ITEM 3 - LEGAL PROCEEDINGS
We are involved from time to time in litigation arising in the ordinary course of business, none of which is expected to have a material adverse effect on us.
ITEM 4
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the fourth quarter of the year ended October 31, 1999 no matters were submitted to a vote of security holders.
EXECUTIVE OFFICERS OF THE REGISTRANT
Information on executive officers of the registrant is incorporated herein from Part III, Item 10.
PART II
ITEM 5
ITEM 5 - MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDERS MATTERS
The number of shares and all data presented on a per share basis in this Form 10-K have been adjusted to give effect to all stock splits. Our Class A Common Stock is traded on the American Stock Exchange and was held by 728 shareholders of record at December 31, 1999. There is no established public trading market for our Class B Common Stock, which was held by 629 shareholders of record at December 31, 1999. In order to trade Class B Common Stock, the shares must be converted into Class A Common Stock on a one-for-one basis. The high and low sales prices for our Class A Common Stock were as follows for each fiscal quarter during the years ended October 31, 1999, 1998, and 1997:
Class A Common Stock ------------------------------------------------ Oct. 31, 1999 Oct. 31, 1998 Oct. 31, 1997 -------------- -------------- -------------- Quarter High Low High Low High Low - ------- ------ ------ ------ ------ ------ ------ First........ $ 9.25 $ 7.75 $ 9.25 $ 6.50 $7.63 $5.63 Second....... $ 8.94 $ 6.81 $11.50 $ 8.56 $7.00 $6.25 Third........ $ 9.50 $ 7.88 $11.19 $ 8.50 $7.13 $5.69 Fourth....... $ 8.88 $ 6.00 $ 9.88 $ 6.00 $8.13 $6.75
On August 7, 1999 and October 1, 1999 we acquired two homebuilding companies. As part of the purchase price 1,845,359 shares of unregistered Class A Common Stock were issued to the sellers. 483,302 of these shares are being held in escrow (and thus not reported as issued and outstanding at October 31, 1999). There were no underwriters associated with these transactions. These shares were issued in private transactions in reliance upon Section 4(2) of the Securities Act of 1933.
Certain debt instruments to which we are a party contain restrictions on the payment of cash dividends. As a result of the most restrictive of these provisions, approximately $35,415,000 was free of such restrictions at October 31, 1999. We have never paid dividends nor do we currently intend to pay dividends.
ITEM 6
ITEM 6 - SELECTED CONSOLIDATED FINANCIAL DATA
The following table sets forth selected financial data and should be read in conjunction with the financial statements included elsewhere in this Form 10- K. Per common share data and weighted average number of common shares outstanding reflect all stock splits.
RATIOS OF EARNINGS TO FIXED CHARGES AND EARNINGS TO COMBINED FIXED CHARGES AND PREFERRED STOCK DIVIDENDS
For purposes of computing the ratios of earnings to fixed charges and earnings to combined fixed charges and preferred dividends, earnings consist of earnings (loss) from continuing operations before income taxes, minority interest, extraordinary items and cumulative effect of accounting changes, plus fixed charges (interest charges and preferred share dividend requirements of subsidiaries, adjusted to a pretax basis), less interest capitalized, less preferred share dividend requirements of subsidiaries adjusted to a pretax basis and less undistributed earnings of affiliates whose debt is not guaranteed by us.
The following table sets forth the ratios of earnings to fixed charges and earnings to combined fixed charges and preferred dividends for the periods indicated:
Years Ended October 31, -------------------------------------------------- 1999 1998 1997 1996 1995 -------- -------- -------- -------- ---------- Ratio of earnings to fixed charges............ 3.0 2.6 (a) 1.6 1.4 Ratio of earnings to combined fixed charges and preferred stock dividends................. 3.0 2.6 (a) 1.6 1.4
(a) No ratio is presented for the year ended October 31, 1997 as the earnings for such period were insufficient to cover fixed charges by $9,197,000.
ITEM 7
ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
CAPITAL RESOURCES AND LIQUIDITY
Our cash uses during the twelve months ended October 31, 1999 were for operating expenses, seasonal increases in housing inventories, construction, income taxes, interest, the repurchase of common stock, the redemption of subordinated indebtedness, and the acquisition of two homebuilding companies. We provided for our cash requirements from housing and land sales, the issuance of $150,000,000 Senior Notes, the revolving credit facility, the sale of commercial facilities, financial service income, and other revenues. We believe that these sources of cash are sufficient to finance our working capital requirements and other needs.
Our net income historically does not approximate cash flow from operating activities. The difference between net income and cash flow from operating activities is primarily caused by changes in inventory levels, mortgage loans and liabilities, and depreciation and impairment losses. When we are expanding our operations, which was the case in fiscal 1999, inventory levels increase causing cash flow from operating activities to decrease. Liabilities also increase as inventory levels increase. The increase in liabilities partially offsets the negative effect on cash flow from operations caused by the increase in inventory levels. As mortgage loans increase, cash flow from operations decreases. Conversely, as such loans decrease, cash flow from operations increases. Depreciation and impairment losses always increase cash flow from operating activities since they are non-cash charges to operations. We expect to be in an expansion mode in fiscal 2000. As a result, we expect cash flow from operations to be less than net income in fiscal 2000.
In December 1998 the Board of Directors increased the stock repurchase program to purchase up to 3 million shares of Class A Common Stock. This authorization expires on December 31, 2000. As of October 31, 1999, 2,364,400 shares were repurchased under this program of which 772,900 were repurchased during the year ended October 31, 1999.
Our bank borrowings are made pursuant to a revolving credit agreement (the "Agreement") which provides a revolving credit line and letter of credit line of up to $275,000,000 through July 2002. Interest is payable monthly and at various rates of either the prime rate or Libor plus 1.45%. We believe that we will be able either to extend the Agreement beyond July 2002 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. As of October 31, 1999, borrowings under the Agreement were $70,125,000.
The subordinated indebtedness issued by us and outstanding as of October 31, 1999 was $100,000,000 9 3/4% Subordinated Notes due June 2005. On May 4, 1999, we issued $150,000,000 9 1/8% Senior Notes due in April 2009. On June 7, 1999, we redeemed the remaining $45,449,000 principal amount 11 1/4% Subordinated Notes due April 2002. The early retirement of these notes resulted in an extraordinary loss of $868,000 net of income taxes of $468,000. The remaining proceeds were used to reduce the outstanding balance on our "Revolving Credit Facility" to zero at that time and for general corporate purposes.
Our mortgage banking subsidiary borrows under a $100,000,000 bank warehousing arrangement which expires in June 2000. Other finance subsidiaries formerly borrowed from a multi-builder owned financial corporation and a builder owned financial corporation to finance mortgage backed securities but in fiscal 1988 decided to cease further borrowing from multi-builder and builder owned financial corporations. These non-recourse borrowings have been generally secured by mortgage loans originated by one of our subsidiaries. As of October 31, 1999, the aggregate outstanding principal amount of such borrowings was $33,733,000.
The book value of our inventories, rental condominiums, and commercial properties completed and under development amounted to the following:
October 31, October 31, 1999 1998 ------------ ------------
Residential real estate inventory....... $527,121,000 $375,733,000 Senior residential rental property...... 10,650,000 10,794,000 ------------ ------------ Total residential real estate....... 537,771,000 386,527,000 Commercial properties................... 109,000 17,832,000 ------------ ------------ Combined Total...................... $537,880,000 $404,359,000 ============ ============
Total residential real estate increased $151,244,000 from October 31, 1998 to October 31, 1999 as a result of an inventory increase of $151,388,000 less depreciation of senior residential rental property. The increase in residential real estate inventory was primarily due to the acquisition of two homebuilding companies during the quarter ended October 31, 1999 and increases in California where we expect to significantly grow our business in fiscal 2000. These increases were offset by a decrease in our Northeast Region where delivery of homes is expected to decrease in fiscal 2000. Residential homes under construction or completed and included in residential real estate inventory at October 31, 1999 are expected to be closed during the next twelve months. Most residential real estate, completed or under development, is financed through our line of credit, senior notes and subordinated indebtedness.
We usually option property for development prior to acquisition. By optioning property, we are only subject to the loss of a small option fee and predevelopment costs if we choose not to exercise the option. As a result, our commitment for major land acquisitions is kept to a minimum.
The following table summarizes housing lots included in our total residential real estate:
Total Contracted Remaining Home Not Lots Lots Delivered Available -------- ---------- --------- October 31, 1999: Owned.......................... 9,730 1,825 7,905 Optioned....................... 17,078 96 16,982 -------- ---------- --------- Total........................ 26,808 1,921 24,887 ======== ========== =========
October 31, 1998: Owned.......................... 8,054 1,673 6,381 Optioned....................... 13,668 8 13,660 -------- ---------- --------- Total........................ 21,722 1,681 20,041 ======== ========== =========
The following table summarizes our started or completed unsold homes in active, substantially completed and suspended communities:
October 31, October 31, 1999 1998 -------------------------- ------------------------- Unsold Unsold Homes Models Total Homes Models Total ------ ------ ------ ------ ------ ------
Northeast Region(1). 114 31 145 180 16 196 North Carolina...... 129 -- 129 93 -- 93 Florida............. 5 -- 5 24 6 30 Metro D.C........... 13 9 22 23 11 34 California.......... 53 10 63 78 21 99 Texas............... 225 28 253 -- -- -- Poland.............. 14 -- 14 11 -- 11 ------ ------ ------ ------ ------ ------ Total 553 78 631 409 54 463 ====== ====== ====== ====== ====== ======
(1) Includes 6 unsold homes and 2 model homes from a New Jersey homebuilder acquired on August 7, 1999.
Prior to the second quarter of fiscal 1997, our commercial properties represented long-term investments in commercial and retail facilities completed or under development. At the end of the second quarter of fiscal 1997, we announced we were planning an orderly exit from the business of owning investment properties. During fiscal 1997 and 1998, we sold all our commercial facilities and a 50% owned partnership sold its retail center. During fiscal 1999 we sold three land parcels. See "Results of Operations - Investment Properties."
Collateral Mortgage Financing - collateral for bonds payable consists of collateralized mortgages receivable which are pledged against non-recourse collateralized mortgage obligations. Financial Services - mortgage loans held for sale consist of residential mortgages receivable of which $32,844,000 and $71,002,000 at October 31, 1999 and October 31, 1998, respectively, are being temporarily warehoused and awaiting sale in the secondary mortgage market. The balance of mortgage loans held for sale are being held as an investment. We may incur risk with respect to mortgages that are delinquent, but only to the extent the losses are not covered by mortgage insurance or resale value of the house. Historically, we have incurred minimal credit losses.
RESULTS OF OPERATIONS
Our operations consist primarily of residential housing development and sales in our Northeast Region (comprised primarily of New Jersey, southern New York state, and eastern Pennsylvania), in southeastern Florida, North Carolina, Metro D. C. (northern Virginia), southern California, Texas and Poland. Our Texas operations are the result of the acquisition of a Texas homebuilder on October 1, 1999. In addition, we had developed and operated commercial properties as long-term investments in New Jersey, and, to a lesser extent, Florida, but have exited this business (see "Investment Properties" below).
During the years ended October 31, 1999, 1998, and 1997, our Northeast Region, California Division and North Carolina Division housing operations consistently produced operating profits. In fiscal 1999, our Metro D.C. Division and Texas acquisition also produced profits. In 1999 and 1998, financial services operations were profitable. In addition, in 1998 and 1997 we earned profits from the liquidation of commercial properties. These profits have been reduced by net losses from our other housing divisions, corporate overhead, the writedown of certain residential inventories and commercial properties to their estimated fair value and the write-off of optioned properties and related approval, engineering and capitalized interest costs. See "Notes to Consolidated Financial Statements - Note 11".
Prior to fiscal 1998, our first two quarters produced the least amount of deliveries for the year and the fourth quarter produced the most deliveries for the year, sometimes in excess of 40% of total homes delivered. In fiscal 1998 management made a concerted effort to change this trend using new management tools to focus on delivery evenness and through a new quarterly bonus incentive plan. The percentage distribution of deliveries for the last three years is as follows:
Quarter Ended ---------------------------------------------------------- January 31 April 30 July 31 October 31 Total ---------- ---------- ---------- ---------- ---------- 1999........... 22% 22% 25% 31% 100% 1998........... 24% 23% 26% 27% 100% 1997........... 16% 19% 25% 40% 100%
During the year ended October 31, 1999 a higher percentage was delivered in the fourth quarter due to the acquisition of two homebuilding companies. In fiscal 2000 we expect a higher percentage of deliveries later in the fiscal year resulting from the projected flow of deliveries from recent homebuilding company acquisitions and the timing of community grand openings in our Northeast Region and California Division.
Total Revenues
Compared to the same prior period, revenues increased (decreased) as follows: Year Ended ----------------------------- October October October 31, 1999 31, 1998 31, 1997 --------- --------- --------- (Dollars in Thousands) Homebuilding: Sale of homes......................$ 12,909 $163,837 $(32,875) Land sales and other revenues...... 1,998 (11,572) 8,371 Financial services................... 1,141 8,363 (481) Investment properties................ (9,544) (2,646) 2,838 Collateralized mortgage financing.... (164) (171) (1,181) --------- --------- --------- Total change....................$ 6,340 $157,811 $(23,328) ========= ========= ========= Percent change.................... 0.7% 20.1% (2.9%) ========= ========= =========
Homebuilding
Compared to the same prior period, housing revenues increased $12.9 million or 1.4% for the year ended October 31, 1999, after increasing $163.8 million or 22.4% for the year ended October 31, 1998, and decreasing $32.9 million or 4.3% for the year ended October 31, 1997. Housing revenues are recorded at the time each home is delivered and title and possession have been transferred to the buyer.
Information on homes delivered by market area is set forth below:
Year Ended --------------------------------- October October October 31, 1999 31, 1998 31, 1997 --------- --------- --------- (Dollars in Thousands) Northeast Region (1): Housing Revenues............$560,586 $595,873 $445,817 Homes Delivered............. 2,063 2,530 2,128
North Carolina: Housing Revenues............$145,153 $127,592 $125,242 Homes Delivered............. 756 687 695
Florida: Housing Revenues............$ 36,566 $ 44,168 $ 74,146 Homes Delivered............. 159 241 418
Metro D.C.: Housing Revenues............$ 45,493 $ 38,904 $ 14,398 Homes Delivered............. 198 152 70
California: Housing Revenues............$ 105,941 $ 82,546 $ 69,252 Homes Delivered............. 514 457 365
Texas: Housing Revenues............$ 13,184 -- -- Homes Delivered............. 66 -- --
Poland: Housing Revenues............$ 1,630 $ 6,561 $ 2,952 Homes Delivered............. 12 71 41
Totals: Housing Revenues............$ 908,553 $895,644 $731,807 Homes Delivered............. 3,768 4,138 3,717
(1) Fiscal 1999 includes $31,961,000 housing revenues and 88 homes from a New Jersey homebuilder acquired on August 7, 1999.
The overall increase in housing revenues was the net result of increases in average sales prices offset by decreased deliveries. The increase in average sales prices during the year ended October 31, 1999 is primarily due to the increases in all markets except Metro D. C. The increased average sales prices in the Northeast Region and North Carolina were primarily attributed to the rise in base home prices and the sale of more decorator and structural options. In Florida, average sales prices increased as a result of fewer communities, all of which are higher priced single family developments. In Metro D.C., average sales prices decreased because of a change in product mix to smaller single family homes. In California, sales prices increased due to a change in product mix to larger, more expensive homes.
The decrease in homes delivered was primarily due to significant decreases in the Northeast Region and Florida while the other divisions increased deliveries slightly. The decrease in the Northeast Region was attributable to fewer communities open for sale. We expect the Northeast Region to stay at roughly the 2,000 home level in fiscal 2000 and then increase in fiscal 2001 due to an increase of active selling communities. In Florida, due to operating losses we decided to cut back operations in fiscal 1997 and have only one active community delivering homes in fiscal 2000. All other divisions increased home deliveries in 1999 due to the increase in the number of active selling communities. In fiscal 2000 we expect a significant home delivery increase in California. In addition, consolidated home deliveries will increase in fiscal 2000 due to a full year of operations in Texas.
Unaudited quarterly housing revenues and net sales contracts using base sales prices by market area for the years ending October 31, 1999, 1998, and 1997 are set forth below:
Quarter Ended ------------------------------------------ October July April January 31, 1999 31, 1999 30, 1999 31, 1999 --------- --------- --------- --------- (In Thousands) Housing Revenues: Northeast Region (1)....... $164,899 $142,503 $126,501 $126,683 North Carolina............. 47,251 38,269 30,553 29,080 Florida.................... 9,012 9,690 9,531 8,333 Metro D.C.................. 15,541 11,400 6,005 12,547 California................. 37,290 24,792 26,548 17,311 Texas...................... 13,184 -- -- -- Poland..................... 282 417 -- 931 --------- --------- --------- --------- Total.................. $287,459 $227,071 $199,138 $194,885 ========= ========= ========= =========
Sales Contracts (Net of Cancellations): Northeast Region (1)....... $135,514 $111,083 $114,924 $ 90,163 North Carolina............. 25,757 33,078 50,673 31,111 Florida.................... 2,532 4,471 9,050 11,530 Metro D.C.................. 12,246 14,338 16,201 11,077 California................. 36,197 37,788 24,135 17,817 Texas...................... 5,416 -- -- -- Poland..................... 698 172 -- 482 --------- --------- --------- --------- Total.................. $218,360 $200,930 $214,983 $162,180 ========= ========= ========= =========
(1) Includes $31,961,000 housing revenues and $12,922,000 sales contracts in the quarter ended October 31, 1999 from a New Jersey homebuilder acquired on August 7, 1999.
Quarter Ended ------------------------------------------ October July April January 31, 1998 31, 1998 30, 1998 31, 1998 --------- --------- --------- --------- (In Thousands) Housing Revenues: Northeast Region........... $157,882 $162,847 $136,133 $139,011 North Carolina............. 38,997 34,655 28,264 25,676 Florida.................... 11,291 8,111 15,254 9,512 Metro D.C.................. 16,687 11,256 4,843 6,118 California................. 22,980 18,832 17,613 23,121 Poland..................... 2,283 2,199 1,460 619 --------- --------- --------- --------- Total.................. $250,120 $237,900 $203,567 $204,057 ========= ========= ========= =========
Sales Contracts (Net of Cancellations): Northeast Region........... $114,144 $124,144 $188,082 $ 98,814 North Carolina............. 37,085 33,302 35,990 23,903 Florida.................... 5,385 9,503 8,631 7,802 Metro D.C.................. 11,834 15,265 9,583 3,866 California................. 21,325 25,402 9,535 18,769 Poland..................... 1,758 516 332 1,277 --------- --------- --------- --------- Total.................. $191,531 $208,132 $252,153 $154,431 ========= ========= ========= =========
Quarter Ended ------------------------------------------ October July April January 31, 1997 31, 1997 30, 1997 31, 1997 --------- --------- --------- --------- (In Thousands) Housing Revenues: Northeast Region........... $193,513 $118,186 $ 70,678 $ 63,440 North Carolina............. 41,566 35,293 26,341 22,042 Florida.................... 28,951 14,325 17,042 13,828 Metro D.C.................. 5,214 2,759 3,018 3,407 California................. 23,317 15,113 18,489 12,333 Poland..................... 1,212 1,008 667 65 --------- --------- --------- --------- Total.................. $293,773 $186,684 $136,235 $115,115 ========= ========= ========= =========
Sales Contracts (Net of Cancellations): Northeast Region........... $134,280 $124,860 $118,840 $ 92,544 North Carolina............. 29,409 30,339 35,988 31,506 Florida.................... 11,134 15,296 21,399 9,708 Metro D. C................. 5,618 3,761 5,279 2,478 California................. 24,255 22,785 22,383 16,268 Poland..................... 2,109 436 468 1,607 --------- --------- --------- --------- Total.................. $206,805 $197,477 $204,357 $154,111 ========= ========= ========= =========
Our contract backlog using base sales prices by market area is set forth below:
October October October 31, 1999 31, 1998 31, 1997 --------- --------- --------- (Dollars in Thousands) Northeast Region (1): Total Contract Backlog........$286,149 $270,753 $266,889 Number of Homes............... 1,125 1,132 1,287
North Carolina: Total Contract Backlog........$ 44,534 $ 48,713 $ 45,879 Number of Homes............... 207 235 232
Florida: Total Contract Backlog........$ 8,705 $ 14,800 $ 25,315 Number of Homes............... 37 73 150
Metro D.C.: Total Contract Backlog........$ 34,484 $ 26,083 $ 7,621 Number of Homes............... 149 115 27
California: Total Contract Backlog........$ 34,313 $ 20,721 $ 25,636 Number of Homes............... 129 119 137
Texas: Total Contract Backlog........$ 51,610 -- -- Number of Homes............... 261 -- --
Poland: Total Contract Backlog........$ 865 $ 746 $ 2,974 Number of Homes............... 13 7 39
Totals: Total Contract Backlog........$460,660 $381,816 $374,314 Number of Homes............... 1,921 1,681 1,872
Fiscal 1999 includes $38,832,000 total contract backlog and 123 number of homes from a New Jersey homebuilder acquired on August 7, 1999.
We have written down or written off certain residential inventories $2.1, $4.0 million, and $14.0 million during the years ended October 31, 1999, 1998, and 1997, respectively, to their estimated fair value. See "Notes to Consolidated Financial Statements - Note 11" for additional explanation. These writedowns and writeoffs were incurred primarily because of lower property values, a change in the marketing strategy to liquidate a particular property, or the decision not to exercise an option.
During the year ended October 31, 1999 we wrote off one residential land option including approval and engineering costs amounting to $0.3 million. We did not exercise this option because the community's proforma profitability did not produce an adequate return on investment commensurate with the risk. In addition, we wrote down one land parcel in Florida, one residential community in New York and two residential communities in North Carolina. The Florida land parcel was written down based on recent purchase offers. The communities were written down based on our decision to discontinue selling homes and offer the remaining lots for sale. The result of the above decisions was a reduction in inventory carrying amounts to fair value, resulting in a $1.8 million impairment loss in accordance with FAS 121.
During the year ended October 31, 1998, we wrote down one Florida residential community and one New Jersey parcel of land for sale. In the Florida residential community, higher discounts were being offered to speed up sales. At the New Jersey land site, lots were being contracted at prices lower than anticipated. The result of the above decisions was a reduction in inventory carrying amounts to fair value, resulting in a $1.9 million impairment loss in accordance with FAS 121. We also wrote off three New Jersey residential land options including approval, engineering and capitalized interest costs amounting to $2.1 million. We did not exercise these options because of changes in local market conditions and difficulties in obtaining government approvals.
During the year ended October 31, 1997, we wrote down certain residential communities, and wrote off certain residential land options including approval, engineering and capitalized interest costs. In Florida, our return on investment was unsatisfactory. As a result, we established a goal to reduce our investment in Florida by $25.0 million. To do so on an accelerated basis, we reduced prices and offered pricing concessions in all Florida residential communities. We also decided to sell all inactive properties in Florida. In the Northeast Region, we changed the product type to be constructed on a parcel of land we own. In an active community in the Northeast Region, we incurred unforeseen development costs. Also in the Northeast, we decided to sell an optioned property instead of developing it. The result of the above decisions was a reduction in fair values below carrying amounts and, in accordance with FAS 121, we recorded an impairment loss on the related inventories. At October 31, 1997, residential inventories were reduced $9.3 million to reduce such inventories to estimated fair value. The Northeast Region also wrote off costs associated with three optioned properties and related approval, engineering and capitalized interest costs amounting to $4.7 million. In two cases, we decided not to exercise the option due to environmental problems. The third option was not exercised because the community's proforma profitability did not produce an adequate return on investment commensurate with the risk.
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:
Year Ended --------------------------------- October October October 31, 1999 31, 1998 31, 1997 --------- --------- --------- (Dollars In Thousands)
Sale of homes.............. $908,553 $895,644 $731,807 Cost of sales.............. 718,259 740,871 617,312 --------- --------- --------- Housing gross margin....... $190,294 $154,773 $114,495 ========= ========= ========= Gross margin percentage.... 20.9% 17.3% 15.6% ========= ========= =========
Cost of sales expenses as a percentage of home sales revenues are presented below: Year Ended --------------------------------- October October October 31, 1999 31, 1998 31, 1997 --------- --------- ---------
Sale of homes.............. 100.0% 100.0% 100.0% --------- --------- --------- Cost of sales: Housing, land and development costs....... 71.0 74.8 76.0 Commissions.............. 2.0 1.9 2.0 Financing concessions.... 0.8 0.7 0.9 Overheads................ 5.3 5.3 5.5 --------- --------- --------- Total cost of sales........ 79.1 82.7 84.4 --------- --------- --------- Gross margin percentage.... 20.9% 17.3% 15.6% ========= ========= =========
We sell a variety of home types in various local communities, each yielding a different gross margin. As a result, depending on the mix of both the communities and of home types delivered, consolidated gross margin will fluctuate up or down. During the year ended October 31, 1999, our gross margin percentage increased 3.6% from the previous year. This can be attributed to higher gross margins being achieved in each of our markets. Higher gross margins are primarily attributed to positive effects from process redesign and quality programs that reduced the housing and land development costs, selective price increases or reduced selling incentives in our stronger markets, and an increased percentage of deliveries from the better performing communities. Another factor affecting the gross margin percentage is in the Northeast Region gross margin percentages are higher compared to our other markets. In 1999, the gross margin was negatively affected by a lower percentage of housing revenues from the Northeast Region amounting to 61.7% in fiscal 1999 compared to 66.5% in fiscal 1998. In fiscal 2000 we expect margins to remain the same or decrease slightly. This is primarily the result of a higher percentage of deliveries coming from outside the Northeast Region where margins are historically lower.
During the year ended October 31, 1998, gross margins increased in all our markets compared to the prior year except Florida. The reasons for the increase in 1998 are the same as above for 1999. In addition, deliveries increased in the Northeast Region to 66.5% compared to the prior year of 60.9%.
Selling and general administrative expenses as a percentage of homebuilding revenues increased to 8.8% for the year ended October 31, 1999 from 7.5% for the year ended October 31, 1998 which had decreased from 8.2% for the year ended October 31, 1997. The dollar amount of selling and general expenses has increased the last two years to $81.4 million for the year ended October 31, 1999 from $67.5 million for the year ended October 31, 1998 which increased from $62.5 million for the previous year. The overall percentage and dollar increases in such expenses in 1999 are attributable to increases in all our markets but primarily due to fewer deliveries in our Northeast Region and due to Northeast Region and California administration cost increases. The percentage decrease during the year ended October 31, 1998 was due to increased deliveries. The dollar increase in 1998 was due to increased administration and marketing costs.
Land Sales and Other Revenues
Land sales and other revenues consist primarily of land and lot sales, interest income, contract deposit forfeitures, cash discounts, national contract rebates, and corporate owned life insurance benefits.
A breakout of land and lot sales is set forth below:
Year Ended ---------------------------- October October October 31, 1999 31, 1998 31, 1997 -------- -------- -------- (In Thousands)
Land and lot sales................... $12,077 $ 8,636 $22,855 Cost of sales........................ 11,766 8,070 17,005 -------- -------- -------- Land and lot sales gross margin...... $ 311 $ 566 $ 5,850 ======== ======== ========
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 consists primarily of originating mortgages from our homebuyers, as well as from third parties, selling such mortgages in the secondary market, and title insurance activities. During the year ended October 31, 1999 and 1998 financial services provided a $1.0 and $2.1 million pretax profit, respectively, up from break even in 1997. In the market areas served by our wholly-owned mortgage banking subsidiaries, approximately 57%, 58%, and 51% of our non-cash homebuyers obtained mortgages originated by these subsidiaries during the years ended October 31, 1999, 1998, and 1997, respectively. Our mortgage banking goals are to improve profitability by increasing the capture rate of our homebuyers and expanding our business to include originations from unrelated third parties. During the years ended October 31, 1999 and 1998, third party loans amounted to 48% and 40%, respectively, of total mortgage closings. Most servicing rights on new mortgages originated by us will be sold as the loans are closed.
Investment Properties
Investment Properties consist of rental properties, property management, and gains or losses from sale of such property. See "Capital Resources and Liquidity" for information on our decision to sell our investment properties. We plan to liquidate all properties except for our senior rentals. At October 31, 1999, all properties except one small land parcel had been liquidated. During the year ended October 31, 1999 we sold three land parcels for a total sales price of $20.8 million and recorded a net loss before income taxes of $0.5 million. During the years ended October 31, 1998 and 1997, investment property revenues included a $6.5 million pretax gain and a $4.9 million pretax gain, respectively, from the sale of its commercial facilities and land. Investment properties' expenses do not include interest expense (see "Interest" below).
Collateralized Mortgage Financing
In the years prior to February 29, 1988 we pledged mortgage loans originated by our mortgage banking subsidiaries against collateralized mortgage obligations ("CMOs"). Subsequently, we discontinued our CMO program. As a result, CMO operations are diminishing as pledged loans are decreasing through principal amortization and loan payoffs, and related bonds are reduced. In recent years, as a result of bonds becoming callable, we have also sold a portion of our CMO pledged mortgages.
Corporate General and Administrative
Corporate general and administrative expenses includes 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, and administration of insurance, quality, and safety. As a percentage of total revenues, such expenses were 3.0%, 2.2%, and 1.9% for the years ended October 31, 1999, 1998, and 1997, respectively. In 1999, the increase was primarily attributed to increased expenditures for long term improvement initiatives. In 1998, the increase was primarily attributed to increased bonus accruals (there were no bonus accruals based on the Return on Equity incentive program in 1997), increased depreciation from the amortization of capitalized process redesign costs in prior years and increased expenditures for long term improvement initiatives. Our long term improvement initiatives include total quality, process redesign (net of capitalized expenses), and training. Such initiatives resulted in additional expenses for the years ended October 31, 1999, 1998, and 1997 amounting to $7.5 million, $3.8 million, and $2.2 million, respectively. Beginning in fiscal year 2000 we will be required to capitalize certain computer software development costs in accordance with SOP 98-1, "Accounting For the Costs of Computer Software Development For or Obtained For Internal Use." We have not yet determined the impact on net income in connection with the adoption of SOP 98-1.
Interest
Interest expense includes housing, land and lot, and rental properties interest. Interest expense is broken down as follows:
Year Ended ------------------------------- October October October 31, 1999 31, 1998 31, 1997 --------- --------- --------- (In Thousands)
Sale of homes.................. $28,093 $ 31,499 $ 29,505 Land and lot sales............. 1,082 652 962 Rental properties.............. 1,168 2,272 5,308 --------- --------- --------- Total.......................... $30,343 $ 34,423 $ 35,775 ========= ========= =========
Housing interest as a percentage of sale of home revenues amounted to 3.1%, 3.5%, and 4.0% for the years ended October 31, 1999, 1998, and 1997, respectively. The decrease in the percentage for the years ended October 31, 1999 and 1998 was primarily due to decreased levels of debt during the year compared to the prior year. This decrease is the result of management's goal to deleverage the Company, and debt reductions from cash generated by the liquidation of investment properties and earnings.
Other Operations
Other operations consist primarily of miscellaneous residential housing operations, amortization of senior and subordinated note issuance expenses, earnout payments from homebuilding company acquisitions and corporate owned life insurance loan interest.
Total Taxes
Total taxes as a percentage of income before income taxes amounted to 38.9% and 36.7% for the years ended October 31, 1999 and 1998, respectively. Net tax benefits as a percentage of the loss before income taxes amounted to 42.5% for the year ended October 31, 1997. 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. (See "Notes to Consolidated Financial Statements - Note 10" for an additional explanation of taxes.)
Extraordinary Loss
On June 7, 1999, we redeemed $45,449,000 of our outstanding 11 1/4% Subordinated Notes due 2002 at an average price of 101.875% of par which resulted in an extraordinary loss of $868,000 net of income taxes of $468,000.
Year 2000 Issues
We have fully implemented a plan to resolve our information technology ("IT") and non-IT system year 2000 issues. We designated a full-time year 2000 project leader, engaged consultants to review and evaluate our plan, completed the identification of our IT and non-IT noncompliant systems and evaluated subcontractors' and suppliers' state of readiness. Our plan prioritized our efforts on our software systems and computer hardware equipment. We believe we have upgraded, fixed or retired 100% of our critical noncompliant systems. All other IT and non-IT systems are not considered critical to our operations, and if noncapable for year 2000, would only be an inconvenience. The cost of implementing the plan did not have a material impact on earnings in fiscal 1999 and was funded through operations.
We are concerned about the readiness of our subcontractors and suppliers. We have communicated with 100% of these third parties. We have been informed that substantially all of the subcontractors and suppliers are year 2000 compliant. Any third parties whose lack of readiness as to year 2000 issues would have an impact on our operations are being replaced. In most cases, we use more than one subcontractor and supplier so finding replacements was not difficult.
We believe we have solved all significant year 2000 issues. We do not believe we will have material lost revenues due to the year 2000 issues. Based on the above, we did not develop a worst-case year 2000 scenario. However, we have a year 2000 contingency plan which, if necessary, is ready to implement.
Inflation
Inflation has a long-term effect on us because increasing costs of land, materials and labor result in increasing sales 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 inflationary risk faced by the housing industry generally is that rising housing 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 we sell homes, we have not found this risk to be a significant problem.
Inflation has a lesser short-term effect on us because we generally negotiate fixed price contracts with our subcontractors and material suppliers for the construction of our homes. These prices usually are applicable for a specified number of residential buildings or for a time period of between four to twelve months. Construction costs for residential buildings represent approximately 57% of our homebuilding cost of sales.
Item 7(A) - 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 FNMA, FHLMC, GNMA securities and 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 tables set forth as of October 31, 1999 and 1998, our long term debt obligations, principal cash flows by scheduled maturity, weighted average interest rates and estimated fair market value ("FMV"). There have been no significant changes in our market risk from October 31, 1998 to October 31, 1999.
Item 8
Item 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Financial statements of Hovnanian Enterprises, Inc. and its consolidated subsidiaries are set forth herein beginning on Page.
Item 9
Item 9 - CHANGES IN OR DISAGREEMENT WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
During the years ended October 31, 1999, 1998, and 1997, there have not been any changes in or disagreements with accountants on accounting and financial disclosure.
PART III
Item 10
Item 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information called for by Item l0, except as set forth below under the heading "Executive Officers of the Registrant", is incorporated herein by reference to our definitive proxy statement to be filed pursuant to Regulation l4A, in connection with the Company's annual meeting of shareholders to be held on March 16, 2000, which will involve the election of directors.
Executive Officers of the Registrant
Our executive officers are listed below and brief summaries of their business experience and certain other information with respect to them are set forth following the table. Each executive officer holds such office for a one year term.
Year Started Name Age Position With Company
Kevork S. Hovnanian 76 Chairman of the Board and l967 Director of the Company.
Ara K. Hovnanian 42 Chief Executive Officer, President 1979 and Director of the Company.
Paul W. Buchanan 49 Senior Vice President-Corporate l981 Controller and Director of the Company.
William L. Carpitella 45 Senior Vice President, Organizational Development 1997
Peter S. Reinhart 49 Senior Vice President and General 1978 Counsel and Director of the Company.
John D. Roberts 37 Vice President Process Redesign 1998
J. Larry Sorsby 44 Senior Vice President, Treasurer 1988 and Chief Financial Officer and Director of the Company
Mr. K. Hovnanian founded the predecessor of the Company in l959 (Hovnanian Brothers, Inc.) and has served as Chairman of the Board of the Company since its incorporation in l967. Mr. K. Hovnanian was also Chief Executive Officer of the Company from 1967 to July 1997.
Mr. A. Hovnanian was appointed President in April 1988, after serving as Executive Vice President from March 1983. He has also served as Chief Executive Officer since July 1997. Mr. A. Hovnanian was elected a Director of the Company in December l98l. Mr. A. Hovnanian is the son of Mr. K. Hovnanian.
Mr. Buchanan has been Senior Vice President-Corporate Controller since May l990. Mr. Buchanan was elected a Director of the Company in March l982.
Mr. Carpitella joined the Company in September 1997 as Senior Vice President, Organizational Development. Prior to joining the Company Mr. Carpitella was Vice President, Human Resources for a division of Pulte Home Corp. from April 1995 to August 1997. From February 1992 Mr. Carpitella was Vice President Human Resources for Geo. J. Ball Co.
Mr. Reinhart has been Senior Vice President and General Counsel since April 1985. Mr. Reinhart was elected a Director of the Company in December l98l.
Mr. Roberts joined the Company in January 1998 as Vice President Process Redesign. Prior to joining the Company Mr. Roberts worked for Deloitte & Touche Consulting Group ("D & T") from August 1993. At D & T Mr. Roberts was Senior Consultant until August 1994, then Manager until August 1995 and then Senior Manager until he joined the Company.
Mr. Sorsby was appointed Senior Vice President, Treasurer and Chief Financial Officer of the Company in February, 1996 after serving as Senior Vice President-Finance/Treasurer of the Company since March 1991.
Item 11
Item 11 - EXECUTIVE COMPENSATION
The information called for by Item ll is incorporated herein by reference to our definitive proxy statement to be filed pursuant to Regulation l4A, in connection with our annual meeting of shareholders to be held on March 16, 2000, which will involve the election of directors.
Item 12
Item 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information called for by Item l2 is incorporated herein by reference to our definitive proxy statement to be filed pursuant to Regulation l4A, in connection with our annual meeting of shareholders to be held on March 16, 2000, which will involve the election of directors.
Item 13
Item 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information called for by Item l3 is incorporated herein by reference to our definitive proxy statement to be filed pursuant to Regulation l4A, in connection with our annual meeting of shareholders to be held on March 16, 2000, which will involve the election of directors.
PART IV
Item 14
Item 14 - EXHIBITS, FINANCIAL STATEMENTS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
Page
Financial Statements:
Index to Consolidated Financial Statements....................... Report of Independent Auditors................................... Consolidated Balance Sheets at October 31, 1999 and 1998......... Consolidated Statements of Operations for the years ended October 31, 1999, 1998, and 1997.............................. Consolidated Statements of Stockholders' Equity for the years ended October 31, 1999, 1998, and 1997........................ Consolidated Statements of Cash Flows for the years ended October 31, 1999, 1998, and 1997.............................. Notes to Consolidated Financial Statements.......................
No schedules are applicable to us or have been omitted because the required information is included in the financial statements or notes thereto.
Exhibits:
3(a) Certificate of Incorporation of the Registrant.(1) 3(b) Certificate of Amendment of Certificate of Incorporation of the Registrant.(6) 3(c) Bylaws of the Registrant.(6) 4(a) Specimen Class A Common Stock Certificate.(6) 4(b) Specimen Class B Common Stock Certificate.(6) 4(c) Indenture dated as of May 28, 1993, relating to 9 3/4% Subordinated Notes between Registrant and First Fidelity Bank, National Association, New Jersey, as Trustee, including form of 9 3/4% Subordinated Note due 2005.(4) 4(d) Indenture dated as of May 4, 1999, relating to 9 1/8% Senior Notes between the Registrant and First Fidelity Bank, including form of 9 1/8% Senior Notes due May 1, 2009.(7) 10(a) Amended and Restated Credit Agreement dated July 29, 1998 among K. Hovnanian Enterprises, Inc., Hovnanian Enterprises, Inc., certain Subsidiaries Thereof, PNC Bank, National Association, First Union National Bank, NationsBank, National Association, First National Bank of Boston, Bank of America National Trust and Savings Association, The First National Bank of Chicago, Comerica Bank, Credit Lyonnais New York Branch and Guaranty Federal F.S.B. 10(b) Amendment to the Amended and Restated Credit Agreement (Exhibit 10(a)) dated July 13, 1999 10(c) Description of Management Bonus Arrangements.(6) 10(d) Description of Savings and Investment Retirement Plan.(1) 10(e) Stock Incentive Plan (9). 10(f) Management Agreement dated August 12, 1983 for the management of properties by K. Hovnanian Investment Properties, Inc.(1) 10(g) Agreement dated July 8, 1981 between Hovnanian Properties of Atlantic County, Inc. and Kevork S. Hovnanian.(2) 10(h) Management Agreement dated December 15, 1985, for the management of properties by K. Hovnanian Investment Properties, Inc.(3) 10(i) Description of Deferred Compensation Plan.(5) 12 Ratio of Earnings to Fixed Charges 21 Subsidiaries of the Registrant. 23 Consent of Independent Auditors 27 Financial Data Schedules (1) Incorporated by reference to Exhibits to Registration Statement (No. 2-85198) on Form S-1 of the Registrant. (2) Incorporated by reference to Exhibits to Registration Statement (No. 33-46064) on Form S-3 of the Registrant. (3) Incorporated by reference to Exhibits to Annual Report on Form 10 -K for the year ended February 28, 1986 of the Registrant. (4) Incorporated by reference to Exhibits to Registration Statement (No. 33-61778) on Form S-3 of the Registrant. (5) Incorporated by reference to Exhibits to Annual Report on Form 10- K for the year ended February 28, 1990 of the Registrant. (6) Incorporated by reference to Exhibits to Annual Report on Form 10-K for the year ended February 28, 1994 of the Registrant. (7) Incorporated by reference to Exhibits to Registration Statement (No. 333-75939) on Form S-3 of the Registrant. (8) Incorporated by reference to Exhibits to Quarterly Report on Form 10Q for the quarter ended July 31, 1999 of the Registrant. (9) Incorporated by the Proxy Statement of the Registrant Filed on Schedule 14A dated January 15, 1999.
Reports on Form 8-K
The Company did not file any reports on Form 8-K during the quarter ended October 31, 1999.
SIGNATURES
Pursuant to the requirements of Section l3 or l5(d) 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. By:
/S/KEVORK S. HOVNANIAN Kevork S. Hovnanian Chairman of the Board
Pursuant to the requirements of the Securities Exchange Act of l934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated
/S/KEVORK S. HOVNANIAN Chairman of The Board 1/13/00 Kevork S. Hovnanian and Director
/S/ARA K. HOVNANIAN Chief Executive Officer, 1/13/00 Ara K. Hovnanian President and Director
/S/PAUL W. BUCHANAN Senior Vice President 1/13/00 Paul W. Buchanan Corporate Controller and Director
/S/PETERS. REINHART Senior Vice President and 1/13/00 Peter S. Reinhart General Counsel and Director
/S/J. LARRY SORSBY Senior Vice President, 1/13/00 J. Larry Sorsby Treasurer, Chief Financial Officer and Director
/S/WILLIAM L. CARPITELLA Senior Vice President, 1/13/00 William L. Carpitella Organizational Development
HOVNANIAN ENTERPRISES, INC.
Index to Consolidated Financial Statements
Page Financial Statements:
Independent Auditors' Report...................................
Consolidated Balance Sheets as of October 31, 1999 and 1998....
Consolidated Statements of Operations for the Years Ended October 31, 1999, 1998, and 1997...............................
Consolidated Statements of Stockholders' Equity for the Years Ended October 31, 1999, 1998, and 1997.........................
Consolidated Statements of Cash Flows for the Years Ended October 31, 1999, 1998, and 1997...............................
Notes to Consolidated Financial Statements.....................
No schedules have been prepared because the required information of such schedules is not present, is not present in amounts sufficient to require submission of the schedule or because the required information is included in the financial statements and notes thereto.
REPORT OF INDEPENDENT AUDITORS
To the Stockholders and Board of Directors of Hovnanian Enterprises, Inc.
We have audited the accompanying consolidated balance sheets of Hovnanian Enterprises, Inc. and subsidiaries as of October 31, 1999 and 1998, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended October 31, 1999. These financial statements and schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Hovnanian Enterprises, Inc. and subsidiaries at October 31, 1999 and 1998 and the consolidated results of their operations and their cash flows for each of the three years in the period ended October 31, 1999 in conformity with generally accepted accounting principles.
/S/Ernst & Young LLP
New York, New York December 16, 1999
HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED OCTOBER 31, 1999, 1998, AND 1997.
BASIS OF PRESENTATION AND SEGMENT INFORMATION
Basis of Presentation - The accompanying consolidated financial statements include our accounts and all wholly-owned subsidiaries after elimination of all significant intercompany balances and transactions.
Segment Information - Statement of Financial Accounting Standards No. 131 ("FAS 131") "Disclosures About Segments of an Enterprise and Related Information" established new standards for segment reporting based on the way management organizes segments within a company for making operating decisions and assessing performance. Our financial reporting segments consist of homebuilding, financial services, collateralized mortgage financing, and corporate. Our homebuilding operations comprise the most substantial part of our business, with approximately 97% of consolidated revenues in years ended October 31, 1999, 1998, and 1997 contributed by the homebuilding operations. We are a Delaware corporation, currently building and selling homes in more than 110 new home communities in New Jersey, Pennsylvania, New York, Florida, North Carolina, Virginia, California, Texas and Poland. We offer a wide variety of homes that are designed to appeal to first time buyers, first and second time move up buyers, luxury buyers, active adult buyers and empty nesters. Our financial services operations provide mortgage banking and title services to the homebuilding operations' customers and third parties. We do not retain or service the mortgages that we originate but rather, sell the mortgages and related servicing rights to investors. Corporate primarily includes the operations of our corporate office whose primary purpose is to provide information services, human resources, management reporting, training, cash management, internal audit, risk management, and administration of process redesign, quality and safety. Assets, liabilities, revenues and expenses of our reportable segments are separately included in the consolidated balance sheets and consolidated statements of operations.
2. SIGNIFICANT ACCOUNTING POLICIES
Use of Estimates - The preparation of financial statements in conformity with generally accepted accounting principles 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.
Business Combinations - When we make an acquisition of another company, we use the purchase method of accounting in accordance with Accounting Principal Board Opinion 16 ("APB 16") "Business Combinations". Under APB 16 we record as our cost 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 identified intangible assets less liabilities is recorded as goodwill. The reported income of an acquired company includes the operations of the acquired company after acquisition, based on the acquisition costs.
Income Recognition - Income from sales is recorded when title is conveyed to the buyer, subject to the buyer's financial commitment being sufficient to provide economic substance to the transaction.
Cash and Cash Equivalents - Cash and cash equivalents include cash deposited in checking accounts, overnight repurchase agreements, certificates of deposit, Treasury bills and government money market funds with original maturities of 90 days or less when purchased.
Fair Value of Financial Instruments - The fair value of financial instruments is determined by reference to various market data and other valuation techniques as appropriate. Our financial instruments consist of cash equivalents, mortgages and notes receivable, mortgages and notes payable, and the senior and subordinated notes payable. Unless otherwise disclosed, the fair value of financial instruments approximates their recorded values.
Inventories - For inventories of communities under development, a loss is recorded when events and circumstances indicate impairment and the undiscounted future cash flows generated are less than the related carrying amounts. The impairment loss is based on expected revenue, cost to complete including interest, and selling costs. Inventories and long-lived assets held for sale are recorded at the lower of cost or fair value less selling costs. Fair value is defined in Statement of Financial Accounting Standard No. 121 "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" ("FAS 121") 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 in a community are amortized equally based upon the number of homes to be constructed in each housing community.
Interest costs related to properties in progress are capitalized during the construction period and expensed along with the associated cost of sales as the related inventories are sold (see Note 7).
The cost of land options is 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.
Property - Historically, our rental operations arose primarily from rental of commercial properties. All commercial rental property has been liquidated as of October 31, 1998. At October 31, 1999 we own two senior residential rental properties.
Intangible Assets - Any intangible assets acquired by us are amortized on a straight line basis over its useful life. Goodwill resulting from company acquisitions during the year ended October 31, 1999 is being amortized over 10 years and reported in the consolidated statements of income as "Other Operations". During the years ended October 31, 1999, 1998, and 1997, goodwill amortization amounted to $261,000, $134,000, and $134,000, respectively. The carrying amount of goodwill is reviewed if facts and circumstances suggest that it may be impaired. If this review indicates that goodwill will not be recoverable, as determined based on the estimated undiscounted cash flows of the company acquired over the remaining amortization period, the carrying amount of the goodwill is reduced by the estimated shortfall of cash flows. In addition, we assess long-lived assets for impairment under FAS 121. Under those rules, goodwill associated with assets acquired in a purchase business combination is included in impairment evaluations when events or circumstances exist that indicate the carrying amount of those assets may not be recoverable.
Post Development Completion Costs - In those instances where a development is substantially completed and sold and we have additional construction work to be incurred, an estimated liability is provided to cover the cost of such work.
Advertising Costs - Advertising costs are treated as period costs and expensed as incurred. During the years ended October 31, 1999, 1998, and 1997, advertising costs expensed amounted to $11,995,000, $10,531,000, and $12,559,000, respectively.
Deferred Income Tax - Deferred income taxes or income tax benefits are provided for temporary differences between amounts recorded for financial reporting and for income tax purposes.
Common Stock - Each share of Class A Common Stock entitles its holder to one vote per share and each share of Class B Common Stock entitles its holder to ten votes per share. The amount of any regular cash dividend payable on a share of Class A Common Stock will be an amount equal to 110% of the corresponding regular cash dividend payable on a share of Class B Common Stock. If a shareholder desires to sell shares of Class B Common Stock, such stock must be converted into shares of Class A Common Stock.
On December 10, 1998, our Board of Directors approved an increase in the stock repurchase plan to purchase up to 3 million shares. The 3 million shares equals 13.0% of our total and outstanding shares as of December 16, 1996 when the initial repurchase plan was approved by the Board. As of October 31, 1999, 2,364,400 shares have been repurchased under this program.
Depreciation - The straight-line method is used for both financial and tax reporting purposes for all assets.
Prepaid Expenses - Prepaid expenses which relate to specific housing communities (model setup, architectural fees, homeowner warranty, etc.) are amortized to costs of sales as the applicable inventories are sold. All other prepaid expenses are amortized over a specific time period or as used and charged to overhead expense.
Stock Options - Statement of Financial Accounting Standards No. 123 "Accounting for Stock-Based Compensation" establishes a fair value-based method of accounting for stock-based compensation plans, including stock options. Registrants may elect to continue accounting for stock option plans under Accounting Principles Board Opinion No. 25 ("APB 25"), "Accounting for Stock Issued to Employees," but are required to provide proforma net income and earnings per share information "as if" the new fair value approach had been adopted. We intend to continue accounting for our stock option plan under APB 25. Under APB 25, no compensation expense was recognized because the exercise price of our employee stock options equals the market price of the underlying stock on the date of grant (see Note 13).
Per Share Calculations - Statement of Financial Accounting Standards No. 128 ("FAS 128") "Earnings Per Share" requires the presentation of basic earnings per share and diluted earnings per share, and is effective for annual periods ending after December 15, 1997. We adopted FAS 128 in the year ended October 31, 1998. Basic earnings per common share is computed using the weighted average number of shares outstanding and is the same calculation as reported in prior years. Basic weighted average shares outstanding at October 31, 1999, 1998, and 1997 amounted to 21,404,473 shares, 21,781,105 shares, and 22,409,063 shares, respectively. Diluted earnings per common share has been presented for prior years and is computed using the weighted average number of shares outstanding adjusted for the incremental shares attributed to outstanding options to purchase common stock of 208,000, 235,000, and 97,000 for the years ended October 31, 1999, 1998, and 1997, respectively.
Accounting Pronouncements Not Yet Adopted - In March 1998, the AICPA issued SOP-98-1, Accounting For the Costs of Computer Software Developed For or Obtained For Internal Use. We plan to adopt the SOP on November 1, 1999. The SOP will require the capitalization of certain costs incurred after the date of adoption in connection with developing or obtaining software for internal use. We currently expense such costs as incurred. We have not yet determined the impact on net income or earnings per share in connection with the adoption of SOP 98-1.
Reclassifications - Certain amounts in the 1998 and 1997 consolidated financial statements have been reclassified to conform to the 1999 presentation.
3. CORPORATE INITIATIVES
We have embarked on long term improvement initiatives of total quality, process redesign, and training. Included in Corporate General and Administrative is $7,502,000, $3,756,000, and $2,216,000 for the years ended October 31, 1999, 1998, and 1997, respectively, related to such initiatives.
4. PROPERTY
Homebuilding property, plant, and equipment consists of land, land improvements, buildings, building improvements, furniture and equipment used to conduct day to day business. Homebuilding accumulated depreciation related to these assets at October 31, 1999 and October 31, 1998 amounted to $19,550,000 and $15,088,000, respectively. We owned and held for sale three parcels of commercial land at October 31, 1998. During the three months ended January 31, 1999 we sold the three land parcels for a total sales price of $20.8 million and recorded a loss before income taxes of $0.5 million. At October 31, 1999 all commercial facilities and land (except for one small parcel) have been liquidated. We are retaining two senior citizen residential rental communities. Accumulated depreciation on rental property at October 31, 1999 and October 31, 1998 amounted to $2,211,000 and $1,826,000, respectively.
5. ESCROW CASH
We hold escrow cash amounting to $5,578,000 and $4,775,000 at October 31, 1999 and October 31, 1998, respectively, which primarily represents customers' deposits which are restricted from use by us. We are able to release escrow cash by pledging letters of credit. At October 31, 1999 and October 31, 1998, $10,000,000 and $14,000,000 was released from escrow and letters of credit were pledged, respectively. Escrow cash accounts are substantially invested in short-term certificates of deposit or time deposits.
6. MORTGAGES AND NOTES RECEIVABLE
Our wholly-owned mortgage banking subsidiary originates mortgage loans, primarily from the sale of our homes. Such mortgage loans are sold in the secondary mortgage market, servicing released, or prior to February 28, 1987 pledged against, collateralized mortgage obligations ("CMOs"). At October 31, 1999 and October 31, 1998, respectively, $32,844,000 and $71,002,000 of such mortgages were pledged against our mortgage warehouse line (see "Notes to Consolidated Financial Statements - Note 7"). We may incur risk with respect to mortgages that are delinquent and not pledged against CMOs, but only to the extent the losses are not covered by mortgage insurance or resale value of the home. Historically, we have incurred minimal credit losses. The mortgage loans held for sale are carried at the lower of cost or market value, determined on an aggregate basis. There was no valuation adjustment at October 31, 1999.
7. MORTGAGES AND NOTES PAYABLE
Substantially all of the nonrecourse land mortgages are short-term borrowings. Nonrecourse mortgages secured by operating properties are installment obligations having annual principal maturities in the following years ending October 31, of approximately $119,000 in 2000, $132,000 in 2001, $138,000 in 2002, $2,585,000 in 2003, $74,000 in 2004 and $613,000 after 2004. The interest rates on these obligations range from 7.000% to 8.375%.
We have an unsecured Revolving Credit Agreement ("Agreement") with a group of banks which provides up to $275,000,000 through July 2002. Interest is payable monthly and at various rates of either the prime rate or LIBOR plus 1.45%. In addition, we pay a fee equal to .325% per annum on the weighted average unused portion of the line.
Interest costs incurred, expensed and capitalized were:
Year Ended ---------------------------- October October October 31, 1999 31, 1998 31, 1997 -------- -------- -------- (Dollars in Thousands) Interest incurred (1): Residential(3)................. $23,426 $26,675 $29,469 Commercial(4).................. 1,168 2,272 5,308 ------- ------- ------- Total incurred................. $24,594 $28,947 $34,777 ======= ======= ======= Interest expensed: Residential(3)................. $29,175 $32,151 $30,467 Commercial(4).................. 1,168 2,272 5,308 ------- ------- ------- Total expensed................. $30,343 $34,423 $35,775 ======= ======= ======= Interest capitalized at beginning of year.............. $25,545 $35,950 $39,152 Plus acquired entity interest.... 3,397 Plus interest incurred........... 24,594 28,947 34,777 Less interest expensed........... 30,343 34,423 35,775 Less impairment write-off........ 460 1,220 Less sale of assets.............. 1,227 4,469 984 ------- ------- ------- Interest capitalized at end of year.................... $21,966 $25,545 $35,950 ======= ======= ======= Interest capitalized at end of year: Residential(3)................. $21,516 $23,868 $29,804 Commercial(2).................. 450 1,677 6,146 ------- ------- ------- Total interest capitalized................... $21,966 $25,545 $35,950 ======= ======= =======
1) Data does not include interest incurred by our mortgage and finance subsidiaries. (2) Data does not include a reduction for depreciation. (3) Represents acquisition interest for construction, land and development costs which is charged to interest expense when land is not under active development and when homes are delivered. (4) Represents interest allocated to or incurred on long term debt for investment properties and charged to interest expense.
Average interest rates and average balances outstanding for short-term debt are as follows:
October October October 31, 1999 31, 1998 31, 1997 -------- -------- -------- (Dollars In Thousands)
Average outstanding borrowings................. $ 55,495 $ 98,090 $133,760 Average interest rate during period..................... 9.2% 8.4% 8.2% Average interest rate at end of period(1)............... 7.2% 6.9% 7.8% Maximum outstanding at any month end.................. $117,085 $125,325 $184,550
(1) Average interest rate at the end of the period excludes any charges on unused loan balances.
In addition, we have a secured mortgage loan warehouse agreement with a group of banks which provides up to $100,000,000 through June 27, 2000. Interest is payable monthly and at various rates. The interest rate at October 31, 1999 was 6.4%.
8. SENIOR AND SUBORDINATED NOTES
On April 29, 1992, we issued $100,000,000 principal amount of 11 1/4% Subordinated Notes due April 15, 2002. In October 1998, we redeemed $44,551,000 principal amount at an average price of 101.6% of par. The funds were provided by the revolving credit agreement and resulted in an extraordinary loss of $748,000 net of an income tax benefit of $403,000. In June 1999, we redeemed the remaining $45,449,000 principal amount at an average price of 101.875% of par. The funds for this redemption were provided by the issuance of Senior Notes and resulted in an extraordinary loss of $868,000 net of an income tax benefit of $468,000.
On June 7, 1993, we issued $100,000,000 principal amount of 9 3/4% Subordinated Notes due June 1, 2005. Interest is payable semi-annually. The notes are redeemable in whole or in part at our option, initially at 104.875% of their principal amount on or after June 1, 1999 and reducing to 100% of their principal amount on or after June 1, 2002.
On May 4, 1999, we issued $150,000,000 principal amount of 9 1/8% Senior Notes due May 1, 2009. Interest is payable semi-annually. The notes are redeemable in whole or in part at our option, initially at 104.563% of their principal amount on or after May 1, 2004 and reducing to 100% of their principal amount on or after May 1, 2007.
The indentures relating to the Senior and Subordinated Notes and the Revolving Credit Agreement contain restrictions on the payment of cash dividends. At October 31, 1999, $35,415,000 of retained earnings were free of such restrictions.
The fair value of both the Senior Notes and Subordinated Notes is estimated based on the quoted market prices for the same or similar issues or on the current rates offered to us for debt of the same remaining maturities. The fair value of the Senior Notes and Subordinated Notes is estimated at $143,250,000 and $94,500,000, respectively, as of October 31, 1999.
9. RETIREMENT PLAN
In December 1982, we established a defined contribution savings and investment retirement plan. Under such plan there are no prior service costs. All associates are eligible to participate in the retirement plan and employer contributions are based on a percentage of associate contributions. Plan costs charged to operations amount to $1,976,000, $1,523,000, and $1,520,000 for the years ended October 31, 1999, 1998, and 1997, respectively.
10. INCOME TAXES
Income Taxes payable (receivable) including deferred benefits, consists of the following:
October October 31, 1999 31, 1998 --------- --------- (In Thousands)
State income taxes: Current.......................... $ 437 $ 2,897 Deferred......................... (758) (1,495) Federal income taxes: Current.......................... 4,311 36 Deferred......................... (5,713) (8,769) --------- --------- Total.......................... $ (1,723) $ (7,331) ========= =========
The provision for income taxes is composed of the following charges (benefits):
Year Ended ----------------------------------- October October October 31, 1999 31, 1998 31, 1997 --------- --------- --------- (In Thousands) Current income tax expense: Federal(1)....................... $ 13,253 $ 9,177 $ (2,381) State(2)......................... 4,954 3,484 2,051 --------- --------- --------- 18,207 12,661 (330) --------- --------- --------- Deferred income tax expense: Federal.......................... 860 1,989 (4,569) State............................ 139 88 (255) --------- --------- --------- 999 2,077 (4,824) --------- --------- --------- Total.......................... $ 19,206 $ 14,738 $ (5,154) ========= ========= =========
(1) The current federal income tax expense includes a tax benefit of $468,000 and $403,000 in the years ended October 31, 1999 and 1998, respectively, relating tothe loss on the redemption of Subordinated Notes that was reported as an extraordinary item in the "Statement of Operations."
(2) The current state income tax expense is net of the use of state loss carryforwards amounting to $5,860,000, $8,495,000, and $13,439,000 for the years ended October 31, 1999, 1998, and 1997.
The deferred tax liabilities or assets have been recognized in the consolidated balance sheets due to temporary differences as follows:
October October 31, 1999 31, 1998 -------- --------- (In Thousands) Deferred tax assets: Deferred income...................... $ 40 $ 40 Maintenance guarantee reserves....... 711 701 Provision to reduce inventory to net realizable value............... -- 136 Inventory impairment loss............ 2,545 6,077 Uniform capitalization of overhead... 3,365 2,967 Post development completion costs.... 4,238 1,379 State net operating loss carryforwards...................... 29,440 27,205 Other................................ 1,378 843 -------- --------- Total.............................. 41,717 39,348 Valuation allowance(2)............... (29,440) (27,205) -------- --------- Deferred tax assets.................. 12,277 12,143 -------- --------- Deferred tax liabilities: Deferred interest.................... 31 31 Installment sales.................... 137 137 Accelerated depreciation............. 2,916 1,711 Acquisition goodwill................. 2,722 -- -------- --------- Total............................... 5,806 1,879 -------- --------- Net deferred tax assets................ $ 6,471 $ 10,264 ======== =========
(3) The net change in the valuation allowance of $2,235,000 results from an increase in the separate company state net operating losses that may not be fully utilized.
The effective tax rates varied from the expected rate. The sources of these differences were as follows: Year Ended ------------------------------ October October October 31, 1999 31, 1998 31, 1997 -------- -------- --------
Computed "expected" tax rate...... 35.0 % 35.0 % (35.0)% State income taxes, net of Federal income tax benefit.............. 6.5 % 6.0 % 11.6 % Company owned life insurance...... (.1)% (1.6)% (6.2)% Low income housing tax credit..... (2.8)% (3.4)% (11.2)% Other............................. .4 % .7 % (1.9)% -------- -------- -------- Effective tax rate................ 39.0 % 36.7 % (42.7)% ======== ======== ========
We have state net operating loss carryforwards for financial reporting and tax purposes of $359,000,000 due to expire between the years October 31, 2000 and October 31, 2014.
11. REDUCTION OF INVENTORY TO FAIR VALUE
In accordance with FAS 121, we record impairment losses on inventories related to communities under development when events and circumstances indicate that they may be impaired and the undiscounted cashflows estimated to be generated by those assets are less than their related carrying amounts. As of October 31, 1998 and 1997, inventory with a carrying amount of $3,077,000 and $33,143,000, respectively, was written down by $353,000 and $9,258,000, respectively, to its fair value. This was based on our evaluation of the expected revenue, cost to complete including interest and selling cost. The writedown during the year ended October 31, 1998 was attributed to one community in Florida where homes are being discounted to accelerate sales. The writedowns during the year ended October 31, 1997 were attributable to numerous communities in Florida after we decided to reduce our investment in that state and two communities in New Jersey resulting from a product type change and unforeseen development costs.
Also in accordance with FAS 121, we record impairment losses on inventories and long-lived assets held for sale when the related carrying amount exceeds the fair value less the selling cost. As of October 31, 1999, 1998 and 1997, inventory and commercial properties with a carrying amount of $4,539,000, $4,629,000 and $32,008,000, respectively, was written down by $1,801,000, $2,588,000 and $12,690,000, respectively, to its fair value. The writedowns during the year ended October 31, 1999 were attributed to one land parcel in Florida and two residential communities in North Carolina. The Florida land parcel was written down based on recent purchase offers. The communities were written down based on our decision to discontinue selling homes and offer the remaining lots for sale. The writedowns during the year ended October 31, 1998 were attributed to one parcel of land being sold as lots and a commercial retail center parcel of land which incurred higher land development costs, both in New Jersey. The writedowns during the year ended October 31, 1997 were attributable to four residential parcels of land in Florida, one residential parcel of land in New Jersey, one multi-use commercial parcel of land in New Jersey and two Florida commercial facilities with expansion land attached to one facility. During the year ended October 31, 1998, when these commercial facilities were liquidated, we recovered the carrying value. During the years ended October 31, 1999, 1998 and 1997, we recovered the carrying value or recognized nominal losses on the land held for sale which was subsequently liquidated.
The total aggregate impairment losses, which are presented in the consolidated statements of operations, on the inventory held for development and the land or commercial facilities held for sale were $1,801,000, $2,941,000, and $21,948,000 for the years ended October 31, 1999, 1998 and 1997, respectively.
On the statement of operations the lines entitled "Homebuilding - Inventory impairment loss" and "Investment Properties - Provision for impairment loss" also include writeoffs of options including approval, engineering and capitalized interest costs. During the year ended October 31, 1999 the writeoffs amounted to $290,000 and zero, respectively. During the year ended October 31, 1998, the writeoffs amounted to $2,091,000 and zero, respectively. During the year ended October 31, 1997, the writeoffs amounted to $4,761,000 and $1,756,000, respectively. During 1999 we did not exercise an option because the community's proforma profitability did not produce an adequate return on investment commensurate with the risk. During 1998, we did not exercise three residential options because of changes in local market conditions and difficulties in obtaining government approvals. During 1997, we decided not to exercise three residential options due to environmental problems or the property's proforma did not produce an adequate return on investment commensurate with the risk and one commercial property option because an anchor tenant with an acceptable credit rating could not be found.
12. TRANSACTIONS WITH RELATED PARTIES
Our Board of Directors has adopted a general policy providing that it will not make loans to our officers or directors or their relatives at an interest rate less than the interest rate at the date of the loan on six month U.S. Treasury Bills, that the aggregate of such loans will not exceed $3,000,000 at any one time, and that such loans will be made only with the approval of the members of our Board of Directors who have no interest in the transaction. At October 31, 1999 and 1998 included in receivables, deposits and notes are related party receivables from officers and directors amounted to $2,718,000 and $2,117,000, respectively. Interest income from these loans for October 31, 1999, 1998, and 1997 amounted to $108,000, $97,000, and $100,000, respectively.
We provide property management services to various limited partnerships including one partnership in which Mr. A. Hovnanian, our Chief Executive Officer, President and a Director, is a general partner, and members of his family and certain officers and directors are limited partners. During the years ended October 31, 1999, 1998, and 1997 we received $80,000, $67,000, and $76,000, respectively, in fees for such management services. At October 31, 1999 and 1998, no amounts were due us by these partnerships.
13. STOCK PLANS
We have a stock option plan for certain officers and key employees. Options are granted by a Committee appointed by the Board of Directors. The exercise price of all stock options must be at least equal to the fair market value of the underlying shares on the date of the grant. Options granted prior to May 14, 1998 vest in three equal installments on the first, second and third anniversaries of the date of the grant. Options granted on or after May 14, 1998 vest in four equal installments on the third, fourth, fifth and sixth anniversaries of the date of the grant. All options expire ten years after the date of the grant. In addition, during the years ended October 31, 1999 and 1997 each of the three outside directors of the Company were granted options to purchase 5,000 shares at the same price and terms as those granted to officers and key employees. Stock option transactions are summarized as follows: