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, 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 COVID-19 Impact and Strategy
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 and overall housing affordability. In general, at the start of our fiscal year, factors including rising levels of household formation, a constrained supply of new and used homes, wage growth, strong employment conditions and mortgage rates that continue to be low by historical standards were contributing to improving conditions for new home sales. However, this year, overall economic conditions inthe United States have been, and continue to be, impacted negatively by the COVID-19 pandemic, which has resulted in, among other things, quarantines, "stay-at-home" or "shelter-in-place" orders, and similar mandates from national, state and local governments that have substantially restricted daily activities and for many businesses to curtail or cease normal operations. Notwithstanding these developments, all of the state and local governments in the markets in which we operate have deemed housing to be an essential business, which has allowed us to continue with construction and sales of homes. Although most of the states in which we operate have begun to resume normal business operations,the United States continues to struggle with rolling outbreaks of the virus. Accordingly, due to uncertainty surrounding this ongoing public health crisis and its continued impact on theU.S. economy, we cannot predict the magnitude of either the near-term or long-term effects that the pandemic will have on our business. Earlier this year, in response to the pandemic, we actively took steps to navigate through this extraordinary period by placing our highest priority on helping to protect the health and safety of our associates, trade partners and customers. We implemented appropriate health and safety protocols so that our community construction and sales activities, wherever authorized, could continue operations, followed recommended social distancing and other health and safety protocols when meeting in person with a customer and transitioned our non-essential office employees to a work from home environment. We also temporarily closed our sales centers, model homes and design studios to the general public, and our sales teams shifted to an appointment-only home sales process, leveraging virtual sales tools to connect with our customers online. Subsequently, in some of our markets, we have re-opened sales offices where allowed by local governments, while continuing to follow the health and safety protocols discussed above. In the field, we continue to implement construction site health and safety guidelines to ensure both our employees and our trade partners adhere to social distancing requirements. During the second quarter of fiscal 2020, when we confronted the initial impact of COVID-19, we experienced adverse business conditions, including a slowdown in customer traffic and sales pace and an increase in cancellations. To mitigate the adverse impacts, the Company implemented initiatives to maximize positive cash flow, retain a strong liquidity position and optimize our organization, which included focusing on closing homes in backlog and limiting cash expenditures, reducing or delaying certain land purchases and land development activity and beginning work on unsold homes and electing to draw in full the$125.0 million available under its Secured Credit Agreement (which was repaid in the third quarter of fiscal 2020). Further, inMay 2020 , the Company announced certain operational optimization measures including streamlining the organizational structure by: (1) transitioning from three homebuilding operational Groups to two; (2) consolidating several business units, resulting in the reduction of three Divisional offices; and (3) gradually phasing out of theChicago market as it sells through its existing communities. In addition, the Company took measures to reduce overhead expenses through a combination of furloughs, layoffs and other cost reduction measures, the implementation of which will continue through fiscal 2020. We expect these steps to reduce our annualized overhead expense by approximately$20 million beginning in fiscal 2021. The Company incurred costs of$2.9 million for severance and other related expenses in the third quarter of fiscal 2020 as a result of this restructuring. 33
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While the broader economic recovery following the nationwide COVID-19 related shutdown is ongoing and there continues to be uncertainty surrounding the virus and various re-opening strategies, the homebuilding industry generally was only impacted from mid-March through April of 2020. Towards the end of April, economic conditions in our markets started to improve, and this improvement continued throughout our fiscal third quarter, due to what we believe is a combination of factors including low interest rates, low inventory levels of existing homes and a general desire for more indoor and outdoor space. During the third quarter of fiscal 2020, we returned to our normal activities with respect to land purchases, land development and resuming the construction of unsold homes. As a result, our operating metrics improved significantly, as described below. Although many of our key metrics have improved since the end of the second quarter of fiscal 2020, the full magnitude and duration of the COVID-19 pandemic is unknown. We may experience material declines in our net contracts, deliveries, revenues, cash flow and/or profitability during the remainder of fiscal 2020 and beyond, compared to the corresponding prior-year periods, and compared to our expectations at the beginning of our 2020 fiscal year. In addition, if conditions in the overall housing market or in a specific market worsen in the future beyond our current expectations, if future changes in our business strategy significantly affect any key assumptions used in our projections of future cash flows, or if there are material changes in any of the other items we consider in assessing recoverability, we may recognize charges in future periods for inventory impairments related to our current inventory assets or other reorganization activities. Any such charges could be material to our consolidated financial statements. Operating Results
We experienced overall positive operating results for the three and nine months
ended
? For the three and nine months ended
? Gross margin dollars increased 25.0% and 24.9% for the three and nine months endedJuly 31, 2020 , respectively, as compared to the same periods of the prior year, as a result of our increased revenues. We achieved these results despite gross margin percentage decreasing to 13.6% for the three months endedJuly 31, 2020 from 14.0% for the three months endedJuly 31, 2019 and decreasing to 13.7% for the nine months endedJuly 31, 2020 from 14.0% for the nine months endedJuly 31, 2019 . Gross margin percentage, before cost of sales interest expense and land charges, decreased from 18.4% for the three months endedJuly 31, 2019 to 17.5% for the three months endedJuly 31, 2019 , and remained flat at 17.7% for the nine months endedJuly 31, 2020 . The decreases were primarily due to increased incentives offered on started unsold homes during the second quarter of fiscal 2020 which were delivered in the third quarter of fiscal 2020, partially offset by increased volume during the periods. ? Selling, general and administrative costs (including corporate general and administrative expenses) as a percentage of total revenue decreased from 12.1% and 13.8% for the three and nine months endedJuly 31, 2019 , respectively, to 9.5% and 10.6% for the three and nine months endedJuly 31, 2020 , respectively. Such costs increased$1.4 million and decreased$3.0 million for the three and nine months endedJuly 31, 2020 , respectively, as compared to the same periods of the prior year.
? Net contracts increased 46.9% and 26.0% for the three and nine months ended
? Net contracts per average active selling community increased to 17.8 for the three months endedJuly 31, 2020 compared to 11.0 in the same period of the prior year, and increased to 38.1 for the nine months endedJuly 31, 2020 compared to 29.4 in the same period of the prior year. This strong absorption pace resulted in our active selling communities atJuly 31, 2020 decreasing by 15.2% over last year's third quarter.
? Contract backlog increased from 2,555 homes at
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Table of Contents CRITICAL ACCOUNTING POLICIES As disclosed in our annual report on Form 10-K for the fiscal year endedOctober 31, 2019 , our most critical accounting policies relate to income recognition from mortgage loans; inventories; unconsolidated joint ventures; and warranty and construction defect reserves. SinceOctober 31, 2019 , there have been no significant changes to those critical accounting policies.
CAPITAL RESOURCES AND LIQUIDITY
Our operations consist primarily of residential housing development and sales in the Northeast (New Jersey andPennsylvania ), the Mid-Atlantic (Delaware ,Maryland ,Virginia ,Washington D.C. andWest Virginia ), the Midwest (Illinois andOhio ), the Southeast (Florida ,Georgia andSouth Carolina ), the Southwest (Arizona andTexas ) and the West (California ). In addition, we provide certain financial services to our homebuilding customers. 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. Due to covenant restrictions in our debt instruments, we are currently limited in the amount of debt we can incur that does not qualify as refinancing indebtedness with certain maturity requirements (a limitation that we expect to continue for the foreseeable future), even if market conditions would otherwise be favorable, which could also impact our ability to grow our business.
Operating, Investing and Financing Activities - Overview
Our total liquidity atJuly 31, 2020 was$334.3 million , including$198.1 million in homebuilding cash and cash equivalents and$125.0 million of borrowing capacity under our senior secured revolving credit facility. This is above our target liquidity range of$170.0 to$245.0 million . The unprecedented public health and governmental efforts to contain the COVID-19 pandemic have created significant uncertainty as to general economic and housing market conditions for the remainder of 2020 and beyond. We believe that these sources of cash together with available borrowings on our senior secured revolving credit facility will be sufficient through fiscal 2020 to finance our working capital requirements. We spent$394.9 million on land and land development during the first three quarters of fiscal 2020. After considering this land and land development and all other operating activities, including revenue received from deliveries, we had$192.8 million in cash provided from operations. During the first three quarters of fiscal 2020, cash used in investing activities was$18.3 million , primarily due to an investment in a new unconsolidated joint venture, partially offset by distributions from existing unconsolidated joint ventures. Cash used in financing activities was$110.5 million during the first three quarters of fiscal 2020, which was primarily due to net payments of$55.0 million made on our mortgage warehouse lines of credit, along with net payments for nonrecourse mortgage financings and also debt repurchases during the period. We intend to continue to use nonrecourse mortgage financings, model sale leaseback, 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 endedJuly 31, 2020 and 2019 were for operating expenses, land purchases, land deposits, land development, construction spending, state income taxes, interest payments, financing transaction costs, debt repurchases, litigation matters and investments in unconsolidated joint ventures. During these periods, we provided for our cash requirements from available cash on hand, housing and land sales, financing transactions, model sale leasebacks, land banking transactions, unconsolidated joint ventures, financial service revenues and other revenues. Our net income (loss) historically does not approximate cash flow from operating activities. The difference between net income (loss) and cash flow from operating activities is primarily caused by changes in inventory levels together with changes in receivables, prepaid and other assets, mortgage loans held for sale, interest and other accrued liabilities, deferred income taxes, accounts payable and other liabilities, and noncash charges relating to depreciation, stock compensation awards and impairment losses for inventory. When we are expanding our operations, inventory levels, prepaids 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 levels, prepaids 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. 35
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Table of Contents Debt Transactions Senior notes and credit facilities balances as ofJuly 31, 2020 andOctober 31, 2019 , were as follows: July 31, October 31, (In thousands) 2020 2019 Senior Secured Notes: 10.0% Senior Secured Notes due July 15, 2022$ 111,214 $ 218,994 10.5% Senior Secured Notes due July 15, 2024 69,683
211,391
10.0% Senior Secured 1.75 Lien Notes due
158,502
-
7.75% Senior Secured 1.125 Lien Notes due
350,000
350,000
10.5% Senior Secured 1.25 Lien Notes due
282,322
282,322
11.25% Senior Secured 1.5 Lien Notes due February 15, 2026 162,269 103,141 Total Senior Secured Notes$ 1,133,990 $ 1,165,848 Senior Notes: 8.0% Senior Notes due November 1, 2027 (1) $ - $ - 13.5% Senior Notes due February 1, 2026 90,590
90,590
5.0% Senior Notes dueFebruary 1, 2040 90,120
90,120
Total Senior Notes$ 180,710
$ 39,551
$ 81,498 $ - Senior Secured Revolving Credit Facility (2) - $ - Net discounts and premiums$ 19,476 $ (49,145 ) Net debt issuance costs$ (23,150 ) $ (19,970 ) Total Senior Notes and Credit Facilities, net of discount, premium and debt issuance costs$ 1,432,075 $ 1,479,990 (1)$26.0 million of 8.0% Senior Notes are owned by a wholly-owned consolidated subsidiary of HEI. Therefore, in accordance with GAAP, such notes are not reflected on the Condensed Consolidated Balance Sheets of HEI. OnNovember 1, 2019 , the maturity of the 8.0% Senior Notes was extended toNovember 1, 2027 .
(2) At
Except forK. Hovnanian , the issuer of the notes and borrower under the Credit Facilities (as defined below), 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 (except that certain of the Notes Guarantors do not guarantee the 10.5% Senior Secured Notes due 2024 as discussed in Note 12 to the Condensed Consolidated Financial Statements included elsewhere in this Quarterly Report on Form 10-Q) and senior notes outstanding atJuly 31, 2020 (collectively, the "Notes Guarantors"). The credit agreements governing the Credit Facilities and the indentures governing the senior secured and senior notes (together, the "Debt Instruments") outstanding atJuly 31, 2020 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, includingK. Hovnanian , to incur additional indebtedness (other than non-recourse indebtedness, certain permitted indebtedness and refinancing indebtedness), pay dividends and make distributions on common and preferred stock, repay 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 made under the Unsecured Term Loan Facility (defined below) (the "Unsecured Term Loans"), loans made under the Secured Term Loan Facility (defined below) (the "Secured Term Loans") and loans made under the Secured Credit Agreement (as defined below) (the "Secured Revolving Loans") 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 ofJuly 31, 2020 , we believe we were in compliance with the covenants of the Debt Instruments. 36
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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, including dividends, and from incurring indebtedness other than certain permitted indebtedness, refinancing indebtedness and nonrecourse indebtedness. As a result of this ratio restriction, we are currently restricted from paying dividends (in the case of the payment of dividends on preferred stock, our secured debt leverage ratio must also be less than 4.0 to 1.0), which are not cumulative, on our 7.625% Series A Preferred Stock. We anticipate that we will continue to be restricted from paying dividends for the foreseeable future. Our inability to pay dividends is in accordance with covenant restrictions and will not result in a default under our Debt Instruments or otherwise affect compliance with any of the covenants contained in our Debt Instruments. Under the terms of our Debt Instruments, we have the right to make certain redemptions and prepayments and, depending on market conditions 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 and/or extend maturities, and will seek to do so with the right opportunity. We may also continue to make debt purchases and/or exchanges for debt or equity from time to time through tender offers, exchange offers, 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 that does not qualify as refinancing indebtedness with certain maturity requirements as discussed above (a limitation that we expect to continue for the foreseeable future), even if market conditions would otherwise be favorable, which could also impact our ability to grow our business. We have certain stand-alone cash collateralized letter of credit agreements and facilities under which there was a total of$11.0 million and$19.2 million letters of credit outstanding atJuly 31, 2020 andOctober 31, 2019 , respectively. These agreements and facilities require us to maintain specified amounts of cash as collateral in segregated accounts to support the letters of credit issued thereunder, which will affect the amount of cash we have available for other uses. AtJuly 31, 2020 andOctober 31, 2019 , the amount of cash collateral in these segregated accounts was$11.2 million and$19.9 million , respectively, which is reflected in "Restricted cash and cash equivalents" on the Condensed Consolidated Balance Sheets.
See Note 12 to the Condensed Consolidated Financial Statements included
elsewhere in this Quarterly Report on Form 10-Q for a discussion of the
Unsecured Term Loans, the Secured Term Loans and Secured Revolving Loans and
Mortgages and Notes Payable We have nonrecourse mortgage loans for certain communities totaling$179.8 million and$203.6 million (net of debt issuance costs) atJuly 31, 2020 andOctober 31, 2019 , respectively, which are secured by the related real property, including any improvements, with an aggregate book value of$396.3 million and$410.2 million , respectively. The weighted-average interest rate on these obligations was 7.0% and 8.3% atJuly 31, 2020 andOctober 31, 2019 , 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. In certain instances, we retain the servicing rights for a small amount of loans.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 ofJuly 31, 2020 andOctober 31, 2019 , we had an aggregate of$85.2 million and$140.2 million , respectively, outstanding under several ofK. Hovnanian Mortgage's short-term borrowing facilities.
See Note 11 to the Condensed Consolidated Financial Statements for a discussion of these agreements.
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Table of Contents Inventory Activities Total inventory, excluding consolidated inventory not owned, decreased$83.5 million during the nine months endedJuly 31, 2020 fromOctober 31, 2019 . Total inventory, excluding consolidated inventory not owned, decreased in the Northeast by$23.9 million , in the Mid-Atlantic by$11.2 million , in the Midwest by$0.5 million , in the Southeast by$18.4 million , in the Southwest by$7.4 million and in the West by$22.1 million . The net decrease was primarily attributable to home deliveries during the period, partially offset by new land purchases and land development. During the nine months endedJuly 31, 2020 , we wrote-off costs in the amount of$6.2 million related to land options that expired or that we terminated, as the communities' forecasted profitability was not projected to produce adequate returns on investment commensurate with the risk. 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 atJuly 31, 2020 are expected to be delivered during the next six to nine months. Consolidated inventory not owned increased$4.5 million . Consolidated inventory not owned consists of options related to land banking and model financing transactions that were added to our Condensed Consolidated Balance Sheet in accordance with US GAAP. The increase fromOctober 31, 2019 toJuly 31, 2020 was primarily due to an increase in land banking transactions, along with a slight increase in the sale and leaseback of certain model homes during the period. We have land banking arrangements, whereby we sell land parcels to the land bankers and they provide us an option to purchase back finished lots on a predetermined schedule. Because of our options to repurchase these parcels, for accounting purposes in accordance with ASC 606-10-55-70, these transactions are considered a financing rather than a sale. For purposes of our Condensed Consolidated Balance Sheet, atJuly 31, 2020 , inventory of$139.9 million was recorded to "Consolidated inventory not owned," with a corresponding amount of$91.9 million (net of debt issuance costs) recorded to "Liabilities from inventory not owned" for the amount of net cash received from the transactions. In addition, we 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. As a result of our continued involvement, for accounting purposes in accordance with ASC 606-10-55-68, these sale and leaseback transactions are considered a financing rather than a sale. Therefore, for purposes of our Condensed Consolidated Balance Sheet, atJuly 31, 2020 , inventory of$54.9 million was recorded to "Consolidated inventory not owned," with a corresponding amount of$53.0 million (net of debt issuance costs) recorded to "Liabilities from inventory not owned" for the amount of net cash received from the transactions. When possible, we option property for development prior to acquisition. By optioning property, we are only subject to the loss of the cost of the option and predevelopment costs if we choose not to exercise the option. As a result, our commitment for major land acquisitions is reduced. The costs associated with optioned properties are included in "Land and land options held for future development or sale" on the Condensed Consolidated Balance Sheets. Also included in "Land and land options held for future development or sale" are amounts associated with inventory in mothballed communities. We mothball (or stop development on) certain communities when we determine the current performance does not justify further investment at the time. That is, we believe we will generate higher returns if we decide against spending money to improve land today and save the raw land until such time as the markets improve or we determine to sell the property. As ofJuly 31, 2020 , we had mothballed land in 12 communities. The book value associated with these communities atJuly 31, 2020 was$13.1 million , which was net of impairment charges recorded in prior periods of$120.4 million . We continually review communities to determine if mothballing is appropriate. During the first three quarters of fiscal 2020, we did not mothball any additional communities, or sell any previously mothballed communities, but we re-activated one previously mothballed community and also re-activated a portion of one previously mothballed community. Inventories held for sale, which are land parcels where we have decided not to build homes and are actively marketing the land for sale, are reported at the lower of carrying amount or fair value less costs to sell. At bothJuly 31, 2020 andOctober 31, 2019 , there were no inventories held for sale. In determining fair value for land held for sale, management considers, among other things, prices for land in recent comparable sale transactions, market analysis studies, which include the estimated price a willing buyer would pay for the land (other than in a forced liquidation sale) and recent bona fide offers received from outside third parties. 38
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The following tables summarize home sites included in our total residential real estate. The decrease in total home sites available atJuly 31, 2020 compared toOctober 31, 2019 is attributable to delivering homes and terminating certain option agreements, as well as contributing eight previously owned communities, including four active communities, to a new unconsolidated joint venture in the first quarter of fiscal 2020, partially offset by signing new land option agreements and acquiring new land parcels. Active Proposed Active Communities Developable Total Communities(1) Homes Homes HomesJuly 31, 2020 : Northeast 3 442 2,862 3,304 Mid-Atlantic 14 2,038 3,347 5,385 Midwest 10 1,360 794 2,154 Southeast 10 1,773 1,197 2,970 Southwest 54 4,309 3,320 7,629 West 26 2,185 2,400 4,585 Consolidated total 117 12,107 13,920 26,027 Unconsolidated joint ventures (2) 20 4,888 - 4,888 Owned 6,368 3,762 10,130 Optioned 5,460 10,158 15,618 Controlled lots 11,828 13,920 25,748 Construction to permanent financing lots 279 - 279 Consolidated total 12,107 13,920 26,027
(1) Active 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 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. 39
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Table of Contents Active Proposed Active Communities Developable Total Communities(1) Homes Homes HomesOctober 31, 2019 : Northeast 6 499 2,798 3,297 Mid-Atlantic 25 2,281 3,016 5,297 Midwest 16 1,758 2,140 3,898 Southeast 17 2,628 2,065 4,693 Southwest 58 4,487 2,701 7,188 West 19 2,465 2,795 5,260 Consolidated total 141 14,118 15,515 29,633 Unconsolidated joint ventures (2) 22 4,226 - 4,226 Owned 7,522 3,852 11,374 Optioned 6,341 11,663 18,004 Controlled lots 13,863 15,515 29,378 Construction to permanent financing lots 255 - 255 Consolidated total 14,118 15,515 29,633
(1) Active 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 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. 40
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The following table summarizes our started or completed unsold homes and models, excluding unconsolidated joint ventures, in active and substantially completed communities. The decrease in unsold homes fromOctober 31, 2019 toJuly 31, 2020 was primarily due to our decision to delay starting unsold homes given the uncertainty caused by the COVID-19 pandemic during the second quarter of fiscal 2020, along with the increased sales pace during the third quarter of fiscal 2020. July 31, 2020 October 31, 2019 Unsold Unsold Homes Models Total Homes Models Total Northeast 5 7 12 58 12 70 Mid-Atlantic 24 9 33 63 12 75 Midwest 15 9 24 31 10 41 Southeast 40 17 57 78 15 93 Southwest 160 17 177 320 12 332 West 44 18 62 213 19 232 Total 288 77 365 763 80 843 Started or completed unsold homes and models per active selling communities (1) 2.5 0.6 3.1 5.4 0.6 6.0
(1) Active selling communities (which are communities that are open for sale with
ten or more home sites available) were 117 and 141 at
completed communities, which are communities with less than ten home sites
available.
Other Balance Sheet Activities
Homebuilding Restricted cash and cash equivalents decreased$7.5 million fromOctober 31, 2019 to$13.4 million atJuly 31, 2020 . The decrease was due to a reduction in cash collateralization of our stand-alone letters of credit during the period. Investments in and advances to unconsolidated joint ventures decreased$1.4 million to$125.7 million atJuly 31, 2020 compared toOctober 31, 2019 . The decrease was primarily due to unconsolidated joint venture partner distributions during the period, partially offset by a new unconsolidated joint venture entered into in the first quarter of fiscal 2020. As ofJuly 31, 2020 andOctober 31, 2019 , we had investments in 11 and ten unconsolidated homebuilding joint ventures, respectively, and one unconsolidated land development joint venture for both periods. We have no guarantees associated with our unconsolidated joint ventures, other than guarantees limited only to performance and completion of development, environmental indemnification and standard warranty and representation against fraud, misrepresentation and similar actions, including a voluntary bankruptcy. Receivables, deposits and notes, net decreased$7.6 million fromOctober 31, 2019 to$37.3 million atJuly 31, 2020 . The decrease was primarily due to the timing of home closings, along with the receipt of a receivable during the period related to the funding of the satisfaction and discharge of certain of our senior secured notes in the fourth quarter of fiscal 2019.
Prepaid expenses and other assets were as follows as of:
July 31, October 31, Dollar (In thousands) 2020 2019 Change Prepaid insurance$ 3,043 $ 2,061 $ 982 Prepaid project costs 30,592 32,015 (1,423 ) Other prepaids 8,298 10,808 (2,510 ) Other assets 366 820 (454 ) Lease right of use asset 21,200 - 21,200 Total$ 63,499 $ 45,704 $ 17,795 41
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Prepaid insurance increased during the three months endedJuly 31, 2020 due to the timing of premium payments. These costs are amortized over the life of the associated insurance policy, which can be one to three years. Prepaid project costs consist of community specific expenditures that are used over the life of the community. Such prepaid costs are expensed as homes are delivered. Other prepaids decreased primarily due to the amortization of deferred financing costs and costs for certain software and related services during the period. Lease right of use asset represents the net present value of our operating leases which, in connection with the Company's adoption of ASU 2016-02 onNovember 1, 2019 , are now required to be recorded as an asset on our Condensed Consolidated Balance Sheets. See Note 9 to the Condensed Consolidated Financial Statements for further information. Financial services assets consist primarily of residential mortgages receivable held for sale of which$96.0 million and$163.0 million atJuly 31, 2020 andOctober 31, 2019 , respectively, were being temporarily warehoused and are awaiting sale in the secondary mortgage market. The decrease in mortgage loans held for sale fromOctober 31, 2019 was related to a decrease in the volume of loans originated during the third quarter of 2020 compared to the fourth quarter of 2019, primarily due to the decrease in deliveries, partially offset by an increase in the average loan value. Nonrecourse mortgages secured by inventory decreased to$179.8 million atJuly 31, 2020 from$203.6 million atOctober 31, 2019 . The decrease was primarily due to the payment of existing mortgages, partially offset by additional loan borrowings on existing mortgages, along with new mortgages for communities in most of our segments obtained during the nine months endedJuly 31, 2020 .
Accounts payable and other liabilities are as follows as of:
July 31, October 31, Dollar (In thousands) 2020 2019 Change Accounts payable$ 131,654 $ 141,667 $ (10,013 ) Reserves 94,260 92,083 2,177 Lease liability 22,188 - 22,188 Accrued expenses 9,403 19,208 (9,805 ) Accrued compensation 45,630 53,157 (7,527 ) Other liabilities 17,285 14,078 3,207 Total$ 320,420 $ 320,193 $ 227 The decrease in accounts payable was primarily due to the lower volume of deliveries in the third quarter of fiscal 2020 compared to the fourth quarter of fiscal 2019. Reserves increased due to new accruals, partially offset by claim payments during the period. Lease liability represents the net present value of our minimum lease obligations, which as discussed above, are required to be recorded on our Condensed Consolidated Balance Sheets as a result of the Company's adoption of ASU 2016-02 onNovember 1, 2019 . Accrued expenses decreased primarily due to the timing of property tax payments, along with the timing of certain accruals for legal fees associated with debt financing transactions during fiscal 2019. The decrease in accrued compensation was primarily due to the payment of our fiscal year 2019 bonuses during the first quarter of fiscal 2020, partially offset by the accrual of fiscal 2020 bonuses during the nine months endedJuly 31, 2020 . Other liabilities increased primarily due to deferred payroll tax withholdings, partially offset by the transfer of a municipal loan from a previously consolidated community to a new unconsolidated joint venture formed in the first quarter of fiscal 2020
Customers deposits increased
Financial Services (liabilities) decreased$54.9 million from$169.1 million atOctober 31, 2019 , to$114.2 million atJuly 31, 2020 . The decrease was primarily due to a decrease in amounts outstanding under our mortgage warehouse lines of credit, and directly correlated to the decrease in the volume of mortgage loans held for sale during the period. Accrued interest increased$31.2 million to$50.3 million atJuly 31, 2020 . The increase was primarily due to the timing of new accruals partially offset by payments during the period, along with slightly higher interest rates on our new senior secured notes resulting from our financing transactions in fiscal 2020. 42
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RESULTS OF OPERATIONS FOR THE three and nine months ended
Total Revenues
Compared to the same prior period, revenues increased as follows:
Three Months Ended July 31, July 31, Dollar Percentage (Dollars in thousands) 2020 2019 Change Change Homebuilding: Sale of homes$ 605,933 $ 467,849 $ 138,084 29.5 % Land sales and other revenues 908 1,428 (520 ) (36.4 )% Financial services 21,295 12,764 8,531 66.8 % Total revenues$ 628,136 $ 482,041 $ 146,095 30.3 % Nine Months Ended July 31, July 31, Dollar Percentage (Dollars in thousands) 2020 2019 Change Change Homebuilding: Sale of homes$ 1,608,513 $ 1,257,536 $ 350,977 27.9 % Land sales and other revenues 2,360 11,111 (8,751 ) (78.8 )% Financial services 49,670 34,679 14,991 43.2 % Total revenues$ 1,660,543 $ 1,303,326 $ 357,217 27.4 % Homebuilding For the three and nine months endedJuly 31, 2020 , sale of homes revenues increased$138.1 million , or 29.5% and$351.0 million , or 27.9%, respectively, as compared to the same periods of the prior year. These increases were primarily due to the number of home deliveries increasing 31.1% and 27.1% for the three and nine months endedJuly 31, 2020 , respectively, compared to the three and nine months endedJuly 31, 2019 . The average price per home decreased to$390,169 in the three months endedJuly 31, 2020 from$394,809 in the three months endedJuly 31, 2019 . The average price per home increased to$390,985 in the nine months endedJuly 31, 2020 from$388,488 in the nine months endedJuly 31, 2019 . The minor fluctuations in the average price for the three and nine months endedJuly 31, 2020 were a result of the geographic and community mix of our deliveries. Land sales are ancillary to our homebuilding operations and are expected to continue in the future but may significantly fluctuate up or down. For further details on the decrease in land sales and other revenues, see the section titled "Land Sales and Other Revenues" below. 43
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Information on homes delivered by segment is set forth below:
Three Months Ended July 31, Nine Months Ended July 31, (Dollars in thousands) 2020 2019 % Change 2020 2019 % Change Northeast: Dollars$ 41,354 $ 20,694 99.8 %$ 133,409 $ 46,239 188.5 % Homes 95 35 171.4 % 270 80 237.5 % Mid-Atlantic: Dollars$ 111,160 $ 86,811 28.0 %$ 288,426 $ 220,808 30.6 % Homes 213 159 34.0 % 536 412 30.1 % Midwest: Dollars$ 62,901 $ 47,261 33.1 %$ 165,836 $ 135,020 22.8 % Homes 197 158 24.7 % 540 448 20.5 % Southeast: Dollars$ 65,595 $ 50,217 30.6 %$ 158,592 $ 143,446 10.6 % Homes 155 121 28.1 % 379 352 7.7 % Southwest: Dollars$ 214,608 $ 152,615 40.6 %$ 548,796 $ 414,112 32.5 % Homes 641 449 42.8 % 1,649 1,245 32.4 % West: Dollars$ 110,315 $ 110,251 0.1 %$ 313,454 $ 297,911 5.2 % Homes 252 263 (4.2 )% 740 700 5.7 % Consolidated total: Dollars$ 605,933 $ 467,849 29.5 %$ 1,608,513 $ 1,257,536 27.9 % Homes 1,553 1,185 31.1 % 4,114 3,237 27.1 % Unconsolidated joint ventures(1) Dollars $ 132,014 $ 120,423 9.6 %$ 330,559 $ 340,226 (2.8 )% Homes 228 195 16.9 % 565 542 4.2 %
(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 for a further discussion of our unconsolidated joint ventures.
As discussed above, the overall increase in consolidated housing revenues during the three and nine months endedJuly 31, 2020 as compared to the same periods of the prior year was attributed to an increase in deliveries. 44
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An important indicator of our future results are recently signed contracts and our home contract backlog for future deliveries. Our sales contracts and homes in contract backlog by segment are set forth below: Net Contracts (1) for the Net Contracts (1) for the Three Months Ended Nine Months Ended Contract Backlog as of July 31, July 31, July 31, (Dollars in thousands) 2020 2019 2020
2019 2020 2019 Northeast: Dollars$ 51,586 $ 37,560 $ 107,855 $ 135,090 $ 61,002 $ 119,347 Homes 102 65 231 221 113 192 Mid-Atlantic: Dollars$ 152,511 $ 99,807 $ 374,865 $ 299,566 $ 269,972 $ 242,958 Homes 307 197 737 547 523 402 Midwest: Dollars$ 79,394 $ 58,794 $ 192,171 $ 164,584 $ 149,016 $ 136,713 Homes 263 197 624 559 534 505 Southeast: Dollars$ 79,846 $ 58,648 $ 195,512 $ 163,880 $ 145,947 $ 128,571 Homes 172 147 436 397 304 296 Southwest: Dollars$ 260,891 $ 202,553 $ 626,817 $ 510,521 $ 308,918 $ 277,263 Homes 814 589 1,924 1,510 938 788 West: Dollars$ 258,067 $ 131,483 $ 488,317 $ 309,117 $ 299,564 $ 149,654 Homes 568 320 1,083 761 644 372 Consolidated total: Dollars$ 882,295 $ 588,845 $ 1,985,537 $ 1,582,758 $ 1,234,419 $ 1,054,506 Homes 2,226 1,515 5,035 3,995 3,056 2,555 Unconsolidated joint ventures:(2) Dollars $ 135,869 $ 122,925 $ 384,910 $ 339,776 $ 271,222 $ 247,578 Homes 374 272 1,078 635 1,030 488
(1) Net contracts are defined as new contracts executed during the period for the purchase of homes, less cancellations of contracts in the same period.
(2) Represents net contract dollars, net contract homes and contract backlog dollars and homes 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. In the first three quarters of fiscal 2020, our open for sale community count decreased to 117 from 141 atOctober 31, 2019 , which was the net result of opening 39 new communities, closing 59 communities and contributing four communities to an unconsolidated joint venture since the beginning of fiscal 2020. Our reported level of sales contracts (net of cancellations) was positively impacted by an increase in sales pace per community in the first three quarters of fiscal 2020, as compared to the same period of the prior year. Despite the impact of the COVID-19 pandemic, net contracts per average active selling community for the three months endedJuly 31, 2020 increased to 17.8 compared to 11.0 for the same period in the prior year. Net contracts per average active selling community for the nine months endedJuly 31, 2020 increased to 38.1 compared to 29.4 for the same period in the prior year. The increase in net contracts per average active selling community in fiscal 2020 was the primary reason for the decrease in open for sale community count. 45
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Cancellation rates represent the number of cancelled contracts in the quarter divided by the number of gross sales contracts executed in the quarter. For comparison, the following are historical cancellation rates, excluding unconsolidated joint ventures:
Quarter 2020 2019 2018 2017 2016 First 19 % 24 % 18 % 19 % 20 % Second 23 % 19 % 17 % 18 % 19 % Third 18 % 19 % 19 % 19 % 21 % Fourth 21 % 23 % 22 % 20 %
Another common and meaningful way to analyze our cancellation trends is to compare the number of contract cancellations as a percentage of the beginning backlog. The following table provides this historical comparison, excluding unconsolidated joint ventures:
Quarter 2020 2019 2018 2017 2016 First 14 % 16 % 12 % 12 % 13 % Second 20 % 20 % 15 % 16 % 14 % Third 21 % 16 % 14 % 13 % 12 % Fourth 14 % 13 % 12 % 11 % 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. As shown in the tables above, contract cancellations over the past several years have been within what we believe to be a normal range, although in the second quarter of fiscal 2020, contract cancellations as a percentage of gross sales contracts increased, as the number of contract cancellations increased and gross sales contracts decreased due to the COVID-19 pandemic. However, in the third quarter of fiscal 2020, contract cancellations as a percentage of gross sales contracts decreased as gross sales rebounded and were very strong during the period. In the third quarter of fiscal 2020, contract cancellations as a percentage of beginning backlog increased further, primarily due to a lower beginning backlog as a result of lower gross sales contracts in the second quarter of fiscal 2020. Market conditions and further impacts from COVID-19 remain uncertain, and it is difficult to predict what cancellation rates will be in the future. Total cost of sales on our Condensed Consolidated Statements of Operations includes expenses for consolidated housing and land and lot sales, including inventory impairment loss and land option write-offs (defined as "land charges" in the tables below). A breakout of such expenses for housing sales and homebuilding gross margin 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 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 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 level of impairments and levels of debt. 46
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Table of Contents Three Months Ended Nine Months Ended July 31, July 31, (Dollars in thousands) 2020 2019 2020 2019 Sale of homes$ 605,933 $ 467,849 $ 1,608,513 $ 1,257,536 Cost of sales, excluding interest expense and land charges 499,654 381,906
1,323,916 1,034,953
Homebuilding gross margin, before cost of sales interest expense and land charges 106,279 85,943
284,597 222,583
Cost of sales interest expense, excluding land sales interest expense 21,794 18,824 58,467 42,964
Homebuilding gross margin, after cost of sales interest expense, before land charges 84,485 67,119 226,130 179,619 Land charges 2,364 1,435 6,202 3,601 Homebuilding gross margin$ 82,121 $ 65,684 $ 219,928 $ 176,018 Gross margin percentage 13.6 % 14.0 % 13.7 % 14.0 % Gross margin percentage, before cost of sales interest expense and land charges 17.5 % 18.4 %
17.7 % 17.7 %
Gross margin percentage, after cost of sales interest expense, before land charges 13.9 % 14.3 % 14.1 % 14.3 % Cost of sales expenses as a percentage of consolidated home sales revenues are presented below: Three Months Ended Nine Months Ended July 31, July 31, 2020 2019 2020 2019 Sale of homes 100.0 % 100.0 % 100.0 % 100.0 % Cost of sales, excluding interest expense and land charges: Housing, land and development costs 72.8 % 72.2 % 72.6 % 72.3 % Commissions 3.9 % 3.8 % 3.7 % 3.6 % Financing concessions 1.5 % 1.3 % 1.4 % 1.3 % Overheads 4.3 % 4.3 % 4.6 % 5.1 % Total cost of sales, before interest expense and land charges 82.5 % 81.6 % 82.3 % 82.3 % Cost of sales interest 3.6 % 4.1 % 3.6 % 3.4 % Land charges 0.3 % 0.3 % 0.4 % 0.3 % Gross margin percentage 13.6 % 14.0 % 13.7 % 14.0 % Gross margin percentage, before cost of sales interest expense and land charges 17.5 % 18.4 % 17.7 % 17.7 % Gross margin percentage, after cost of sales interest expense and before land charges 13.9 % 14.3 % 14.1 % 14.3 % 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 13.6% during the three months endedJuly 31, 2020 compared to 14.0% for the same period last year and decreased to 13.7% during the nine months endedJuly 31, 2020 compared to 14.0% for the same period last year. This decrease for the three and nine months endedJuly 31, 2020 was primarily attributed to an increase in total cost of sales interest expense and was also the result of the mix of communities delivering in each period. Also, contributing to the decrease for the three months endedJuly 31, 2020 was the impact of additional incentives on spec homes which were delivered during the fiscal third quarter. The decrease for the nine months endedJuly 31, 2020 was also attributed to the impact of additional incentives on spec homes delivered in the first quarter of fiscal 2020. Gross margin percentage, before cost of sales interest expense and land charges, decreased from 18.4% for the three months endedJuly 31, 2019 to 17.5% for the three months endedJuly 31, 2020 , and remained at 17.7% for both the nine months endedJuly 31, 2019 and the nine months endedJuly 31, 2020 . This decrease for the three months endedJuly 31, 2020 was primarily attributed to the mix of communities delivering in each period, as well as the impact of additional incentives on spec homes which were delivered during the fiscal third quarter.
Due to significantly increased demand in June and July of 2020, we began increasing home prices. We believe that these price increases should offset potential material and labor cost increases related to increased demand and could also result in improved gross margin as a percentage of revenues in future quarters.
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Reflected as inventory impairment loss and land option write-offs in cost of sales, we wrote-off or wrote-down certain inventories totaling$2.4 million and$1.4 million during the three months endedJuly 31, 2020 and 2019, respectively, and$6.2 million and$3.6 million during the nine months endedJuly 31, 2020 and 2019, respectively, to their estimated fair value. During the three and nine months endedJuly 31, 2020 , we wrote-off residential land options and approval and engineering costs amounting to$2.4 million and$6.2 million , respectively, compared to$1.3 and$2.5 million , respectively, for the three and nine months endedJuly 31, 2019 , which are included in the total land charges discussed above. Option, approval and engineering costs are written-off when a community's pro forma profitability is not projected to produce adequate returns on the investment commensurate with the risk and when we believe it is probable, we will cancel the option, or when a community is redesigned, engineering costs related to the initial design are written-off. Such write-offs were located in all of our segments in the first three quarters of fiscal 2020 and 2019. We did not record any inventory impairments during the three and nine months endedJuly 31, 2020 . We recorded inventory impairments of$0.1 and$1.1 million for the three and nine months endedJuly 31, 2019 , respectively, which were primarily related to three communities in the Mid-Atlantic, Southeast and Southwest. It is difficult to predict impairment levels, and should it become necessary or desirable to have additional land sales, further lower prices, or should the estimates or expectations used in determining estimated cash flows or fair value decrease or differ from current estimates in the future, we may need to recognize additional impairments.
Land Sales and Other Revenues
Land sales and other revenues consist primarily of land and lot sales. A breakout of land and lot sales is set forth below:
Three Months Ended Nine Months Ended July 31, July 31, (In thousands) 2020 2019 2020 2019 Land and lot sales$ 25 $ 542 $ 100 $ 8,050 Cost of sales, excluding interest 41 33 161 7,390 Land and lot sales gross margin, excluding interest (16 ) 509 (61 ) 660 Land and lot sales interest expense 20 205 72 205 Land and lot sales gross margin, including interest$ (36 ) $ 304 $ (133 ) $ 455 Land sales are ancillary to our residential homebuilding operations and are expected to continue in the future but may significantly fluctuate up or down. Although we budget land sales, they are often dependent upon receiving approvals and entitlements, the timing of which can be uncertain. As a result, projecting the amount and timing of land sales is difficult. Revenue associated with land sales can vary significantly due to the mix of land parcels sold. There was one land sale in both the three months endedJuly 31, 2020 and 2019. There were four land sales in the nine months endedJuly 31, 2020 compared to five land sales in the same period of the prior year, resulting in a decrease of$8.0 million in land sales revenues. Land sales and other revenues decreased$0.5 million and$8.8 million for the three and nine months endedJuly 31, 2020 , respectively, as compared to the same periods in the prior year. Other revenues include income from contract cancellations where the deposit has been forfeited due to contract terminations, interest income, cash discounts and miscellaneous one-time receipts. The slight decrease for the three months endedJuly 31, 2020 and the decrease for the nine months endedJuly 31, 2020 compared to the same periods of the prior year was mainly due to the decrease in land sales discussed above.
Homebuilding Selling, General and Administrative
Homebuilding selling, general and administrative ("SGA") expenses decreased$3.0 million and$8.6 million for the three and nine months endedJuly 31, 2020 , respectively, compared to the same periods last year. The decrease for the three and nine months endedJuly 31, 2020 was primarily attributed to lower selling overhead and advertising costs, as a result of the reduction of our community count and a reduced need for advertising as home sales have improved. SGA expenses as a percentage of homebuilding revenues decreased to 6.7% and 7.6% for the three and nine months endedJuly 31, 2020 , respectively, compared to 9.3% and 10.3% for the three and nine months endedJuly 31, 2019 , respectively, as a result of the reduction in dollars spent and the 29.3% and 27.0% increase in homebuilding revenue for the same periods, respectively. 48
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HOMEBUILDING OPERATIONS BY SEGMENT
Segment Analysis Three Months Ended July 31, (Dollars in thousands, except average sales price) 2020 2019 Variance Variance % Northeast Homebuilding revenue$ 41,370 $ 20,696 $ 20,674 99.9 % Income before income taxes$ 5,240 $ 283 $ 4,957 1,751.6 % Homes delivered 95 35 60 171.4 % Average sales price$ 435,305 $ 591,257 $
(155,952 ) (26.4 )%
Mid-
Homebuilding revenue$ 111,402 $ 86,948 $ 24,454 28.1 % Income before income taxes$ 11,024 $ 5,111 $ 5,913 115.7 % Homes delivered 213 159 54 34.0 % Average sales price$ 521,878 $ 545,981 $ (24,103 ) (4.4 )%
Midwest
Homebuilding revenue$ 63,003 $ 47,858 $ 15,145 31.6 % Income before income taxes$ 765 $ 191 $ 574 300.5 % Homes delivered 197 158 39 24.7 % Average sales price$ 319,294 $ 299,120 $ 20,174 6.7 %
Southeast
Homebuilding revenue$ 65,790 $ 50,233 $ 15,557 31.0 % Loss before income taxes$ (253 ) $ (2,198 ) $ 1,945 88.5 % Homes delivered 155 121 34 28.1 % Average sales price$ 423,194 $ 415,017 $ 8,177 2.0 %
Southwest
Homebuilding revenue$ 214,918 $ 152,831 $ 62,087 40.6 % Income before income taxes$ 20,072 $ 8,598 $ 11,474 133.4 % Homes delivered 641 449 192 42.8 % Average sales price$ 334,802 $ 339,900 $ (5,098 ) (1.5 )%
West
Homebuilding revenue$ 110,323 $ 110,274 $ 49 0.0 % Income before income taxes$ 226 $ 6,584 $ (6,358 ) (96.6 )% Homes delivered 252 263 (11 ) (4.2 )% Average sales price$ 437,758 $ 419,205 $ 18,553 4.4 % 49
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Table of Contents Nine Months Ended July 31, (Dollars in thousands, except average sales price) 2020 2019 Variance Variance % Northeast Homebuilding revenue$ 133,444 $ 53,696 $ 79,748 148.5 % Income before income taxes$ 17,703 $ 6,287 $ 11,416 181.6 % Homes delivered 270 80 190 237.5 % Average sales price$ 494,107 $ 577,988 $ (83,881 ) (14.5 )% Mid-Atlantic Homebuilding revenue$ 288,899 $ 221,225 $ 67,674 30.6 % Income before income taxes$ 20,548 $ 5,497 $ 15,051 273.8 % Homes delivered 536 412 124 30.1 % Average sales price$ 538,108 $ 535,942 $ 2,166 0.4 % Midwest Homebuilding revenue$ 166,120 $ 135,716 $ 30,404 22.4 % Loss before income taxes$ (3,063 ) $ (1,252 ) $ (1,811 ) (144.6 )% Homes delivered 540 448 92 20.5 % Average sales price$ 307,104 $ 301,384 $ 5,720 1.9 % Southeast Homebuilding revenue$ 158,933 $ 143,606 $ 15,327 10.7 % Loss before income taxes$ (4,514 ) $ (9,259 ) $ 4,745 51.2 % Homes delivered 379 352 27 7.7 % Average sales price$ 418,449 $ 407,517 $ 10,932 2.7 % Southwest Homebuilding revenue$ 549,471 $ 414,880 $ 134,591 32.4 % Income before income taxes$ 41,744 $ 15,270 $ 26,474 173.4 % Homes delivered 1,649 1,245 404 32.4 % Average sales price$ 332,805 $ 332,620 $ 185 0.1 % West Homebuilding revenue$ 313,547 $ 298,058 $ 15,489 5.2 % Income before income taxes$ 4,560 $ 28,599 $ (24,039 ) (84.1 )% Homes delivered 740 700 40 5.7 % Average sales price$ 423,586 $ 425,587 $ (2,001 ) (0.5 )% 50
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Homebuilding Results by Segment
Northeast - Homebuilding revenues increased 99.9% for the three months endedJuly 31, 2020 compared to the same period of the prior year. The increase for the three months endedJuly 31, 2020 was attributed to a 171.4% increase in homes delivered, partially offset by a 26.4% decrease in average sales price. The decrease in average sales price was the result of new communities delivering smaller single family homes, townhomes and affordable-housing homes in mid to higher-end submarkets of the segment in the three months endedJuly 31, 2020 compared to some communities delivering in the three months endedJuly 31, 2019 that had higher priced, single family homes in higher-end submarkets of the segment that are no longer delivering. Also impacting the decrease in average sales price was an increase in pricing concessions and a decrease in location premiums in certain communities. Income before income taxes increased$5.0 million to$5.2 million for the three months endedJuly 31, 2020 as compared to the prior year period, which was primarily the result of the increase in homebuilding revenues discussed above, a$3.0 million increase in income from unconsolidated joint ventures and a$0.7 million decrease in selling, general and administrative costs, while gross margin percentage before interest expense was flat. Homebuilding revenues increased 148.5% for the nine months endedJuly 31, 2020 compared to the same period of the prior year. The increase was attributed to a 237.5% increase in homes delivered, partially offset by a 14.5% decrease in average sales price and a$7.4 million decrease in land sales and other revenue. The decrease in average sales price was the result of new communities delivering smaller single family homes, townhomes and affordable-housing homes in mid to higher-end submarkets of the segment in the nine months endedJuly 31, 2020 compared to some communities delivering in the nine months endedJuly 31, 2019 that had higher priced, single family homes in higher-end submarkets of the segment that are no longer delivering. Also impacting the decrease in average sales price was an increase in pricing concessions and a decrease in location premiums in certain communities. Income before income taxes increased$11.4 million to$17.7 million for the nine months endedJuly 31, 2020 as compared to the prior year period. The increase was mainly due to the increase in homebuilding revenues discussed above, a$1.3 million decrease in selling, general and administrative costs, and an increase in gross margin percentage before interest expense, partially offset by a$4.5 million decrease in income from unconsolidated joint ventures. Mid-Atlantic - Homebuilding revenues increased 28.1% for the three months endedJuly 31, 2020 compared to the same period of the prior year. The increase was primarily due to a 34.0% increase in homes delivered, partially offset by a 4.4% decrease in average sales price for the three months endedJuly 31, 2020 compared to the same period of the prior year. 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 three months endedJuly 31, 2020 compared to some communities delivering in the three months endedJuly 31, 2019 that had higher priced, larger single family homes and townhomes in higher-end submarkets of the segment that are no longer delivering. Income before income taxes increased$5.9 million to$11.0 million for the three months endedJuly 31, 2020 compared to the same period of the prior year, which was primarily due to the increase in homebuilding revenue discussed above, a$0.8 million decrease in selling, general and administrative costs and a slight increase in gross margin percentage before interest expense for the period compared to the same period of the prior year. Homebuilding revenues increased 30.6% for the nine months endedJuly 31, 2020 compared to the same period of the prior year. The increase was primarily due to a 30.1% increase in homes delivered, while the average sales price was essentially flat with a 0.4% increase.
Income before income taxes increased
Midwest - Homebuilding revenues increased 31.6% for the three months endedJuly 31, 2020 compared to the same period of the prior year. The increase was due to a 24.7% increase in homes delivered and a 6.7% increase in average sale 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 in the three months endedJuly 31, 2020 compared to some communities delivering in the three months endedJuly 31, 2019 that had lower priced, smaller single family homes in lower-end submarkets of the segment that are no longer delivering. Income before income taxes increased$0.6 million to$0.8 million for the three months endedJuly 31, 2020 compared to the same period of the prior year. The improvement was primarily due to the increase in homebuilding revenue discussed above, partially offset by a slight decrease in gross margin percentage before interest expense. 51
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Homebuilding revenues increased 22.4% for the nine months endedJuly 31, 2020 compared to the same period of the prior year. The increase was primarily due to a 20.5% increase in homes delivered, while the average sales price was essentially flat with a 1.9% increase. Loss before income taxes increased$1.8 million to a loss of$3.1 million for the nine months endedJuly 31, 2020 as compared to the prior year period, primarily due to the$2.7 million increase in inventory impairment loss and land option write-offs, partially offset by the increase in homebuilding revenue discussed above. Gross margin percentage before interest expense was flat for the nine months endedJuly 31, 2020 compared to the same period of the prior year. Southeast - Homebuilding revenues increased 31.0% for the three months endedJuly 31, 2020 compared to the same period of the prior year. The increase was due to a 28.1% increase in homes delivered and a 2.0% increase in average sales price. The increase in average sales price was the result of new communities delivering higher priced, larger single family homes in higher-end submarkets of the segment in the three months endedJuly 31, 2020 compared to some communities delivering in the three months endedJuly 31, 2019 that had lower priced, smaller single family homes in lower-end submarkets of the segment that are no longer delivering. Loss before income taxes improved$1.9 million to a loss of$0.3 million for the three months endedJuly 31, 2020 compared to the prior year period, primarily due to the increase in homebuilding revenue discussed above, a$0.9 million decrease in selling, general and administrative costs and a slight increase in gross margin percentage before interest expense. Homebuilding revenues increased 10.7% for the nine months endedJuly 31, 2020 compared to the same period of the prior year. The increase for the nine months endedJuly 31, 2020 was attributed to a 7.7% increase in homes delivered, as well as a 2.7% increase in average sales price. The increase in average sales price was the result of new communities delivering higher priced, larger single family homes in higher-end submarkets of the segment in the nine months endedJuly 31, 2020 compared to some communities delivering in the nine months endedJuly 31, 2019 that had lower priced, smaller single family homes in lower-end submarkets of the segment that are no longer delivering. Loss before income taxes improved$4.7 million to a loss of$4.5 million for the nine months endedJuly 31, 2020 compared to the prior year period, primarily due to the increase in homebuilding revenues discussed above, a$2.7 million decrease in selling, general and administrative costs, and a slight increase in gross margin percentage before interest expense. Southwest - Homebuilding revenues increased 40.6% for the three months endedJuly 31, 2020 compared to the same period of the prior year. The increase in homebuilding revenues was primarily due to a 42.8% increase in homes delivered, while average sales price was essentially flat with a 1.5% decrease for the three months endedJuly 31, 2020 . Income before income taxes increased$11.5 million to$20.1 million for the three months endedJuly 31, 2020 compared to the same period of the prior year. The increase was primarily due to the increase in homebuilding revenue discussed above, a$1.6 million increase in income from unconsolidated joint ventures and a slight increase in gross margin percentage before interest expense for the three months endedJuly 31, 2020 compared to the same period of the prior year. Homebuilding revenues increased 32.4% for the nine months endedJuly 31, 2020 compared to the same period of the prior year. The increase was primarily due to a 32.4% increase in homes delivered, while average sales price was essentially flat with a 0.1% increase for the nine months endedJuly 31, 2020 . Income before income taxes increased$26.5 million to$41.7 million for the nine months endedJuly 31, 2020 compared to the same period of the prior year. The increase was due to the increase in homebuilding revenues discussed above and an increase in gross margin percentage before interest expense. 52
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West - Homebuilding revenues were flat for the three months endedJuly 31, 2020 compared to the same period of the prior year. Homebuilding revenues were impacted by a 4.2% decrease in homes delivered, partially offset by a 4.4% increase in average sales price. The increase in average sales price was the result of new communities delivering higher priced, larger single family homes in higher-end submarkets of the segment in the three months endedJuly 31, 2020 compared to some communities delivering in the three months endedJuly 31, 2019 that had lower priced, smaller single family homes in lower-end submarkets of the segment that are no longer delivering. Income before income taxes decreased$6.4 million to$0.2 million for the three months endedJuly 31, 2020 . The decrease for the three months endedJuly 31, 2020 was primarily due to a significant decrease in gross margin percentage before interest expense for the period compared to the same period of the prior year, partly due to increases in estimated land development costs in some of our communities in the segment. Homebuilding revenues increased 5.2% for the nine months endedJuly 31, 2020 compared to the same period of the prior year. The increase for the nine months endedJuly 31, 2020 was primarily attributed to a 5.7% increase in homes delivered, while the average sales price was essentially flat with a 0.5% decrease. Income before income taxes decreased$24.0 million to$4.6 million for the nine months endedJuly 31, 2020 . The decrease was primarily due to a significant decrease in gross margin percentage before interest expense for the nine months endedJuly 31, 2020 compared to the same period of the prior year, partly due to increases in estimated land development costs in some of our communities in the segment. Financial Services Financial services consist 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. These instruments involve, to varying degrees, elements of credit and interest rate risk. Credit risk associated with MBS forward commitments and loan sales transactions is managed by limiting our counterparties to investment banks, federally regulated bank affiliates and other investors meeting our credit standards. Our risk, in the event of default by the purchaser, is the difference between the contract price and fair value of the MBS forward commitments. For the first three quarters of fiscal 2020 and 2019,Federal Housing Administration andVeterans Administration ("FHA/VA ") loans represented 30.2% and 29.4%, respectively, of our total loans. The origination of FHA/VA loans increased from the first three quarters of fiscal 2019 to the first three quarters of fiscal 2020 and our conforming conventional loan originations as a percentage of our total loans increased slightly from 66.0% to 68.4% for these periods, respectively. The origination of loans which exceed conforming conventions decreased from 4.6% for the first three quarters of fiscal 2019 to 1.4% for the first three quarters of fiscal 2020. Profits and losses relating to the sale of mortgage loans are recognized when legal control passes to the buyer of the mortgage and the sales price is collected. During the three and nine months endedJuly 31, 2020 , financial services provided a$10.8 million and$20.0 million pretax profit, respectively, compared to$3.8 million and$8.6 million , respectively, of pretax profit for the same periods of fiscal 2019. This increase in pretax profit was attributed to the increase in the homebuilding deliveries and an increase in the average price of the loans settled. Also impacting the increase for the three and nine months endedJuly 31, 2020 was the increase in the basis point spread between the loans originated and the implied rate from the sale of the loans. In the market areas served by our wholly owned mortgage banking subsidiaries, 68.2% and 69.0% of our noncash homebuyers obtained mortgages originated by these subsidiaries during the three months endedJuly 31, 2020 and 2019, respectively, and 68.6% and 69.3% of our noncash homebuyers obtained mortgages originated by these subsidiaries for the nine months endedJuly 31, 2020 and 2019, respectively.
Corporate General and Administrative
Corporate general and administrative expenses include the operations at our headquarters inNew 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$19.3 million for the three months endedJuly 31, 2020 compared to$15.0 million for the three months endedJuly 31, 2019 . The increase for the three months endedJuly 31, 2020 compared to 2019 was primarily due to a lower adjustment to reserves for self-insured medical claims in the current fiscal quarter compared to the prior fiscal quarter, which were reduced based on claim estimates and higher compensation expense from a new grant under long-term incentive plans. Corporate general and administrative expenses increased to$54.3 million for the nine months endedJuly 31, 2020 compared to$48.8 million for the nine months endedJuly 31, 2019 , primarily due to a lower adjustment to reserves for self-insured medical claims in the current fiscal period compared to the prior fiscal period, which were reduced based on claim estimates, and additional costs pertaining to software licenses and support fees for cybersecurity and monitoring services. 53
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Table of Contents Other Interest Other interest increased$4.7 million for the three months endedJuly 31, 2020 compared to the three months endedJuly 31, 2019 and increased$11.6 million for the nine months endedJuly 31, 2020 compared to the nine months endedJuly 31, 2019 . Our assets that qualify for interest capitalization (inventory under development) are less than our debt, and therefore the portion of interest not covered by qualifying assets is directly expensed. Other interest increased for the three and nine months endedJuly 31, 2020 compared to the three and nine months endedJuly 31, 2019 because we incurred more interest from our third party inventory financing during fiscal 2020, and as a result of the debt exchange in the fourth quarter of fiscal 2019.
Gain on Extinguishment of Debt
OnDecember 10, 2019 , the Company entered into a credit agreement providing for$81.5 million of senior secured 1.75 lien term loans in exchange for$163.0 million of senior unsecured term loans. OnDecember 10, 2019 , the Company also issued$158.5 million of 10.0% Senior Secured 1.75 Lien Notes due 2025 in exchange for$23.2 million of 10.0% Senior Secured Notes due 2022 and$141.7 million 10.5% Senior Secured Notes due 2024. These transactions were accounted for in accordance with ASC 470-60, resulting in a gain on extinguishment of debt of$9.5 million . Additional costs incurred pertaining to this transaction resulted in a$0.2 million and less than$0.1 million loss on extinguishment of debt during the three months endedApril 30, 2020 andJuly 31, 2020 , respectively. During the three months endedJuly 31, 2020 , the Company repurchased in open market transactions$25.5 million aggregate principal amount of 10.0% 2022 Notes. The aggregate repurchase price for these repurchases was$21.4 million , which included accrued and unpaid interest. These repurchases resulted in a gain on extinguishment of debt of$4.1 million for the three months endedJuly 31, 2020 , net of the write-off of unamortized financing costs and fees. The gains from the repurchases are included in the Condensed Consolidated Statement of Operations as "Gain of extinguishment of debt".
Income from
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$1.9 million to$5.7 million for the three months endedJuly 31, 2020 and decreased$7.1 million to$13.4 million for the nine months endedJuly 31, 2020 compared to the same periods of the prior year. The increase for the three months period was primarily due to certain of our joint ventures delivering more homes, resulting in higher profits in the current fiscal third quarter as compared to the prior fiscal year's third quarter, as well as the recognition of loss in the prior year fiscal third quarter from writing down the investment of one of our joint ventures where the full amount of the investment was deemed to be other than temporarily impaired which did not recur. The decrease for the nine-month periods was primarily due to the recognition of our share of income from certain of our joint ventures delivering fewer homes in the current fiscal period as compared to the prior fiscal period. Also impacting the decrease was income recorded in the first quarter of fiscal 2019 related to the return of capital from an unconsolidated joint venture for which we had previously written-off our investment. Total Taxes The total income tax expense for the three and nine months endedJuly 31, 2020 was$0.9 million and$2.7 million , respectively, and$0.5 million and$1.2 million , respectively, for the same periods of the prior year. For both the three and nine months endedJuly 31, 2020 and the three and nine months endedJuly 31, 2019 , the total income tax expense was primarily related to state tax expense from income generated that was not offset by tax benefits in states where we fully reserve the tax benefit from net operating losses. In addition, the expense for the nine months endedJuly 31, 2020 was related to state tax expense from the impact of a cancellation of debt income recorded for tax purposes but not for GAAP purposes, creating a permanent difference. Inflation Inflation has a long-term effect, because increasing costs of land, materials and labor result in increasing sale prices of our homes. In general, 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, will 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 twelve months. Construction costs for residential buildings represent approximately 52.9% of our homebuilding cost of sales for the nine months endedJuly 31, 2020 . 54
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Table of Contents 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 result of a variety of factors. Such risks, uncertainties and other factors include, but are not limited to:
? The material and adverse disruption, and the expected continued disruption,
to our business caused by the present outbreak and worldwide spread of
COVID-19 and the measures that international, federal, state and local
governments, agencies, law enforcement and/or health authorities implement to
address it;
? Changes in general and local economic, industry and business conditions and
impacts of a significant homebuilding downturn;
? Adverse weather and other environmental conditions and natural disasters;
? 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; ? 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;
? Shortages in, and price fluctuations of, raw materials and labor, including
due to 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;
? 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;
? Fluctuations in interest rates and the availability of mortgage financing;
? Changes in tax laws affecting the after-tax costs of owning a home;
? Operations through unconsolidated joint ventures with third parties;
? Government regulation, including regulations concerning development of land,
the home building, sales and customer financing processes, tax laws and the
environment;
? 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; ? Successful identification and integration of acquisitions; ? Significant influence of the Company's controlling stockholders; ? Availability of net operating loss carryforwards; ? Utility shortages and outages or rate fluctuations; ? Geopolitical risks, terrorist acts and other acts of war; ? Diseases, pandemics or other severe public health events;
? Loss of key management personnel or failure to attract qualified personnel;
? Information technology failures and data security breaches; and ? Negative publicity. 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 endedOctober 31, 2019 as updated by Part II, Item 1A "Risk Factors" in our Quarterly Report on Form 10-Q for the fiscal quarter endedApril 30, 2020 . 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. 55
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