Item 1. Business.
Sears DC Corp. ("SDC"), a wholly-owned subsidiary of Sears, Roebuck and Co. ("Sears") organized under the laws of Delaware in January 1987, was formed to borrow in domestic and foreign debt markets and lend the proceeds of such borrowings to direct and indirect subsidiaries of Sears ("SDC borrowers") in exchange for unsecured notes. SDC raised funds through the sale of its medium-term notes and direct placement of commercial paper with corporate and institutional investors. Commercial paper was sold by Sears Roebuck Acceptance Corp., an affiliate of SDC, as agent, with expenses, but no fees, being paid by SDC.
Historically, the proceeds of SDC's borrowings were loaned to Sears Consumer Financial Corporation of Delaware ("SCFCD"), a wholly-owned subsidiary of Dean Witter, Discover & Co. ("DWDC"), to finance the accounts receivable generated by the Discover Card and consumer installment notes receivable. However, as a result of the strategic repositioning of Sears in 1993, the business of SDC changed significantly. In the last quarter of 1992, SDC stopped selling medium-term notes. On March 1, 1993, DWDC, until then a wholly-owned subsidiary of Sears, completed the sale of 19.9% of its outstanding capital stock through a primary initial public offering. Also in March 1993, SDC discontinued issuing commercial paper, and was repaid by SCFCD the amounts outstanding and owing to SDC. In June of 1993, Sears spun-off its 80.1% ownership interest in DWDC to Sears shareholders.
On March 9, 1993, SDC entered into a loan agreement with Sears for the investment of funds received upon the prepayment of the notes of SCFCD. The interest rate paid to SDC by Sears under this agreement is designed to produce earnings sufficient to cover SDC's fixed charges (principally interest on SDC's indebtedness) at least 1.005 times (reduced from the previous amount of 1.25 times in March 1994, since SDC is no longer actively involved in new financing). Required payments of principal and interest to SDC under the Sears borrowing agreement will be sufficient to allow SDC to make timely payments of principal and interest to the holders of its securities.
The Net Worth Maintenance Agreement between Sears and SDC is still in effect for the benefit of holders of debt securities issued by SDC. This agreement provides for Sears to maintain ownership of and positive stockholder's equity in SDC.
At February 28, 1995, SDC had no employees on its payroll and its officers and directors consisted of employees of affiliated companies. Its offices are located at 3711 Kennett Pike, Greenville, Delaware 19807.
Item 2.

Item 3. Legal Proceedings.
None.
Item 4.

Item 4. Submission of Matters to a Vote of Security Holders.
Not applicable.
PART II
Item 5.

Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.
There is no established public trading market for SDC's common stock. As of February 28, 1995, Sears owned all outstanding shares of SDC's common stock. The Board of Directors of SDC declared a $167.4 million dividend on December 20, 1993 to Sears, payable on December 30, 1993. The Board also approved payment to Sears on December 30, 1993 of $319.1 million out of Capital in Excess of Par Value; such payment is characterized as a dividend under the Delaware General Corporation Law. Payment was effected by reducing SDC's investment in the notes of Sears by $486.5 million.
Item 6.

Item 6. Selected Financial Data.
Not applicable.
Item 7.

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
Financial Condition
On March 15, 1993, SDC received funds from DWDC's initial public offering, and a concurrent debt issuance, through SCFCD in amounts sufficient to repay the balances on the notes of SCFCD. SDC used these funds to repay short-term borrowings and current maturities of medium-term notes. SDC invested the remainder of these funds in the promissory notes of Sears, which pay interest sufficient to cover SDC's fixed charges 1.005 times, and in highly liquid short-term investments. As of December 31, 1994, the remaining proceeds of $1.6 billion were fully invested in the notes of Sears. SDC intends to use these funds to repay the maturities of its medium-term notes.
In March 1993, SDC discontinued issuing commercial paper. The last of SDC's commercial paper matured in October 1993. SDC had discontinued the sale of medium-term notes in the last quarter of 1992. The $1.5 billion in outstanding medium-term notes as of December 31, 1994 are not redeemable prior to their stated maturity except for notes having a stated maturity at the time of issue of more than seven years which may be redeemed under certain circumstances in the event of declining Discover Card receivables.
The financial information appearing in this annual report on Form 10-K is presented in historical dollars which do not reflect the decline in purchasing power that results from inflation. As is the case for most financial companies, substantially all of SDC's assets and liabilities are monetary in nature. Interest rates on SDC's investment in Sears notes are set to provide for a ratio of earnings to fixed charges of at least 1.005. This maintenance mechanism insulates SDC from bearing the effects of inflation-based interest rate increases.
Results of Operations
Due to the significant reduction in SDC's outstanding debt, interest and related expenses decreased 28.0% to $137.3 million in 1994 from $190.6 million in 1993. The Company's net income decreased significantly in 1994 from 1993 due to the reduction in the interest rate on Sears notes to produce earnings sufficient to cover SDC's fixed charges (principally interest on SDC's indebtedness) to at least 1.005 times from the 1993 amount of 1.25 times. Earnings covered fixed charges 1.005 times in 1994 and 1.32 times in 1993.
Item 8.

Item 8. Financial Statements and Supplementary Data.
SEARS DC CORP.
STATEMENTS OF INCOME Year Ended December 31, millions 1994 1993 1992 ------- ------- ------- Revenues Earnings on notes of Sears $138.3 $196.9 $ - Earnings on notes of SCFCD - 52.6 289.4 Earnings on invested cash - 2.7 8.8 ------- ------- ------- Total revenues 138.3 252.2 298.2
Expenses Interest and related expense 137.3 190.6 236.6 Operating expenses 0.3 1.5 1.9 ------- ------- ------- Total expenses 137.6 192.1 238.5 ------- ------- ------- Income before income taxes 0.7 60.1 59.7 Income taxes 0.2 21.0 20.3 ------- ------- ------- Net Income $ 0.5 $39.1 $39.4 ======= ======= =======
Ratio of earnings to fixed charges 1.005 1.32 1.25
See notes to financial statements.
SEARS DC CORP.
STATEMENTS OF FINANCIAL POSITION
December 31, millions 1994 1993 ------- ------- Assets Notes of Sears $1,552.6 $2,194.4 Cash and invested cash 0.1 0.1 Accrued interest and other assets 3.6 5.6 -------- -------- Total assets $1,556.3 $2,200.1 ======== ========
Liabilities Medium-term notes $1,521.4 $2,147.8 Accrued interest and other liabilities 30.6 48.5 -------- -------- Total liabilities 1,552.0 2,196.3 -------- -------- Stockholder's Equity Capital stock, par value $1.00 per share 1,000 shares authorized,issued and outstanding - - Retained income 4.3 3.8 -------- -------- Total stockholder's equity 4.3 3.8 -------- -------- Total liabilities and stockholder's equity $1,556.3 $2,200.1 ======== ========
See notes to financial statements.
SEARS DC CORP.
STATEMENTS OF SHAREHOLDER'S EQUITY Year Ended December 31, millions 1994 1993 1992 -------- -------- -------- Capital stock $ - $ - $ - -------- -------- --------
Capital in excess of par value Beginning of year - 319.1 319.1 Return of capital paid to Sears - (319.1) - -------- -------- -------- End of year - - 319.1 -------- -------- --------
Retained income Beginning of year 3.8 132.1 92.7 Net income 0.5 39.1 39.4 Dividend paid to Sears - (167.4) - -------- -------- -------- End of year 4.3 3.8 132.1 -------- -------- --------
Total shareholder's equity $ 4.3 $ 3.8 $451.2 ======== ======== ========
See notes to financial statements.
STATEMENTS OF CASH FLOWS Year Ended December 31, millions 1994 1993 1992 ------- ------- ------- Cash Flows From Operating Activities Net income $ 0.5 $ 39.1 $ 39.4 Adjustments to reconcile net income to net cash provided by (used in) operating activities Net change in accrued interest and other assets and accrued interest and other liabilities (15.9) 31.7 (0.7) ------- ------- ------- Net cash provided by (used in) operating activities (15.4) 70.8 38.7
Cash Flows From Investing Activities Decrease(increase) in notes of SCFCD - 4,622.4 (914.9) Decrease(increase) in notes of Sears 641.8 (2,680.9) - -------- -------- --------- Net cash provided by (used in) investing activities 641.8 1,941.5 (914.9)
Cash Flows From Financing Activities Decrease in commercial paper, primarily 90 days or less - (1,840.0) (225.5) Proceeds from medium-term notes - - 1,501.0 Repayments of medium-term notes (626.4) (257.6) (405.4) --------- --------- -------- Net cash provided by (used in) financing activities (626.4) (2,097.6) 870.1 --------- --------- --------
Net decrease in cash and invested cash - (85.3) (6.1) Cash and invested cash, beginning of year 0.1 85.4 91.5 --------- --------- --------- Cash and invested cash, end of year $ 0.1 $ 0.1 $ 85.4 --------- --------- ---------
Supplemental Disclosure of Cash Flow Information Cash paid during the year Interest $141.9 $181.7 $230.5 Income taxes 11.8 32.1 13.1
See notes to financial statements.
NOTES TO FINANCIAL STATEMENTS
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Sears DC Corp. ("SDC"), a wholly-owned subsidiary of Sears, Roebuck and Co. ("Sears"), was principally engaged in the borrowing in domestic and foreign debt markets and lending the proceeds of such borrowings to certain direct and indirect subsidiaries of Sears in exchange for their unsecured notes. Effective May 26, 1993, the company's name was changed to Sears DC Corp. from Discover Credit Corp.
Historically, the proceeds of SDC's borrowings were loaned to Sears Consumer Financial Corporation of Delaware ("SCFCD"), a wholly-owned subsidiary of Dean Witter, Discover & Co. ("DWDC"), to finance the accounts receivable generated by the Discover Card and consumer installment notes receivable. However, as a result of the strategic repositioning of Sears, the business of SDC changed significantly. In the last quarter of 1992, SDC stopped selling medium-term notes. On March 1, 1993, DWDC, until then a wholly-owned subsidiary of Sears, completed the sale of 19.9% of its outstanding capital stock through a primary initial public offering. Sears spun-off its 80.1% ownership interest in DWDC to Sears shareholders in June 1993. Also in March 1993, SDC discontinued issuing commercial paper, and was repaid by SCFCD the amounts outstanding and owing to SDC.
On March 9, 1993, SDC entered into a loan agreement with Sears for the investment of funds received upon the prepayment of the notes of SCFCD. The interest rate paid to SDC by Sears under this agreement was designed to produce earnings sufficient to cover SDC's fixed charges (principally interest on SDC's indebtedness) at least 1.25 times. On March 22, 1994, the agreement was amended to reduce the fixed charge coverage to 1.005. Required payments of principal and interest to SDC under the Sears borrowing agreement will be sufficient to allow SDC to make timely payments of principal and interest to the holders of its securities.
Cash and invested cash is defined to include all highly liquid investments with maturities of three months or less. The return of capital and dividend totalling $486.5 million paid to Sears in 1993 were effected through a non-cash transaction as a reduction in SDC's investment in Sears Notes.
The results of operations of SDC are included in the consolidated federal income tax return of Sears. Tax liabilities and benefits are allocated as generated by SDC, whether or not such benefits would be currently available on a separate return basis. Taxes are provided based on the statutory federal income tax rate.
2. BORROWINGS
The medium-term notes are not redeemable except for notes having a stated maturity at the time of issue of more than seven years which may be redeemed under certain circumstances in the event of declining Discover Card receivables. The fair market value of medium-term notes approximated $1,533.8 million and $2,297.5 million at December 31, 1994 and 1993, respectively, based on discounted cash flows using interest rates of comparable borrowings. Selected details of SDC's borrowings are shown below. Weighted average interest rates are based on the actual number of days in the year and borrowings net of unamortized discount. December 31, millions 1994 1993 -------- -------- 3.24% to 9.26% medium-term notes due 1994-2012 $1,521.4 $2,147.8 ======== ========
-------------------- Maximum millions Average (month-end) -------------------- Commercial paper outstanding $ 546.8 $1,781.8
Average Year-end -------------------- Weighted Interest Rates 4.02% -
At December 31, 1994, medium-term note maturities for the next five years were as follows:
1995 $292.7 1996 449.8 1997 335.1 1998 111.3 1999 119.5
Item 9.

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
PART III
Item 10.

Item 10. Directors and Executive Officers of the Registrant.
Not applicable.
Item 11.

Item 11. Executive Compensation.
Not applicable.
Item 12.

Item 12. Security Ownership of Certain Beneficial Owners and Management.
Not applicable.
Item 13.

Item 13. Certain Relationships and Related Transactions.
Not applicable.
PART IV
Item 14.

Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.
(a) The following documents are filed as a part of this report:
1. An "Index to Financial Statements" has been filed as a part of this report on page S-1 hereof.
2. No financial statement schedules are included herein because they are not required or because the information is contained in the financial statements and notes thereto, as noted in the "Index to Financial Statements" filed as part of this report.
3. An "Exhibit Index" has been filed as part of this report beginning on page E-1 hereof.
(b) Reports on Form 8-K: There were no reports on Form 8-K filed by the Registrant during the 4th Quarter of 1994.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
SEARS DC CORP. (Registrant)
By Paul D. Melancon* Vice President and Controller
March 28, 1995
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the date indicated.
Signature Title Date
Alice M. Peterson* Director, President and ) Chief Executive Officer ) (Principal Executive ) Officer) ) ) ) Paul D. Melancon* Vice President and Controller )March 28, 1995 (Principal Accounting ) Officer) ) ) ) Larry R. Raymond* Vice President and Treasurer ) (Principal Financial Officer)) ) James A. Blanda* Director ) ) ) James D. Constantine* Director ) )
*By /s/ PAUL D. MELANCON Individually and as Attorney-in-Fact Paul D. Melancon
SEARS DC CORP.
YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992
PAGE
STATEMENTS OF INCOME 4
STATEMENTS OF FINANCIAL POSITION 5
STATEMENTS OF STOCKHOLDER'S EQUITY 6
STATEMENTS OF CASH FLOWS 7
NOTES TO FINANCIAL STATEMENTS 8-9
REPORT OF INDEPENDENT CERTIFIED S-2 PUBLIC ACCOUNTANTS
S-1
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Stockholder and Board of Directors Greenville, DE
We have audited the accompanying Statements of Financial Position of Sears DC Corp. (formerly Discover Credit Corp.) (a wholly-owned subsidiary of Sears, Roebuck and Co.) as of December 31, 1994 and 1993, and the related Statements of Income, Stockholder's Equity and Cash Flows for each of the three years in the period ended December 31, 1994. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such financial statements present fairly, in all material respects, the financial position of Sears DC Corp. as of December 31, 1994 and 1993, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles.
Deliotte & Touche LLP Chicago, Illinois February 24, 1995
S-2
EXHIBIT INDEX
3(a) Certificate of Incorporation of Discover Credit Corp. dated January 9, 1987 [Incorporated by reference to Exhibit 3(a) to Form 10 of the Registrant (Form 10)*]
3(b) Amendment to Certificate of Incorporation of Discover Credit Corp. dated April 9, 1987 [Incorporated by reference to Exhibit 3(b) to Form 10*]
3(c) By-laws of Discover Credit Corp., as amended to May 22, 1992 [Incorporated by reference to Exhibit 3(c) to Annual Report on Form 10-K of the Registrant for the year ended December 31, 1992*]
4(a) Net Worth Maintenance Agreement between Discover Credit Corp. and Sears, Roebuck and Co., dated as of November 13, 1987 [Incorporated by reference to Exhibit 4 to Form 10*]
4(b) $1,850,000,000 Credit Agreement dated as of June 23, 1992, among Discover Credit Corp., the Banks Listed therein, The Lead Managers Referred to therein, The Co-Agents Referred to therein, and Chemical Bank, as Agent [Incorporated by reference to Exhibit 4(b) to Quarterly Report of the Registrant on Form 10-Q for the quarter ended June 30, 1992*]
4(c) Forms of fixed rate Medium-Term Note and floating rate Medium-Term Note [Incorporated by reference to Exhibits 4.1 and 4.2 to Current Report on Form 8-K of the Registrant dated February 9, 1990*]
4(d) Indenture, dated as of June 1, 1991 between Discover Credit Corp. and Bank of Delaware as Trustee [Incorporated by reference to Exhibit 4 to Registration Statement No. 33-40056]
4(e) Forms of fixed rate Medium-Term Note Series II and floating rate Medium- Term Note Series II [Incorporated by reference to Exhibits 4.2 and 4.3 to Current Report on Form 8-K of the Registrant dated June 20, 1991*]
4(f) Indenture, dated as of February 15, 1992, between Discover Credit Corp. and Harris Trust Company of New York [Incorporated by reference to Exhibit 4.1 to Current Report on Form 8-K of the Registrant dated February 28, 1992*]
4(g) Forms of fixed rate Medium Term Note Series III and floating rate Medium Term Note Series III [Incorporated by reference to Exhibits 4.2 and 4.3 to Current Report on Form 8-K of the Registrant dated February 28, 1992*]
4(h) The Registrant hereby agrees to furnish the Commission, upon request, with each instrument defining the rights of holders of long-term debt of the Registrant with respect to which the total amount of securities authorized does not exceed 10% of the total assets of the Registrant.
_________________________________________ * SEC File No. 0-17955
E-1
10(a) Letter Agreement dated March 9, 1993 between Sears, Roebuck and Co. and Discover Credit Corp. [Incorporated by reference to Exhibit 10(g) to Annual Report on Form 10-K of the Registrant for the year ended December 31, 1992*]
10(b) Amendment dated March 22, 1994 to letter Agreement dated March 9, 1993 between Sears, Roebuck and Co. and Discover Credit Corp.**
12 Calculation of ratio of earnings to fixed charges**
23 Consent of Deloitte & Touche LLP**
24 Power of attorney**
28(a) Current Report on Form 8-K of Sears, Roebuck and Co., for January 17, 1995 [Incorporated by reference, File No. 1-416]
28(b) Current Report on Form 8-K of Sears, Roebuck and Co., for February 7, 1995 [Incorporated by reference, File No. 1-416]
28(c) Annual Report on Form 10-K of Sears, Roebuck and Co. for the year ended December 31, 1994 [Incorporated by reference, File No. 1-416]
______________________________ * SEC File No. 0-17955 ** Filed herewith
Exhibit 12
SEARS DC CORP. CALCULATION OF RATIO OF EARNINGS TO FIXED CHARGES
millions
Year Ended December 31 1994 1993 1992 NET INCOME $ 0.5 $ 39.1 $ 39.4 INCOME TAXES 0.2 21.0 20.3
FIXED CHARGES, INTEREST AND RELATED CHARGES 137.3 190.6 236.6
(i) EARNINGS AVAILABLE FOR FIXED CHARGES 138.1 250.7 296.3 (ii) FIXED CHARGES 137.3 190.6 236.6
RATIO OF EARNINGS TO FIXED CHARGES (i/ii) 1.005 1.32 1.25
Exhibit 23
CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
We consent to the incorporation by reference in Registration Statement No. 33-44671 of Sears DC Corp. (formerly Discover Credit Corp.) of our report dated February 24, 1995 appearing in this Annual Report on Form 10-K of Sears DC Corp. for the year ended December 31, 1994.
Deloitte & Touche LLP Chicago, Illinois March 28, 1995
Exhibit 24
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each of the undersigned, being a director or officer, or both, of SEARS DC CORP., a Delaware corporation (the "Corporation"), does hereby constitute and appoint JAMES A. BLANDA, ALICE M. PETERSON, LARRY R. RAYMOND, PAUL D. MELANCON, RICHARD F. KOTZ and KEITH E. TROST, with full power to each of them to act alone as the true and lawful attorneys and agents of the undersigned, with full power of substitution and resubstitution to each of said attorneys, to execute, file and deliver any and all instruments and to do any and all acts and things which said attorneys and agents, or any of them, deem advisable to enable the Corporation to comply with the Securities Exchange Act of 1934, as amended, and any requirements of the Securities and Exchange Commission in respect thereto, relating to annual reports on Form 10-K, including specifically, but without limitation of the general authority hereby granted, the power and authority to sign his name in the name and on behalf of the Corporation or as a director or officer, or both, of the Corporation, as indicated below opposite his signature, to annual reports on Form 10-K or any amendment or papers supplemental thereto; and each of the undersigned does hereby fully ratify and confirm all that said attorneys and agents, or any of them, or the substitute of any of them, shall do or cause to be done by virtue hereof.
IN WITNESS WHEREOF, each of the undersigned has subscribed these presents, as of this 28th day of March, 1995.
NAME TITLE
/S/ ALICE M. PETERSON Director, President and Alice M. Peterson Chief Executive Officer (Principal Executive Officer)
/S/ LARRY R. RAYMOND Vice President and Treasurer Larry R. Raymond (Principal Financial Officer)
/S/ PAUL D. MELANCON Vice President and Controller Paul D. Melancon (Principal Accounting Officer)
/S/ JAMES A. BLANDA Director James A. Blanda
/S/ JAMES D. CONSTANTINE Director James D. Constantine


ITEM 3 - LEGAL PROCEEDINGS
During fiscal 1989, the Company became aware that certain fire-retardant plywood commonly used in the roof construction of multi-family homes may contain a product defect causing accelerated deterioration of the plywood. The Company has determined that such plywood was used in 33 of its communities containing approximately 11,750 homes.
Common areas, including roofs, in each of the Company's multi-family condominium developments are governed and controlled by homeowners' associations for each development, rather than by individual homeowners. Certain of the 33 homeowners' associations in the affected developments have asserted claims against the Company. As of February 28, 1993, the Company had entered separate agreements with 31 of the 33 associations (the "Settling Associations"), covering 10,850 homes.
In August 1989 the Company brought suit in an action entitled K. Hovnanian at Bernards I, Inc., et al. v. Hoover Treated Wood Products, Inc., et al. (No. L-11822-89) against the plywood material manufacturers, treaters, suppliers and others (the "Defendants") to determine the proper responsibility for damages, to protect its interests and to recover its damages.
In November 1992 the Company and the Settling Associations entered into a settlement agreement with most of the Defendants. Based upon the settlement monies received, the use of the Settling Associations' roof shingle reserves, and the actual expenditures in performing the repairs, the Company believes the repair costs will not require it to set aside future reserves for such roof repairs.
The Company is continuing to litigate with the two non-settling associations which contain 900 homes. Because the litigation is in its early discovery stages, the Company is unable to predict at this time the ultimate outcome of the litigation. However, due to the small size of this remaining litigation, the Company does not believe an adverse decision will have a material effect on the Company.
In addition, the Company is involved from time to time in litigation arising in the ordinary course of business, none of which is expected to have a material adverse effect on the Company.
ITEM 4

ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the fourth quarter of the year ended February 28, 1994, no matters were submitted to a vote of security holders. PART II
ITEM 5

ITEM 5 - MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDERS MATTERS
The number of shares and all data presented on a per share basis in this Form 10-K have been adjusted to give effect to all stock splits. The Company's Class A Common Stock is traded on the American Stock Exchange and was held by approximately 1,200 shareholders of record at May 13, 1994. Prior to the Company's recapitalization in September 1992 the Company's Common Stock was also traded on the American Stock Exchange. (See "Notes to Consolidated Financial Statements - Note 12" for additional explanation on recapitalization.) The high and low sales prices were as follows for each fiscal quarter during the years ended February 28, 1994 and 1993:
Class A Common Stock ---------------------------------- Common Stock Fiscal 1994 Fiscal 1993 Fiscal 1993 -------------- ---------------- --------------- Quarter High Low High Low High Low - - ------- ---- --- ---- --- ---- --- First........... $12.38 $10.50 -- -- $14.25 $ 9.25 Second.......... $14.13 $10.63 -- -- $12.38 $ 8.13 Third........... $18.13 $13.25 $11.25 $ 8.50 $10.75 $ 9.13 Fourth.......... $16.00 $13.00 $13.13 $10.63 -- --
Certain debt instruments to which the Company is a party contain restrictions on the payment of cash dividends. As a result of the most restricted of these provisions, approximately $33,432,000 was free of such restrictions at February 28, 1994. The Company has never paid dividends nor does it currently intend to pay dividends.
ITEM 6

ITEM 6 - SELECTED CONSOLIDATED FINANCIAL DATA
The following table sets forth selected financial data for the Company and its consolidated subsidiaries and should be read in conjunction with the financial statements included elsewhere in this Form 10-K. Per common share data and weighted average number of common shares outstanding reflect all stock splits. Fiscal Year Ended Summary Consolidated February February February February February Income Statement Data 28, 1994 28, 1993 29, 1992 28, 1991 28, 1990 - - --------------------- -------- -------- -------- -------- -------- (In Thousands Except Per Share Data)
Revenues................ $587,010 $429,315 $318,527 $275,428 $410,409 Costs and expenses..... 557,859 414,790 316,633 296,610 371,193 Income (loss) before income taxes, extraordinary loss and cumulative effect of change in accounting for income taxes..... 29,151 14,525 1,894 (21,182) 39,216 State and Federal income taxes................. 9,229 4,735 299 (5,937) 17,428 Extraordinary loss...... (1,277) -- -- -- -- Cumulative effect of change in accounting for income taxes...... -- -- 883 -- -- -------- -------- --------- -------- ------- Net income (loss)....... $ 18,645 $ 9,790 $ 2,478 $(15,245) $21,788 ======== ======== ======== ======== ========
Earnings per common share: Income (loss) before extraordinary loss and cumulative effect of change in accounting for income taxes....... . $ .87 $ .43 $ .07 $ (.74) $ 1.05 Extraordinary loss.... (.05) -- -- -- -- Cumulative effect of change in account- ing for income taxes -- -- .04 -- -- -------- -------- -------- -------- ------- Net income (loss).... $ .82 $ .43 $ .11 $ (.74) $ 1.05 ======== ======== ======== ======== =======
Weighted average number of common shares outstanding........... 22,821 22,775 21,988 20,695 20,834
Summary Consolidated February February February February February Balance Sheet Data 28, 1994 28, 1993 29, 1992 28, 1991 28, 1990 - - -------------------- -------- -------- -------- -------- -------- (In Thousands) Total assets............ $539,602 $465,029 $399,455 $437,930 $457,567 Mortgages, and notes payable............... $ 68,244 $ 66,699 $105,071 $158,836 $121,420 Bonds collateralized by mortgages receivable. $ 30,343 $ 39,914 $ 49,879 $ 55,456 $ 60,677 Participating senior subordinated debent- ures and subordinated notes................. $200,000 $152,157 $ 67,723 $ 71,559 $ 81,794 Stockholders' equity.... $171,001 $151,937 $141,989 $125,421 $140,666
ITEM 7

ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
CAPITAL RESOURCES AND LIQUIDITY
The Company's cash uses in fiscal 1994 were for operating expenses, seasonal increases in housing inventories, construction of commercial facilities, redemption of subordinated indebtedness, income taxes and interest. The Company provided for its cash requirements from outside borrowings, including the issuance of $100,000,000 of subordinated indebtedness, the revolving credit facility and land purchase notes, as well as from housing revenues. The Company believes that these sources of cash are sufficient to finance its working capital requirements and other needs.
The Company's bank borrowings are made pursuant to a revolving credit agreement (the "Agreement") which provides a revolving credit line of up to $130,000,000 through July 1996. The Company believes that it will be able either to extend the Agreement beyond July 1996 or negotiate a replacement facility, but there can be no assurance of such extension or replacement facility. The Company currently is in compliance and intends to maintain compliance with its covenants under the Agreement. As of February 28, 1994, there were no borrowings outstanding under the Agreement.
The aggregate principal amount of subordinated indebtedness issued by the Company and outstanding as of February 28, 1994 was $200,000,000. On June 7, 1993, the Company issued $100,000,000 9 3/4% Subordinated Notes due 2005. There are no sinking fund payments prior to maturity. In July 1993, the Company redeemed all of its outstanding 12 1/4% Subordinated Notes due 2005 at a price of 102% of par.
The Company's mortgage banking subsidiary borrows under a bank warehousing arrangement. Other finance subsidiaries formerly borrowed from a multi-builder owned financial corporation and a builder owned financial corporation to finance mortgage backed securities but in fiscal 1988 decided to cease further borrowing from multi-builder and builder owned financial corporations. These non-recourse borrowings have been generally secured by mortgage loans originated by one of the Company's subsidiaries. As of February 28, 1994, the aggregate outstanding principal amount of such borrowings was $30,755,000.
The book value of the Company's inventories, rental condominiums, and commercial properties completed and under development amounted to the following:
February 28, ------------------------------ 1994 1993 ------------ ------------
Residential real estate inventory......... $278,738,000 $243,391,000 Residential rental property............... 8,411,000 3,973,000 ------------ ------------ Total residential real estate......... 287,149,000 247,364,000 Commercial properties..................... 68,240,000 58,217,000 ------------ ------------ Combined Total........................ $355,389,000 $305,581,000 ============ ============
Total residential real estate increased $39,785,000 at February 28, 1994 from February 28, 1993 as a result of an inventory increase of $35,347,000 and a residential rental property increase of $4,438,000. The increase in residential real estate inventory was primarily due to the Company's increase in construction activities for increased deliveries next year and expansion within its existing markets. Residential homes under construction or completed and included in residential real estate inventory at February 28, 1994 are expected to be closed during the next twelve months. The Company's residential rental property increased during fiscal 1994 due to the Company's construction of senior citizen rentals amounting to $5,862,000 less liquidation of New Hampshire rentals through deep discount sales amounting to $1,424,000. The senior rentals consist of 96 homes. By building these homes and renting to seniors the Company expects to receive federal tax credits amounting to approximately $6,000,000 over the next ten years. Most residential real estate completed or under development is financed through the Company's lines of credit.
The following table summarizes housing lots included in the Company's total residential real estate:
Total Contracted Remaining Home Not Lots Lots Closed Available ------ ---------- ---------
February 28, 1994: Owned.......................... 8,255 1,643 6,612 Optioned....................... 12,898 283 12,615 ------- ---------- --------- Total 21,153 1,926 19,227 ====== ========== =========
February 28, 1993: Owned.......................... 8,983 1,379 7,604 Optioned....................... 9,785 70 9,715 ------- ---------- --------- Total 18,768 1,449 17,319 ====== ========== =========
The Company's commercial properties represent long-term investments in commercial and retail facilities completed or under development (see "Rental Program" and "Other Operations" under "Results of Operations"). When individual facilities are completed and substantially leased, the Company will have the ability to obtain long-term financing on such properties. At February 28, 1994 the Company had long-term non-recourse financing aggregating $18,474,000 on three commercial facilities, a decrease of $98,000 from February 28, 1993, due to principal amortization.
The Company's mortgages and notes receivable amounted to the following:
February 28, ------------------------------- 1994 1993 ----------- ----------- Collateralized mortgages receivable...... $30,755,000 $40,355,000 Residential mortgages receivable......... 50,673,000 34,108,000 Land and lot mortgages receivable........ 2,609,000 1,343,000 Notes from the sale of subsidiaries...... 1,199,000 3,047,000 ----------- ----------- Total Mortgages and Notes Receivable... $85,236,000 $78,853,000 =========== ===========
The collateralized mortgages receivable are pledged against non-recourse collateralized mortgage obligations. Residential mortgages receivable amounting to $43,502,000 and $25,868,000 at February 28, 1994 and 1993, respectively, are being temporarily warehoused and awaiting sale in the secondary mortgage market. The balance of such mortgages are being held as an investment by the Company. The Company may incur risk with respect to mortgages that are delinquent but only to the extent the losses are not covered by mortgage insurance or resale value of the house. Historically, the Company has incurred minimal credit losses. Land and lot mortgages are usually short term (5 years or less) and not subject to construction loan subordination. Notes from the sale of subsidiaries are secured by the assets or stock of the subsidiaries and amortized over ten years. (See "Notes to Consolidated Financial Statements - Note 9" for information on the writedown of a note from the sale of a subsidiary.)
RESULTS OF OPERATIONS
The Company's operations consist primarily of residential housing development and sales in its Northeast Region (comprised primarily of New Jersey and eastern Pennsylvania), in southeastern Florida, North Carolina and metro Washington D. C. (northern Virginia). In addition, the Company develops and operates commercial properties as long-term investments in New Jersey, and, to a lesser extent, Florida. During the last three fiscal years, the Company's Northeast Region, North Carolina Division and metro Washington D. C. Division have produced operating profits. These profits have been reduced by losses from its other operations and the establishment of reserves to reduce the book value of certain residential properties to their estimated net realizable value. Over this time, the Company has improved its profitability from a net income in fiscal 1992 of $2,478,000 to a net income in fiscal 1994 of $18,645,000. Also over this time, net sales contracts have increased each year from 2,756 homes, or $348,032,000 in fiscal 1992, to 4,305 homes, or $606,601,000 in fiscal 1994. The Company sees this trend continuing and currently expects higher operating profits, net income and net sales contracts during the year ending February 28, 1995.
The following table sets forth, for the periods indicated, certain income statement items as percentages of total revenues:
Year Ended ------------------------------------ February February February 28, 1994 28, 1993 29, 1992 -------- -------- --------
Total Revenues..................... 100.0% 100.0% 100.0% -------- -------- -------- Costs and Expenses: Construction, land, interest and operations..................... 77.6 77.3 78.0 Provision to reduce inventory to estimated net realizable value........................... -- .7 -- Selling, general and administrative................. 13.0 13.3 13.9 Mortgage banking and finance operations..................... 1.8 2.1 2.7 Rental and other operations...... 2.6 3.2 4.8 -------- -------- -------- Total costs and expenses....... 95.0 96.6 99.4 -------- -------- -------- Income Before Income Taxes, Extraordinary Item and Cumulative Effect of Change in Accounting for Income Taxes. 5.0 3.4 .6 Total Taxes........................ 1.6 1.1 .1 -------- -------- -------- 3.4 2.3 .5
Extraordinary Loss................. (.2) -- -- Cumulative Effect of Change in Accounting for Income Taxes...... -- -- .3 -------- -------- -------- Net Income.................... 3.2% 2.3% .8% ======== ======== ========
TOTAL REVENUES
Compared to fiscal 1993, total fiscal 1994 revenues increased $157.7 million, or 36.7%, due to a $160.2 million housing revenue increase, a $6.8 million decrease in land and lot sales, and a $4.3 million increase in other revenue sources. Compared to fiscal 1992, total fiscal 1993 revenues increased $110.8 million, or 34.8%, due to a $105.6 million housing revenue increase, a $7.7 million increase in land and lot sales, and a $2.5 million decrease in other revenue sources.
HOUSING OPERATIONS
Fiscal 1994 housing revenues increased by $160.2 million, or 40.3%, compared to fiscal 1993. Fiscal 1993 housing revenues increased by $105.6 million, or 36.2%, compared to fiscal 1992. Housing revenues are recorded at the time each home is delivered and title and possession have been transferred to the buyer.
Information on homes delivered by market area is set forth below:
Year Ended ------------------------------------------ February 28, February 28, February 29, 1994 1993 1992 ------------ ------------ ------------ (Dollars in Thousands)
Northeast Region(1): Housing Revenues........... $389,577 $311,347 $216,274 Homes Delivered............ 2,527 2,226 1,582
North Carolina: Housing Revenues........... $ 72,639 $ 59,399 $ 45,698 Homes Delivered............ 580 517 420
Florida: Housing Revenues........... $ 48,780 $ 19,900 $ 20,512 Homes Delivered............ 405 184 282
Metro Washington, D. C.: Housing Revenues........... $ 44,783 $ 3,327 $ -- Homes Delivered............ 288 28 --
Other: Housing Revenues........... $ 1,710 $ 3,333 $ 9,271 Homes Delivered............ 28 44 99
Totals: Housing Revenues........... $557,489 $397,306 $291,755 Homes Delivered........... 3,828 2,999 2,383
(1) Excludes suspended operations in New York which are included with New Hampshire in "Other".
The increase in housing revenue during fiscal 1994 and 1993 was the result of more homes delivered and increased average sales prices. Increased deliveries are primarily the result of opening up more housing developments for sale over this period and expanding into eastern Pennsylvania and metro Washington, D. C. The increased average sales prices are primarily the result of diversifying the Company's product mix in the Northeast Region to include more detached single family homes and larger townhouses with garages designed for the move-up buyer. Also, average sales prices have increased in Florida because substantially all its new developments are detached single family homes.
The Company's contract backlog using base sales prices by market area is set forth below:
February 28, ------------------------ 1994 1993 --------- --------- (Dollars in Thousands) Northeast Region: Total Contract Backlog..................$173,430 $130,095 Number of Homes......................... 1,182 885
North Carolina: Total Contract Backlog..................$ 55,620 $ 26,630 Number of Homes......................... 402 221
Florida: Total Contract Backlog..................$ 37,837 $ 28,461 Number of Homes......................... 278 234
Metro Washington D. C.: Total Contract Backlog..................$ 10,377 $ 14,088 Number of Homes......................... 50 101
Other: Total Contract Backlog..................$ 863 $ 477 Number of Homes......................... 14 8
Totals: Total Contract Backlog..................$278,127 $199,751 Number of Homes 1,926 1,449
The Company has established reserves to reduce certain residential inventories to their estimated net realizable values including costs to carry and dispose. These reserves were established primarily because of lower property values due to economic downturns or a change in the marketing strategy to liquidate a particular property. The established reserves are reduced for carrying costs (i.e., property taxes, interest, etc.) incurred and upon property sale. During fiscal 1993, the Company established reserves of $3.1 million. The reserves were substantially attributable to two Florida developments where sales prices were reduced to accelerate their sellout. At February 28, 1994 and February 28, 1993, remaining reserves of $9.6 million and $13.8 million, respectively, reduced residential inventories. (See "Notes to Consolidated Financial Statements - Note 1" for an additional explanation of reserves.)
Construction, land, interest and operating expenses include such expenses for housing and land and lot sales. A breakout of construction, land, interest and operations expenses for housing sales and housing gross margin is set forth below:
Year Ended -------------------------------- February February February 28, 1994 28, 1993 29, 1992 -------- -------- -------- (Dollars in Thousands) Housing Sales............................ $557,489 $397,306 $291,755 -------- -------- -------- Construction, land and operations expenses............................... 434,653 306,707 230,235 Interest expense......................... 17,424 15,671 15,584 -------- -------- -------- Total expenses......................... 452,077 322,378 245,819 -------- -------- -------- Housing gross margin..................... $105,412 $ 74,928 $ 45,936 Gross margin percentage.................. 18.9% 18.9% 15.7% ======== ======== ========
While the Company's housing gross margin remained flat in fiscal 1994 compared to fiscal 1993, construction, land and operating expenses as a percentage of housing sales increased 0.8% to 78.0% from 77.2%. This increase is primarily the result of the decreased percentage of home revenues coming from the Northeast Region where gross margins are greater. The Northeast Region has declined to 69.9% of the Company's housing revenues in fiscal 1994 from 78.4% in fiscal 1993. In addition, the increase was also caused by sharply rising material costs (primarily lumber) as demand for such materials is greater than current supplies. The 1.7% reduction of these expenses as a percentage of housing sales in fiscal 1993 compared to fiscal 1992 (to 77.2% from 78.9%) was primarily the result of decreased land costs and increased average sales prices. This improvement was aided in fiscal 1993 by the reversal of $1.0 million of previously accrued post-development completion costs.
Housing interest has declined 0.8% and 1.4% as a percentage of housing sales to 3.1% and 3.9% for fiscal 1994 and 1993, respectively. This decrease is primarily the result of the Company's increased inventory turnover and reduced average interest rates.
Selling, general and administrative expenses increased $19.2 million in fiscal 1994 from fiscal 1993 and increased $12.7 million in fiscal 1993 from fiscal 1992. The increase in fiscal 1994 and 1993 was primarily due to increased selling expenses resulting from increased new sales contracts, home deliveries and the opening of the metro Washington, D. C. division. As a percentage of total revenues, such expenses decreased to 13.0% in fiscal 1994 from 13.3% in fiscal 1993, and from 13.9% in fiscal 1992.
LAND AND LOT OPERATIONS
A breakout of construction, land, interest and operating expenses for land and lot sales and gross margin is set forth below:
Year Ended -------------------------------- February February February 28, 1994 28, 1993 29, 1992 -------- -------- -------- (Dollars in Thousands)
Land and lot sales......................... $ 4,188 $ 10,946 $ 3,220 -------- -------- -------- Construction, land and operations expenses................................. 3,158 8,564 2,243 Interest expense........................... 198 789 316 -------- -------- -------- Total expenses........................... 3,356 9,353 2,559 -------- -------- -------- Land and lot sales Gross margin............................. $ 832 $ 1,593 $ 661 ======== ======== ========
Land and lot sales are incidental to the Company's residential housing operations and are expected to continue in the future but may significantly fluctuate up or down. During fiscal 1994, land and lot sales consisted of four land sales and one lot sale community in the Northeast Region, one land sale in metro Washington, D. C. and one lot sale community in Florida. During fiscal 1993, land and lot sales consisted of three land sales and one lot sale community in the Northeast Region and two land sales and lot sales in Florida. During fiscal 1992 land and lot sales consisted of one land sale and one lot sale community in the Northeast Region and lot sales in Florida. The Florida land and lot sales are the result of the liquidation of lots in suspended communities or the sale of land not suited for its current product line.
MORTGAGE BANKING AND FINANCE OPERATIONS
Mortgage banking and finance operations consisted primarily of originating mortgages from sales of the Company's homes, and selling such mortgages in the secondary market. Approximately 27%, 26% and 32% of the Company's customers obtained mortgages originated by the Company's wholly- owned mortgage banking and finance subsidiaries in fiscal 1994, 1993 and 1992, respectively. This represents a 40% increase in mortgage originations from fiscal 1992 to fiscal 1994 due to the increase in homes delivered by the Company. Such operations also include interest income and expense from the Company's collateralized mortgages receivable and related collateral mortgage obligations. Such operations are expected to operate at a slight profit. Most servicing rights on new mortgages originated by the Company will be sold as the loans are closed.
RENTAL PROGRAM
At February 28, 1994, the Company owned and was leasing three office buildings, four office/warehouse facilities, three retail centers and one mini-storage facility. During fiscal 1994, rental operations increased due to the completion and leasing of additional commercial properties and the acquisition of a retail center mid-year. During fiscal 1993, rental operations decreased primarily due to the sale of a retail center. Rental operations include interest expense amounting to $4.9 million, $5.8 million and $6.6 million for fiscal 1994, 1993, and 1992, respectively. The Company also rented residential homes in Florida, New York and New Hampshire but liquidated most of these rentals by the end of fiscal 1992. The Company expects such operations to operate at a loss after deducting interest and depreciation.
OTHER OPERATIONS
In fiscal 1994, 1993 and 1992, other operations consisted primarily of title insurance activities, investment properties operations and other income from residential housing operations including interest income, contract deposit forfeitures and low and moderate income housing subsidies. The investment properties division supervises the construction of commercial properties and manages completed properties for the Company. Such properties, when completed, result in additional rental operations for the Company. During fiscal 1994, the Company sold a retail center in New Jersey. Included in other income is the pretax gain from this sale amounting to $538,000.
TOTAL TAXES
Total taxes as a percentage of income before income taxes amounted to 31.7%, 32.5% and 15.8% in fiscal 1994, 1993 and 1992, respectively. The Company applied for and received a refund of federal income taxes for fiscal 1992 based on a loss carryback amounting to approximately $1.6 million. Deferred federal and state income tax assets for fiscal 1994 and 1993 primarily represents the deferred tax benefits arising from temporary differences between book and tax income which will be recognized in future years. (See "Notes to Consolidated Financial Statements - Note 8" for an additional explanation of taxes.)
CUMMULATIVE EFFECT OF CHANGE IN ACCOUNTING FOR INCOME TAXES
The Company elected to adopt early application of Statement of Financial Accounting Standards No 109 - "Accounting for Income Taxes" ("FAS 109"). Among other things, FAS 109 changes the method of recognizing deferred tax assets. Deferred tax assets are recognized for temporary differences that will result in deductible amounts in future years and for carryforwards. A valuation allowance is recognized if it is more likely than not that some portion of the deferred asset will not be recognized. The effect of initially applying FAS 109 in fiscal 1992, resulted in recording additional deferred tax assets and increasing net income by $0.9 million.
EXTRAORDINARY LOSS
In July 1993, the Company redeemed all of its outstanding 12 1/4% Subordinated Notes due 1998 at a price of 102% of par. The principal amount redeemed was $50,000,000 and the redemption resulted in an extraordinary loss of $1,277,000 net of income taxes of $658,000.
INFLATION
Inflation has a long-term effect on the Company because increasing costs of land, materials and labor result in increasing sales prices of its homes. In general, these price increases have been commensurate with the general rate of inflation in the Company's housing markets and have not had a significant adverse effect on the sale of the Company's homes. A significant inflationary risk faced by the housing industry generally is that rising housing costs, including land and interest costs, will substantially outpace increases in the income of potential purchasers. In recent years, in the price ranges in which it sells homes, the Company has not found this risk to be a significant problem.
Inflation has a lesser short-term effect on the Company because the Company generally negotiates fixed price contracts with its subcontractors and material suppliers for the construction of its homes. These prices usually are applicable for a specified number of residential buildings or for a time period of between four to twelve months. Construction costs for residential buildings represent approximately 51% of the Company's total costs and expenses.
Item 8

Item 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Financial statements of Hovnanian Enterprises, Inc. and its consolidated subsidiaries, are set forth herein beginning on page.
Item 9

Item 9 - CHANGES IN OR DISAGREEMENT WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
During the past twenty-four months there have not been any changes in or disagreements with accountants on accounting and financial disclosure.
PART III
Item 10

Item 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information called for by Item l0, except as set forth below under the heading "Executive Officers of the Registrant", is incorporated herein by reference to the Company's definitive proxy statement to be filed pursuant to Regulation l4A, in connection with the Company's annual meeting of shareholders to be held in July 1994, which will involve the election of directors.
Executive Officers of the Registrant
The executive officers of the Company are listed below and brief summaries of their business experience and certain other information with respect to them are set forth following the table.
Year Started Name Age Position With Company
Kevork S. Hovnanian 71 Chairman of the Board, Chief l967 Executive Officer, and Director of the Company.
Ara K. Hovnanian 36 President and Director of l979 the Company.
Paul W. Buchanan 43 Senior Vice President-Corporate l981 Controller and Director of the Company.
Timothy P. Mason 53 Senior Vice President-Adminis- 1975 tration/Secretary and Director of the Company.
Peter S. Reinhart 44 Senior Vice President and General 1978 Counsel and Director of the Company.
John J. Schimpf 45 Executive Vice President and 1981 Director of the Company.
J. Larry Sorsby 38 Senior Vice President-Finance/ 1988 Treasurer
Mr. K. Hovnanian founded the predecessor of the Company in l959 (Hovnanian Brothers, Inc.) and has served as Chairman of the Board of the Company since its incorporation in l967. Mr. K. Hovnanian was also President of the Company from 1967 to April 1988.
Mr. A. Hovnanian was appointed President in April 1988, after serving as Executive Vice President from March 1983. Mr. A. Hovnanian was elected a Director of the Company in December l98l. Mr. A. Hovnanian is the son of Mr. K. Hovnanian.
Mr. Buchanan was appointed Senior Vice President-Corporate Controller in May l990, after serving as Vice President-Corporate Controller from March 1983. Mr. Buchanan was elected a Director of the Company in March l982.
Mr. Mason was appointed Senior Vice President of Administration/ Secretary of the Company in March 1991, after serving as Vice President - Administration/Treasurer and Secretary of the Company since March l982. Mr. Mason was elected a Director of the Company in 1980.
Mr. Reinhart was appointed Senior Vice President and General Counsel in April 1985 after serving as Vice President and Chief Legal Counsel since March l983. Mr. Reinhart was elected a Director of the Company in December l98l.
Mr. Schimpf was appointed Executive Vice President of the Company in April 1988 after serving as Senior Vice President from April 1985. Mr. Schimpf was elected a Director of the Company in June 1986.
Mr. Sorsby was appointed Senior Vice President-Finance/Treasurer of the Company in March 1991, after serving as Vice President/Finance of the Company since September l988.
Item 11

Item 11 - EXECUTIVE COMPENSATION
The information called for by Item ll is incorporated herein by reference to the Company's definitive proxy statement to be filed pursuant to Regulation l4A, in connection with the Company's annual meeting of shareholders to be held in July 1994, which will involve the election of directors.
Item 12

Item 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information called for by Item l2 is incorporated herein by reference to the Company's definitive proxy statement to be filed pursuant to Regulation l4A, in connection with the Company's annual meeting of shareholders to be held in July l994, which will involve the election of directors.
Item 13

Item 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information called for by Item l3 is incorporated herein by reference to the Company's definitive proxy statement to be filed pursuant to Regulation l4A, in connection with the Company's annual meeting of shareholders to be held in July 1994, which will involve the election of directors. PART IV
Item 14

Item 14 - EXHIBITS, FINANCIAL STATEMENTS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
Page
Financial Statements:
Index to Consolidated Financial Statements....................... Independent Auditors' Report..................................... Consolidated Balance Sheets at February 28, 1994 and 1993........ Consolidated Statements of Income for the Years Ended February 28, 1994, February 28, 1993 and February 29, 1992............................................. Consolidated Statements of Stockholders' Equity for the Years Ended February 28, 1994, February 28, 1993 and February 29, 1992....................... Consolidated Statements of Cash Flows for the Years Ended February 28, 1994, February 28, 1993 and February 29, 1992......................................... Notes to Consolidated Financial Statements.......................
Financial Statement Schedules:
VIII Valuation and Qualifying Accounts.......................... X Supplementary Income Statement Information................. XI Real Estate and Accumulated Depreciation...................
All other schedules are either not applicable to the Company or have been omitted because the required information is included in the financial statements or notes thereto.
Exhibits:
3(a) Certificate of Incorporation of the Registrant.(1) 3(b) Certificate of Amendment of Certificate of Incorporation of the Registrant.(8) 3(c) Bylaws of the Registrant.(8) 4(a) Specimen Class A Common Stock Certificate.(8) 4(b) Specimen Class B Common Stock Certificate.(8) 4(c) Indenture dated as of April 29, 1992, relating to 11 1/4% Subordinated Notes between the Registrant and First Fidelity Bank, including form of 11 1/4% Subordinated Notes due April 15, 2002.(2) 4(d) Indenture dated as of May 28, 1993, relating to 9 3/4% Subordinated Notes between Registrant and First Fidelity Bank, National Association, New Jersey, as Trustee, including form of 9 3/4% Subordinated Note due 2005.(4) 10(a) Credit Agreement dated July 30, 1993 among K. Hovnanian Enterprises, Inc., Hovnanian Enterprises, Inc., certain Subsidiaries Thereof, Midlantic National Bank, Chemical Bank, United Jersey Bank/Central, N.A., and NBD Bank, N.A.(7) 10(b) Description of Management Bonus Arrangements.(8) 10(c) Description of Savings and Investment Retirement Plan.(1) 10(d) Stock Option Plan.(6) 10(e) Management Agreement dated August 12, 1983 for the management of properties by K. Hovnanian Investment Properties, Inc.(1) 10(f) Agreement dated July 8, 1981 between Hovnanian Properties of Atlantic County, Inc. and Kevork S. Hovnanian.(2) 10(g) Management Agreement dated December 15, 1985, for the management of properties by K. Hovnanian Investment Properties, Inc.(3) 10(h) Description of Deferred Compensation Plan.(5) 22 Subsidiaries of the Registrant. (1) Incorporated by reference to Exhibits to Registration Statement (No. 2-85198) on Form S-1 of the Registrant. (2) Incorporated by reference to Exhibits to Registration Statement (No. 33-46064) on Form S-3 of the Registrant. (3) Incorporated by reference to Exhibits to Annual Report on Form 10 -K for the year ended February 28, 1986 of the Registrant. (4) Incorporated by reference to Exhibits to Registration Statement (No. 33-61778) on Forms S-3 of the Registrant. (5) Incorporated by reference to Exhibits to Annual Report on Form 10- K for the year ended February 28, 1990 of the Registrant. (6) Incorporated by reference to the Proxy Statement dated June 15, 1990. (7) Incorporated by reference to an Exhibit to Quarterly Report on Form 10-Q for the quarter ended August 31, 1993, of the Registrant. (8) Incorporated by reference to Exhibits to Annual Report on Form 10- for the year ended February 28, 1993 of the Registrant.
Reports on Form 8-K
The Company did not file any reports on Form 8-K during the quarter ended February 28, 1994.
SIGNATURES
Pursuant to the requirements of Section l3 or l5(d) of the Securities Exchange Act of l934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Hovnanian Enterprises, Inc. By:
/S/KEVORK S. HOVNANIAN Kevork S. Hovnanian Chairman of the Board and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of l934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated
/S/ KEVORK S. HOVNANIAN Chairman of The Board 5/20/94 Kevork S. Hovnanian and Director Date
/S/ ARA K. HOVNANIAN President and Director 5/20/94 Ara K. Hovnanian Date
/S/ PAUL W. BUCHANAN Senior Vice President 5/20/94 Paul W. Buchanan Corporate Controller and Date Director
/S/ TIMOTHY P. MASON Senior Vice President- 5/20/94 Timothy P. Mason Administration/Secretary Date and Director
/S/ PETER S. REINHART Senior Vice President and 5/20/94 Peter S. Reinhart General Counsel and Director Date
/S/ JOHN J. SCHIMPF Executive Vice President 5/20/94 John J. Schimpf and Director Date
/S/ J. LARRY SORSBY Senior Vice President/ 5/20/94 J. Larry Sorsby Finance and Treasurer Date
PART IV
Item 14 - EXHIBITS, FINANCIAL STATEMENTS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K Page Financial Statements:
Index to Consolidated Financial Statements..................... Independent Auditors' Report................................... Consolidated Balance Sheets at February 28, 1994 and 1993...... Consolidated Statements of Income for the Years Ended February 28, 1994, February 28, 1993 and February 29, 1992............................................ Consolidated Statements of Stockholders' Equity for the Years Ended February 28, 1994, February 28, 1993 and February 29, 1992...................... Consolidated Statements of Cash Flows for the Years Ended February 28, 1994, February 28, 1993 and February 29, 1992........................................ Notes to Consolidated Financial Statements.....................
Financial Statement Schedules:
VIII Valuation and Qualifying Accounts.......................... X Supplementary Income Statement Information................. XI Real Estate and Accumulated Depreciation...................
All other schedules have been omitted because the required information of such other schedules is not present, is not present in amounts sufficient to require submission of the schedule or because the required information is included in the financial statements.
INDEPENDENT AUDITORS' REPORT
To the Stockholders and Board of Directors of Hovnanian Enterprises, Inc.
We have audited the consolidated balance sheets of Hovnanian Enterprises, Inc. and subsidiaries as of February 28, 1994 and 1993, and the related consolidated statements of income, changes in stockholders' equity and cash flows for each of the years in the three year period ended February 28, 1994 and the schedules listed in the accompanying index. These financial statements and the schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules based upon our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and schedules are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements and schedules. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement and schedule presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respect, the financial position of Hovnanian Enterprises, Inc. and subsidiaries as of February 28, 1994 and 1993, and the results of their operations and their cash flows for each of the years in the three year period ended February 28, 1994, in conformity with generally accepted accounting principles. Further, it is our opinion that the schedules referred to above present fairly the information set forth therein.
/S/ Kenneth Leventhal and Company Kenneth Leventhal and Company
New York, New York April 21, 1994, except for Note 9 as to which the date is May 10, 1994
HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED FEBRUARY 28(29), 1994, 1993 AND 1992
1. SUMMARY OF ACCOUNTING POLICIES
Operations - The Company, a Delaware Corporation, principally develops housing communities in New Jersey, Pennsylvania, Florida, North Carolina and Virginia. In addition, the Company develops and operates income producing properties.
Principles of Consolidation - The accompanying consolidated financial statements include the accounts of the Company and all wholly-owned or majority owned subsidiaries after elimination of all significant intercompany balances and transactions. The Company's investments in joint ventures in which the Company's interest is 50% or less are accounted for by the equity method of accounting. The financial statements for prior years have been conformed to the format used at February 28, 1994.
The Company reports income taxes in accordance with Statement of Financial Accounting No. 109 ("FAS 109"), "Accounting For Income Taxes". Among other things, FAS 109 changes the method of recognizing deferred tax assets. Deferred tax assets are recognized for temporary differences that will result in deductible amounts in future years and for carryforwards. A valuation allowance is recognized if it is more likely than not that some portion of the deferred asset will not be recognized. The effect of initially applying FAS 109 in fiscal 1992 resulted in recording additional deferred tax assets and increasing net income by $883,000, or $.04 per common share.
Income Recognition - Income from sales is recorded when title is conveyed to the buyer, subject to the buyer's financial commitment being sufficient to provide economic substance to the transaction.
Cash - Cash includes cash deposited in checking accounts, overnight repurchase agreements, certificates of deposit, Treasury bills and government money market funds.
Inventories - Inventories are recorded at the lower of cost or market. Market is defined as the estimated proceeds upon disposition less all future costs to complete and expected costs to sell. Construction costs are accumulated during the period of construction and charged to cost of sales under specific identification methods. Land, land development and common facility costs are amortized based upon the number of homes to be constructed in each housing community utilizing a relative sales value allocation method.
Interest costs related to properties in progress are capitalized during the construction period and charged to cost of sales as the related inventories are sold (see Note 5).
The cost of land options is capitalized when incurred and either included as part of the purchase price when the land is acquired or charged to operations when the Company determines it will not exercise the option.
During fiscal 1993, the Company provided for a $3.1 million reserve to reduce certain residential properties to their estimated net realizable values. This reserve is substantially attributable to two Florida communities where the Company significantly reduced sales prices. Although these communities have very few standing unsold houses, by reducing sales prices the Company plans to accelerate their buildout. The Company believes the rapid liquidation of these properties will enable it to concentrate on newer and more profitable developments. In addition, in years prior to fiscal 1992 the Company established similar reserves attributable to Florida, New Hampshire and New York communities.
During fiscal 1994, 1993 and 1992, the Company charged $4,176,000, $5,245,000 and $7,525,000, respectively, against reserves for losses realized from the sales of certain homes. In fiscal 1994, 1993 and 1992, respectively, these charges consisted of $3,620,000, $4,459,000 and $5,678,000 of construction, and operations costs, $195,000, $201,000 and $476,000 of selling, general and administration expenses and $361,000, $583,000 and $1,371,000 of interest expenses. At February 28, 1994 and 1993, respectively, inventory and residential rental inventory have been reduced by an allowance of $9,591,000 and $13,767,000 to reflect the carrying amounts at estimated net realizable value.
Property - Various condominium homes, not yet under contract of sale, are rented under short-term leases. Such homes are reclassified from inventory and depreciated after a reasonable selling period not to exceed one year. Rental operations of the Company arise from these incidental rentals and from rental of commercial properties.
Post Development Completion Costs - In those instances where a development is substantially completed and sold and the Company has additional construction work to be incurred, an estimated liability is provided to cover the cost of such work.
Deferred Income Tax - Deferred income taxes are provided for temporary differences between amounts recorded for financial reporting and for income tax purposes.
Depreciation - The straight-line method is used for both financial and tax reporting purposes for all assets except office furniture and equipment which are depreciated using the declining balance method over their estimated useful lives.
Prepaid Expenses - Prepaid expenses which relate to specific housing communities are amortized to costs of sales as the applicable inventories are sold.
Per Share Calculations - Per share amounts are calculated on a weighted average basis and reflect the recapitalization described in Note 12.
2. PROPERTY
Operating property consists of land, land improvements, buildings, building improvements, furniture and equipment used by the Company and its subsidiaries to conduct day to day business. Rental property consists of rental condominiums, three office buildings, four office warehouse facilities, three retail shopping centers, and a mini-storage facility. The condominiums located in New Hampshire, are either sold and waiting to close or being temporarily rented and are being actively marketed for sale.
3. ESCROW CASH
Escrow cash primarily represents customers' deposits which are restricted from use by the Company. The Company is able to release escrow cash by pledging letters of credit and as a result, $6,453,000 and $5,024,000 was released from escrow at February 28, 1994 and 1993, respectively. Escrow cash accounts are substantially invested in short-term certificates of deposit or time deposits.
4. MORTGAGES AND NOTES RECEIVABLE
The Company's wholly-owned mortgage banking and finance subsidiaries originate mortgage loans, primarily from the sale of the Company's homes. Such mortgage loans are sold in the secondary mortgage market or in years prior to fiscal 1988 pledged against collateralized mortgage obligations ("CMO's"). At February 28, 1994 and 1993, mortgage loans owned by the Company amounted to $81,428,000 and $74,463,000, respectively, of which $30,755,000 and $40,355,000, respectively, were pledged against CMO's with the remainder held for sale. At February 28, 1994 and 1993, respectively, $43,502,000 and $25,868,000 of such mortgages were pledged against the Company's mortgage warehouse line (see "Notes to Consolidated Financial Statements - Note 5"). The Company may incur risk with respect to mortgages that are delinquent and not pledged against CMO's, but only to the extent the losses are not covered by mortgage insurance or resale value of the home. Historically, the Company has incurred minimal credit losses. The mortgage loans held for sale are carried at the lower of cost or market value, determined on an aggregate basis. There was no valuation adjustment at February 28, 1994.
In connection with certain bulk sales of condominium homes, land sales and the sale of certain subsidiaries, the Company made loans. At February 28, 1994 and February 28, 1993, such loans amounted to $3,808,000 and $4,890,000, respectively, with interest rates at February 28, 1994 ranging up to 12%.
5. MORTGAGES AND NOTES PAYABLE
Substantially all of the land and construction mortgages are short-term borrowings. The mortgages secured by buildings, land and land improvements are installment obligations having annual principal maturities of approximately $1,107,000 in fiscal 1995, $186,000 in fiscal 1996, $205,000 in fiscal 1997, $225,000 in fiscal 1998, and $19,815,000 after fiscal 1998.
The Company has a Revolving Credit Agreement ("Agreement") with a group of banks which provides up to $130,000,000 through July 1996. Interest is payable monthly and at various rates of either prime plus 1/2% or LIBOR plus 2%. In addition, the Company pays 3/8% per annum on the weighted average unused portion of the line. The Company believes that it will be able either to extend the Agreement beyond July 1996 or negotiate a replacement facility, but there can be no assurance of such extension or replacement facility. Interest costs incurred, expensed and capitalized were:
Year Ended --------------------------------- February February February 28, 1994 28, 1993 29, 1992 -------- -------- -------- (Dollars in Thousands) Interest incurred (1): Residential(3)......................... $20,830 $15,990 $13,701 Commercial(4).......................... 5,138 6,165 6,762 ------- ------- ------- Total incurred......................... $25,968 $22,155 $20,463 ======= ======= =======
Interest expensed: Residential(3)......................... $17,622 $16,460 $15,900 Commercial(4).......................... 4,908 5,809 6,557 ------- ------- ------- Total expensed......................... $22,530 $22,269 $22,457 ======= ======= =======
Interest capitalized at beginning of year...................... $23,366 $24,062 $27,427 Plus: Interest incurred................. 25,968 22,155 20,463 Less: Interest expensed................. 22,530 22,269 22,457 Less: Charged to reserves............... 361 583 1,371 ------- ------- ------- Interest capitalized at end of year...... $26,443 $23,365 $24,062 ======= ======= =======
Interest capitalized at end of year (5): Residential(3)......................... $20,209 $15,727 $16,780 Commercial(2).......................... 6,234 7,638 7,282 ------- ------- ------- Total interest capitalized............ $26,443 $23,365 $24,062 ======= ======= =======
(1) Data does not include interest incurred by the Company's mortgage and finance subsidiaries. (2) Data does not include a reduction for depreciation. (3) Represents acquisition interest for construction, land and development costs which is charged to cost of sales. (4) Represents interest charged to rental operations. (5) Capitalized residential interest at February 28, 1994 includes $1,635,000 reported at February 28, 1993 as capitalized commercial interest. This reclassification was the result of the transfer of two parcels of land from commercial due to a change in the intended use to residential housing. Average interest rates and balances outstanding for short-term debt are as follows:
February February February 28, 1994 28, 1993 29, 1992 -------- -------- -------- (Dollars In Thousands)
Average outstanding borrowings.......... $ 39,632 $ 32,788 $110,910 Average interest rate during period(1).. 5.39% 6.21% 8.35% Average interest rate at end of period.. -- 6.50% 7.07% Maximum outstanding at any month end.... .$ 72,700 $ 68,350 $138,904
(1) Total interest incurred for the year divided by average outstanding short term borrowings.
6. SUBORDINATED NOTES
On June 24, 1988, the Company issued $50,000,000 principal amount of 12 1/4% Subordinated Notes due June 15, 1998. Interest is payable semi- annually. Annual sinking fund payments of $10,000,000 are required to commence June 15, 1996, and are calculated to retire 40% of the issue prior to maturity. In July 1993, the Company redeemed all of these notes at a price of 102% of par. The redemption resulted in an extraordinary loss of $1,277,000 net of an income tax benefit of $658,000.
On April 29, 1992, the Company issued $100,000,000 principal amount of 11 1/4% Subordinated Notes due April 15, 2002. Interest is payable semi- annually. Annual sinking fund payments of $20,000,000 are required to commence April 15, 2000, and are calculated to retire 40% of the issue prior to maturity.
On June 7, 1993, the Company issued $100,000,000 principal amount of 9 3/4% Subordinated Notes due June 1, 2005. Interest is payable semiannually. The notes are redeemable in whole or in part at the Company's option, initially at 104.875% of their principal amount on or after June 1, 1999 and reducing to 100% of their principal amount on or after June 1, 2002.
The indentures relating to the subordinated notes and the Revolving Credit Agreement contain restrictions on the payment of cash dividends. At February 28, 1994, $33,432,000 of retained earnings were free of such restrictions.
7. RETIREMENT PLAN
On December 1, 1982, the Company established a defined contribution savings and investment retirement plan. Under such plan there are no prior service costs. Plan costs charged to operations amount to $788,000 , $477,000 and $434,000 for the years ended February 28, 1994, February 28, 1993 and February 29, 1992, respectively.
8. INCOME TAXES
Deferred income taxes have been provided (reduced) due to temporary differences as follows: Year Ended -------------------------------- February February February 28, 1994 28, 1993 29, 1992 -------- -------- -------- (Dollars In Thousands)
Capitalized interest................. $ (3) $ (16) $ (96) Homeowner association maintenance reserves.......................... 166 53 (117) Installment sales.................... (493) (578) (592) Provision to reduce inventory to net realizable value................... 1,324 954 2,563 Deferred expenses.................... (727) (608) (484) Depreciation......................... 298 Post development completion costs.... (1,988) Net operating losses................. (129) Other................................ (21) -------- -------- -------- Benefit (Provision) - total.......... $(1,573) $ (195) $ 1,274 ======== ======== ========
The deferred tax liabilities or assets have been recognized in the consolidated balance sheets due to temporary differences and loss carryforwards as follows: February February 28, 1994 28, 1993 -------- -------- (Dollars In Thousands) Deferred Tax Liabilities: Deferred interest....................... $ 252 $ 256 Installment sales....................... 784 1,278 Accelerated depreciation................ 1,104 807 -------- -------- Total................................. 2,140 2,341 -------- --------
Deferred Tax Assets: Deferred income......................... 369 333 Maintenance guarantee reserves.......... 490 656 Provision to reduce inventory to net realizable value...................... 3,577 4,901 Uniform capitalization of overhead..... 2,018 1,579 Post development completion costs....... 1,988 Other................................... 793 394 -------- -------- Total................................. 9,235 7,863 -------- -------- Net Deferred Tax Assets................... $ (7,095) $ (5,522) ======== ========
The effective tax rates varied from the expected rate. The sources of these differences were as follows:
February February February 28, 1994 28, 1993 29, 1992 -------- -------- --------
Computed "expected" tax rate.............. 35.0% 34.0% 34.0% State income taxes, net of Federal income tax benefit...................... 1.8% 7.3% 20.1% Loss carryforward of New Fortis subsidiary.............................. (2.1%) (2.6%) (26.5%) Other..................................... (3.0%) (6.2%) (11.8%) -------- -------- -------- Effective tax rate........................ 31.7% 32.5% 15.8% ======== ======== ========
The Company has available at February 28, 1994 a federal operating loss carryforward for financial reporting purposes and tax purposes of $274,000, which may provide future tax benefits. The carryforward expires during the years ended February 28, 2005 and 2006. The Company has state net operating loss carryforwards for financial reporting and tax purposes of $164,000,000 due to expire between the years February 28, 1995 and February 28, 2009.
9. TRANSACTIONS WITH RELATED PARTIES
The Company's Board of Directors has adopted a general policy providing that it will not make loans to officers or directors of the Company or their relatives at an interest rate less than the interest rate at the date of the loan on six month U.S. Treasury Bills, that the aggregate of such loans will not exceed $2,000,000 at any one time, and that such loans will be made only with the approval of the members of the Company's Board of Directors who have no interest in the transaction. Notwithstanding the policy stated above, the Board of Directors of the Company concluded that the following transactions were in the best interests of the Company.
On March 1, 1990, the Company sold all the assets and liabilities of its wholly-owned engineering subsidiary Najarian and Associates ("N & A") to the employees of N & A for $3,600,000. One of these employees and former President of N & A was Tavit O. Najarian, the son-in-law of Mr. K. Hovnanian, Chairman of the Board and Director of the Company. The sale was approved by members of the Company's Board of Directors who were not related to Mr. Najarian. At the closing the Company received a cash payment of $720,000 and a $2,880,000 note. Originally the note carried an annual interest rate of 10% and was to amortize over ten years. As long as any portion of the note is outstanding, the Company receives 25% of the net cash flow. During fiscal 1992, N & A began to experience a significant decrease in business activity. As a result, the note was modified by changing the interest rate to prime, add accrued interest from September 1, 1991 to September 1, 1992 to principal and reschedule principal payments over the balance of the term of the note. As a result of continued financial difficulties, a committee consisting of independent directors of the Board of Directors of the Company (the "Committee") engaged an outside consultant to determine the fair market value of the above note. Based on the consultant's findings, the Committee recommended a reduction in the note including accrued interest from $2,983,000 to $1,100,000 at February 28, 1994. This reduction of the note was charged to operations in the current fiscal year. In addition, the Committee recommended a new term of ten years with annual interest on the note of 5% for the first two years adjusting to prime thereafter. Amortization would begin in year three with an annual minimum amount of 5%, ranging up to 30% in year 10, or 85% of cash flow after interest, whichever is greater. The Committee also recommended a $300,000 discount if the loan was paid in full during the first two years.
The Company provides property management services to various limited partnerships including two partnerships in which Mr. A. Hovnanian, President and a Director of the Company, is a general partner, and members of his family and certain officers and directors of the Company are limited partners. At February 28, 1994, these partnerships owed the Company $27,000.
On May 10, 1994, the Board of Directors approved the acquisition of the 10% minority interest in certain Florida subsidiaries owned by Paul W. Asfahl, President of the Company's Florida Division. For his 10% interest, the Company issued 45,000 shares of Class A Common Stock to Mr. Asfahl.
10. STOCK OPTION PLAN
The Company has a stock option plan for certain officers and key employees. Options are granted by a Committee appointed by the Board of Directors. The exercise price of all stock options must be at least equal to the fair market value of the underlying shares on the date of the grant. Stock option transactions are summarized as follows:
February February February 28, 1994 28, 1993 29,1992 --------- --------- ---------
Options outstanding at beginning of year 1,004,000 530,500 590,949 Granted................................ -- 509,500 -- Exercised............................ 58,500 28,000 60,449 Cancelled.............................. 7,000 8,000 -- ---------- --------- --------- Options outstanding at end of year... 938,50 1,004,000 530,500 ========== ========= =========
Options exercisable at end of year..... 598,833 336,500 198,500
Price range of options exercised..... $3.00-$9.44 $5.13-$9.44 $3.00-$9.44
Price range of options outstanding....$5.13-$11.50 $3.00-$11.50 $3.00-$9.44
11. COMMITMENTS AND CONTINGENT LIABILITIES
During fiscal 1989, the Company became aware that certain fire-retardant plywood commonly used in the roof construction of multi-family homes may contain a product defect causing accelerated deterioration of the plywood. The Company has determined that such plywood was used in 33 of its communities containing approximately 11,750 homes.
Common areas, including roofs, in each of the Company's multi-family condominium developments are governed and controlled by homeowners' associations for each development, rather than by individual homeowners. Certain of the 33 homeowners' associations in the affected developments have asserted claims against the Company. As of February 28, 1993, the Company had entered separate settlement agreements with 31 of the 33 associations, (the "Settling Associations") covering 10,850 homes.
In August 1989 the Company brought suit against the plywood material manufacturers, treaters, suppliers and others (the "Defendants") to determine the proper responsibility for damages, to protect its interests and to recover its damages.
In November 1992, the Company and the Settling Associations entered into a settlement agreement with most of the Defendants. Based upon the settlement monies received, the use of the Settling Associations' roof shingle reserves and the actual expenditures in performing the repairs, the Company believes the repair costs will not require it to set aside future reserves for such roof repairs.
The Company is continuing to litigate with the two non-settling associations which contain 900 homes. Because the litigation is in its early discovery stages, the Company is unable to predict at this time the ultimate outcome of the litigation. However, due to the limited amount of this remaining litigation, the Company does not believe that the resolution of this litigation will have a material effect on the Company.
In addition, the Company is involved from time to time in litigation arising in the ordinary course of business, none of which is expected to have a material adverse effect on the Company.
As of February 28, 1994 and 1993, respectively, the Company is obligated under various letters of credit amounting to $5,114,000 and $10,340,000.
12. RECAPITALIZATION
In September 1992, the Company's stockholders approved a Plan of Recapitalization (the "Recapitalization"). The Recapitalization became effective September 11, 1992.
On the effective date, each outstanding share of the Company's common stock, par value $.01 per share, was converted into one-half of a share of "Class A Common Stock", par value $.01 per share having one vote per share, and one-half of a share of "Class B Common Stock", par value $.01 per share having ten votes per share. The amount of any regular cash dividend payable on a share of Class A Common Stock will be an amount equal to 110% of the corresponding regular cash dividend payable on a share of Class B Common Stock.
If a shareholder desires to sell shares of Class B Common Stock, such stock must be converted into shares of Class A Common Stock. Shareholders may convert their shares of Class B Common Stock into an equal number of shares of Class A Common Stock at any time. A holder of Class B Common Stock can wait until the time of sale and deliver the Class B Common Stock to a broker. The broker will then present the Class B Common Stock to the Company's transfer agent, which will issue the purchaser shares of Class A Common Stock.
13. UNAUDITED SUMMARIZED CONSOLIDATED QUARTERLY INFORMATION
Summarized quarterly financial information for the years ended February 28, 1994 and 1993 is as follows:
Three Months Ended (In Thousands Except Per Share Data) ----------------------------------------- February November August May 28, 1994 30, 1993 31, 1993 31, 1993 -------- -------- -------- --------- Revenues........................... $257,691 $143,078 $123,291 $ 62,950 Costs and expenses................. $241,046 $136,157 $116,093 $ 64,563 Income (loss) before income taxes and extraordinary loss........... $ 16,645 $ 6,921 $ 7,198 $ (1,613) State and Federal income tax....... $ 5,277 $ 2,152 $ 2,426 $ (626) Income (loss) before extraordinary loss............................ $ 11,368 $ 4,769 $ 4,772 $ (987) Extraordinary loss from extinguishment of debt, net of income taxes.................. $ (1,277)
Net income (loss).................. $ 11,368 $ 4,769 $ 4,772 $ (2,264) Earnings (loss) per common share: Income (loss) before extraordinary loss............. $ .50 $ .21 $ .21 $ (.05) Extraordinary loss............... $ (.05) Net income (loss).................. $ .50 $ .21 $ .21 $ (.10) Weighted average number of common shares outstanding........ 22,842 22,839 22,818 22,784 _____________________________________________________________________________
Three Months Ended (In Thousands Except Per Share Data) ---------------------------------------- February November August May 28, 1993 30, 1992 31, 1992 31, 1992 -------- -------- -------- -------- - - - Revenues............................ $184,950 $115,594 $ 83,585 $ 45,186 Costs and expenses.................. $172,214 $112,486 $ 82,173 $ 47,917 Income (loss) before income taxes... $ 12,736 $ 3,108 $ 1,412 $ (2,731) State and Federal income tax....... $ 4,444 $ 1,152 $ 188 $ (1,049) Net income (loss)................... $ 8,292 $ 1,956 $ 1,224 $ (1,682) Earnings (loss) per common share....$ .36 $ .09 $ .05 $ (.07) Weighted average number of common shares outstanding......... 22,784 22,779 22,779 22,755
SCHEDULE X HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES SUPPLEMENTAL INCOME STATEMENT INFORMATION
Charged To Cost And Expenses ---------------------------------------- February 28, February 28, February 29, 1994 1993 1992 ----------------------------------------
Advertising..................... $8,587,000 $5,895,000 $4,776,000 Depreciation.................... $3,035,000 $2,924,000 $2,888,000 Maintenance guarantee reserves.. $1,237,000 $2,764,000 $1,257,000