Good morning and thank you for joining us today for Hovnanian Enterprises Fiscal 2021 Second Quarter Earnings Conference Call. An archive of the webcast will be available after the completion of the call and run for 12 months. This conference is being recorded for rebroadcast and all participants are currently in a listen-only mode.

Management will make some opening remarks about the second quarter results and then open the line for questions. The company will also be webcasting a slide presentation along with the opening comments from management. The slides are available on the Investors page of the company's website at www.khov.com.

Those listeners who would like to follow along should now log on to website. I would like to turn the call over to Jeff O'Keefe, Vice President, Investor Relations. Jeff, please go ahead. .

Thank you, Liz and thank you all for participating in the call this morning to review the results for our second quarter. All statements in this conference call that are not historical facts should be considered as forward-looking statements within the meaning of Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995.

Such statements involve known and unknown risks, uncertainties and other factors that may cause actual results, performance or achievements of the company to be materially different from any future results, performance or 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 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 date they are made, are not guarantees of future performance or results and are subject to risks, uncertainties and assumptions that are difficult to predict or quantify.

Therefore, actual results could differ materially and adversely from those forward-looking statements as a result of a variety of factors.

Such risks, uncertainties and other factors are described in detail in the sections entitled Risk Factors and Management's Discussion and Analysis particularly the portion of MD&A entitled Safe Harbor Statement in our Annual Report on Form 10-K for the fiscal year ended October 31, 2020, and subsequent filings with the Securities and Exchange Commission.

Except 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 on the call are Ara Hovnanian, Chairman, President and CEO; Larry Sorsby, Executive Vice President and CFO; and Brad O'Connor, Senior Vice President Chief Accounting Officer and Treasurer. I'll now turn the call over to Ara. Ara, go ahead. .

Thanks, Jeff. I'm going to review our second quarter results and then address the current market environment. As usual Larry Sorsby, our CFO will follow me with more details and we'll end with Q&A. On slide 4, we compare our second quarter results to the guidance we gave on our first quarter conference call.

Our total revenues, adjusted gross margin, adjusted EBITDA and adjusted pre-tax income were all within the guidance range that we gave. However SG&A was higher than anticipated.

The SG&A miss was related to $17.5 million of incremental phantom stock expense related solely to our common stock price increasing from $51 at the end of the first quarter to $133 at the end of the second quarter. Only one-time in our company's history during 2019 phantom stock was issued for an equity grant.

And it was because our stock price was very low at the time and we are concerned about the negative impact that dilution could have on our shareholders. While we certainly have been bullish in our long-term stock price, we not budget for the magnitude of the increase in one quarter.

Larry will talk more about the phantom stock expense in just a few moments. In the third column, we show what our results would have been without the incremental stock expense. The SG&A would have been better than the guidance we gave.

Additionally, our results would have been above the high end of the range for adjusted EBITDA and adjusted pre-tax income. Moving on to slide 5. We show year-over-year comparisons for the second quarter performance metrics. We begin with total revenues in the upper left-hand portion of the slide.

Our total revenues for the second quarter increased 31% to $703 million. Moving to the upper right-hand portion of the slide, you can see that our adjusted gross margin increased 310 basis points year-over-year. Adjusted gross margin was 21.3% this year compared to 18.2% in last year's second quarter.

As we've said on previous calls in anticipation of cost increases and our desire to improve margins, we pivoted to increasing home prices back in June of 2020. During the first half of 2021, housing demand remained strong and we saw both labor and material costs, especially lumber continue to increase.

As a result, we continue to both aggressively increase home prices and limit home sales to a pace similar to our home starts. These actions will help ensure that we stay ahead of future cost increases. We'll talk more about that and the impact on -- of margins in a moment.

In the lower left-hand quadrant of the slide, you can see that our SG&A was certainly impacted by the incremental phantom stock expense. If you were to ignore the incremental stock expense the SG&A ratio would have improved to 9.3% as shown in the lower blue compared -- in the lighter blue compared to the 10.4% in last year's second quarter.

We're benefiting from the normal leverage of scale as we grow. In the lower right-hand quadrant of the slide, we show that adjusted EBITDA increased 47% from $52 million in last year's second quarter to $76 million this year.

While we were within the guidance range for EBITDA once again if you ignore the incremental phantom stock expense, our adjusted EBITDA would have increased 80% to $94 million, above the upper end of our guidance range.

On slide 6, our adjusted pretax income before land charges and gains or losses from the extinguishment of debt improved to a $31 million profit this year from a $5 million profit last year. Once again ignoring the phantom stock expenses would have resulted in a higher profit of $49 million this year.

On slide 7, we show that our net income for the second quarter of 2021 was $489 million, compared to $4 million in the same quarter of last year. A huge portion of that year-over-year increase or $469 million was due to the reduction of our valuation allowance.

The profit for the quarter combined with the reduction in our valuation allowance resulted in total shareholders' equity increasing sequentially by $489 million.

On the left-hand portion of the slide, we show that our quarterly contracts increase -- excuse me -- on the left-hand portion of slide 8, we show that our quarterly contracts increased 19% to 1,771 homes.

Contracts during the second quarter last year were adversely impacted by the early stages of the COVID shutdown, making this year's second quarter comparisons much easier. We achieved a 62% increase to 18.3 contracts per community for the second quarter of this year compared to 11.3 contracts per community for last year's second quarter.

The strength of the market has been widespread across product types and by geography. During the second quarter Phoenix, Delaware and Dallas-Fort Worth had the largest year-over-year increases in contracts per community. Each of these divisions posted year-over-year increases of more than 135%. Our other markets continue to do well also.

But in many of those cases, we have been more focused on slowing down sales pace and increasing price. Slide 9, shows the number of consolidated contracts on a monthly basis over the past year. As we discussed last quarter, we consciously raised prices significantly in February to slow the sales pace and improve our margins.

While we held the sales pace to comparable numbers in the months of March and April with steady price adjustments, the contracts are still up over the prior year because the comparisons were much easier. Turning to slide 10, you can see the contracts per community for the past several months.

This shows a similar pattern of significant increases compared to the same month last year, but even more significant again with particularly easy comparisons for last April and March. We spiked at seven contracts per community in January.

Then, we saw the intended impact from our aggressive home price increases and the restriction of sales in certain locations. In both February and March, contracts per community slowed to 6.1, and in April, it came down further to 5.5 contracts per community.

Even at these lower contract paces per community, our annualized paces are the highest they have been for over a decade. A sales pace of six to seven per month per community is difficult to match in production today and we pivoted harder to a greater focus on margin.

As I mentioned earlier, we'd like to control our sales pace to the point where it aligns more closely with starts. This strategy significantly reduces the risk of construction cost increases reducing our margins.

As we stated in our analyst call last quarter, we expected the year-over-year sales comparison for March and April to be much easier due to the COVID shutdown last year. We also stated that the comparisons would be more difficult in May and over the summer months due to the surge in COVID housing demand last year.

Further, over the past several quarters, we were particularly aggressive regarding raising sales prices to both increase margins and slow sales to a more rational pace.

During the recent months, we've significantly metered sales and temporarily stopped sales in certain communities in order to better match our sales pace with our ability to start homes. As a result, compared to intrinsic demand, we believe our May sales pace is artificially low. You can see the start of these more difficult comparisons on slide 11.

During the month of May, due to restricting sales, and especially difficult comparison to a very strong May last year and a lower community count, our contracts per community declined 19% and our contract dollars decreased 23%, and total contracts declined by 266 homes year-over-year.

However, we achieved our objectives and our May contracts had the highest gross margin percentage at the point of contract for any month in over a decade. As we intended the slowing of our sales pace has kicked in, the difficult comparison to last year's sales pace will continue over the summer months.

This was the last -- this was a time last year when the market was absolutely on fire. And we and the homebuilding industry had not begun to aggressively throttle back contract paces. However, like the month of May, we expect significantly higher gross margins in our new contracts compared to last summer's contracts.

The broad strength in the housing market continues to be driven by the same factors that have been in place over the past year, solid demographic trends, limited supply of new and existing homes, historically low mortgage rates and an ever-improving economy. The potential for an infrastructure bill can only improve the economic conditions.

We plan to continue to raise prices in order to keep up with rising material and labor costs, align our sales pace with our ability to start homes and improve our margins. All signs indicate that our 2021 financial results are expected to be dramatically better than last year. I'll now turn it over to Larry Sorsby, our Chief Financial Officer..

first, ensure a multiyear well-laddered debt maturity. Second, refinance our high-cost of debt with lower cost of capital that's more in line with our industry peers. Third, issue no tranche sizes that would achieve high-yield index inclusion, secondary market liquidity and price transparency.

Finally, we would want to reduce our reliance on secured debt, ultimately resulting in an unencumbered balance sheet. As we continue to post strong results, we believe we can refinance our entire debt structure with significantly improved turns.

As always, we will analyze and evaluate our capital structure and explore transactions to further strengthen our balance sheet and our financial performance. On Slide 23, we show that our total backlog, including domestic unconsolidated joint ventures at the end of the second quarter increased 63% to 4,373 homes.

You can also see that the dollar value of this backlog increased 80% to $2.04 billion. The strength of this backlog including solid expected gross margin sets us up nicely for strong results over the remainder of this fiscal year.

Our financial guidance for both the third quarter and the full year for fiscal 2021 assumes no adverse changes in current market conditions and excludes further impact to SG&A expense from phantom stock expense related solely to stock price movements from the $132.59 stock price at the end of our fiscal 2021 second quarter.

However, our guidance for the quarter and for the year include phantom stock impacts we absorbed in the second quarter. For every $4 that our stock price increases or decreases, there is approximately $1 million increase or decrease, respectively of incremental phantom stock expense.

At yesterday's closing price of $136.81, that would create roughly $1 million of incremental phantom stock expense. Ironically, if the stock price falls from that level, we actually create income. On Slide 24, we provide guidance for the third quarter of fiscal 2021.

We expect to report total revenues for the third quarter of fiscal 2021 between $700 million and $750 million. We also expect gross margins to be in the range of 20.5% to 21.5%, up substantially compared to the 17.5% in last year's third quarter and SG&A, as a percentage of total revenues to be between 10.5% and 11.5%, compared with 9.5% last year.

Excluding land-related charges and gains or losses on extinguishment of debt, we expect adjusted EBITDA to be between $80 million and $90 million, up between 24% and 39%, compared to the same quarter last year.

Finally, we expect our adjusted pretax profit for the third quarter of fiscal 2021 to grow between $35 million and $45 million, compared to a $15 million profit in the same period last year. Turning to slide 25. I will discuss our increased guidance for the full year.

We expect to report total revenues between $2.65 billion and $2.8 billion, up from $2.34 billion last year. We also expect gross margins to be in the range of 20.5% to 21.5%, compared to 18.4% last year and SG&A as a percentage of total revenues between 10.5% and 11.5% compared with 10.3% in the prior year.

This includes the $17.5 million of incremental phantom expense discussed earlier. Excluding land-related charges and gains and losses on extinguishes debt, we expect adjusted EBITDA to be between $310 million and $350 million, up between 32% and 49% compared to last year.

Finally, we expect our adjusted pretax profit for fiscal 2021 to grow to between $150 million and $170 million, up 195% to 234% compared to $51 million in pretax earnings last year. This is a $10 million increase from our previous guidance of $140 million to $160 million.

Were it not for the $17.5 million of incremental phantom stock expense in the second quarter, our guidance would have increased by $27.5 million. Given our pretax profit guidance for the second half of the year, our shareholders' equity should double from today's level by October 31, 2021.

Assuming no changes in current market conditions, our expected earnings growth in fiscal 2022 from fiscal 2021 levels should also significantly further enhance shareholders' equity by the end of 2022's fiscal year. Turning now to slide 26. Here, we illustrate the growth, we've seen in adjusted EBITDA.

On the left-hand portion of the slide, you can see that our third quarter estimated for adjusted EBITDA is 31% more than the third quarter of 2020. And that was after a 76% growth from the year before that. You can see a similar trend on the right-hand portion of the slide, where we show adjusted EBITDA for 2019, 2020 and our expectation for 2021.

In 2020, we achieved a 35% growth in adjusted EBITDA. And in 2021, we now expect to achieve an additional 41% growth in EBITDA. These increases are representative of the progress we've made in materially improving our operating results. We've taken numerous steps to achieve our improved results.

On slide 27, we show some of the strategies, we're utilizing to achieve long-term profitability and more importantly value creation for all of our stakeholders. This slide shows the growth-oriented strategies on the top of the slide, with the actions undertaken, listed below the individual strategies.

Beginning on the far left-hand portion of the slide, we start with growth -- grow revenues to improve scale and enhanced margin profile. In order to achieve this strategy, we have focused on higher inventory turns to allow for growth.

Regarding margins, we've actively managed the sales pace through home price increases and limiting the number of homes for sale in each community. Longer term, we're focused on reducing cost further and streamlining our organization. Moving to the right, we show risk adverse land strategy.

Our preferred method of controlling lots is through the use of options, which only require minimal cash deposits. Ideally, we'd like to have less than 18 months of owned land and then control as much land as practical through option contracts.

We remain extremely focused on utilizing high inventory turnover to be more efficient and to increase our returns on capital. And finally, by achieving significantly improved operating results, we generate excess cash flow, which helps significantly improve our balance sheet flexibility.

The combination of our expected improved financial performance this year and the deferred tax asset valuation allowance reversal will meaningfully increase our year-end book value per share. Those increases to book value, combined with executing our debt reduction strategy this year, should significantly improve our balance sheet at year-end.

Assuming no changes in current market conditions, our expected earnings growth in fiscal 2022 from fiscal 2021 levels should also significantly further enhance shareholders' equity by the end of fiscal 2022. That concludes our prepared remarks and I'll be happy now to turn it over for our Q&A..

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 you will have to get back in the queue to ask another question. [Operator Instructions] Our first question comes from Alan Ratner with Zelman. .

Hey, guys. Good morning. Thanks for taking my questions. So, first one I'd love to dig in on, you guys mentioned several times this notion of trying to match your sales to start pace, which I think a lot of builders in the industry are doing right now.

So if we look at your absorption rate going from 7 a month a few months ago down to 4-plus here in May, what is your production pace running at currently? And at what point do you think you can maybe open up the spigot a little bit more and perhaps let that absorption rate run a bit hotter than it is today, or is 4 kind of the new normal that you're kind of solving for at this point?.

I'd say, Alan, part of that is dependent on when we can get our new communities on pace on the market. What we're being cautious, we don't want to gap out, so to speak, and sell-out too quickly. As we get more storefronts open. And as you saw our option position is growing a lot, our land spend positions are growing a lot.

We've just got to get those communities open. As we get them open, then we can feel a little more comfortable letting the absorption pace grow more rapidly and go to a higher pace than the 4.5..

Got it. Okay. That's helpful. Second question, just in terms of the margin on homes you sold in May, you mentioned it's the highest level in a decade. I was a bit surprised, just looking at your margin guidance for the back half of the year. It doesn't really imply much improvement from the second quarter level.

So can you talk a little bit about what the absolute margins are on homes you're selling today? And presumably, when that would begin to filter through to the P&L?.

Well, yes, first, the homes that we're selling today are not really going to be delivering this fiscal year. Most of what we're delivering this fiscal year has already been in backlog. You'll begin to see these higher margins from our current contracts in next fiscal year, beginning with our first quarter.

Obviously, we haven't started all of those just at this moment. So we are still subject to potential cost increases, but the margins in our current contracts are substantially higher. So we feel pretty confident, we're going to generate some pretty good margins as we deliver those homes..

I appreciate that, Ara. I guess, what I was thinking, you didn't just start raising prices in May, you've been raising prices for several months. And I think you've mentioned starting January, February, is where you really started to get aggressive there. So presumably, some of those homes would deliver before the end of the year.

So that's where I was referring to, being a little bit surprised..

Some of them will. We're obviously being fairly cautious on margin guidance, given that it's a very challenging environment with cost increases in general. What's happened with lumber, up and down and other material costs and labor costs. So we're trying to be on the conservative side on our guidance..

Understood. Okay. Thanks a lot. Appreciate it. Good luck..

Thanks..

[Operator Instructions] Our next question comes from Alex Barrón with Housing Research Center. .

Yes. Thanks, guys. I wanted to ask about the deferred tax asset.

What drove the fact that you didn't get the whole thing on the state side? And is that expected to get done later in the year, or how does that work?.

When you evaluate the valuation allowance for state you have to look to each state individually and states will have different rules in terms of how long you can carry forward net operating losses. We also have states that since those NOLs were generated we're no longer operating in, or we've significantly reduced our operations.

And as an example, we're winding our business down in Chicago. Currently, we're not operating in Pennsylvania. So we've got markets that we've left, and therefore, unlikely to at least at the moment to weren't able to forecast that we would use those NOLs in time before they would expire. It is something we would continue to evaluate.

But I wouldn't anticipate that valuation allowance that currently on our books at $103 million to change dramatically in the coming – certainly the rest of this year, and maybe not much going forward. It will depend on changes in our operations in those states where we currently can't forecast using those NOLs..

Got it.

And for modeling purposes, what kind of tax rate do you suggest using going forward?.

I would say high – at the moment high 28%, 29% something in that range for federal and state..

Okay. Great. And then on the phantom stock –.

Sorry. Just to add to something Larry said, while that will be our tax expense, we won't be paying taxes especially the federal taxes, because of our deferred tax asset I just want to make sure that was clear..

Correct, yes.

And then on the phantom stock issue is that – it seems like it's going to be an ongoing issue based on your stock price, but is there a certain amount of stock that was issued and that's it, or is there going to be more issuances coming down the road?.

No. It was a onetime event. And just keep in mind, it does go up and down. At – today, our stock price is down as all homebuilders are down and it would actually result in a lowering of expense and an increase of profit of about $2.5 million at the moment. So it goes in both directions..

Got it. And if I could ask one last one. I think you said, your contracts for May were 413, because you're raising prices and maximizing margins.

Is that roughly you think a run rate for the remainder of the year, or is this likely to go up from here based on other factors?.

Yeah. Go ahead, Brad..

Well, I think as Ara mentioned during the prepared remarks and even previously on one of the responses, as our additional communities opened later this year that we've talked about we should obviously get additional contracts and then be at a faster pace than we're currently running in May.

And we also mentioned right now, we're intentionally restricting sales, because of our ability to produce and get caught up on our existing backlog. So I think as that frees up, and we get those fees open, you might see us increase sales space even on the existing communities at that point..

Okay. Great. Thanks. I’ll get back in the queue..

Okay..

Our next question comes from Jordan Hymowitz with Philadelphia Financial..

Thanks, guys.

A couple of questions on the debt refinancing and pay down, what is the earliest first of all you could pay down the 2024s?.

Well, it's dependent upon us achieving certain secured debt leverage ratio results. And so we are not there yet, and we are monitoring that each quarter end, but we're not projecting that at the moment. But if you look at the indentures, you probably could get a pretty good estimate all that yourself..

But it looks like around the September, October time period? And I guess would your goal be to refinance those as soon as possible?.

I don't think we've made any decisions on precisely when we're going to do that. We certainly intend to do it in advance of maturity and hopefully well in advance of maturity, but I don't think we put a fine point on precisely when..

And in addition at the current moment, our plan is not to refinance, but rather just have a reduction in our -- the amount of our debt..

You said it all. .

Perfect.

And are you -- once that occurs, I assume the ratings agencies would take a look at upgrading the rating for your company overall?.

You would assume that and we hope that that is true and we intend to meet with the rating agencies in the not-too-distant future just to further update them on our improved performance..

Okay.

And different topic is -- doesn't the adjusted EBITDA add back the $17 million of SG&A expense?.

Because it's not taxes or interest depreciation or amortization. I mean, is it SG&A expense. I know you're trying to do it as a non-cash item. So you theoretically can do that on your own, but from a definition of EBITDA it's not any of those items. .

But adjusted EBITDA by nature is a non-cash definition and it's a non-cash item..

You feel free to add it back. .

Okay. And final question.

what do you think current coupons are if you were able to refinance the 2026s?.

That's a difficult question to answer given the lack of liquidity in our current bonds, you really just don't trade. But if look at what similarly rated homebuilders to us are trading at yield wise, it's dramatically lower than our current coupon.

But the fact that that is occurring versus, our ability to actually refinance our whole structure, we've got some work to do to reeducate the high-yield market on our improved performance and I'm very optimistic as we do that that the coupons that we can refinance that are materially lower and much closer to what our similar situated peers have..

And what are your similarly situated peers have for those of us that are less familiar with the debt markets?.

Yes. They're less than 6%..

Okay. Thank you..

Our next question comes from Alex Barrón with Housing Research Center. .

Yes. Thanks. I was wondering if you could talk about build times.

Have those been extended to various supply chain disruptions? And if so by how much roughly?.

They have been extended partly due to supply chain disruptions, partly due to pressures on labor. Many builders are experiencing what we're experiencing, most builders with dramatically improved sales, which means a lot of strain on labor capacity.

I'd say, depending on the geography in the moment, we've seen delays of 30 days to 60 days in many locations and product types. And we factored those delays into our guidance..

Got it, and in terms of your spec strategy, given the rise in cost and delays and so forth? How has that shifted if anything when you guys are -- how many specs you're starting, versus at what point in the construction cycle you guys are selling the homes?.

Yeah. I know the strategy varies quite a bit by builder. Some builders are almost 100% spec. Some builders are still almost 100%, build to order. We're somewhere in between.

At the moment, frankly, sales have been so robust, that all of our capabilities are going into starting the sold homes we have, which leaves a little less capacity for starting specs, just extremely active right now. So I'd say, in general, we're starting fewer specs than we did a year or two ago..

Okay. Thanks a lot. And best of luck..

Okay. Thank you..

I'm showing no further questions in queue. I'd like to turn the call back to Ara Hovnanian, for closing remarks..

Great. Well thank you very much. We're pleased with our results overall. And we're excited about, what we're going to be reporting in future quarters. So we look forward to sharing some good news in upcoming quarters. Thank you..

This concludes our conference call for today. Thank you all for participating. And have a nice day. All parties may now disconnect..