Hovnanian Enterprises, Inc. (HOV) Earnings Call Transcript & Summary

Good morning, and welcome to Deutsche Bank's 29th Annual Leverage Finance Conference. I'm Ian Wood from the Industrials Investment Banking Group. And thank you for joining today's Hovnanian Enterprises presentation. We are pleased to have from the company, Larry Sorsby, Chief Financial Officer; Brad O'Connor, VP, CAO and Controller; and Jeff O'Keefe, VP of Investor Relations. With that, Larry, I'll turn it over to you.

Thank you, Ian, and we always look forward to this conference every year. And hopefully, this time next year, we will be face-to-face and in person. In the meantime, we're happy to participate virtually today. I'm going to go through a series of slides, and then we're going to -- I'll turn it over to Brad to do about half of them, and then we will leave plenty of time for Q&A, which is what I think the audience really wants anyway. So I'll just start by saying this is the standard forward-looking statement, read it at your pleasure. And we have released updated guidance, and this gives you some information with respect to all the caveats. So I'm going to start by just saying what's new about the Hovnanian story. We suffered through the great housing recession just like our peers did. But unlike many of our peers that either went out of business, sold themselves to larger companies or did highly dilutive recapitalization. We've kind of fought through this the old fashion way. And for many years, we had underperforming markets, we weren't able to grow as fast as some of our competitors. But we've now condensed and focused on our stronger markets with improving market share. Our profitability for a number of years was weak to nonexistent. More recently, we've returned to strong profitability and growing profitability for many years after the great housing recession, we had weak cash flow generation. We are now generating stronger and stronger cash flow even after land reinvestment. Our inventory strategy after the great housing recession, we had a strong overreliance really on costly on and off balance sheet financing to acquire lots, thereby reducing our returns because of our lack of access to increased capital. More recently, we've increased our inventory efficiency and high inventory turnover and driving higher and higher returns on invested capital. And then our real problem after the Great Housing Recession was, although we wrote off $2.8 billion with a B of debt, we weren't able -- excuse me, of land, we weren't able to write off any debt. So we were constantly faced with the short-dated difficult to extend near-term maturities. And more recently, we've really created significant runway on our maturity ladder. And we have gone from a perspective of treading water and just trying to refinance that now trying to really prepare the balance sheet with our improved financial performance, and we've actually recently paid off a significant chunk of debt, which we'll talk about here in a minute. So we've been successfully implementing our strategies for long-term property and value creation. We want to grow revenues to improve scale and enhance margins. We really have a very risk-averse land strategy, which we'll talk about, and we want to maintain a multiyear supply of lots, primarily through options, high returns on invested capital and sharpened our asset efficiency and generating excess cash flow to improve the balance sheet. And we'll talk a little bit more about each of these as we go through the deck. We did release revised guidance after the market closed last night. We weren't immune to the same kind of supply chain disruption at many of the public homebuilder peers. And frankly, it's across all industries, is a global issue. And the waccamaw game has continued to get more and more difficult and it's elongating our cycle times, but we're not seeing cancellation rates increase or anything like that. Demand remains very strong. We're just being challenged to actually get homes closed on time because of supply chain disruption. So even with the slight downward revision in our guidance, we expect year-over-year improvements and our pretax profitability for full year to exceed 200%. You can see here our previous guidance kind of in the middle column and the box column on the right, our revised guidance. Revenues are still expected to be somewhere between $2.75 billion and $2.80 billion. Adjusted gross margin really didn't change 21% to 22%. SG&A as a percent of total revenues didn't change at 9.5% to 10.5% for the full year. Adjusted EBITDA did decline by $15 million to $330 million to $345 million, and that compares to $234 million a year ago in fiscal '20. And our adjusted income before income taxes also downward adjusted by about $15 million. The range now is $160 million to $175 million, and that compares to $51 million a year ago. So still a very, very strong year, and we feel very good about continued growth in 2022 as well in profitability. So in June of 2018, you can see the guidance that we put out for and our annual key metric targets in that boxed number. At that point in time, if you look at the trailing 12 months as of April 2018, you can see where we were then. So these were some aggressive growth projections and improvement in profitability projection targets that we've had. We've green check marked those annual key metric targets that we've actually achieved on a trailing 12-month basis or overachieved. As you can see on the far right-hand column, we have the trailing 12 months as of July 2021. So we did improve our revenues to above $2.65 billion. Our adjusted homebuilding gross margins in excess of 19.5% on a trailing 12-month basis or 21.1%. SG&A didn't quite get down to 10%, but very close at 10.3%. Adjusted EBITDA, we blew through that $275 million target at $330 million. And adjusted pretax profit blew through the $100 million target at $161 million on a trailing 12-month basis. So again, we have established a track record of doing what we said we were going to do. I'm going to shift a little bit to recent operating and financial performance. For those of you that aren't all that familiar with Hovnanian just -- or just to refresh your memory, we're among the top 15 homebuilders in the United States, both on homebuilding revenues and home deliveries. We market and build homes across the product and buy our spectrum with the first-time and move-up kind of focus. You can see home deliveries by product in the upper right-hand quadrant. There, first time buyers represented 42% of our deliveries in fiscal 2020, move up at 33%. Our active adult or active lifestyle at 13% and luxury at 12%. You can see in the lower left-hand quadrant, the 14 states that we operate in, color coded by the publicly reported market segments, and the percentages there are just the percentages of the homebuilding revenue by those publicly reported segments. And then in the lower right-hand quadrant, you can just see the lots controlled by those publicly reported segments as of July 31, 2021, on a percentage kind of basis. Third quarter operating results, we improved revenues from $628 million to almost $700 million in the third quarter of '21 versus the third quarter of '20. Adjusted gross margins were up 460 basis points to 22.1%. Total SG&A ratio was actually at 8.7% on publicly reported, but we did get a little benefit from something called the Phantom stock plan effect. So that would have been 9.7% without that benefit. And adjusted EBITDA grew almost 60% to $103 million. So quite strong performance in our most recent quarter. And obviously, people are asking about our land position and how we control land. In the left-hand half of this slide, the bottom portion there, the lighter color shows you how we've been increasing our percentage of lots controlled via option and how in the darker blue color, the percentage of lots that we actually own has been shrinking of our total controlled. And above that, you see a line graph that just shows that we ended the third quarter '21 with 5.1 years supply of lots controlled. So we've actually been derisking our land position by focusing more on controlling land by auction. It also enhances our inventory turns and our returns on invested capital, which is a key component of our strategy. On the right-hand half of the slide, we show the land, and land development spend that we've been making since 2015 on an annual basis. And if you look at the far right side, after the dash line there, you can see that we've actually been increasing our spend most recently on a trailing 12-month basis by 36%. So we're gearing up once again to begin growing our deliveries and our community count, which we'll talk about a little bit here on this next slide. On the left-hand side of this slide, you can see our community count was adversely impacted by the surge in demand for homes kind of post the COVID lockdown 1.5 years ago. We were selling through our communities much more rapidly than we anticipated, higher pace per community than we anticipated. And you can see that we kind of bottomed out in the second quarter of 2021 at 117 communities. We've turned that corner. And in the third quarter of '21 ending July of '21, we actually started to see our community count begin to go back and increase and we've refreshed our projection for active selling community count at the end of our fiscal year to return to 135, which is the same place it was at the end of the fourth quarter of 2020. One of the ways that we've been able to do that on the right-hand half of this slide is just been very active in the land market. You can see our land position from the third quarter 2020 through the third quarter of 2021 and it has continued to grow. You can see in gray, the owned lots at the end of the third quarter 2021, about 10,500 own lots and about 20,500 optioned lots. So that is the raw material that we need in order to replenish and actually grow our community count and you're going to continue to see that happen through the end of the fourth quarter. And then we actually have virtually all the land and communities necessary to achieve growth in fiscal 2022 compared to the very substantial growth that we had in 2021. All those lands and communities are already under contract, under our control today. So we're not scrambling to try to get land for '22 deliveries. We're primarily focused now on 2023 and beyond deliveries. And if you look that 31,000 lots is kind of boxed in the middle of the page there, it represents 5.1 years supply of lots on a trailing 12-month basis. And then on the far right here, what it shows is newly controlled lots in the third quarter of '21 in that first column, 4,500. And we delivered homes and lot sales of about 1,600 in that same quarter. So we were really replenishing at a much faster write, almost 3,000 homes in excess of what we actually delivered in the third quarter. And on a trailing 12-month basis, 5,200 additional lots in excess of what we actually delivered in a trailing 12-month basis. So again, showing good visibility into our anticipated future growth. Rapid inventory turns drive our improved performance. Again, what this shows on the top half of the slide is that we are the third highest builder in terms of controlling land via auctions. Only D.R. Horton and NVR control a higher percentage of their land by options than we do. And what that has resulted in is we have the second highest inventory turn rate of all the public homebuilders only behind NVR, and we're significantly above the next highest at 1.5. We're at 1.8. And that, again, is a very key component of our strategy, both historically and going forward. We have a very highly profitable financial services business made up of both mortgage and title. It complements our homebuilding operation. We provide mortgage originations in every state we operate in and title services in most of the states. On a trailing 12-month basis as of the end of the third quarter, we had $84 million in revenues, $40 million in operating income and 48% operating margin. On the right-hand half of the slide, you can just see that the overwhelming majority of our originations are conforming kind of prime loans at 69%, about 30% FHA and VA and a tiny 1.1% nonconforming. And with that, I'm going to turn it over to Brad to finish up.

Great. Thank you, Larry. So I'm going to just spend a few minutes talking about our liquidity, capital structure, balance sheet management. On the first slide here, Larry has walked you through our recent operations. From a cash flow generations perspective, as a result of those improved operations on the right-hand side, you can see what our net operating cash flow before land and land development spend has been over the last 3 fiscal years through 2020 as well as the trailing 12-month of July '20 compared to July of '21 and the strong improvement in the last trailing 12 months as a result of the strong operations that Larry walked you through. On the bottom of the slide, it's net operating cash flow as reported, meaning after the land and land development spend. And as Larry showed you, we've been increasing our lot count and land position. So we've spent more on land more recently, but still generated strong net operating cash flow. A couple of key metrics. We generated $1.7 billion of net cash flow before land and land development spend over the past 3 years. We have really strong year-over-year improvement in operating cash flow, and that improvement, while letting us grow our land and land development spend, has also allowed us to pay down some debt and improve our debt position during the third quarter, as I'll show you in a moment. We paid off $111 million of debt that was coming due in 2022. So a year early. And then in August, we paid off another $70 million of debt that was coming due in 2024. So we've used that strong operating cash flow to improve our balance sheet position. Our liquidity position over the last 3 years by quarters on this slide. We target at quarter end between $170 million and $245 million of liquidity. You can see over this time frame that in every period, we were either at the high end of the range or, in fact, over our liquidity target. So we've been in good shape there. And certainly, in the last 4 quarters, we've been above the liquidity target, which is what allowed us to pay down the debt I just discussed. Here you can see at July 31, we were still above at $308 million. And we did use $70 million of cash in August, which would still have kept us at the very high end of the liquidity range, assuming that debt pay down. This next slide shows you our current debt position, our senior note structure by lean position. It's an order of priority on the right-hand side there. So we have a number of different lean positions for secured notes. And then in the hashed-out section, you can see the 2 notes that I just described that were paid off in late July and then early August, removing that debt. So we've paid that off. And what we're really looking to try to do going forward is continue to deleverage through debt paydowns, increased equity and with our operations improvement and then ideally refinance these notes into multiyear well-laddered debt maturity, ideally unsecured and in tranches that are of a size necessary to achieve a high-yield index inclusion and have better liquidity and price transparency than our current secured notes have. This is the maturity profile of the debt we just looked at on the other slides. So you can see here, with the payoff of the 2022 notes that occurred in July not reflected here at all. And then the box showing you what we paid off in August, earlier this quarter, and now that's gone away. All we have between now and 2026 is our secured revolving credit agreement, and that's the highest priority lean debt we have. So we should have no trouble refinancing that at the time in sometime in advance of maturity for that. So what this shows is a really healthy long runway between now and when our maturities come due, although the large stack in 2026, and we would like to work on refinancing that ideally at better rates and with a better step ladder going forward. Some key credit metrics and the improvement in those metrics over the last few years as a result of our continued improved performance. On the left-hand side, you can see our total debt to adjusted EBITDA at 4.4% and projected to be at 4.1% and then even -- and the net debt, same kind of improvement just between even lower level and adjusted EBITDA. And then coverage on the right-hand side of adjusted EBITDA, the interest incurred just at 2% at the end of the third quarter on a trailing 12-month basis and continues to improve -- projected to improve into the -- for the full year of fiscal '21. And then on the bottom right, you can see that our equity value, we've now flipped to having positive equity. Earlier this fiscal year, we were able to reverse a large portion of our deferred tax asset valuation allowance, which goes through income and tax -- income on the tax line, and then is now flips us to a positive equity. At the end of the third quarter, you can see we're at $121 million and we're projected to be at the end of this fiscal year have at $160 million. And coming off of obviously a relatively low book value with the anticipated fiscal '22 operations that we have. Our equity should have -- we'll have a very high growth rate over the coming years, coming off a low base. And with that, I think we're now ready for any questions.

Guys, I don't see any questions yet, but maybe as we wait, if I could just ask about what your thoughts are on affordability trends and mortgage rates and how you'd expect that to impact the industry and Hovnanian, specifically?

Yes. Mortgage rates remain near historical lows. Even if they go up a little bit, if you look at the affordability index, which really takes median income and meeting home prices, rates could go up, I think, 175 basis points to get us to the longer-term average affordability index across the country. Obviously, that varies a little bit market by market. We certainly don't anticipate a significant increase in rates anything close to that. And even if rates do begin to trend up a little bit. What historically has happened as consumers will take less options and upgrades, maybe even pick a smaller house and continue and want to have a new home. So we're not really overly concerned about interest rates movements at this point in time.

Got it. Well, I don't see any questions here.

Well, if there's no questions, we again appreciate the invitation. If anyone wants to reach out to us call either Jeff O'Keefe or myself, then we'll be happy to answer any questions offline that you may have, but I appreciate the participation.

Thanks a lot, guys. Appreciate it.