Hovnanian Enterprises Inc: Form 10-Q for the period ended Jul 31, 2024

Hovnanian Enterprises, Inc. (“HEI”) conducts all of its homebuilding and financial services operations through its subsidiaries (references herein to the “Company,” “we,” “us” or “our” refer to HEI and its consolidated subsidiaries and should be understood to reflect the consolidated business of HEI’s subsidiaries).

Key Performance Indicators

The following key performance indicators are commonly used in the homebuilding industry and by management as a means to better understand our operating performance and trends affecting our business and compare our performance with the performance of other homebuilders. We believe these key performance indicators also provide useful information to investors in analyzing our performance:

• Net contracts is a volume indicator which represents the number of new contracts executed during the period for the purchase of homes, less cancellations of contracts in the same period. The dollar value of net contracts represents the dollars associated with net contracts executed in the period. These values are an indicator of potential future revenues;
• Contract backlog is a volume indicator which represents the number of homes that are under contract, but not yet delivered as of the stated date. The dollar value of contract backlog represents the dollar amount of the homes in contract backlog. These values are an indicator of potential future revenues;
• Active selling communities is a volume indicator which represents the number of communities which are open for sale with ten or more home sites available as of the end of a period. We identify communities based on product type; therefore, at times there are multiple communities at one land site. These values are an indicator of potential revenues;
• Net contracts per average active selling community is used to indicate the pace at which homes are being sold (put into contract) in active selling communities and is calculated by dividing the number of net contracts in a period by the average number of active selling communities in the same period. Sales pace is an indicator of market strength and demand; and
• Contract cancellation rates is a volume indicator which represents the number of sales contracts cancelled in the period divided by the number of gross sales contracts executed during the period. Contract cancellation rates as a percentage of backlog is calculated by dividing the number of cancelled contracts in the period by the contract backlog at the beginning of the period. Cancellation rates as compared to prior periods can be an indicator of market strength or weakness.

Overview

Market Conditions and Operating Results

The demand for new and existing homes is dependent on a variety of demographic and economic factors, including job and wage growth, household formation, consumer confidence, mortgage financing, interest rates, inflation and overall housing affordability.

From January 2022 to October 2023, 30-year mortgage rates more than doubled. The sharp increase in interest rates, persistently high levels of inflation and doubt about the stability of the economy, negatively impacted housing demand beginning in the second half of fiscal 2022 and into fiscal 2023. During the first quarter of fiscal 2024, mortgage rates declined, which had a positive effect on our sales pace. Rates fluctuated in the second and third quarters of fiscal 2024 and affordability generally remains challenging for homebuyers. We have been aggressive in our pricing, incentives and concessions in order to align with the current market.

We continue to use our increased inventory of quick move-in homes ("QMI homes") to help meet buyers’ needs for more affordable housing in the recent uncertain interest rate environment. The time between contract signing and closing is shorter with a QMI home as compared to a to be built home, which provides customers with more certainty on their mortgage pricing. The availability of QMI homes also allows us to offer mortgage interest rate buydown assistance, which is a tool we offer through our wholly-owned mortgage banking subsidiary ("K. Hovnanian Mortgage"), to help ease the impact of higher monthly payments from rising interest rates. We pay the cost of interest rate buydowns for customers that qualify through K. Hovnanian Mortgage and decide to use the program. The level of interest rate based incentives utilized differs across our markets and is one of several available options we use to drive sales and close homes.

The number of existing home sales listings remain at all-time low levels, which limits the supply of homes available for purchase, leading to increased demand for new homes. There was strong demand for our homes in the first and second quarters of fiscal 2024 as compared to the same periods of the prior year, which led to a significant increase in net contracts and net contracts per average active selling community, as compared to the first half of fiscal 2023. However, demand declined during the third quarter of fiscal 2024, partially due to volatility in interest rates impacting homebuyers’ decisions. In addition, we had extended construction disruptions from Hurricane Beryl across our Texas operations, which is our largest state by deliveries. Overall, we were able to increase net prices in approximately 33% of our communities during the third quarter of fiscal 2024.

There still remains a great degree of uncertainty due to inflation, the continued possibility of an economic recession, employment risk and the potential for further mortgage rate increases. While we continue to experience some lingering supply chain issues, we remain focused on continuing to shorten our construction cycle times and building on our national initiatives to drive down costs with our material providers and trade partners. The changing conditions in the housing market, and in the general economy, makes it difficult to predict how strongly our business will be impacted by these external factors over fiscal 2024 and beyond.

Our cash position allowed us to spend $677.0 million on land purchases and land development for long-term growth during the nine months ended July 31, 2024, and still have total liquidity of $251.3 million, including $122.0 million of homebuilding cash and cash equivalents and $125.0 million of borrowing capacity under our senior secured revolving credit facility as of July 31, 2024.

Information on our operating results for the three and nine months ended July 31, 2024 are as follows:

• Sale of homes revenues increased to $687.4 million for the three months ended July 31, 2024 from $630.4 million for the three months ended July 31, 2023, and increased to $1.9 billion for the nine months ended July 31, 2024 from $1.8 billion for the nine months ended July 31, 2023. There was a 4.8% and 7.1% increase in the number of home deliveries for the three and nine months ended July 31, 2024, respectively, compared to the prior year periods, as well as an increase in average prices of 4.1% and 1.0% for the three and nine months ended July 31, 2024, respectively, compared to the prior year periods. The increase in average price was the result of the geographic and community mix of our deliveries.
• Gross margin dollars increased 3.5% and 9.0% for the three and nine months ended July 31, 2024, respectively, as compared to the same periods of the prior year, while gross margin percentage decreased from 20.1% for the three months ended July 31, 2023 to 19.1% for the three months ended July 31, 2024, and increased slightly from 18.8% for the nine months ended July 31, 2023 to 18.9% for the nine months ended July 31, 2024. Gross margin percentage, before cost of sales interest expense and land charges, decreased from 23.2% for the three months ended July 31, 2023 to 22.1% for the three months ended July 31, 2024, and increased from 21.9% for the nine months ended July 31, 2023 to 22.2% for the nine months ended July 31, 2024. The decrease in gross margin percentage for the three months ended July 31, 2024 was primarily due to increased use of incentives and concessions, including additional mortgage interest rate buydowns, to make our homes more affordable. The increase in gross margin percentage for the nine months ended July 31, 2024 was primarily due to decreases in base construction costs per square foot across each of our segments.
• Selling, general and administrative costs (including corporate general and administrative expenses) ("Total SGA") was $89.5 million, or 12.4% of total revenues, in the three months ended July 31, 2024 compared with $75.1 million, or 11.6% of total revenues, in the three months ended July 31, 2023. For the nine months ended July 31, 2024, Total SGA was $254.5 million, or 12.6% of total revenues, compared with $224.0 million, or 12.0% of total revenues, in the same period of the prior fiscal year. The increase in Total SGA dollars is primarily due an increase in advertising expenses and compensation expense, mainly related to increased headcount and annual merit increases, along with grants of phantom stock awards under our 2019 and 2023 long-term incentive plans, for which expense is impacted by the change in our stock price each period.
• Other interest decreased to $6.3 million and $25.7 million for the three and nine months ended July 31, 2024, respectively, from $13.5 million and $43.1 million for the three and nine months ended July 31, 2023, respectively, primarily due to a reduction in principal of our senior notes as a result of redemptions during fiscal 2023 and the first quarter of fiscal 2024, and the debt exchange executed in the third quarter of fiscal 2024.
• Income before taxes increased to $97.3 million for the three months ended July 31, 2024 from $70.4 million for the three months ended July 31, 2023, and increased to $199.2 million for the nine months ended July 31, 2024 from $134.6 million for the nine months ended July 31, 2023. Income before taxes include gains from the consolidation of joint ventures of $45.7 million and $19.1 million for the three and nine months ended July 31, 2024 and 2023, respectively. Net income increased to $72.9 million for the three months ended July 31, 2024 from $55.8 million for the three months ended July 31, 2023, and increased to $147.7 million for the nine months ended July 31, 2024 from $108.6 million for the nine months ended July 31, 2023. Earnings per share, basic and diluted, increased to $10.61 and $9.75, respectively, for the three months ended July 31, 2024 compared to $7.92 and $7.38, respectively, for the three months ended July 31, 2023. Earnings per share, basic and diluted, increased to $20.85 and $19.15, respectively, for the nine months ended July 31, 2024 compared to $14.97 and $13.97, respectively, for the nine months ended July 31, 2023.
• Net contracts decreased 17.5% and increased 3.3% for the three and nine months ended July 31, 2024, respectively, compared to the same periods of the prior year. The decrease for the three months ended July 31, 2024 is primarily due to a historically strong third quarter of fiscal 2023, which included a high number of build for rent contracts. The increase in the nine months is primarily driven by demand for new homes resulting from the low supply of existing homes for sale, slightly lower mortgage rates than the prior year, job creation in the employment market and overall growth in the broader economy.
• Net contracts per average active selling community decreased to 10.1 from 13.4 for the three months ended July 31, 2024, and increased to 32.7 from 32.3 for the nine months ended July 31, 2024 compared to the same periods of the prior year. The fluctuations for the three and nine months ended July 31, 2024 were primarily due to the fluctuations in net contracts discussed above. Also, our active selling communities increased from 102 at July 31, 2023 to 126 at July 31, 2024, however, a significant amount of the community openings occurred during July 2024. Therefore, while the community count used in the calculation increased, the timing of the newly opened communities did not provide the benefit of a full quarter to sell homes therefrom.
• Contract backlog decreased from 2,403 homes at July 31, 2023 to 2,041 homes at July 31, 2024, and the dollar value of contract backlog decreased to $1.2 billion, a 12.6% decrease in dollar value compared to the prior year, as our backlog conversion ratio has increased from the prior year period due to our focus on having more QMI homes available to sell and deliver.

Results of Operations

Total Revenues

Compared to the same period in the prior year, revenues increased (decreased) as follows:

(Dollars in thousands)

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(Dollars in thousands)

Homebuilding: Sale of Homes

For the three and nine months ended July 31, 2024, sale of homes revenues increased 9.1% and 8.2%, respectively, compared to the same periods in the prior year. The sale of homes revenue increased due to a 4.8% and 7.1% increase in homes delivered, respectively, as well as a 4.1% and 1.0% increase in the average price per home for the three and nine months ended July 31, 2024, respectively, compared with the prior year periods. The average price per home increased to $547,748 in the three months ended July 31, 2024 from $526,186 in the three months ended July 31, 2023. The average price per home increased to $540,958 in the nine months ended July 31, 2024 from $535,770 in the nine months ended July 31, 2023. The increase in average price was the result of the geographic and community mix of our deliveries. For further detail on changes in segment revenues see “Homebuilding: Operations by Segment” below. For further detail on land sales and other revenues, see “Homebuilding: Land Sales and Other Revenues” below.

Information on the sale of homes is set forth in the table below:

(Dollars in thousands, except average sales price)

(1) Represents housing revenues and home deliveries for our unconsolidated homebuilding joint ventures for the period. We provide this data as a supplement to our consolidated results as an indicator of the volume managed in our unconsolidated joint ventures. See Note 18 to the Condensed Consolidated Financial Statements included elsewhere in this Quarterly Report on Form 10-Q for a further discussion of our unconsolidated joint ventures.

Homebuilding: Land Sales and Other Revenues

Land sales and other revenues increased $11.5 million and decreased $1.3 million for the three and nine months ended July 31, 2024, respectively, compared to the same periods in the prior year. Revenue associated with land sales can vary significantly due to the mix of land parcels sold. There were one and two land sales in the three and nine months ended July 31, 2024, respectively, and zero and two land sales in the three and nine months ended July 31, 2023, respectively. Land sales revenues increased $13.8 million and decreased $0.3 million during the three and nine months ended July 31, 2024, respectively, compared to the same periods in the prior year.

Homebuilding: Cost of Sales

Cost of sales includes expenses for homebuilding and land and lot sales, including inventory impairments and land option write-offs (defined as “land charges” in the tables below). A breakout of such expenses for homebuilding and land and lot sales and the gross margins for each is set forth below.

Homebuilding gross margin, before cost of sales interest expense and land charges, is a non-GAAP financial measure. This measure should not be considered as an alternative to homebuilding gross margin determined in accordance with U.S. GAAP as an indicator of operating performance.

Management believes this non-GAAP measure enables investors to better understand our operating performance. This measure is also useful internally, helping management evaluate our operating results on a consolidated basis and relative to other companies in our industry. In particular, the magnitude and volatility of land charges for the Company, and for other homebuilders, have been significant and, as such, have made comparable financial analysis of our industry more difficult. Homebuilding metrics excluding land charges, as well as interest amortized to cost of sales, and other similar presentations prepared by analysts and other companies are frequently used to assist investors in understanding and comparing the operating characteristics of homebuilding activities by eliminating many of the differences in companies’ respective levels of impairments and debt.

(Dollars in thousands)

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Cost of sales as a percentage of consolidated home sales revenues are presented below:

We sell a variety of home types in various communities, each yielding a different gross margin. As a result, depending on the mix of communities delivering homes, consolidated gross margin may fluctuate up or down. Total homebuilding gross margin percentage decreased to 19.1% and increased to 18.9% for the three and nine months ended July 31, 2024, respectively, compared to 20.1% and 18.8% for the prior year periods, respectively. Total homebuilding gross margin percentage, before cost of sales interest expense and land charges decreased to 22.1% and increased to 22.2% for the three and nine months ended July 31, 2024, respectively, compared to 23.2% and 21.9% for the three and nine months ended July 31, 2023, respectively. The decrease in gross margin percentage for the three months ended July 31, 2024 was primarily due to increased use of incentives and concessions, including additional mortgage interest rate buydowns, to make our homes more affordable. The increase in gross margin percentage for the nine months ended July 31, 2024 was primarily due to decreases in base construction costs per square foot across each of our segments.

Land and lot sale expenses and gross margins are set forth below:

(In thousands)

35

Land sales are ancillary to our homebuilding operations and are expected to continue in the future but may fluctuate significantly.

Homebuilding: Inventory Impairments and Land Option Write-Offs

Inventory impairments and land option write-offs reflects certain inventories we have either written off or written down to their estimated fair value totaling $3.1 million and $0.3 million in expense for the three months ended July 31, 2024 and 2023, respectively, and $3.6 million and $0.9 million in expense for the nine months ended July 31, 2024 and 2023, respectively. Inventory impairments amounted to $2.7 million and zero during the three and nine months ended July 31, 2024 and 2023, respectively. The impairment recorded for fiscal 2024 was for one community in the West segment. We wrote-off residential land option, approval and engineering costs across each of our segments during the first nine months of fiscal 2024 and 2023.

Homebuilding: Selling, General and Administrative

Homebuilding selling, general and administrative (“SGA”) expenses increased $3.3 million to $51.0 million for the three months ended July 31, 2024 and increased $0.3 million to $146.4 million for the nine months ended July 31, 2024 compared to the same periods in the prior year. The increase for the three and nine months ended July 31, 2024 compared to the same periods in the prior year was primarily due to an increase in selling overhead from higher advertising costs and an increase in total compensation expense as a result of an increase in headcount and bonuses related to positive overall market conditions and specific company performance, slightly offset by an increase in unconsolidated joint venture deliveries, where we receive a management fee on each delivery, which offsets our SGA expenses incurred.

Homebuilding: Key Performance Indicators

Net Contracts Per Average Active Selling Community

Net contracts per average active selling community for the three and nine months ended July 31, 2024 were 10.1 and 32.7, respectively, compared to 13.4 and 32.3 for the same periods in the prior year, respectively. The calculation for the three months ended July 31, 2024 was impacted by the increase in our active selling communities from 102 at July 31, 2023 to 126 at July 31, 2024, however, a significant amount of the community openings occurred during July 2024. Therefore, while the community count used in the calculation increased, the timing of the newly opened communities did not provide the benefit of a full quarter to sell homes therefrom.

Contract Cancellation Rates

The following table provides historical quarterly cancellation rates, which represents the number of cancelled contracts in the quarter divided by the number of gross sales contracts executed in the quarter, excluding unconsolidated joint ventures:

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The following table provides quarterly contract cancellations as a percentage of the beginning backlog, excluding unconsolidated joint ventures:

Most cancellations occur within the legal rescission period, which varies by state but is generally less than two weeks after the signing of the contract. Cancellations also occur as a result of a buyer’s failure to qualify for a mortgage, which generally occurs during the first few weeks after signing. Due to our solid backlog position, our cancellation rate as a percentage of beginning backlog for the third quarter of fiscal 2024 was 12%, which approximates our historical normal rate. When sales pace is increasing, the cancellation rate as a percentage of beginning backlog tends to lag the changes seen in our cancellation rate as a percentage of gross sales. Market conditions, although improving, still remain uncertain and it is difficult to predict what cancellation rates will be in the future.

Contract Backlog

Our consolidated sales contracts and homes in contract backlog, excluding unconsolidated joint ventures, by segment is set forth below:

(Dollars in thousands)

37

Contract backlog dollars decreased 12.6% as of July 31, 2024 compared to July 31, 2023, and the number of homes in backlog decreased 15.1% as of July 31, 2024 compared to July 31, 2023. The decrease in contract backlog dollars and number of homes as of July 31, 2024 compared to July 31, 2023 was primarily driven by an increase in sales of QMI homes and improved contract backlog conversion.

Homebuilding: Operations by Segment

Financial information relating to our homebuilding operations by segment was as follows:

(Dollars in thousands, except average sales price)

(Dollars in thousands, except average sales price)

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Homebuilding Results by Segment

Northeast - Homebuilding revenue increased 26.5% for the three months ended July 31, 2024 compared to the same period in the prior year. The increase for the three months ended July 31, 2024 was attributed to a 13.2% increase in homes delivered and a 12.1% increase in average sales price. The increase in average sales price was the result of new communities delivering higher priced, larger single family homes and townhomes in higher-end submarkets of the segment for the three months ended July 31, 2024 compared to some communities delivering lower priced, smaller single family homes and townhomes in lower-end submarkets of the segment in the three months ended July 31, 2023, which were no longer delivering in the current year.

Income before income taxes increased $10.9 million to $40.0 million for the three months ended July 31, 2024 as compared to the same period in the prior year. This was primarily due the increase in homebuilding revenue discussed above and a $2.9 million increase in income from unconsolidated joint ventures, slightly offset by a decrease in gross margin percentage.

Homebuilding revenue increased 3.3% for the nine months ended July 31, 2024 compared to the same period in the prior year. The increase for the nine months ended July 31, 2024 was attributed to a 4.9% increase in average sales price, slightly offset by a 1.7% decrease in homes delivered. The increase in average sales price was the result of new communities delivering higher priced, larger single family homes and townhomes in higher-end submarkets of the segment for the nine months ended July 31, 2024 compared to some communities delivering lower priced, smaller single family homes in lower-end submarkets of the segment in the nine months ended July 31, 2023, which were no longer delivering in the current year.

Income before income taxes increased $21.3 million to $107.6 million for the nine months ended July 31, 2024 as compared to the same period in the prior year. This was primarily due to the increase in homebuilding revenue discussed above, a $12.3 million increase in income from unconsolidated joint ventures and a $3.6 million decrease in SGA, while gross margin percentage was relatively flat.

Southeast – Homebuilding revenue decreased 4.4% for the three months ended July 31, 2024 compared to the same period in the prior year. The decrease was due to a 4.8% decrease in average sales price, partially offset by a 0.4% increase in homes delivered. The decrease in average sales price was the result of new communities delivering lower priced, smaller single family homes and townhomes in lower-end submarkets of the segment for the three months ended July 31, 2024 compared to some communities delivering higher priced, larger single family homes and townhomes in mid to higher-end submarkets of the segment in the three months ended July 31, 2023, which were no longer delivering in the current year.

Income before income taxes decreased $3.0 million to $20.4 million for the three months ended July 31, 2024 compared to the same period in the prior year. This was primarily due to the decrease in homebuilding revenue discussed above, a $1.5 million increase in SGA and a $1.1 million decrease in income from unconsolidated joint ventures, while gross margin percentage was relatively flat.

Homebuilding revenue increased 18.5% for the nine months ended July 31, 2024 compared to the same period in the prior year. The increase was due to a 23.3% increase in homes delivered, partially offset by a 4.1% decrease in average sales price. The decrease in average sales price was the result of new communities delivering lower priced, smaller single family homes and townhomes in lower-end submarkets of the segment in the nine months ended July 31, 2024 compared to some communities for the nine months ended July 31, 2023 that had higher priced, larger single family homes and townhomes in mid to higher-end submarkets, which were no longer delivering in the current year.

Income before income taxes increased $12.5 million to $62.4 million for the nine months ended July 31, 2024 compared to the same period in the prior year. This was primarily due to the increase in homebuilding revenue discussed above, and a $2.2 million increase in income from unconsolidated joint ventures, while gross margin percentage was relatively flat.

West – Homebuilding revenue increased 7.1% for the three months ended July 31, 2024 compared to the same period in the prior year. The increase was due to a $13.5 million increase in land sales and other revenue and a 1.5% increase in homes delivered, while average sales price increased by 1.2%.

Income before income taxes decreased $6.9 million to $21.0 million for the three months ended July 31, 2024 compared to the same period in the prior year. This was primarily due to a $2.8 million increase in inventory impairments and land option write offs and a decrease in gross margin percentage.

Homebuilding revenue increased 8.0% for the nine months ended July 31, 2024 compared to the same period in the prior year. The increase was due to an 7.6% increase in homes delivered, while average sales price increased by 0.7%.

Income before income taxes increased $11.2 million to $77.2 million for the nine months ended July 31, 2024 compared to the same period in the prior year. The increase is primarily due to the increase in homebuilding revenue discussed above, along with a $1.3 million increase in income from unconsolidated joint ventures and a slight increase in gross margin percentage.

Financial Services

Financial services consists primarily of originating mortgages from our home buyers, selling such mortgages in the secondary market, and title insurance activities. We use mandatory investor commitments and forward sales of mortgage-backed securities (“MBS”) to hedge our mortgage-related interest rate exposure on agency and government loans. For the nine months ended July 31, 2024 and 2023, Federal Housing Administration and Veterans Administration (“FHA/VA”) loans represented 34.1% and 30.4%, respectively, of our total loans. For the nine months ended July 31, 2024 compared to the same period in the prior year, our conforming conventional loan originations as a percentage of our total loans decreased from 68.8% to 65.3%. The origination of loans which exceed conforming conventions decreased from 0.8% to 0.6% for the nine months ended July 31, 2024 compared to the same period in the prior year.

During the three and nine months ended July 31, 2024 and 2023, financial services provided $6.5 million and $15.5 million of income before income taxes, respectively, compared to $4.3 million and $11.5 million for the same periods in the prior year, respectively. The increase in financial services income before income taxes for the three and nine months ended July 31, 2024 compared to the same periods in the prior year was primarily due to an increase in the volume of loans closed and an increase in the average size of the loans settled. In the markets served by our wholly owned mortgage banking subsidiaries, 81.4% and 70.1% of our non-cash homebuyers obtained mortgages originated by these subsidiaries during the three months ended July 31, 2024 and 2023, respectively, and 79.7% and 67.8% of our non-cash homebuyers obtained mortgages originated by these subsidiaries during the nine months ended July 31, 2024 and 2023, respectively.

Corporate General and Administrative

Corporate general and administrative expenses include operations at our headquarters in New Jersey. These expenses include payroll, stock compensation, facility costs and rent and other costs associated with our executive offices, legal expenses, information services, human resources, corporate accounting, training, treasury, process redesign, internal audit, national and digital marketing, construction services and administration of insurance, quality and safety. Corporate general and administrative expenses increased to $38.5 million for the three months ended July 31, 2024 compared to $27.4 million for the three months ended July 31, 2023 and increased to $108.1 million for the nine months ended July 31, 2024 compared to $77.9 million for the nine months ended July 31, 2023. The increase for the three months ended July 31, 2024 was primarily due to an increase in compensation expense, mainly related to increased headcount and annual merit increases and by increased expense related to grants of phantom stock awards under our 2019 and 2023 long-term incentive plans, for which expense is impacted by the change in our stock price each period. During the nine months of fiscal 2024, equity awards including phantom stock were also granted under a new long-term incentive program, which increased stock compensation expense compared to the same period in the prior year.

Other Interest

Other interest decreased $7.2 million to $6.3 million for the three months ended July 31, 2024 and decreased $17.4 million to $25.7 million for the nine months ended July 31, 2024 compared to the same periods in the prior year, respectively. Our assets that qualify for interest capitalization (inventory under development) exceeded our debt during the third quarter of fiscal 2024, therefore, all of the related interest incurred during fiscal 2024 qualified for interest capitalization instead of being directly expensed. Also, contributing to the decrease in Other interest for the three and nine months ended July 31, 2024, was the reduction in principal of our senior notes as a result of redemptions during fiscal 2023 and the first quarter of fiscal 2024, and the debt exchange executed in the third quarter of fiscal 2024.

Gain on Extinguishment of Debt, Net

On November 15, 2023, K. Hovnanian redeemed in full all of the $113.5 million aggregate principal amount of its 10.0% Senior Secured 1.75 Lien Notes due 2025 for a redemption price of $119.2 million, which included accrued and unpaid interest. This redemption resulted in a gain on extinguishment of debt of $1.4 million for the nine months ended July 31, 2024, including the write-off of unamortized premium, debt issuance costs and fees.

Income from Unconsolidated Joint Ventures

Income from unconsolidated joint ventures consists of our share of the earnings or losses of our unconsolidated joint ventures. Income from unconsolidated joint ventures increased $2.3 million to $10.7 million for the three months ended July 31, 2024 and increased $15.8 million to $36.8 million for the nine months ended July 31, 2024 compared to the same periods in the prior year, respectively. The increase for the three and nine months ended July 31, 2024 compared to the same periods of the prior year was primarily due to the recognition of additional income from three of our unconsolidated joint ventures; because the joint venture partner achieved certain return hurdles, the Company was able to recognize a higher share of the unconsolidated joint ventures' income than it had in the prior year.

Income Taxes

Income tax expense for the three and nine months ended July 31, 2024 was $24.4 million and $51.6 million, respectively, and $14.6 million and $25.9 million for the same periods in the prior year, respectively. For both the three and nine months ended July 31, 2024, and both prior year periods, the expense was primarily driven by federal and state tax expense on income before income taxes and permanent differences, partially offset by the generation of energy efficient home tax credits. Income tax expense for the three and nine months ended July 31, 2024 was impacted by discrete net tax expenses related to the gain on consolidation of a joint venture, cancellation of debt income from the debt exchanges executed in the third quarter of fiscal 2024 and stock-based compensation as a result of current period activity. The state tax expense for the three and nine months ended July 31, 2023 included the release of a valuation allowance as a result of a change in tax law. The federal tax expense is not paid in cash as it is offset by the use of our existing NOL carryforwards.

Capital Resources and Liquidity

Overview

Our total liquidity at July 31, 2024 was $251.3 million, including $122.0 million in homebuilding cash and cash equivalents and $125.0 million of borrowing capacity under our senior secured revolving credit facility. We believe that our cash on hand together with available borrowings on our senior secured revolving credit facility will be sufficient for at least the next 12 months to finance our working capital requirements.

We have historically funded our homebuilding and financial services operations with cash flows from operating activities, borrowings under our credit facilities, the issuance of new debt and equity securities, and other financing activities. We may not be able to obtain desired financing even if market conditions, including then-current market available interest rates (in recent years, we have not been able to access the traditional capital and bank lending markets at competitive interest rates due to our highly leveraged capital structure), would otherwise be favorable, which could impact our ability to grow our business.

Operating, Investing and Financing Cash Flow Activities

We spent $677.0 million on land and land development during the first three quarters of fiscal 2024, along with $113.5 million for the redemption of our 10.0% Senior Secured 1.75 Lien Notes due 2025. After land and land development spending and all other operating activities, including revenue received from deliveries, cash used in operations was $92.2 million. During the first three quarters of fiscal 2024, cash used in investing activities was $40.3 million, primarily due to a new joint venture entered into during the second quarter of fiscal 2024, along with spending on capitalized software, partially offset by distributions of capital from existing unconsolidated joint ventures. Cash used in financing activities was $161.2 million during the first three quarters of fiscal 2024, which in addition to the $113.5 million debt redemption mentioned above, was primarily due to cash payments of $31.5 million related to the May 2024 debt exchange, net payments for nonrecourse mortgage financings, treasury stock purchases and payments of preferred dividends, partially offset by net proceeds related to our mortgage warehouse lines of credit, and net proceeds for land banking financings and model sale leaseback financings. We intend to continue to use nonrecourse mortgages, model sale leasebacks, joint ventures, and, subject to covenant restrictions in our debt instruments, land banking programs as our business needs dictate.

Our cash uses during the nine months ended July 31, 2024 and 2023 were for operating expenses, land purchases, land deposits, land development, construction spending, investments in unconsolidated joint ventures, land banking transactions, state income taxes, debt reductions, interest payments, preferred dividends, treasury stock purchases and litigation matters. During these periods, we provided for our cash requirements from available cash on hand, housing and land sales, nonrecourse mortgage transactions, income from unconsolidated joint ventures, financial service revenues and other revenues.

Our net income historically does not approximate cash flow from operating activities. The difference between net income and cash flow from operating activities is primarily caused by changes in inventory levels together with changes in receivables, prepaid expenses and other assets, mortgage loans held for sale, accrued interest, deferred income taxes, accounts payable and other liabilities, and noncash charges relating to depreciation, stock compensation and impairments. When we are expanding our operations, inventory levels, prepaid expenses and other assets increase causing cash flow from operating activities to decrease. Certain liabilities also increase as operations expand and partially offset the negative effect on cash flow from operations caused by the increase in inventory, prepaid expenses and other assets. Similarly, as our mortgage operations expand, net income from these operations increases, but for cash flow purposes, net income is partially offset by the net change in mortgage assets and liabilities. The opposite is true as our investment in new land purchases and development of new communities decrease, causing us to generate positive cash flow from operations.

Debt Transactions

Senior notes and credit facilities balances as of July 31, 2024 and October 31, 2023, were as follows:

(In thousands)

(1) On May 21, 2024, K. Hovnanian exchanged $64.0 million aggregate principal amount of 13.5% Senior Notes due February 1, 2026 and cash, $65.2 million aggregate principal amount of 5.0% Senior Notes due February 1, 2040 and all of its $39.6 million aggregate principal amount of loans under the Senior Unsecured Term Loan Credit Facility due February 1, 2027 and cash for an additional $93.5 million aggregate principal amount of loans under the Senior Secured 1.75 Lien Term Loan Credit Facility due January 31, 2028.

(2) At July 31, 2024, provides for up to $125.0 million in aggregate amount of senior secured first lien revolving loans. The revolving loans thereunder have a maturity of June 30, 2026 and borrowings bear interest, at K. Hovnanian’s option, at either (i) a term secured overnight financing rate (subject to a floor of 3.00%) plus an applicable margin of 4.50% or (ii) an alternate base rate (subject to a floor of 4.00%) plus an applicable margin of 3.50%. In addition, K. Hovnanian will pay an unused commitment fee on the undrawn revolving commitments at a rate of 1.00% per annum.

Except for K. Hovnanian, the issuer of the notes and borrower under the credit agreements governing our term loans and revolving credit facilities (collectively, the "Credit Facilities"), our home mortgage subsidiaries, certain of our title insurance subsidiaries, joint ventures and subsidiaries holding interests in our joint ventures, we and each of our subsidiaries are guarantors of the Credit Facilities, the senior secured notes and senior notes outstanding at July 31, 2024 (collectively, the “Notes Guarantors”).

The credit agreements governing the Credit Facilities and the indentures governing the senior secured and senior notes (together with the Credit Facilities, the “Debt Instruments”) outstanding at July 31, 2024 do not contain any financial maintenance covenants, but do contain restrictive covenants that limit, among other things, the ability of HEI and certain of its subsidiaries, including K. Hovnanian, to incur (including through exchange or certain other types of transactions) indebtedness, pay dividends and make distributions on common and preferred stock, repay/repurchase certain indebtedness prior to its respective stated maturity, repurchase common and preferred stock, make other restricted payments (including investments), sell certain assets (including in certain land banking transactions), incur liens, consolidate, merge, sell or otherwise dispose of all or substantially all of their assets and enter into certain transactions with affiliates. The Debt Instruments also contain customary events of default which would permit the lenders or holders thereof to exercise remedies with respect to the collateral (as applicable), declare the loans (the "Unsecured Term Loans") made under the Senior Unsecured Term Loan Credit Facility due February 1, 2027, loans (the "Secured Term Loans") made under the Senior Secured 1.75 Lien Term Loan Credit Facility due January 31, 2028, and loans (the "Secured Revolving Loans") made under the Senior Secured Revolving Credit Agreement due June 30, 2026, or notes to be immediately due and payable if not cured within applicable grace periods, including the failure to make timely payments on the Unsecured Term Loans, Secured Term Loans, Secured Revolving Loans or notes or other material indebtedness, cross default to other material indebtedness, the failure to comply with agreements and covenants and specified events of bankruptcy and insolvency, with respect to the Unsecured Term Loans, Secured Term Loans and Secured Revolving Loans, material inaccuracy of representations and warranties and with respect to the Unsecured Term Loans, Secured Term Loans and Secured Revolving Loans, a change of control, and, with respect to the Secured Term Loans, Secured Revolving Loans and senior secured notes, the failure of the documents granting security for the obligations under the secured Debt Instruments to be in full force and effect, and the failure of the liens on any material portion of the collateral securing the obligations under the secured Debt Instruments to be valid and perfected. As of July 31, 2024, we believe we were in compliance with the covenants of the Debt Instruments.

If our consolidated fixed charge coverage ratio is less than 2.0 to 1.0, as defined in the applicable Debt Instrument, we are restricted from making certain payments and dividends (in the case of certain of such payments, our secured debt leverage ratio must also be less than 4.0 to 1.0), and from incurring indebtedness other than certain permitted indebtedness and nonrecourse indebtedness. Beginning as of October 31, 2021, as a result of our improved operating results, we were no longer restricted from paying dividends. As such, we have made dividend payments of $2.7 million to preferred shareholders in every quarter since the first quarter of fiscal 2022. We currently believe our ratios will permit us to continue to make dividend payments on our preferred stock. However, with general economic uncertainty, it is difficult to predict long-term market conditions and the effects on our business and if and when we may be restricted under our Debt Instruments from continuing to pay dividends on our Series A preferred stock. Dividends on the Series A preferred stock are not cumulative and, accordingly, if for any reason we do not declare a dividend on the Series A preferred stock for a quarterly dividend period (regardless of our availability of funds), holders of the Series A Preferred Stock will have no right to receive a dividend for that period, and we will have no obligation to pay a dividend for that period.

Under the terms of our Debt Instruments, we have the right to make certain redemptions and prepayments and, depending on market conditions, our strategic priorities and covenant restrictions, may do so from time to time. We also continue to actively analyze and evaluate our capital structure and explore transactions to simplify our capital structure and to strengthen our balance sheet, including those that reduce leverage, interest rates and/or extend maturities, and will seek to do so with the right opportunity. We may also continue to make debt or equity purchases and/or exchanges from time to time through tender offers, exchange offers, redemptions, open market purchases, private transactions, or otherwise, or seek to raise additional debt or equity capital, depending on market conditions and covenant restrictions.

Any liquidity-enhancing or other capital raising or refinancing transaction will depend on identifying counterparties, negotiation of documentation and applicable closing conditions and any required approvals. Due to covenant restrictions in our Debt Instruments, we are currently limited in the amount of debt we can incur, even if market conditions, including then-current market available interest rates (in recent years, we have not been able to access the traditional capital and bank lending markets at competitive interest rates due to our highly leveraged capital structure), would otherwise be favorable, which could also impact our ability to grow our business.

See Note 12 to the Condensed Consolidated Financial Statements included elsewhere in this Quarterly Report on Form 10-Q for a further discussion of K. Hovnanian’s Credit Facilities, senior secured notes and senior notes, including information with respect to the collateral securing our secured Debt Instruments.

Mortgages and Notes Payable

We have nonrecourse mortgage loans for certain communities totaling $115.4 million and $91.5 million, net of debt issuance costs, at July 31, 2024 and October 31, 2023, respectively, which are secured by the related real property, including any improvements, with an aggregate book value of $336.7 million and $331.6 million, respectively. The weighted-average interest rate on these obligations was 9.1% and 8.5% at July 31, 2024 and October 31, 2023, respectively, and the mortgage loan payments on each community primarily correspond to home deliveries.

Our wholly owned mortgage banking subsidiary, K. Hovnanian American Mortgage, LLC (“K. Hovnanian Mortgage”), originates mortgage loans primarily from the sale of our homes. Such mortgage loans and related servicing rights are sold in the secondary mortgage market within a short period of time. K. Hovnanian Mortgage finances the origination of mortgage loans through various master repurchase agreements, which are recorded in "Financial services" liabilities on the Condensed Consolidated Balance Sheets. The loans are secured by the mortgages held for sale and are repaid when we sell the underlying mortgage loans to permanent investors. As of July 31, 2024 and October 31, 2023, we had an aggregate of $134.4 million and $110.8 million, respectively, outstanding under several of K. Hovnanian Mortgage’s short-term borrowing facilities.

See Note 11 to the Condensed Consolidated Financial Statements included elsewhere in this Quarterly Report on Form 10-Q for a further discussion of these agreements

Equity

On September 1, 2022, our Board of Directors authorized a repurchase program for up to $50.0 million of our Class A common stock. Under the program, repurchases may be made from time to time in open market transactions, in privately negotiated transactions or otherwise. The timing and the actual dollar amount repurchased will depend on a variety of factors, including legal requirements, price, future tax implications and economic and market conditions. The repurchase program may be changed, suspended or discontinued at any time and does not have a specified expiration date.

During the nine months ended July 31, 2024, we repurchased 188,800 shares under the stock repurchase program, with a market value of $26.5 million, or $140.31 per share, and during the nine months ended July 31, 2023, we repurchased 118,478 shares, with a market value of $4.8 million, or $40.51 per share. As of July 31, 2024, $6.5 million of our Class A common stock is available to be purchased under the stock repurchase program.

On July 12, 2005, we issued 5,600 shares of 7.625% Series A preferred stock, with a liquidation preference of $25,000 per share. Dividends on the Series A preferred stock are not cumulative and are payable at an annual rate of 7.625%. The Series A preferred stock is not convertible into the Company’s common stock and is redeemable in whole or in part at our option at the liquidation preference of the shares. The Series A preferred stock is traded as depositary shares, with each depositary share representing 1/1000th of a share of Series A preferred stock. We paid dividends of $2.7 million and $8.0 million on the Series A preferred stock for the three and nine months ended July 31, 2024 and 2023, respectively.

Unconsolidated Joint Ventures

We have investments in unconsolidated joint ventures in various markets where our homebuilding operations are located. Investments in and advances to unconsolidated joint ventures increased $28.4 million to $126.3 million at July 31, 2024 compared to October 31, 2023. The increase was primarily due a new joint venture entered into during the second quarter of fiscal 2024, along with increases in our share of income recognized for three of our existing unconsolidated joint ventures during the period, partially offset by the consolidation of a previously unconsolidated joint venture in the third quarter of fiscal 2024, and partner distributions. As of July 31, 2024 and October 31, 2023, we had investments in six and seven unconsolidated homebuilding joint ventures and one unconsolidated land development joint venture, respectively. We have no guarantees associated with our unconsolidated joint ventures, other than guarantees limited to performance and completion of development activities, environmental indemnification and standard warranty and representation against fraud, misrepresentation and similar actions, including a voluntary bankruptcy.

Inventories

Total inventory, excluding consolidated inventory not owned, increased $309.6 million to $1.4 billion at July 31, 2024 compared to October 31, 2023. Total inventory, excluding consolidated inventory not owned, increased by $114.2 million in the West, $5.3 million in the Southeast and $190.1 million in the Northeast. The increases were primarily attributable to new land purchases and land development during the period, partially offset by home deliveries. In the last few years, we have been able to acquire new land parcels at prices that we believe will generate reasonable returns under current homebuilding market conditions. This trend may not continue in either the near or the long term. Substantially all homes under construction or completed and included in inventory at July 31, 2024 are expected to be delivered during the next six to nine months.

Consolidated inventory not owned, which consists of options related to land banking and model financing, decreased $8.3 million from October 31, 2023 to July 31, 2024. The decrease was primarily due to a decrease in land banking transactions, partially offset by an increase in the sale and leaseback of certain model homes during the period. We have land banking arrangements, whereby we sell land parcels to land bankers and they provide us with an option to purchase finished lots on a predetermined schedule. On our Condensed Consolidated Balance Sheet, at July 31, 2024, inventory of $167.5 million was recorded to “Consolidated inventory not owned,” with a corresponding amount of $86.2 million (net of debt issuance costs) recorded to “Liabilities from inventory not owned” for the amount of net cash received from land banking transactions. We also sell and lease back certain of our model homes with the right to participate in the potential profit when each home is sold to a third-party at the end of the respective lease. On our Condensed Consolidated Balance Sheet, at July 31, 2024, inventory of $48.9 million was recorded to “Consolidated inventory not owned,” with a corresponding amount of $49.4 million (net of debt issuance costs) recorded to “Liabilities from inventory not owned” for the amount of net cash received from sale and leaseback transactions.

The following tables summarize home sites included in our total residential real estate. The increase in total home sites available at July 31, 2024 compared to October 31, 2023 is attributable to increased community count and acquiring new land parcels during the period, partially offset by delivering homes and terminating certain option agreements.

(1) Active selling communities are open for sale communities with ten or more home sites available. We identify communities based on product type. Therefore, at times there are multiple communities at one land site.

(2) Represents active selling communities and home sites for our unconsolidated homebuilding joint ventures for the period. We provide this data as a supplement to our consolidated results as an indicator of the volume managed in our unconsolidated joint ventures. See Note 18 to the Condensed Consolidated Financial Statements for a further discussion of our unconsolidated joint ventures.

45

The following table summarizes our started or completed unsold homes and models, excluding unconsolidated joint ventures, in active selling communities and substantially completed communities.

(1) Active selling communities (which are communities that are open for sale with ten or more home sites available) were 126 at July 31, 2024 and 113 at October 31, 2023. This ratio does not include substantially completed communities, which are communities with less than ten home sites available.

Financial Services Assets and Liabilities

Financial services assets increased $37.7 million to $206.4 million at July 31, 2024, compared to October 31, 2023. Financial services assets consist primarily of residential mortgage receivables held for sale of which $145.9 million and $127.6 million at July 31, 2024 and October 31, 2023, respectively, were being temporarily warehoused and are awaiting sale in the secondary mortgage market. The increase in mortgage loans held for sale from October 31, 2023 was primarily related to an increase in the volume of loans originated during the third quarter of fiscal 2024 compared to the fourth quarter of fiscal 2023, along with an increase in the average loan value.

Financial services liabilities increased $37.8 million to $186.0 million at July 31, 2024 compared to October 31, 2023. The increase was primarily due to an increase in amounts outstanding under our mortgage warehouse lines of credit and directly correlates to the increase in the volume of mortgage loans held for sale during the period.

Inflation

The annual rate of inflation in the United States was 2.9% in July 2024, as measured by the Consumer Price Index, which is much improved from its peak of 9.1% in June 2022. Inflation has a long-term effect, because higher costs for land, materials and labor results in increasing sales prices of our homes. Historically, these price increases have been commensurate with the general rate of inflation in our housing markets and have not had a significant adverse effect on the sale of our homes. A significant risk faced by the housing industry generally is that rising house construction costs, including land and interest costs, could substantially outpace increases in the income of potential purchasers and therefore limit our ability to raise home sale prices, which may result in lower gross margins.

Inflation has a lesser short-term effect, because we generally negotiate fixed-price contracts with many, but not all, of our subcontractors and material suppliers for the construction of our homes. These prices usually are applicable for a specified number of residential buildings or for a time period of between three to 12 months. Construction costs for residential buildings represented approximately 53.0% of our homebuilding cost of sales for the nine months ended July 31, 2024.

Critical Accounting Policies

As disclosed in our Annual Report on Form 10-K for the fiscal year ended October 31, 2023, our most critical accounting policies relate to inventories, unconsolidated joint ventures, warranty and construction defect reserves and income taxes. Since October 31, 2023, there have been no significant changes to those critical accounting policies.

Safe Harbor Statement

All statements in this Quarterly Report on Form 10-Q that are not historical facts should be considered as “Forward-Looking Statements” within the meaning of the “Safe Harbor” provisions of the Private Securities Litigation Reform Act of 1995. Such statements involve known and unknown risks, uncertainties and other factors that may cause actual results, performance or achievements of the Company to be materially different from any future results, performance or 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: (i) speak only as of the date they are made, (ii) are not guarantees of future performance or results and (iii) 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 include, but are not limited to:

• Changes in general and local economic, industry and business conditions and impacts of a significant homebuilding downturn;
• Shortages in, and price fluctuations of, raw materials and labor, including due to geopolitical events, changes in trade policies, including the imposition of tariffs and duties on homebuilding materials and products, and related trade disputes with, and retaliatory measures taken by other countries;
• Fluctuations in interest rates and the availability of mortgage financing, including as a result of instability in the banking sector;
• Adverse weather and other environmental conditions and natural disasters;
• The seasonality of the Company’s business;
• The availability and cost of suitable land and improved lots and sufficient liquidity to invest in such land and lots;
• Reliance on, and the performance of, subcontractors;
• Regional and local economic factors, including dependency on certain sectors of the economy, and employment levels affecting home prices and sales activity in the markets where the Company builds homes;
• Increases in cancellations of agreements of sale;
• Increases in inflation;
• Changes in tax laws affecting the after-tax costs of owning a home;
• Legal claims brought against us and not resolved in our favor, such as product liability litigation, warranty claims and claims made by mortgage investors;
• Levels of competition;
• Utility shortages and outages or rate fluctuations;
• Information technology failures and data security breaches;
• Negative publicity;
• High leverage and restrictions on the Company’s operations and activities imposed by the agreements governing the Company’s outstanding indebtedness;
• Availability and terms of financing to the Company;
• The Company’s sources of liquidity;
• Changes in credit ratings;
• Government regulation, including regulations concerning development of land, the home building, sales and customer financing processes, tax laws and the environment;
• Operations through unconsolidated joint ventures with third parties;
• Significant influence of the Company’s controlling stockholders;
• Availability of net operating loss carryforwards;
• Loss of key management personnel or failure to attract qualified personnel; and
• Public health issues such as a major epidemic or pandemic.

Certain risks, uncertainties and other factors are described in detail in Part I, Item 1 “Business” and Part I, Item 1A “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended October 31, 2023. 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 after the date of this Quarterly Report on Form 10-Q.

Substantially all of our long-term debt requires fixed interest payments and we have limited exposure to variable rates. In connection with our mortgage operations, mortgage loans held for sale and the associated mortgage warehouse lines of credit under our Master Repurchase Agreements are subject to interest rate risk; however, such obligations reprice frequently and are short-term in duration. In addition, we are able to hedge the interest rate risk on mortgage loans by obtaining forward commitments from private investors. Accordingly, the interest rate risk from mortgage loans is not significant. We do not use financial instruments to hedge interest rate risk except with respect to mortgage loans. The following table sets forth as of July 31, 2024, our long-term debt obligations, principal cash flows by scheduled maturity, weighted-average interest rates and estimated fair value (“FV”).

(Dollars in thousands)

(1) Does not include:

• the mortgage warehouse lines of credit made under our Master Repurchase Agreements;
• $115.4 million of nonrecourse mortgages secured by inventory, which have various maturities spread over the next two to three years and are paid off as homes are delivered; and
• our $125.0 million Secured Credit Facility under which there were no borrowings outstanding as of July 31, 2024.

The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the Company’s reports under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to the Company’s management, including its chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosures. Any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. The Company’s management, with the participation of the Company’s chief executive officer and chief financial officer, has evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of July 31, 2024. Based upon that evaluation and subject to the foregoing, the Company’s chief executive officer and chief financial officer concluded that the design and operation of the Company’s disclosure controls and procedures are effective to accomplish their objectives.

There was no change in the Company’s internal control over financial reporting that occurred during the quarter ended July 31, 2024, that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.