Hovnanian Enterprises, Inc.

Nian Enterprises Festival 2022 Second Quarter Earnings Conference Call. An archive of the webcast will be available after the completion of the call and run for 12 months. This conference is being recorded for rebroadcast and all participants are currently in a listen-only mode. Management will make some opening remarks about the second quarter results and then open the lines for questions. The company will also be webcasting a slide presentation along with the opening comments from management. The slides are available on the investor page of the company's website at www.khof.com. Those listeners who would like to follow along should now log onto the website I will now turn the call over to Jeff O'Keefe, Vice President, Investor Relations. Jeff, please go ahead.

Thank you, Carmen, and thank you all for participating in this morning's call to review the results for our second quarter, which ended April 30th, 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 Securities Litigation Reform Act of 1995. Such statements involve known and unknown risks, uncertainties, and other factors may cause actual results, performance, or achievements of the company to be materially different from any future results, performance, or achievements expressed or implied by the forward-looking statements. 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 in or 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 or 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's discussion and analysis, particularly the portion of MDMA entitled Safe Harbor Statement and our end report on Form 10-K for the fiscal year ended October 31, 2021, and subsequent filings with the Securities and Exchange Commission. As otherwise required by applicable securities 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 Hobnamian, 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 second quarter results, and I'll also comment on the current housing environment. Larry Sorsby, our CFO, will follow me with more details, and then we'll open it up to Q&A. Despite the steady presence of supply chain issues, lumber volatility, rising mortgage rates, labor shortages, and uncertainty in the economy, we are very pleased with our second quarter results. On slide five, we compare our results to our guidance. Additionally, we added a third column to compare our results without the benefit of $6 million of phantom stock benefit this quarter. If you focus on that third column, you can see that our revenue was within our guidance range and our SG&A was 0.1 percent over our guidance range. The standouts were gross margin and adjusted pre-tax income, which were both well above the upper end of our guidance range. Moving on to slide six, we show year-over-year comparisons for our second quarter. Starting in the left-hand portion of the slide, you can see that our total revenues for the second quarter were $703 million, about flat with last year. Moving to the right-hand portion of the slide, you can see that our adjusted gross margin increased 530 basis points to 26.6% this year compared to 21.3% in last year's second quarter. The magnitude of this increase is due to strong home demand that allowed us to raise home prices more than labor and material cost increases and brought our average sales price to approximately $507,000 per home delivered. Turning to slide seven, here you can see that lumber prices have been very volatile over the past two years. Lumber prices have dropped significantly in recent weeks. The homes that we are about to start will benefit from this price decline. The lower lumber costs from these homes will show up in our results in the first half of fiscal 23 as these homes begin to deliver. At the same time, lumber prices have been trending down our average sales price for new contracts is trending up. In the second quarter, our new contracts averaged a sales price of $564,000. That is about 10% higher than the homes we just delivered. These two facts will be helpful as the cooling of the housing market will likely cause pressure on gross margins. As of the last few weeks, gross margins on new contracts have stayed exceptionally strong. On slide eight, we show lumber prices over the long term. While lumber prices have declined recently, we're still a long way from normal lumber pricing. We use current lumber pricing in our internal budgets However, it's reasonable to assume that as the housing market slows from the white hot pace we recently experienced, and as supply chain disruptions are resolved, lumber pricing will return to normal levels. Lumber, as you know, is a major cost component of housing, and that will be very helpful. Turning now to slide nine, in the left-hand portion of this slide, you can see that our SG&A was 9.7% for the second quarter compared to 11.7% in last year's second quarter. If the COVID-related delays did not adversely affect our delivery count, our SG&A ratio would have been lower yet. In the right-hand portion of the slide, we show that adjusted EBITDA increased 63% year-over-year to $124 million. Turning to slide 10, you can see the benefit of the $181 million reduction of senior notes that we completed last year. Our percentage of interest expense to total revenues decreased 130 basis points from 6.2% in last year's second quarter to 4.9% this year. The absolute dollar amount of interest was down 22%, from $44 million in last year's second quarter to $34 million this year. Given the fact that we reduced our senior notes by an additional $100 million at the very end of the second quarter, and that we expect to pay off at least an additional $100 million of senior notes later this year, we anticipate even lower interest costs in the future. On slide 11, you can see that our adjusted pre-tax income improved 184% to $88 million compared to $31 million last year. Our net income for the second quarter of 2022 was $62 million. Net income in last year's second quarter would have been $20 million if you reduced our actual net income by the $469 million from the valuation allowance reduction. Regardless of the gap federal tax expense this year compared to the huge benefit last year, We do not have to use cash to actually pay federal income taxes for the next $1.5 billion of pre-tax income as a result of our deferred tax asset. This allows us to generate substantially more cash than our net income implies. We're using a significant portion of the cash we generate to reduce debt and strengthen our balance sheet. Now let me talk about our second quarter sales environment when we saw 30-year mortgage rates increase from about 3.6 percent to 5.1 percent. On the right-hand portion of slide 12, we show contracts per community for the second quarter going all the way back to 2017. You can see that our contract pace jumped from an average of 10.7 in the second quarters of fiscal 17, 18, and 19 to a white-hot pace of 18.3 in fiscal 21. That was a 71% increase. While not as strong as last year, our sales pace of 15 contracts per community in the second quarter was still much stronger than the pre-COVID years of 17, 18, and 19. Further to the left, we show that the average second quarter contract pace from 97 to 02 was 13.5. This was a time that was neither a boom nor a bust for the housing industry. The current pace of 15 contracts per community in this year's second quarter is higher than our historical average. Given all the uncertainties regarding inflation, the Ukrainian war, rising mortgage rates, and a fear of recession, it's reasonable to assume home demand may slow down further this summer. In a related topic, Larry will discuss our conservatism in underwriting land purchases a little later in our presentation. Due to our ability to raise home prices more than construction costs, our recent home contracts continue to be written with very high gross margins. If home demand softens further, similar to sales pace returning to normal levels, it's also reasonable to expect that gross margins will return to more normal levels. While we're not going to review our multi-year key metric targets that we discussed last quarter, I will note that when we prepared those key metric targets, we assumed and showed that our pace and gross margins would eventually decline to lower, more normal levels. For greater transparency, on slide 13, we show contracts per community monthly from May through April, the last month of our quarter. The most recent month is in dark green, The same month a year ago is in light blue. The same month two years ago is in gray. For all 12 months shown on this slide, our contracts have been lower than last year's blazing pace. However, we compare favorably every month with the same month's pre-COVID sales pace. The sales pace shown on this slide reflects a decreasing sales pace from last year, but also shows that demand for homes remained strong every month in our second quarter. Although we continue to raise home prices in many communities during the month of May, if mortgage rates rise further going forward, it's reasonable to expect moderation in both current sales pace and in home prices. Turning to slide 14, we show contracts per community for the month of May beginning in 19 all the way through 22, which just ended yesterday. We had 3.2 contracts per community for May of 22. Unlike every month of the second quarter where our sales pace was greater than the pre-COVID pace, in May of 22, the pace was slightly lower than the pre-COVID pace of 19. There is little doubt that the rise in interest rate, as well as fears of inflation, the war in Ukraine, et cetera, have dampened home demand in May. As of today, we still have very modest use of incentives and concessions. We believe this to be true for the industry as well. If sales paces reduce further, it's likely that both we and the industry will return to normal use of incentives and concessions. For us, that would increase concessions and incentives from about 3% recently to our more historical levels of about 6.5%. The additional incentives could be used to qualify customers by buying down mortgage rates. Fortunately, today's gross margins are quite high, and can sustain increases to more normalized concessions while still generating strong returns. On slide 15, we show how quickly mortgage rates have risen since the beginning of the calendar year. This slide shows that since January 1st of this year, mortgage rates have increased about 190 basis points. It's interesting to note that mortgage rates have declined slightly over the past few weeks. Perhaps it's a sign that rates are stabilizing for now. Any increase in mortgage rates is not helpful as a portion of homebuyers will not be able to qualify for the same mortgage that they were able to before. When the rate increase happens this quickly, it usually takes time for some consumers to adjust to the reality of higher mortgage rates and reset their expectations for of how large and expensive of a home they can afford. On slide 16, we show a long-term perspective of where the 30-year fixed rate mortgages have been since the early 70s. Although it has increased to 5.1 percent, today's 30-year fixed rate mortgage remains among the lowest levels that we have seen for the past five decades. While I recognize home prices have increased significantly, they've increased in double-digit percentages many times in the past. As you can see on slide 17, the increase in mortgage rates has had very little impact on our cancellation rates. For the second quarter of 22, our cancellation rate was 17 percent compared to 16 percent in last year's second quarter. If you look back on this slide, you can see that a normal cancellation rate is in the range of the high teens to the low 20s. The 17% cancellation rate in the second quarter is consistent with what we have seen in the second quarter since 2015. On slide 18, we show existing single family inventory for sale over the last 40 years. As you can see on this slide, the number of existing homes currently for sale is near an all-time low at 910,000 homes. Even if you doubled this supply, we would still be below the historical average of 2.1 million homes. This lack of supply of existing homes for sale is one of the reasons that demand for new homes remains as strong as it is. With respect to new homes, there are virtually no finished specs on the ground today for both us and the industry in general. On slide 19, we show that we had 2.0 spec homes per community, which is significantly below our long-term average of 4.4 spec homes per community. Like existing homes, if we doubled our specs per community, we would still be below our long-term average. We also show on this slide that we had 205 homes started that were unsold at the end of the second quarter. We consider a home a spec the day we start construction. Only two of our 205 started unsold homes in the entire country were finished. There is very little supply. On slide 20, we show that our community count increased slightly year over year. Our consolidated community count increased by five communities or 5% year over year at the end of the second quarter. We expect our community count to increase in the second half of this year. Given no material changes in market conditions, we expect to end the year with a community count at or slightly higher than 135 communities, including unconsolidated joint ventures. This is slightly lower than our previous guidance due to land development delays and permitting delays, which have set our scheduled openings slightly behind the pace we initially anticipated. We are incredibly pleased with our performance through the first half of 22. We couldn't have achieved these higher levels of profitability without the combined efforts of our dedicated company associates throughout the country. As we look at the back half of this year, we still have a lot of homes we need to deliver, but I'm confident that our teams can get this job done. We already have all of this year's expected deliveries in backlog, and we've begun to build our backlog for fiscal 23. We firmly believe we're going to be able to achieve the significant profit growth of our fiscal 22 guidance. I'll now turn it over to Larry Sorsby, our Chief Financial Officer.