31, October 31, Dollar 2005 2004 Change --------- ----------- -------- Accounts payable.......................$126,832 $ 113,866 $ 12,966 Reserves............................... 95,571 72,289 23,282 Accrued expenses....................... 43,098 28,016 15,082 Accrued compensation................... 62,586 78,283 (15,697) Property secured by a mortgage......... - 11,750 (11,750) Other liabilities...................... 52,833 25,417 27,416 --------- ----------- -------- $380,920 $ 329,621 $ 51,299 ========= =========== ======== The increase in accounts payable was primarily due to increases in homes under construction in the third quarter of 2005 compared to the fourth quarter of 2004 throughout our markets, which results in more activity and higher payables. Reserves increased for our general liability insurance deductible, owner controlled insurance program and bonding. The increase in accrued expenses is due to liabilities associated with acquisition earnout obligations, as well as the increase of accruals for uninvoiced payables as our business grows. The decrease in accrued compensation was due to the payout of our fiscal year 2004 bonuses during the first quarter of 2005. Property secured by a mortgage decreased as the result of a property in our Northeast Region that was secured by a mortgage at October 31, 2004, that was paid for in cash in the quarter, thus relieving the liability. The increase in other liabilities is primarily due to increased executive incentives from increased contributions, increased payroll withholding due to timing of insurance claims and a note payable in our Southeast Region related to an acquisition. Financial Services - Mortgage loans held for sale consist of residential mortgages receivable of which $182.1 million and $209.2 million at July 31, 2005 and October 31, 2004, respectively, are being temporarily warehoused and awaiting sale in the secondary mortgage market. 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, 2005 COMPARED TO THE THREE AND NINE MONTHS ENDED JULY 31, 2004 Total Revenues: Compared to the same prior period, revenues increased as follows: Three Months Ended -------------------------------------------- July 31, July 31, Dollar Percentage 2005 2004 Change Change ----------- ----------- -------- ---------- (Dollars In Thousands) Homebuilding: Sale of homes........ $1,289,373 $1,044,610 $244,763 23.4% Land sales and other revenues........... 4,820 2,756 2,064 74.9% Financial Services..... 18,533 13,683 4,850 35.4% ----------- ----------- -------- ---------- Total Revenues... $1,312,726 $1,061,049 $251,677 23.7% =========== =========== ======== ========== Nine Months Ended ---------------------------------------------- July 31, July 31, Dollar Percentage 2005 2004 Change Change ----------- ----------- ----------- ---------- (Dollars In Thousands) Homebuilding: Sale of homes........ $3,495,014 $2,702,826 $ 792,188 29.3% Land sales and other revenues........... 32,747 8,549 24,198 283.1% Financial Services... 48,995 41,926 7,069 16.9% ----------- ----------- ----------- ---------- Total Revenues... $3,576,756 $2,753,301 $ 823,455 29.9% =========== =========== =========== ========== For further details on land sales and other revenues, see paragraph titled "Land Sales and Other Revenues" later in this document. Homebuilding: Compared to the same prior period, housing revenues increased $244.8 million or 23.4% during the three months ended July 31, 2005 and increased $792.2 million or 29.3% during the nine months ended July 31, 2005. Housing revenues are recorded when title is conveyed to the buyer, adequate cash payment has been received, and there is no continued involvement. 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. Information on homes delivered by market area is set forth below: Three Months Ended Nine Months Ended July 31, July 31, --------------------- ---------------------- 2005 2004 2005 2004 ---------- ---------- ---------- ---------- (Dollars in Thousands) Northeast Region: Dollars............ $ 244,973 $ 261,470 $ 750,679 $ 661,998 Homes.............. 644 792 2,056 2,101 Southeast Region (1): Dollars............ $ 405,467 $ 272,395 $1,004,201 $ 716,942 Homes.............. 1,212 1,004 3,232 2,778 Southwest Region: Dollars............ $ 189,766 $ 181,491 $ 489,810 $ 463,869 Homes.............. 1,021 1,045 2,636 2,653 West Region: Dollars............ $ 449,167 $ 329,254 $1,250,324 $ 860,017 Homes.............. 1,090 897 3,057 2,460 Consolidated Total: Dollars............ $ 1,289,373 $ 1,044,610 $3,495,014 $2,702,826 Homes.............. 3,967 3,738 10,981 9,992 Unconsolidated Joint Ventures (2): Dollars............ $ 195,716 $ 11,611 $ 331,033 $ 22,921 Homes.............. 571 27 944 56 Totals: Housing Revenues... $ 1,485,089 $ 1,056,221 $3,826,047 $2,725,747 Homes Delivered.... 4,538 3,765 11,925 10,048 (1) The number and dollar amount of deliveries in the Southeast Region in fiscal 2005 include the effect of the Cambridge Homes acquisition, which closed in March 2005. (2) The number and dollar amount of deliveries in the Unconsolidated Joint Ventures in fiscal 2005 include the effect of the Town & Country Homes acquisition, which closed in March 2005. An important indicator of our future results are recently signed contracts and home contract backlog for future deliveries. Our sales contracts and homes in contract backlog using base sales prices by market area are set forth below: Net Contracts(2) for the Nine Months Ended Contract Backlog July 31, as of July 31, ------------------------- ------------------------ 2005 2004 2005 2004 ----------- ----------- ----------- ----------- (Dollars in Thousands) Northeast Region (1): Dollars............ $ 729,637 $ 778,303 $ 798,113 $ 768,066 Homes.............. 1,981 2,405 2,181 2,522 Southeast Region (3): Dollars............ $1,308,952 $ 886,696 $1,232,152 $ 772,073 Homes.............. 3,630 3,132 3,305 2,558 Southwest Region: Dollars............ $ 647,975 $ 503,157 $ 333,875 206,540 Homes.............. 3,320 2,871 1,608 1,207 West Region: Dollars............ $1,272,462 $1,339,917 $ 840,758 $ 777,598 Homes.............. 3,076 3,600 1,936 1,933 Consolidated Total: Dollars............ $3,959,026 $3,508,073 $3,204,898 $2,524,277 Homes.............. 12,007 12,008 9,030 8,220 Unconsolidated Joint Ventures (4): Dollars............ $ 671,277 $ 179,174 $ 993,259 $ 172,130 Homes.............. 1,426 301 2,301 281 Totals: Dollars............ $ 4,630,303 $3,687,247 $4,198,157 $2,696,407 Homes............... 13,433 12,309 11,331 8,501 (1) During the first quarter of 2005, a community in the Northeast Region was contributed to a joint venture. As a result, the 56 contracts in consolidated backlog at October 31, 2004 for that community were moved to unconsolidated joint ventures backlog. (2) Net contracts are defined as new contracts signed during the period for the purchase of homes, less cancellations of prior period contracts. (3) The number and the dollar amount of net contracts and backlog in the Southeast in fiscal 2005 include the effect of the Cambridge Homes acquisition, which closed in March 2005. (4) The number and the dollar amount of net contracts and backlog in Unconsolidated Joint Ventures in fiscal 2005 include the effect of the Town & Country Homes acquisition, which closed in March 2005. During August 2005, we signed an additional 1,467 net contracts amounting to $498.9 million in consolidated communities and 182 net contracts amounting to $75.1 million in unconsolidated joint ventures compared to 1,290 net contracts amounting to $417.4 million in consolidated communities and 44 net contracts amounting to $24.5 million in unconsolidated joint ventures in the same month last year. In addition, as a result of our acquisitions of First Home Builders of Florida and Oster Homes in August 2005, we acquired contract backlog of 4,153 homes with a dollar value of $913 million. 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, --------------------- ----------------------- 2005 2004 2005 2004 ---------- ---------- ---------- ---------- (Dollars in Thousands) Sale of Homes.............. $1,289,373 $1,044,610 $3,495,014 $2,702,826 Cost of Sales, excluding interest................. 939,815 778,121 2,571,916 2,014,799 ---------- ---------- ---------- ---------- Housing Gross Margin, before interest expense......... 349,558 266,489 923,098 688,027 Cost of Sales Interest..... 19,229 13,369 46,850 39,138 ---------- ---------- ---------- ---------- Housing Gross Margin, after interest expense......... $ 330,329 $ 253,120 $ 876,248 $ 648,889 ========== ========== ========== ========== Gross Margin Percentage, before interest expense... 27.1% 25.5% 26.4% 25.4% Gross Margin Percentage, after interest expense.... 25.6% 24.2% 25.1% 24.0% Cost of Sales expenses as a percentage of home sales revenues are presented below: Three Months Ended Nine Months Ended July 31, July 31, ------------------- -------- -------- 2005 2004 2005 2004 -------- -------- -------- -------- Sale of Homes................ 100.0% 100.0% 100.0% 100.0% -------- -------- -------- -------- Cost of Sales, excluding interest: Housing, land & development costs.... 64.8% 66.7% 65.5% 66.6% Commissions............ 2.6% 2.2% 2.3% 2.2% Financing concessions.. 1.0% 1.0% 1.0% 1.0% Overheads.............. 4.6% 4.6% 4.9% 4.7% -------- -------- -------- -------- Total Cost of Sales, before interest expense........... 72.9% 74.5% 73.6% 74.5% -------- -------- -------- -------- Gross Margin Percentage, before interest expense.... 27.1% 25.5% 26.4% 25.4% Cost of sales interest....... 1.5% 1.3% 1.3% 1.4% -------- -------- -------- -------- Gross Margin Percentage, after interest expense..... 25.6% 24.2% 25.1% 24.0% ======== ======== ======== ======== We sell a variety of home types in various local communities, each yielding a different gross margin. As a result, depending on the geographic mix of deliveries and the mix of both communities and of home types delivered, consolidated quarterly gross margin will fluctuate up or down and may not be representative of the consolidated gross margin for the year. The consolidated gross margin before interest expense for the three and nine months ended July 31, 2005 was 160 and 100 basis points, respectively, higher than the same periods in 2004. Our gross margin after interest expense for the three and nine months ended July 31, 2005 was 140 and 110 basis points, respectively, more than the same periods last year. Cost of sales interest related to homes sold as a percentage of home revenues amounted to 1.5% and 1.3% for the three and nine months ended July 31, 2005, respectively, and 1.3% and 1.4% for the three and nine months ended July 31, 2004, respectively. These minor fluctuations from period to period in cost of sales interest as a percentage of home revenues are due to the mix of homes sold and the inventory carrying period for those homes. Homebuilding selling, general, and administrative expenses as a percentage of homebuilding revenues increased to 9.0% and 9.1% for the three and nine months ended July 31, 2005, respectively, compared to 7.9% and 8.7% for the three and nine months ended July 31, 2004. Such expenses increased $33.8 million and $84.8 million for the three and nine months ended July 31, 2005 compared to the same period last year. The dollar and percentage increases were in line with our growth goals as we increase selling, general and administrative costs associated with the expected increase in the number of active selling communities in all of our regions. Land Sales and Other Revenues: Land sales and other revenues consist primarily of land and lot sales. A breakout of land and lot sales is set forth below: Three Months Ended Nine Months Ended July 31, July 31, ------------------ ------------------ 2005 2004 2005 2004 -------- -------- -------- -------- Land and Lot Sales................ $ 441 $ 230 $ 24,618 $ 1,815 Cost of Sales..................... 387 95 16,369 1,458 -------- -------- -------- -------- Land and Lot Sales Gross Margin... 54 135 8,249 357 -------- -------- -------- -------- Interest Expense.................. 28 - 239 21 -------- -------- -------- -------- Land and Lot Sales Profit Before Tax............................. $ 26 $ 135 $ 8,010 $ 336 ======== ======== ======== ======== Land and lot sales are incidental to our residential housing operations and are expected to continue in the future but may significantly fluctuate up or down. Financial Services Financial services consist primarily of originating mortgages from our homebuyers and selling such mortgages in the secondary market, and title insurance activities. For the three and nine months ended July 31, 2005, financial services provided a $6.2 million and $15.3 million profit before income taxes, respectively, compared to a profit of $5.0 million and $16.6 million for the same periods in 2004, respectively. The decrease in pretax profit for the nine months ended July 31, 2005 is primarily due to reduced spreads resulting from the steady rise in homebuyers choosing to use Adjustable Rate Mortgage (ARM) products which historically are less profitable to originate and lower gross spreads due to increased competition for purchase mortgages as the market for refinancing mortgages has significantly declined. The financial services profits were also reduced due to additional overhead expenses in advance of our anticipated growth. Corporate General and Administrative Corporate general and administrative expenses represent 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 1.4% for the three months ended July 31, 2005 from 1.2% for the prior year's three months and decreased to 1.4% for the nine months ended July 31, 2005 from 1.5% for the prior year's nine months. Corporate general and administrative expenses increased $5.9 million and $7.4 million during the three and nine months ended July 31, 2005, compared to the same periods last year. The increase in corporate general and administrative expenses is primarily attributed to additional salary and employee expense due to increased headcount as our company continues to grow, as well as additional professional services related to Sarbanes-Oxley compliance. Other Interest Other interest declined $0.1 million and $1.3 million for the three months and nine months ended July 31, 2005, respectively. This reduction is primarily due to lower borrowing rates and the ratio of capitalized interest to total interest incurred. Other Operations Other operations consist primarily of miscellaneous residential housing operations expenses, senior rental residential property operations, amortization of senior and senior subordinated note issuance expenses, earnout payments from homebuilding company acquisitions, minority interest relating to consolidated joint ventures, and corporate owned life insurance. The increase in other operations to $7.4 million for the three months ended July 31, 2005, compared to $3.4 million for the three months ended July 31, 2004 is primarily due to increased earnout expenses related to several recent acquisitions. Intangible Amortization We are amortizing our definite life intangibles over their expected useful life, ranging from three to seven years. Intangible amortization increased $2.1 million and $13.1 million for the three and nine months ended July 31, 2005, when compared to the same periods last year. This increase was the result of the amortization expense associated with the fiscal 2002 California acquisition brand name, which is being phased out, as well as amortization related to the Cambridge Homes acquisition in March 2005. Recent Accounting Pronouncements In December 2004, the FASB issued SFAS No. 123 (Revised 2004) "Share Based Payment" ("SFAS 123R"), which is a revision of SFAS 123 and supersedes APB 25 and SFAS 148. This statement requires that the cost resulting from all share-based payment transactions be recognized in an entity's financial statements. This statement establishes fair value as the measurement objective in accounting for share-based payment arrangements and requires all entities to apply a fair value based measurement method in accounting for share-based payment transactions with employees except for equity instruments held by employee share ownership plans. See Note 2 to the Condensed Consolidated Financial Statements for a further description of SFAS 123R and its expected impact on our first quarter fiscal 2006 net income. In March 2005, the Securities and Exchange Commission released SEC Staff Accounting Bulletin ("SAB") No. 107, "Share-Based Payment". SAB No. 107 provides the SEC staff position regarding the application of SFAS No. 123R. SAB No. 107 contains interpretive guidance related to the interaction between SFAS No. 123R and certain SEC rules and regulations, as well as provides the staff's views regarding the valuation of share- based payment arrangements for public companies. SAB No. 107 also highlights the importance of disclosures made related to the accounting for share-based payment transactions. We are currently evaluating SAB No. 107 and will be incorporating it as part of our adoption of SFAS No. 123R. In December 2004, the FASB issued Staff Position 109-1 ("FSP 109- 1"), Application of FASB Statement No. 109 ("FASB No. 109"), "Accounting for Income Taxes", to the Tax Deduction on Qualified Production Activities Provided by the American Jobs Creation Act of 2004. FSP 109-1 clarifies guidance that applies to the new deduction for qualified domestic production activities. When fully phased-in, the deduction will be up to 9% of the lesser of "qualified production activities income" or taxable income. FSP 109-1 clarifies that the deduction should be accounted for as a special deduction under FASB No. 109 and will reduce tax expense in the period or periods that the amounts are deductible on the tax return. Any tax benefits resulting from the new deduction will be effective for our fiscal year ending October 31, 2006. We are in the process of assessing the impact, if any, the new deduction will have on our financial statements. In June 2005, the Emerging Issues Task Force ("EITF") released Issue No. 04-5 "Determining Whether a General Partner, or the General Partners as a Group, Controls a Limited Partnership or Similar Entity When the Limited Partners Have Certain Rights" ("EITF 04-5"). EITF 04-5 creates a framework for evaluating whether a general partner or a group of general partners controls a limited partnership and therefore should consolidate the partnership. EITF 04-5 states that the presumption of general partner control would be overcome only when the limited partners have certain specific rights as outlined in EITF 04-5. EITF 04-5 is effective immediately for all newly formed limited partnerships and for existing limited partnership agreements that are modified. For general partners in all other limited partnerships, EITF 04-5 is effective no later than the beginning of the first reporting period in fiscal years beginning after December 15, 2005. Implementation of EITF 04-5 is not expected to have a material impact on the Company's results of operations or financial position. Total Taxes Total taxes as a percentage of income before taxes increased for the three months ended July 31, 2005 to 40.4% from 38.1% for the three months ended July 31, 2004 and for the nine months ended July 31, 2005 to 39.4% from 37.7% for the same period last year. The prior year effective rates were lower than the current year due to refunds recorded in the second quarter of 2004 related to adjustments to previous years' taxes, as well as due to higher than estimated taxes upon filing our 2004 tax returns in the third quarter of 2005. 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, 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, because we generally negotiate fixed price contracts with many, but not all, of our subcontractors and material suppliers for the construction of our homes. These prices usually are applicable for a specified number of residential buildings or for a time period of between three to twelve months. Construction costs for residential buildings represent approximately 56% of our homebuilding cost of sales. Mergers and Acquisitions On March 1, 2005, we acquired for cash the assets of Cambridge Homes, a privately held Orlando homebuilder and provider of related financial services, headquartered in Altamonte Springs, Florida. The acquisition provides us with a presence in the greater Orlando market, which is the 9th largest housing market in the U.S., based on 2003 new home starts. Cambridge Homes designs, markets and sells both single family homes and attached townhomes and focuses on first-time, move up and luxury homebuyers. Cambridge Homes also provides mortgage financing, as well as title and settlement services to its homebuyers. The Cambridge Homes acquisition was accounted for as a purchase, with the results of its operations included in our consolidated financial statements as of the date of the acquisition. On March 2, 2005, we acquired the operations of Town & Country Homes, a privately held homebuilder and land developer headquartered in Lombard, Illinois, which occurred concurrently with our entering into a joint venture agreement with affiliates of Blackstone Real Estate Advisors in New York to own and develop Town & Country's existing residential communities. The joint venture is being accounted for under the equity method. Town & Country Homes operations beyond the existing owned and optioned communities, as of the acquisition date, are wholly owned and included in our consolidated financial statements. The Town & Country acquisition provides us with a strong initial position in the greater Chicago market, which is the 6th largest housing market in the U.S., based on 2003 new home starts. This acquisition also expands our operations into the Florida markets of West Palm Beach, Boca Raton and Fort Lauderdale and bolsters our current presence in Minneapolis/St. Paul, which is the 10th largest housing market in the U.S., based on 2003 new home starts. Town & Country designs, markets and sells a diversified product portfolio in each of its markets, including single family homes and attached townhomes, as well as mid-rise condominiums in Florida. Town & Country serves a broad customer base including first-time, move-up and luxury homebuyers. On August 8, 2005 we acquired substantially all of the assets of First Home Builders of Florida, a privately held homebuilder and provider of related financial services headquartered in Cape Coral, Florida. First Home Builders is a leading builder in Western Florida and ranked 1st in the greater Fort Myers-Cape Coral market and 51st nationally based on 2004 permit activity as tracked by Builder Magazine. Thus, the acquisition provides Hovnanian with the number one market position in the high growth Fort Myers-Cape Coral market, which is the 18th largest housing market in the U.S. as ranked by Builder Magazine based on 2004 permits. First Home Builders of Florida designs, markets and sells single family homes, with a focus on the first-time home buying segment. The company also provides mortgage financing, title and settlement services to its homebuyers. In 2004, First Home Builders delivered 1,819 homes with revenues of $308 million. As of July 31, 2005, First Home Builders had 4,048 homes in contract backlog with a sales value of $888 million. On August 3, 2005, we acquired substantially all of the homebuilding assets of Oster Homes, a privately held Ohio homebuilder, headquartered in Lorain, Ohio. The acquisition provides Hovnanian with a complementary presence to its Ohio "build-on-your-own-lot" homebuilding operations. Oster Homes builds in Lorain County in Northeast Ohio, just west of Cleveland. Lorain is part of the greater Cleveland MSA, which is the 50th largest housing market in the U. S., based on 2004 new home starts. Oster Homes designs, markets and sells single family homes, with a focus on first-time and move up homebuyers. Additionally, Oster Homes utilizes a design center to market extensive pre-prices options and upgrades. In its 2004 fiscal year, Oster Homes delivered 247 homes with revenue of $56 million. As of August 3, 2005, Oster Homes currently has approximately 105 homes in contract backlog, with a sales value of $25 million, and owns or controls approximately 3,000 lots throughout the greater Cleveland area. Oster Homes ranked as the 4th largest builder in the Cleveland MSA in 2004 by Builder Magazine. Both the First Home Builders of Florida and Oster acquisitions will be accounted for as purchases with the results of their operations included in our consolidated financial statements as of the dates of the acquisitions. 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 Reform 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; . Adverse weather conditions and natural disasters; . Changes in market conditions; . Changes in home prices and sales activity in the markets where the Company builds homes; . Government regulation, including regulations concerning development of land, the home building, sales and customer financing processes, and the environment; . Fluctuations in interest rates and the availability of mortgage financing; . Shortages in, and price fluctuations of, raw materials and labor; . The availability and cost of suitable land and improved lots; . Levels of competition; . Availability of financing to the Company; . Utility shortages and outages or rate fluctuations; and . Geopolitical risks, terrorist acts and other acts of war. Certain risks, uncertainties, and other factors are described in detail in Item 1 and 2 "Business and Properties" in our Form 10-K for the year ended October 31, 2004. Item 3. 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, 2005,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, 2005 -------------------------------------------------- Expected Maturity Date
FMV @ 2005 2006 2007 2008 2009 2010 Thereafter Total 7/31/05 ------- ------- -------- ------- -------- -------- --------- --------- ----------- (Dollars in Thousands) Long Term Debt(1): Fixed Rate.... $31,221 $ 644 $140,937 $ 737 $ 786 $100,841 $ 985,803 $1,260,967 $1,306,841 Average interest rate 8.40% 6.66% 10.48% 6.70% 6.72% 6.01% 7.14% 7.46% Variable Rate. Average interest rate (1) Does not include bonds collateralized by mortgages receivable.
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, 2005. Based upon that evaluation and subject to the foregoing, the Company's chief executive officer and chief financial officer concluded that the design and operation of the Company's disclosure controls and procedures are effective to accomplish their objectives. In addition, there was no change in the Company's internal control over financial reporting that occurred during the quarter ended July 31, 2005 that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting. PART II. Other Information Item 1. Legal Proceedings We are subject to extensive and complex regulations that affect the development and home building, sales and customer financing processes, including zoning, density, building standards and mortgage financing; and we are involved in litigation arising in the ordinary course of business, none of which is expected to have a material adverse effect on our financial position or results of operations. In addition, in March 2005, we received two requests for information pursuant to Section 308 of the Clean Water Act from Region 3 of the Environmental Protection Agency ("EPA") requesting information about storm water discharge practices in connection with completed, ongoing and planned homebuilding projects by subsidiaries in the states and district that comprise EPA Region 3. We also received a notice of violations for one project in Pennsylvania and requests for sampling plan implementation in two projects in Pennsylvania. The amount requested by the EPA to settle the asserted violations at the one project was not material. We have provided the information requested. To the extent that the information provided were to lead the EPA to assert violations of state and/or federal regulatory requirements and request injunctive relief and/or civil penalties, we will defend and attempt to resolve such asserted violations. Our sales and customer financing processes are subject to the jurisdiction of the U. S. Department of Housing and Urban Development ("HUD"). In connection with the Real Estate Settlement Procedures Act, HUD has recently inquired about our process of referring business to our affiliated mortgage company and has separately requested documents related to customer financing. We have responded to HUD's inquiries. At this time, we cannot predict the outcome of the EPA's or HUD's reviews or estimate the costs that may be involved in resolving such matters. Item 2. Unregistered Sales of Equity Securities and Use of Proceeds This table provides information with respect to purchases of shares of our Class A Common Stock made by or on behalf of Hovnanian Enterprises during the fiscal third quarter of 2005. Issuer Purchases of Equity Securities (1)
Total Number Of Shares Maximum Number of Purchased as Shares That May Part of Publicly Yet Be Purchased Total Number of Average Price Announced Plans Under The Plans Period Shares Purchased Paid Per Share or Programs or Programs ---------------- ---------------- -------------- ---------------- ----------------- May 1, 2005 Through May 31, 2005 1,787,668 ------------------------------------------------------------------------------------- June 1, 2005 Through June 30, 2005 100,000 $61.58 100,000 1,687,668 ------------------------------------------------------------------------------------- July 1, 2005 Through July 31, 2005 1,687,668 ------------------------------------------------------------------------------------- Total 100,000 $61.58 100,000 ================ ============== ================
(1) In July 2001, our Board of Directors authorized a stock repurchase program to purchase up to 4 million shares of Class A Common Stock. On March 5, 2004, our Board of Directors authorized a 2-for-1 stock split in the form of a 100% stock dividend. All share information reflects our dividend. No shares of our Class B Common Stock were purchased by or on behalf of Hovnanian Enterprises during the fiscal third quarter of 2005. Item 6. Exhibits Exhibit 3(a) Certificate of Incorporation of the Registrant. (1) Exhibit 3(b) Certificate of Amendment of Certificate of Incorporation of the Registrant. (2) Exhibit 3(c) Certificate of Amendment of Certificate of Incorporation of the Registrant. (3) Exhibit 3(d) Restated Bylaws of the Registrant. (4) Exhibit 4(a) Indenture, dated as of August 8, 2005, relating to 6.25% Senior Notes due 2016, among K. Hovnanian Enterprises, Inc., the Guarantors named therein and Wachovia Bank, National Association, as trustee, including form of 6.25% Senior Notes due 2016. (5) Exhibit 4(b) Certificate of Designations, Powers, Preferences and Rights of the 7.625% Series A Preferred Stock of Hovnanian Enterprises, Inc., dated July 12, 2005.(6) Exhibit 10(a) Fifth Amended and Restated Credit Agreement dated June 14, 2005. (5) Exhibit 10(b) Amended and Restated Guaranty and Suretyship Agreement, dated June 14, 2005. (5) Exhibit 31(a) Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer. Exhibit 31(b) Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer. Exhibit 32(a) Section 1350 Certification of Chief Executive Officer. Exhibit 32(b) Section 1350 Certification of Chief Financial Officer. (1) Incorporated by reference to Exhibits to Registration Statement (No. 2-85198) on Form S-1 of the Registrant. (2) Incorporated by reference to Exhibit 4.2 to Registration Statement (No. 333-106761) on Form S-3 of the Registrant. (3) Incorporated by reference to Exhibits to Quarterly Report on Form 10-Q of the Registrant for the quarter ended January 31, 2004. (4) Incorporated by reference to Exhibit 3.2 to Registration Statement (No. 1-08551) on Form 8-A of the Registrant. (5) Incorporated by reference to Exhibits to Registration Statement (No. 333-127806) on Form S-4 of the Registrant. (6) Incorporated by reference to Exhibits to the Current Report on Form 8-K of the Registrant, filed on July 13, 2005. 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 9, 2005 /S/J. LARRY SORSBY J. Larry Sorsby, Executive Vice President and Chief Financial Officer DATE: September 9, 2005 /S/PAUL W. BUCHANAN Paul W. Buchanan, Senior Vice President Corporate Controller