UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K ( X )ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (FEE REQUIRED) For the twelve months ended OCTOBER 31, 1998 ( )TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED) 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.) 10 Highway 35, P.O. Box 500, Red Bank, N.J. 07701 (Address of principal executive offices) 732-747-7800 (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: Name of Each Exchange on Title of Each Class Which Registered - -------------------- ------------------------ Class A Common Stock, $.01 par value American Stock Exchange per share Securities registered pursuant to Section 12(g) of the Act - None Indicate by check mark whether the registrant (l) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 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. ( X )Yes ( ) No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. As of the close of business on January 7, 1999, there were outstanding 13,830,820 shares of the Registrant's Class A Common Stock and 7,688,600 shares of its Class B Common Stock. The approximate aggregate market value (based upon the closing price on the American Stock Exchange) of these shares held by non- affiliates of the Registrant as of January 7, 1999 was $71,038,000. (The value of a share of Class A Common Stock is used as the value for a share of Class B Common Stock as there is no established market for Class B Common Stock and it is convertible into Class A Common Stock on a share-for-share basis.) Documents Incorporated by Reference: Part III - Those portions of registrant's definitive proxy statement to be filed pursuant to Regulation l4A in connection with registrant's annual meeting of shareholders to be held on March 23, 1999 which are responsive to Items l0, ll, l2 and l3. HOVNANIAN ENTERPRISES, INC. FORM 10-K TABLE OF CONTENTS Item Page PART I 1 and 2 Business and Properties...................... 4 3 Legal Proceedings............................ 16 4 Submission of Matters to a Vote of Security Holders........................... 16 Executive Officers of the Registrant......... 16 PART II 5 Market for the Registrant's Common Equity and Related Stockholder Matters............ 16 6 Selected Financial Data...................... 17 7 Management's Discussion and Analysis of Financial Condition and Results of Operations................................. 19 8 Financial Statements and Supplementary Data....................................... 34 9 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure................................. 34 PART III 10 Directors and Executive Officers of the Registrant................................. 35 Executive Officers of the Registrant......... 35 11 Executive Compensation....................... 36 12 Security Ownership of Certain Beneficial Owners and Management...................... 36 13 Certain Relationships and Related Transactions............................... 36 PART IV 14 Exhibits, Financial Statement Schedules and Reports on Form 8-K....................... 37 SIGNATURES................................... 39 PART I ITEMS 1 AND 2 - BUSINESS AND PROPERTIES The Company primarily designs, constructs and markets multi-family attached condominium apartments and townhouses and single family detached homes in planned residential developments in its Northeast Region (comprised primarily of New Jersey, southern New York state, and eastern Pennsylvania), southeastern Florida, North Carolina, northern Virginia, southern California, and Poland. The Company markets its homes to first time buyers. In addition, the Company provides financial services (mortgage loans and title insurance) to its homebuilding customers and third parties. The Company also developed and held for investment income producing properties but has exited this business. The Company employed approximately 1,200 full-time associates as of October 31, 1998. The Company was incorporated in New Jersey in 1967 and was reincorporated in Delaware in 1982. RESIDENTIAL DEVELOPMENT ACTIVITIES The Company's residential development activities include evaluating and purchasing properties, master planning, obtaining governmental approvals and constructing, marketing and selling homes. A residential development generally includes a number of residential buildings containing from two to twenty-four individual homes per building and/or single family detached homes, together with amenities such as recreational buildings, swimming pools, tennis courts and open areas. By using standardized cost efficient designs and materials and by rigorous control of subcontracting costs, the Company attempts to keep costs low. The Company attempts to reduce the effect of certain risks inherent in the housing industry through the following policies and procedures: - The Company acquires land for future development principally through the use of land options which need not be exercised before the completion of the regulatory approval process. The Company structures these options in most cases with flexible takedown schedules rather than with an obligation to takedown the entire parcel upon approval. Additionally, the Company purchases improved lots in certain markets by acquiring a small number of improved lots with an option on additional lots. This allows the Company to minimize the economic costs and risks of carrying a large land inventory, while maintaining its ability to commence new developments during favorable market periods. - In an attempt to reduce its land acquisition costs, the Company monitors housing industry cycles and seeks to acquire land options near the cyclical trough of specific geographic housing cycles. - The Company generally begins construction on a residential multi-family building only after entering into contracts for the sale of at least 50% of the homes in that building. Single family detached homes are generally started after a contract is signed and mortgage approvals obtained. This limits the build-up of inventory of unsold homes and the costs of maintaining and carrying that inventory. - The Company finances all construction, land acquisition and operations through equity, non-recourse purchase money mortgages, long term debt, its unsecured revolving credit facility or cash flow. This eliminates the need of obtaining specific community construction financing, which is especially important at times when obtaining such community financing is difficult. - Through its presence in multiple geographic markets, the Company's goal is to reduce the effects that housing industry cycles, seasonality and local conditions in any one area may have on its business. In addition, the Company plans to achieve a significant market presence in each of its markets in order to obtain powers and economies of scale. - The Company looks to diversify its product line to provide housing to a broad range of customers. Currently the Company's customers primarily consist of first-time buyers, first and second time move-up buyers, move down buyers and active adult buyers. - The Company offers a wide range of customer options to satisfy individual customer tastes. In its larger communities the Company has constructed decoration centers where the customer can better see customization possibilities for their new home. The Company is also planning larger regional design centers and expects to open one in New Jersey and one in California during the next year. - Through operational excellence the Company attempts to reduce its housing construction costs. Operational excellence is further discussed under "Certain Operating Policies and Procedures" below. The Company offers a broad array of products consisting of moderately priced, multi-family attached condominium apartments and townhouses, which are marketed primarily to first time buyers, as well as moderately priced townhouses with garages and single family detached homes, which are marketed primarily to first and second time move-up buyers and to active adult buyers. The Company also offers detached single family homes and larger townhouses with garages designed for the move-up buyer and age restricted communities for active adults. Current base prices for the Company's homes in contract backlog at October 31, 1998 (exclusive of upgrades and options) range from $41,000 to $921,000 in its Northeast Region, from $157,000 to $352,000 in Florida, from $100,000 to $413,000 in North Carolina, from $140,000 to $355,000 in Virginia, from $113,000 to $307,000 in California, and from $84,000 to $94,000 in Poland. Closings generally occur and are typically reflected in revenues from two to twelve months after sales contracts are signed. Information on homes delivered by market area is set forth below: Year Ended --------------------------------- October October October 31, 1998 31, 1997 31, 1996 --------- -------- -------- (Housing Revenue in Thousands) Northeast Region: Housing Revenues........ $595,873 $445,817 $460,931 Homes Delivered......... 2,530 2,128 2,364 Average Price........... $235,522 $209,500 $194,979 North Carolina: Housing Revenues........ $127,592 $125,242 $123,347 Homes Delivered......... 687 695 738 Average Price........... $185,723 $180,204 $167,137 Florida: Housing Revenues........ $ 44,168 $ 74,146 $ 99,085 Homes Delivered......... 241 418 632 Average Price........... $183,269 $177,382 $156,780 Virginia: Housing Revenues........ $ 38,904 $ 14,398 $ 16,749 Homes Delivered......... 152 70 75 Average Price........... $255,947 $205,685 $223,320 California: Housing Revenues........ $ 82,546 $ 69,252 $ 64,570 Homes Delivered......... 457 365 325 Average Price........... $180,625 $189,731 $198,677 Poland: Housing Revenues........ $ 6,561 $ 2,952 -- Homes Delivered......... 71 41 -- Average Price........... $ 92,408 $ 72,000 -- Combined Total: Housing Revenues........ $895,644 $731,807 $764,682 Homes Delivered......... 4,138 3,717 4,134 Average Price........... $216,443 $196,881 $184,974 Information on homes delivered by product type is set forth below: Year Ended ----------------------------- October October October 31, 1998 31, 1997 31, 1996 -------- -------- -------- (Housing Revenues in Thousands) First Time Buyer Product(1) Housing Revenues............. $ 34,987 $ 52,589 $ 77,682 Homes Delivered.............. 279 407 619 Percentage of Housing Revenues.................... 4% 7% 10% Move-Up Buyer Product(2) Housing Revenues............. $860,657 $679,218 $687,000 Homes Delivered.............. 3,859 3,310 3,515 Percentage of Housing Revenues.................... 96% 93% 90% (1) First time buyer product consists of all of the Company's multi-family attached home products other than townhouses with garages. (2) Move-up buyer product consists of single family detached homes and townhouses with garages. The Company's net sales contracts increased to $806,247,000 for the year ended October 31, 1998 from $762,750,000 for the year ended October 31, 1997 or 5.7%, and was the net result of a 4.8% decrease in the number of homes contracted to 3,877 in 1998 from 4,073 in 1997 and a 11.0% increase in the average home base sales prices. On a market area and dollar basis, Virginia achieved the highest increase of 136.6%, followed by the Northeast Region with an 11.6% increase and North Carolina with a 2.4% increase. The large increase in Virginia was the result of an acquisition of a small Virginia developer on May 1, 1998. Net sales contracts decreased in California, Florida and Poland. In California and Poland, contracts decreased due to fewer homes available for sale. Florida's decrease was due to the downsizing of the division. During the year ended October 31, 1998 the Company has written down one Florida residential community and one New Jersey parcel of land for sale. In the Florida community, higher discounts are being offered to speed up sales. At the New Jersey land site, lots are 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. The Company has also written off three New Jersey residential land options including approval, engineering and capitalized interest costs amounting to $2.1 million. The Company did not exercise these options because of changes in local market conditions and difficulties in obtaining government approvals. Total writedowns and write-offs of residential inventories are presented on the consolidated statement of income as "Inventory impairment loss." See "Notes to Consolidated Financial Statements - Note 10" for additional explanation. As of October 31, 1998, the following table summarizes the Company's active communities under development: (1) (2) Contracted Remaining Commun- Approved Homes Not Home Sites ities Lots Delivered Delivered Available ------- -------- --------- --------- ---------- Northeast Region...... 31 10,111 3,818 1,126 5,167 North Carolina........ 32 3,740 1,285 232 2,223 Florida............... 4 970 622 73 275 Virginia.............. 11 1,033 250 115 668 California............ 6 1,036 466 119 451 Poland................ - 130 112 7 11 ------- -------- --------- --------- ---------- Total 84 17,020 6,553 1,672 8,795 ======= ======== ========= ========= ========== (1) Includes 8 lots under option. (2) Of the total home sites available, 460 were under construction or completed (including 54 models and sales offices), 4,570 were under option, and 330 were financed through purchase money mortgages. In addition, in substantially completed or suspended developments, the Company had 11 homes under construction or completed including 8 homes which are under contract. The Company also had 281 lots without construction (1 under contract) in these substantially completed or suspended developments. As of October 31, 1998, the following table summarizes the Company's total started or completed unsold homes: Unsold Homes Models Total ------ ------ ----- Northeast Region.................. 180 16 196 North Carolina.................... 93 - 93 Florida........................... 24 6 30 Virginia.......................... 23 11 34 California........................ 78 21 99 Poland............................ 11 - 11 ------ ------ ----- Total 409 54 463 ====== ====== ===== BACKLOG Sales of the Company's United States residential homes typically are made pursuant to a standard sales contract. This contract requires a nominal customer deposit at the time of signing with the remainder of a 5% to 10% down payment due 30 to 60 days after signing and provides the customer with a statutorily mandated right of rescission for a period ranging up to 15 days after execution. The contract may include a financing contingency, which permits the customer to cancel his obligation in the event mortgage financing at prevailing interest rates (including financing arranged or provided by the Company) is unobtainable within the period specified in the contract. This contingency period typically is four to eight weeks following the date of execution. At October 31, 1998 and October 31, 1997, the Company had a backlog of signed contracts for 1,681 homes and 1,872 homes, respectively, with sales values aggregating $381,816,000 and $374,314,000, respectively. Substantially all of the Company's backlog at October 31, 1998 is expected to be completed and closed within the next twelve months. At December 31, 1998 and 1997, the Company's backlog of signed contracts was 1,584 homes and 1,779 homes, respectively, with sales values aggregating $359,213,000 and $360,969,000, respectively. RESIDENTIAL LAND INVENTORY It is the Company's objective to control a supply of land, primarily through options, consistent with anticipated homebuilding requirements in its housing markets. Controlled land as of October 31, 1998, exclusive of communities under development described under "Business and Properties -- Residential Development Activities," is summarized in the following table: Number of Proposed Total Land Proposed Developable Option Book Communities Lots Price Value(1)(2) ----------- ----------- ----------- ----------- (In Thousands) Northeast Region: Under Option........ 23 6,217 $ 127,469 $ 16,288 Owned............... 3 359 14,593 -------- ----------- ----------- Total............ 26 6,576 30,881 -------- ----------- ----------- North Carolina: Under Option........ 8 651 $ 11,610 268 Owned............... 1 82 1,058 -------- ----------- ----------- Total............ 9 733 1,326 -------- ----------- ----------- Florida: Owned............... 3 1,033 3,923 -------- ----------- ----------- California: Under Option........ 14 2,136 $ 63,384 6,028 -------- ----------- ----------- Poland: Owned............... 1 485 1,350 -------- ----------- ----------- Totals: Under Option........ 45 9,004 22,584 Owned............... 8 1,959 20,924 -------- ----------- ----------- Combined Total........ 53 10,963 $ 43,508 ======== =========== =========== (1) Properties under option also includes costs incurred on properties not under option but which are under investigation. For properties under option, the Company paid, as of October 31, 1998, option fees and deposits aggregating approximately $11,085,000. As of October 31, 1998, the Company spent an additional $11,499,000 in non-refundable predevelopment costs on such properties. (2) The book value of $43,508,000 is identified on the balance sheet as "Inventories - land, land options, and cost of projects in planning." In its Northeast Region, the Company's objective is to control a supply of land sufficient to meet anticipated building requirements for at least three to five years. In North Carolina and Virginia, some land historically has been acquired from land developers on a lot takedown basis. Under a typical agreement with the lot developer, the Company purchases a minimal number of lots. The balance of the lots to be purchased are covered under an option agreement or a non- recourse purchase agreement. Due to the dwindling supply of improved lots in North Carolina and Virginia, the Company is currently optioning parcels of unimproved land for development. In Florida, the Company is focusing its development efforts primarily in the southeast. Emphasis is principally on building single family detached homes. As a result of its decision to downsize, the Company is attempting to sell all its land in other locations, including the parcels of owned land included in the table on the previous page. In California, the Company has focused its development efforts in the southern region. Here the emphasis is on affordable housing and will consist of single family attached and detached homes. Where possible, the Company plans to option developed or partially developed lots with no more than fifty to seventy- five lots to be taken down during any twelve month period. With a dwindling supplyin California of developed lots, some land parcels will be optioned which will require the full range of development activities. Option fees range up to 10% of the land value. CUSTOMER FINANCING At the Company's communities, on-site personnel facilitate sales by offering to arrange financing for prospective customers through K. Hovnanian Mortgage, Inc. ("KHM"). Management believes that the ability to offer financing to customers on competitive terms as a part of the sales process is an important factor in completing sales. KHM's business consists of providing the Company's customers as well as unrelated third parties with competitive financing and coordinating and expediting the loan origination transaction through the steps of loan application, loan approval and closing. KHM has its headquarters in Red Bank, New Jersey. It originates loans in New Jersey, New York, Pennsylvania, North Carolina, Florida, California, South Carolina and Illinois. KHM's principal sources of revenues are: (i) net gains from the sale of loans; (ii) revenues from the sale of the rights to service loans; and (iii) interest income earned on mortgage loans during the period they are held by KHM prior to their sale to investors. KHM is approved by the Government National Mortgage Association ("GNMA") as a seller-servicer of Federal Housing Administration ("FHA") and Veterans Administration ("VA") loans. A portion of the conventional loans originated by KHM (i.e., loans other than those insured by FHA or guaranteed by VA) qualify for inclusion in loan guarantee programs sponsored by the Federal National Mortgage Association ("FNMA") or the Federal Home Loan Mortgage Corporation ("FHLMC"). KHM also originates conventional loans which are sold to a number of private investors. KHM arranges for fixed and adjustable rate, conventional, privately insured mortgages, FHA-insured or VA-guaranteed mortgages, and mortgages funded by revenue bond programs of states and municipalities. KHM is a delegated underwriter under the FHA Direct Endorsement and VA Automatic programs in accordance with criteria established by such agencies. Additionally, KHM has delegated underwriting authority from FNMA and FHLMC. As a delegated underwriter, KHM may underwrite and close mortgage loans under programs sponsored by these agencies without their prior approval, which expedites the loan origination process. KHM, like other mortgage bankers, customarily sells nearly all of the loans that it originates. Additionally, KHM sells virtually all of the loan servicing rights to loans it originates. Loans are sold either individually or in pools to GNMA, FNMA, or FHLMC or against forward commitments to institutional investors, including banks and savings and loan associations. KHM plans to grow its mortgage banking operations. Initially, KHM focused on originating loans from customers who purchase homes from Hovnanian Enterprises, Inc. affiliates. KHM's objective is to increase the capture rate of non-cash homebuyers from the 58% rate achieved in fiscal 1998 to 70% over the next several years. KHM has now expanded to offer its mortgage products and services to unrelated third parties. During the year ended October 31, 1998, third party loans amounted to 40% of total mortgage closings. RENTAL PROPERTY DEVELOPMENT ACTIVITIES AND LAND INVENTORY The Company had previously diversified its business, on a limited scale, through the development, acquisition and ownership of commercial properties, primarily in central New Jersey, and, to a lesser extent, in Florida, but has exited this business (see "Item 7 - Management's Dicsussion and Analysis of Financial Condition and Results of Operations"). CERTAIN OPERATING POLICIES AND PROCEDURES Financial Goals. The Company has been focusing on housing margin improvement and de-emphasizing revenue growth. Housing margins had declined from 18.0% for the year ended February 28, 1994 to 15.6% for the year ended October 31, 1997. To improve its housing margin, the Company is focusing on increasing associate productivity, reducing overheads and reducing construction costs by decreasing construction cycle times, designing and building cost efficient products, and using national and regional contracts. Also the Company has consolidated its vendor base and centralized purchasing functions in the Northeast Region. As a result of the combination of these efforts, the Company's housing margin increased to 17.3% for the year ended October 31, 1998. Strategic Initiatives. In order to help improve housing margins the Company previously introduced three strategic initiatives. These initiatives are Partners In Excellence, Process Redesign, and Training. Partners In Excellence (the Company's total quality management initiative) is intended to focus on improving the way operations are performed. It involves all Company associates through a systematic, team-oriented approach to improvement. It increases the Company's profits by streamlining processes and by reducing errors which cost money. The Company was recognized for its efforts by receiving the 1997 gold National Housing Quality Award from Professional Builder and The NAHB Research Center. Process Redesign is a fundamental rethinking and radical redesign of our processes to achieve dramatic improvements in performance. The Company's Process Redesign efforts are currently focused on streamlining and standardizing all of its key business processes. In addition, the Company is working to implement a new enterprise wide "Enterprise Resource Package" computer software system. Training is designed to provide our associates with the knowledge, attitudes, skill and habits necessary to succeed at their jobs. The Company's Training Department regularly conducts training classes in sales, construction, administrative, and managerial areas. In addition, as Process Redesign develops new processes, the Training Department is responsible for educating the Company's associates on the processes, procedures, and operations. Land Acquisition, Planning and Development. Before entering into a contract to acquire land, the Company completes extensive comparative studies and analyses which assist the Company in evaluating the economic feasibility of such land acquisition. The Company generally follows a policy of acquiring options to purchase land for future community developments. The Company attempts to acquire land with a minimum cash investment and negotiate takedown options, thereby limiting the financial exposure to the amounts invested in property and predevelopment costs. This policy of land acquisition may somewhat raise the price of land that the Company acquires, but significantly reduces risk. Further, this policy generally allows the Company to obtain necessary development approvals before acquisition of the land, thereby enhancing the value of the options and the land eventually acquired. The Company's option and purchase agreements are typically subject to numerous conditions, including, but not limited to, the Company's ability to obtain necessary governmental approvals for the proposed community. Generally, the deposit on the agreement will be returned to the Company if all approvals are not obtained, although predevelopment costs may not be recoverable. By paying an additional, nonrefundable deposit, the Company has the right to extend a significant number of its options for varying periods of time. In all instances, the Company has the right to cancel any of its land option agreements by forfeiture of the Company's deposit on the agreement. In such instances, the Company generally is not able to recover any predevelopment costs. The Company's development activities include site planning and engineering, obtaining environmental and other regulatory approvals and constructing roads, sewer, water and drainage facilities, and for the Company's residential developments, recreational facilities and other amenities. These activities are performed by the Company's staff, together with independent architects, consultants and contractors. The Company's staff also carries out long-term planning of communities. Design. The Company's residential communities are generally located in suburban areas near major highways. The communities are designed as neighborhoods that fit existing land characteristics. The Company strives to create diversity within the overall planned community by offering a mix of homes with differing architecture, textures and colors. Wherever possible, recreational amenities such as a swimming pool, tennis courts and tot lots are included. Construction. The Company designs and supervises the development and building of its communities. Its homes are constructed according to standardized prototypes which are designed and engineered to provide innovative product design while attempting to minimize costs of construction. The Company employs subcontractors for the installation of site improvements and construction of homes. Agreements with subcontractors are generally short term and provide for a fixed price for labor and materials. The Company rigorously controls costs through the use of a computerized monitoring system. Because of the risks involved in speculative building, the Company's general policy is to construct a residential multi-family building only after signing contracts for the sale of at least 50% of the homes in that building. Single family detached homes are usually constructed after the signing of a contract and mortgage approval has been obtained. Materials and Subcontractors. The Company attempts to maintain efficient operations by utilizing standardized materials available from a variety of sources. In addition, the Company contracts with subcontractors representing all building trades in connection with the construction of its homes. In recent years, the Company has experienced no significant construction delays due to shortages of materials or labor. The Company cannot predict, however, the extent to which shortages in necessary materials or labor may occur in the future. Marketing and Sales. The Company's residential communities are sold principally through on-site sales offices. In order to respond to its customers' needs and trends in housing design, the Company relies upon its internal market research group to analyze information gathered from, among other sources, buyer profiles, exit interviews at model sites, focus groups and demographic data bases. The Company makes use of newspaper, radio, magazine, its website, billboard, video and direct mail advertising, special promotional events, illustrated brochures, full-sized and scale model homes in its comprehensive marketing program. For the year ended October 31, 1998, the Company's advertising expenditures totaled $10,531,000. Customer Service and Quality Control. The Company's associates responsible for customer service participate in pre-closing quality control inspection as well as responding to post-closing customer needs. Prior to closing, each home is inspected and any necessary completion work is undertaken by the Company. In some of its markets the Company is also enrolled in a standard limited warranty program which, in general, provides a homebuyer with a one-year warranty for the home's materials and workmanship, a two-year warranty for the home's heating, cooling, ventilating, electrical and plumbing systems and a ten-year warranty for major structural defects. All of the warranties contain standard exceptions, including, but not limited to, damage caused by the customer. Customer Financing. The Company sells its homes to customers who generally finance their purchases through mortgages. During the year ended October 31, 1998, approximately 58% of the Company's non-cash customers obtained mortgages originated by the Company's wholly-owned mortgage banking subsidiary, with a substantial portion of the Company's remaining customers obtaining mortgages from various independent lending institutions. Mortgages originated by the Company's wholly-owned mortgage banking subsidiary are sold in the secondary market. Financing arrangements with independent lending institutions are at prevailing rates and on terms in accordance with the lending institutions policies. Mortgages offered by the Company's subsidiary are on terms similar to those offered by independent lending institutions. There are no assurances that mortgage financing will remain readily available to the Company's customers at affordable rates. COMPETITION The Company's residential business is highly competitive. The Company competes in each of the geographic areas in which it operates with numerous real estate developers, ranging from small local builders to larger regional and national builders and developers, some of which have greater sales and financial resources than the Company. Resales of housing and the availability of rental housing provide additional competition. The Company competes primarily on the basis of reputation, price, location, design, quality, service and amenities. REGULATION AND ENVIRONMENTAL MATTERS General. The Company is subject to various local, state and federal statutes, ordinances, rules and regulations concerning zoning, building design, construction and similar matters, including local regulations which impose restrictive zoning and density requirements in order to limit the number of homes that can eventually be built within the boundaries of a particular locality. In addition, the Company is subject to registration and filing requirements in connection with the construction, advertisement and sale of its communities in certain states and localities in which it operates even if all necessary government approvals have been obtained. The Company may also be subject to periodic delays or may be precluded entirely from developing communities due to building moratoriums that could be implemented in the future in the states in which it operates. Generally, such moratoriums relate to insufficient water or sewerage facilities or inadequate road capacity. Environmental. The Company is also subject to a variety of local, state and federal statutes, ordinances, rules and regulations concerningprotection of health and the environment ("environmental laws"). The particular environmental laws which apply to any given community vary greatly according to the community site, the site's environmental conditions and the present and former uses of the site. These environmental laws may result in delays, may cause the Company to incur substantial compliance and other costs, and prohibit or severely restrict development in certain environmentally sensitive regions or areas. The Florida Growth Management Act of 1985 became fully effective in Palm Beach County on February 1, 1990. The act requires that infrastructure, including roads, sewer and water lines must be in existence concurrently with the construction of the development. If such infrastructure is not concurrently available, then the community cannot be developed. This will have an effect on limiting the amount of land available for development and may delay approvals of some developments. Fair Housing Act. In July 1985, New Jersey adopted the Fair Housing Act which established an administrative agency to adopt criteria by which municipalities will determine and provide for their fair share of low and moderate income housing. This agency adopted such criteria in May 1986. Its implementation thus far has caused some delay in approvals for some of the Company's New Jersey communities and may result in a reduction in the number of homes planned for some properties. Both prior to the enactment of the Fair Housing Act and in its implementation thus far, municipal approvals in some of the New Jersey municipalities in which the Company owns land or land options required the Company to set aside up to 22% of the approved homes for sale at prices affordable to persons of low and moderate income. In order to comply with such requirements, the Company must sell these homes at a loss. The Company attempts to reduce some of these losses through increased density, certain cost saving construction measures and reduced land prices from the sellers of property. Such losses are absorbed by the market priced homes in the same developments. State Planning Act. Pursuant to the 1985 State Planning Act, the New Jersey State Planning Commission has adopted a State Development and Redevelopment Plan ("State Plan"). The State Plan, if fully implemented, would designate large portions of the state as unavailable for development or as available for development only at low densities, and other portions of the state for more intense development. State government agencies would be required to make permitting decisions in accordance with the State Plan, if it is fully implemented. The state government agencies have not yet adopted policies and regulations to fully implement the State Plan. However, at least one state agency has issued an Executive Order requiring compliance with the State Plan. It is unclear what effect this Executive Order may have on the Company's ability to develop its lands. Conclusion. Despite the Company's past ability to obtain necessary permits and approvals for its communities, it can be anticipated that increasingly stringent requirements will be imposed on developers and homebuilders in the future. Although the Company cannot predict the effect of these requirements, they could result in time-consuming and expensive compliance programs and substantial expenditures for pollution and water quality control, which could have a material adverse effect on the Company. In addition, the continued effectiveness of permits already granted or approvals already obtained is dependent upon many factors, some of which are beyond the Company's control, such as changes in policies, rules and regulations and their interpretation and application. Company Offices. The Company owns its corporate headquarters, a four- story, 24,000 square feet office building located in Red Bank, New Jersey, a 17,450 square feet office building located in Winston-Salem, North Carolina, and 17,255 square feet in a Middletown, New Jersey condominium office building. The Company leases office space consisting of 63,691 square feet in various New Jersey locations, 3,300 square feet in Woodbridge, Virginia, 18,456 square feet in various North Carolina locations, 15,900 square feet in West Palm Beach, Florida, and 10,520 square feet in southern California. ITEM 3 - LEGAL PROCEEDINGS The Company is 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 the Company. ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS During the fourth quarter of the year ended October 31, 1998 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 - 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. The Company's Class A Common Stock is traded on the American Stock Exchange and was held by approximately 800 shareholders of record at January 7, 1999. There is no established public trading market for the Company's Class B Common Stock,which was held by approximately 670 shareholders of record at January 7, 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 the Company's Class A Common Stock were as follows for each fiscal quarter during the years ended October 31, 1998, 1997, and 1996: Class A Common Stock ------------------------------------------------ Oct. 31, 1998 Oct. 31, 1997 Oct. 31, 1996 -------------- -------------- -------------- Quarter High Low High Low High Low - ------- ------ ------ ------ ------ ------ ------ First........ $ 9.25 $ 6.50 $7.63 $5.63 $7.75 $6.25 Second....... $11.50 $ 8.56 $7.00 $6.25 $8.25 $6.25 Third........ $11.19 $ 8.50 $7.13 $5.69 $7.25 $5.06 Fourth....... $ 9.88 $ 6.00 $8.13 $6.75 $6.63 $5.50 Certain debt instruments to which the Company is a party contain restrictions on the payment of cash dividends. As a result of the most restrictive of these provisions, approximately $42,995,000 was free of such restrictions at October 31, 1998. The Company has never paid dividends nor does it currently intend to pay dividends. ITEM 6 - SELECTED CONSOLIDATED FINANCIAL DATA The following table sets forth selected financial data for the Company and its consolidated subsidiaries 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. <TABLE> <CAPTION> Eight Year Year Ended Months Ended -------------------------------------- Ende --------- Summary Consolidated October October October October October February Income Statement Data 31, 1998 31, 1997 31, 1996 31, 1995 31, 1994 28, 1994 - ------------------------------- -------- -------- -------- -------- -------- -------- (In Thousands Except Per Share Data) <S> <C> <C> <C> <C> <C> <C> Revenues....................... $941,947 $784,136 $807,464 $777,745 $386,585 $587,010 Expenses....................... 900,655 796,260 782,458 756,091 402,090 557,859 -------- -------- -------- -------- -------- -------- Income(loss) before income taxes and extraordinary loss. 41,292 (12,124) 25,006 21,654 (15,505) 29,151 State and Federal income taxes. 15,141 (5,154) 7,719 7,526 (5,075) 9,229 Extraordinary loss............. (748) -- -- -- -- (1,277) -------- -------- -------- -------- -------- -------- Net income (loss).............. $ 25,403 $ (6,970) $ 17,287 $ 14,128 $(10,430) $ 18,645 ======== ======== ======== ======== ======== ======== Per Share Data: Basic:: Income (loss) before extraordinary loss......... $ 1.20 $ (0.31) $ 0.75 $ 0.61 $ (0.46) $ 0.87 Extraordinary loss........... (0.03) -- -- -- -- (0.05) -------- -------- -------- -------- -------- -------- Net income (loss)............ $ 1.17 $ (0.31) $ 0.75 $ 0.61 $ (0.46) $ 0.82 ======== ======== ======== ======== ======== ======== Weighted average number of common shares outstanding.. 21,781 22,615 23,037 23,032 22,906 22,821 Assuming Dilution: Income (loss) before extraordinary loss......... $ 1.19 $ (0.31) $ 0.75 $ 0.61 $ (0.45) $ 0.86 Extraordinary loss........... (0.03) (0.05) -------- -------- -------- -------- -------- -------- Net income (loss)............ $ 1.16 $ (0.31) $ 0.75 $ 0.61 $ (0.45) $ 0.81 ======== ======== ======== ======== ======== ======== Weighted average number of common shares outstanding.. 22,016 22,712 23,120 23,079 23,061 23,072 Summary Consolidated October October October October October February Balance Sheet Data 31, 1998 31, 1997 31, 1996 31, 1995 31, 1994 28, 1994 - ------------------------------- -------- -------- -------- -------- -------- -------- Total assets................... $589,102 $637,082 $614,111 $645,378 $612,925 $539,602 Mortgages and notes payable.... $150,282 $184,519 $145,336 $183,044 $167,179 $ 68,244 Bonds collateralized by mortgages receivable......... $ 5,652 $ 7,855 $ 9,231 $ 17,880 $ 20,815 $ 30,343 Participating senior subordinated debentures and subordinated notes....... $145,449 $190,000 $200,000 $200,000 $200,000 $200,000 Stockholders' equity........... $201,392 $178,762 $193,622 $176,335 $162,130 $171,001 </TABLE> 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 subisidiaries, adjusted to a pretax basis), less interest capitallized, less preferred share dividend requirements of subsidiaries adjusted to a pretax basis and less undistributed earnings of affiliates whose debt is not guaranteed by the Company. The following table sets forth the ratios of earnings to fixed charges and earnings to combined fixed charges and preferred dividends for the Company for the periods indicated: <TABLE> <CAPTION> Eight Months Years Ended October 31, Ended -------------------------------------- October 31 February 28, 1998 1997 1996 1995 1994 1994 -------- -------- -------- -------- ---------- ------------ <S> <C> <C> <C> <C> <C> <C> Ratio of earnings to fixed charges............. 2.6 (a) 1.6 1.4 (b) 1.8 Ratio of earnings to combined fixed charges and preferred stock dividends................. 2.6 (a) 1.6 1.4 (b) 1.8 (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. (b) No ratio is presented for the eight months ended Octber 31, 1994 as the earnings for such period were insufficient to cover fixed charges by $18,803,000. </TABLE> ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS CAPITAL RESOURCES AND LIQUIDITY The Company's cash uses during the twelve months ended October 31, 1998 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 net reduction of the revolving credit line. The Company provided for its cash requirements from housing and land sales, the revolving credit facility, the sale of commercial facilities, financial service fees, and other revenues. The Company believes that these sources of cash are sufficient to finance its working capital requirements and other needs. 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, 1998, 1,591,500 shares were repurchased under this program of which 407,100 were repurchased during the year ended October 31, 1998. The Company's 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 $280,000,000 through July 2001. Interest is payable monthly and at various rates of either the prime rate or Libor plus 1.45%. The Company believes that it will be able either to extend the Agreement beyond July 2001 or negotiate a replacement facility, but there can be no assurance of such extension or replacement facility. The Company currently is in compliance and intends to maintain compliance with its covenants under the Agreement. As of October 31, 1998, borrowings under the Agreement were $68,000,000. The aggregate principal amount of subordinated indebtedness issued by the Company and outstanding as of October 31, 1998 was $145,449,000. During the year ended October 31, 1998, the Company reduced its subordinated debt by $44,551,000. See "Results of Operations - Extraordinary Loss." Payments of $45,449,000 and $100,000,000 are due in April 2002 and June 2005, respectively. The Company's mortgage banking subsidiary borrows under a bank warehousing arrangement. 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 the Company's subsidiaries. As of October 31, 1998, the aggregate outstanding principal amount of such borrowings was $72,318,000. The book value of the Company's inventories, rental condominiums, and commercial properties completed and under development amounted to the following: October 31, October 31, 1998 1997 ------------ ------------ Residential real estate inventory....... $375,733,000 $410,393,000 Senior residential rental property...... 10,794,000 11,412,000 ------------ ------------ Total residential real estate....... 386,527,000 421,805,000 Commercial properties................... 17,832,000 38,946,000 ------------ ------------ Combined Total...................... $404,359,000 $460,751,000 ============ ============ Total residential real estate decreased $35,278,000 from October 31, 1997 to October 31, 1998 as a result of an inventory decrease of $34,660,000 and depreciation of senior residential rental property. The decrease in residential real estate inventory was primarily due to decreases in the Company's Northeast Region where fewer deliveries are planned for the first quarter of fiscal year 1999 compared to the same period in fiscal 1998. Residential homes under construction or completed and included in residential real estate inventory at October 31, 1998 are expected to be closed during the next twelve months. Most residential real estate, completed or under development, is financed through the Company's line of credit and subordinated indebtedness. The following table summarizes housing lots included in the Company's total residential real estate: Total Contracted Remaining Home Not Lots Lots Delivered Available -------- ---------- --------- October 31, 1998: Owned.......................... 8,054 1,673 6,381 Optioned....................... 13,668 8 13,660 -------- ---------- --------- Total........................ 21,722 1,681 20,041 ======== ========== ========= October 31, 1997: Owned.......................... 8,266 1,848 6,418 Optioned....................... 12,159 24 12,135 -------- ---------- --------- Total........................ 20,425 1,872 18,553 ======== ========== ========= The following table summarizes the Company's started or completed unsold homes in active, substantially completed and suspended communities: October 31, October 31, 1998 1997 -------------------------- ------------------------- Unsold Unsold Homes Models Total Homes Models Total ------ ------ ------ ------ ------ ------ Northeast Region.... 180 16 196 279 63 342 North Carolina...... 93 -- 93 83 -- 83 Florida............. 24 6 30 47 11 58 Virginia............ 23 11 34 16 10 26 California.......... 78 21 99 60 16 76 Poland.............. 11 -- 11 10 2 12 ------ ------ ------ ------ ------ ------ Total 409 54 463 495 102 597 ====== ====== ====== ====== ====== ====== Prior to the second quarter of fiscal 1997, the Company's 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, the Company announced it was planning an orderly exit from the business of owning investment properties. During fiscal 1998, the Company sold all its remaining commercial facilities which had a book value of $23,920,000 and outstanding loan balances of $19,241,000 as of October 31, 1997. In addition, a 50% owned partnership sold its retail center. The Company has various parcels of land approved for commercial development. The Company has contracts on all such parcels and expects to close substantially all such land sales in the first quarter of 1999. 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 $71,002,000 and $47,660,000 at October 31, 1998 and October 31, 1997, respectively, are being temporarily warehoused and awaiting sale in the secondary mortgage market. The balance of mortgage loans held for sale is being held as an investment by the Company. The Company 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, the Company has incurred minimal credit losses. RESULTS OF OPERATIONS The Company's operations consist primarily of residential housing development and sales in its Northeast Region (comprised primarily of New Jersey, southern New York state, and eastern Pennsylvania), in southeastern Florida, North Carolina, northern Virginia, southern California, and Poland. In addition, the Company had developed and operated commercial properties as long- term investments in New Jersey, and, to a lesser extent, Florida, but has exited this business (see "Investment Properties" below). During the years ended October 31, 1998, 1997, and 1996, the Company's Northeast Region and North Carolina Division housing operations consistently produced operating profits. The Company's California housing operations produced profits in 1998 and 1997. In 1998, financial services and the sale of commercial properties also contributed profits to the Company. These profits have been reduced by net losses from its other housing divisions, 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 10". Historically, the Company's 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%. The Company's management has 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 ---------- ---------- ---------- ---------- ---------- 1998........... 24% 23% 26% 27% 100% 1997........... 16% 19% 25% 40% 100% 1996........... 14% 18% 25% 43% 100% Total Revenues Compared to the same prior period, revenues increased (decreased) as follows: Year Ended ----------------------------- October October October 31, 1998 31, 1997 31, 1996 --------- --------- --------- (Dollars in Thousands) Homebuilding: Sale of homes......................$163,837 $(32,875) $ 24,201 Land sales and other revenues...... (11,572) 8,371 3,214 Financial services................... 8,363 (481) 868 Investment properties................ (2,646) 2,838 1,388 Collateralized mortgage financing.... (171) (1,181) 48 --------- --------- --------- Total change....................$157,811 $(23,328) $ 29,719 ========= ========= ========= Percent change.................... 20.1% (2.9%) 3.8% ========= ========= ========= Homebuilding Compared to the same prior period, housing revenues increased $163.8 million or 22.4% for the year ended October 31, 1998, after decreasing $32.9 million or 4.3% for the year ended October 31, 1997, and increasing $24.2 million or 3.3% for the year ended October 31, 1996. 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, 1998 31, 1997 31, 1996 --------- --------- --------- (Dollars in Thousands) Northeast Region: Housing Revenues............$595,873 $445,817 $460,931 Homes Delivered............. 2,530 2,128 2,364 North Carolina: Housing Revenues............$127,592 $125,242 $123,347 Homes Delivered............. 687 695 738 Florida: Housing Revenues............$ 44,168 $ 74,146 $ 99,085 Homes Delivered............. 241 418 632 Virginia: Housing Revenues............$ 38,904 $ 14,398 $ 16,749 Homes Delivered............. 152 70 75 California: Housing Revenues............$ 82,546 $ 69,252 $ 64,570 Homes Delivered............. 457 365 325 Poland: Housing Revenues............$ 6,561 $ 2,952 -- Homes Delivered............. 71 41 -- Totals: Housing Revenues............$895,644 $731,807 $764,682 Homes Delivered............. 4,138 3,717 4,134 The overall increase in housing revenues is acombination of higher deliveries and increases in average sales prices. The increase in the number of homes delivered during the year ended October 31, 1998 is primarily due to the increased deliveries in the Northeast Region, California and Virginia which was partially offset by decreased sales in Florida. The increase in the Northeast was due to the timing of deliveries in fiscal 1997 and the Company's desire to even out deliveries over the four quarters of fiscal 1998. In California, deliveries increased due to the opening of additional communities. In Virginia, deliveries increased due to the acquisition of a small home developer on May 1, 1998. In Florida, deliveries declined since the Company cut back its operations due to a highly competitive market. The increased average sales prices are primarily the result of diversifying the Company's product mix in the Northeast Region to include more detached single family homes and larger townhouses with garages designed for the move-up buyer 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 Virginia, average sales prices increased because there was a higher percentage of single family detached homes delivered. In North Carolina, average sales prices did not show a significant change. In California, sales prices decreased due to a change in product mix to smaller, less expensive homes. Unaudited quarterly housing revenues and sales contracts using base sales prices by market area for the years ending October 31, 1998, 1997, and 1996 are set forth below: 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 Virginia................... 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 Virginia................... 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 Virginia................... 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 Virginia................... 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 ========= ========= ========= ========= Quarter Ended ------------------------------------------ October July April January 31, 1996 31, 1996 30, 1996 31, 1996 --------- --------- --------- --------- (In Thousands) Housing Revenues: Northeast Region........... $210,951 $112,665 $ 81,950 $ 55,365 North Carolina............. 44,334 33,506 24,445 21,062 Florida.................... 38,910 21,407 20,890 17,878 Virginia................... 5,538 3,614 3,200 4,397 California................. 25,747 15,936 13,019 9,868 --------- --------- --------- --------- Total.................. $325,480 $187,128 $143,504 $108,570 ========= ========= ========= ========= Sales Contracts (Net of Cancellations): Northeast Region........... $149,930 $ 94,933 $147,576 $ 55,785 North Carolina............. 28,973 31,485 43,136 19,594 Florida.................... 13,485 19,668 41,003 19,315 Virginia................... 1,638 2,249 5,821 3,463 California................. 16,419 14,847 19,496 8,209 Poland..................... 1,306 -- -- -- --------- --------- --------- --------- Total.................. $211,751 $163,182 $257,032 $106,366 ========= ========= ========= ========= The Company's contract backlog using base sales prices by market area is set forth below: October October October 31, 1998 31, 1997 31, 1996 --------- --------- --------- (Dollars in Thousands) Northeast Region: Total Contract Backlog........$270,753 $266,889 $198,248 Number of Homes............... 1,132 1,287 977 North Carolina: Total Contract Backlog........$ 48,713 $ 45,879 $ 43,587 Number of Homes............... 235 232 233 Florida: Total Contract Backlog........$ 14,800 $ 25,315 $ 36,910 Number of Homes............... 73 150 217 Virginia: Total Contract Backlog........$ 26,083 $ 7,621 $ 4,252 Number of Homes............... 115 27 24 California: Total Contract Backlog........$ 20,721 $ 25,636 $ 8,073 Number of Homes............... 119 137 46 Poland: Total Contract Backlog........$ 746 $ 2,974 $ 1,306 Number of Homes............... 7 39 19 Totals: Total Contract Backlog........$381,816 $374,314 $292,376 Number of Homes............... 1,681 1,872 1,516 The Company has written down or written off certain residential inventories $4.0 million, $14.0 million and $1.6 million during the years ended October 31, 1998, 1997, and 1996, respectively, to their estimated fair value. See "Notes to Consolidated Financial Statements - Note 10" for additional explanation. These writedowns and writeoffs were incurred primarily because of lower property values due to economic downturns, 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, 1998, the Company has written down one Florida residential community and one New Jersey parcel of land for sale. In the Florida residential community, higher discounts are being offered to speed up sales. At the New Jersey land site, lots are 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. The Company has also written off three New Jersey residential land options including approval, engineering and capitalized interest costs amounting to $2.1 million. The Company 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, the Company had written down certain residential communities, and written off certain residential land options including approval, engineering and capitalized interest costs. In Florida, the Company's return on investment was unsatisfactory. A a result, the Company established a goal to reduce its investment in Florida by $25.0 million. To do so on an accelerated basis, it reduced prices and offered pricing concessions in all Florida residential communities. The Company also decided to sell all inactive properties in Florida. In the Northeast Region, the Company changed the product type to be constructed on a parcel of land it owns. In an active community in the Northeast Region, the Company incurred unforeseen development costs. Also in the Northeast, the Company 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, the Company 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, the Company 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. The writedowns of residential inventories during the year ended October 31, 1996 were primarily attributable to one community in New Jersey, a parcel of land in Florida and one community and a parcel of land in Virginia. In New Jersey, the writedown was due to the change in use of a parcel of land from residential to commercial. In Florida, a parcel of idle land was written down due to a decline in land values. In Virginia, the writedown was primarily due to reduced sales prices in one community. Also in Virginia, a reserve was recorded against a parcel of land which the Company was attempting to liquidate through lot sales. 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, 1998 31, 1997 31, 1996 --------- --------- --------- (Dollars In Thousands) Sale of homes.............. $895,644 $731,807 $764,682 Cost of sales.............. 740,871 617,312 638,944 --------- --------- --------- Housing gross margin....... $154,773 $114,495 $125,738 ========= ========= ========= Gross margin percentage.... 17.3% 15.6% 16.4% ========= ========= ========= Cost of sales expenses as a percentage of home sales revenues are presented below: Year Ended --------------------------------- October October October 31, 1998 31, 1997 31, 1996 --------- --------- --------- (Dollars In Thousands) Sale of homes.............. 100.0% 100.0% 100.0% --------- --------- --------- Cost of sales: Housing, land and development costs....... 74.8 76.0 75.5 Commissions.............. 1.9 2.0 1.7 Financing concessions.... 0.7 0.9 1.0 Overheads................ 5.3 5.5 5.4 --------- --------- --------- Total cost of sales........ 82.7 84.4 83.6 --------- --------- --------- Gross margin............... 17.3% 15.6% 16.4% ========= ========= ========= The Company sells 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, 1998, the Company's gross margin increased 1.7% from the previous year. This can be attributed to higher gross margins being achieved in each of the Company's markets except Florida. 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 the Company's stronger markets, and an increased percentage of deliveries from the better performing communities. In addition, gross margin percentages are higher in the Northeast Region compared to the Company's other markets. In 1998, the gross margin benefited from a higher percentage of housing revenues from the Northeast Region amounting to 66.5% in fiscal 1998 compared to 60.9% in fiscal 1997. During the year ended October 31, 1997, gross margins decreased in all the Company's markets compared to the prior year. This decline was primarily caused by higher housing, land and development costs and commission expenses. 0.3% of the increase was the result of unforeseen development costs in one community in the Northeast Region. The balance of the increase in housing, land and development costs was due to a higher number of communities not obtaining acceptable housing, land and development cost performance. The increase in commissions was the result of more co-broker sales and sales associate incentives to increase sales. Selling and general administrative expenses as a percentage of homebuilding revenues decreased to 7.5% for the year ended October 31, 1998 from 8.2% for the year ended October 31, 1997 which had increased from 7.7% for the year ended October 31, 1996. The percentage decrease during the year ended October 31, 1998 is due to increased deliveries. The percentage increase during the year ended October 31, 1997 was due to increased costs while home deliveries declined. Such expenses increased $5.7 million and $1.8 million for the years ended October 31, 1998 and 1997, respectively, from the previous year. The dollar increase is due primarily to increased salary and bonus administration costs in 1998 and increased advertising and sales center operations in 1997. 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, 1998 31, 1997 31, 1996 -------- -------- -------- (In Thousands) Land and lot sales................... $ 8,636 $22,855 $13,998 Cost of sales........................ 8,070 17,005 12,548 -------- -------- -------- Land and lot sales gross margin...... $ 566 $ 5,850 $ 1,450 ======== ======== ======== Land and lot sales are incidental to the Company's 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 the Company's homebuyers, as well as from third parties, selling such mortgages in the secondary market, and title insurance activities. During the year ended October 31, 1998 financial services provided a $2.1 million pretax profit, up from break even the prior year and up from a pretax profit of $.5 million in 1996. In the market areas served by the Company's wholly-owned mortgage banking subsidiaries, approximately 58%, 51%, and 51% of the Company's non-cash homebuyers obtained mortgages originated by these subsidiaries during the years ended October 31, 1998, 1997, 1996, respectively. The Company's mortgage banking goals are to improve profitability by increasing the capture rate of its homebuyers and expanding its business to include originations from unrelated mortgages. The Company has initiated efforts to originate mortgages from unrelated third parties and expects these third party loans to increase as a percentage of the Company's total loan volume over the next few years. During the year ended October 31, 1998, third party loans amounted to 40% of total mortgage closings. Most servicing rights on new mortgages originated by the Company 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 the Company's decision to sell its investment properties. The Company plans to liquidate all properties except for its senior rentals. At October 31, 1998, all properties had been liquidated except various parcels of land. These parcels are under contract and are expected to close during 1999. During the year ended October 31, 1998 one of these contracted parcels was written down $1.0 million due to increased land development costs. 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 the Company pledged mortgage loans originated by its mortgage banking subsidiaries against collateralized mortgage obligations ("CMOs"). Subsequently, the Company discontinued its 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, the Company has also sold a portion of its CMO pledged mortgages. Corporate General and Administrative Corporate general and administrative expenses includes the operations at the Company's headquarters in Red Bank, New Jersey. As a percentage of total revenues, such expenses were 2.2%, 1.9%, and 1.7% for the years ended October 31, 1998, 1997, and 1996, respectively. 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. The Company's 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, 1998, 1997, and 1996 amounting to $3.8 million, $2.2 million, and $1.6 million, respectively. 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, 1998 31, 1997 31, 1996 --------- --------- --------- (In Thousands) Sale of homes.................. $ 31,499 $ 29,505 $ 25,992 Land and lot sales............. 652 962 657 Rental properties.............. 2,272 5,308 5,508 --------- --------- --------- Total.......................... $ 34,423 $ 35,775 $ 32,157 ========= ========= ========= Housing interest as a percentage of sale of home revenues amounted to 3.5%, 4.0%, and 3.4% for the years ended October 31, 1998, 1997, and 1996, respectively. The decrease in the percentage for the year ended October 31, 1998 was primarily due to decreased levels of debt during the year compared to 1997. This decrease was the result of the Company delivering a more even flow of homes during 1998. The increase in the percentage for the year ended October 31, 1997 was primarily the result of the Company discontinuing the capitalization of interest on communities in planning which were not under active development. As a result, interest expense increased approximately $2.8 million for the year ended October 31, 1997. Other Operations Other operations consist primarily of miscellaneous residential housing operations, amortization of subordinated note issuance expenses, and corporate owned life insurance loan interest. Total Taxes Total taxes as a percentage of income before income taxes amounted to 36.7% and 30.9% for the years ended October 31, 1998 and 1996, 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. (See "Notes to Consolidated Financial Statements - Note 9" for an additional explanation of taxes.) Extraordinary Loss In October 1998, the Company redeemed $44,551,000 of its outstanding 11 1/4% Subordinated Notes due 2002 at an average price of 101.6% of par which resulted in an extraordinary loss of $748,000 net of income taxes of $403,000. Year 2000 Issues The Company has assessed and formulated a plan to resolve its information technology ("IT") and non-IT system year 2000 issues. The Company has designated a full-time year 2000 project leader, engaged consultants to review and evaluate its plan, completed the identification of Company IT and non-IT noncompliant systems and is in the process of evaluating subcontractors' and suppliers' state of readiness. The Company's plan has prioritized its efforts on its software systems and computer hardware equipment. The Company has upgraded, fixed or retired 80% of its noncompliant systems. The Company expects to have substantially all critical IT software year 2000 capable and tested by June 30, 1999. All other Company IT and non-IT systems are not considered critical to Company operations, and if noncapable for year 2000, would only be an inconvenience. The Company does not anticipate the costs of implementation of its plan to have a material impact on future earnings and is expected to be funded through operations. The Company is concerned about the readiness of its subcontractors and suppliers. The Company is in the process of communicating with these third parties. If the Company finds third parties whose lack of readiness as to year 2000 issues would have a substantial impact on the Company's operations, the Company will look to replace such subcontractors and suppliers. In most cases, the Company uses more than one subcontractor and supplier so it believes finding replacements will not be difficult. The Company believes it is on track to solve its year 2000 issues. It does not believe it will have material lost revenues due to the year 2000 issues. Based on the above, it sees no need to develop a worst-case year 2000 scenario. However, the Company is in the process of developing year 2000 contingency plans which are approximately 75% complete. Inflation Inflation has a long-term effect on the Company because increasing costs of land, materials and labor result in increasing sales prices of its homes. In general, these price increases have been commensurate with the general rate of inflation in the Company's housing markets and have not had a significant adverse effect on the sale of the Company's 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 it sells homes, the Company has not found this risk to be a significant problem. Inflation has a lesser short-term effect on the Company because the Company generally negotiates fixed price contracts with its subcontractors and material suppliers for the construction of its 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 55% of the Company's homebuilding cost of sales. Item 7(A) - Quantitative and Qualitative Disclosures About Market Risk. The primary market risk facing the Company is interest rate risk on it's long term debt. In connection with the Company's 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 and accordingly the risk is not material. The Company does not hedge interest rate risk using financial instruments. The Company is also subject to foreign currency risk but this risk is not material. The following table sets forth as of October 31, 1998, the Company's long term debt obligations, principal cash flows by scheduled maturity, weighted average interest rates and estimated fair market value ("FMV"). <TABLE> <CAPTION> Year Ended October 31, -------------------------------------- FMV @ 1999 2000 2001 2002 2003 Thereafter Total 10/31/98 ------ ------ ------ ------ ------ ---------- ------- --------- (Dollars in Thousands) <S> <C> <C> <C> <C> <C> <C> <C> <C> Long Term Debt(1): Fixed Rate.......$ 115 $ 119 $ 132 $50,804 $2,581 $100,685 $154,436 $145,186 Average interest rate........... 7.59% 7.62% 7.60% 10.70% 7.04% 9.74% 10.01% - Variable Rate....$1,932 $ 600 $ 926 $ 0 $ 0 $ 0 $ 3,458 $ 3,458 Average interest rate........... 9.22% 8.00% 8.64% - - - 8.85% - (1) Does not include bonds collateralized by mortgages receivable. </TABLE> Item 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Financial statements of Hovnanian Enterprises, Inc. and its consolidated subsidiaries are set forth herein beginning on Page F-1. Item 9 - CHANGES IN OR DISAGREEMENT WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. During the years ended October 31, 1998, 1997, and 1996, there have not been any changes in or disagreements with accountants on accounting and financial disclosure. PART III 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 the Company's 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 23, 1999, which will involve the election of directors. Executive Officers of the Registrant The executive officers of the Company 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 75 Chairman of the Board and l967 Director of the Company. Ara K. Hovnanian 41 Chief Executive Officer, President 1979 and Director of the Company. Paul W. Buchanan 48 Senior Vice President-Corporate l981 Controller and Director of the Company. William L. Carpitella 44 Senior Vice President, Organizational Development 1997 Peter S. Reinhart 48 Senior Vice President and General 1978 Counsel and Director of the Company. John D. Roberts 36 Vice President Process Redesign 1998 J. Larry Sorsby 43 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 - EXECUTIVE COMPENSATION The information called for by Item ll is incorporated herein by reference to the Company's 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 5, 1999, which will involve the election of directors. Item 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information called for by Item l2 is incorporated herein by reference to the Company's 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 5, l999, which will involve the election of directors. Item 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information called for by Item l3 is incorporated herein by reference to the Company's 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 5, 1999, which will involve the election of directors. PART IV Item 14 - EXHIBITS, FINANCIAL STATEMENTS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K Page Financial Statements: Index to Consolidated Financial Statements....................... F-1 Independent Auditors' Report..................................... F-2 Consolidated Balance Sheets at October 31, 1998 and 1997......... F-3 Consolidated Statements of Operations for the years ended October 31, 1998, 1997, and 1996.............................. F-5 Consolidated Statements of Stockholders' Equity for the years ended October 31, 1998, 1997, and 1996........................ F-6 Consolidated Statements of Cash Flows for the years ended October 31, 1998, 1997, and 1996.............................. F-7 Notes to Consolidated Financial Statements......................... F-8 Financial Statement Schedules: XI Real Estate and Accumulated Depreciation................... F-21 All other schedules are either not applicable to the Company 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 April 29, 1992, relating to 11 1/4% Subordinated Notes between the Registrant and First Fidelity Bank, including form of 11 1/4% Subordinated Notes due April 15, 2002.(2) 4(d) 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) 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) Description of Management Bonus Arrangements.(6) 10(c) Description of Savings and Investment Retirement Plan.(1) 10(d) Stock Option Plan. 10(e) Management Agreement dated August 12, 1983 for the management of properties by K. Hovnanian Investment Properties, Inc.(1) 10(f) Agreement dated July 8, 1981 between Hovnanian Properties of Atlantic County, Inc. and Kevork S. Hovnanian.(2) 10(g) Management Agreement dated December 15, 1985, for the management of properties by K. Hovnanian Investment Properties, Inc.(3) 10(h) Description of Deferred Compensation Plan.(5) 22 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. Reports on Form 8-K The Company did not file any reports on Form 8-K during the quarter ended October 31, 1998. 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 1/15/99 Kevork S. Hovnanian and Director /S/ARA K. HOVNANIAN Chief Executive Officer, 1/15/99 Ara K. Hovnanian President and Director /S/PAUL W. BUCHANAN Senior Vice President 1/15/99 Paul W. Buchanan Corporate Controller and Director /S/PETER S. REINHART Senior Vice President and 1/15/99 Peter S. Reinhart General Counsel and Director /S/J. LARRY SORSBY Senior Vice President, 1/15/99 J. Larry Sorsby Treasurer, Chief Financial Officer and Director /S/WILLIAM L. CARPITELLA Senior Vice President, 1/15/99 William L. Carpitella Organizational Development HOVNANIAN ENTERPRISES, INC. Index to Consolidated Financial Statements Page Financial Statements: Independent Auditors' Report................................... F-2 Consolidated Balance Sheets as of October 31, 1998 and 1997.... F-3 Consolidated Statements of Operations for the Years Ended October 31, 1998, 1997, and 1996............................... F-5 Consolidated Statements of Stockholders' Equity for the Years Ended October 31, 1998, 1997, and 1996......................... F-6 Consolidated Statements of Cash Flows for the Years Ended October 31, 1998, 1997, and 1996............................... F-7 Notes to Consolidated Financial Statements........................ F-8 Financial Statement Schedules: XI Real Estate and Accumulated Depreciation.................. F-21 All other schedules have been omitted because the required information of such other 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. INDEPENDENT AUDITORS' REPORT 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, 1998 and 1997, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended October 31, 1998. Our audits also included the financial statement schedules listed in the Index at Item 14(a). 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, 1998 and 1997 and the consolidated results of their operations and their cash flows for each of the three years in the period ended October 31, 1998 in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein. /S/ERNST & YOUNG LLP Ernst & Young LLP New York, New York December 15, 1998 <TABLE> HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In Thousands) <CAPTION> October 31, October 31, ASSETS 1998 1997 ------------ ------------ <S> <C> <C> Homebuilding: Cash and cash equivalents(Note 4)................. $ 13,306 $ 7,952 ------------ ------------ Inventories - At cost, not in excess of fair value (Notes 6 and 10): Sold and unsold homes and lots under development.................................... 332,225 363,592 Land and land options held for future development or sale........................... 43,508 46,801 ------------ ------------ Total Inventories............................. 375,733 410,393 ------------ ------------ Receivables, deposits, and notes (Notes 5 and 11). 29,490 35,723 ------------ ------------ Property, plant, and equipment - net (Note 3)..... 16,831 18,027 ------------ ------------ Prepaid expenses and other assets................. 32,650 36,708 ------------ ------------ Total Homebuilding............................ 468,010 508,803 ------------ ------------ Financial Services: Cash.............................................. 1,486 2,598 Mortgage loans held for sale (Note 5)............. 71,611 48,382 Other assets...................................... 3,717 2,518 ------------ ------------ Total Financial Services...................... 76,814 53,498 ------------ ------------ Investment Properties: Held for sale: Rental property - net (Notes 3 and 10).......... 23,920 Land and improvements (Notes 3 and 10).......... 17,832 15,026 Other assets.................................... 295 1,397 Held for investment: Cash............................................ 762 763 Rental property - net (Note 3).................. 10,794 11,412 Other assets.................................... 868 1,072 ------------ ------------ Total Investment Properties................... 30,551 53,590 ------------ ------------ Collateralized Mortgage Financing: Collateral for bonds payable (Note 5)............. 5,970 7,999 Other assets...................................... 426 627 ------------ ------------ Total Collateralized Mortgage Financing....... 6,396 8,626 ------------ ------------ Income Taxes Receivable - Including deferred tax benefits (Note 9)................................. 7,331 12,565 ------------ ------------ Total Assets........................................ $589,102 $637,082 ============ ============ See notes to consolidated financial statements. </TABLE> <TABLE> HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In Thousands) <CAPTION> October 31, October 31, LIABILITIES AND STOCKHOLDERS' EQUITY 1998 1997 ------------ ------------ <S> <C> <C> Homebuilding: Nonrecourse land mortgages (Note 6)................. $ 11,846 $20,625 Accounts payable and other liabilities.............. 53,765 45,521 Customers' deposits (Note 4)........................ 23,857 22,422 Nonrecourse mortgages secured by operating properties (Note 6)............................... 3,770 3,830 ------------ ------------ Total Homebuilding.............................. 93,238 92,398 ------------ ------------ Financial Services: Accounts payable and other liabilities.............. 2,422 1,522 Mortgage warehouse line of credit (Note 5).......... 66,666 45,823 ------------ ------------ Total Financial Services........................ 69,088 47,345 ------------ ------------ Investment Properties: Accounts payable and other liabilities.............. 1,373 502 Nonrecourse mortgages secured by rental property.... 19,241 ------------ ------------ Total Investment Properties..................... 1,373 19,743 ------------ ------------ Collateralized Mortgage Financing: Accounts payable and other liabilities.............. 6 10 Bonds collateralized by mortgages receivable(Note 5) 5,652 7,855 ------------ ------------ Total Collateralized Mortgage Financing......... 5,658 7,865 ------------ ------------ Notes Payable: Revolving credit agreement (Note 6)................. 68,000 95,000 Subordinated notes (Note 7)......................... 145,449 190,000 Accrued interest.................................... 4,904 5,969 ------------ ------------ Total Notes Payable............................. 218,353 290,969 ------------ ------------ Total Liabilities............................... 387,710 458,320 ------------ ------------ Commitments and Contingent Liabilities (Notes 4 and 13) Stockholders' Equity (Notes 11 and 12): Preferred Stock,$.01 par value-authorized 100,000 shares; none issued Common Stock,Class A,$.01 par value-authorized 87,000,000 shares; issued 15,803,297 shares (including 1,937,374 shares in 1998 and 1,530,274 shares in 1997 held in Treasury)........ 157 156 Common Stock,Class B,$.01 par value (convertible to Class A at time of sale) -authorized 13,000,000 shares; issued 8,040,171 shares (including 345,874 shares held in Treasury)................................ 80 81 Paid in Capital..................................... 34,561 33,935 Retained Earnings (Note 7).......................... 183,182 157,779 Treasury Stock - at cost............................ (16,588) (13,189) ------------ ------------ Total Stockholders' Equity...................... 201,392 178,762 ------------ ------------ Total Liabilities and Stockholders' Equity............ $589,102 $637,082 ============ ============ See notes to consolidated financial statements. </TABLE> <TABLE> HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (In Thousands Except Per Share Data) <CAPTION> Year Ended ------------------------------- October October October 31, 1998 31, 1997 31, 1996 --------- --------- --------- <S> <C> <C> <C> Revenues: Homebuilding: Sale of homes............................. $895,644 $731,807 $764,682 Land sales and other revenues............. 15,411 26,983 18,612 --------- --------- --------- Total Homebuilding...................... 911,055 758,790 783,294 Financial Services.......................... 19,098 10,735 11,216 Investment Properties....................... 11,111 13,757 10,919 Collateralized Mortgage Financing........... 683 854 2,035 --------- --------- --------- Total Revenues.......................... 941,947 784,136 807,464 --------- --------- --------- Expenses: Homebuilding: Cost of sales............................. 748,941 634,317 651,492 Selling, general and administrative....... 68,170 62,475 60,704 Inventory impairment loss (Note 10)....... 3,994 14,019 1,608 --------- --------- --------- Total Homebuilding...................... 821,105 710,811 713,804 --------- --------- --------- Financial Services.......................... 17,010 10,780 10,669 --------- --------- --------- Investment Properties: Operations................................ 3,395 5,909 6,388 Provision for impairment loss (Note 10)... 1,038 14,446 --------- --------- --------- Total Investment Properties............. 4,433 20,355 6,388 --------- --------- --------- Collateralized Mortgage Financing........... 672 878 2,076 --------- --------- --------- Corporate General and Administration(Note 2) 21,048 15,088 14,002 --------- --------- --------- Interest.................................... 34,423 35,775 32,157 --------- --------- --------- Other operations............................ 1,964 2,573 3,362 --------- --------- --------- Total Expenses.......................... 900,655 796,260 782,458 --------- --------- --------- Income(Loss) Before Income Taxes and Extraordinary Loss.......................... 41,292 (12,124) 25,006 --------- --------- --------- State and Federal Income Taxes: State (Note 9).............................. 3,572 1,796 1,336 Federal (Note 9)............................ 11,569 (6,950) 6,383 --------- --------- --------- Total Taxes............................... 15,141 (5,154) 7,719 --------- --------- --------- Extraordinary Loss From Extinguisement of Debt, Net of Income Taxes................... (748) --------- --------- --------- Net Income (Loss)............................. $ 25,403 $ (6,970) $ 17,287 ========= ========= ========= Per Share Data: Basic: Income (Loss) Per Common Share Before Extraordinary Loss...................... $ 1.20 $ (0.31) $ 0.75 Extraordinary Loss........................ (.03) --------- --------- --------- Income (Loss)............................. $ 1.17 $ (0.31) $ 0.75 ========= ========= ========= Assuming Dilution: Income (Loss)Per Common Share Before Extraordinary Loss...................... $ 1.19 $ (0.31) $ 0.75 Extraordinary Loss........................ (.03) --------- --------- --------- Income (Loss)............................. $ 1.16 $ (0.31) $ 0.75 ========= ========= ========= See notes to consolidated financial statements. </TABLE> <TABLE> HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (Dollars in Thousands) <CAPTION> A Common Stock B Common Stock ------------------- ------------------- Shares Shares Issued and Issued and Paid-In Retained Treasury Outstanding Amount Outstanding Amount Capital Earnings Stock Total ----------- ------ ----------- ------ ------- -------- -------- --------- <S> <C> <C> <C> <C> <C> <C> <C> <C> Balance, October 31, 1995... 15,038,483 $154 7,998,570 $83 $33,935 $147,462 ($5,299) $176,335 Conversion of Class B to Class A common stock.... 96,865 1 (96,865) (1) Net Income.................. 17,287 17,287 ----------- ------ ----------- ------ ------- -------- -------- --------- Balance, October 31, 1996... 15,135,348 155 7,901,705 82 33,935 164,749 (5,299) 193,622 Conversion of Class B to Class A common stock...... 146,893 1 (146,893) (1) Treasury stock purchases.... (1,184,400) (7,890) (7,890) Net Loss.................... (6,970) (6,970) ----------- ------ ----------- ------ ------- -------- --------- --------- Balance, October 31, 1997... 14,097,841 156 7,754,812 81 33,935 157,779 (13,189) 178,762 Sale of Common Stock Under Employee Stock Option Plan...................... 114,667 626 626 Conversion of Class B to Class A common stock...... 60,515 1 (60,515) (1) Treasury stock purchases.... (407,100) (3,399) (3,399) Net Income.................. 25,403 25,403 ----------- ------ ----------- ------ ------- -------- --------- --------- Balance, October 31, 1998... 13,865,923 $157 7,694,297 $80 $34,561 $183,182 ($16,588) $ 201,392 =========== ====== =========== ====== ======= ======== ========= ========= See notes to consolidated financial statements. </TABLE> <TABLE> HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (In Thousands) <CAPTION> Year Ended ---------------------------------- October October October 31, 1998 31, 1997 31, 1996 ---------- ---------- ---------- <S> <C> <C> <C> Cash Flows From Operating Activities: Net Income (Loss)............................... $ 25,403 $ (6,970) $ 17,287 Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation................................ 4,293 5,032 5,246 Loss (gain)on sale and retirement of property and assets....................... (6,189) (4,760) (1,998) Deferred income taxes....................... 1,987 (4,568) (820) Impairment losses........................... 5,032 28,465 1,608 Decrease (increase) in assets: Receivables, prepaids and other assets.... 6,828 (6,830) (4,297) Mortgage notes receivable................. (19,485) 2,858 (10,966) Inventories............................... 30,666 (48,105) 26,498 Increase (decrease) in liabilities: State and Federal income taxes............ 3,248 (7,325) 6,509 Customers' deposits....................... 1,490 10,007 774 Interest and other accrued liabilities.... 2,235 3,726 (3,366) Post development completion costs......... 4,438 (8,746) 4,062 Accounts payable.......................... 2,233 5,034 (3,681) Net cash provided by (used in) ---------- ---------- ---------- operating activities.................... 62,179 (32,182) 36,856 ---------- ---------- ---------- Cash Flows From Investing Activities: Net proceeds from sale of property and assets... 30,436 14,997 10,308 Purchase of property............................ (3,135) (3,156) (5,882) Investment in and advances to unconsolidated affiliates.................................... 243 195 3,792 Investment in income producing properties....... (3,844) (11,099) (2,134) Net cash provided by (used in) ---------- ---------- ---------- investing activities.................... 23,700 937 6,084 ---------- ---------- ---------- Cash Flows From Financing Activities: Proceeds from mortgages and notes............... 632,531 1,139,780 1,142,106 Principal payments on mortgages and notes..... (668,987) (1,101,969) (1,188,449) Principal payments on subordinated debt......... (44,551) (10,000) Investment in mortgage notes receivable......... 2,142 1,474 8,941 Purchase of treasury stock...................... (3,399) (7,890) Proceeds from sale of stock..................... 626 Net cash provided by (used in) ---------- ---------- ---------- financing activities.................... (81,638) 21,395 (37,402) ---------- ---------- ---------- Net Increase (Decrease) In Cash................... 4,241 (9,850) 5,538 Cash and Cash Equivalent Balance, Beginning Of Period....................................... 11,313 21,163 15,625 ---------- ---------- ---------- Cash and Cash Equivalent Balance, End Of Period.......................................... $ 15,554 $ 11,313 $ 21,163 ========== ========== ========== Supplemental Disclosures Of Cash Flow: Cash paid during the year for: Interest (net of amount capitalized).......... $ 35,315 $ 35,869 $ 32,194 ========== ========== ========== Income Taxes.................................. $ 12,303 $ 6,809 $ 6,875 ========== ========== ========== Non-cash Investing and Finance Activities: Debt assumed on sale of property and assets..... $ 13,530 ========== See notes to consolidated financial statements </TABLE> HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED OCTOBER 31, 1998, 1997, AND 1996. 1. SUMMARY OF ACCOUNTING POLICIES Operations - The Company, a Delaware Corporation, principally develops housing communities in New Jersey, Pennsylvania, New York, Florida, North Carolina, Virginia, California and Poland. In addition, the Company provides financial services to its homebuilding customers and third parties. The Company also developed and held for investment income producing properties but has exited from this business. Principles of Consolidation - The accompanying consolidated financial statements include the accounts of the Company and all wholly-owned or majority- owned subsidiaries after elimination of all significant intercompany balances and transactions. The Company's investments in joint ventures in which the Company's interest is 50% or less are accounted for by the equity method of accounting. 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. 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 - Cash includes cash deposited in checking accounts, overnight repurchase agreements, certificates of deposit, Treasury bills and government money market funds with original maturities of less than 90 days at date of issuance. 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. The Company's financial instruments consist of cash equivalents, mortgages and notes receivable, mortgages and notes payable, and the 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 6). 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 the Company determines it will not exercise the option. Property - Rental operations of the Company arise primarily from rental of commercial properties. In addition, the Company has, from time to time, rented under short-term leases condominium homes not yet under contract of sale. Such homes are reclassified from inventory and depreciated after a reasonable selling period not to exceed one year. Post Development Completion Costs - In those instances where a development is substantially completed and sold and the Company has additional construction work to be incurred, an estimated liability is provided to cover the cost of such work. 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, the Company's 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 the Company's total and outstanding shares as of December 16, 1996 when the initial repurchase plan was approved by the Board. As of October 31, 1998, 1,591,500 shares have been repurchased under this program. Depreciation - The straight-line method is used for both financial and tax reporting purposes for all assets except office furniture and equipment which are depreciated using the declining balance method over their estimated useful lives. Prepaid Expense - Prepaid expenses which relate to specific housing communities (marketing materials, 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. The Company intends to continue accounting for its stock option plan under APB 25. Under APB 25, no compensation expense was recognized because the exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of grant (see Note 12). Per Share Calculations - New Accounting Pronouncement - 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. The Company has adopted FAS 128 for the year ending 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. 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 235,000, 97,000, and 83,000 for the years ended October 31, 1998, 1997, and 1996, respectively. New Accounting Pronouncement - Statement of Financial Accounting Standards No. 131 ("FAS 131") "Disclosures About Segments of an Enterprise and Related Information" requires disclosure about operating segments and is effective for fiscal years beginning after December 15, 1997. At October 31, 1998, the Company has not adopted FAS 131. The Company believes the requirements of FAS 131 is not expected to materially impact the Company. 2. CORPORATE INITIATIVES The Company has embarked on long term improvement initiatives of total quality, process redesign, and training. Included in Corporate General and Administration is $3,756,000, $2,216,000, and $1,601,000 for the years ended October 31, 1998, 1997, and 1996, respectively, related to such initiatives. 3. PROPERTY Homebuilding property, plant, and equipment consists of land, land improvements, buildings, building improvements, furniture and equipment used by the Company and its subsidiaries to conduct day to day business. Homebuilding accumulated depreciation related to these assets at October 31, 1998 and October 31, 1997 amounted to $15,088,000 and $15,338,000, respectively. At October 31, 1997, held for sale - rental property consisted of two office buildings, three office warehouse facilities and one retail shopping center. All held for sale - rental property was sold during the year ended October 31, 1998 for $33,442,000 resultingin a pretax gain of $6,475,000. In addition at October 31, 1998 and 1997, two senior residential rental properties were classified as held for investment - rental property. Accumulated depreciation on rental property at October 31, 1998 and October 31, 1997 amounted to $1,826,000 and $10,450,000, respectively. The Company owned and held for sale three parcels of commercial land at October 31, 1998. All three parcels are under contract and are expected to close during the year ended October 31, 1999 for $20,955,000. During the year ended October 31, 1998 a 50%-owned partnership also sold its retail center resulting in the Company recording a pretax gain of $1,418,000. 4. ESCROW CASH The Company holds escrow cash amounting to $4,775,000 and $3,248,000 at October 31, 1998 and October 31, 1997, respectively, which primarily represents customers' deposits which are restricted from use by the Company. The Company is able to release escrow cash by pledging letters of credit. At October 31, 1998 and October 31, 1997, $14,000,000 and $13,500,000 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. 5. MORTGAGES AND NOTES RECEIVABLE The Company's wholly-owned mortgage banking subsidiary originates mortgage loans, primarily from the sale of the Company's 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, 1998 and October 31, 1997, respectively, $71,002,000 and $47,660,000 of such mortgages were pledged against, the Company's mortgage warehouse line (see "Notes to Consolidated Financial Statements - Note 6"). The Company 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, the Company has 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, 1998. 6. 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 $115,000 in 1999, $119,000 in 2000, $132,000 in 2001, $138,000 in 2002, $2,581,000 in 2003, and $685,000 after 2003. The interest rates on these obligations range from 7.000% to 8.375%. The Company has an unsecured Revolving Credit Agreement ("Agreement") with a group of banks which provides up to $280,000,000 through July 2001. Interest is payable monthly and at various rates of either the prime rate or LIBOR plus 1.45%. In addition, the Company pays .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, 1998 31, 1997 31, 1996 -------- -------- -------- (Dollars in Thousands) Interest incurred (1): Residential(3)................. $26,675 $29,469 $30,058 Commercial(4).................. 2,272 5,308 5,493 ------- ------- ------- Total incurred................. $28,947 $34,777 $35,551 ======= ======= ======= Interest expensed: Residential(3)................. $32,151 $30,467 $26,649 Commercial(4).................. 2,272 5,308 5,508 ------- ------- ------- Total expensed................. $34,423 $35,775 $32,157 ======= ======= ======= Interest capitalized at beginning of year.............. $35,950 $39,152 $36,182 Plus interest incurred........... 28,947 34,777 35,551 Less interest expensed........... 34,423 35,775 32,157 Less impairment adjustments...... -- 275 424 Less property written off........ 460 945 -- Less sale of assets.............. 4,469 984 -- ------- ------- ------- Interest capitalized at end of year.................... $25,545 $35,950 $39,152 ======= ======= ======= Interest capitalized at end of year (5): Residential(3)................. $23,868 $29,804 $32,669 Commercial(2).................. 1,677 6,146 6,483 ------- ------- ------- Total interest capitalized................... $25,545 $35,950 $39,152 ======= ======= ======= (1) Data does not include interest incurred by the Company's 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. (5) Commercial interest for October 31, 1997 includes $832,000 reported at October 31, 1996 as capitalized residential interest. This reclassification was the result of the transfer of two parcels of land and related capitalized interest from homebuilding to investment properties. Average interest rates and average balances outstanding for short-term debt are as follows: October October October 31, 1998 31, 1997 31, 1996 -------- -------- -------- (Dollars In Thousands) Average outstanding borrowings................. $ 98,090 $133,760 $127,770 Average interest rate during period..................... 8.4% 8.2% 8.5% Average interest rate at end of period(1)............... 6.9% 7.8% 7.6% Maximum outstanding at any month end.................. $125,325 $184,550 $157,125 (1) Average interest rate at the end of the period excludes any charges on unused loan balances. 7. SUBORDINATED NOTES On April 29, 1992, the Company issued $100,000,000 principal amount of 11 1/4% Subordinated Notes due April 15, 2002. Interest is payable semi-annually. In November and December 1996, the Company redeemed $10,000,000 principal amount at an average price of 100.3% of par. In October 1998, the Company also redeemed $44,551,000 principal amount at an average price of 101.6% of par. The funds for this redemption 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. The remaining principal amount is due April 2002. On June 7, 1993, the Company 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 the Company's 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. The indentures relating to the subordinated notes and the Revolving Credit Agreement contain restrictions on the payment of cash dividends. At October 31, 1998, $42,995,000 of retained earnings were free of such restrictions. The fair value of the Subordinated Notes is estimated based on the quoted market prices for the same or similar issues or on the current rates offered to the Company for debt of the same remaining maturities. The combined fair value of the Subordinated Notes is estimated at $136,329,000 as of October 31, 1998. 8. RETIREMENT PLAN In December 1982, the Company 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 $1,523,000, $1,520,000, and $1,406,000 for the years ended October 31, 1998, 1997, and 1996, respectively. 9. INCOME TAXES Income Taxes payable (receivable) including deferred benefits, consists of the following: October October 31, 1998 31, 1997 --------- --------- (In Thousands) State income taxes: Current.......................... $ 2,897 $ 1,387 Deferred......................... (1,495) (1,586) Federal income taxes: Current.......................... 36 (1,611) Deferred......................... (8,769) (10,755) --------- --------- Total.......................... $ (7,331) $(12,565) ========= ========= The provision for income taxes is composed of the following charges (benefits): Year Ended ----------------------------------- October October October 31, 1998 31, 1997 31, 1996 --------- --------- --------- (In Thousands) Current income tax expense: Federal(1)....................... $ 9,177 $ (2,381) $ 7,205 State............................ 3,484 2,051 1,768 --------- --------- --------- 12,661 (330) 8,973 --------- --------- --------- Deferred income tax expense: Federal.......................... 1,989 (4,569) (822) State............................ 88 (255) (432) --------- --------- --------- 2,077 (4,824) (1,254) --------- --------- --------- Total.......................... $ 14,738 $ (5,154) $ 7,719 ========= ========= ========= (1) The current federal income tax expense includes a tax benefit of $403,00 in the year ended October 31, 1998 relating to the loss on the redemption of Subordinated Notes that was reported as an extraordinary item in the "Statement of Operations." The deferred tax liabilities or assets have been recognized in the consolidated balance sheets due to temporary differences as follows: October October 31, 1998 31, 1997 -------- --------- (In Thousands) Deferred tax assets: Deferred income...................... $ 40 $ 321 Maintenance guarantee reserves....... 701 481 Provision to reduce inventory to net realizable value............... 136 95 Inventory impairment loss............ 6,077 8,621 Uniform capitalization of overhead... 2,967 3,972 Post development completion costs.... 1,379 509 State net operating loss carryforwards...................... 27,205 22,227 Other................................ 843 639 -------- --------- Total.............................. 39,348 36,865 Valuation allowance(2)............... (27,205) (22,227) -------- --------- Deferred tax assets.................. 12,143 14,638 -------- --------- Deferred tax liabilities: Deferred interest.................... 31 31 Installment sales.................... 137 208 Accelerated depreciation............. 1,711 2,058 -------- --------- Total............................... 1,879 2,297 -------- --------- Net deferred tax assets................ $ 10,264 $ 12,341 ======== ========= (2) The net change in the valuation allowance of $4,978,000 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, 1998 31, 1997 31, 1996 -------- -------- -------- Computed "expected" tax rate...... 35.0 % (35.0)% 35.0 % State income taxes, net of Federal income tax benefit.............. 6.0 % 11.6 % 3.2 % Company owned life insurance...... (1.6)% (6.2)% (2.9)% Low income housing tax credit..... (3.4)% (11.2)% (5.3)% Other............................. .7 % (1.9)% .9 % -------- -------- -------- Effective tax rate................ 36.7 % (42.7)% 30.9 % ======== ======== ======== The Company has state net operating loss carryforwards for financial reporting and tax purposes of $359,000,000 due to expire between the years October 31, 1999 and October 31, 2013. 10. REDUCTION OF INVENTORY TO FAIR VALUE In accordance with FAS 121, the Company records 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, 1997 and 1996, inventory with a carrying amount of $3,077,000, $33,143,000 and $2,240,000, respectively, was written down by $353,000, $9,258,000 and $1,289,000, respectively, to its fair value. This was based on the Company's 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 the Company decided to reduce its 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, the Company records 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, 1998, 1997 and 1996, inventory and commercial properties with a carrying amount of $4,629,000, $32,008,000 and $12,031,000, respectively, was written down by $2,588,000, $12,690,000 and $3,795,000, respectively, to its fair value. 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, the Company recovered the carrying value. During the years ended October 31, 1998, 1997 and 1996, the Company 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 $2,941,000, $21,948,000, and $1,608,000 for the years ended October 31, 1998, 1997 and 1996, 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, 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 1998, the Company did not exercise three residential options because of changes in local market conditions and difficulties in obtaining government approvals. During 1997, the Company 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. 11. TRANSACTIONS WITH RELATED PARTIES The Company's Board of Directors has adopted a general policy providing that it will not make loans to officers or directors of the Company 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 the Company's Board of Directors who have no interest in the transaction. At October 31, 1998 and 1997 included in receivables, deposits and notes are related party receivables from officers and directors amounted to $2,117,000 and $1,889,000, respectively. Notwithstanding the policy stated above, the Board of Directors of the Company concluded that the following transactions were in the best interests of the Company. The Company provides property management services to various limited partnerships including one partnership in which Mr. A. Hovnanian, Chief Executive Officer, President and a Director of the Company, is a general partner, and members of his family and certain officers and directors of the Company are limited partners. At October 31, 1998, no amounts were due the Company by these partnerships. 12. STOCK OPTION PLAN The Company has 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 after ten years after the date of the grant. In addition, during the year ended October 31, 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: <TABLE> <CAPTION> Weighted Weighted Weighted Average Average Average October Exercise October Exercise October Exercise 31, 1998 Price 31, 1997 Price 31, 1996 Price --------- -------- --------- -------- --------- -------- <S> <C> <C> <C> <C> <C> <C> Options outstanding at beginning of period. 1,336,500 $7.83 1,156,000 $8.04 1,176,000 $8.00 Granted.............. 291,500 $9.09 190,500 $6.47 Exercised............ 114,667 $5.45 Forfeited............ 98,333 $9.98 10,000 $5.81 20,000 $5.81 --------- --------- ---------- Options outstanding at end of period......... 1,415,000 $8.13 1,336,500 $7.83 1,156,000 $8.04 ========= ========= ========== Options exercisable at end of period....... 1,013,166 1,069,333 996,000 Price range of options $5.13- $5.13- $5.13- outstanding......... $11.50 $11.50 $11.50 Weighted-average remaining contractual life................ 5.4 yrs. 5.4 yrs. 5.8 yrs. </TABLE> Pro forma information regarding net income and earnings per share is required under the fair value method of Financial Accounting Standards No. 123 ("FAS 123") "Accounting for Stock-Based compensation" and is to be calculated as if the Company had accounted for its stock options under the fair value method of FAS 123. The fair value for these options is established at the date of grant using a Black-Scholes option pricing model with the following weighted- average assumptions for 1998 and 1997: risk- free interest rate of 4.5% and 5.8%, respectively; divided yield of zero; volatility factor of the expected market price of the Company's common stock of 0.46 and 0.47, respectively; and a weighted-average expected life of the option of 7.5 and 7.0 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 the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective imput assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options and are not likely to be representative of the effects on reported net income for future years, if applicable. For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. The Company's pro forma information follows (in thousands except for earnings per share information): Year Ended ----------------------------------- October October October 31, 1998 31, 1997 31, 1996(1) ---------- ---------- ----------- Pro forma net income (loss)............. $ 25,107 $ (7,131) $ 17,287 ========== ========== =========== Pro forma basic earnings (loss) per share............................. $ 1.15 $ (0.32) $ 0.75 ========== ========== =========== Pro forma diluted earnings (loss) per share............................. $ 1.14 $ (0.32) $ 0.75 ========== ========== =========== (1) No options were granted in 1996, as a result pro forma amounts equal actual per the income statement. 13. COMMITMENTS AND CONTINGENT LIABILITIES The Company is 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 the Company. As of October 31, 1998 and 1997, respectively, the Company is obligated under various performance letters of credit amounting to $6,934,000 and $6,834,000. 14. UNAUDITED SUMMARIZED CONSOLIDATED QUARTERLY INFORMATION Summarized quarterly financial information for the years ended October 31, 1998, 1997, and 1996 is as follows: Three Months Ended ----------------------------------------- October July April January 31, 1998 31, 1998 30, 1998 31, 1998 -------- -------- -------- --------- (In Thousands Except Per Share Data) Revenues........................... $267,542 $248,125 $212,320 $213,960 Expenses........................... $255,268 $235,735 $204,710 $204,942 Income before income taxes and extraordinary loss............... $ 12,274 $ 12,390 $ 7,610 $ 9,018 State and Federal income tax....... $ 4,762 $ 4,677 $ 2,597 $ 3,105 Extraordinary loss from extinguish- ment of debt, net of income taxes $ (748) Net income......................... $ 6,764 $ 7,713 $ 5,013 $ 5,913 Per Share Data: Basic: Income per common share before extraordinary loss............. $ 0.35 $ 0.35 $ 0.23 $ 0.27 Extraordinary loss............... $ (.03) Net Income....................... $ 0.32 $ 0.35 $ 0.23 $ 0.27 Weighted average number of common shares outstanding...... 21,661 21,785 21,848 21,834 Assuming Dilution: Income per common share before extraordinary loss...... $ 0.34 $ 0.35 $ 0.23 $ 0.27 Extraordinary loss............... $ (.03) Net Income....................... $ 0.31 $ 0.35 $ 0.23 $ 0.27 Weighted average number of common shares outstanding...... 21,896 22,018 22,042 21,985 Three Months Ended(1) ------------------------------------------ October July April January 31, 1997 31, 1997 30, 1997 31, 1997 -------- -------- -------- --------- (In Thousands Except Per Share Data) Revenues........................... $315,150 $205,107 $143,526 $120,353 Expenses........................... $302,494 $196,105 $173,453 $124,208 Income before income taxes and extraordinary loss............... $ 12,656 $ 9,002 $(29,927) $ (3,855) State and Federal income tax....... $ 4,930 $ 2,782 $(10,785) $ (2,081) Net income (loss).................. $ 7,726 $ 6,220 $(19,142) $ (1,774) Per Share Data: Basic: Net income (loss) per common share.......................... $ 0.35 $ 0.27 $ (0.83) $ (.08) Weighted average number of common shares outstanding...... 22,098 22,409 22,925 23,037 Assuming dilution: Net income (loss) per common share......................... $ 0.35 $ 0.27 $ (0.83) $ (.08) Weighted average number of common shares outstanding...... 22,195 22,485 22,999 23,121 Three Months Ended(1) ----------------------------------------- October July April January 31, 1996 31, 1996 30, 1996 31, 1996 -------- -------- -------- --------- (In Thousands Except Per Share Data) Revenues........................... $342,049 $195,812 $152,464 $117,139 Expenses........................... $323,474 $191,280 $150,881 $116,823 Income before income taxes......... $ 18,575 $ 4,532 $ 1,583 $ 316 State and Federal income tax....... $ 6,146 $ 1,422 $ 335 $ (184) Net income......................... $ 12,429 $ 3,110 $ 1,248 $ 500 Per Share Data: Basic: Net income per common share..... $ 0.54 $ 0.13 $ 0.06 $ 0.02 Weighted average number of common shares outstanding...... 23,037 23,037 23,037 23,037 Assuming dilution: Net income per common share..... $ 0.54 $ 0.13 $ 0.06 $ 0.02 Weighted average number of common shares outstanding...... 23,120 23,115 23,112 23,093 (1) The earnings per share for the years ended October 31, 1997 and 1996 have been restated as required to comply with FAS 128. For further discussion of earnings per share and the impact of FAS 128, see Note 1. <TABLE> SCHEDULE XI HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES REAL ESTATE AND ACCUMULATED DEPRECIATION OCTOBER 31, 1998 <CAPTION> Gross Amounts (A)(B)(C) --------------------------- Building/ Tax Accumulated Description Land Improvements Total Basis Depreciation - --------------------- ----------- ------------ ----------- ----------- ------------ <S> <C> <C> <C> <C> <C> 1 Hidden Meadows $ 544,000 $ 5,750,000 $ 6,294,000 $ 6,294,000 $854,000 Ocean Twp, NJ Senior Rentals 2 Norfolk Village 640,000 5,573,000 6,213,000 6,213,000 618,000 Mahwah, NJ Senior Rentals 3 Hovnanian Corp. Center 0 9,127,000 9,127,000 12,143,000 0 North Brunswick, NJ Land/Land Improvement Approval & Flex Building Under Construction 4 Land Improvement and Approval Costs Merrimack Commercial 75,000 100,000 175,000 300,000 0 Merrimack, NH Land/Land Improvement Costs 5 NB Theatre 3,000 5,372,000 5,375,000 8,314,000 0 North Brunswick,NJ Land/Land Improvement 6 Allaire 50,000 56,000 106,000 106,000 0 Wall, NJ Land/Land Improvement 7 Wall Town Center 3,200,000 645,000 2,807,000 4,883,000 0 Wall, NJ Land/Land Improvement ----------- ------------ ----------- ----------- ------------ $ 4,512,000 $ 26,623,000 $30,097,000 $38,253,000 $1,472,000 =========== ============ =========== =========== ============ (A) Fiscal Year Construction Completed: 1 - 1993 2 - 1995 3 through 7 - not completed </TABLE> SCHEDULE XI (CONCLUDED) (B) Depreciable Life: 40 years - Depreciation expense was $446,000 for the year ended October 31, 1998. Depreciation expense was $1,854,000 for the year ended October 31, 1997. Depreciation expense was $2,665,000 for the year ended October 31, 1996. Depreciation expense was $1,973,000 for the year ended October 31, 1995. (C) Items marked 4 through 7 consist of land improvement, building construction, and approval costs on land held for future development. Balance - October 31, 1995 84,119,000 Additions: Improvements 1,115,000 Deletions: Cost of rental condominiums sold (152,000) Cost of commercial center sold (8,457,000) Cost of commercial land sold (114,000) Cost of inventory sold (9,000) ------------- Balance - October 31, 1996 76,502,000 Additions: Improvements 193,000 Land purchase and development 11,100,000 Deletions: Transfer to inventory (258,000) Cost of commercial center sold (12,283,000) Provision for impairment loss (14,446,000) ------------- Balance - October 31, 1997 60,808,000 Additions: Land purchase and development 5,466,000 Deletions: Cost of commercial properties sold (33,522,000) Cost of inventory sold (1,617,000) Provision for impairment loss (1,038,000) ------------- Balance - October 31, 1998 $ 30,097,000 ============= Balance at October 31, 1998 is reported on the consolidated balance sheet as investment properties held for sale and held for investment.