Q2 2022 Hovnanian Enterprises Inc Earnings Call

June 1, 2022

Good morning, and thank you for joining us today for Hovnanian Enterprises fiscal 2022 second quarter earnings Conference call.

<unk> 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 two quick questions. The company will also be webcasting, a slide presentation, along with the opening comments from management.

Slides are available on the Investor page of the company's website at Www dot.

<unk> dot com those listeners.

Who would like to follow along should now log onto the website.

I will now to turn the call over to Jeff O'keefe, Vice President Investor Relations. 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 30 of 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 1095, such statements involve known.

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.

<unk> 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 MD&A.

Entitled Safe Harbor statement in our annual report on form K.

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 Hovnanian, Chairman, President and CEO , Larry <unk> Executive Vice President and CFO , and Brad O'connor, Senior Vice President and Chief Accounting Officer, and Treasurer I will now.

I will turn the call over to our CEO Eric go ahead.

Thanks, Jeff.

Im going to review, our second quarter results and I'll also comment on the current housing environment, Larry <unk>, 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.

You focus on the third column you can see that our revenue was within our guidance range and our SG&A was 0.1% 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.

Right.

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.

Magnitude of this increase is due to strong home demand that allowed us to raise home prices more than labor and material cost increases.

Brought our average sales price to approximately $507000 per home delivered.

Turning to slide seven here you can see the lumber prices have been very volatile over the past two years.

Lumber prices have dropped significantly in recent weeks.

The homes that were about to start we 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 'twenty three as these homes begin to deliver.

At the same time prices lumber prices have been trending down our average sales price for a new contract is trending up in.

In the second quarter, our new contract average sales price of $564000 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 contract has 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've recently experienced and as supply chain disruptions are resolved.

<unk> pricing will return to normal levels.

<unk> as you know is a major cost component of housing and that will be very helpful.

Turning now to slide nine.

The left hand portion of this slide you can see that our SG&A was nine 7% for the second quarter compared to 11, 7% in last year's second quarter.

The COVID-19 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 EBIT.

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 six 2% in last year's second quarter to four 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 pretax 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.

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 cash to actually pay federal income taxes for the next one $5 billion of pre tax income as a result of our deferred tax.

<unk> 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 a 30 year mortgage rates increased from about three 6% to five 1% on.

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 seven in the second quarters of fiscal 2017, 18, and 19 to a white hot pace of $18 three in fiscal 'twenty one.

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-19 years up 17, 18 and 19.

Further to the left we show that the average second quarter contract pace from 97% <unk> was 13, 5%.

This was a time that was neither a boom nor 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 Ukrainian war rising mortgage rates and the fear of recession, it's reasonable to assume home demand may slow down further this summer.

On a related topic, Larry will discuss our conservatism and 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 multiyear 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 in gross margins would eventually decline to lower more normal levels.

For greater transparency on slide 13, we show contracts per community monthly for May through April the last month of our quarter.

Most recent month is in dark green the same month, a year ago was 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 months pre COVID-19 sales pace.

The sales pace shown on this slide reflect 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.

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 'twenty, two which just ended yesterday.

We had three two contracts per community for May of 'twenty two.

Unlike every month of the second quarter, where our sales pace was greater than the pre COVID-19 pace in may of 'twenty, two the pace was slightly lower than the pre COVID-19 pace of 19.

There is little doubt that the rise in interest rate as well as fears of inflation. The war on Ukraine et cetera have dampened home demand in Ms.

As of today, we still have very modest use of incentives and concessions. We believe this to be true for the industry as well as <unk>.

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 six 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 one 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.

<unk> signed the rates are.

<unk> for now.

Any increase in mortgage rates is not helpful. As a portion of homebuyers, who will not be able to qualify for the same mortgage that they were able to before.

When the rate increase happened. This quickly it usually takes time for some consumers to adjust to the reality of higher mortgage rates and reset their expectations of how large and expensive homes. 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 seventies.

Although it has increased to five 1% today's 30 year fixed rate mortgage remains among the lowest levels that we've seen for the past five decades, while I recognize home prices increase.

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 'twenty two our cancellation rate was 17% compared to 16% 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 low twenties.

The 17% cancellation rate in the second quarter is consistent with what we've 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 910000 homes.

Even if you doubled the 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.

<unk> of $4 four 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.

We're 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 are set or would you have said our scheduled openings slightly behind the pace. We initially anticipated.

We are incredibly pleased with our performance through the first half of 'twenty. Two we couldnt 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.

Already have all of this year's expected deliveries in backlog and we've begun to build our backlog for fiscal 'twenty three.

We firmly believe we're going to be able to achieve the significant profit growth of our fiscal <unk> guidance I'll now turn it over to Larry <unk>, Our Chief Financial Officer.

Thanks, Sarah I'm going to start with the progress we've made in growing our lot position, which is the key raw material, we need to build our homes.

Turning to slide 21, we show that our year over that year over year, our lot count increased by more than 5400 lots or by 19%. We now control about 33500 lots based on trailing 12 month deliveries this equates to a $5 eight year supply.

Hi.

Primarily through the use of finished lot options, we have been steadily increasing our lot position over the past couple of years.

As you can see our owned lot position remained flat year over year, while our lot opposition position increased.

On slide 22, we show the percent of lots controlled by option increased from 45% in the second quarter of 2015% to 69% by the second quarter of 'twenty two.

Low percentage of owned lots gives us tremendous flexibility and a shifting market.

The market for land acquisitions remains rational and we continue to feel very comfortable with the acquisitions, we've made over the past year.

We now have a five eight year supply of lots.

Until the housing market stabilizes, we will remain cautious when making new land acquisitions.

Using current home prices current construction cost and current sales pace to underwrite to a 20 plus percent internal rate of return hurdle rate and a minimum 6% pretax profit.

Our underwriting standards.

Automatically self adjust to changes in market conditions.

However, since the onset of the Covid fueled the increase in sales pace in the late summer of 2020.

We've taken a more conservative approach to underwriting our new land parcels by consistently using lower more normal pre COVID-19 sales paces, rather than the unsustainable higher COVID-19 sales paces, we experienced over the past 20 months.

Even when using the slower sales paces, we've been able to win our fair share of land deals and grow our land position.

Given the recent slowdown in sales pace per community and concerns regarding inflation and rising mortgage rates. We recently further tightened our underwriting standards to assume that we will increase our use of incentives and concessions when underwriting new land deals today.

Keep in mind that there's a lag between when we place lots under control and when those same lots will be fully developed and we can open a community for sale.

Most of the land, we put under control during our second quarter of fiscal 'twenty, two will not be opened for sale until the fourth quarter of fiscal 'twenty three and beyond.

We currently control, 100% of the land and communities necessary to achieve our significant growth in revenues and profits during fiscal 'twenty, two and control virtually all of the lots we need to achieve our current fiscal 'twenty three revenue and profit targets.

On slide 23, we show the vintage of our land position.

82%.

Of our total 33000 lots controlled were put under contract before October 31 of 2021, and 46% were controlled prior to October 31 2020.

Those lots were underwritten at substantially lower home prices than todays housing market, which if needed provides us the room to adjust concessions and incentives while still delivering very strong margins.

Turning to slide 24.

Even after $155 million of land spend and paying off a $100 million of senior notes during the second quarter. We ended the second quarter with $282 million of liquidity.

That means that we continue to have excess liquidity today. Our land acquisition teams are primarily focused on obtaining control of some additional land for home deliveries in fiscal 'twenty, four but primarily they're focused on fiscal 'twenty five and beyond.

Given rising mortgage rates, the uncertain economic environment and a cooling housing market outlook. We are now taken an even more conservative underwriting approach on new land purchases.

Turning now to slide 25.

Compared to our peers you see that we have the third highest percentage of land controlled via options.

We continue to use land options whenever possible to achieve high inventory turns enhance our returns on capital and reduce risk.

Our use of land options increased from 63% at the end of the second quarter of fiscal 'twenty, 1% to 69% at the end of the second quarter of 'twenty two.

Turning now to slide 26.

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 27.

On this slide we show our debt maturity ladder at the end of the second quarter.

Last year.

We paid off $181 million of senior notes and at the end of the second quarter of 2002, we paid off an additional $100 million of our 7% and three quarter percent senior notes due in 2006.

The more we're committed to paying off at least another $100 million of senior notes during the remainder of fiscal 'twenty two.

We believe that we should be able to refinance our currently undrawn revolving credit facility ahead of its maturity in the first quarter of fiscal 2003.

After that we do not have any note maturities until fiscal 'twenty six.

Given our $401 million deferred tax asset, we will not have to pay federal income taxes on approximately $1 $5 billion of future pre tax earnings. This tax benefit will significantly enhance our cash flows in years to come and we will accelerate our progress are rapidly improving our balance.

Once sheet, our focus in the coming years is to further reduce our debt.

Okay.

On slide 28, we show the dollar value of our consolidated backlog increased 16% year over year to $2 $1 billion at the end of the second quarter.

Sequentially backlog dollars were up 9% from the end of the first quarter of 'twenty two to the end of the second quarter of 'twenty two.

Given the recent sharp rise in mortgage Reits are mortgage and homebuilding teams have been diligently analyzing our contract backlog to make sure our customers can still qualify for a mortgage.

If customers are not able to qualify at current mortgage rates, we attempt to provide them with alternative mortgage programs, where they can be approved.

We have performed stress test on our backlog.

If mortgage rates increased to six or six 5%, we estimate that roughly 10% and 12% respectively of our customers currently in backlog would not be able to obtain a mortgage.

The strength of our backlog, including a strong expected gross margin sets us up nicely to achieve our expected improvements in our fiscal 'twenty two financial performance, we're already developing our backlog for fiscal 'twenty three as well.

Our financial guidance for the third quarter and the full year of fiscal 'twenty two assumes no adverse changes in current market conditions, including no further deterioration in our supply chain our material increases in mortgage rates.

Our guidance assumes continued extended construction cycle times of 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 Phantom stock expenses related solely to the <unk>.

Stock price movement from $46 <unk> stock price of <unk> at the end of the second quarter of 'twenty two.

Due to uncertainty surrounding ongoing supply chain issues persistent labor market tightness lumber price fluctuations and potential mortgage rate increases we are reiterating rather than increasing our guidance for the full year of fiscal 'twenty two.

Moving now to slide 29.

We provide guidance for the third quarter of fiscal 'twenty. Two we expect total revenues for the third quarter to be between 780 and $830 million. We also expect gross margins to be in the range of 24% to 26% SG&A is expected to be between nine five and 10 five.

Percent finally, we expect our adjusted pre tax profit for the third quarter of fiscal 'twenty two to grow to between 70 and $85 million.

On slide 30, we reiterate guidance for our full fiscal 'twenty two year.

We expect total revenues for the year to be between two eight and $3 billion. We also expect gross margins to be in the range of 23, 5% to 25, 5% SG&A as a percent of total revenues is expected to be between nine three and 10, 3%.

Adjusted EBITDA is expected to be between 410 and $460 million we.

Our adjusted pre tax profit for fiscal 'twenty, two to be between 260 and $310 million. Finally, we expect our earnings per share, assuming a 30% tax rate to be between 26%.

50 and $32 per share.

Given where our stock closed yesterday and the midpoint of our EPS guidance, we're only trading at 175 multiple of earnings.

On Slide 31, you can see our credit metrics have significantly improved over the past few years as well as the further improvement we expect to achieve at the mid point of our guidance for fiscal 'twenty two.

Total debt to adjusted EBITDA has declined from nine seven times and physical 19 to three eight times in 'twenty, one and three two times projected for fiscal 'twenty two.

Net debt to adjusted EBITDA declined from eight nine times in fiscal 19 to three one times in fiscal 'twenty, one and a two six times projected for fiscal 'twenty two.

Adjusted EBITDA to interest incurred coverage has more than doubled from one times in fiscal 19 to two three times for fiscal 'twenty, one and up to two eight times projected for fiscal 'twenty two.

Turning to slide 32.

Assuming we hit the midpoint of our fiscal 'twenty two guidance for pre tax profit our shareholders' equity is expected to more than double from fiscal 'twenty, one fiscal year end level.

This improvement in our equity position will result at our net debt to capital ratio continuing to decline from 146% at year end fiscal 19, 87% at the end of fiscal 'twenty one.

And at the endpoint of midpoint of our guidance its projected reduced further to 76% by the end of fiscal 'twenty. Two 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 expect to continue our trend of improving our credit metrics in future periods.

On slide 33, we show that at 33, 9%, we have the fourth highest consolidated EBIT return on inventory compared to our peers.

On slide 34, we showed that we have the highest return on equity when compared to our peers at above 100% for the last 12 months.

And on Slide 35, we show the trailing 12 month price earnings ratio for us and our peer group.

The entire homebuilding industry is being valued as if we're going to have a repeat of the great housing recession.

Which we believe is very unlikely to occur.

We recognize that our stock should trade at a discount to the group because of our higher leverage however, given how our returns on equity and our EBIT return on inventory stack up compared to our peers and given how rapidly we've been improving our balance sheet. We believe our stock is the most undervalued.

<unk> of the entire universe of public homebuilders.

Based on our price earnings multiple of 199 times at yesterday's closing stock price of $51 20.

We are trading at a 34% discount to the next lowest peer and a 61% discount to the industry average.

We remain focused on increasing our levels of profitability and further strengthening our balance sheet.

Market will eventually give us credit for our superior performance.

Now I'll turn it back to Ara for some brief closing comments.

Thanks, Larry.

Start by making one correction I mentioned may sales, which ended last night were three two contracts per community were actually slightly higher at three three.

To wrap up the call by saying that while many of our peers have already reduced their debt levels and have had the luxury of buying back stock with their excess cash over the last two years, we've been focused on using our cash to aggressively reduce our debt and strengthen our balance.

Sheet.

On Slide 36, we show the outstanding principal value of our public debt from the end of fiscal 19 through the guidance. We gave for the end of this year.

Over this period of time, we will have reduced our debt by almost $500 million.

If you turn to slide 37, you can see that we've made some significant progress in strengthening our balance sheet from 2019 to the end of this fiscal year, our equity is expected to increase by $854 million.

Simultaneously, we've reduced our public debt by almost $500 million.

We believe that the steps we are currently taking to strengthen our balance sheet, we will have a positive impact on.

On our future cost of debt and the valuations of our stock price.

On slide 38.

We show single family housing starts for the past 50 years.

It gives you a good perspective of the current state of the housing market.

In the previous boom, we clearly as an industry produced homes well over the long term averages for several years, thanks to subprime mortgages.

At this time.

The industry has just recently reached the long term average production levels.

21 was the first time, we had more than a million single family starts since 2006 and this year.

Slightly over that at the current pace.

More importantly, the previous 14 years, so housing production at dramatically lower than average levels.

I know there are varying views on demographics and average levels of production arent necessarily indicative of the future, but it is a good benchmark and the housing supply in the industry.

Definitely better positioned.

We recognize the housing market will likely be cooling off regarding the sales pace and price, having said that we feel like it will be nothing like the great recession of the late two thousands and we feel like Hovnanian enterprises is better prepared and in a better position than we've been.

At any time in the last decade and half.

We have a strong land position much of which we controlled at fixed prices prior to the recent significant home price increases we have a very large backlog of $2 $1 billion with really solid margins, we're seeing lumber prices trending down.

We have solid gross margins in our current home sales, which give us room to absorb net price declines and we have the flexibility of large land option position.

We know that there is a lot of uncertainty out there we feel very prepared all in all we are excited about our future and we look forward to reporting continued solid performance in the quarters ahead.

Thank you that concludes our formal comments and we will be happy to turn it over for Q&A.

Thank you and the company will now answer questions. So that everyone has an opportunity to ask questions.

<unk> will be limited to one question and a follow up after which they will have to get back into the queue to ask another question.

So we will open the call for your questions have you press Star one you will be in the queue and to remove yourself press the pound or housekeeping.

Your first question comes from Alan Ratner with Zelman and Associates. Your line is open. Please go ahead.

Hey, guys. Good morning, Thanks for taking my questions and I appreciate all the color and comments so far.

First just on the May activity and thank you for that.

That disclosure.

When you look at the sales pace in kind of the cooling you saw in may versus the second quarter can you talk a little bit about whether there were any notable differences either across price points or across your various markets, where you saw a greater pullback in demand.

Adding to that can you just talk about cancellation trends in the month as well and whether that contributed to the to the sequential pullback.

Sure I'd say.

A big picture perspective.

Active adult segment has been stronger.

And the Uber entry level has been slightly weaker.

And everything in between has been around the same.

And regarding cancellation rates no.

He has been.

Very solid I mean, we've our mortgage team in our divisions have been working diligently to make sure. The backlog. We have is qualified or can qualify for alternative mortgage program. So.

At this stage as Larry commented.

We've been pretty good as far as cancellations, yes.

Just to make it crystal clear we saw no change to speak of at all in our cancellation rates in the month of May.

Perfect. Thanks, guys.

Second.

This is kind of a multipart question, but if I look at gross margin obviously.

Well in excess of what you guided to for the quarter.

It looks like the guidance in the back half of the year implies some pullback from these levels.

On the other hand, Youre, saying, you haven't really increased incentives yet it sounds like maybe you.

You are getting some benefit on lumber, although that might be coming more next year, what's what's contributing to the expected pullback in margins over the next quarter or two because presumably those were homes that were predominantly sold before this run up in mortgage rates and when do you hit that point, where you would likely start to think about increasing incentives if the sales pace.

At these levels or even move slower.

Alan first.

Regarding gross margins.

In this supply chain disrupted environment.

And this labor shortage environment, it's a very tricky number two.

Predict super accurately.

Cause we're allowing for a little extra cost for these last minute solutions, where all of a sudden we've got a handful of windows missing or garage doors are gone or we've got a replacement appliances, where the higher end appliance because it's back ordered so.

We're trying to be a little more cautious in our costs and as it turns out we've been able to do a little bit better than we were cautious about and hence that was part of the reason why our gross margins.

We're.

Better than the upper end of our guidance range.

So you can take that same comment interview.

Guarding the balance of the year I mean generally speaking our gross margins in our new contracts are brand new as of this weekend have been really really solid.

I don't know what more to tell you about that Theyre, just really solid we've seen pace for a little more as you saw in may.

And then finally regarding the last part of your multi part question and then I'll turn it to Larry to answer some more.

We are looking community by community it's not.

An average movement in terms of slowness.

We have communities that were still metering sales and increasing sales prices on the other hand, we have some communities that are definitely slowed and those are the communities that would be the first ones that we start going back to normal concessions.

So we're looking carefully at this stage, we haven't really implemented going back to normal concessions across the board at all and we will continue to be tactical and look community by community Larry.

A couple more points on the gross margin.

Emphasized the difficulty in making the projections. The first point I'd make is I believe that.

We projected the second quarter.

Back in December and reiterated it when we announced our first quarter.

<unk> any cancellations that occurred from December .

Forward.

Ironically, we were able to resell at a higher price and higher margin from anticipated.

Home prices continue to go up so that's one of the things that led to it.

The thing is lumber prices, which are the biggest single component that goes into the home construction, but very volatile.

And.

Back to certainly in the second half of this year.

In terms of the deliveries that we're going to have lumber prices went up a few months ago.

And that is coming through in a higher cost than we had anticipated.

Previously as well so that could lead to some dampening.

The margin out in the second half of the year.

So I'll leave it at that I think Erez explanation was pretty comprehensive.

Great. Thanks, Thanks, a lot for you guys for the detailed answers.

And your next question comes from Alex Barron with housing Research Center. Your line is open. Please go ahead.

Yes.

Thank you gentlemen.

Congratulations on.

Strong results and good job on paying down the debt so far in strengthening the balance sheet.

On that note.

I wanted to ask I know you guys had previously.

Some potential kind of global refi at this point.

More likely that you guys are just going to go down the path of bank.

Now and have you set for the rest of the year.

Yes, I think that for.

Right now obviously the high yield.

Market is also.

Been disrupted by inflation.

Higher rates et cetera. So.

Didn't have any pressure to refinance earlier, we would opportunistically do it if we saw a great opportunity, but I think given changes in the market. It's safe to say that we're just going to continue to pay down debt.

Also concerned about refinancing and then given our expectations as expressed in the key metric targets, we gave last quarter have to pay.

Corporate teams on that we would have refinanced so right now I think you'll just see us continue to chip away at the debt and.

At some point in the future as we've got our balance sheet and better.

Condition strengthen we will look at refinancing nothing.

Nothing near term is on the horizon there.

Okay. Good the good thing is.

They don't need it to do it so that's that.

On the other hand, I wanted to ask about your backlog.

The discussion on incentives.

What extent have you guys.

Bert.

People that their fiscal year through some extended rate locks or something that minimize that.

Potential cancellations.

Along those lines.

What if any incentives or are you guys offering or you guys buy down.

Okay, great locked in.

So who is paying for that customer or are you guys.

Well first.

Ill just mentioned I mean, we've been closing homes in April and May and those have been largely were market rate.

Mortgage rates in the 5% levels.

We haven't seen huge cancellations and as I mentioned the team has been working diligently to check on the qualifications of our buyers.

Larry you want to comment on rate locks yeah.

We obviously have.

Been offering.

Both short term and long term rate locks too.

Our contract backlog and Thats been taken by some and refused by others.

Encouraged.

By kind of the.

Recent last few weeks that rates have dropped a little bit at least they haven't been going back up maybe that's given.

Comfort to some consumers as well.

Having said that I would say more than 50% of our third quarter backlog has already been locked.

And that's a little higher than it would normally be.

And.

If in fact, when we scrub the.

The backlog and when you have it.

<unk>.

Okay.

Sorry.

Thanks, Rob.

And we have a.

Customer here and there that does need.

Some assistance in order to.

Still qualify we'll make those decisions case by case.

Because our margins are so strong.

<unk> seen instances that.

Our divisions will decide to help buy down our rate our help with the rate lock.

To provide comfort to our consumer but I would tell you those those have been isolated at this point in time, but they have occurred.

Okay.

Suffocation as Larry mentioned, we've offered rate locks.

Two.

All of our backlog that hasn't been offered at our cost generally the consumer can look at it and consider the costs themselves.

Correct.

Got it and.

If I could ask one more on new communities that haven't opened yet.

I mean, it's no secret that home prices are gone up very significantly and that combined with the interest rates have perhaps made it difficult for some people to afford a home. So on the new communities is there any plan to somehow make them more affordable either introduce smaller sizes or fewer upped.

<unk> included in the houses or.

Just start them off at lower Asps or something can you comment anything along those lines.

Sure it's.

Good question.

All of our communities, we typically offer a range of <unk>.

Home sizes and home prices and we also offer a range of upgrades.

When the rates were lower.

We were selling a lot of our largest most expensive homes that were offered they could select small homes, but they tended to gravitate towards the larger end.

Of the home size spectrum.

Similarly, there, we're adding a fair amount of upgrades.

I want to mention our gross margin, we typically price.

A very very similar gross margin percentage, whether it's a small home or a large home reprice margins almost the same.

I'd say more recently, we've definitely seen more interest at the same community without changing our product offerings. There has just been a little greater selection from our smaller homes or midsize homes at least and a little tampering.

Sure.

<unk> excuse me of the options or upgrades that had been collecting so there is an ability without us really doing anything that the customers can make their own decisions and make their homes more affordable having said that a lot of times in the past when rates rise rapidly.

We definitely see a little hesitation.

And I think you saw that in May people are disappointed.

That all of a sudden they have to reduce the upgrades they were hoping for or choose the next how smaller it takes a little time for them to adjust their expectations, but they have the ability to do that and obviously, we still sold a lot of homes in may and many buyers did make those adjustments.

<unk>.

Okay, well. Thank you very much for all the explanation good luck and I'll get back in the queue.

Thank you. Thank you.

Thank you. Your next question comes from <unk> <unk> with Goldman Sachs. Please go ahead. Your line is open hi, guys. Congrats on the quarter just wanted to follow up on the month of May if you'll permit me to kind of get a sense of.

What youre seeing in terms of our buyer attitude at the current mortgage rates, specifically I'm trying to compare between what we're seeing today versus what we saw in late 2018, when we saw comparable surge in mortgage rates.

Additionally, on that I'm trying to get a sense of you mentioned $3 three.

Absorption pace is there a level of debt.

If you go below you start to introduce more incentives.

Into the marketplace I'll stop there.

I'll start with that.

But just responding again that is highly neighborhood and community specific.

We still have a metering situation.

Price increases at many communities. That's certainly the case, we see it in many in Dallas in many communities in Phoenix and many communities in Delaware.

Southeast, Florida, and south in the Carolinas.

We have many examples where we wouldn't pay.

Pace hasnt been slowing so it's community by community.

It has a lot to do with our internal budgets and getting a regular pace. If we have communities that fall off on pace.

And some of our very entry communities.

And off on pace.

That can be again, some of that phenomenon that I mentioned before the expectations have been.

Not met then they're disappointed but.

They don't ultimately adjust at those communities and by a smaller home then we'd look at concessions.

They are to be able to get that community back on pace. Fortunately gross margins are very high as we've mentioned numerous times.

There is plenty of room to return to some normal concessions.

And just a quick clarification on that as the pace level that youre targeting internally I'm not sure. If you reveal is at around three per community per month or is it somewhere else.

It varies dramatically from community to community, our higher end communities would be lower than that or three or lower.

Our very entry level communities might be higher than that so it's.

Very much a community by community basis.

Got you I appreciate the color on that.

And just a follow up on a different sort of question here in terms of your contract cancellation would would you guys be willing to.

Talk about what you've been seeing in terms of cancellation out of backlog over the past two quarters.

And if you look at what.

<unk>.

Buyers from our backlog are doing well.

What's the what's the spread or a combination or I guess, if you'd have to.

Split the pie.

How many are moving to adjustable rate mortgages versus buy downs versus <unk>.

Greater down payments et cetera.

Yes again.

Our.

Contract cancellation rate has been very modest by historical standards still well below normalized cancellation rates, we do provide I think in the end.

In Q, Brad what our backlog cancellation rate.

It is.

<unk>.

So those two.

Have not materially.

That's different than what R. R.

Historical trends have been they've been lower.

On the contract cancellation rate I just don't.

So I don't have it at my Fingertips frankly, Brett.

And look that up I wouldn't say that we've seen a significant shift at this point to adjustable rate mortgages to answer the second part of your question, we've seen a little bit of a use of adjustable rate because there is not a huge.

Spread and rate between call. It a five one arm versus a 30 year fixed.

Not a lot of people are going that direction certainly there's some people that just can't qualify the 30 year fixed rate, but can qualify it in adjustable.

Theyre going that direction, but it hasn't been a material number at this point in time.

I will add one other bit of color, we'd probably have a little bit of a greater percentage of age restricted communities than many of our peers.

Those consumers are typically not very affected at all by mortgage rates.

Many of them are cash buyers many of them.

Small mortgages. So that's part of the reason I made the comment earlier, we just see.

More strength in that segment and I suspect.

They're more indifferent about mortgage rates.

Adding to Larry's comment.

Insulation rate on backlog beginning backlog for the quarter.

It was 9% which is exactly the same as it was last year's second quarter.

That.

Historically, that's relatively low.

I appreciate the color guys best of luck for the rest of the year.

Thank you.

Thank you and as a reminder to ask a question simply press star one on your telephone.

Next question is from Alex Barron with housing Research Center. Please go ahead.

Yes, thanks for taking my follow up.

Regarding specs it doesn't sound like you guys have any or very little completed specs.

I'm just wondering.

You guys see a need at this point to slow down any any spec start.

Or do you see a risk that you could end up with with some finished specs by the end of the year if things don't.

Don't don't improve in terms of sales pace.

My first question.

There are many things to worry about in this time of uncertainty right now.

We're just scrambling to start the homes, we have in backlog, we have a huge backlog of over $2 billion. So we're just not focused on specs nor are we very worried about our specs we are less than half the number of specs per community.

Historically.

Less than half so it's far from a concern and we have virtually zero I think we have to the entire country. Two finished spec. So it's just not on our radar of one of the many concerns.

Got it.

I also wanted to ask in terms of.

In any communities, where you are starting to do.

And as rate buy downs right lots, whatever how much would that impact margins generally is it like one or 2%.

Yeah.

Okay.

And I think as mentioned just kind of be.

Community specific it's not going to be a broad brush across the whole company.

So I think in terms of impacting margins.

Near term it will be.

Streamline modest or not even noticeable.

If in fact, the market slows further and use of incentives by the industry and then by US starts to increase.

There is room.

Increased use of incentives I, just think it'll be gradual over time.

But.

If we decided at a slow selling to innovate increased incentives.

A couple of hundred basis points I, just don't think.

One or two or three half a dozen communities would be noticeable when anytime soon but as you do more and more communities if that.

It becomes an industry trend it would come through.

Maybe the second half of next year.

Alan I do want to add.

We are not.

Delusional about the uncertainty in the marketplace and we certainly don't think that the.

The gross margins, we just reported and the gross margins that were currently selling.

We don't think that can happen indefinitely I mean, the market will eventually normalize and as I mentioned earlier.

Last quarter we.

<unk>.

Talked about our multi year key metrics and in that in those metrics, we forecasted that we ultimately get back to a 20% gross margin right now we're not seeing anything like that its far better, but we think eventually the markets.

Going to gravitate to normalcy.

And that will eventually make its way into our results as well.

Yes. It is.

Good you've implemented that.

Conservatism in your outlook, because even though you guys might not have a ton of specs or almost any.

Obviously, a lot of your peers did start.

None of homes on spec and we're hoping to sell them at the last minute.

We'll see what happens.

Thanks, very much and good luck.

Thank you.

Thank you and this concludes our Q&A session I will turn the call back to Ara Hovnanian for his final remarks.

Well. Thank you very much we've tried to be as transparent as possible.

I don't think.

Body else has reported may.

Contracts, yet so hopefully you've got fresh information and.

We look forward to giving you.

Continued good results in our upcoming quarters. Thank you.

And this concludes our conference call for today. Thank you all for participating and have a nice day you may now disconnect.

[music].

Sure.

Okay.

Yes.

Sure.

[music].

Yes.

Okay.

[music].

Good morning, and thank you for joining us today for Hovnanian Enterprises fiscal 2022 second quarter earnings Conference call an archive of the webcast will be available.

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 to quick question. 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.

<unk> K half dot com.

Those listeners who.

Who would like to follow along should now log onto the website.

I would like to turn the call over to Jeff O'keefe, Vice President Investor Relations. 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 32022.

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.

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 MD&A entitled Safe Harbor statement in our annual report on form 10.

Joining me today are Ara Hovnanian, Chairman, President and CEO , Larry stores, the executive Vice President and CFO , and Brad O'connor, Senior Vice President and Chief Accounting Officer, and Treasurer, I'll now turn the call over to our CEO Eric go ahead.

Thanks, Jeff.

Going to review, our second quarter results and I'll also comment on the current housing environment, Larry <unk>, Our CFO will follow me with more details and then we'll open it up to Q&A.

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% 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 this 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.

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 $570000 per home delivered.

Turning to slide seven here you can see the 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 we 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 'twenty three as these homes begin to deliver.

At the same time prices lumber prices have been trending down our average sales price for a new contract is trending up in.

In the second quarter, our new contract average sales price of $564000 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 contract 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.

Lumber pricing will return to normal levels.

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 nine 7% for the second quarter compared to 11, 7% in last year's second quarter.

If the COVID-19 related delays did not adversely affect our delivery count our SG&A ratio would have been lower yet in.

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 a reduction of senior notes that we completed last year.

Our percentage of interest expense to total revenues decreased 130 basis points from six 2% in last year's second quarter to four 9% this year.

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.

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.

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 devaluation allowance reduction.

Yet.

This allows us to generate substantially more cash than our net income implies.

We are 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 a 30 year mortgage rates increased from about three 6% to five 1% on.

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 seven in the second quarters of fiscal 17, 18, and 19 to a white hot pace of $18 three in fiscal 'twenty one.

That was a 71% increase while not as strong as last year, our sales pace up 15 contracts per community in the second quarter was still much stronger than the pre Covid years, 17, 18 and 19.

Further to the left we show that the average second quarter contract pace from 97% <unk> was 13, 5%.

This was a time that was neither a boom nor 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 Ukrainian war rising mortgage rates and the fear of recession, it's reasonable to assume home demand may slow down further this summer.

On 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.

Well, we're not going to review our multiyear 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 in gross margins would eventually decline to lower more normal levels.

For greater transparency on slide 13, we show contracts per community monthly for May through April the last month of our quarter.

Most recent month is in dark green the same month, a year ago was in light blue. The same month two years ago is in gray for all 12 months shown on this slide our contracts had been lower than last year's blazing pace.

However, we compare favorably every month with the same months pre COVID-19 sales pace.

The sales pace shown on this slide reflect the decreasing sales pace from last year, but also shows that demand for homes remained strong every month in our second quarter.

Although we continued 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 'twenty, two which just ended yesterday.

Had three two contracts per community for May of 'twenty two.

Unlike every month of the second quarter, where our sales pace was greater than the pre COVID-19 pace in may of 'twenty, two that pace was slightly lower than the pre COVID-19 pace of 19.

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 Ms.

As of today, we still have very modest use of incentives and concessions. We believe this to be true for the industry as well.

As 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 six 5%.

The additional incentives could be used to qualify customers by buying down mortgage rates.

Fortunately today's gross margins are quite high and consistent increases to more normalized concessions, while still generating strong returns.

It's interesting to note that mortgage rates have declined slightly over the past few weeks.

It's a sign that rates are stabilizing for now.

The increase in mortgage rates is not helpful.

Portion of homebuyers, who will not be able to qualify for the same mortgage that they were able to before.

On slide 16, we show a long term perspective of where the 30 year fixed rate mortgages have been since the early seventies.

Although it has increased to five 1% today's 30 year fixed rate mortgage remains among the lowest levels that we've seen for the past five decades, while I recognize home prices.

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 in our cancellation rates for the second quarter of 'twenty two our cancellation rate was 17% compared to 16% 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 low twenties.

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 910000 homes.

Even if you doubled the 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 of spec homes per community, which is significantly below our long term.

Average of $4 four spec homes per community.

Like existing homes, if we doubled our specs per community, we would still be below our long term average.

We're 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 are set or Scott would you have said our scheduled openings slightly behind the pace. We initially anticipated.

As we look at the back half of this year, we still have a lot of homes, we need to deliver but I am confident that our teams can get this job done.

Already have all of this year as expected deliveries in backlog and we've begun to build our backlog for fiscal 'twenty three.

We firmly believe we're going to be able to achieve the significant profit growth of our fiscal <unk> guidance I will now turn it over to Larry <unk>, Our Chief Financial Officer.

Thanks, Sarah I'm going to start with the progress we've made in growing our lot position, which is the key raw material, we need to build our hubs.

<unk>.

Primarily through the use of finished lot options, we have been steadily increasing our lot position over the past couple of years.

As you can see our owned lot position remained flat year over year, while a lot of opposition position increased.

On slide 22, we show the percent of lots controlled by option increased from 45% in the second quarter of 2015% to 69% by the second quarter of 'twenty two.

A low percentage of owned lots gives us tremendous flexibility and a shifting market.

The market for land acquisitions remains rational and we continue to feel very comfortable with the acquisitions. We've made over the past year. We now have a five eight year supply of lots.

Until the housing market stabilizes, we will remain cautious when making new land acquisitions.

Using current home prices current construction cost and current sales pace to underwrite to a 20 plus percent internal rate of return hurdle rate and a minimum 6% pre tax profit.

Our underwriting standards.

Automatically self adjust to changes and market conditions.

However, since the onset of the Covid fueled the increase in sales pace in the late summer of 2020, we have taken a more conservative approach to underwriting our new land parcels by consistently using lower more normal pre COVID-19 sales paces, rather than the unsustainable higher COVID-19 sales.

Paces, we experienced over the past 20 months.

Even when using a slower sales paces, we've been able to win our fair share of land deals and grow our land position.

Keep in mind that there's a lag between when we place lots under control and when those same lots will be fully developed and we can open a community for sale.

Most of the land, we put under control during our second quarter of fiscal 'twenty, two will not be opened for sale until the fourth quarter of fiscal 'twenty three and beyond.

We currently control, 100% of the land and communities necessary to achieve our significant growth in revenues and profits during fiscal 2002 and control virtually all of the lots we need to achieve our current fiscal 'twenty three revenue and profit targets.

On slide 23, we show the vintage of our land position.

82%.

Of our total 33000 lots controlled were put under contract before October 31 of 2021, and 46% were controlled prior to October 31 2020.

Turning to slide 24.

Even after $155 million of land spend and paying off a $100 million of senior notes during the second quarter. We ended the second quarter with $282 million of liquidity.

Given rising mortgage rates, the uncertain economic environment and a cooling housing market outlook. We are now taken an even more conservative underwriting approach on new land purchases.

Turning now to slide 25.

Compared to our peers you see that we have the third highest percentage of land controlled via options.

We continue to use land options whenever possible to achieve high inventory turns enhance our returns on capital and reduce risk.

Our use of land options increased from 63% at the end of the second quarter of fiscal 'twenty, 1% to 69% at the end of the second quarter of 'twenty two.

Turning now to slide 26.

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 our inventory turns and our returns on inventory in future years.

Turning now to slide 27.

On this slide we show our debt maturity ladder at the end of the second quarter.

Last year.

We paid off $181 million of senior notes and at the end of the second quarter of 2002, we paid off an additional $100 million of.

Of our 7% and three quarter percent senior notes due in 2006.

Furthermore, we're committed to paying off at least another $100 million of senior notes during the remainder of fiscal 'twenty two.

We believe that we should be able to refinance our currently undrawn revolving credit facility ahead of its maturity in the first quarter of fiscal 2003.

After that we do not have any note maturities until fiscal 'twenty six.

Given our $401 million deferred tax asset, we will not have to pay federal income taxes on approximately one $5 billion of future pre tax earnings. This tax benefit will significantly enhance our cash flows in years to come and we will accelerate our progress of rapidly improving our balance.

Let's shift our focus in the coming years is to further reduce our debt.

Okay.

On slide 28, we show the dollar value of our consolidated backlog increased 16% year over year to $2 $1 billion at the end of the second quarter.

Sequentially backlog dollars were up 9% from the end of the first quarter of 'twenty two to the end of the second quarter of 'twenty two.

Given the recent sharp rise in mortgage rates are mortgage and homebuilding teams have been diligently analyzing our contract backlog to make sure our customers can still qualify for a mortgage.

If customers are not able to qualify at current mortgage rates, we attempt to provide them with alternative mortgage programs, where they can be approved.

We have performed stress test on our backlog if mortgage rates increased to six or six 5%, we estimate that roughly 10, and 12% respectively of our customers currently in backlog would not be able to obtain a mortgage.

The strength of our backlog, including a strong expected gross margin sets us up nicely to achieve our expected improvements in our fiscal 'twenty two financial performance, we are already developing our backlog for fiscal 'twenty, three as well our financial guidance for the third quarter and the full year.

In fiscal 'twenty, two assumes no adverse changes in current market conditions, including no further deterioration in our supply chain our material increases in mortgage rates.

Our guidance assumes continued extended construction cycle times of six to seven months compared to our pre COVID-19 cycle times for contraction of approximately four months further it excludes any impact to our SG&A expense from Phantom stock expenses related solely to the stock.

Price movement from $46 <unk> stock price of <unk> at the end of the second quarter of 'twenty two.

Okay.

Moving now to slide 29.

Finally, we expect our adjusted pre tax profit for the third quarter of fiscal 'twenty two to grow to between 70 and $85 million.

On slide 30, we reiterate guidance for our full fiscal 'twenty two year.

We expect total revenues for the year to be between two eight and $3 billion.

We also expect gross margins to be in the range of 23, 5% to 25, 5% SG&A as a percent of total revenues is expected to be between nine three and 10, 3%.

Adjusted EBITDA is expected to be between 410 and $460 million, we expect our adjusted pre tax profit for fiscal 'twenty two to be between 260 and $310 million. Finally, we expect our earnings per share assuming a 30% tax rate to be between 26.

<unk>.

50 and $32 per share.

Given where our stock closed yesterday and the midpoint of our EPS guidance, we're only trading at 175 multiple of earnings.

Total debt to adjusted EBITDA declined from nine seven times of physical 19 to three eight times in 'twenty, one and the $3 two times projected for fiscal 'twenty two.

Net debt to adjusted EBITDA declined from eight nine times in fiscal 19 to three one times in fiscal 'twenty, one and a two six times projected for fiscal 'twenty two.

Adjusted EBITDA to interest incurred coverage has more than doubled from one times in fiscal 19 to two three times for fiscal 'twenty, one and up to two eight times projected for fiscal 'twenty two.

Turning to slide 32.

Assuming we hit the midpoint of our fiscal 'twenty two guidance for pre tax profit our shareholders' equity is expected to more than double from fiscal 'twenty, one fiscal year end level.

This improvement in our equity position will result in our net debt to capital ratio continuing to decline from 146% at year end fiscal 19, 87% at the end of fiscal 'twenty one.

And at the endpoint of mid point of our guidance its projected reduced further to 76% by the end of fiscal 'twenty. Two 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 expect to continue our trend of improving our credit metrics in future periods.

On slide 33, we show that at 33, 9%, we have the fourth highest consolidated EBIT return on inventory compared to our peers on.

On slide 34, we show that we have the highest return on equity when compared to our peers at above 100% for the last 12 months.

And on Slide 35, we show the trailing 12 month price earnings ratio for Us and our peer group the entire homebuilding industry is being valued as if we're going to have a repeat of the great housing recession.

Which we believe is very unlikely to occur.

The entire universe of public homebuilders based.

Based on our price earnings multiple of 199 times at yesterday's closing stock price of $51 20.

We are trading at a 34% discount to the next lowest peer and a 61% discount to the industry average.

We remain focused on increasing our levels of profitability and further strengthening our balance sheet. The market will eventually give us credit for our superior performance.

Now I'll turn it back to Ara for some brief closing comments.

Thanks, Larry let me start by making one correction I mentioned may sales, which ended last night were three two contracts per community were actually slightly higher at three three.

Like to wrap up the call by saying that while many of our peers have already reduced their debt levels and they've had the luxury of buying back stock with their excess cash over the last two years, we've been focused on using our cash to aggressively reduce our debt and strengthen our.

Balance sheet.

On Slide 36, we show the outstanding principal value of our public debt from the end of fiscal 19 through the guidance. We gave for the end of this year.

Over this period of time, we will have reduced our debt by almost $500 million.

And simultaneously, we have reduced our public debt by almost $500 million.

We believe that the steps we are currently taking to strengthen our balance sheet. We will have a positive impact on our on our future cost of debt and the valuations of our stock price.

On slide 38.

We show single family housing starts for the past 50 years.

It gives you a good perspective of the current state of the housing market.

In the previous boom, we clearly as an industry produced homes well over the long term averages for several years, thanks to subprime mortgages.

This time the.

The industry has just recently reached the long term average production levels.

<unk> 21 was the first time, we had more than a million single family starts since 2006 and this year.

Slightly over that at the current pace.

More importantly, the previous 14 years, so housing production at dramatically lower than average levels.

I know there are varying views on demographics and average levels of production aren't necessarily indicative of the future, but it's a good benchmark and the housing supply in the industry is definitely better positioned.

And any time in the last decade and half.

We have a strong land position much of which we controlled at fixed prices prior to the recent significant home price increases.

Have a very large backlog of $2 $1 billion with really solid margins, we're seeing lumber prices trending down we have solid gross margins in our current home sales, which give us room to absorb net price declines and we have.

The flexibility of a large land option position.

We know that there is a lot of uncertainty out there we feel very prepared.

All in all we are excited about our future and we look forward to reporting continued solid performance in the quarters ahead.

Thank you that concludes our formal comments and we will be happy to turn it over for Q&A.

Thank you.

And the company will now answer questions. So that everyone has an opportunity to ask questions participants will be limited to one question and a follow up.

After which they will have to get back into the queue to ask another question.

We will open the call for your questions have you press Star one you will be in the queue and to remove yourself press the pound or housekeeping.

Your first question comes from Alan Ratner with Zelman and Associates. Your line is open. Please go ahead.

Hey, guys. Good morning, Thanks for taking my questions and I appreciate all the color and comments so far.

Firstly, just on the May activity and thank you for that.

Disclosure.

Pullback in demand.

Adding to that can you just talk about cancellation trends in the month as well and whether that contributed to the to the sequential pullback.

Sure I'd say.

From.

A big picture perspective.

Active adult segment has been stronger and the Uber entry level has been slightly weaker.

And everything in between has been around the same.

And regarding cancellation rates no.

He has been there.

Very solid I mean, we've our mortgage team in our divisions have been working diligently to make sure. The backlog. We have is qualified or can qualify for alternative mortgage program. So.

At this stage as Larry commented.

We've been pretty good as far as cancellations.

Just to make it crystal clear we saw no change to speak of at all in our cancellation rates in the month of May.

Perfect. Thanks, guys.

Second.

I guess this is kind of a multipart question, but if I look at gross margin obviously.

Well in excess of what you guided to for the quarter.

It looks like the guidance in the back half of the year implies some pullback from these levels.

On the other hand, Youre, saying, you haven't really increased incentives yet it sounds like maybe.

Youre getting some benefit on lumber, although that might be coming more next year, what's what's contributing to the expected pull back in margins over the next quarter or two because presumably those were homes that were predominantly sold before this run up in mortgage rates and when do you hit that point, where you would likely start to think about increasing incentives if the sales pace.

At these levels or even move slower.

Alan first.

Regarding gross margins.

In this supply chain disrupted environment.

And this labor shortage environment, it's a very tricky number to predict super accurately.

Cause we're allowing for a little extra cost for these last minute solutions, where all of a sudden we've got a handful of windows missing or garage doors are gone or we've got to replace an appliance with a higher end appliance because it's back ordered so.

Sure.

Better than the upper end of our guidance range.

So you can take that same comment interview.

Regarding the balance of the year I mean generally speaking our gross margins in our new contracts are brand new as of this weekend have been really really solid.

I don't know what more to tell you about that Theyre, just really solid we've seen pace for a little more as you saw in may.

And then finally regarding the last part of your multi part question and then I'll turn it to Larry to answer some more.

We are looking community by community it's not.

An average movement in terms of slowness.

A couple more points on the margin.

Emphasized the difficulty in making the projections. The first point I'd make is I believe that.

We projected the second quarter back in December and reiterated it when we announced our first quarter results any cancellations that occurred from December .

Forward.

Ironically, we were able to resell at a higher price and got higher margins than we anticipated.

Because home prices continue to go up so that's one of the things that led to it. The other thing is lumber prices, which are the biggest single component that goes into our construction, but very volatile.

And.

Back to.

Certainly in the second half of this year.

In terms of the deliveries that we're going to have lumber prices went up a few months ago.

And that is coming through in a higher cost than we had anticipated.

Previously as well so that could lead to some dampening of the margin out in the second half of the year.

So I'll leave it at that.

<unk> explanation was pretty comprehensive.

Great. Thanks, Thanks, a lot for you guys for the detailed answers.

And your next question comes from Alex Barron with housing Research Center. Your line is open. Please go ahead.

Yes.

Thank you gentlemen.

Congratulations on the strong.

Results and good job on paying down the debt so far in strengthening the balance sheet.

On that note.

I wanted to ask I know you guys had previously correct.

Some potential kind of global refi at this point or is it more likely that you guys go down the path.

Got it.

Now in my view set for the rest of the year.

Yes, I like that.

Right now obviously the high yield.

Market is also.

Been disrupted by inflation.

Higher rates et cetera. So we didn't have any pressure to refinance earlier, we would opportunistically do it.

We saw a great opportunity, but I think given changes in the market. It's safe to say that we're just going to continue to pay down debt.

We were also concerned about refinancing and then given our expectations as expressed in the key metric targets, we gave last quarter have to pay.

Our corporate teams on that we would have refinanced so right now I think you'll just see us continue to chip away at the debt and at some point in the future as we've got our balance sheet and better.

Condition strengthen we will look at refinancing.

Nothing near term is on the horizon there.

Okay. Good well the good thing is.

They don't need it to do it.

Sure.

On the other hand, I wanted to ask about your backlog.

The discussion on incentives.

What extent have you guys.

Kurt.

People.

For fiscal year through some extended rate locks or something that minimize that.

Potential cancellations.

Along those lines.

What if any incentives or are you guys offering or you guys buy down.

Okay, great locked in.

So who is paying for that customer or are you guys.

Well first.

Ill just mentioned I mean, we've been closing homes in April and May and those have been largely were market rate.

Mortgage rates in the 5% levels.

We haven't seen huge cancellations and as I mentioned the team has been.

Working diligently to check on the qualifications of our buyers.

Larry you want to comment on rate locks.

We obviously have.

Been offering.

Both short term and long term rate locks too.

Our contract backlog and Thats been taken by some and refused by others. We're encouraged.

By kind of the.

Recent last few weeks that rates have dropped a little bit at least they haven't been going back up maybe thats given.

Comfort this with consumers as well.

Having said that I would say more than 50% of our third quarter backlog has already been locked.

And that's a little higher than it would normally be.

And.

If in fact, when we scrub the.

The backlog and when you have it.

<unk>.

Okay.

Sorry.

Thanks, Rob.

And we have a.

Customer here and there that does need.

Some assistance in order to.

Still qualify we'll make those decisions case by case.

And because our margins are so strong.

We've seen incidence but.

Our divisions will decide to help buy down our rate our help with a rate lock to.

To provide comfort to our consumer but I would tell you those those have been isolated at this point in time, but they have occurred.

Okay.

Our expectation as Larry mentioned, we've offered rate locks.

Two.

All of our backlog that has been offered at our cost generally the consumer can look at it and consider the costs themselves.

Correct.

Got it and.

If I could ask one more on new communities that haven't opened yet.

I mean, it's no secret that home prices are gone up very significantly and that combined with the interest rates, perhaps made it difficult for some people to afford a home. So on the new communities is there any plan to somehow make them more affordable either introduce smaller sizes or fewer up.

<unk> included in the houses or.

Just start them off at lower Asps or something can you comment anything along those lines pure it's a good question at all of our communities. We typically offer a range of <unk>.

Home sizes and home prices and we also offer a range of upgrades.

When the rates were lower.

We were selling a lot of our largest most expensive homes that were offered they could select small homes, but they tended to gravitate towards the larger end.

The home size spectrum.

Similarly, there, we're adding a fair amount of upgrades.

I want to mention our gross margin, we typically price.

Had a very very similar gross margin percentage, whether it's a small home or a large home reprice margins almost the same.

I would say more recently, we've definitely seen more interest at the same community without changing our product offerings. There has just been a little greater selection from our smaller homes or midsize homes at least and a little tampering.

Sure.

Dampening excuse me of the options or upgrades that had been collecting so there is an ability without us really doing anything that the customers can make their own decisions and make their homes more affordable having said that a lot of times in the past when rates rise rapidly.

We definitely see a little hesitation.

And I think you saw that in May people are disappointed.

<unk>.

Okay, well. Thank you very much for all the explanation good luck and I'll get back in the queue.

Thank you. Thank you.

Definitely on that I'm trying to get a sense you mentioned $3 three.

Absorption pace is there a level of debt.

If you go below you start to introduce more incentives.

Into the marketplace I'll stop there.

I'll start with that.

By responding again that is highly neighborhood and community specific.

We still have a metering situation and.

Price increases at many communities, that's certainly the case and we see it in many in Dallas in many communities in Phoenix and many communities in Delaware.

Southeast, Florida, and south in the Carolinas.

We have many examples where we wouldn't pay.

Pace hasnt been slowing so it's community by community.

It has a lot to do with our internal budgets and getting a regular pace.

We have communities that fall off on pace and.

Some of our very entry communities.

Have fallen off on pace.

If that can be cut again for some of that phenomenon that I mentioned before the expectations have been not met then theyre disappoint.

Disappointed but.

They don't ultimately adjust at those communities and by a smaller home then we'd look at concessions.

There to be able to get that community back on pace. Fortunately gross margins are very high as we've mentioned numerous times.

And there is plenty of room to return to some normal concessions.

And just a quick clarification on that as the pace level that youre targeting internally I'm not sure. If you reveal is at around three opera community per month or is it somewhere else.

It varies dramatically from community to community, our higher end communities would be lower than that or three or lower are very entry level communities might be higher than that so it's.

<unk> very much a community by community basis.

Got you I appreciate the color on that.

Just a follow up on a different sort of question here in terms of your contract cancellation would would you guys be willing to.

To.

Talk about what you've been seeing in terms of cancellation out of backlog over the past two quarters.

And if you look at what.

<unk>.

Buyers from our backlog are doing.

What's the what's the spread or a combination or I guess, if you have to.

Split the pie.

How many are moving to adjustable rate mortgages versus buy downs versus <unk>.

Greater down payments et cetera.

Yes again.

Our.

Contract cancellation rate has been very modest by historical standards still well below normalized cancellation rates, we do provide I think in the.

In the K and Q, Brad what our backlog cancellation rate.

Yes.

Those two.

Not materially.

That's different than than what R. R.

Storage trends have been there have been lower.

On the contract cancellation rate.

Our backlog has I don't have it at my Fingertips, frankly, Brad can.

Spread and rate between call. It a five one arm versus a 30 year fixed.

Not a lot of people are going that direction and certainly there is some people that just can't qualify the 30 year fixed rate that can qualify and an adjustable.

And they are going that direction, but it hasn't been a material number.

This point in time.

We will add one other bit of color, we probably have a little bit of a greater percentage of age restricted communities than many of our peers. Those consumers are typically not very affected at all by mortgage rates.

Many of them are cash buyers many of them.

Small mortgages. So that's part of the reason I made the comment earlier, we just see.

More strength in that segment and I suspect.

They're more indifferent about mortgage rates.

Adding to Larry's comment the cancellation rate on backlog beginning backlog for the quarter was 9%, which is exactly the same as it was last year's second quarter.

Historically, that's relatively low.

I appreciate the color guys best of luck for the rest of the year.

Thank you.

Thank you and as a reminder to ask a question simply press star one on your telephone next.

The next question is from Alex Barron with housing Research Center. Please go ahead.

Yes, thanks for taking my follow up.

Regarding specs it doesn't sound like you guys have any or very little completed specs.

I'm just wondering.

Do you guys see a need at this point to slow down.

Any spec start.

Or do you see a risk that you could end up with with some finished specs by the end of the year if things don't.

Don't don't improve in terms of sales pace.

My first question.

There are many things to worry about in this time of uncertainty right now.

We're just scrambling.

To start the homes, we have in backlog, we have a huge backlog of over $2 billion. So we're just not focused on specs nor are we very worried about our specs we are less than half the number of specs per community.

Historically.

Less than half so it's far from a concern and we have virtually zero I think we have to in the entire country. Two finished spec. So it's just not on our radar of one of the many concerns.

Got it.

I also wanted to ask in terms of.

Any communities, where you are starting to do.

Santander rate buy downs rate locks or whatever how much would that impact margins generally is it like one or 2%.

Yes.

But again I think.

As mentioned just kind of be.

Community specific it's not going to be a broad brush across the whole company. So I think in terms of impacting margins.

Near term it will be extremely modest or not even noticeable.

If in fact, the market slows further and use of incentives by the industry and then by US starts to increase.

There is room.

<unk> increased.

Use of incentives I, just think it'll be gradual over time.

Scott.

If we decided at a.

<unk> increased incentives.

Couple of hundred basis points I, just don't think.

One or two or three half a dozen communities would be noticeable when anytime soon but as you do more and more communities if that.

It becomes an industry trend it would come through.

Maybe the second half of next year.

Alan I do want to add.

We are not.

Delusional about the uncertainty in the marketplace and we certainly don't think that the.

The gross margins, we just reported and the gross margins that were currently selling.

We don't think that can happen indefinitely I mean, the market will eventually normalize and as I mentioned earlier.

Last quarter we.

<unk>.

Talked about our multi year key metrics and in that in those metrics, we forecasted that.

Ultimately get back to a 20% gross margin right now, we're not seeing anything like that its far better, but we think eventually the market's going to gravitate to normalcy.

And that will eventually make its way into our results as well.

Yes.

It's good you have implemented that.

Conservatism in your outlook, because even though you guys might not have a ton of specs are almost any.

Obviously, a lot of your peers did start.

Non of homes on spec and we're hoping to sell them at the last minute.

We'll see what happens.

Thanks, very much and good luck.

Thank you.

Thank you and this concludes our Q&A session I will turn the call back to Ara Hovnanian for his final remarks.

Great well. Thank you very much we've tried to be as transparent as possible.

I don't think.

Anybody else has reported may.

Contracts, yet so hopefully you've got fresh information and we look forward to giving you.

Continued good results in our upcoming quarters. Thank you.

And this concludes our conference call for today. Thank you all for participating and have a nice day you may now disconnect.

Q2 2022 Hovnanian Enterprises Inc Earnings Call

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