Hovnanian Enterprises, Inc.

Good morning and thank you for joining us today for Hudnavian Enterprise's fiscal 2022 third quarter earnings conference call. An archive of the webcast will be available after the completion of the call and will run for 12 months. This conference is being recorded for rebroadcast and all participants are currently in a listen-only mode. Manage will make some opening remarks about the third 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. These slides are available on the investor page of the company's website at www.khov.com. Those listeners would like to follow along with should now log into the website. I would now like to turn and call over to Jeff O'Keefe, Vice President of Investor Relations. Jeff, please go ahead.

Thank you, Norma. And thank you all for participating in this morning's call to review the results for our third quarter, which ended July 31st, 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 and 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 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 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 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, uncertainties, and other factors are described in detail in the sections entitled Risk Factors and Management's Discussion and 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 otherwise 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 on the call are Ara Hovnanian, Chairman, President, and CEO, Larry Soursby, 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. Eric, go ahead.

Thanks, Jeff. I'm going to review our third quarter results and I'll also comment on the current housing environment. Larry Sorsby, our CFO, will follow me with more details and then, as usual, we'll open it up for Q&A. Our third quarter seemed like a tale of two cities. On the one hand, we had our most profitable quarter since the third quarter of 2006, On the other hand, a wave of negative economic news has weighed on the mind of homebuyers, and we've seen them hesitate on finalizing their new homebuying decisions. I'll start with the good news. On slide five, we compare our results to our guidance, and you can see that our revenues were slightly below our guidance range, our gross margin was above our guidance range, and our SG&A was toward the lower end of our guidance range. The net result was an adjusted income before taxes significantly above our guidance range. Even without land sale profits of $10 million for the quarter, we still would have been significantly above the high end of our guidance range for adjusted pre-tax profits. Moving on to year-over-year comparisons for our third quarter. Starting in the left-hand position of slide six, you can see that our total revenues for the third quarter were $768 million, an increase of 11% over last year. We achieved this increase in revenues despite persistent supply chain issues that we continue to battle every day. Some of the issues lately have been delays in utility companies bringing electricity to homes and developments due to a shortage of transformers and utility crews, as well as delays in delivery of cabinetry, windows, and garage doors. Moving to the right-hand portion of the slide, you can see that our adjusted gross margin increased 420 basis points to 26.3% this year compared to 22.1% in last year's third quarter. Much of this increase was due to our ability to raise home prices more than labor and material prices increased due to strong demand for homes when they were sold seven to nine months ago. The average sales price for homes delivered in the third quarter increased 18% to $522,000. Turning now to slide seven. On the left-hand portion of the slide, you can see that our SG&A, as reported, was 9.8% for the third quarter compared to 8.7% in last year's third quarter. If you ignore the impact of the incremental phantom stock expenses, something that we've talked about in the past, the SG&A ratio would have been 9.7% in both years, which we show on the right-hand portion of the slide. As the sales environment has slowed down, we're carefully monitoring our SG&A expenses, including filling vacancies or staffing new positions. Turning to slide eight, we show that adjusted EBITDA increased 42% year over year to $147 million. Turning to slide nine, you can see the benefit of the $281 million reduction of senior notes that we've completed since July of 2021. Our percentage of interest expense to total revenues decreased 140 basis points from 5.6% in last year's third quarter to 4.2% this year. The absolute dollar amount of interest was down 16% from $38 million in last year's third quarter to $32 million this year. Given the fact that we expect to reduce our senior notes by an additional $100 million in the fourth quarter, We anticipate incurring less interest in the future. On the left-hand portion of slide 10, you can see that our adjusted pre-tax income improved 78% to $113 million compared to $63 million in the last year. On the right-hand portion of the slide, you can see that our net income for the third quarter of 2022 was $83 million compared with $48 million in last year's third quarter. We're pleased with our third quarter profitability. Now, let me talk about the change in sentiment that has dramatically impacted the current sales environment. Beginning in May of 22, home demand slowed. and it continued to slow further through the summer months. We believe this striking shift in homebuyer sentiment is due to the sharp rise in mortgage rates since January, year-over-year home price increases, record high inflation levels, and fears of an economic recession. Today's economic uncertainties have caused consumers to temporarily pause their home purchase decisions. On the right-hand portion of slide 11, we show contracts per community for the third quarter of 22 decreased to 7.4 from 11.6 contracts per community in last year's third quarter. On slide 12, we show contracts per community monthly from August through July, 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 per community have been lower than last year's strong pace. Up until May, we compared favorably every month with the same month's pre-COVID sales pace. That was in 2019. However, since the month of May, we have seen a steep drop off in sales. While we're the first builder to report contracts for the full month of August, we're not the only builder that's reported declines in sales. You can see contracts per community restacked as if we had a June quarter end so that we could compare our results to 10 of our public peers who reported June quarter ends, as we do on slide 13. We're basically in the middle of the pack. Turning to slide 14, we show contracts per community for each month since May of 2022. During these four months, the market seems to have found a floor and stabilized, albeit at much lower level. The slight sequential decrease from 2.1 contracts per community in June and July to 2.0 in August is due to August being a seasonally slower month and that there were only four Sundays in August to five Sundays in July. We've seen a decrease in foot traffic per community during the quarter, and that's clearly more than a season of slowdown in the summer months. Encouragingly, however, We've experienced an upward trend in foot traffic over the past six weeks, which is unusual for this time of year. Furthermore, we see other positive signs of increasing home buyer interest when we look at our website activity, which we believe is a leading indicator of future demand. Turning to slide 15, Here we show daily website visits per community with the blue line near the bottom of the graph representing 2019 pre-COVID website visits. The dark green line is 2020 and the gray line is 2021, both of which were elevated during a time of extremely high demand for new homes during the COVID surge. On slide 16, We show that the 2022 website visits in July have certainly been less than the very high levels that we experienced in 2020 and 2021, but were better than the 2019 pre-COVID levels. On slide 17, we've seen website visits in the past few weeks approach those very high levels that we saw in 2020 and 2021. Frankly, it's been somewhat surprising. Our online leads have been following a similar trend. Again, we believe visits to the website and online leads are both leading indicators of demand for our homes. Both indicators have turned strong. Despite the recent slowdown in contracts, it's clear that potential buyers are looking for and researching new homes but we believe they are not yet confident enough to make a final decision to purchase a home. Since our last conference call, the use of incentives and concessions is much more prevalent today across the entire new home industry. We have increased our use of incentives on both specs and to-be-built homes. One of the most popular incentives is to buy down today's higher mortgage rates to something more affordable. On quick move-in homes, we recently offered a 3.99% 30-year fixed rate on homes that could close by October 31. For to-be-built homes, the rate was lower than today's market-marked mortgage rates but higher than we offered for quick move-in homes as the futures market for mortgage rates is more expensive. In addition to permanent buy-downs of mortgage rates, we also offer our homebuyers incentive choices such as paying closing costs, discounts on options, and upgrades or temporary mortgage buy-downs during the first years of homeownership. There is not one size that fits all consumers. So we typically offer a consumer a choice on what incentive meets their needs the best. The last thing a builder typically wants to do is lower their base price as that upsets both customers and backlog in existing home buyers. To date, we have not seen much of that occurring across the country. By August, incentives in our new contract had increased from the 2% level that we averaged in the first half of the year to roughly 6%, which is much more in line with our historical average incentive rate. Even after increasing our use of incentives, the margin on new homes that we're selling today remain in the mid-20% range, well above our historical average gross margin of 20%. I'm going to repeat that. Gross margins on new home sales today remain very high, even after the increase in incentives I just described. Having said that, our industry has clearly shifted to a buyer's market, and we're acting accordingly. We're closely monitoring our competitors' incentive trends and testing even higher levels of incentive. But to date, we have not seen a resultant increase in our home sales when we offer a higher incentive. Therefore, we're hesitant to further increase incentives across the board. Due to current economic uncertainties, many home buyers just remain entrenched on the sidelines. However, given increasing rents, high inflation, and the strong website traffic and leads we've recently experienced, we remain optimistic that our sales pace will ultimately rebound as the uncertainty in the economy is reduced. Needless to say, it's not clear when that's going to occur. In the interim, if the economy worsens, we and the industry may have to increase our use of incentives and concessions to convince consumers to buy now. As you can see on slide 18, when you look at our cancellations as a percentage of backlog, the cancellation rate for the third quarter of fiscal 22 was 8%. Given current market conditions, we were both pleased and somewhat surprised that we had an increase of only 2% versus the 6% backlog cancellation rate that we experienced in the same period last year. Further demonstrating the strength of our backlog, sequentially, our backlog cancellation rate actually dropped from 9% in the second quarter of 2022 to 8% in the third quarter. It remains well below our historical average backlog cancellation rate. This is vastly different than what we experienced during the great housing recession. However, due to the sharp decline in gross sales during the third quarter, our cancellation rate as a percentage of gross sales increased to 27% compared to 16% during the third quarter last year. The third quarter's gross cancellation rate is higher than our historical normal range of the high teens to the low 20s. Today, we're finding that home buyers want both the lowest mortgage rate possible and to reduce the risk that rates may rise further prior to closing on their new home. In a rising rate environment, consumers want to lock in their mortgage rate when they sign their purchase contract. That's harder to achieve when purchasing a home to be built that averages six to seven months to complete in today's environment because the rate on mortgages closing seven months in the future is materially higher than the rate for closing the home in the next 90 days. While we have typically and historically been focused on a bill-to-order model in most of our markets, in a sharply rising mortgage rate environment, there's a compelling case to be made for having more spec homes available so consumers can lock in their mortgage rate and close faster. Because buyers want to have certainty in rates, there is an increased demand for homes that can be closed in the next 30 to 90 days. Consumers remain laser focused on affordability. Until the mortgage and housing markets stabilize, we are consciously increasing our number of started unsold homes per community to try to capture some of those buyers looking to close quickly so they can lock in their lower mortgage rates. This temporary shift in our spec strategy will lower monthly payments and make our homes more affordable with the mortgage rate buy-down. Frankly, with the permit delays and time required to start backlog homes, it's been challenging to get more specs in the ground. But we're making progress, as you can see on the graph on slide 19. While we believe more started, unsold homes will satisfy consumer demand and drive more sales for us, we'll take steps to make sure that we sell these homes prior to completion so that our inventory levels do not needlessly increase. On this slide, we also show that we had 3.2 spec homes per community at the end of the third quarter. While this increased from the average of 1.9 spec homes per community we had for the last eight quarters, it's still significantly below our long-term average of 4.4 spec homes per community. We had a total of 350 spec homes at the end of the third quarter. We consider a spec home to be a spec the day we start construction. Only 18 of our 350 spec homes were finished as of the end of the third quarter. There is strong demand for finished spec homes. one additional very important point i want to mention is our initial build for rent efforts last quarter we began construction in our first 200 home build for rent community which is pre-sold at solid margins additionally we have recently signed two lois for another two communities with two different investors for approximately 350 homes also at solid margins and returns. Build for Rent is a large potential revenue source that can help fill some of our pipeline gap from our traditional for sale homes market during this time of extreme buyer hesitation and we're seeing tremendous investor interest and therefore we're considering expanding our operations in this growing segment. The terms and IRRs can actually outperform our for-sale returns, and we're quite excited about our opportunities in this growing sector. The homes are essentially similar to our existing affordable homes and are much simpler to build because of the lack of options, consistent color selections, and the rapid, steady pace. I'll now turn it over to Larry Sorsby, our Chief Financial Officer.