Hovnanian Enterprises Inc (HOVNP) 2004 Q3 法說會逐字稿

Good morning and thank you for joining us today for Hovnanian Enterprises fiscal 2004 third quarter earnings conference call. By now you should have all received a copy of the earnings press release. However, if anyone is missing a copy and would like one, please contact Dana Almack at 732-747-7800. We'll 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 after completion of the call and run for three months. The replay can be accessed by dialing 888-286-8010, passcode 72525198. Again the replay number is 888-286-8010, passcode 72525198. This conference is being recorded for rebroadcast and all participants are currently in a listen-only mode. Management will make some openings remarks about the third quarter results and then open up the line 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 you that -- everyone that the cautionary language about forward-looking statements contained in the press release also applies to comments made during the call and to the information in the slide presentation. I would now turn the conference call over to Ara Hovnanian, President and Chief Executive Officer of Hovnanian Enterprises. Ara, please go ahead.

Thank you. Good morning and thank you for participating in today's call to review the results of our third quarter. Joining me 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 Churipka, Assistant Director of Investor Relations. We are extremely pleased to report record revenues, earnings, deliveries and backlog for the third quarter of fiscal '04; which ended July 31st. For those of you who are viewing the slides on the Investor page of our website at khov.com, you may begin with slide 3. We significantly exceeded last year's third quarter earnings by reporting net income of $1.33 per fully diluted share for the third quarter ended July 31st. This represents a 25% increase in earnings per share from the prior record earnings of $1.06 per share achieved in third quarter last year, and exceeded our most recent projections for the quarter of $1.25 to $1.30 per share. This, by the way as you recall, was a 25--this 25% increase was on top of last year's 76% improvement over the third quarter of that previous year. So pretty tough comparison quarter as well.

Our performance in the third quarter this year was even more impressive after excluding the effect of certain charges. In our third quarter this year we incurred $13.7 million of pretax charges related to the discontinuation of the Forecast Homes brand name and the early retirement of debt, amounting to 13 cents per share. Excluding these charges the company earned $1.46 per share, which was an increase of about 36% from the third quarter of fiscal '03. As shown on slide number 4, net income of 86.7 million for the third quarter increased by 26% over last year's third quarter income of 68.8 million. Slide number 5. We continue to produce some of the highest returns in the industry and create exceptional value for our shareholders, achieving a 42% after tax return on beginning equity and a 23% after tax return on beginning capital over the most recent 12-month period ending July 31st. Slide number 6, total revenues for the three months ended July 31st increased 25% to $1.1 billion from 849 billion -- excuse me, 849 million in the year earlier period; setting a new record for our third quarter.

Slide number 7, deliveries increased 22% to 3,765 homes, also a new record for the quarter. This pace of activity surpassed '03's record third quarter deliveries of 3,075 homes. Slide number 8. Net contracts were valued at $1.3 billion, representing 4,173 homes, an increase of 34% in dollar value from last year's results. This is on top of a 48% increase in dollar value of net contracts during the third quarter of fiscal '03, again, another tough comparison period. Our growth from organic operations continues at a solid pace as evidenced by the considerable increases in our net contracts after adjustments for acquisitions. At July 31st, the year-to-date dollar value of our net contracts in the northeast increased 32% excluding the effect of the Summit Homes acquisition in Ohio. The dollar value of net contracts for the nine month period increased 20% in the southeast, not including the Winward Homes acquisition; and 21% in the southwest, not including the impact of Brighton Homes and Great Western Homes. In the west, which was not affected by any acquisitions, the dollar value of our net contracts increased 52%.

These increases in our net contracts demonstrate our ability to continue to achieve substantial organic growth. This morning, we announced our net contracts for the month of August. Once again, we experienced a significant double-digit increase in the pace of our year-over-year net contracts for the month. The dollar value of the net contracts for the month increased 57% over the same period in fiscal '03. Further indication that demand for our homes remains strong. Slide number 9. Over the past several quarters, we continue to redeploy our earnings and our capital into developing new communities for future growth, particularly in our most profitable high return markets. At July 31, we had 285 communities open companywide, a 16% increase over the prior year. Due to the lengthening of the regulatory land approval process in many of our markets, the exact timing of new community openings is becoming increasingly difficult to project. However, our current plans anticipate about 290 communities open at the end of fiscal '04. This represents about a 13% increase from the 257 communities open at the end of fiscal '03. Our experience and size are an advantage in many of our markets in acquiring land and negotiating through the approval process.

Slide number 10, contract backlog at July 31st reached 8,501 homes with a sales value of $2.7 billion, including 281 homes from unconsolidated joint ventures. The number of homes in backlog and the dollar value of backlog are both all-time records for any quarter end in our history. The value of our contract backlog represents a 68% increase over the end of July '03. We have begun to build a backlog, a substantial one, in fact, for fiscal '05 deliveries; as I'll elaborate in a moment. Our strong contract backlog and construction status gives us the confidence that we will exceed our earlier earnings target for fiscal '04. Slide number 11, one year ago our guidance for earnings was $4.13 per share for '04, with each subsequent quarter as we gained confidence in our permitting, the sales pace, pricing, and costs; we steadily raised our estimates to $4.50 per share, $4.75 per share, and most recently, to more than $5 per share. We are now, once again, increasing our projection for the year to more than $5.30 per fully diluted share. This revised projection represents over a 34% increase from last year's record earnings of $3.93 per share.

These projections would represent a 40% increase in earnings per share without the 20 cents per share charges from the extinguishment of debt and the Forecast Homes name change amortization cost. This annual projection for fiscal '04 implies a fourth quarter EPS of more than $2, representing a 43% increase from last year's fourth quarter earnings of $1.40. Fiscal '04 total revenue is now expected to climb more than 28% to $4.1 billion on deliveries of more than 14,700 homes. Net income is expected to grow by roughly 36% to more than $350 million. While we have already booked more than 4,000 homes in contract backlog for fiscal '05, it is still too early to give highly accurate guidance for EPS. We have many homes remaining to sell, we have many communities yet to open. There is still uncertainty in material pricing and uncertainty in regards to the direction of -- and the rate of home price increases. Nonetheless, assuming no home price increases, economic conditions remaining stable and our planned openings remaining on schedule; we are comfortable projecting that our fiscal '05 earnings will increase by about 20% to $6.30 per share.

We also expect a better and more even pattern of quarterly deliveries and profits starting with a strong first quarter. We currently have about 75% of our first quarter deliveries in backlog. We expect our first quarter EPS to increase at least 60% compared to last year's first quarter, to exceed $1.40 per share. And I'd like to remind everyone that our first quarter begins in less than 60 days. Since we expect deliveries to be more even in fiscal '05, it is likely that we'll not experience such a significant year-over-year growth in every single quarter. Details on our updated summary projections for fiscal year ended October 31st, '04, are available on the financial information page of the Investor Relations section of our website at www.khov.com. I'll now turn it over to Larry Sorsby to discuss our financial performance in greater detail.

Thank you, Ara. A summary of our nine-month results is displayed on slide 12 showing a strong performance for the first three-quarters of the year. Total revenues increased from 2.2 billion to 2.8 billion, and net income increased 29% from 166.1 million to $214.9 million. Earnings for the first three quarters of fiscal 2004 increased from $2.53 per diluted share in fiscal 2003 to $3.30 per fully diluted share over the nine month period in fiscal 2004. I will now get into some of the specifics for the quarter.

Turning to slide 13, the company's gross margin for the most recent three month period was 25.5%, equal to the 25.5% gross margin reported in the prior year's third quarter; despite about a 200-basis point negative impact on margins due to the effect of increases in lumber, concrete, and other material costs, and a 60-basis point impact of lower margins from two acquisitions that closed during the interim time period. Based on our backlog of homes expected to close during our fourth quarter we are projecting our gross margin for the full 2004 fiscal year to increase slightly from last year's results of 25.5%. Turning to slide 14, total selling, general, and administrative expense, including corporate expense as a percentage of total revenues, was 9% for the third quarter of 2004; an 80 basis point reduction from 9.8% in last year's third quarter. We anticipate that our total SG&A expense ratio will represent less than 9.2% of total revenues for the full year in fiscal 2004, down 80 basis points from 10% in fiscal 2003.

Moving to slide 15, the average sales price per home delivered companywide for the three months ended July 31st, was 280,500, a 3.6% increase from the average sales price of 270,800 in the prior year's third quarter. These prices include the impact of our unconsolidated joint ventures. The average sales price in our markets increased primarily as a result of the mix of our communities. Slide 16. EBITDA for the third quarter rose 32% to 178.8 million from 135 million in the third quarter of 2003. EBITDA represents earnings before interest expense, income taxes, depreciation, and amortization. The reconciliation of our company's EBITDA to net income can be found as an attachment to our quarterly earnings release. Slide 17. EBITDA covered the amount of interest incurred in the quarter by 8.3 times, an increase from 7.6 times during the same period of fiscal 2003. And total debt to EBITDA at quarter end was 1.8 times, reflecting the strength of our balance sheet and our ability to more than adequately service our debt requirements.

These parameters would justify an investment grade debt rating in nearly any other industry. During the quarter we strengthened our balance sheet by increasing the size of our unsecured revolving credit facility to 900 million from 590 million and extended the maturity through July, 2008. The expansion of our credit facility, improves our overall liquidity, and provides additional flexibility in our capital structure to fund ongoing operations and meet our targeted growth objectives. We deployed capital during the quarter to fund our seasonally high summer backlog of homes under construction. We also purchased land inventory for communities that we are planning to open. Moving to slide 18, despite discontinued investment in capital, our ratio of net recourse debt to capitalization at July 31st, 2004, was 51.3%. And we anticipate that the Company's year end net recourse debt to capitalization will be about 45%, and average net recourse debt to capitalization ratio for fiscal 2004 will be at or below 50%; in line with our previously stated targets. During the third quarter, we redeemed all of our outstanding 9 1/8% senior notes due 2009, resulting in an 8 cent charge. However this refinancing will result in annual interest savings of approximately 4 cents per diluted share going forward. This charge has been factored into the updated earnings projections for fiscal 2004 and 2005.

Slide 19. We passed a significant milestone this quarter as shareholders equity grew to more than $1 billion for the first time in our company's 45-year history. We're extremely proud of this accomplishment. At quarter end, shareholders equity was $1.05 billion, an increase from 970 million at the end of the second quarter. Based on a revised earnings projection for fiscal 2004, we now expect shareholders equity to grow to approximately 1.2 billion by October 31st, 2004. We purchased 102,000 shares of class-A common stock during the third quarter at an average price of $30.17. We now have approximately 2.1 million shares under our share buyback authorization of 4 million shares available to repurchase in the market. Profitability and margins on our mortgage operations remain under competitive pressure related to the significant fall-off in the mortgage refinance business as well as the increased popularity of ARMs, which historically are less profitable to originate.

The credit quality of our home buyers remains very strong. In fact, our average loan-to-value ratio decreased to 75% for the third quarter of fiscal 2004 compared to 78% in the third quarter of fiscal 2003. For the third quarter, adjustable rate mortgages represented 42% of our origination volume versus 19% ARM origination in the same period of fiscal 2003. The vast majority of our homebuyers that are choosing adjustable rate mortgage are selecting a three-year or five-year arm. The average FICO scores for home buyers using ARMs are actually higher than the home buyers choosing fixed-rate mortgages. For the quarter, our average FICO scores remained quite high at 718, an increase from the score of 707 in the same period of the prior fiscal year. Going to slide 20, our land position of roughly 92,000 total lots owned or controlled under option contracts provides a tremendous competitive advantage and excellent forward visibility as we look to meet our growth objectives over the next several years. This is one of the longest controlled land positions in the industry, representing nearly a six-year supply based on 2004 projected deliveries.

Most of the lots for our future communities are already owned by the Company or controlled under option. So our lot costs are locked in, providing greater forward earnings visibility as we look to meet our growth objectives over the next several years; and increasing our confidence in our financial projections. Seventy-one percent of our lots are controlled under option contract, which minimize our risk exposure to any significant decrease in the value of land. We are continuing to employ a strategy of using land and lot option contracts whenever possible to minimize our risk and give us flexibility if there is ever a slowdown in our sales within a particular community or a particular market.

Slide 21 shows our aggregate option position for all of our lot options and the amount of aggregate deposits we have at risk; which are only 7.1% of the total purchase price of the lots. We believe that this strategy maximizes our ability to reduce risk associated with landownership. Our decision to change the Forecast name allowed to us recategorize those assets from a non-amortizing indefinite life intangible on our balance sheet to a fully-amortizing definite life intangible. At July 31, 2004, we had $32.7 million of goodwill on our balance sheet, or only a little over 1% of our total assets. Our '05 projections include 43.7 million of definite life intangible amortization, representing costs of about 40 cents per share. After this amortization, our total remaining definite life intangibles will be approximately 67 million at fiscal '05 year end; assuming that we make no further acquisitions. We continue to believe that our financial treatment of acquisition premiums is among the most conservative in the industry and is the most appropriate way to represent our balance sheet. Now I'll turn it back to Ara for some closing comments.

Thanks, Larry. We're very proud of the continued strength in our financial performance and we're very pleased with the recent sales activity. The efforts of our talented group of associates in executing our business strategies have helped our company achieve earnings growth and return on invested capital that ranks at the very top of our industry. I'm pleased to say that for the third consecutive year we are recognized by Fortune Magazine as one of the top performing growth companies in the United States. Hovnanian Enterprises ranked 12th overall in the annual list, up from 15th in 2003 and I can't help but add that seven of those that are ahead of us had profits of less than $30 million; so significantly smaller companies. We ranked 14th on total return to investors with a three-year annualized return of 69% and an annualized growth in revenue and earnings per share of 40% and 71%, respectively. Our revised guidance for the next year's earnings means that our company is likely to continue achieving such recognition. While we have achieved a 64% compounded growth in earnings over the past five years, our stock, and that of all major homebuilders, continues to trade at a significant discount to industries that are not even producing close to comparable returns. The industry average PE multiple of only seven times projected '04 earnings are already less than half the equivalent multiples on the S & P 500.

Our closing share price on Friday represents a low multiple of about 6.5 times our revised projection for fiscal '04 and 5.5 times our projection for fiscal '05 earnings. While we believe that it's reasonable to assume that interest rates will gradually rise at some point in the future, we believe that they are likely to do so when the economy is much stronger. Historically, strong economies with strong job growth, consumer confidence and GDP growth have also been good periods for the housing industry. We think this positive will help mitigate the negative effects of increasing interest rates. Larger homebuilders have consistently demonstrated an ability to achieve significant double-digit growth in earnings over the past decade. As consolidation continues, large homebuilders like Hovnanian will continue to exert greater leverage over smaller builders. We expect to continue gaining market share from smaller builders regardless of whether the housing starts go up or down by 5 or 10% next year.

Our stock value is clearly not reflecting that likelihood. The market share gains we've achieved, partially as a result of industry consolidation trends have been one of the drivers of our strong financial performance over the last several years. Slide 22. While we have achieved industry leading growth and earnings over the past several years, through selective acquisition of smaller builders and by expanding our existing operations; we remain focused on improving our profitability and maximizing the efficiency of our home building operations. Our backlog for the third quarter represents an all-time record for any quarter in our company's history. As we mentioned earlier, up 68% over the prior year. With our current sales backlog and our strong land position in each of our most highly regulated markets, we remain well positioned to achieve our objectives for growth and return on capital for the remainder of fiscal '04 and into fiscal '05. That concludes our presentation and we would now be pleased to open up the call for questions.

[Caller Instructions] Please hold for your first question. We'll take a question from Margaret Whelan of UBS. Please go ahead.

Good morning, guys.

Good morning.

Good morning.

Super quarter. Well done.

Thank you.

Thank you.

Will you talk a little about, on a market-by-market basis, the competitive environment and how that might be changing right now?

Sure. Overall it's been relatively stable, in our different geographies. Perhaps with the exception that in the Houston market we're seeing a little weakness in the higher price points, but good strength in the lower price points; where, certainly, a lot of our activity is located. Obviously with some of the storm activity in the Florida area, results aren't quite as strong as you'd hope over the past couple of weeks. But, obviously, we're quite convinced that that's really a matter of the hurricanes.

So does that impact your closings or your orders in a larger magnitude, or is it the same for both?

It doesn't really impact them in a large magnitude. The -- Tampa is our only affected market and relatively speaking, it's not as big a contributor and won't have that big of an impact to us.

Okay. And then what about Texas and California?

Texas, other than what I mentioned about Houston, relatively stable. Dallas is doing just fine. Which is interesting because that's contrary to what I hear from some of my peers. We have an exceptional operation there and are very pleased with the results. California, really we're operating in at least three distinct markets there. Northern California, in the Sacramento area. Southern California along the coastal areas, the more expensive areas, then all the way inland an hour and a half away from the coast in the Riverside County and San Bernardino area. All of those areas are very, very solid. The northeast remains very solid. The Washington D.C. market remains very solid as well. Phoenix has been doing quite nicely. Perhaps I guess the only other comment is that Ohio, again, relatively small part of our overall plan is slightly weaker than it's been.

It's been weaker for awhile though, right?

Yeah, that's not a dramatic change in what it's been. So overall pretty steady conditions and continued strength in our prime markets.

Let me just add a little color since we also put out this morning our August orders. In terms of dollar amount, and all of these numbers will exclude the impact of acquisitions with the exception of our southeast region which includes our Windward Home acquisition. But the northeast, no acquisitions, up 56.4% in dollar amount year-over-year. Southwest, no acquisitions, up 30.5% year-over-year. Our west operations which is only California, no acquisitions, up 72.2% year-over-year. In the southeast, which does include the impact of our Windward Homes acquisition, up 21%. So we're having solid growth in virtually all of our major regions as we aggregate them for public reporting.

Then if you think about it, Larry, I mean obviously the outlook going into '05 is strong, but when you're thinking about your uses of capital, you reference the stock being so inexpensive and it's obviously the case. But, how do you think about allocating capital going forward in terms of putting incremental dollars in land or communities or acquisitions or share repurchasing? What's the thought process there and is the M&A pipeline picking up or going down?

We are, number one, continue to be committed to organic growth and we are reinvesting in all of our markets. Keep in mind, given that we invest and secure land for the future primarily through options, it gives us flexibility in case, you know, the market does change direction. But I will add that our core markets, all the California markets, the northeast, the D.C. market; those are highly regulated markets, and there's just a very restricted land supply there. So we feel really good about the land positions and where we're going with organic growth. So our safety, as I mentioned, is the fact that we structure them as options in case we have any errors there.

Regarding the stock price, you know, it's always a dilemma that we talk about in stock repurchases. We continue to believe it's extremely cheap relative to our performance. On the other hand, we are able to deploy our capital and earn a 42% after-tax return on equity, so, you know, you hate to reduce equity, which is effectively what happens when you buy back stock. So we just balance those two, look at the stock price from time to time and make decisions as we go along. You know, we've been a buyer over the last three or four years and it's been a great decision all along. We did buy this last quarter. We don't have any specific plans right now other than to say we still have a couple million shares remaining on our authorization.

On your authorization, sure. Okay. And then just the last question that I have is that, you know, we definitely assume that demand overall is going to slow over the next couple of years cyclically as rates go up. You know, not drop off a cliff, but do you think that organic growth might be a little tougher in the event that demand is coming down overall or do you think you'll just continue to grow organically?

Well, first of all, we don't agree that demand will drop. If you look at almost everyone's projections on household growth, when you factor in immigration for the United States. Almost everybody is projecting identical or very close to identical long-term growth for households and it's very healthy. Right around the exact same level we've been experiencing over the last three years. Now, there could be year-to-year fluctuations without a doubt. But we're relatively comfortable with the position. Now, keep in mind, we have grown substantially even though the market has grown overall by only a few percent over the last few years. We've been growing our revenues over 30, 40, 50%. So obviously even if the market were to slow down, we feel very comfortable about our ability to experience organic growth. In addition to that, if the market does slow down, we think there could be even more opportunities in the M&A area.

That you would capture?

Yes.

Okay. Sounds good. Thank you very much. Well done.

Thank you.

We'll take our next question from Ivy Zelman of CSFB.

Good morning, guys. Can you talk about how much you capitalized in interest? It looks like your interest expense as a percent of sales was down notably relative to the year ago period. And also on the corporate expense side, my first two questions with respect to significant fall-off in those expense as well. Are those sustainable numbers or are we going to see them fluctuate going into '05?

Paul or Larry, would you like to address that?

Let me get the number in front of me first. In terms of capitalized interest, I think what's happening there is, obviously, we're opening a lot of new communities and we have a lot of homes in backlog that have not yet come through. So it's logical to expect that we're going to be capitalizing more that we have in prior periods. That will come through as an expense item as we sell and deliver those homes in future quarters. So, I don't think there's anything unusual about the activity that's going on there other than an indication that we're growing in terms of our sales pace.

Larry, one of things you might --.

--as a percent of sale, you do see a change there, so maybe if you --

I think the thing you might add, Larry, on that comment, is, uh, many of our acquisitions, including Summit Homes, which has virtually no capitalized interest since they don't develop land-- or has very little capitalized interest. But also Windward Homes, which doesn't develop a lot of its own land and also our Houston acquisitions and our Arizona acquisitions; all of those tend to do a lot fewer land developments on their own as opposed to buying improved lots. The result of that is you tend to have a little less capitalized interest. A lot more of that occurs in the markets where you develop your own land. So I would suspect that's probably also part of what's going on in that percentage. Other than that there's not really a significant trend or change that's happening within any of our individual markets. It's probably just a change in the mix.

Okay. So what was the percent of capitalized interest in the quarter versus a year ago?

Kevin I think has that data.

Well, yeah, Ivy, over the last couple year this is a trend that we've been experiencing as our leverage generally has been coming down as well as lower rates that we're paying on our debt. Our interest expense as a percentage of cost of sales was 3.8% in '01, 3.1% in '02, 2.7% last year and in our updated guidance, that's on our website as of this morning, we're showing 2.7% for this year which is the same as last year. It did come this down this quarter a little bit, but it is, as Larry said, a little hard to project because of some of the acquisitions and the effects. So we're still projecting it at around 2.7% this year and, at this point, we would -- we're not getting into a lot of detail on '05; but we would expect a continuing decline in our interest expense as a percentage of our cost of sales.

And then the corporate expense to clients?

The corporate expense as an absolute level?

Absolute dollars obviously have gone up.

No, as a percent of revenue it was down--

As a percent of revenues, we're a bigger organization, we're able to spread our fixed costs more efficiently--

Is it sustainable?

Yes, definitely. We definitely do not need to grow corporate overhead at the same pace our revenues are growing. So that is absolutely sustainable as we continue to grow. That's been a trend for a while. Is it possible to talk a little bit about your trends, going back to your comments Ara regarding California. Obviously that market's been on a tear and getting a lot of price appreciation and your August order activity with the west up 72%. How much of that was coming from price, in August? We don't break that down in each of our markets, but I can tell you pricing was generally quite strong in August and remains strong right now. There still continues to be, you know, an ability to raise prices. It's primarily related to just a very restrictive supply. It's very --.

So your magnitude of price increases year-over-year has not changed whatsoever in California anyway?

No, I would say it has, Ivy. Without having the specific number, at hand, I can just tell you anecdotally that we are not being as aggressive on price increases across the board in California as we might have been say 6 or 9 months ago. Having said that, we still continue to raise prices and it continues to be a very strong market. And I'd say that for all three of those different areas: the whole Sacramento, Stockton, Modesto market up north. The inland empire market, south, and the coastal areas all remain very, very healthy.

Have you seen a change in the resale activity in the inland empire with more product on the market that might, in fact, have some impact on your business in San Diego as well?

To be honest we are seeing--obviously by our sales pace and our sales results, we--at this point in time demand is simply not a factor right now. It's just really strong. More of the issue is just getting supply on line. Particularly in the inland empire, the permitting process is just becoming ever more difficult. The regulatory conditions are just as onerous as they've ever been. And, you know, it makes had quite difficult to get supply on land. That is much more of an issue than the demand side..

Okay. And then lastly, your comments with respect to market consolidation and, you know, the large builders gaining share and continuing to do. Looking at your position, for example, in the Riverside/San Bernardino market just as one example where you're very dominant. Would you anticipate that the rate of growth can be sustained that you've enjoyed and therefore you can continue to see share gains or will it become more difficult, at some point, for you to continue at the rate of growth and you'll to have expand defensively or strategically into other market or is that an issue for Hovnanian?

Well, we while we are, for example, in the southern California inland area we are a very strong player. Having said that, there is still a lot of room for consolidation. We have a very broad product array, as you know. And as an example of that, the multi-family housing-- for sale housing in southern California, in the inland empire market has never been-- or in recent history hasn't been a big factor; but it's a product we know very well. We are now introducing that kind of product into that marketplace. We're being much more aggressive in the active adult sector. We just think there are many opportunities to dramatically expand our market share in our current market, even where we already have a strong position.

The northeast is another example of that. We are--you know, the market overall is flat in terms of starts and that's primarily driven by the lack of supply. Yet we continue to increase our market share. I think there will be great opportunities for market share expansion in our current market for several years to come. Obviously, at some point, that does become an issue and the markets are just so large. So geographic expansion is an imperative for us and we will, in all likelihood, continue to do that primarily through acquisitions. But--and by the way there is plenty of deal flow out there and opportunities to look at. Obviously, we have not announced much in the last nine months, so we've been extremely selective. But we continue to evaluate many opportunities.

At the same time we are expanding also through a significant expansion of some of our current geographies. In southern California an example is, our coastal operation is expanding into the Bakersfield area. That is completely different smsa. We're doing it by start-up and moving one of our people there. It's about a two-hour drive from our existing office but gets us into a whole other geography and another economic driver in that economy. We're also, as you know, started up Minneapolis via a start-up. So we'll continue to experiment with both, but I would guess that other than the expansion of the geographies to adjacent smsa's, you'll probably continue to see more of our activity of expansion through acquisition

Just one quick follow up on the multi-family. Are multi-family margins any different than single family margins?

No. We're really-- our product are fairly consistent in margins. Having said that, as you know, we're extremely ROI focused much more than simply profit margin. So while I say yes, I mean, the more appropriate response is our IRR's for condominiums are basically pretty consistent. In fact, they're consistent with -- IRRs are pretty consistent in all of our different product types.

Just an absolute profit would lower?

No, absolute profit sometimes can be higher in condominiums but it also really varies more by the deal structure regardless of the product. Where we develop our own land, our profit margins tend to be higher. They have to be in order to generate the IRR returns that we're looking for.

Don't you also though take more risk because you have to build more units and not necessarily all of them are presold? How does that work on condos?

No, not necessarily very different at all in California where it's pretty comparable the amount of pre-sales we do. We typically try to limit ourselves to ten homes in California--to about ten homes that we start, 10 to 15 that we start in the location without contracts in place. That's our general rule. Frankly, the markets have been so strong, we've been pre-selling far more than we normally do in our California market.

Ivy one follow-up on the capitalized interest. Although the absolute capitalized interest did increase from 26 million a year ago July to 36 million this July; the right way to measure that, I think, is a percentage of inventory. As a percent of inventory at July 31, 2003, that 26 million was 1.9% of inventories; the 36 million as of the end of July 31, '04 is only 1.7% of inventories. So as a percent of inventories, capitalized interest is going down.

Thank you.

Uh-huh.

We'll take your next question from Stephen Kim of Smith Barney.

Thanks a lot. Congratulations. Really great quarter.

Thank you, Steve.

First question I had relates to your sub count. You talked about, you know, 290, I think, by the end of the year, I think you've been bringing that down and you've explained why and that's very understandable. Was wondering if could you make some sort of commentary on '05. Are you still thinking we might see 320 by the end of '05 or roughly 10% increases year-on-year kind of thing?

Well, Steve, the first thing I'll comment on is that a subdivision is not a subdivision is not a subdivision.

I agree.

And what I mean by that, in California for example, we've opened up a high-rise community which is doing extraordinarily well. We're averaging about five contracts per week. That's a pace of 250 homes per year at one location, for one subdivision. On the other hand, we could open a new subdivision in North Carolina or Dallas, Texas, where the average absorption may be 35 to 50 homes per year. They're both considered one subdivision. So we're not as focused on precise subdivision count as analysts are. We're more focused on, you know, what the velocity is because that-- overall in a division, because that takes into account the different types of communities. Also, by the way, even in the same geography, when we open up a high-end community we obviously expect much lower sales velocity than a lower end community.

Yeah, I'm aware of all those. I actually don't -- I agree with you 100%. That having been said, I guess what I'm trying to get at is the overall wherewithal that the Company has either in terms of the sales people on the ground or the number of phases and the number of units within those phases that are available for somebody to purchase. That kind of overall breadth that you are offering to the consumer, do you expect that to be flat, down, or slightly up, or up in '05?

Let me take a shot. You know, Steve, we're going to give a lot more detail in terms of our '05 projection when we announce our fiscal '04 year end results. We'll give you some delivery expectations, revenues, margins, as well as community count. Having said that, it's safe to say that in order for us to have the kind of growth that's implied by our more than 6.30 EPS number for '05 that we do have to, in fact, grow our community count. Your guess of 10% is as good a guess as any at this early stage of the game.

Okay, great. Let's continue to trend our way towards that guidance of 6.30 in '05. Talk to me a little bit about the margin trend. Margins have been extremely strong. You indicated, Larry, in your comment that 200 bps was a head wind you face in the form of higher costs. You put lumber first, concrete second. You didn't mention land. Was wondering if could you give us an indication of how much land was up -- or contributed to that 200 basis point increase in cost?

I don't have that data easily available?

How much was lumber?

You know, what we did was we actually pulled all of our divisions to get an impact and the average that we got from all of our divisions on year-over-year material cost increases from lumber, concrete, and other commodities was about 200 basis points. I didn't have them give me the detail of lumber versus concrete versus whatever. I did it in the aggregate.

Steve, what is important to note is, as you know, a lot of these material prices are quite cyclical. We are at a cyclical high. So the good news is, just based on long term historic averages, we probably will, over time, be moving downward in material costs in those areas.

Right. Exactly. I was actually trying to figure out how much that 200 bps was going to start going the other direction on you next year. I assume land probably won't, but the other costs probably will. Okay, 60 bps you said you also sustained from the fact you closed a couple of acquisitions. I assume that what you meant there was the fact you got purchase accounting, 60 basis point drag this quarter. I assume that will probably only last another quarter or two then that 60 basis point drag goes away. Is that a right way of looking at it Larry?

I'm sorry, Steve, repeat the question.

You mentioned in addition to the 200 basis point cost drag to your gross margin, 60 basis points of a drag to your gross margin this quarter from --.

The new acquisitions?

Exactly, which I assume is purchase accounting which will go away. So that 60 basis point drag will go away in another quarter or two, right?

You know, it's not in another quarter or two because it takes a few years to amortize fully the purchase accounting adjustments. But it also could be just that the companies that we acquired get to their higher returns on investment by lower margins and higher turns than we do on average in our operation. So I don't think that's necessarily a safe assumption.

Okay, so you're not talking about a 60 basis point drag from a closing of backlog that you acquired. You're talking about an overall drag to -- that could last for a couple of years as you work through some of the land that you acquired with those acquisitions--

Yeah, it's a combination of both, I mean, clearly we have depressed the margins by our purchase accounting adjustments.

Right.

So there will be some tick up. I'm just saying that, in certain markets, when you make an acquisition of a company they could just have pre-purchase accounting, lower margins, but higher turns in order to get to the kind of return targets we're looking at. So it's a combination of the two.

Steve what I think is worthy of emphasizing is that our company does take, I think one of the more conservative approaches to purchase accounting that's possible.

Right.

And we aggressively write off any premium we can over as short a period as we can. The good news of that is, as our acquisitions continue to mature, that amortization really comes down rather rapidly and that means our earnings ability is much higher. For example, as we stated in the release, this coming year, fiscal '05, we are amortizing definite life intangibles which is the primary area that our premium goes to, other than stepping up the land. That will be amortizing over 40 million dollars. I think the number is about 45 million actually. By the end of this coming year our total amount of definite life intangibles will be about $67 million. So you can see how rapidly that will be expiring and as that expires, obviously, we won't have the $40 plus million of charges and that goes straight to our bottom line.

Right. Exactly. No, I think that's a great way of handling it. Respect to your gross margin, sort of trying to close the loop here on this. The outlook for your EPS, I would assume, has baked into it an assumption that gross margins don't really go down in '05 is that --can you be comfortable enough saying that?

I'd rather not make any specific comments. We just -- we're giving you any EPS number, we're just not going to give you any details at this time.

Yeah, we will probably give a little more guidance with our -- what we call our original budget toward the end of this year with our next quarter's conference call as we are about to begin our fiscal year end. We'll give you more details at that time.

So, okay, well basically just running our initial model, it looks like unless you're looking for some whopping land profits or something really unusual out of financial services or other; you're obviously going to be looking for some sort of favorable margin trend.

I'll answer the first two parts of that question.

That would be good.

There's nothing unusual expected in the financial service and nothing unusual with respect to land profits.

That pretty much answers my question. Last question, if I could. Just-- really this is just kind of a technical issue. When you have somebody who buys a home from you, okay, obviously they've signed the contract and so forth, it goes into your backlog, right? Let's say a month later, three weeks later, they say you know what I'd really like to add another $5,000 in options, I saw something I really like that didn't get included in the contract. Let me go ahead and buy that extra, whatever it is. Does that incremental option increase show up in the backlog? Like, so when you give us your backlog contract value does it reflect not only --.

It does not show up in backlog, Steve. If that's your question, it only shows up in deliveries, it does not show up in backlog.

Okay. So in other words, at any given point in time, when you say--just pick a number, you've got, whatever, couple million dollars in backlog in a particular community. You may actually have more in forthcoming revenues coming from options that were purchased slightly after the contract was signed. Is that what you're saying?

Yes, actually, I think what I'm saying is it excludes all upgrades and extras in our contract backlog. We don't report that at all in contract backlog it's only reported when the home delivers.

Interesting. Okay.

Virtually all cases.

Yeah, it varies a little bit depending on the systems in the different markets. I will mention that we will probably be changing that as we deploy our new system and we will report our backlog including that, but that's going to take a couple of years to get across the country. So for the moment it's a mixed result.

So, in summary, for Hovnanian specifically, sounds like your average price per backlog unit is probably a little understated.

That's a fair comment.

Okay. Thanks. Great job, guys.

Thank you.

We'll take our next question from Greg Gieber of A. G. Edwards.

Good morning, gentlemen. I wonder if you could give us a little bit more information on the -- on the lots that you control. You have some 65,000 lots under control. Could you --.

We actually have 92,000 lots under control.

Oh, 92. I'm sorry.

Yeah, the 62 would include just the option lots, I believe, and then you have to add the owned lots also to that.

Thank you. I was misreading the chart when I went back to it. Could you give us some idea what percentage above those two numbers would be concentrated in markets like New Jersey and California where land is obviously rather dear versus say markets like, you know, Phoenix or Texas where permits and land's more easily available?

Yeah, we actually in our 10-Q every quarter give a break out by major geographic area so you can actually see it yourself. We've not yet released that information for this quarter in terms of lots controlled.

I will say in general you will see that we tend to run a much higher land position in the more highly regulated markets than we do in markets that aren't as highly regulated. You know, we don't run as big a position in Phoenix or Houston or Dallas, et cetera, where the approvals are just not as lengthy. And we run much more in general, in proportion to our business, in the northeast region or D.C. as examples.

Actually, let me go ahead and give it to you by breakout. The northeast region of the 92,000 home sites that we control roughly, in our northeast region we control 25,743, in our southeast region we control 30,259, in our southwest region we control 15,581, and in our west region we control 20,314. For a grand total of 91,897 homes as of July 31st, 2004.

Thank you. That's useful. Now, could you talk about a little more as you go forward how you're going to handle the geographic dispersion of your capital? Will it be pretty much where are you now? Are there particular markets you feel that you should be putting more capital in and trying to grow faster?

Yes, in general, I'd say we're seeing more capital investment in our northeast in D.C. and in our -- in the different California markets. Those also tend to be markets that take more capital because land is more expensive. We are also growing fairly rapidly, relatively speaking, in the Phoenix and the Houston markets as well. I'd say the only market that's seeing much more modest growth at the moment is probably the North Carolina market. And the reason for that is our returns at the moment are a little lower in North Carolina and, therefore, we're not allocating as much capital to that marketplace.

Okay. Thank you very much.

We'll take our next question from Alex Barron of JMP Securities.

Yes, good morning. Great numbers.

Thank you.

I was hoping you could elaborate a little bit more on the SG&A question that Ivy talked about earlier. On an absolute dollars basis on the corporate end of it you came in at 13 million. And that seems to be quite a bit lower than last year where you had less sales, and even last quarter. I was wondering what accounted for that.

Part of that actually is related into Geaton DeCesaris and his department. He was our COO. As you may know he was diagnosed with lung cancer which he has successfully fought, but didn't feel that he quite had the energy to get back into the COO position which requires 80-hour weeks. So he has started up a land investment group for our company and so his expenses and related expenses of himself and his group have moved out of corporate and out there. So that's a part of what is causing that effect at corporate.

Probably two other issues. One is last year we had some outside consulting fees related to some system work that we were doing in SG&A, which we don't have this year's third quarter. And additionally, what we do with corporate bonuses is we, you know, estimate it based on our projected full year's return on equity; because that's primarily what drives corporate bonuses. But it's only charged as a percentage of our expected total profits for the year. So we're going to have a pretty big fourth quarter and you'll see that number increase in the fourth quarter, certainly, as compared to the third quarter.

Okay. But going forward I guess there will be some element, it sounds like, that would be a little bit less going forward.

Definitely.

Yes, I think, just as we get to be bigger we're more efficient in terms of being able to run a bigger organization without the same increase in SG&A costs at corporate.

And corporate executive bonuses budgeted this year are not budgeted to be any greater than last year. So, naturally they'd be a lower percentage of our --.

Much to our chagrin.

Well, I'm sure shareholders will be happy about that. In terms of your orders I know a number of builders have had sort of hiccups where they've shown pretty strong growth for awhile and it turns out the next quarter their orders are down on a percentage basis because they run out of communities too soon. Is there any regions or anything where, you know, that might happen, say in the next quarter or two? Or do you anticipate pretty smooth flow of orders?

That's probably the most difficult thing to project in terms of precisely when we're going to be able to open a particular community. The other thing that could happen is you actually sell out of a community sooner than you had previously expected and, therefore, there's less communities in a subsequent quarter. So it's a very difficult number to get a handle on. We have been experiencing this year regulatory delays in terms of opening communities in many parts of the country. You know, the time frame in which it takes to get these communities open is longer than it has been historically. It's just a very, very difficult thing to project. But I would not be surprised if from one month to the next, much less one quarter to the next, there could be particular geographic markets that have what I'll call weirdness in there community count because of that fact.

Okay. And one last question if I could. I was hoping you could elaborate a little bit on your consolidated joint ventures? If you could help us understand why it seems you're expanding that whereas before you really hadn't? Where those are, what kind of products you're doing? And also, you know, what percentage do you own and where are we seeing those in the income statement reported, the income coming from those?

Sure. I'll begin and perhaps Larry or Paul can elaborate. First, there are a variety of different types of -- and reasons why we'll enter a joint venture. Several of the cases, that is the only way the seller will dispose of his land. In several cases, one in New Jersey-- actually several in New Jersey, and I think two in the Washington D.C. market; the seller would simply not sell it outright, but was prepared to sell it on a more favorable terms in return for the ability to become a partner in the property. So that is one of the cases. One of the types of categories. And that can happen really in any geography.

In another case there are instances where several home builders, together want to buy a piece of property and we enter a joint venture to do it and we divvy up who gets what lots and we divvy up the cost of the improvements. That's another category and that happens, again, in a couple of different markets; not necessarily market-specific. The third area is the one that's a newer one for us, and that is where we actually have partnered up with a financial institution, where we feel that the risk or the amount of dollars are a little too concentrated in one location for us. And that-- the first one began in the northeast, with a mid-rise community, that is doing quite well. But we thought it would be more prudent to look at that with a joint venture equity partner on that specific project.

All in all it's still a very small part of our business. As you can see, we only had 128 homes I think in backlog out of thousands of homes. But, nonetheless, one that we think could be growing for sure in all three categories as land becomes more difficult to get to there are instances on prime parcels where it is a necessary part on the part of some sellers. And we think we see more opportunities for larger parcels where we may decide to bring in equity partners. So that may be growing just a bit.

Just to reiterate Ara's comment with respect to it's relatively tiny. Right now, Alex, we report it under the revenue line land sales and other revenue. It's such a small number today that we don't break it out and provide more detail. At it does grow for us in the future, we'll be providing additional detail. It's just insignificant today.

Yeah, because I guess it seemed that-- you reported you delivered 27 units and I understand that that's pretty small, but since the backlog was 281, I was imagining that we'd see a growing number there in the next couple of quarters.

Well, one of the reasons is because some of that backlog in JV is for that mid-rise community I mentioned, and that will not be -- that has a long build time and will not be delivering for several quarters.

And are the terms roughly 50/50 that you guys are sort of sharing profits on these?

Well, again, it depends on what category. In the first category, it might be, and they vary all over. In the -- at least two of them, I believe, are 50/50. They're putting up half the capital or equivalent based on the value of the land they're contributing. In the case where we're doing with another builder a completely--it's really--it shows up as a joint venture but it's just a way to divide up the land and so it just depends on the land deal. Perhaps we have two other partners in an instance, so we may be roughly a third, a third, a third; in terms of buying the land and splitting it up. In the last case where we team up with a financial partner, what typically happens is we put up a percentage of the equity required; typically 10 to 20%. We all get a pro rata return on that, the financial partner gets a preferred return, and then our return increases quite substantially after certain hurdle rates. So the net result, we pro forma typically to be about somewhere around 50% but it varies depending on the situation.

Okay. Great. And if I could ask just one last short one, with regards to your expensing of the Forecast brand name. You mentioned it was going to be split over this quarter and next quarter. How much was this quarter and how much is left over for next quarter?

Well, first of all, the entire amortization is not just split over these two quarters. I think what you heard was just our reference to this fiscal year. The actual complete amortization will take place probably over about two years, a chunk of that occurring in the year we're about to begin in '05. But, Paul, do you have the amortization break down for Forecast specifically for third and fourth quarter?

For the third quarter it was just over $5 million. I think it's around $7 million for the fourth quarter.

Okay. Great. Thank you.

[Caller Instructions] In the meantime we'll take a question from Justin Martos of Grant. Please go ahead.

Just had a question regarding your ASPs. You said it was due more towards the mix of the products you were selling. But can you just talk about on ASPs per region, just growth what you're seeing when you sort of strip out the sort of the mix that affected that ASP?

Well, again, I think even in a particular region the vast majority of any increase in the average sales prices is because of the mix of the product or the mix of communities that happened to be delivering. Yes we are having some increases in home prices especially in our heavily regulated markets along the west coast and New Jersey and Washington D.C. markets along the east coast. So that does have a factor in and we don't have specific data to provide you the difference between product--difference in product selling, different communities versus just absolute organic increases in prices. We don't have that data available.

And then can you just remind us where ARMs were as a percentage as of last quarter?

I think it was 19 versus 42, I think is the year-over-year difference.

And do you expect ARMs to continue to increase or do think they'd level out here at like 50%?

I really don't know how to make a projection on that. We just continue to monitor what it is and we'll continue to report on it on a quarterly basis.

Thank you.

We'll take our next question from Margaret Whelan of UBS.

Hi, just a quick follow-up. Do you have any sense for the speculative supply that's available in your markets and whether or not that's changing right now?

Speculative meaning of investor owners?

Well I guess there's spec supply in terms of inventory, and then spec demand terms of slipping or buyers who are buying as an investment. So if you could answer both that would be great.

Regarding the spec homes built by builders, I have not noticed any discernible change over the recent period. And I can't really comment on investor-owned, you know, inventory so to speak of other home builders. I can just say for our homeowners it's a very small number. Extremely small, and we really haven't seen a dramatic shift this quarter from whatever it was.

Okay. That's good.

I will mention we, like several other home builders, actually have a clause in our contract that severely discourages investors.

And that's within the deed, so it is legally binding, right?

Yes. We don't do that at every single community but in those communities that we expect there to be high demand for investor sales, we do put it into the deed so that it is legally binding. The other issue in terms of spec inventory, Margaret, I mean the national averages for supply spec inventory is running somewhere between four and five months worth of started unsold homes. Hovnanian runs at a far lower level, again, something we report every quarter in our Q is the number of started unsold homes both with and without models. Excluding models, as of the July 31st quarter end, we had about 1,300 started unsold homes which is about a four-week supply to us compared to the market of four month supply. So we're certainly minimizing our spec inventory.

Okay, sounds good. Thank you.

We'll take our next question from Joe Locker of Benchmark.

Yes, just getting back to, I guess, the margins for next year; what you factor in. The materials were up 200 basis points. What is your margin impact going forward? Lower, higher, or the same for next year?

Well, what we do when we make our projections is we make no assumptions with respect to we're going to be able to increase the sales price of our homes.

Right.

We also make no assumptions with respect to whether our labor and material costs are going to go up or going to go down. So when we make our internal projections we assume flat for both.

Flat for both? Thanks a lot.

Okay.

Any other questions?

There's a question from Justin Martos of Grant.

I'm sorry, it was answered.

At this time I'm showing no questions, I'll turn the call back over to you for closing remarks.

Thank you very much. Obviously, we're very pleased with the results and we're also very pleased with our indicators for the quarters to come. We look forward to continuing to report great results and updating you on our next quarterly conference call. As usual, we're all available to answer additional questions that may come after the call. Thank you, and we look forward to continued good news.

Ladies and gentlemen, thank you for joining us on the conference call. You may now disconnect.