Hovnanian Enterprises Inc (HOVNP) 2003 Q2 法說會逐字稿

Good morning and thank you for joining us today for Hovnanian's fiscal 2003 second quarter conference call. By now you should have all received a copy of the earnings press release.

However, if anyone's missing a company and would like one, please contact Dana Almac (ph). 732-747-7800. We will send you a copy of the release and ensure that you are on the company's distribution list.

There will be a replay of today's call. This replay will be available one hour after the completion of the call and run for one week. The replay can be accessed by dialing 800-428-6051, pass code 294469.

Again, the replay number is 800-428-6051, pass code 294469. This conference is being recorded for rebroadcast, and all participants are currently in a listen-only mode.

Management will make some opening remarks about the second quarter results, and then open up the lines for questions. The company will also be webcasting a slide presentation along with the opening comments from management. The slides are available on the investors page of the company's Website at www.khov.com.

Those listeners who would like to follow along should log on to the website at this time.

Before we begin, I would like to remind everyone that the cautionary language about forward-looking statements contained in the press release also applies to my comments made during this conference call and to the information in the slide presentation.

I would now like to turn the conference over to Ara Hovnanian President and Chief Executive Officer of Hovnanian Enterprises. Ara, please go ahead.

Good morning and thank you for joining us. I'm pleased to report the results for our second quarter of fiscal '03. We set all-time second quarter records for our company in virtually all categories of our financial performance including net contracts, sales backlog, revenues, net income, and we doubled our prior year's second quarter earnings per share.

Once again, we exceeded our own plans and the market expectations for earnings. During the second quarter we continued to achieve significant organic growth. We strengthened our balance sheet, and we further expanded and diversified our company's operations by completing the acquisition of an on your lot home building operation in Ohio.

Hovnanian Enterprises continues to report a return on equity and return on invested capital that are among the highest in our industry, and the return levels for our industry have been consistently among the highest of any sector.

For the second quarter our annualized return on average equity was 33.2%, and our after tax return on average invested capital was 18.6%. These are extremely healthy returns that are well in excess of our cost of capital, indicating that we are creating tremendous value for our shareholders.

Joining me on the call today from the company are Larry Sorsby, Executive Vice President and Chief Financial Officer, Paul Buchanan, Senior Vice President and Corporate Controller, Kevin Hake, Vice President and Treasurer, and Brian Cheripka, Assistant Director of Investor Relations.

Hovnanian Enterprises reported net income of $1.60 per fully diluted share for the second quarter ended April 30th, '03. This represents a 100% increase in earnings per share from the earnings of 80 cents per share achieved in fiscal '02 second quarter, as shown on slide number 1 for those of you that are following along and viewing the slides in our Website, www.khov.com.

Last year's second quarter earnings of 80 cents per share set the previous record for any second quarter, and were a 67% improvement over 2001's second quarter.

Now in the second quarter of '03 we have continued our pattern of exceptional growth and doubled our EPS to $1.60 per fully diluted share for the quarter. This is the third consecutive quarter that Hovnanian has doubled earnings per share over the same period in the previous year.

As shown on slide number 2, net income of $52.6m increased by 103% over last year's second quarter income of $25.9m.

We also continued our trend of sizable improvement in other performance measures during the quarter with revenues and earnings setting records for any second quarter, and net contracts and backlogs setting all-time company records for our 43-year history.

Slide number 3, total revenues for the three months ended April 30th, '03 increased 21% to $680m from $561m in the year earlier period.

Slide 4, our company's pretax margin in the quarter increased by an impressive 500 basis points, to 12.4% from 7.4% in the prior year's second quarter--an indication of our improved operating efficiency as well as our ability to raise prices in a number of communities.

We have remained very focused on achieving sustainable growth through improved operating efficiencies, which is evident in our ability to grow our earnings at a faster pace than our revenues and drive pretax margins higher.

Slide 5, deliveries increased to 2,496 homes, eclipsing '02's record second quarter deliveries of 2,158 homes by 16%. Slide 6. We sold more homes in the second quarter than in any other quarter in our company's history. Net contracts in the period Rose to an all-time company record of 3,389 homes, valued at $910m, an increase of 19% in dollar value from last year's results.

These results are a positive sign for our continued strong performance going forward, since we will be closing these homes and recording the profits from them over the next six to nine months.

The value of our new contracts increased 24% in the northeast and 20% in California over last year's second quarter, two particularly strong markets.

The dollar value of our net contracts in Texas including the effects of our two recent acquisitions in Houston grew 97% over last year's second quarter, increasing our position in the Texas market.

As shown in slide 7, sales backlog at April 30th reached 5,300 homes with a sales value of $1.4b, both an all-time record for any quarter and in our history.

The value of sales backlog represents an 18% increase over the end of the second quarter in '02.

We are encouraged by the depth of our backlog as we head into the second half of fiscal '03. During the quarter we acquired sales backlog of 532 homes valued at $67.2m. While we completed another company acquisition during the quarter and have now made three acquisitions of smaller builders since the start of fiscal '03, nearly all of the year over year increase in our financial results in the second quarter came from organic growth in our operations.

Healthy consumer demand for our homes allowed us to continue increasing home prices in many communities and contributed to our strong results. In addition, our process improvement initiative continued to gain momentum and we remain focused on applying efficient practices throughout our organization, plus we are achieving economies of scale, particularly in corporate overhead, as we grow our company.

We are experiencing solid demand for new housing in the majority of our markets despite the weakness in various parts of the U.S. economy.

Sales activity in pricing and traffic continue to benefit from the record low mortgage rates, while long-term demographic factors such as immigration, population growth, and household formation are driving underlying demand.

At the same time regulatory restrictions on development are increasing and provide an artificial restraint on available supply, leading to pent-up demand in many of our markets. The markets with the greatest regulatory challenges continue to have the greatest home price appreciation.

In our case approximately 2/3 of our housing deliveries are in markets with extremely difficult regulatory conditions, which helps contribute to our industry-leading performance.

While praise increases may not continue at the same pace that we've been experiencing, the underlying demand for housing in our highly regulated markets is likely to continue to exceed the available supply and ensure a more stable level of activity and profitability, with very little prospect for overbuilding or sharp increase in competitive pressures. We will be releasing our net orders for the month of may next week, and month-to-date results indicate that it has been another solid month for our company.

As we have grown over the past several years, so too has our competitive advantage in buying and developing new parcels of land. Consistent with our conservative approach to land, we seek to maximize the number of total lots controlled via option.

At April 30th we controlled more than 61,000 lots, and almost 75% of those through options. Although we are not averse to owning and developing land, we feel lot options provide additional flexibility in our home-building operations while mitigating risk associated with large land inventories.

Our strong land position gives us the assurance that we will be able to meet our projections for organic growth well into the future.

As you can see on slide number 8, we now control 100% of the lots needed to meet our '03 delivery projections, 99% of the lots needed to achieve our '04 plan, and 71% of the lots needed for our '05 growth objectives for home deliveries.

We are pleased with the excellent land position we've established in many of our markets over the past several years. The depth of our controlled lot position will allow us to achieve considerable organic growth for over the latter half of '03 and into '04. We will also continue to achieve healthy organic growth through the expansion of our diverse product mix.

For example, economists predict that there will be about 10.2m more households in the 45 to 65-year-old range in 2010 than there were at the start of the century. And the home ownership rate in that age group is in excess of 79%. As aging baby boomers are creating pent-up demand for active adult communities, luxury homes, and second homes, we are expanding our focus in that area particularly in the active adult product area.

Slide number 9, we currently control more than 19,000 active adult home sites throughout our markets and earn an excellent position to capitalize on this demographic trend over the next several years.

As you can see on slide number 10, given the 19,000 active adult home sites we control, our total number of deliveries in the active adult segment is expected to grow substantially over the next several years. In fact, we expect total volume of our active adult deliveries to triple by 2006. Many active adult buyers do not obtain a mortgage to finance their purchase. So this segment is less sensitive to any increase in mortgage rates. The ability to deploy a diverse array of homes and communities allows us to take advantage much strong demographic trends.

We remain focused on achieving 15% to 20% organic growth in earnings. Slide number 11. We have 244 communities open companywide as of April 30th. It's a 19% increase over the prior year.

Our current plan is to have about 260 communities, including about 35 in Houston, open at our fiscal year end, October 31, '03.

This will represent a 33% increase from the 196 communities open at the end of fiscal '02, or a 15% increase without the Houston communities.

Although we are subject to potential delays in the exact timing of regulatory approvals in a few of the new communities, we have significant experience in managing the approval process and in the amount of time involved, which is also quite lengthy. Each of these additional communities is already owned by the company or in some cases controlled under option, So our lot costs are locked in, providing good earnings visibility and enabling us to have the confidence in our ability to continue earning solid returns going forward.

The full benefit of sales from many of these communities will not be felt until fiscal '04. We are very optimistic about our prospects for continued organic growth in fiscal '04.

We're also very excited about our recent acquisition of Summit Homes, a privately held home building company headquartered in Canton, Ohio. Hovnanian acquired at sets of Summit Homes on April 8th, '03. So a few weeks of their operations were included in our results for the quarter from the date of closing. The acquisition marks Hovnanian's entry into the Ohio market and expands the company's build on your own lot home building operations.

Summit Homes provides a successful platform for growth, and it's an excellent fit with our strategy of diversifying further into wider segments of the housing market. Our company will gain from Summit's production knowledge and capabilities and will learn from this unique operating model.

At the same time our national purchasing contracts will allow Summit Homes to achieve greater efficiencies on top of their high level of efficiency and cost savings that they've obtained in their relationships with regional subcontractors and suppliers.

We expect to apply the benefits of scale and capital availability toward further growth of the Summit operation. We expect to deliver more than 500 homes in this market in fiscal '03.

More than 96% of our earnings in the second quarter came from growth in our organic operations. The recent acquisitions in Texas and Ohio have not had a significant impact on our financial results to date. I think this is further evidence of our ability to integrate past acquisitions and show solid growth within these new markets relatively quickly.

As we mentioned during our first quarter conference call, we were as conservative as possible with respect to the creation of goodwill in the Texas acquisitions and we continued that practice with the Summit Homes acquisition. We attempt to minimize, if not Eliminate, the amount of acquisition premium booked to goodwill since it can no longer be amortized. We have stepped up the value of inventories and assigned a balance of the purchase premium to intangible assets with finite lives whenever possible. These write-ups, unlike goodwill, can be depreciated over a range of two to seven years.

As a result of these conservative measures, the acquisition of Parkside Homes, Brighton Homes, and Summit Homes contributed only 6 cents per fully diluted share per second quarter.

Had we booked the respective premiums entirely to goodwill, we would have increased our reported earnings from what we actually did report. Although this conservative practice results in lower earnings from our acquisitions over the first few years, it will ensure better returns on invested capital from a GAAP accounting perspective over the long term and will ensure that our balance sheet remains conservative.

Now let me comment on our Updated '03 projections. Slide number 12.

The continued solid demand for new homes in most of our markets along with a strong second quarter results and healthy sales backlog has given us the confidence to increase the projections for the current fiscal year to a range of earnings between $6.50 and $6.75 per fully diluted share.

The mid-point of this range would represent a 55% increase from last year's record earnings of $4.28 per share and is on top of the 66% compounded growth in annual earnings that we have achieved over the past three years.

This revised projection of EPS represents an increase of more than $2 per share, or about 44% over our initial guidance for '03, which we provided last summer.

We are excited about our prospects Fossett remainder of '03, and we are confident in our updated projections for the year, since our backlog plus delivered homes to date represent 94% of our predicted delivery numbers for '03.

The spring selling season got off to a very strong start, and new contracts were ahead of our plan for the quarter. As we stated before, our projections assume that current absorption rates continue at our communities that are open for sale. And we assume 0 home price appreciation from the current levels.

While we do raise prices aggressively wherever we can, and we have been able to do that and continue that recently, we also strive to continue a healthy sales pace in each of our communities. If home prices appreciate, there is additional upside in our margins.

Slide number 13. Fiscal '03 revenue is expected to climb more than 12%, to nearly $3b, and deliveries are anticipated to exceed 10,500 homes.

Net after tax income is expected to grow by more than 53% to a range of $211m to $219m.

We are now also providing our first projection for fiscal '04, as we are starting to build a backlog of homes that will be delivered in early '04. Keep in mind we begin in just five months.

Assuming economic conditions consistent with what we are currently experiencing, we expect earnings per share to grow in fiscal '04 to more than $7.50 per share.

Details on our updated summary projections for fiscal '03 are available on our financial information page of the investor section of the company's Website at www.khov.com.

I'll now turn it over to Larry Sorsby to discuss the financial performance in greater detail.

Thank you, Ara. If everyone will turn to slide 14, you'll see a summary of our six-month results displayed, showing a strong performance for the first half of the year.

Earnings per share rose 111% from $1.40 last year to $2.95 per share this year on only a 29% increase in revenues. We always like to see our bottom line grow faster than our top line.

Our second quarter contracts backlog revenues and earnings all represent record levels for any second quarter in our history.

I will now get into some of the specifics for the quarter. Turning to slide 15, the company's consolidate the home building gross margin for the second quarter, excluding land sales was 25.6%, 490 basis points higher than in the second quarter of fiscal 2002.

This improvement was primarily due to increases in home prices and improved operating efficiency.

Turning to slide 16, total selling general and administrative expense including corporate expense as a percentage of total revenues was 10.7% in the second quarter of 2003--a 30 basis point increase from 10.4% in last year's second quarter, primarily as a result of increased administrative cost associated with opening additional communities that will begin to sell later this year.

Turning to slide 17, the average sales price for homes delivered companywide for the three months was $267,000, an 8.2% increase from the average sales price of $246,700 in the prior year's second quarter.

The average sales price in our markets increased as a result of our continued ability to raise prices in some communities and a variation in our mix of communities.

We expect our average sales price to remain in the range of $265,000 to $270,000 thousand dollars for the remainder of this fiscal year.

Turning to slide 18, our financial services segment also continues to improve on its healthy performance. Pretax earnings from financial services were $4.7m in the second quarter, up 32% from $3.6m in the prior year's second quarter.

This segment consists of our mortgage company, which only services our own home buyers, as well as our title company operations. The volume of business in this segment is generally tied to the level of home closings in our home building operation, but we've also been able to improve our financial services performance by increasing our mortgage capture rate to more than 75% of our non-cash home buyers.

Additionally, we've been improving the margins we're achieving on each mortgage originated by improving the efficiency of our mortgage operations.

In fiscal 2003 we should average about $3,000 of pretax profits on each loan closed through our mortgage subsidiary.

Turning to slide 19, we expect to continue the year with a solid third quarter, with earnings in the range of $1.70 to $1.75 per share, showing a healthy increase in EPS over last year's third quarter operating earnings of $1.43 per share.

We expect that the third and fourth quarters will each exceed last year's results by at least 20%, but they will not continue our recent pattern of doubling the prior year's results given the very strong results that we achieved in the last six months of fiscal 2002.

Our updated projections for the remainder of 2003 reflect an increase in margins and average sales prices from our prior projections to reflect the levels we are currently achieving. We've also revised our projected tax rate for the third and fourth quarters to reflect our actual effective tax rate of approximately 38% in the first two quarters.

Now I'll address some changes in our balance sheet.

On May 2nd, 2003, during the first week of our fiscal third quarter, Hovnanian issued 150m of senior subordinated ,notes due in 2013, with a 7 3/4 coupon at par.

Net proceeds were used to repay the outstanding balance of $30 million on our unsecured revolving credit facility with the balance funding ongoing operations in the company's continued growth objectives.

Favorable conditions in the public debt markets provided an opportunity to lock in long-term subordinated debt at a very attractive rate. This long-term debt allows us to maintain ample liquidity under our $513m unsecured revolving credit facility.

The Summit Homes acquisition had no significant impact on the company's leverage. Our credit statistics continue to be excellent, and are at levels that many investment-grade companies would be pleased with.

Hovnanian's growing financial strength was recognized by two major rating agencies during the second quarter.

With Standard & Poor's upgrading the company's senior debt rating to “double B”, and Moody's investor services increasing their ratings outlook to positive.

Turning to slide 20, EBIDTA for the second quarter rose 77% to $104.1m from $59m in the second quarter of 2002. The reconciliation of our company's EBIDTA income before income taxes can be found as an attachment on the previously distributed quarterly earning release.

Turning to slide 21, EBIDTA covered the amount of interest incurred in the quarter by 6.8 times, reflecting the company's ability to more than adequately service its debt requirements.

EBIDTA for the full year is expected to be between $420m and $428m dollars, representing a 33% increase from 2002's level.

As shown on slide 22, the company's ratio of net recourse debt to equity was 1.05 to 1 at April 30th, 2003. This compares with the ratio of net recourse debt to equity of nearly 1.4 to 1 at the end of the second quarter in 2002 after taking $25m of excess cash into consideration in last year's calculation.

We continue to anticipate that the company's average net leverage ratio for fiscal 2003 will be approximately 1 to 1, in line with our long-term goals.

Turning to slide 23, shareholders equity grew 8% to $655.8m, or $21.94 per share as of April 30th, 2003, from $607.3m, or $19.82 per share at the end of January 2003.

We anticipate shareholders equity be greater than $766m at fiscal year end, or approximately $25.63 per share.

During the second quarter of '03 we reduced our outstanding share count by 1 million shares. We bought back 250,000 class A common shares with a total purchase cost of approximately $7.3m, or $29.02 per share.

During the second quarter we also exercised the right to retire, at no cost, 750,000 class A common shares that were held by the selling principal of Forecast Homes under the terms of the Forecast Homes acquisition, which closed in January of 2002.

The retirement of those forecast shares do not affect our current share buyback authorization.

We currently have 1.1 million shares remaining under our July 2001 share repurchase authorization of 2 million shares.

Turning to slide 24, as of the end of the second quarter, on April 30th, Hovnanian adopted (inaudible) interpretation number 46, commonly referred to as FIN 46, with respect to variable interest entities created after January 31st, 2003.

I'll explain our implementation of FIN 46 in some detail, since we are one of the first home builders adopting it and its implementation is likely to attract a fair amount of interest in our industry.

The application of FIN 46 significantly alters the method for evaluating whether certain entities should be consolidated on the company's balance sheet, if such entities are deemed to be variable interest entities, or VIEs.

The FIN 46 evaluation extends to variable interest entities in which the company has no ownership but with which the company has executed lot option contracts.

The application of FIN 46 as of April 30th, 2003, for Hovnanian led to the consolidation of three variable interest entities in which the company has no ownership and resulted in the consolidation of $40.9m in land inventory owned by those entities on which the company holds a lot option contract for the majority, but not all of the lots, and added net of our option deposits, $35.8m of minority interest ownership in those entities to the company's balance sheet as of April 30th, 2003.

Turning to slide 25, FIN 46 was promulgated due to several high-profile corporate scandals such as Enron, WorldCom, Tyco, among others.

It was the accounting industry's attempt to mitigate the likelihood of future similar situations. Unfortunately, FIN 46 was drafted quickly and under political pressure.

While it is applied in an identical manner across all industries, we believe its methodology was aimed at some of these particular problem situations in other industries and its application to the home building industry was not clearly established or particularly well thought out.

Especially with regard to lot option contracts that builders have executed for many years with land sellers. On our lot option contracts, we typically have a deposit in the range of 3% to 15% of the purchase price with an average deposit of 8.1% toward the purchase price as of the end of our second quarter.

Yet for many lot option contracts, with only a 4% deposit at risk, or with even a smaller percentage at risk under fin 46 rules the fair market value of the land parcel is consolidated as inventory on the builder's balance sheet.

For you to understand this, let me describe what FIN 46 requires when a home builder holds an option with the land seller, which is in many cases the farmer or the family trust of the farmer.

The land seller generally sets up a partnership, or more often a limited liability company or LLC, for the exclusive purpose of selling his or her land parcel. Because we have an option contract to purchase the land assets from that entity rather than from the farmer as an individual, FIN 46 requires that we assess from the LLC’s perspective, not the home builder's perspective, whether the LLC or the home builder has more than 50% of the entity's risk of losses.

We assess this by preparing a probability analysis under various up side and down side scenarios to determine whether the LLC or the home builder has the majority of the risk of losses.

And by majority we mean more than 50%. This seems to make sense on the surface. However, the assessment of probabilities for various scenarios is complex and quite subjective for each different land transaction and is likely to lead to inconsistent application of FIN 46 rules across the home building industry. In many cases, particularly where there is no risk related to obtaining regulatory approvals, the analysis assumes that the probability of various down side scenarios for land values is quite low.

In such cases, even in a transaction where the builder has only a 4% deposit at risk or even less than 4%, the builder may end up with a higher likelihood of loss than the land owner.

Although the builder only has a 4% deposit under risk, under FIN 46 rules the fair market value of the land parcel is consolidated as inventory on the builder's balance sheet under this analysis.

In other cases, with significantly higher deposits in the range of 10% to 15% or even higher, the builder may not need to consolidate a variable interest entity under FIN 46 due to nuances in that particular land deal that result in an analysis that there's a greater risk of a 20-plus percent decline in land values in that particular situation.

It will be determined via the probability analysis that the land seller still has over 50% of the risk of losses in that example.

As our examples illustrate, the results of FIN 46 may not be logical or intuitive.

If we have a 15% deposit at risk we may not be required to consolidate. But with only a 4% deposit at risk, FIN 46 could require us to consolidate.

Also, if two or more builders are buying lots from the same LLC and no one builder controls more than 50% of the lots, no one builder will have more than 50% of the risk, and thus none of them will need to consolidate the entity, even though the terms of their lot options may be identical to another builder who does consolidate he is the only buyer from an entity.

Yes, that's correct. Even with identical lot option terms and down side scenario assumptions that require a single builder to consolidate under FIN 46, the same deal is not consolidated if the parcel is sold to two or three different builders rather than one builder.

If one builder options 65% of the lots and another builder options 35% of the lots under identical option agreements, under FIN 46 the builder who options 65% of the lots could end up consolidating 100% of the fair market value of 100% of the lots. Even the 35% of the lots that another builder optioned on their books while the builder with 35% consolidates nothing.

Lastly, if the land seller does not set up an entity such as an LLC, FIN 46 is not applicable regardless of the deal structure.

Turning to slide 26, hopefully, you're beginning to understand why we believe that there are likely to be inconsistencies and unintended consequences as home builders adopt the FIN 46 rules. The methodology of fin 46 does not match our intuition, and does not mirror the economic realities or risk of owning and developing land.

Most importantly, FIN 46 will obscure the true value of risk aversion embedded in lot option contracts. We feel strongly that having protection in case land values decline more than our deposit amount, especially on a community by community basis, is a very worthwhile protection to have.

In addition to being able to walk away from a lot option where lot values have declined more than a deposit amount, we know that we've been able to consistently renegotiate lot option contracts for slower takedowns and lower lot prices when a community does not perform as planned.

And even if the FIN 46 analysis somehow determines that the land seller only retains 30% or 40% of the risk of loss, that's still 40% more than they would have if we purchased the land outright ourselves.

Thus, we continue to feel that our land strategy of using lot options is the best strategy for our company with regard to minimizing our land risk.

Hovnanian has always provided a great deal of information in our public reports filed with the SEC regarding our lot option positions and lot option contracts including the amount of deposits we've invested and the total aggregate purchase price with regard to these option contracts.

We do not believe that FIN 46 will add clarity or transparency to our financial statements. Instead, as companies within the home building industry adopt FIN 46, we believe there may be a fair amount of confusion in consistency of application and reporting consequences that were not intended.

But regardless of our opinion of FIN 46, we are fully complying with this new accounting pronouncement as required. In accordance with the requirements of FIN 46, the company expects to apply the consolidation provision of FIN 46 to all of the company's variable interest entities no later than October 31st, 2003.

To assist the readers of our financial statements, we've added a category entitled "Consolidated Inventory not Owned" ,with a subcategory entitled variable interest inventory to the asset section of our balance sheet.

Note that the offset to this inventory as of April 30th is $35.8m of minority interest since we've consolidated the entities that own this inventory and these entities are 100% owned by land owners and land developers that are obligated to sell us lots under the terms of the option contracts.

The inventory is capitalized on our balance sheet at estimated fair market value. If the land owner would have had debt on the land, we would have reflected that liability on our balance sheet as well.

But since we are not even an investor in the owning entity, we often do not have access to the financial statements of these entities to know whether there's debt or not.

Regardless, we're confident that the consolidation of variable interest entities under fin 46 will not have a negative impact on our leverage ratios.

More importantly, we are confident that our strategy of using lot option contracts is the best strategy for our company with regard to minimizing our land risk and maximizing our ability to adjust to any slowdown in the housing market.

We will consolidate what we're required to consolidate, but we will continue with our current land acquisition strategy of using lot options extensively.

Now I'll turn it back to Ara for some closing comments.

Thanks, Larry. Hovnanian continues to achieve financial results that place us near the top of the industry in terms of earnings growth and return on invested capital.

We are a company that is focused on return on investment. We analyze every new community and every potential acquisition based on return on investment. As a result we've achieved improved financial results and are providing greater returns to our shareholders.

Slide 24. Despite the continued good news to come out of the industry, and the recent increases in home building stocks, home building stocks continue to sell at very low levels with the industry average PE multiple of only 7.7 times projected '03 earnings-- less than half the equivalent PE multiples of the S&P 500 and well below the prior averages for our industry.

While Hovnanian's share price has performed well over the past 12 months and particularly well over the last month, our closing share price yesterday still represents a low multiple of 7.9 times the mid-point of our revised projection for fiscal '03 earnings and we've already sold over 90% of the homes needed to achieve these earnings.

Our share price reflects a multiple of only seven times our initial minimum projection for the fiscal '04 earnings year.

And keep in mind it's only five months away, as I keep repeating, since our fiscal year ends early, we've begun to build backlog already for our first quarter of next year.

This is for a company that has achieved a 40% compounded growth in earnings over the past five years, and for the second consecutive year expects to achieve roe of above 30%.

I recognize that many continue to be worried, as they have been for years, about a pending slowdown in the public home building earnings. If our earnings projection for '04 was off by 50% and our earnings were half next year what we are projecting, we'd be at a 14 times PE, and still low relative to the S&P 500 companies.

We think the down side is absolutely limited.

Our stock is yielding a tremendous return to our shareholders, but remains undervalued relative to its performance.

We've achieved significant organic growth, strengthened our balance sheet, and once again expanded and continued to diversify our company's operations.

Our recent financial achievements are an indication of the significant progress we are making in our efforts to become a better and more efficient home building company. We are confident that the excellent performance of our company and our industry will continue into the foreseeable future.

At current stock price levels our shares continue to represent an exceptional opportunity for growth and value.

This concludes our opening comments, and we'll now be pleased to open up the call for questions.

Thank you, sir. The question and answer session will begin at this time. To use your speaker phone please pick up the handset before pressing any numbers.

Should you have a question, please press star 1 on your push button telephone. If you'd like to withdraw your question, please press star 2. Your questions will be taken in the order that it is received. Please stand by for your first question.

Our first question comes from Stephen Kim with Smith Barney. Please state your question.

Thanks very much, gentlemen. Obviously, congratulations. Great quarter.

Thanks, Steve.

First of all, I wanted to see if you could comment a little bit on your gross margins going forward.

Obviously, you've been posting some very consistent increases, not only year over year, but also sequentially here now for looks like close to six quarters in a row.

I was wondering whether or not you anticipated, you know, that kind of consistency to continue for the next -- let's say the next couple of quarters or whether or not it's primarily the year over year increase that we should be looking at.

Steve, we're going to be posting on our website today as we always do updates to our projection.

And what those are going to reflect is that for '03 we expect our home building gross margin to be between 24.5% and 25%.

Okay. And that compares to the 24.7% and 25.6% that you've reported over the last two quarters, correct?

That's correct.

Okay. That would seem to imply we should probably not assume the gross margin you're running at right now is going to be continued in the back half. Is that going to be a function of mixed shift, result in maybe purchase accounting? Or can you sort of elaborate on that?

I think that as we always do, we only project based on our most recent internal projections using current sales prices. And as we add new communities into our mix, we are estimating that we will come in at slightly lower gross margins than our existing mix of communities.

If we've misguessed that and the market continues to be strong, it's possible that margins will show some up side, but that's not what we're forecasting at this time.

Sure. Sure. Okay. Well, we've seen that movie before. It seems to be a pretty conservative way to go with things.

If you could talk a little bit about your share count and your specific income tax rates that you've assumed.

From your comments I'm assuming you're suggesting something like 38.5 for the back half of the year in terms of income tax rate. And I was wondering what kind of share count was embedded in your projections.

Weighted average shares, again, on the -- what we're going to put on the Website is 32.5 million shares for all of 2003.

Obviously, that is going to drop a little bit in the second half of the year because of the 1m shares we've retired and will be increased a little bit by an estimated exercise of a few options.

And 38% is in the ballpark of what we expect our tax rate to be for the year. It's not unusual if you go back last year, our tax rate was a little higher in the second half of the year than it was in the first half of the year.

Still looking to do buybacks here going forward?

You know, we take buybacks, you know, kind of at the point in time and review it regularly.

We have purchased 250,000 shares. We received back 750,000 shares related to the forecast transaction.

So we've effectively retired a million shares. That's a pretty good number, considering our float. So you know, we'll look at it from time to time, and we'll be opportunistic buyers if it, continues to trade at these low multiples.

Okay. And lastly, I just had a philosophical question for you. If mortgage rates, fixed rates, were to take another dive from here, from where we've been running, which is already very, very low.

Would it be your opinion that that would be an opportunity to get more aggressive, or should open the door to become more aggressive in terms of locking in land positions or to expand the company or rather, conversely, would you react to that perhaps with additional caution?

I just wanted to sort of understand how you would react in the event mortgage rates were to take a significant dive from here and stay there for let's say six months.

Steve, I don't think we would dramatically change our strategies at all.

As I mentioned on numerous occasions, we're pretty comfortable with rates and even seeing an escalation of rates because our philosophy is a reasonable scenario for interest rates to go up is an environment in which the economy's doing better, consumer confidence is better, job growth is better, and usually, we'll take that trade, you know, with higher rates and home builders do much better in that kind of environment as a whole.

So we're not overly worried about interest rates. But secondly, we really have got a really solid land position. At 61,000 lots, we have one of the greatest land positions in terms of number of years controlled in the entire home building industry.

And keep in mind a lot of our land position is in these highly restricted markets. So if there is any continued appreciation, and we project 0, that really helps the value of our land holdings.

What's also important is that 75% of those 61,000 lots are controlled through options. So if by chance we're wrong, we have a lot of flexibility in our balance sheet without a very great cost impact to our company.

But basically Steady as she goes irrespective of the interest rate environment?

Absolutely. We continue to be focused on organic growth, and we are finding opportunities in really all of our markets, particularly those where we want to grow slightly more aggressively.

And we're not having a problem. You know, one of the benefits of our strategy, which is the strategy of being a dominant builder in our markets, as opposed to being all over the country with a small presence, is that we tend to get some really good land opportunities, we tend to get first peek at them rather than getting leftover crumbs as a smaller builder in a marketplace.

So that's allowed us to have some great successes, and I think is one of the contributing factors to why we're outperforming the industry overall, and keep in mind that industry performance has been great.

Great. Thanks very much.

Mm-hmm.

The next question comes from Ivy Zelman with CSFB. Please state your question.

Thank you, gentlemen. Actually, Dennis McGill on behalf of Ivy.

I was hoping you could talk about the efficiency gains that you've mentioned frequently here and if you're able to quantify what those are.

And if possible, if you could take the 470 basis point improvement this quarter and tell us exactly how much of that might have come from pricing versus cost.

We really don't track the information that shows how much of it comes from price increases versus cost. So that's impossible to give you.

There are so many variables. And you know, how much of it is in the option selections from the customers, how much of it is in premiums, it's really not a particularly relevant number.

But the kind of efficiencies we're talking about have to do with national purchasing efficiencies. The larger we get, the better the opportunities are on our buying. Not unlike Wal-Mart, as they continue to grow they've got more power with the suppliers.

We are definitely seeing that, and certainly it's one of the areas where the growth is helping.

We just recently did an acquisition in Houston, as we talked about earlier, of Brighton Homes.

They're an excellent company. Typical mid-size builder. They are building about 850 homes a year in that market. Very astute buyers, yet our national contracts were able to save us a minimum of $1450 per house. That is real. And it's getting to be a bigger and bigger savings area.

Another area of improved operating efficiencies just has to do with economies of scale of getting larger.

Our corporate overhead is growing at a smaller pace than our overall revenue growth. And hence, corporate overhead gets allocated and amortized over more homes and becomes more efficient from that perspective.

But finally, in addition to that we are embarking on a variety of initiatives anywhere from purchasing to areas like cycle time reduction to overhead reduction through improved processes and accounts payable, and a variety of other areas, including the employment of technology, where we think we're gaining efficiencies in a variety of the home building process-related areas.

And we think the opportunities exist to continue in those efficiencies. We're about to do a test pilot on a brand new technology and software that we expect to pilot in our Virginia operation this November.

We think it will give us added efficiencies.

And if the pilot is as successful as we hope, we'll be slowly rolling it out over the next two to three years throughout the entire company. So we think there will be added opportunities for efficiencies.

Okay. Last quarter you mentioned, and you got a gross margin in the range of 23.5 to 24.5. You obviously came in at quite above that range. And what you told me last quarter was if the variation in that range would be the level of pricing you ultimately realized.

Can we assume, then, that that total up side to the 25.6 was all pricing?

Well, pricing was part of it. As you know, the northeast in particular and the whole east coast has seen a lot of difficult weather conditions.

It was snow in the winter and tremendous amounts of precipitation, you know, in the spring.

In fact, we're continuing to see that over the next few days. That costs us money in our business. And you know, it's hard to put a finite number on it. I think in retrospect we were slightly conservative as to what those costs are, but I think that's a better way to go. And to the extent that we don't spend as much in terms of additional costs for the bad weather, you know, that's opportunity for improvement as well.

One last point on that is we were in a wartime environment and really didn't know what that was going to do to our backlog, whether there was going to be any cancellations or anything that might also have impacted the mix of our deliveries, which could have altered the margin as well.

Yeah. The great news is that we experienced very little cancellation. And, frankly, you know, historically, we've been through many recessions in our 45-plus-year history, we've been through wars, recessions, high interest rates, et cetera, and we rarely see spikeups in cancellation rates. In many of our markets we get pretty substantial deposits, and that is not subject to being refunded once a buyer qualifies for a mortgage, which we tend to do very rapidly.

So we don't tend to get a lot of cancellation once they go to contract.

Well-a long those same lines am I correct that you guys said that you would be -- your projections incorporate an average closing price of 265 to 275 for the last two quarters?

We said that's what it was going to be the remainder of this fiscal year.

The remainder of this year. Is that -- it seems surprising given that your last four quarters of backlog have an average price probably of 272 or so and even on a year-over-year basis that would be a decline in the fourth quarter on pricing.

Keep in mind, mix has a tremendous amount to do with where our average price is. And you know, we are selling at slightly lower price points in Ohio and in Houston, and that certainly affects our backlog average prices.

The other thing is the Texas acquisitions in Houston have significantly lower average sales prices that's will impact that over time.

But it's safe to say that at 265 price anything above that is direct up side to your guidance?

Well, again, depending on what the mix changes are.

Okay. Real quick, guys, I'm sorry, but your guidance for this year, typically you've been bumping it up each quarter by, say, a quarter or maybe 50 cents.

We saw a bigger move up in the guidance of $1.25 on each end this quarter.

Is that -- can we see that as maybe you guys raising the bar for yourself, or is this similar to the past where it's pretty conservative and likely to be exceeded?

You know, we recognize we've been very conservative. We certainly would prefer to underpromise and overdeliver. We have exceeded almost every quarter for the last five years or so and continue to raise our projections. But having said that, I don't want to be any more specific going forward.

I would encourage you to be cautious in trying to jump over our guidance that we're giving you.

Yeah. We certainly don't want to encourage people to assume the kind of outperformance by quarter that we have in this quarter. We don't want to have everybody assume that for each of the quarters coming up.

Right.

We're very comfortable, however, with the projections we put forward.

All right. I appreciate it, guys.

The next question comes from Timothy Jones with Wasserman and Associates. Please state your question.

Good morning. Couple questions. Couple easy ones. Your orders were down in D.C. Is that just a lack of subdivisions or available product?

It's really two factors. One is we want to get more subdivisions online sooner and the regulatory process has held us up a bit, but probably a slightly bigger factor is the weather.

And you know, depending on where you're based you know what that has been like along the whole east coast, certainly the mid-Atlantic, has really slowed down some of the land development.

So our communities are coming on a little later for that reason. And we don't want to sell too far in advance and risk getting our customers a little upset if we're late on deliveries.

So the market remains very solid. And we continue to be able to pass on price increases.

I guess to that extent ironically some of these delays are helpful because we would have sold the houses at lower prices.

But we're confident we're going to get the community count back online. Hopefully the weather will give us a little break. And typically the summer months are dryer months, anyway. So we're feeling very good about the D.C. market.

Most of your competitors are actively holding back orders in the hot Southern California and D.C. markets, simply because the appreciation is so strong and they wanted to take advantage of it. Are you doing that, also?

No, I can't say we're really trying to anticipate the market. You know, we're manufacturers.

We're not real estate speculators, so to speak. So we're trying to make sure we have a balanced approach. We don't want to get ahead of ourselves and really just producing and opening up sections as they're really ready for production.

Okay. Second of three questions is what was your capture rate in the quarter?

Mortgage capture rate in the quarter was around 75%, and it's rising as we are capturing even a higher percentage of new applications.

Your $3,000 profit per origination relates to that 75% that you --

Yes, but it's only in markets where we're completely -- where we have our mortgage companies deployed, and Tim, we don't have it deployed in our entire California operation.

We've only recently started to originate there. So you can't just do the simple math.

Does this have -- do you include -- can you break it out with title and insurance --

That is purely mortgage profit.

You're just talking about origination profit?

Yes.

That's extremely high. That surprises me.

Well, keep in mind -- first of all, we do have a particularly efficient model in our company. And we're really pleased with our profit. But keep in mind, captive home builder mortgage companies definitely are more efficient than broader mortgage companies, and virtually all of our business is captive home building business. We do not go out and compete in the broad open market for mortgage business.

What got me confused is mortgage origination fees usually run 1%, and you've got a 1% of that price of the house. And I can't --

We're selling the servicing rights. It's not just the origination fee. We're selling the servicing right. We have the spread on the warehouse line. There's a number of revenue streams that go into that number. And then after the expenses of our --

I got you. What are you selling the servicing -- 150 basis points on the 75?

It depends on whether it's FHA, VA, or conventional. But even higher than that.

Really?

Yes.

Last question. This FIN 46 definitely interests me. Of the three parcels that you decided to put on the balance sheet, how many of your roughly 15,000 lots did they represent?

It's a tiny percentage, but keep in mind that we've only applied FIN 46 to new option agreements signed after January 31st, 2003.

There's a phase-in on FIN 46, in that between now and the end of our fiscal year we will apply it to the remainder of our option agreements.

You have to analyze each one individually. It takes quite a bit of time. It's a very complex calculation that you go through. But by October 31st, 2003, we'll apply the FIN 46 rules to the remainder of our lot position.

The only way that I can think of, and would you please correct me, that if you have a 4% down payment or 10% down payment that you can have a bigger risk than the developer is that you have specific performance clauses --

It has nothing to do with specific performance whatsoever. I can't really get into the finite details of the calculations, but our auditors are Ernst & Young, they audit the majority of the public home builders. They actually gave us a spreadsheet with all the formulas put in, and we put in probabilities, land parcel by land parcel, of up side and down side, various scenarios, and it calculates who has the majority of risk in a very complex, comprehensive manner.

And it's really, applying to our industry something that was never intended to be applied to our industry. And the way the calculations work, even with a 4% deposit on a approved land parcel it shows that the builder with the 4% deposit has more risk than the land seller.

Illogical, not intuitive, we don't agree with it --

This sounds insane to me, absolutely insane.

We do have some specific performance contracts, not very many at all. But those are broken out specifically and separately on our balance sheet.

Tim, we agree with you.

I'll give Larry a call on this because obviously this is going to take some time.

Yeah. There is one other factor that is really not covered by the actual rule, but it's a subjective factor but I think an important one.

Our strategy has been to be a dominant player in the markets where we are.

We're the number one builder in the New Jersey market, number two in D.C., number two in North Carolina, number two in the Southern California market, in the Inland Empire market, number two in the Sacramento, Modesto, central valley market.

The reason I'm mentioning that is because even though we do have option dollars and in some cases maybe have, let's say, a 10% deposit, the reality is if the market is slowing down and we found the price to be not in line with current markets or the absorption and takedown pace is not in line with current markets, the land seller looks at his portfolio and says, look, they're the biggest or one of the biggest builders in the marketplace, if they think it's overpriced or they can't justify the absorption I doubt somebody else can, they're a solid builder in this market, let's work with them and get a win-win.

Why can't the land seller just declare bankruptcy in that case?

Ara Hovnanian Well, in many cases we have recorded contracts. But frankly, it rarely has anything to do with solvency.

I mean, most of the land purchases we're buying are not by owners that are marginally able to make a profit selling us the land.

You know, and certainly in many cases there are farmers that have ongoing businesses. So it's not a matter of their financial wherewithal to do it. And we've been very successful. We've been using this same technique for 45 years in our company's history. We've been through good markets, bad markets, and all kinds of markets. And it's worked very well for us.

I've been doing it 35 years, and this sounds like one of the screwiest things that the accounting board's come up with.

We agree with you.

We agree with you.

Okay.

The next question comes from Robert Manowitz of UBS Warburg. Please state your question.

Yeah, hi. Good morning. Just one follow-up question on FIN 46. And that is obviously you've spent a lot of time on it. Any initial read from the rating agencies, how they will treat the minority interest? They focus on debt to capital pretty substantially.

I do not have a preliminary read from the rating agencies, but we would expect them to treat it similar to what they do with joint ventures today. When a builder has a joint venture with minority interest.

We've ignored it in our equity calculations or debt to equity ourselves.

Okay. And then at what point do you think you would provide, you know, some estimate of what the total dollar impact would be as you consolidate the full amount of the VIEs?

That will happen when we know the answer. We haven't gone through it ourselves yet. But we don't know whether we're going to report it in the October quarter or in the July quarter. And you'll know it soon as we know it.

Fair enough. Thank you very much.

The next question comes from Mike Kender with Salomon Smith Barney.

A couple of quick with ones. One is on the Ohio acquisition. Are you going to report that out as a separate geographic segment or is it going to be in one of them?

It's going to be within our northeast region at this point.

Okay. The second question was you talked about the D.C. market and orders being down because of weather and project delays. Can you talk about North Carolina? Was that drop also weather-related?

North Carolina also has had similar effects from the weather as has the whole northeastern market. However, as we've been seeing for the last two years, the North Carolina market overall continues to be one of our weaker markets.

It certainly is a profitable market for us. But it has the lower returns compared to our other geographies and is below our target returns right now.

We are seeing, ironically, signs of a little bit of pickup there, and we think our performance there may be slightly better than last year.

But nonetheless, it remains below our target levels. And it's one of the few places where we're not forecasting growth or investing additional dollars at the moment.

Okay.

Thank you.

The next question comes from Alex Banner with Franklin Templeton. Please state your question.

Good morning and congratulations. Awesome job.

Thank you.

A couple questions here. Well, first of all, I wanted to commend you on the level and quality of your disclosure. I really appreciate all the detail in every region as well as the releases of the monthly orders.

And one question I had for you was whether you can give us your expectations for deliveries for your three recent acquisitions for this year and if you have any for next year.

I'm sorry. Deliveries from our acquisitions?

Right. For each one.

You'll see that to some degree as we report, but that's really not something we make projections on.

But in just general levels we're expecting to deliver about 1,000 houses this year from our Houston operations, and I mentioned in our conference call we expect about 500 homes in Ohio. And that obviously is not for a full year since we only close on them on April 9th.

In general, both of those markets are very strong, and we are forecasting good solid growth for '04. And we feel certainly in Houston's case we have the land position to make that happen.

In Ohio's case we don't need land since we don't own land there, we build on customers' lots, but we're seeing strength in the market there.

And we are adding some new model centers. So we feel fairly confident that we'll be increasing our deliveries in both of those markets. Obviously, in Ohio we'll also have the benefit of a full year of production.

Okay. Can you comment how the return on capital for Summit compares to the rest of your company?

The return on capital for Summit Homes is absolutely off the charts.

We're intrigued by the whole notion of building on customers' lots. We started a small operation in New Jersey. We're very pleased with this initial progress. But it's quite small in relation to summit.

Keep in mind the biggest area of investment in home building is in the land area and land development.

In the case of Summit we build on the customer's land, so it never hits our balance sheet, and we have no obligation in that area.

Further, as we're building the home for the customer, they pay us along the way as we're progressing.

So the investment levels are minimal, and we're getting fabulous returns on investment. We're very excited about those opportunities.

And frankly, we think there are opportunities to expand that concept to many of our other markets, and we've got the great expertise there in Summit Homes. They really run a fabulous ship.

One additional comment on that. Although Summit Homes is off the chart in terms of the return on capital, because of our conservative purchase accounting treatment, those returns will not be quite as spectacular in the first few years as we amortize the premium that we're going to be allocating to definite life intangibles that will bring those returns back down to reality.

But in future years, as we grow It, we expect them to be hitting the ball out of the park again in terms of returns.

So are those definite life intangibles something you'll be expensing, I guess, every quarter, then?

That is correct.

That's right.

Okay. Can you give me your lot position for the end of the quarter in terms of options versus owned lots?

It's almost exactly 75, just shy of 75% optioned and 25% owned at the end of the quarter.

Okay. And the total number?

Ara Hovnanian61,000.

We had 61,371 total lots. Of that 15,632 were owned and 45,739 were optioned.

Thank you. And one last question on FIN 46. What happens in the case where you decide to walk away from an option agreement at the end, you've already brought, say, a lot onto your balance sheet the way this statement requires? Do you then just back it out or --

Yeah. I mean, our option deposit, if non-refundable, will be expensed. And then the balance of the inventory and the minority interest will just go away.

It does not flow through the P& L.

Okay.

I would like to, you know, add that in the 45 years we've been doing that we rarely end up having to walk away from options. It's a very rare occurrence in our company.

Correct. No, I understand. And is it retroactive or not? It seems --

It is retroactive in terms if we need to go back, Alex, and assess every single option agreement between now and the end of our fiscal year.

Okay. And again, what was the nuance that determines whether it gets brought onto the balance sheet or not?

There's a whole bunch of nuances. The first one is whether we're buying from an entity. So if the farmer sells it to us as an individual, FIN 46 doesn't apply. But more times than not, that farmer, even though he's an individual, is advised by his legal Counsel to set up an LLC for the single purpose of selling the land. If he does that, it gets pulled into these FIN 46 rules.

If gets pulled into the FIN 46 rules, then there's a very complex series of probability analysis that we go through to determine whether the entity, the farmer's LLC, or ourselves, has the majority of down side risk. We don't agree with the calculations, we go through it. If it says we have the majority of risk, we pull it on the balance sheet. If it says the farmer and his LLC has the majority of risk, we don't consolidate it. There's a whole bunch of other nuances to it. If you call me, I'll be glad to try to educate you further. But it's fairly complex.

Could I ask one quick question? On the share retirement forecast was that laid into the quarter? In other words, can we expect the share count to --

It happened on the last day of the second quarter. So there was really no impact to the share reduction in terms of the forecast, 750,000 shares. So it will be there for the average, it will show a decline in the third quarter.

Okay. Thank you again, and congratulations.

Thank you.

The next question comes from Greg Nejmeh with Deutsche bank. Please state your question.

Good afternoon, all. And there's a certain pleasant monotony to these calls that I find soothing.

It can become habit forming in terms of the better than expected numbers.

A couple of things. One, Larry, let me just follow up on FIN 46, if I could, for a minute. Do you think that this pronouncement, and depending on the degree to which it causes certain companies in the industry to have to add the debt associated with those deals to their books, do you think it could change the nature of option agreements as they currently exist?

I don't believe so. And I don't think so.

The only thing that may change is some people may start putting a clause in the option agreement that requires the seller to disclose whether they have debt or not.

I mean, you can imagine that most sellers aren't going to care to disclose to us whether they own the thing outright or whether they have debt on it. They're going to kind of say that's none of your business.

So it's going to be very difficult to even ascertain that information. But we may attempt to put a paragraph in our option agreements that say they need to disclose that to us.

But I believe that the industry will continue to use options just as they have historically.

Greg, if you'll recall back after the '86 tax act and some changes to the installment sales tax treatment about that same period of time, builders were forced to put on their books these collateralized mortgage obligations, both the asset and the liability side of the equation.

I think, you know, analysts ended up just ignoring it. We've isolated it on our balance sheet as consolidated inventory, not owned, and we'll also disclose how much goes into minority interest versus other liabilities.

Our expectations, because of the illogicalness of applying 1046 from the home building industry's perspective is we think both the rating agencies and equity analysts and shareholders and investors, all of them will likely ignore it once they fully understand it.

You know, in a not exactly parallel situation, most home builders have mortgage subsidiaries, and the mortgage subsidiaries are typically leveraged because of the much lower risk profile more than the home building operations, but most analysts really ignore that leverage in considering the overall consolidated debt to equity of home builders.

So I think this may be, as Larry's describing, a similar thing over time. If they don't change the rules, which do seem ridiculous to us, I think analysts will do much like they did with the mortgage segment of the balance sheet of home builders.

Ara, if I could on that point-- I mean, the mortgage company debt is legally is non-recoursed to the parent.

So you know, would the debt that would be added vis-à-vis FIN 46 be characterized in that same fashion and therefore would analysts in the investment community tend to discount it as they do the mortgage-related debt?

Greg, not only is the debt not legally ours. We don't even know whether it exists or not.

And conceivably, in the one example I gave to you where there's two home builders, one optioning 65% from the farmer's entity and another 35%. The 65% ends up with 100% of the assets and 100% of the liability. They don't even have an option agreement on 35% of them.

I mean, we think it's less than non-recourse. We don't even own it.

Let me ask you this. I have a battery of questions here. I don't want to dwell on this too too much, but is there some type of builder's council or consortium that's going to approach the appropriate agencies to discuss this topic and --

Given the timing of our year-end, we are really one of the first to have to deal with this issue. I'm sure we're going to hear it from other builders. And you know, I'm sure this will be revisited.

Who knows where it will end up? But FIN 46 was not directed to the home building industry. It was directed to the industry at large. But it has particularly odd ramifications in our industry because of the nature of our business.

Currently the FASB (ph) is not even accepting inquiries about exceptions to FIN 46. There was a lot of pressure on FASB to react very, very timely to the Enron, WorldCom, Tyco, among other type scandals. And we're not the only industry that believes some of this is illogical as applied to specific industries.

And they have pretty much put up a brick wall and are not even -- you know, clearly indicating they will not issue any exceptions for anybody at this point.

Okay. Ara, on the Summit acquisition you mentioned that there are certain implications for that particular model.

Is one of the potential implications that you could begin to explore opportunities in much, much smaller markets, markets that perhaps you wouldn't have considered previously just given the fact that they aren't of the scale and scope that you would typically consider but that Summit's model is such that you could enter smaller markets, perhaps more custom, one-off markets, than would have been the case without Summit in the fold?

that is one of the opportunities strategically. And we're excited about that, particularly as there's more and more consolidation and the top builders really capture a larger percentage of the top 50 markets.

It is going to be important strategically for having a good model to penetrate the smaller markets. This is one of them.

There are numerous opportunities in addition to going to smaller markets. The other opportunity for us is to do it in our existing large markets. There are buyers that want to build on their own lot. And in some cases, by the way, keep in mind that means teardowns. In, you know, strong infill areas. You might think, how many people own lots?

Well, there are a lot of people that buy an older house in a good neighborhood, tear it down, and all of a sudden they have a lot. So we think there's a lot of opportunity there, particularly with the growth restrictions. So that's the second opportunity. The first being going into smaller markets.

The third opportunity is they operate a very efficient distribution facility and buy materials by railroad cars, and we think there are efficiencies there. It happens to dovetail nicely with our market concentration approach.

It's hard to make that efficient if you're building 350 homes in Minneapolis, but if you're doing 2,000 homes in D.C. or 3,000 homes in southern Cal, et cetera, that is a real alternative and viable option for us. We'll be exploring that opportunity as well.

Lastly, they only build on their own lot. They do no conventional business in Ohio. And we think we can really enter that market through the back door by adding a second operation over time that does conventional business but capitalizes on their efficiencies, building off of their current base and using a distribution facilities and their current management team and purchasing team with conventional housing. We think that can give us a great cost advantage over some of the other builders in that marketplace.

So there are numerous strategic opportunities that come about from the Summit Homes acquisition.

We're very excited about it, and we think we've got a great management team there as well.

Conceptually, Ara, as I think about it, Hovnanian to date typically operates in markets where single-family permit issuance is probably no less than 5,000 units per year and arguably more like 7,500 units per year and up. Is it safe to say that Summit typically operates in markets that are 5,000 permits per year and less? Is that kind of the --

They do both, Greg. And it really depends on how you define the markets. They build all over Ohio. They build on the fringe of Cleveland, on the fringe of Cincinnati, on the fringe of Columbus. Some of that housing is typically within the metropolitan statistical area, which would be over 5,000 homes.

A lot of it is beyond what's technically considered that and is definitely in markets which are well less than the 5,000 homes per year. That's why we are excited about that -- this opportunity. They operate within a three-hour driving radius of the distribution facilities. That gets them into some pretty small markets, and they do it very efficiently, and we think it's an interesting model.

With regard to pricing, Ara, a lot has been asked regarding your ability to raise prices. I have a different question.

When you look at the average or medium price at which you price your product, vis-à-vis the average or medium price in the markets where you operate, would you characterize your pricing to be below the average or median price that you're typically competing against?

And the reason I ask is because at my conference a month ago several of the builders including yourselves detailed the cost advantage that you think you enjoy vis-à-vis many of your private competitors and therefore it appears to me based on survey work I've conducted that many of those private builders set price points because of their higher cost profiles that may actually provide a bit of a pricing umbrella to the publics, who have proportionately lower costs.

Have you analyzed that? And if so, could you comment on that theory?

You know, I think our costs are lower in a number of areas. Not just in some of the areas that we discussed, but frankly we price to market. So costs a little lower price to market.

That's what's yielding some of the superior returns that the public builders are getting in general, and our company is achieving in particular.

It's a very good market condition overall with that.

Mm-hmm. Two other quick ones. One, with regard to dividend policy, obviously, in view of the administration's tax proposal and in view of your excess cash flow and the strength in earnings that you're demonstrating and ongoing visibility. Any serious consideration to altering your dividend policy?

You know, Greg, it's awfully tempting. As you know, our family still has half the company, and we'd be a great beneficiary of it.

But given the fact that last year we achieved a 34% after-tax return on beginning equity, this year we'll absolutely exceed that, we think keeping equity in the company and taking advantage of opportunities is the way to go. And we think it's the most prudent use of the shareholders' capital.

So for the immediate period, we think we'll continue to do as we're doing and reinvesting every dollar right back into the company.

There remain some great opportunities, and there's a lot of the country we're not covering yet, and we don't want to leverage ourselves. We like our conservative financial foundation. So I wouldn't say there's anything in the immediate future right now.

Larry, one mechanical question related to the EPS guidance.

Recognizing the shares that you bought back at the end of the quarter, your shares have obviously advanced sharply, as have that of the other builders.

What guidance are you issuing with regard to your share count? And what guidance with regard to the share count is implicit in the new guidance that you provided?

Because I take it that the exercise of options and the computation surrounding options is such that you're going to see a higher share count as a consequence of the appreciation in the stock.

We did it based on 32.2m shares for the rest of this year. I mean, it's possible that we'll see some more options become exercised that will alter that number, but that is not -- that's not factored in.

What's the average weighted share count that you're assuming for the year, fiscal 2003, and what's implicit in the preliminary guidance you provided for '04 in terms of the share count?

32.5 for the year, Greg.

For this year?

Ara Hovnanian Do you have that number for '04, Larry?

For '04? Greg, I'll call you back.

Okay. Thanks much.

Okay.

The next question comes from Todd Voight with Cliffwood Partners. Please state your question.

Yes. Good morning or afternoon. I've noticed on some of your more recent acquisitions you've not disclosed pricing. And I think the last good disclosure you had was Forecast Homes where you filed an 8 K.

I'd just love to better understand what you're paying for these companies you're buying relative to book value.

Keep in mind most of the acquisitions we've done other than Washington Homes are private companies and we really need to respect the wishes of the sellers, and many of them prefer keeping their personal matters private.

Forecast Homes, because of the magnitude, we did disclose it.

But frankly, also, for competitive reasons, we are not, disclosing a lot of that information. We really pride ourselves on the exceptional job we're doing on acquisitions. However, what you can figure out fairly clearly is, any premium to book, that shows itself in intangibles. And you know, that gives some guidance.

But generally speaking, most of the industry right now is not giving out that competitive information.

We wouldn't want to do that anymore than we'd show publicly what our land costs are or building costs are or any other confidential competitive information.

Now, would you characterize the current environment as a land seller's market or a land buyer's market? In terms of pricing.

For land? I'd --

For land or for companies.

Well, to a certainly extent it's a land seller's market because it's -- you know, there is a restricted supply out there and there is demand.

On the other hand, one of the positive benefits of having the large public builders have a larger and larger market share, is that they are disciplined, sophisticated buyers.

So you know, they -- (inaudible) Similar to what we are doing. They are not typically shoot from the hip buyers as some of the small private builders can be from time to time.

So that creates a fairly disciplined market. And while it's difficult we are not seeing land purchases that don't make sense.

We only buy -- when we buy new land parcels, it has to achieve our target returns at current prices.

In 99% of the cases we assume on any land acquisition that we must achieve exceptional returns at current prices.

So we've been able to do that. So from that perspective it's neither a buyer nor a seller's market. It's a good balanced market from the land perspective.

Without disclosing pricing, can you at least disclose on the call, you know, what premium to book you've been paying for these last acquisitions?

I would say that premium to book is not the we even look at it. We look at it as return on capital deployed. And if we pay somebody one-time book to get our return on capital deployed, we're happy. And if we pay them three times book and get the return on capital deployed that we're looking for, we're equally happy.

So each deal is looked at on a stand alone basis, and at the end of the day, some of what Ara just described, we're looking at on individual land parcels, because we're in the acquisition business whether we acquire land one parcel at a time or in bulk or actually buy a company. Every single delivery we have is from acquisitions because we're not like a typical retailer that has stores that stay open or factories that stay open all the time.

Ours are opening and shut, and we have to acquire the new land for every single community that we build regardless of whether we buy the company, buy five parcels at a time, or buy it individual at a time, we're looking at cash on cash returns.

You know, I guess the best parallel point to make to really emphasize what Larry is saying is people don't ask us when we're buying land, “Gee, what was that relative to the book value of the land seller?” It's irrelevant.

I mean, we often will buy land from a land holder, a farmer or whatever, that has owned the land for 50 years, and they may own it for $100,000, and they're selling it to us for $10m.

So that's selling at 100 times book value. Should you be concerned about that? Absolutely not.

The key is we're doing our return on investment analysis, we're looking at realistic absorption rates, we're looking at current house sale prices, and we're justifying that purchase of land based on all of those parameters.

And book is really somewhat irrelevant. It's really the same as in buying companies because keep in mind one of the important factors--not the only important factor but one of the important factors--is their land holdings. And their land holdings on book may have no relevance to what the market value is.

So that's really why we're being somewhat evasive in it, not to mention the fact what I said earlier, that it's competitive information. We don't want to give it out, and most of the private sellers really prefer not to have that information out.

And if we gave you some of the book value multiples, it might not be too difficult, given you could see what the debt is, additions could be not too difficult to calculate some of those things.

So that's why most of the home builders are not giving out the information on smaller transactions.

Now, these are smaller transactions. If we did any larger transaction we would likely disclose that information.

I would, as an investor, it would be nice to get that information, particularly if you view the business as a real estate business, right now the wind is at your back and you guys are doing a great job, but whenever things go the other way, who knows when that is going to be, investors are going to want know who owns land at good price points and --

Well, but you don't know that on our land purchases, either, and they're far more significant than our company acquisitions. Again, there are many competitive reasons why you don't want to have all the information available out there.

But look, I think we have established ourselves as a prudent buyer.

I think the fact that our returns are spectacular demonstrate that.

And the one very important factor is on all of the new acquisitions we've talked about we have booked zero to goodwill. Instead, we either step up the assets on inventory, and therefore expense it out of our balance sheet very rapidly, typically in a period of one, two, sometimes three years, it gets off of the balance sheet.

Or secondarily we book it through definite life intangibles and we similarly take as aggressive a write down as we can legitimately do, so that in very short order after the acquisitions we are in any scenario back to book value, especially as we grow.

Can you speak about the process of allocating between that intangible and the write-up of land?

Sure. Well, we engage outside appraisers that are experts at the valuations of intangibles. Some of those areas include the value of the name in the marketplace, the value of the floor plans, and a variety of other factors.

And we look at that, subtract that from the premium. The balance would most typically today go to stepping up the land basis.

Ara?

Yes, Paul.

The land basis is stepped up to fair market value at the date of acquisition first, and then we evaluate the intangibles. And if our premium is less than the valuation of the intangibles then it all goes to the intangibles, and if then the value of the premium after those two is greater then you might have something left for goodwill but we haven't on the recent acquisitions.

And fair market value is determined by who?

It's determined by the company and based on a standard methodology we've used in every single acquisition we've ever done.

are you talking about fair market value of the land or fair market value of some of the intangibles?

fair market value of the land.

No, the question is to the person who just asked the question.

The land. I'm just trying to understand, there could be an incentive to not mark up the land to increase margins.

I'm going to tell you, we do the exact opposite. I don't know whether we've been clear enough. Most of our peers, when they've done significant acquisitions, have booked virtually 100% of the premium to goodwill. It's not amortized. They get the benefit of higher EPS.

We've done the exact opposite. We're not booking anything to goodwill. We're booking it to either stepped up inventories or to definite life intangibles that amortize.

Had we done that, had we done some of what our peers had done, our EPS would be significantly higher than what we're reporting now.

Now, we used to book parts of the acquisitions to goodwill. In fact, in the forecast acquisition, as we disclosed in detail, we did half to stepped up basis, half to goodwill.

But those were the days when you were allowed to amortize goodwill, which we did. We disagreed, just like we disagree with FIN 46, we disagree with the concept of not amortizing goodwill. We do not think that's a prudent practice. And we try to avoid booking any premium to goodwill as long as we can legitimately do that because we're not allowed to do that.

If we did as Larry stated -- in fact, in prior calls we've actually quantified what that difference is. If we did, we'd have much higher earnings. But we've chosen to take the more conservative approach, amortize these expenses, and reduce our reported earnings.

Great. Thank you very much.

Thank you. Our final question comes from Ari Sclochet with Millennium Partners.

His line disconnected. We do have another final question that will come from Alex Banner of Franklin Templeton.

One quick follow-up. On your community count did you give out some guidance as far as what you expected. What is it today and what you expect it to be at the end of the year?

Actually, that's one of the slides in the presentation. And it's slide number 11. But at the end of January -- excuse me, the end of October '02 we were at 196 active selling communities. At the end of act '03 we expect to be at 260 active selling communities.

Included in that 260 is 35 from our Houston acquisition. None from our Ohio acquisition because they don't own land.

Great.

Thank you.

Well, thank you all very much. We're certainly pleased to report these great results, and we're confident we're going to continue to give you positive results in the quarters to come.

As usual, our whole team is available for questions in more detail after the call. Thanks again, and looking forward to updating you at the next quarterly conference call.

Ladies and gentlemen, again, if you wish to access the replay for this call, you may do so by dialing 1-80000-428-6051 with an I.D. number of 294469.

This will be available in approximately one hour, and it will run for one week. This concludes our conference for today. Thank you all for participating and have a nice day. All parties may now disconnect.