This conference call transcript was computer generated and almost certianly contains errors. This transcript is provided for information purposes only.EarningsCall, LLC makes no representation about the accuracy of the aforementioned transcript, and you are cautioned not to place undue reliance on the information provided by the transcript.
Operator
The conference will begin shortly. To raise your hand during Q&A, you can dial star 1 1.
Larry
Good morning and thank you for joining us today for Hubnanian Enterprises Fiscal 2022 Fourth 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 fourth 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's 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 would like to turn the call over to Jeff O'Keefe, Vice President, Investor Relations. Jeff, please go ahead.
Jeff O'Keefe
Thank you, Lateef, and thank you all for participating in this morning's call to review the results for our fourth quarter in year, which ended October 31st, 2022. All statements on 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 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 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 in Management's Discussion and Analysis, particularly the portion of MD&A entitled Safe Harbor Statement in our annual report on Form 10-K for the fiscal year ended October 31st, 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 are Ara Obnanian, Chairman, President, and CEO, Larry Suresby, 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 Ara.
Lateef
Thanks, Jeff. I'm going to review our fourth quarter and full year 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. Similar to the third quarter, we are reporting very strong levels of profitability, but a weaker number of new contracts. I'll discuss all of this in my discussions. On slide five, we compare our full year results to our guidance. Total revenues of $2.9 billion, adjusted gross margin of 25%, SG&A at 10.1%, and EPS of $29 per share were all within our guidance range. Our adjusted EBITDA and adjusted pre-tax income both exceeded the high end of our guidance range. All in all, our financial performance in fiscal 22 was strong, the best we've had in any single year since the Great Housing Recession. Slide 6 shows year-over-year comparisons for our fourth quarter. Starting in the upper left-hand portion, we show that our total revenues for the fourth quarter were $887 million, an increase of 9% over last year. Moving to the upper right-hand portion of the slide, you can see that our adjusted gross margin increased 140 basis points to 24.2% this year compared to 22.8% last year. In the lower left-hand portion of the slide, you can see that our SG&A was 9.1% this year compared to 8.6% last year. In the lower right-hand portion of the slide, we show that adjusted EBITDA increased 19% year-over-year to $144 million. On the left-hand portion of slide 7, you can see that our adjusted pre-tax income improved 28% in the quarter to $104 million compared to $81 million last year. On the right-hand portion of the slide, you can see that our net income for the fourth quarter of 22 was $56 million compared to $52 million in last year's fourth quarter. Profitability in the fourth quarter was solid, which certainly stands in sharp contrast to the current sales environment that I'll discuss now. Turning to slide eight. contracts per community for the current period are down significantly compared to a year ago. Here we show that contracts per community for the fourth quarter of 22 decreased to five compared to 10.2 last year. There's no doubt that sales were very strong in 20 and 21, which makes comparisons to that period very difficult. The start of 22 also saw strong sales. However, beginning in May of 22, home demand slowed and it continued to slow further through the end of November. There are a number of factors that you're all familiar with that have created this fall off in demand, including concerns about inflation, quick sharp increase in mortgage rates and an overwhelming sense that the US is headed toward a recession the end result is many consumers have temporarily paused their home purchase decisions and are waiting for more clarity with respect to inflation their own job stability and where mortgage rates might stabilize turn into slide 9 we show that our fourth quarter is getting close to the 4.3 contracts sales pace that we had in the trough of the great financial crisis back in 08. Although the industry's current sales pace is similar to the great housing recession, we do not believe that the duration of this downturn will be anywhere near as long. Our belief is based on the current low levels of listings of existing homes for sale, the fact that home builders did not overbuild new construction nearly as much as they did prior to the great housing recession, there was not a subprime speculative buying spree of homes this cycle, plus a few other factors that I'll discuss. On the right hand portion of slide 10, we break out contracts per community for the fourth quarter by our three geographic segments. Similar to what many of our home building peers have reported, it's clear that contracts per community in our west segment are significantly lower than our northeast and southeast segments. On slide 11, we show annual contracts per community for the past several years. You can see that for the full year of 22, the last gray bar to the right, contract per community retreated to almost the same level we had for the full year of 2019 before the pandemic. But that doesn't tell the whole story because as 22 unfolded in later quarters, the sales pace progressively worsened. If you annualize and seasonally adjust our fourth quarter sales pace, you get to 21 sales per community, a slow sales pace and one that we haven't seen since the great financial crisis of 08. On slide 12, we show contracts per community monthly from December last year through the recent month of November. The most recent months are in dark green, the same month a year ago in light blue, the same month in 20 is in light gray, and the same months in 2019 are showing up in a darker gray. Of course, sales comparison to the COVID housing surge are difficult. Because of that, pre-COVID sales in 2019 are a more representative benchmark. On slide 13, we compare only fiscal 22 and the pre-COVID years of 2019 by month. You can see that we were tracking ahead of 2019 until the month of May. That was definitely the pivot point as the cumulative effect of rising mortgage rates became clear. From that point on, we've been selling fewer homes per month than the pre-COVID sales pace. On slide 14, we show our cancellations as a percentage of the entire backlog. The cancellation rate for the fourth quarter of fiscal 22 was 13%, which is right in line with our historical average. However, if you look at cancellations as a percentage of gross contracts during a period, our fourth quarter was 41% compared to a normal cancellation rate in the high teens or the low 20s. The absolute number of cancellations has not changed much. In fiscal 21, we averaged 96 cancellations per month, and in fiscal 22, that number only rose to 107 cancellations per month. The issue is that our gross contracts have been unusually low in the back half of fiscal 22, which has led to a spike in cancellation rates. This phenomenon is not unique to us, as you know, but is being seen across the industry. On slide 15, we show single-family housing starts for the past 50 years. If you look at the middle of the chart, leading up to the great housing recession and circled in red, you can see that for 14 straight years, the housing industry built more homes per year than the long-term average. This overbuilding created an excess supply in the market, which was one of the many factors that impacted the great housing recession. That period was followed by a 14-year downturn where the industry substantially underproduced long-term average levels, which is circled on the graph in green. The most recent new home construction start cycle was lengthy on the upswing and stayed below the long-term average for many, many years. If you exclude the last cycle, the previous three cycles shown on this chart in the 70s, 80s, and 90s were painful, but those downturns were brief and less severe in comparison to the great recession that we recently saw. Most recently, we were only above the long-term starts average for one year in 21, and it looks like we'll certainly be below the average when the full year of 22 is disclosed. Another indicator that the duration this time around should be shorter is that since the Great Housing Recession recovery began, the industry produced significantly fewer homes than the prior cycle and did not overbuild anywhere near the levels of the last housing boom. Slide 16 gives another data point. that makes us comfortable that this down cycle will be shorter in duration than the prior down cycle. On this slide, we show that the number of existing homes for sale currently stands at 1.1 million homes, which is about half of the historical 2.1 million homes normally for sale on average. Yes, it has risen a bit in the last six months, and that makes a lot of headlines, but it's risen from some of the lowest levels in recent history. Even after this small increase, we're still at the lowest level of existing homes for sale in four decades. To put this into perspective, there was three times the supply of existing homes for sale at the beginning of the Great Housing Recession compared to now. 3.4 million existing homes for sale then, 1.1 million now. Given the low supply of both new and existing homes for sale, it's hard to believe that the current downturn will be as long or as painful as the Great Housing Recession. Another positive sign that the duration of this downturn may be brief is our website visits continue to be strong. We show our website activity on slide 17, and we believe this is a leading indicator of future demand. 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 20 and the gray line is 2021. Both of these years were elevated during the time of extremely high demand for new homes during the COVID surge. On slide 18, you can see the 2022 daily website visits per community. It's shown in the bright yellow line. For the past several months, There have certainly been fewer website visits than the very high levels that we experienced in 20 and 21, but there are definitely better than the more normalized 2019 pre-COVID levels. This continuation of high levels of website activity is encouraging. The high website traffic has not yet translated into normalized sales, However, the fact that so many people are taking the time to come to our website and spending time on it, indicates that there's interest and quite possibly pent up home demand building. This is yet another reason that we believe the duration of the downturn should be shorter. We're hopeful that as mortgage rates and the economy stabilize, more people will become comfortable enough to buy a home and we'll see the healthy level of website visits convert to increased levels of contracts. We have no illusion that the current state of new home sales or the housing market overall is not good. It is indeed bad. However, for the reasons that we've just cited, we think that pain might be deep but will last a relatively short period of time. I'll now talk about several of the steps we're taking in other areas to address the current market. The good news is that we have a very seasoned management team that has the experience necessary to successfully navigate through this downturn. In this rising and uncertain mortgage rate environment, consumers are seeking homes that they can close quickly. As a result of that shift in consumer demand, we're temporarily pivoting to more quick move-in homes, or QMI homes, in order to provide our customers with more certainty on what their mortgage payment will be at closing. We consider a home to be a QMI home the day we begin construction. If you turn to slide 19, you can see that our QMIs per community are consciously on the rise. we've gone from 3.2 QMI's per community in the third quarter to 5.6 at the end of the fourth quarter. This level of QMI's is higher than our historical average, but similar to levels we had right before the COVID surge in demand. As a result, in the recent weeks, QMI sales account for 60% of our weekly sales versus about 40% historically. In this rising rate environment, we are temporarily targeting approximately seven QMIs per community, with a few just beginning construction and a few midway through construction, and we're certainly focused on selling those that are near the end of construction. Once that level is achieved, we will match our start schedules with our 2023 spring selling season pace. This approach will ensure that we do not start an excessive level of unsold homes. Furthermore, we will focus on selling these homes before completion. Second, as we try to find the market in terms of home price and sales pace, we are closely monitoring our competitors' use of incentives, concessions, and base price reductions on a community by community, state by state basis. Given the strong margins in our fourth quarter backlog, we decided not to be too aggressive with concessions on new contracts to minimize any potential disruptions to our fourth quarter deliveries. Now that the fourth quarter is behind us, we've increased our use of incentives and concessions. In some cases, we even need to offer incentives to customers in backlog to get them to the closing table. We've been offering our customers incentive choices, such as paying for permanent or temporary below market mortgage rates, paying for closing costs, offering discounts on options or upgrades, or discounting home prices on select QMI homes. There is not a one size that fits all consumers, so we typically offer a consumer a choice on what incentives meet their needs the best. For QMI homes that are nearing completion, we can lock in a below market fixed interest rate. The below market fixed interest rate is prohibitively expensive for to-be-built homes. In general, higher levels of incentives are reserved for our more challenging communities and our more challenging home sites. The last thing that a home builder typically wants to do is lower their base prices across the board. This would only upset customers both in backlog and existing home buyers. However, when home builders open new communities, they are generally starting with lower market-driven base prices rather than using large incentives and concessions. By November, incentives in our new contracts had increased from the 3% level that we averaged in the first half of fiscal 22 to roughly 9.5%, which is higher than our historical average incentive rate. Even after increasing our use of incentives, the margin on most of the new homes that we're selling today remain in the low 20% range, slightly above our historical average gross margin of 20%. Let me repeat that. Even after increasing our use of incentives, Our average margin on new homes that we're selling today remains in the low 20% range. One reason our margins on new contracts remain this high is because we're selling more homes in the Northeast and Southeast where sales and margins are stronger and fewer homes in the West where sales and margins are weaker. Another reason that margins continue to be high despite our increased use of higher incentives and concessions is lower lumber costs. In addition, given the housing market decline, we believe our trade partners and suppliers need to share the burden of declining home prices. We have begun discussions with them to reduce their costs, which should soften the impact of margin declines in the future due to increased incentives. Some other steps we've taken to deal with the slower market in general and the uncertainty includes postponing further debt reductions until the housing market stabilizes, re-underwriting all of our existing land and lot option contracts to make sure that they still make sense even if the market deteriorates a little further from the current market conditions, temporarily suspending most of our new land acquisitions, slowing land development spend on land that we already own on a community-by-community basis where we don't want improvements to get too far ahead of our needs, and reviewing our staffing needs on a division-by-division basis. This is obviously an evolving situation, and we will continue to reassess the steps that we're taking to make sure they're appropriate in light of changing market conditions. I'll now turn it over to Larry Sorsby, our Chief Financial Officer.
Jeff
Thanks, Sarah. I'm going to start with slide 20. You can see that we ended the year with 133 communities open for sale. If not for the supply chain and production delays in opening new communities, that number would have been even higher. We've been trying to grow our community count to our pre-COVID levels for several years. After enduring long entitlement processes and slowed land development schedules, we project that we will finally be catching up during fiscal 2023. Additionally, given the recent slower sales pace per community, the expected lifespan of our communities is lengthening. While there are many factors that affect community count, We believe we will be able to return to our pre-COVID community count of approximately 160 by the end of fiscal 23. About 70% of our expected community count growth will take place in our northeast and southeast segments, and 30% will come from the west. As it turns out, given the recent better sales and margin trends in our northeast and southeast segments, that is a fortuitous ratio. Turning now to slide 21. On this slide, we show that our lot count seems to have peaked in the second quarter of fiscal 22 at 33,501 lots. During each of the subsequent quarters, our lot count decreased and we ended fiscal 2022 with 31,518 lots. Reflecting our risk adverse land strategy, it's important to highlight that our owned land position declined by 10.5% sequentially to just over 9,000 lots. I also want to point out that 62% of our total lots are located in our stronger northeast and southeast segments versus 38% in the west. To make certain that land we control by option continues to meet our underwriting hurdle rates, we've been re-underwriting all previously approved land acquisitions with the assumption of further market deterioration. During this year's fourth quarter, we walked away from about 2,100 lots and $3.9 million of lot option deposits and pre-development costs. The 2,100 lots we walked away from in the fourth quarter were either during their due diligence period or we're at the point that our option agreement required us to take down land. By using current home prices, current construction costs, and current sales pace to underwrite to a 20-plus percent internal rate of return, our underwriting standards automatically self-adjust to changes in market conditions. In addition, we are building in an extra buffer to our underwriting returns to absorb some potential future home price deterioration. I also want to comment on the impairment that we took in one community in Southern California, a particularly weak market. We took an $8 million impairment on a single community that was originally bought before the Great Housing Recession. We had unmothballed that community and built through the first phase, which consisted primarily of finished lots with reasonable success. However, as we moved on to the later phases of the community, which was raw land, the market began to weaken, and to make matters worse, land development costs began to rise. The combination of these negative factors resulted in this one formerly mothballed community triggering an impairment. I want to now give a brief update on our efforts in the build for rent space. BFR sales will be helpful in picking up a little of the slack in our traditional build for sale business. We currently have a few hundred homes under contract or closed with build for rent companies. Although this is not a significant portion of our business, all sales are helpful in today's market environment. We have been deliberately increasing our use of land options to increase our inventory turnover and our return on investment as well as to reduce risk associated with own land. On slide 22, we show our percentage of lots controlled by option increased from 46% in the fourth quarter of fiscal 15 to 66% in the fourth quarter of fiscal 21 and to 71% by the fourth quarter of fiscal 22. This has been a specific part of our strategy for many years and we continue to make progress. A low percentage of owned lots strongly mitigates land risk and gives us flexibility in a shifting market to renegotiate land price and terms. On slide 23, we show the vintage of our land position. Seventy-two percent of our total 31,518 lots controlled were put under contract before October 31, 2021. and 39% were controlled prior to October 31st, 2020. The vast majority of those lots were underwritten at lower home prices than today's housing market, which provides us with the flexibility to increase concessions and incentives while still delivering strong margins and returns. We are looking very carefully at the lots that were put under option during fiscal 22. Many of those lots have not survived our rigorous re-underwriting process with today's price and pace assumptions and have resulted in renegotiating option terms with sellers or walking away from that land parcel. Turning to slide 24. After $205 million of land spend in the fourth quarter and paying off $100 million of senior notes during the second quarter, we ended the year with $457 million of liquidity, well above the high end of our targeted liquidity range. Our land spend in the fourth quarter increased from the prior year. As we discussed earlier, our community count had been shrinking, and some of the properties we optioned before the COVID surge to counter our shrinking community count finally entitled ready for development or lot takedowns during the fourth quarter and we move forward on most importantly these communities continued to underwrite it yields above our 20% IRR hurdle rates even at today's lower sales pace and today's current net home prices needless to say We are only moving forward with land acquisitions if they still meet our return hurdles in today's slower sales pace and declining net home price environment. Despite the slightly higher land and land development spend compared to last year's fourth quarter, we still have fewer owned lots and fewer open for sale communities than at the end of fiscal 2021. Most of our new community openings are older vintage lots which still generate strong returns. Turning now to slide 25, compared to our peers, you see that we still have the third highest percentage of land controlled via option. We continue to use land options whenever possible to achieve higher inventory turns, enhance our returns on capital, and to reduce risk. Turning to slide 26, we show year's supply of owned lots for us and our peers. With 1.6 years supply, we are tied for the second lowest year supply of owned lots. Having a shorter supply of owned lots is a good way to reduce risk in a declining housing market. On slide 27, you can see that we also have 5.7 years supply of controlled land, both owned and optioned lots. Our focus on controlling land by option and choosing not to be overly long-owned land at this point in the cycle mitigates our risk from declining land values. Turning now to slide 28. Compared to our peers, we continue to have the second highest inventory turnover rate. High inventory turns are a key component of our overall strategy. We believe we have opportunities to continue to increase our use of land options and to further improve inventory turns and our returns on inventory in future years. Turning now to slide 29. On this slide, we show our debt maturity ladder at the end of the fourth quarter. We retired early $281 million of senior notes over the past two years. Early in the fourth quarter, we amended our revolving credit facility to extend the maturity date to June 30, 2024. After that, we don't have any debt maturing until the first quarter of fiscal 2026. Due to the Due to current market conditions, we have temporarily shifted our focus to preserving liquidity and paused our near-term debt reduction plans. We remain committed to strengthening our balance sheet and intend to revisit our debt retirement initiatives once market conditions improve. Given our $344 million deferred tax assets, we will not have to pay federal income taxes on approximately $1.3 billion of future pre-tax earnings. This benefit will significantly enhance our cash flows in years to come and will accelerate our progress of rapidly improving our balance sheet once the market stabilizes. Our financial guidance for the first quarter of fiscal 23 assumes no adverse changes in current market conditions. including no further deterioration in our supply chain or material increases in mortgage rates, inflation, or our cancellation rates. Our guidance assumes continued extended construction cycle times averaging six to seven months compared to our pre-COVID cycle times for construction of approximately four months. Further, it excludes any impact to our SG&A expense from Bantam stock expenses related solely to the stock price movement from $40.33 stock price at the end of the fourth quarter of fiscal 22. While we have met or exceeded most of our guidance metrics over many quarters, there is a greater degree of uncertainty in current environment given inflation, the potential of an economic recession, employment risk, utility company delays, and mortgage rate increases. Additionally, given the difficult economic backdrop and the resulting uncertainty in the housing market, the company will not be providing full fiscal year 2023 guidance at this time. With those caveats in mind, on slide 30, we show our guidance for the first quarter of fiscal 23. We expect total revenues for the first quarter to be between $500 and $600 million. We also expect adjusted gross margins to be in the range of 21 to 22 and a half percent. SG&A as a percent of total revenue is expected to be between 13 and 14 percent. Our guidance for adjusted EBITDA is between 42 and 57 million dollars. Our adjusted pre-tax income for the first quarter of fiscal 23 is expected to be between 5 and 20 million dollars. Our SG&A ratio is expected to increase over the prior year as we anticipate opening additional communities as well as a higher than normal increase in wages as a result of inflationary pressures. Due to slow market conditions, we are also anticipating increasing our advertising spend over the prior year. Despite lower levels of home building debt, our interest expense is expected to increase during fiscal 2020 23 for two reasons. First, a slower sales pace extends the average community lifespan and results in higher total interest costs. These interest costs are expensed in cost of sales interest on a per delivery basis. Therefore, the cost of sales expense per home will be higher in fiscal 23 than fiscal 22. Second, our inventory not owned has increased from a year ago, which has a corresponding increase in interest costs. Lastly, in response to competitive pressure from outside lenders and in order to offer lower mortgage rates so that more of our customers can qualify to purchase one of our homes, we also expect our financial service business will be significantly less profitable during fiscal 2023. On slide 31, you can see how our credit metrics have significantly improved over the past few years. Total debt to adjusted EBITDA has declined from 9.7 times in fiscal 19 to 2.7 times in fiscal 22. Net debt to adjusted EBITDA has declined from 8.9 times in fiscal 19 to 2 times in fiscal 22. Adjusted EBITDA and interest-incurred coverage has increased significantly from one time in fiscal 19 to 3.6 times coverage for fiscal 22. Turning to slide 32. Our shareholders' equity has increased from a deficit of 490 million in fiscal 19 to 383 million at the end of fiscal 22. Our net debt decreased $588 million from 1.55 billion at the end of fiscal 19 to $965 million at the end of fiscal 22. This improvement in our equity position and net debt resulted in our net debt to capital ratio continuing to decline from 146% at year-end fiscal 19 to 71.6% at the end of fiscal 22. Over the long term, we expect to continue improving our balance sheet by reducing debt and growing equity. Our goal is to achieve a mid-30% net debt to capital ratio. We are happy with progress we've made in improving these credits and balance sheet metrics over the past several years. Given the current housing environment, in the near term, it will be difficult to achieve similar improvements. However, we remain committed to our long-term balance sheet improvement goals. On slide 33, we show that at 37.5%, we have the third highest consolidated EBIT return on investment compared to our peers. We believe this is the most accurate measure of pure home building performance without regard to leverage. On slide 34, we show the trailing 12-month price to earnings ratio for us and our peer group. The entire home building industry is being valued as if there will be another long duration downturn like the great housing recession. We believe that is a scenario very unlikely to occur. We recognize that our stock should trade at a discount to the group because of our higher leverage. However, given our returns on equity and our even return on inventory compare favorably to our peers, And given how rapidly we've been improving our balance sheet, we believe our stock is the most undervalued of the entire universe of public home builders. Based on our price earnings multiple of 1.66 times at yesterday's closing stock price of $48.14, we're trading at a 12% discount to the next lowest peer and a 62% discount to the industry average. We remain focused on further strengthening our balance sheet. Standard & Poor's and Moody's both upgraded our credit ratings during fiscal 22. At some point, the stock market will give us credit for superior performance as well. And now I'll turn it back to Eric for some brief closing remarks.
Lateef
Thanks, Larry. Fiscal 22 was a phenomenal year of growth and profits. As we discussed, the new home sales market shifted dramatically in May of this year, and remains challenging, although we've been pleasantly surprised by a slight pickup in contracts over the last three weeks. The good news is that we've been through worse and we've taken steps to address the current market environment. Our initiatives to pay down debt early were well-timed and put us in a position with a much more solid financial footing today than at any time since the great housing recession. We reduced our net debt outstanding as Larry described by about half a billion dollars since the end of fiscal 19, just before this pandemic began. There is no doubt that these are challenging times. We have an experienced management team in place. 22 was a great year of returns for all home builders. Nonetheless, we're proud of the fact that we were the third highest among all home builders for return ebit return on investment and the absolute highest among our mid-sized peers we we have a proven record of industry leading return on investment and we'll take step the steps necessary to navigate through this current difficult market that concludes our formal comments and we'll be happy to turn it over to q a
Larry
The company will now answer questions. So that everyone has an opportunity to ask questions, participants will be limited to one question and one follow-up, after which they will have to get back in the queue to ask another question. We will open up the call to questions. To queue up at this time, please press star 1-1 on your telephone. Again, that's star 1-1 on your telephone to ask a question. Please stand by as we compile the Q&A roster. Our first question comes from the line of Alan Ratner of Zellman and Associates. Your question, please.
Alan Ratner
Hey, guys. Good morning. Thanks, as always, for the great information and detail. My first question, you know, I'd love to just kind of dig in a little bit more on the incentives, you know, disclosure you gave up to 9% of price in November. If I compare that to your order numbers for November, I see November was down a little bit from October and still at pretty low levels overall. At first glance, my takeaway there is that the higher incentives really have not had much of an impact in terms of finding that point of price elasticity, but I'm sure there's more to it than that. So just curious if you could talk a little bit about what you're seeing when you do offer these incentives. Is it helping to pull people into the market? Do you feel like you need to maybe kind of shift around the types of incentives in order to better find that point of elasticity? Any color you can give around that would be very helpful. Thank you.
Lateef
Sure, Alan. I'll address a few points. First, we report our net contracts. The ones you're focusing are in November. October was obviously our highest closing month of deliveries. That's when a lot of cancellations came through because consumers were forced to close and many were certainly nervous. A lot of those cancellations get processed in November. You have to process it properly in order to keep customers' deposits if we're entitled to it. So I'd say overall we feel like our incentives are making a difference, particularly for our QMI's. As we mentioned, one of the nice incentives you can offer today for homes that are closing soon are fixed mortgage rate buy downs, and that is attractive. The other thing to consider, obviously, is November is a slower seasonal month, and we expect December will be even slower. Alan, I think as a piece you wrote that came out yesterday, you noted surprisingly better sales. It might have been on the West Coast that you were speaking of in your report. just over the last few weeks, we've kind of felt the same thing, and again, mostly focused on our gross sales. So that's a little encouraging, but this is a time, as you know well, that's very slow in general, so we don't get overly excited or overly depressed by sales right now. What's going to be critical is what happens starting the middle of January.
Alan Ratner
That's really helpful additional color there. I appreciate it. Second, and maybe this is for Larry or Yara, on the disclosure of your land vintage, that's very helpful, so we appreciate that. I guess on the 28% of lots that were underwritten or tied up in 22, I would imagine the vast, vast majority of those are held under option contracts, just given your land acquisition strategy. Are you able to talk a little bit about how much capital is tied up in those deals currently? And I know the assumption is you're probably working to renegotiate the terms on those, whether it's price or takedown schedules. But any kind of thought on how we should think about those 28% of the lot count, how many of those are likely to be ultimately walked away from or what the timing of those walkaways could be? Thank you.
Jeff
Jeff, what's the average deposit we have on land options?
Jeff O'Keefe
I know we have $181 million in deposits. Let me get the average for you. I don't have that right in my fingertips.
Jeff
As a percent, yeah. But as he's looking that up, Alan, I don't have anything specifically broke out just on the 22s, so I can give you the average deposit so it gives you a perspective of what we've historically invested on average as a percent. of the land value. But some of those lots, obviously, were in the early stages just during due diligence so that we could actually walk away with it without even losing our deposit. So not all of those 22s or even that amount at risk. But clearly, the lots that we controlled in you know, 22 are the riskiest land deals that we have. We're not going to move forward and buy it. Even if we do have to risk the entire deposit to walk away, I'd rather do that than continue to invest money in it to develop it and bring it to market if it doesn't pencil what today's home prices, construction costs, and sales pace. But if it doesn't, As you mentioned, we'll try to renegotiate. Most sellers understand that the market's really changed. Some are willing to alter terms. Some aren't. So we don't know how many of those 22 will ultimately make it to the finish line or not.
Lateef
Alan, you did ask a good question about the ownership. We were actually chatting about that yesterday, the vintage by ownership versus the vintage by option. Our guess is like yours, that when we actually calculate it, what we own is generally of older vintage. What we option is newer. But we're going to follow up certainly by our next call. We'll try to get that broken out because it is an interesting point. I will add that a fairly decent number of our new options in 22 were in our northeast or southeast segments. And a lot of those are longer term entitlement land contracts and land options. So while it's controlled in 22, it's very likely on at least several of the ones that we actually approved in the last six months that the actual land purchase will not be for multiple years as we go through some of the difficult entitlement processes.
Jeff O'Keefe
And to follow up on the question, it's 9.5% is what the deposits are? The average deposit. Yeah, the average deposit. Got it.
Alan Ratner
Gotcha. And then before I hang up, I guess since you're following up maybe on the split there of own versus option, if it's possible to follow up maybe just with the gross order trends for October and November, given your response to my question earlier, I don't know if you have that at your fingertips or not, but I'll hang up. And if you do have that and can supply it, that would be great. So thank you.
Lateef
Yeah, we don't have it at our fingertips, and we typically just report net. But we'll take that into consideration as we report our next quarter.
Alan Ratner
Great. Thanks a lot, guys.
Lateef
Thanks.
Larry
Thank you. As a reminder, to ask a question, please press star 1-1 on your telephone. Again, that's star 1-1 on your telephone to ask a question. Our next question comes from the line of Alex Barron of Housing Research Center. Your question, please.
Alex Barron
Yes, thank you. Good morning. I have a few, so see how many you'll allow. If not, I'll get back in the queue. But yeah, I wanted to ask first, you know, we've heard that several builders are talking about getting incoming phone calls from front-end trades. I'm assuming you guys are experiencing the same thing. My question is, are those calls expecting to get paid the same thing and just getting work, or are they willing to give, you know, significant cost concessions to you guys so that you would have an incentive to start building new houses? Where do things kind of stand, any color you can give on that?
Lateef
Well, first, you are correct. We, like other builders, have been receiving inbound calls, and you're also correct. They're typically on the front-end trades. Most of our trades are not new to this rodeo and have been through housing downturns before. They know they enjoy the price appreciation and their price appreciation during the upturn, And I believe most are fully expecting to have lower pricing on new communities going forward. Regardless of whether they're inbound or not, we are definitely working on a national effort to rediscuss pricing in light of the environment with all of our subcontractors and suppliers. to reduce our pricing. And I wouldn't say thus far any of our vendors are particularly shocked. I think it's something that all are expecting. And they're seeing it with other home builders as well. Got it.
Alex Barron
Now, I guess along those fronts, can you talk about how many homes you guys have under construction and how does that split between specs And, you know, build to order, I guess, well, I guess the build to order would be close to your backlog. But I'm just curious on the spec side, how many homes do you guys have and how many of those are completed specs?
spk05
Brad?
Jeff
I think we have a slide on that.
spk05
The completed spec is 142 as of October 31st. The total, I don't know, Jeff, if you have your specs. I know you have what's the average per community, but I don't know if you have the total.
Jeff O'Keefe
Yeah, we give the total slide on that slide. It's 680 at October 31st.
Lateef
So, Alex, to put the finished specs, we call them QMIs, into perspective, it's a little over one per community across the country on average.
Alex Barron
Got it. Okay. That makes sense. You know, I think I heard you say that on pricing and incentives, it seems like you guys are more willing to or have been up until fiscal year end. We're less willing to, you know, upset the backlog and maybe we're more willing to do that on new communities coming out of the ground. But now that you're kind of in the new fiscal year and other guys are, you know, desperately trying to get some sales before year end, I'm sure you're seeing more price cuts from your competitors. So are you guys kind of engaging in those similar ways or are you still waiting maybe more for the spring selling season, you know, and still trying to protect the backlog?
Lateef
I'd say in good time, no, we're not in the phase of protecting backlog in the majority of our communities. There are a few exceptions where we've got a lot of backlog and we don't want to disrupt it. But in general, good times, bad times, rising prices, lowering prices, we're always very aware of what our competitors are doing. I think the thing to focus on is with the incentives that we are currently offering, and again, we have dialed them up since the fiscal year end, our current sales have margins above 20%. And, you know, that's not as good as what we just delivered, but certainly better than one might expect at this time in the housing cycle.
Jeff
One other comment I'd make, or repeat really, is that, you know, we historically have been a builder rather than, you know, having a bunch of, move-in homes or specs. We announced in the last quarter that the demand for homes that were kind of move-in ready had increased. We didn't have much. So as we monitor what our competitors are doing, we're seeing more demand on the homes that are kind of move-in ready. So we are continuing to produce more, and we think that will also help sales as we get more homes that can meet that kind of demand. from a consumer wanting to move quickly so that they can lock in a portable mortgage rate.
Alex Barron
Yeah, correct. Okay, great. Thanks. I'll get back in the queue. Appreciate it.
Lateef
Okay. Alex, if you'd like to ask another question or two, I think we've got time.
Alex Barron
Sure. Yeah, I guess, you know, since you just mentioned you are mostly bill to order, What is the typical deposit you guys get from consumers, from customers, you know, to build that home? In other words, how much money do they typically have at risk if they cancel?
Lateef
It's a good question. It varies quite a bit by geographic region. The East Coast tends to be higher. I think on base price, the higher divisions have about a 10%. purchase price deposit on top of that if they're doing a lot of options and upgrades we take a higher deposit on those options and upgrades on the west coast we tend to have lower deposits I think somewhere close to 3% is very typical on the west coast sometimes when it's higher than There's a negotiation around 3%. So those are kind of the two goalposts.
Alex Barron
It's interesting, yeah, because I think there's a pretty decent correlation between the level of deposits and cancellation rates. So that's why I was kind of asking that. We agree with you. Yeah, we agree. Okay. But at the same time, it seems, you know, I guess competitive pressures are shifting what you were just talking about, people moving towards effect building, I guess, to try to get people, you know, more payment certainty and that type of thing. Now, in terms of seasonality, I guess, you know, this past year was anything but normal, right? with demand super strong at the beginning of the year, low rates, and then the opposite at the end of the year. You know, what is your, I guess, your crystal ball or your expectation for this year? Do you think we're going to see more normal seasonality, or do you think it's still going to be largely driven by interest rates? You know, that if interest rates start to stabilize or come down, you'll see an acceleration in the back end? You know, how do you think things could play out?
Lateef
I think if I was to guess that interest rates will have a big effect on the seasonality. And if rates jump considerably in the spring selling season, I think that will dampen the normal rise you'd see in the spring selling season. If rates level off or even go down toward the end of the year, when you normally see seasonality bring down sales, it might heighten the impact of sales at that time. So I do agree with, I think, what you're expecting, that rates will impact normal seasonality.
Alex Barron
Got it. Thanks, Aaron. Thanks, Larry. Appreciate it. I'll get back to you. Okay.
Larry
Thank you. At this time, I'd like to turn the call back over to our chairman and CEO, Aaron Hovnanian, for closing remarks. Sir?
Lateef
Thanks very much. You know, as we've said before, there are great things about our quarter and things we're not so happy about, particularly regarding new contracts. But we've been down this road before. We've steered through a far more difficult situation, and we're in the best financial foundation that we've had in many, many years. So we look forward to producing good results considering the environment, and we look forward to reporting our first quarter in the not-too-distant future. Thank you.
Larry
This concludes our conference call for today. Thank you all for participating, and have a nice day. All parties may now disconnect.
Operator
Thank you. The conference will begin shortly. To raise your hand during Q&A, you can dial star 1 1. The conference will begin shortly. To raise your hand during Q&A, you can dial star 1 1.
Disclaimer