Hovnanian Enterprises, Inc.

Good morning and thank you for joining us today for Hubnani and Enterprises fiscal 2021 first quarter earnings conference call. The webcast will be available after the completion of the call and run for 12 months. This conference is being recorded for rebrand and all participants are currently in a listen only mode. Management will make some opening remarks about the first quarter results and then open 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 investor page of the company's website at www.khov.com. Those listeners who would like to follow along should now log on to the website. I will now turn the call to Jeff O'Keefe, Vice President, Investor Relations. Jeff, please go ahead.

Thank you, Kevin, and thank you all for participating in this morning's call to review the results for our first quarter, which ended January 31, 2022. All statements in this conference call that are not historical facts should be considered as forward-looking statements within the meaning of the safe harbor provisions of the Private Security and Mitigation Reform Act of 1995. Such statements involve known and unknown risks, uncertainties, and other factors that may cause actual results, performance, or achievements of the company to be materially different from any future results, performance, or achievement expressed or implied by the forward-looking statement. Such forward-looking statements include but are not limited to statements related to the company's goals and expectations with respect to its financial results for future financial periods. Although we believe that our plans, intentions, and expectations reflected and are suggested by such forward-looking statements are reasonable, we can give no assurance that such plans, intentions, or expectations will be achieved. By their nature, forward-looking statements speak only as of the date they are made, are not guarantees of future performance and results, and are subject to risks, uncertainties, and assumptions that are difficult to predict or quantify. Therefore, actual results could differ materially and adversely from those forward-looking statements as a result of a variety of factors. Such risks and uncertainties and other factors are described in detail in the sections entitled Risk Factors and Management Discussion Analysis, particularly the portion of MD&A entitled Safe Harbor Statement, and our annual report on Form 10-K for the fiscal year ended October 31, 2021. and subsequent filings with the Securities and Exchange Commission. Except as required by applicable security laws, we undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, changed circumstances, or any other reason. Joining me today are Ara Hovnanian, Chairman, President, and CEO, Larry Sorsby, Executive Vice President and CFO, and Brad O'Connor, Senior Vice President, Chief Accounting Officer, and Treasurer. I'll now turn the call over to our CEO. Ara, go ahead.

Thanks, Jeff. I'm going to review our first quarter results, and I'll address the current market environment. Larry Soresby, our CFO, will follow me with more details, and then we'll open it up to Q&A. The Omicron COVID variant certainly further exacerbated industry supply chain disruptions and labor shortages. Across the country, during the month of January in particular, we experienced trade partners being unable to work or working short staff due to COVID infections among their teams. Similarly, local building departments and inspectors experienced widespread COVID-related absences. Finally, COVID caused widespread issues among our suppliers. Cabinets, windows, and garage doors were among the many problems due to COVID's impact on labor at their manufacturing and delivery facilities. At the end of our first quarter, many homes across our markets were virtually finished. However, one or two backordered items or the lack of a final inspection prevented us from closing homes all around the country. All of these issues combined resulted in longer construction cycle times and delays in home deliveries. This pushed some of our expected first quarter deliveries into the second quarter and caused us to miss our revenue guidance. However, as we'll describe more fully in a moment, our outperformance in gross margin and several other areas allowed us to exceed the high end of our guidance for pre-tax profit. On slide five, we compare our first quarter results to our guidance. Additionally, we added a third column to compare our results without the $5.7 million of incremental phantom stock expense that was due solely to stock price increases in the quarter. As you can see in the third column, we missed in revenues exceeded the top end of our guidance on gross margin. We're within our guidance range on SG&A and exceeded the top end of the range in income before taxes. Due to 60% of our phantom stock being distributed in January of 22, going forward, fluctuations in stock price will have much less of an effect on our SG&A expense. For every $8 movement in our stock price, we'll have a corresponding $1 million impact on SG&A expense. Moving on to slide six, we show year-over-year comparisons for our first quarter. Given the supply chain disruptions and labor shortages that have been plaguing many industries, certainly including home building, we're pleased with the strong profitability in the quarter. Starting in the upper left-hand portion of the slide, you can see that our total revenues for the first quarter were $565 million. Moving to the upper right-hand portion of the slide, you can see that our adjusted gross margin increased 170 basis points to 22.4% this year compared to 20.7% in last year's first quarter. This clearly illustrates that we've been able to raise home prices more than enough to offset the higher labor and material costs that we've incurred. Keep in mind that these first quarter deliveries were started when lumber costs were much higher and therefore did not get the benefit of the lower lumber costs that we had in the fall of 21. We expect the lower lumber prices from late summer and fall of 21 to positively impact gross margins beginning in the second quarter of fiscal 22 as we deliver homes that started after the lumber prices receded. This is reflected in the large increase in our guidance for second quarter gross margins. Lumber prices have moved up from levels that we saw in the fall, but those increased prices are already factored into our full year guidance. In the lower left-hand quadrant of the slide, you can see that our SG&A ratio was 12.8% for the first quarter compared to 11.1% in last year's first quarter. If you exclude the incremental phantom stock expense, it would improve to 11.8% this year. If the COVID-related delays did not adversely affect our delivery count, our SG&A ratio would have been lower yet. In the lower right-hand quadrant of the slide, we show that adjusted EBITDA was flat year-over-year at $64 million. Excluding the incremental phantom stock expenses, adjusted EBITDA would have increased 9% year-over-year to $70 million. Turning to slide seven, on this slide, you can see the benefit of the $181 million reduction of debt that we completed last year. particularly the reduction of some of our higher cost debt. Our percentage of interest expense to total revenues decreased 240 basis points from 7.2 percent in last year's first quarter to 4.8 percent this year. We anticipate lowering our interest costs further in the future. Regardless of future market conditions, Lower debt levels means lower interest expense in future periods. On slide eight, you can see that excluding incremental phantom stock expenses, our adjusted pre-tax income improved 92 percent to $41 million compared to $21 million last year. Adjusted pre-tax income, including the phantom stock expense, still increased 65% to $36 million. Last year, we did not expense federal income taxes in the first quarter since we had sufficient deferred tax reserves. We subsequently reversed our deferred tax reserve. Therefore, this year, we expensed federal income taxes in the quarter, causing our net income to increase 31% while our pre-tax income increased 65%. Regardless of the federal tax expense this year, we do not have to actually pay federal income taxes for the next $1.6 billion of pre-tax income as a result of our deferred tax asset. Let me talk about our sales environment. On the right-hand portion of slide five, we show contracts per community for the first quarter in each of the last three years. You can see that our contract pace jumped from 9.7 in the first quarter of fiscal 20 to a white hot pace of 16.9 in fiscal 21. That was a 74% year-over-year increase. While not as strong as last year, our sales pace of 14 contracts per community in the first quarter of this year was still exceptionally strong. Compared to the 9.7 contracts per community in the first quarter of 20, our contract pace is up 44 percent. Further to the left, we show that the average first quarter contract pace from 97 to 02 was 8.6, And as we've said many times before, that was a time that was neither a boom nor a bust for the housing industry. The current pace of 14 contracts per community in this year's first quarter is incredibly strong compared to historical averages. Due to our ability to raise prices more than construction costs, our recent contracts are being written with very high gross margins. We expect higher levels of profitability in future periods as we deliver these homes. If mortgage rates rise further, it's reasonable to expect the rate of home price increases will moderate. At the same time, however, material and labor cost increases should also moderate. Despite the high impact of higher mortgage rates, home demand remains strong. Entitled and improved lots remains a scarce commodity, and today we are still increasing home prices in all of our markets. On slide 10, we show contracts per community monthly from March through February. The most recent month is in dark green. The same month a year ago is in light blue, and the same month two years ago is in gray. For the last nine months, Our contracts have been lower than last year's blazing pace. However, we compare favorably every month with the same month two years ago, which was a more historically typical contract pace. There's no doubt that our current sales pace reflects strong consumer demand for our homes. Turning to slide 11, I want to focus on the month of February, given everyone's focus on the current market conditions, and you can't get more current than a month which ended yesterday. I want to begin by saying that February, right through our sales yesterday, was a very strong month. I'm sure many of you have been wondering whether rising rates, fears of inflation, or the problems of Ukraine have affected demand. As you can see in this slide, sales were rock solid and very much above normal. On this slide, we show the contracts per community for the month of February from fiscal 18 through fiscal 22, which ended yesterday. For the first two years on this slide, contracts per community had been steady at about 3.2. This was a historically typical pace. Then the demand in February of 20 exploded to 4.8 contracts per community. This was just before COVID hit. Then in February of 21, we hit a white-hot pace of 6.1 contracts per community, almost double the historical pace. This year, the preliminary results for February put us at five contracts per community, which is a very strong month for the month of February and well above normal, but certainly not as good as it was in 21. On the bottom of the slides, we show what the seasonally annualized sales pace based on the month of February for these same years were to give another perspective. As you can see, the annualized pace for February 22 of 72.5 contracts per community puts us well ahead of 2018 or 19 and was much higher than the non-boom, non-bust sales pace of 44 that we averaged from 1997 through 2002. So let me say it one more time, sales right through our month end yesterday were rock solid and well above normal. I want to take a few moments to talk about interest rates. On slide 12, we show a long-term perspective of where the 30-year fixed rate mortgages have been since the 90s. Today's 4% 30-year fixed rate mortgage remains among the lowest levels that we have seen for the past three decades. If you turn to slide 13, we show that the rates since January 1 of this year, the mortgage rates have increased almost 100 basis points. Despite this recent runoff in mortgage rates, as you just saw, demand for new homes has remained robust right through the end of February. Any increase in mortgage rates is not helpful as a portion of homebuyers will no longer be able to qualify for the same mortgage that they would have previously. However, over the 60 plus years that we've been building homes, we've observed in numerous rising mortgage rate environments, rates certainly impact how large of a mortgage consumers can afford. But time after time, we've seen home buyers adjust their expectations for how much they can afford to buy. When mortgage rates increase, consumers typically will either buy a smaller home or choose fewer options and upgrades. To date, we have not seen much evidence of our customers taking those steps. If mortgage rates continue to increase, we expect that would occur. Incidentally, we make a comparable gross margin ratio in our smaller homes in a community compared to our larger homes. Now, that's not to say interest rates do not affect housing demand. Continued rapid increases could certainly cause sticker shock among homebuyers and cause delays in their home buying decision. As recently as 2018, The housing market suffered from sticker shock as mortgage rates increased 100 basis points in a short time then, and homebuyers delayed their home purchase decision. However, in 2018, the economy was not as strong and the outlook for inflation was nominal. People did not believe mortgage rates would remain high nor that home prices would remain high, so some customers just waited before buying a new home. After just a few months, consumers jumped back into the housing market in a very strong way and that was even before the post-pandemic surge. If consumers need and desire new housing, After adjusting their expectations for what they can afford, they will eventually buy a home. The increase in mortgage rates has had no impact on our cancellation rates. For the first quarter of 22, our cancellation rate was 14% compared to 17% in last year's first quarter. For the months of January and February, when interest rates moved up by 100 basis points, our cancellation rates were 15 percent and 17 percent. Both months are in line with our low cancellation rate trends and remain below our historical average cancellation rates in the low 20 percent area. On slide 14, we show that our community count increased slightly year over year. The most relevant number to keep an eye on is our consolidated community count, which increased by six communities or 6% year over year to 111 at the end of the quarter. We expect our community count is likely to be similar at the end of the second quarter and then increase in both the third and fourth quarter. Given no material changes in market conditions, we expect to end the year with a community count at or slightly higher than the 140 communities that we had at the end of fiscal 21. Further, we expect to maintain a higher average community count for fiscal 22 compared to last year. We already have 86% of the remainder of the year's deliveries in backlog and firmly believe we'll be able to achieve the significant profit growth in our fiscal 22 guidance. I'll now turn it over to Larry Sorsby, our Chief Financial Officer.