HOVNANIAN ENTERPRISES, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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). Overview Our community count increased 14.6% from 123 communities atOctober 31, 2018 to 141 atOctober 31, 2019 . For seven consecutive quarters through the third quarter of fiscal 2019, our total number of lots controlled increased as compared to the same period of the prior year. Although there was a slight decrease in total lots controlled of 3.2% as ofOctober 31, 2019 as compared toOctober 31, 2018 , the growth in lots controlled in previous quarters has led to the year-over-year community count growth. Our strategy has been to grow through increased open for sale communities. As our recently opened communities begin delivering homes, we believe it should lead to additional delivery and revenue growth, and in turn profitability in future periods, absent adverse market factors. Our cash position has allowed us to spend$562.8 million on land purchases and land development during fiscal 2019, and still have total liquidity of$275.9 million , including$131.0 million of homebuilding cash and cash equivalents as ofOctober 31, 2019 . We continue to see opportunities to purchase land at prices that make economic sense in light of our current sales prices, sales pace and construction costs and plan to continue actively pursuing such land acquisitions. New land purchases at pricing that we believe will generate appropriate investment returns and drive greater operating efficiencies are needed to return to sustained profitability; however, we remain cautious and are carefully evaluating market conditions when pursuing new land acquisitions.
Additional results for the year ended
? For the year ended
? Gross margin percentage decreased from 15.2% for the year endedOctober 31, 2018 to 14.2% for the year endedOctober 31, 2019 . This decrease was primarily due to the increase in cost of sales interest as a result of changes in estimates of interest per home for deliveries during fiscal 2019 in connection with our semi-annual community life planning process, along with a decrease due to the mix of communities delivering in each period. During this planning process, the duration of communities and timing of spending thereon could change, resulting in changes in total estimated community life capitalized interest. Estimated community life capitalized interest is written-off with each delivery. Gross margin percentage, before cost of sales interest expense and land charges, decreased slightly from 18.4% for the year endedOctober 31, 2018 to 18.1% for the year endedOctober 31, 2019 , primarily due to the mix of communities delivering. ? Selling, general and administrative costs (including corporate general and administrative expenses) increased$4.3 million for the year endedOctober 31, 2019 as compared to the prior year, primarily as a result of our increased community count, along with a lower adjustment to our warranty reserves (as a result of our annual actuarial analysis) in fiscal 2019 as compared to fiscal 2018. However, as a percentage of total revenue, such costs remained relatively flat at 11.6% for the year endedOctober 31, 2019 compared to 11.5% for the year endedOctober 31, 2018 . ? Active selling communities atOctober 31, 2019 increased 14.6% over last year, and our average active selling communities increased by 5.4% over last year. Net contracts increased 14.3% for the year endedOctober 31, 2019 , compared to the prior year.
? Net contracts per average active selling community increased to 39.0 for the
year ended
? Contract backlog increased from 1,826 homes atOctober 31, 2018 to 2,191 homes atOctober 31, 2019 , with a dollar value of$880.1 million , representing a 18.0% increase in dollar value compared to the prior year. When comparing sequentially from the third quarter of fiscal 2019 to the fourth quarter of fiscal 2019, our gross margin percentage increased slightly from 14.0% to 14.5% and our gross margin percentage, before cost of sales interest expense and land charges, also increased slightly from 18.4% to 18.9%, both primarily as a result of product mix, as well as a minor increase due to the increase in delivery volume. Selling, general and administrative costs (including corporate general and administrative expenses) as a percentage of total revenues decreased from 12.1% to 7.6%, as compared to the third quarter of fiscal 2019, primarily due to the increase in delivery volume. 28
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Table of Contents Critical Accounting Policies
Management believes that the following critical accounting policies require its most significant judgments and estimates used in the preparation of the consolidated financial statements:
Income Recognition from Mortgage Loans - Our Financial Services segment
originates mortgages, primarily for our homebuilding customers. 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.
We elected the fair value option for our mortgage loans held for sale in
accordance with Accounting Standards Codification ("ASC") 825, "Financial
Instruments," which permits us to measure our loans held for sale at fair value.
Management believes that the election of the fair value option for loans held
for sale improves financial reporting by mitigating volatility in reported
earnings caused by measuring the fair value of the loans and the derivative
instruments used to economically hedge them without having to apply complex
hedge accounting provisions.
Substantially all of the mortgage loans originated are sold within a short
period of time in the secondary mortgage market on a servicing released,
nonrecourse basis, although the Company remains liable for certain limited
representations, such as fraud, and warranties related to loan sales. Mortgage
investors could seek to have us buy back loans or compensate them for losses
incurred on mortgages we have sold based on claims that we breached our limited
representations and warranties. We have established reserves for probable
losses. While we believe these reserves are adequate for known losses and
projected repurchase requests, given the volatility in the mortgage industry and
the uncertainty regarding the ultimate resolution of these claims, if either
actual repurchases or the losses incurred resolving those repurchases exceed our
expectations, additional expense may be incurred.
Inventories - Inventories consist of land, land development, home construction
costs, capitalized interest, construction overhead and property taxes.
Construction costs are accumulated during the period of construction and charged
to cost of sales under specific identification methods. Land, land development
and common facility costs are allocated based on buildable acres to product
types within each community, then charged to cost of sales equally based upon
the number of homes to be constructed in each product type.
We record inventories in our consolidated balance sheets at cost unless the
inventory is determined to be impaired, in which case the inventory is written
down to its fair value. Our inventories consist of the following three
components: (1) sold and unsold homes and lots under development, which includes
all construction, land, capitalized interest and land development costs related
to started homes and land under development in our active communities; (2) land
and land options held for future development or sale, which includes all costs
related to land in our communities in planning or mothballed communities; and
(3) consolidated inventory not owned, which includes all costs related to
variable interest entities and other options, which consists primarily of model
homes financed with an investor and inventory related to land banking
arrangements accounted for as financings.
We decide to mothball (or stop development on) certain communities when we
determine that the current performance does not justify further investment at
the time. When we decide to mothball a community, the inventory is reclassified
on our Consolidated Balance Sheets from "Sold and unsold homes and lots under
development" to "Land and land options held for future development or sale." As
of October 31, 2019 , the net book value associated with our 13 mothballed
communities was $13.8 million , net of impairment charges recorded in prior
periods of $138.1 million . We regularly review communities to determine if
mothballing is appropriate. During fiscal 2019, we did not mothball any
communities, but we sold two previously mothballed communities and re-activated
three previously mothballed communities.
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 Consolidated Balance Sheets, at October 31, 2019 , inventory of
$54.2 million was recorded to "Consolidated inventory not owned," with a
corresponding amount of $51.2 million recorded to "Liabilities from inventory
not owned."
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We have land banking arrangements, whereby we sell our land parcels to the land banker and they provide us an option to purchase back finished lots on a quarterly basis. Because of our options to repurchase these parcels, for accounting purposes, in accordance with ASC 606-10-55-70, these transactions are considered financings rather than sales. For purposes of our Consolidated Balance Sheets, atOctober 31, 2019 , inventory of$136.1 million was recorded as "Consolidated inventory not owned," with a corresponding amount of$89.8 million recorded to "Liabilities from inventory not owned" for the amount of net cash received from the transactions. The recoverability of inventories and other long-lived assets is assessed in accordance with the provisions of ASC 360-10, "Property, Plant and Equipment - Overall" ("ASC 360-10"). ASC 360-10 requires long-lived assets, including inventories, held for development to be evaluated for impairment based on undiscounted future cash flows of the assets at the lowest level for which there are identifiable cash flows. As such, we evaluate inventories for impairment at the individual community level, the lowest level of discrete cash flows that we measure. We evaluate inventories of communities under development and held for future development for impairment when indicators of potential impairment are present. Indicators of impairment include, but are not limited to, decreases in local housing market values, decreases in gross margins or sales absorption rates, decreases in net sales prices (base sales price net of sales incentives), or actual or projected operating or cash flow losses. The assessment of communities for indication of impairment is performed quarterly. As part of this process, we prepare detailed budgets for all of our communities at least semi-annually and identify those communities with a projected operating loss. For those communities with projected losses, we estimate the remaining undiscounted future cash flows and compare those to the carrying value of the community, to determine if the carrying value of the asset is recoverable.
The projected operating profits, losses, or cash flows of each community can be significantly impacted by our estimates of the following:
? future base selling prices; ? future home sales incentives; ? future home construction and land development costs; and ? future sales absorption pace and cancellation rates. These estimates are dependent upon specific market conditions for each community. While we consider available information to determine what we believe to be our best estimates as of the end of a quarterly reporting period, these estimates are subject to change in future reporting periods as facts and circumstances change. Local market-specific conditions that may impact our estimates for a community include:
? the intensity of competition within a market, including available home sales
prices and home sales incentives offered by our competitors;
? the current sales absorption pace for both our communities and competitor
communities;
? community specific attributes, such as location, availability of lots in the
market, desirability and uniqueness of our community, and the size and style
of homes currently being offered;
? potential for alternative product offerings to respond to local market
conditions;
? changes by management in the sales strategy of the community;
? current local market economic and demographic conditions and related trends of
forecasts; and
? existing home inventory supplies, including foreclosures and short sales.
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These and other local market-specific conditions that may be present are considered by management in preparing projection assumptions for each community. The sales objectives can differ between our communities, even within a given market. For example, facts and circumstances in a given community may lead us to price our homes with the objective of yielding a higher sales absorption pace, while facts and circumstances in another community may lead us to price our homes to minimize deterioration in our gross margins, although it may result in a slower sales absorption pace. In addition, the key assumptions included in our estimate of future undiscounted cash flows may be interrelated. For example, a decrease in estimated base sales price or an increase in homes sales incentives may result in a corresponding increase in sales absorption pace. Additionally, a decrease in the average sales price of homes to be sold and closed in future reporting periods for one community that has not been generating what management believes to be an adequate sales absorption pace may impact the estimated cash flow assumptions of a nearby community. Changes in our key assumptions, including estimated construction and development costs, absorption pace and selling strategies, could materially impact future cash flow and fair-value estimates. Due to the number of possible scenarios that would result from various changes in these factors, we do not believe it is possible to develop a sensitivity analysis with a level of precision that would be meaningful to an investor. If the undiscounted cash flows are more than the carrying value of the community, then the carrying amount is recoverable, and no impairment adjustment is required. However, if the undiscounted cash flows are less than the carrying amount, then the community is deemed impaired and is written down to its fair value. We determine the estimated fair value of each community by determining the present value of its estimated future cash flows at a discount rate commensurate with the risk of the respective community, or in limited circumstances, 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. Our discount rates used for all impairments recorded fromOctober 31, 2017 toOctober 31, 2019 ranged from 16.8% to 19.8%. The estimated future cash flow assumptions are virtually the same for both our recoverability and fair value assessments. Should the estimates or expectations used in determining estimated cash flows or fair value, including discount rates, decrease or differ from current estimates in the future, we may be required to recognize additional impairments related to current and future communities. The impairment of a community is allocated to each lot on a relative fair value basis. From time to time, we write off deposits and approval, engineering and capitalized interest costs when we determine that it is no longer probable that we will exercise options to buy land in specific locations or when we redesign communities and/or abandon certain engineering costs. In deciding not to exercise a land option, we take into consideration changes in market conditions, the timing of required land takedowns, the willingness of land sellers to modify terms of the land option contract (including timing of land takedowns), and the availability and best use of our capital, among other factors. The write-off is recorded in the period it is deemed not probable that the optioned property will be acquired. In certain instances, we have been able to recover deposits and other pre-acquisition costs that were previously written off. These recoveries have not been significant in comparison to the total costs written off. Inventories held for sale are land parcels ready for sale in their current condition, where we have decided not to build homes but are instead actively marketing for sale. These land parcels represented$6.4 million of our total inventories atOctober 31, 2018 , and are reported at the lower of carrying amount or fair value less costs to sell. There were no inventories held for sale atOctober 31, 2019 . 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.Unconsolidated Homebuilding and Land Development Joint Ventures - Investments in unconsolidated homebuilding and land development joint ventures are accounted for under the equity method of accounting. Under the equity method, we recognize our proportionate share of earnings and losses earned by the joint venture upon the delivery of lots or homes to third parties. Our ownership interests in the joint ventures vary but our voting interests are generally 50% or less. In determining whether or not we must consolidate joint ventures where we are the managing member of the joint venture, we assess whether the other partners have specific rights to overcome the presumption of control by us as the manager of the joint venture. In most cases, the presumption is overcome because the joint venture agreements require that both partners agree on establishing the significant operating and capital decisions of the partnership, including budgets, in the ordinary course of business. The evaluation of whether or not we control a venture can require significant judgment. In accordance with ASC 323-10, "Investments -Equity Method and Joint Ventures - Overall," we assess our investments in unconsolidated joint ventures for recoverability, and if it is determined that a loss in value of the investment below its carrying amount is other than temporary, we write down the investment to its fair value. We evaluate our equity investments for impairment based on the joint venture's projected cash flows. This process requires significant management judgment and estimates. During fiscal 2019 and fiscal 2017, we wrote down certain joint venture investments by$0.9 million and$2.8 million , respectively. There were no write-downs in fiscal 2018. Warranty Costs and Construction Defect Reserves - We accrue for warranty costs that are covered under our existing general liability and construction defect policy as part of our general liability insurance deductible. This accrual is expensed as selling, general, and administrative costs. For homes delivered in fiscal 2019 and 2018, our deductible under our general liability insurance is a$20 million aggregate for construction defect and warranty claims. For bodily injury claims, our deductible per occurrence in fiscal 2019 and 2018 is$0.25 million , up to a$5 million limit. Our aggregate retention for construction defect, warranty and bodily injury claims is$20 million for fiscal 2019 and 2018. We do not have a deductible on our worker's compensation insurance. Reserves for estimated losses for construction defects, warranty and bodily injury claims have been established using the assistance of a third-party actuary. We engage a third-party actuary that uses our historical warranty and construction defect data to assist our management in estimating our unpaid claims, claim adjustment expenses and incurred but not reported claims reserves for the risks that we are assuming under the general liability and construction defect programs. The estimates include provisions for inflation, claims handling and legal fees. These estimates are subject to a high degree of variability due to uncertainties such as trends in construction defect claims relative to our markets and the types of products we build, claim settlement patterns, insurance industry practices and legal interpretations, among others. Because of the high degree of judgment required in determining these estimated liability amounts, actual future costs could differ significantly from our currently estimated amounts. In addition, we establish a warranty accrual for lower cost-related issues to cover home repairs, community amenities and land development infrastructure that are not covered under our general liability and construction defect policy. We accrue an estimate for these warranty costs as part of cost of sales at the time each home is closed and title and possession have been transferred to the homebuyer. See Note 16 to the Consolidated Financial Statements for additional information on the amount of warranty costs recognized in cost of goods sold and administrative expenses. 31
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Recent Accounting Pronouncements
See Note 3 to the Consolidated Financial Statements included elsewhere in this Annual Report on Form 10-K.
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 (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 homebuilding cash balance atOctober 31, 2019 decreased$56.9 million fromOctober 31, 2018 . We spent$562.8 million on land and land development during the period. After considering this land and land development and all other operating activities, including revenue received from deliveries, we used$249.1 million of cash from operations. However, as ofOctober 31, 2019 , we had$125.0 million of borrowing capacity under our Secured Credit Agreement (defined below), and therefore, our total liquidity atOctober 31, 2019 was$275.9 million , which is above our target liquidity range of$170.0 to$245.0 million . During fiscal 2019, we used$8.3 million of cash for investing activities, primarily for investments in joint ventures, partially offset by distributions from joint ventures. Cash provided by financing activities was$206.7 million during fiscal 2019, which included net proceeds of$8.2 million from debt issuances,$78.5 million from land banking and model sale leaseback programs,$109.0 million of net proceeds from nonrecourse mortgages and$27.1 million from in mortgage warehouse lines of credit. Subject to covenant restrictions in our debt instruments, we intend to continue to use nonrecourse mortgage financings, model sale leaseback, joint ventures, and land banking programs as our business needs dictate. Our cash uses during the years endedOctober 31, 2019 and 2018 were for operating expenses, land purchases, land deposits, land development, construction spending, debt refinancings and payments, state income taxes, interest payments, litigation matters and investments in 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, joint ventures, financial service revenues and other revenues. We believe that these sources of cash together with available borrowings under our senior secured revolving credit facility will be sufficient through fiscal 2020 to finance our working capital requirements. 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. In fiscal 2019 and 2018, with continued spending on land purchases and land development, we used cash in operations. As we continue to actively seek land investment opportunities, we will also remain focused on liquidity.
See "Inventory Activities" below for a detailed discussion of our inventory position.
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Table of Contents Debt Transactions Senior notes and credit facilities balances as ofOctober 31, 2019 andOctober 31, 2018 , were as follows: October 31, October 31, (In thousands) 2019(1) 2018(1) Senior Secured Notes: 9.5% Senior Secured Notes due November 15, 2020 $-
2.0% Senior Secured Notes dueNovember 1, 2021 -
53,203
5.0% Senior Secured Notes dueNovember 1, 2021 -
141,797
10.0% Senior Secured Notes dueJuly 15, 2022 218,994
440,000
10.5% Senior Secured Notes dueJuly 15, 2024 211,391
400,000
7.75% Senior Secured 1.125 Lien Notes due
350,000 -
10.5% Senior Secured 1.25 Lien Notes due
282,322 -
11.25% Senior Secured 1.5 Lien Notes due February 15, 2026 103,141 - Total Senior Secured Notes$1,165,848 $1,110,000 Senior Notes: 8.0% Senior Notes due November 1, 2019 (2) $-
$-
13.5% Senior Notes dueFebruary 1, 2026 90,590
90,590
5.0% Senior Notes dueFebruary 1, 2040 90,120
90,120
Total Senior Notes$180,710
Senior Unsecured Term Loan Credit Facility due
$202,547
Senior Secured Revolving Credit Facility (3) $- $- Net discounts and premium$(49,145) $(39,934) Net debt issuance costs$(19,970) $(14,085) Total notes payable, net of discount, premium and debt issuance costs$1,479,990 $1,439,238 (1) " Notes payable" on our Consolidated Balance Sheets as ofOctober 31, 2019 and 2018 consists of the total senior secured and senior notes shown above, as well as accrued interest of$19.1 million and$35.6 million , respectively.
(2)
(3) At
Except forK. Hovnanian , the issuer of the notes and borrower under the senior unsecured term loan facility (the "Term Loan Facility") and under our$125.0 million senior secured revolving credit facility (the "Secured Credit Facility" and together with the term loan facility, 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 atOctober 31, 2019 (collectively, the "Notes Guarantors"), which include the subsidiaries that had guaranteed (collectively, the "Former New Secured Group Guarantors")K. Hovnanian's 9.50% Notes, 2.000% Notes and 5.000% Notes (each as defined under below). As a result of the 2019 Transactions (as defined in and described under below),K. Hovnanian's obligations under the Credit Facilities, the senior secured notes and senior notes are guaranteed by the Notes Guarantors (including the Former New Secured Group Guarantors) and, in the case of the Secured Credit Facility and the senior secured notes, will be secured in accordance with the terms of the applicable Debt Instrument by substantially all of the assets owned byK. Hovnanian and the Notes Guarantors (including the assets owned by theFormer New Secured Group Guarantors), subject to permitted liens and certain exceptions. The credit agreements governing the Credit Facilities and the indentures governing the senior secured and senior notes (together, the "Debt Instruments") outstanding atOctober 31, 2019 do not contain any financial maintenance covenants, but do contain restrictive covenants that limit, among other things, the Company's ability and that of 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 Term Loan Facility (defined below) (the "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 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 Term Loans and Secured Revolving Loans, material inaccuracy of representations and warranties and with respect to the Term Loans and Secured Revolving Loans, a change of control, and, with respect to the Secured Revolving Loans and senior secured notes, the failure of the documents granting security for the Secured Revolving Loans and senior secured notes to be in full force and effect, and the failure of the liens on any material portion of the collateral securing the Secured Revolving Loans and senior secured notes to be valid and perfected. As ofOctober 31, 2019 , 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, 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. 33
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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. OnJanuary 15, 2019 , pursuant to a Commitment Letter, the Company issued$25.0 million in aggregate principal amount of the Additional 10.5% 2024 Notes to certain funds managed, advised or sub-advised by GSO at a discount for a purchase price of$21.3 million in cash. The Additional 10.5% 2024 Notes were issued as additional notes of the same series as the 10.5% 2024 Notes. OnOctober 31, 2019 ,K. Hovnanian , the Company, the Notes Guarantors,Wilmington Trust, National Association , as administrative agent, and affiliates of certain investment managers (the "Investors"), as lenders, entered into a credit agreement (the "Secured Credit Agreement") providing for up to$125.0 million in aggregate amount of Secured Revolving Loans to be used for general corporate purposes, upon the terms and subject to the conditions set forth therein. Secured Revolving Loans are to be borrowed byK. Hovnanian and guaranteed by the Notes Guarantors. Availability under the Secured Credit Agreement will terminate onDecember 28, 2022 and the Secured Revolving Loans will bear interest at a rate per annum equal to 7.75%, and interest will be payable in arrears, on the last business day of each fiscal quarter. In connection with the entering into of the Secured Credit Agreement,K. Hovnanian terminated its then existing Secured Credit Facility. OnOctober 31, 2019 ,K. Hovnanian completed private placements of senior secured notes as follows: (i)K. Hovnanian issued an aggregate of$350.0 million of 7.75% Senior Secured 1.125 Lien Notes due 2026 (the "1.125 Lien Notes") in part pursuant to a Note Purchase Agreement, datedOctober 31, 2019 , amongK. Hovnanian , the Notes Guarantors and certain Investors as purchasers thereof (the "1.125 Lien Notes Purchase Agreement") and in part pursuant to the Exchange Agreement (as defined below), with the proceeds from the sale of 1.125 Lien Notes under the 1.125 Lien Notes Purchase Agreement used to fund the cash payments to certain Exchanging Holders (as defined below) under the Exchange Agreement; and (ii)K. Hovnanian issued an aggregate of$282.3 million of 10.5% Senior Secured 1.25 Lien Notes due 2026 (the "1.25 Lien Notes"), pursuant to a Note Purchase Agreement (the "1.25 Lien Notes Purchase Agreement"), datedOctober 31, 2019 , amongK. Hovnanian , the Notes Guarantors and certain Investors as purchasers thereof (the "1.25 Lien Notes Purchasers"), the proceeds of which were used to fund the Satisfaction and Discharge (as defined below). In addition, onOctober 31, 2019 ,K. Hovnanian completed private exchanges of (i) approximately$221.0 million aggregate principal amount of its 10.0% Senior Secured Notes due 2022 (the "10.0% 2022 Notes") and approximately$114.0 million aggregate principal amount of its 10.5% Senior Secured Notes due 2024 (the "10.5% 2024 Notes" and, together with the 10.0% 2022 Notes, the "Second Lien Notes") held by certain participating bondholders (the "Exchanging Holders") for a portion of the$350.0 million aggregate principal amount of 1.125 Lien Notes described above and/or cash, and (ii) approximately$99.6 million aggregate principal amount of its 10.5% 2024 Notes held by certain of the Exchanging Holders for approximately$103.1 million aggregate principal amount of 11.25% Senior Secured 1.5 Lien Notes due 2026 (the "1.5 Lien Notes" and, together with the 1.125 Lien Notes and the 1.25 Lien Notes, the "New Secured Notes"), pursuant to an Exchange Agreement, datedOctober 30, 2019 (the "Exchange Agreement"), amongK. Hovnanian , the Notes Guarantors and the Exchanging Holders. OnOctober 31, 2019 ,K. Hovnanian issued notices of redemption for all of its outstanding 9.50% Senior Secured Notes due 2020 (the "9.50% Notes"), 2.000% Senior Secured Notes due 2021 (the "2.000% Notes") and 5.000% Senior Secured Notes due 2021 (the "5.000% Notes") and deposited withWilmington Trust, National Association , as trustee under the indenture (the "9.50% Notes Indenture") governing the 9.50% Notes and as trustee under the indenture (the "5.000%/2.000% Notes Indenture") governing the 5.000% Notes and the 2.000% Notes sufficient funds to satisfy and discharge (collectively, the "Satisfaction and Discharge") (i) the 9.50% Indenture and to fund the redemption of all outstanding 9.50% Notes and to pay accrued and unpaid interest on the redeemed notes to, but not including, theNovember 10, 2019 redemption date and (ii) the 5.000%/2.000% Indenture and to fund the redemption of all outstanding 5.000% Notes and 2.000% Notes and to pay accrued and unpaid interest on the redeemed notes to, but not including, theNovember 30, 2019 redemption date. Proceeds from the issuance of the 1.25 Lien Notes together with cash on hand were used to fund the Satisfaction and Discharge. Upon the Satisfaction and Discharge of the 9.50% Notes Indenture, all of the collateral securing the 9.50% Notes was released and the restrictive covenants and events of default contained therein ceased to have effect and upon the Satisfaction and Discharge of the 5.000%/2.000% Notes Indenture, all of the collateral securing the 5.000% Notes and the 2.000% Notes was released and the restrictive covenants and events of default contained therein ceased to have effect as to both such series of Notes. The Company andK. Hovnanian obtained the consent of certain lenders/holders under its existing debt instruments to amend such debt instruments in connection with the issuance of the New Secured Notes and the execution of the indentures governing the New Secured Notes and the Secured Credit Agreement. The Company,K. Hovnanian and the guarantors also amended such debt instruments to add the Former New Secured Group Guarantors as guarantors thereunder and, in the case of the Second Lien Notes, to add the Former New Secured Group Guarantors as pledgors and grantors of their assets (subject to permitted liens and certain exceptions) to secure such Second Lien Notes. 34
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The transactions that were consummated onOctober 31, 2019 , as described, are collectively referred to herein as the "2019 Transactions." The 2019 Transactions resulted in a loss in extinguishment of debt of$42.4 million for the year endedOctober 31, 2019 which is included as "Loss on Extinguishment of Debt" on the Consolidated Statement of Operations. See Note 9 to the Consolidated Financial Statements included elsewhere in this Annual Report on Form 10-K for a further discussion ofK. Hovnanian's Credit Facilities, senior secured notes and senior notes. Mortgages and Notes Payable We have nonrecourse mortgage loans for certain communities totaling$203.6 million and$95.6 million (net of debt issuance costs) atOctober 31, 2019 andOctober 31, 2018 , respectively, which are secured by the related real property, including any improvements, with an aggregate book value of$410.2 million and$241.9 million , respectively. The weighted-average interest rate on these obligations was 8.3% and 6.1% atOctober 31, 2019 andOctober 31, 2018 , 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. The loans are secured by the mortgages held for sale and repaid when we sell the underlying mortgage loans to permanent investors. As ofOctober 31, 2019 and 2018, we had an aggregate of$140.2 million and$113.2 million , respectively, outstanding under several ofK. Hovnanian Mortgage's short-term borrowing facilities.
See Note 8 to the Consolidated Financial Statements for a discussion of these agreements and facilities.
Equity OnJuly 3, 2001 , our Board of Directors authorized a stock repurchase program to purchase up to 0.2 million shares of Class A Common Stock. We did not repurchase any shares under this program during fiscal 2019 or 2018. As ofOctober 31, 2019 , the maximum number of shares of Class A Common Stock that may yet be purchased under this program is 22 thousand. (See Part II, Item 5 for information on equity purchases). OnJuly 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. The depositary shares are listed on the NASDAQ Global Market under the symbol "HOVNP." In fiscal 2019, 2018 and 2017, we did not make any dividend payments on the Series A Preferred Stock as a result of covenant restrictions in our debt instruments. Certain debt instruments to which we are a party contain restrictions on the payment of cash dividends. As a result of the most restrictive of these provisions, we are not currently able to pay any cash dividends. We have never paid a cash dividend to common stockholders. We anticipate that we will continue to be restricted from paying dividends, which are not cumulative, for the foreseeable future. OnOctober 31, 2019 , in connection with the issuance of the 7.75% Senior Secured 1.25 Lien Notes due 2026, we issued and sold an aggregate of 178,427 shares of Class A Common Stock, par value$0.01 per share (and associated Preferred Stock Purchase Rights), to the purchasers of such Notes for an aggregate purchase price of$1,784.27 . The issuance was exempt from registration under Section 4(a)(2) of the Securities Act of 1933. Inventory Activities Total inventory, excluding consolidated inventory not owned, increased$111.9 million during the year endedOctober 31, 2019 fromOctober 31, 2018 . Total inventory, excluding consolidated inventory not owned, increased in the Northeast by$12.6 million , in the Mid-Atlantic by$46.5 million , in the Midwest by$9.7 million , in the Southeast by$3.8 million , in the Southwest by$7.5 million and in the West by$31.8 million . These inventory fluctuations were primarily attributable to new land purchases and land development, partially offset by home deliveries and land sales during the period. During the year endedOctober 31, 2019 , we had aggregate impairments in the amount of$2.7 million . We wrote-off costs in the aggregate amount of$3.6 million during the year endedOctober 31, 2019 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. There can be no assurances that this trend will continue in the near term. Substantially all homes under construction or completed and included in inventory atOctober 31, 2019 are expected to be closed during the next six to nine months. 35
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Consolidated inventory not owned increased$102.4 million . Consolidated inventory not owned consists of options related to land banking and model financing transactions that were added to our Consolidated Balance Sheets in accordance with US GAAP. The increase fromOctober 31, 2018 toOctober 31, 2019 was primarily due to an increase in land banking transactions along with 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 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 Consolidated Balance Sheet, atOctober 31, 2019 , inventory of$136.1 million was recorded to "Consolidated inventory not owned," with a corresponding amount of$89.8 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 Consolidated Balance Sheet, atOctober 31, 2019 , inventory of$54.2 million was recorded to "Consolidated inventory not owned," with a corresponding amount of$51.2 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 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 ofOctober 31, 2019 , we had mothballed land in 13 communities. The book value associated with these communities atOctober 31, 2019 was$13.8 million , which was net of impairment charges recorded in prior periods of$138.1 million . We continually review communities to determine if mothballing is appropriate. During fiscal 2019, we did not mothball any additional communities, but we sold two previously mothballed communities and re-activated three previously mothballed communities. Inventories held for sale, which are land parcels where we have decided not to build homes, and are actively marketing the land for sale, represented$6.4 million of our total inventories atOctober 31, 2018 , and are reported at the lower of carrying amount or fair value less costs to sell. There were no inventories held for sale atOctober 31, 2019 . 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. 36
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The following tables summarize home sites included in our total residential real
estate.
Remaining
Total Contracted Home
Home Not Sites
Sites Delivered Available
October 31, 2019 :
Northeast 3,297 152 3,145
Mid-Atlantic 5,297 343 4,954
Midwest 3,898 450 3,448
Southeast 4,693 282 4,411
Southwest 7,188 663 6,525
West 5,260 301 4,959
Consolidated total 29,633 2,191 27,442
Unconsolidated joint ventures 4,226 461 3,765
Owned 11,374 1,658 9,716
Optioned 18,004 278 17,726
Construction to permanent financing lots 255 255 -
Consolidated total 29,633 2,191
27,442
Lots controlled by unconsolidated joint ventures 4,226 461 3,765 October 31, 2018: Northeast 3,920 51 3,869 Mid-Atlantic 4,795 296 4,499 Midwest 4,758 394 4,364 Southeast 4,671 251 4,420 Southwest 6,783 523 6,260 West 5,630 311 5,319 Consolidated total 30,557 1,826 28,731 Unconsolidated joint ventures 4,029 366 3,663 Owned 12,729 1,356 11,373 Optioned 17,610 252 17,358 Construction to permanent financing lots 218 218
-
Consolidated total 30,557 1,826
28,731
Lots controlled by unconsolidated joint ventures 4,029 366 3,663
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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 increase in the total homes fromOctober 31, 2018 toOctober 31, 2019 is primarily due to the increase in community count during the period, along with a planned increase of additional unsold homes in certain markets to take advantage of increased sales pace. October 31, 2019 October 31, 2018 Unsold Unsold Homes Models Total Homes Models Total Northeast 58 12 70 24 5 29 Mid-Atlantic 63 12 75 38 19 57 Midwest 31 10 41 19 10 29 Southeast 78 15 93 62 11 73 Southwest 320 12 332 335 14 349 West 213 19 232 93 12 105 Total 763 80 843 571 71 642 Started or completed unsold homes and models per active selling communities (1) 5.4 0.6 6.0 4.6 0.6 5.2
(1) Active selling communities (which are communities that are open for sale with
ten or more home sites available) were 141 and 123 at
2018, respectively. This ratio does not include substantially completed
communities, which are communities with less than ten home sites available.
Other Balance Sheet Activities
Homebuilding - Restricted cash and cash equivalents increased$8.1 million fromOctober 31, 2018 to$20.9 million atOctober 31, 2019 . The increase was primarily due to cash collateral for new letters of credit issued during the period. Investments in and advances to unconsolidated joint ventures increased$3.3 million during the fiscal year endedOctober 31, 2019 compared toOctober 31, 2018 . The increase was primarily due to the income from two of our joint ventures during fiscal 2019, along with new capital contributions for existing joint ventures and a new joint venture during fiscal 2019, partially offset by a note receivable from one of our joint ventures that was paid off the fourth quarter of fiscal 2019, along with partner distributions during the period. As ofOctober 31, 2019 andOctober 31, 2018 , we had investments in ten and nine 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 increased$9.7 million fromOctober 31, 2018 to$44.9 million atOctober 31, 2019 . The increase was primarily due to an increase in receivables for reimbursements of expenditures in connection with certain structured lot option agreements, along with increased receivables related to the timing of home closings during the period, as well as a new insurance receivable for premium adjustments and a new receivable related to the funding of the Satisfaction and Discharge as described under " - Capital Resources and Liquidity". These increases were partially offset by a decrease related the return of a municipal receivable during the period.
Prepaid expenses and other assets were as follows as of:
October 31, October 31,
(In thousands) 2019 2018 Dollar Change
Prepaid insurance $2,061 $2,514 $(453 )
Prepaid project costs 32,015 28,667 3,348
Other prepaids 10,808 7,505 3,303
Other assets 820 464 356
Total $45,704 $39,150 $6,554
Prepaid insurance decreased slightly 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
prepaids are expensed as homes are delivered, and therefore have increased as
our community count has increased. Other prepaids increased primarily due to
costs associated with the refinancing of our senior secured revolving credit
facility in the fourth quarter of fiscal 2019.
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Financial services assets consist primarily of residential mortgages receivable held for sale of which$163.0 million and$129.0 million atOctober 31, 2019 and 2018, respectively, were being temporarily warehoused and are awaiting sale in the secondary mortgage market. The increase in mortgage loans held for sale fromOctober 31, 2018 was primarily related to an increase in the volume of loans originated during the fourth quarter of 2019 compared to the fourth quarter of 2018, partially offset by a decrease in the average loan value. Nonrecourse mortgages secured by inventory increased to$203.6 million atOctober 31, 2019 , from$95.6 million atOctober 31, 2018 . The increase was primarily due to a new mortgage on several communities that are part of a consolidated joint venture entered into in the second quarter of fiscal 2019, along with new mortgages for other communities in most of our segments obtained during fiscal 2019, as well as additional loan borrowings on existing mortgages, partially offset by the payment of existing mortgages during the period.
Accounts payable and other liabilities are as follows as of:
October 31, October 31,
(In thousands) 2019 2018 Dollar Change
Accounts payable $141,667 $127,795 $13,872
Reserves 92,083 99,229 (7,146 )
Accrued expenses 19,208 14,884 4,324
Accrued compensation 53,157 53,200 (43 )
Other liabilities 14,078 9,791 4,287
Total $320,193 $304,899 $15,294
The increase in accounts payable was primarily due to the increase in deliveries
in the fourth quarter of fiscal 2019 as compared to the fourth quarter of fiscal
2018. Reserves decreased during the period, primarily due to a reduction in our
construction defect reserves in connection with our annual assessment as our
loss experience has continued to improve over the past few years. Accrued
expenses increased primarily due to accruals for legal fees associated with the
2019 Transactions (as previously defined). Other liabilities increased primarily
due to several new municipal loans and bonds for land development issued during
the period.
Customers' deposits increased
Liabilities from inventory not owned increased$77.6 million to$141.0 million atOctober 31, 2019 . The increase was due an increase in land banking transactions during the period, along with an increase in the sale and leaseback of certain model homes, both of which are accounted for as financing transactions as described above. Accrued interest decreased$16.5 million to$19.1 million atOctober 31, 2019 . The decrease was primarily due to interest payments made on debt in connection with the 2019 Transactions (as previously defined) during the fourth quarter of fiscal 2019. Financial Services (liabilities) increased$25.7 million from$143.4 million atOctober 31, 2018 , to$169.1 million atOctober 31, 2019 . The increase is 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. 39
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Table of Contents Results of Operations Total Revenues
Compared to the prior period, revenues increased (decreased) as follows:
Year Ended
October 31, October 31, October 31,
(Dollars in thousands) 2019 2018 2017
Homebuilding:
Sale of homes $43,454 $(433,805 ) $(260,757 )
Land sales (15,066 ) (24,319 ) (27,445 )
Other revenues (3,502 ) 3,080 1,494
Financial services 797 (5,388 ) (13,874 )
Total change $25,683 $(460,432 ) $(300,582 )
Total revenues percent change 1.3 % (18.8 )% (10.9 )%
Homebuilding
Sale of homes revenues increased $43.5 million , or 2.3%, for the year ended
October 31, 2019 , decreased $433.8 million , or 18.5%, for the year ended October
31, 2018 , and decreased $260.8 million , or 10.0%, for the year ended October 31,
2017 as compared to the same period of the prior year. The increased revenues in
fiscal 2019 were primarily due to the number of home deliveries increasing 2.0%,
and the average price per home increasing to $394,194 in fiscal 2019 from
$393,280 in fiscal 2018. The increase in deliveries in fiscal 2019 were
primarily due to the result of an increase in community count in fiscal 2019 as
compared to fiscal 2018 of 14.6%. The decreased revenues in fiscal 2018 were
primarily due to the number of home deliveries decreasing 13.5% and the average
price per home decreasing to $393,280 in fiscal 2018 from $417,714 in fiscal
2017. The decreased revenues in fiscal 2017 were primarily due to the number of
home deliveries decreasing 13.3%, partially offset by the average price per home
increasing to $417,714 in fiscal 2017 from $402,350 in fiscal 2016. The decrease
in fiscal 2018 and 2017 deliveries were primarily the result of a reduction in
community count by 5.4% and 22.2%, respectively. The fluctuations in average
prices for fiscal 2019, 2018, and 2017 were primarily the result of geographic
and community mix of our deliveries. For fiscal 2018, there were also home price
decreases (which we increase or decrease in communities depending on the
respective community's performance), partially offset by price increases in some
communities primarily in the West. For fiscal 2017, we were also able to raise
home prices in certain communities. For further detail on changes in segment
revenues see "Homebuilding Operations by Segment" below. For further detail on
land sales and other revenue, see the section titled "Land Sales and Other
Revenues" below.
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Information on homes delivered by segment is set forth below:
Year Ended
October 31, October 31, October 31,
(Housing Revenue in thousands) 2019 2018 2017
Northeast:
Housing revenues $116,889 $96,012 $166,752
Homes delivered 192 178 351
Average price $608,797 $539,393 $475,077
Mid-Atlantic:
Housing revenues $356,674 $354,153 $463,271
Homes delivered 652 672 856
Average price $547,046 $527,013 $541,205
Midwest:
Housing revenues $203,734 $196,307 $199,009
Homes delivered 680 662 640
Average price $299,609 $296,536 $310,951
Southeast:
Housing revenues $219,860 $237,948 $257,066
Homes delivered 545 596 614
Average price $403,413 $399,242 $418,675
Southwest:
Housing revenues $627,201 $637,568 $826,422
Homes delivered 1,866 1,873 2,357
Average price $336,121 $340,399 $350,624
West:
Housing revenues $425,324 $384,240 $427,513
Homes delivered 1,011 866 784
Average price $420,696 $443,695 $545,297
Consolidated total:
Housing revenues $1,949,682 $1,906,228 $2,340,033
Homes delivered 4,946 4,847 5,602
Average price $394,194 $393,280 $417,714
Unconsolidated joint ventures:(1)
Housing revenues $485,324 $599,979 $310,573
Homes delivered 774 984 547
Average price $627,034 $609,735 $567,774 (1) Represents housing revenue 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 20 to the Consolidated Financial Statements for a further discussion of our joint ventures.
The increase in housing revenues during year endedOctober 31, 2019 , as compared to year endedOctober 31, 2018 , was primarily attributed to our increased deliveries, as our community count has increased year over year, and by the increase in average sales price. Housing revenues in fiscal 2019 increased in all of our homebuilding segments combined by 2.3%, and average sales price increased by 0.2%, excluding unconsolidated joint ventures. In our homebuilding segments, homes delivered increased in fiscal 2019 as compared to fiscal 2018 by 7.9%, 2.7% and 16.7% in the Northeast, Midwest and West, respectively, and decreased by 3.0%, 8.6% and 0.4% in the Mid-Atlantic, Southeast and Southwest, respectively. Overall in fiscal 2019 as compared to fiscal 2018 homes delivered increased 2.0% across all our segments, excluding unconsolidated joint ventures. The decrease in housing revenues during year endedOctober 31, 2018 , as compared to year endedOctober 31, 2017 , was primarily attributed to our decreased deliveries, as our community count decreased year over year, and by the decrease in average sales price. Housing revenues in fiscal 2018 decreased in all of our homebuilding segments combined by 18.5%, and average sales price decreased by 5.8%, excluding unconsolidated joint ventures. In our homebuilding segments, homes delivered decreased in fiscal 2018 as compared to fiscal 2017 by 49.3%, 21.5%, 2.9% and 20.5% in the Northeast, Mid-Atlantic, Southeast and Southwest, respectively, and increased by 3.4% and 10.5% in the Midwest and West, respectively. Overall in fiscal 2018 as compared to fiscal 2017 homes delivered decreased 13.5% across all our segments, excluding unconsolidated joint ventures. 41
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Quarterly housing revenues and net sales contracts by segment, excluding unconsolidated joint ventures, for the years endedOctober 31, 2019 , 2018 and 2017 are set forth below (net contracts are defined as new contracts executed during the period for the purchase of homes, less cancellations of contracts in the same period): Quarter Ended October 31, July 31, April 30, January 31, (In thousands) 2019 2019 2019 2019 Housing revenues: Northeast$70,650 $20,694 $13,040 $12,505 Mid-Atlantic 135,866 86,811 80,818 53,179 Midwest 68,714 47,261 42,870 44,889 Southeast 76,414 50,217 49,346 43,883 Southwest 213,089 152,615 143,634 117,863 West 127,413 110,251 97,844 89,816 Consolidated total$692,146 $467,849 $427,552 $362,135 Sales contracts (net of cancellations): Northeast$37,860 $37,560 $62,580 $34,950 Mid-Atlantic 86,296 99,807 118,245 81,514 Midwest 54,682 58,794 68,744 37,046 Southeast 69,765 58,648 64,772 40,460 Southwest 166,723 202,553 192,630 115,338 West 102,460 131,483 120,616 57,018 Consolidated total$517,786 $588,845 $627,587 $366,326 Quarter Ended October 31, July 31, April 30, January 31, (In thousands) 2018 2018 2018 2018 Housing revenues: Northeast$25,606 $26,701 $23,513 $20,192 Mid-Atlantic 99,493 79,593 104,058 71,009 Midwest 67,395 45,579 42,816 40,517 Southeast 72,828 47,472 60,974 56,674 Southwest 193,000 157,406 158,958 128,204 West 135,353 86,108 77,798 84,981 Consolidated total$593,675 $442,859 $468,117 $401,577 Sales contracts (net of cancellations): Northeast$16,044 $18,045 $15,278 $25,363 Mid-Atlantic 84,027 76,324 117,399 63,213 Midwest 44,167 43,596 67,308 49,416 Southeast 41,126 71,381 62,741 50,455 Southwest 123,485 177,174 198,487 141,458 West 83,933 102,183 93,213 69,397 Consolidated total$392,782 $488,703 $554,426 $399,302 42
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Quarter Ended
October 31, July 31, April 30, January 31,
(In thousands) 2017 2017 2017 2017
Housing revenues:
Northeast $27,913 $40,015 $45,917 $52,907
Mid-Atlantic 149,881 113,111 100,120 100,159
Midwest 72,944 40,620 41,794 43,651
Southeast 78,267 68,408 54,005 56,386
Southwest 209,223 209,041 224,898 183,260
West 128,555 103,087 100,819 95,052
Consolidated total $666,783 $574,282 $567,553 $531,415
Sales contracts (net of cancellations):
Northeast $24,407 $26,648 $29,918 $38,045
Mid-Atlantic 77,112 97,017 123,045 102,246
Midwest 38,139 48,257 61,489 45,566
Southeast 56,354 73,896 55,577 46,451
Southwest 142,926 177,285 227,500 170,884
West 91,048 103,342 142,522 84,423
Consolidated total $429,986 $526,445 $640,051 $487,615
Contracts per average active selling community in fiscal 2019 were 39.0 compared
to fiscal 2018 of 35.9. Our reported level of sales contracts (net of
cancellations) has been positively impacted by an increase in community count,
along with an increase in the pace of sales in most of the Company's segments
during fiscal 2019. 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 2019 2018 2017 2016 2015
First 24 % 18 % 19 % 20 % 16 %
Second 19 % 17 % 18 % 19 % 16 %
Third 19 % 19 % 19 % 21 % 20 %
Fourth 21 % 23 % 22 % 20 % 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 2019 2018 2017 2016 2015
First 16 % 12 % 12 % 13 % 11 %
Second 20 % 15 % 16 % 14 % 14 %
Third 16 % 14 % 13 % 12 % 13 %
Fourth 14 % 13 % 12 % 11 % 12 %
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, the contract cancellations over the past several
years have been within what we believe to be a normal range. However, market
conditions remain uncertain and it is difficult to predict what cancellation
rates will be in the future.
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An important indicator of our future results is recently signed contracts and
our home contract backlog for future deliveries. Our consolidated contract
backlog, excluding unconsolidated joint ventures, by segment is set forth below:
October 31, October 31, October 31,
(Dollars in thousands) 2019 2018 2017
Northeast:
Total contract backlog $86,557 $30,496 $51,778
Number of homes 152 51 98
Mid-Atlantic: (1)
Total contract backlog $193,387 $180,546 $185,123
Number of homes 343 296 309
Midwest:
Total contract backlog $122,681 $107,149 $98,969
Number of homes 450 394 382
Southeast:
Total contract backlog $121,921 $108,137 $120,382
Number of homes 282 251 285
Southwest:
Total contract backlog $230,898 $180,854 $177,818
Number of homes 663 523 509
West:
Total contract backlog $124,700 $138,448 $173,963
Number of homes 301 311 400
Totals: (1)
Total consolidated contract backlog $880,144 $745,630 $808,033
Number of homes 2,191 1,826 1,983
(1) Contract backlog as of
one of our joint ventures at the time of the joint venture formation.
Contract backlog dollars increased 18.0% as of October 31, 2019 compared to
October 31, 2018 , and the number of homes in backlog increased 20.0% for the
same period. The increase in backlog was driven by a 14.3% increase in net
contracts and the increase in community count for the year ended October 31,
2019 compared to the prior fiscal year. In the month of November 2019 , excluding
unconsolidated joint ventures, we signed an additional 404 net contracts
amounting to $159.1 million in contract value.
Total cost of sales on our 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.
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Year Ended
October 31, October 31, October 31,
(Dollars in thousands) 2019 2018 2017
Sale of homes $1,949,682 $1,906,228 $2,340,033
Cost of sales, excluding interest expense and
land charges 1,596,237 1,555,894 1,937,116
Homebuilding gross margin, before cost of
sales interest expense and land charges 353,445 350,334 402,917
Cost of sales interest expense, excluding land
sales interest expense 70,520 56,588 76,902
Homebuilding gross margin, after cost of sales
interest expense, before land charges 282,925 293,746 326,015
Land charges 6,288 3,501 17,813
Homebuilding gross margin $276,637 $290,245 $308,202
Gross margin percentage 14.2 % 15.2 % 13.2 %
Gross margin percentage, before cost of sales
interest expense and land charges 18.1 % 18.4 % 17.2 %
Gross margin percentage, after cost of sales
interest expense, before land charges 14.5 % 15.4 % 13.9 %
Cost of sales expenses as a percentage of consolidated home sales revenues are
presented below:
Year Ended
October 31, October 31, October 31,
2019 2018 2017
Sale of homes 100.0 % 100 % 100 %
Cost of sales, excluding interest expense and
land charges:
Housing, land and development costs 72.1 % 71.9 % 73.1 %
Commissions 3.7 % 3.6 % 3.4 %
Financing concessions 1.4 % 1.2 % 1.2 %
Overheads 4.7 % 4.9 % 5.1 %
Total cost of sales, before interest expense
and land charges 81.9 % 81.6 % 82.8 %
Cost of sales interest 3.6 % 3.0 % 3.3 %
Land charges 0.3 % 0.2 % 0.7 %
Gross margin percentage 14.2 % 15.2 % 13.2 %
Gross margin percentage, before cost of sales
interest expense and land charges 18.1 % 18.4 % 17.2 %
Gross margin percentage, after cost of sales
interest expense and before land charges 14.5 % 15.4 % 13.9 %
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 14.2% for the year ended
October 31, 2019 compared to 15.2% for the same period last year. This decrease
was primarily due to the increase in cost of sales interest as previously
discussed in " - Overview." Also contributing to the decrease is the mix of
communities delivering compared to the same period of the prior year, along with
a slight increase in direct costs and financing concessions. Total homebuilding
gross margin percentage increased to 15.2% for the year ended October 31, 2018
compared to 13.2% for the same period of the prior year. This increase was
primarily due to the mix of communities delivering homes and the reduction of
our warranty reserves, as a result of our annual analysis performed in the
fourth quarter of each year, along with a $6.3 million benefit from a one-time
credit related to a land development reimbursement from a municipality in
California . For the years ended October 31, 2019 , 2018 and 2017, gross margin
was favorably impacted by the reversal of prior period inventory impairments of
$37.7 million , $51.7 million and $74.4 million , respectively, which represented
1.9%, 2.7% and 3.2%, respectively, of "Sale of homes" revenue.
Reflected as inventory impairment loss and land option write-offs in cost of
sales ("land charges"), we have written off or written down certain inventories
totaling $6.3 million , $3.5 million and $17.8 million during the years ended
October 31, 2019 , 2018 and 2017, respectively, to their estimated fair value.
See Note 12 to the Consolidated Financial Statements for an additional
discussion. During the years ended October 31, 2019 , 2018 and 2017, we wrote off
residential land options and approval and engineering costs totaling $3.6
million , $1.4 million and $2.7 million , respectively, which are included in the
total land charges mentioned 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 segments in fiscal 2019, 2018 and 2017. The
inventory impairments amounted to $2.7 million , $2.1 million and $15.1 million
for the years ended October 31, 2019 , 2018 and 2017, respectively. 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.
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Below is a breakdown of our lot option walk-aways and impairments by segment for fiscal 2019. In fiscal 2019, we walked away from 22.3% of all the lots we controlled under option contracts. The remaining 77.7% of our option lots are in communities that we believe remain economically feasible. The following table represents lot option walk-aways by segment for the year endedOctober 31, 2019 : Walk- Away Dollar Number of % of Lots as a Amount Walk- Walk- Total % of Total of Walk Away Away Option Option (Dollars in millions) Away Lots Lots Lots(1) Lots Northeast$0.6 880 17.1 % 3,681 23.9 % Mid-Atlantic 0.5 976 18.9 % 3,906 25.0 % Midwest 0.9 901 17.5 % 3,427 26.3 % Southeast 0.3 825 16.0 % 3,806 21.7 % Southwest 0.6 778 15.1 % 5,856 13.3 % West 0.7 793 15.4 % 2,481 32.0 % Total$3.6 5,153 100.0 % 23,157 22.3 %
(1) Includes lots optioned at
walked away from in the year ended October 31, 2019 .
The following table represents impairments by segment for the year ended October
31, 2019 :
Dollar Pre- % of Pre-
Amount of % of Impairment Impairment
(In millions) Impairment Impairments Value(1) Value
Northeast $0.2 7.4 % $7.8 2.6 %
Mid-Atlantic 0.3 11.1 % 1.7 17.6 %
Midwest 1.4 51.9 % 4.6 30.4 %
Southeast 0.7 25.9 % 2.2 31.8 %
Southwest 0.1 3.7 % 1.2 8.3 %
West - - % - - %
Total $2.7 100.0 % $17.5 15.4 %
(1) Represents carrying value, net of prior period impairments, if any, at the
time of recording the applicable period's impairments.
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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:
Year Ended
October 31, October 31, October 31,
(In thousands) 2019 2018 2017
Land and lot sales $9,211 $24,277 $48,596
Cost of sales, excluding interest 8,540 10,661 24,688
Land and lot sales gross margin, excluding interest 671 13,616 23,908
Land and lot sales interest expense 205
4,097 11,634
Land and lot sales gross margin, including interest
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. There were six land sales in the year endedOctober 31, 2019 , compared to four in the same period of the prior year, resulting in a$15.1 million decrease in land sales revenue. Despite an increase in the number of land sales in fiscal 2019, there was a significant land sale in the Northeast segment in fiscal 2018 which resulted in the decrease in land sales revenue during fiscal 2019. There were four land sales in the year endedOctober 31, 2018 , compared to ten in the same period of the prior year, resulting in a$24.3 million decrease in land sales revenue. Land sales and other revenues decreased$18.6 million for the year endedOctober 31, 2019 and decreased$21.2 million for the year endedOctober 31, 2018 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 decrease from fiscal 2018 to fiscal 2019 and the decrease from fiscal 2017 to fiscal 2018 was mainly due to the fluctuations in land sales revenue noted above. Slightly offsetting the decrease from fiscal 2017 to fiscal 2018 was the gain recognized from the sale of our former corporate headquarters building in the first quarter of fiscal 2018.
Homebuilding Selling, General and Administrative
Homebuilding selling, general and administrative ("SGA") expenses increased $7.6
million to $166.8 million for the year ended October 31, 2019 as compared to the
year ended October 31, 2018 . The increase was primarily related to a decrease of
joint venture management fees received of $4.2 million , which offset general and
administrative expenses, as a result of less unconsolidated joint venture
deliveries, and $3.3 million less of a reduction of our construction defect
reserves (a $6.9 million reduction in fiscal 2019 as compared to $10.2 million
reduction in fiscal 2018) based on our annual actuarial analysis. SGA decreased
$37.1 million to $159.2 million for the year ended October 31, 2018 as compared
to the year ended October 31, 2017 . The decrease was primarily related to a
$10.2 million reduction in our construction defect reserves based on our annual
actuarial analysis, along with a $2.3 million reduction for a litigation
settlement, and $12.5 million of additional reserves recorded in fiscal 2017
related to the Grandview II litigation. The remaining decrease is due to the
reduction of our community count, a decrease in insurance costs and the increase
of joint venture management fees received, which offset general and
administrative expenses, as a result of more joint venture deliveries.
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Homebuilding Operations by Segment
Financial information relating to the Company's operations was as follows:
Segment Analysis (Dollars in thousands, except average sales price)
Years Ended October 31,
Variance Variance
2019 2018
Compared Compared
2019 to 2018 2018 to 2017 2017
Northeast
Homebuilding revenue $124,372 $8,076 $116,296 $(93,213 ) $209,509
Income before income taxes $20,954 $85 $20,869 $18,569 $2,300
Homes delivered 192 14 178 (173 ) 351
Average sales price $608,797 $69,404 $539,393 $64,316 $475,077
Mid-Atlantic
Homebuilding revenue $357,247 $2,557 $354,690 $(109,436 ) $464,126
Income before income taxes $14,327 $(4,430 ) $18,757 $1,566 $17,191
Homes delivered 652 (20 ) 672 (184 ) 856
Average sales price $547,046 $20,033 $527,013 $(14,192 ) $541,205
Midwest
Homebuilding revenue $204,461 $7,862 $196,599 $(3,171 ) $199,770
(Loss) income before income taxes $(649 ) $(2,177 ) $1,528 $2,679 $(1,151 )
Homes delivered 680 18 662 22 640
Average sales price $299,609 $3,073 $296,536 $(14,415 ) $310,951
Southeast
Homebuilding revenue $220,082 $(21,538 ) $241,620 $(18,782 ) $260,402
Loss before income taxes $(10,060 ) $(146 ) $(9,914 ) $(3,715 ) $(6,199 )
Homes delivered 545 (51 ) 596 (18 ) 614
Average sales price $403,413 $4,171 $399,242 $(19,433 ) $418,675
Southwest
Homebuilding revenue $629,344 $(8,938 ) $638,282 $(189,221 ) $827,503
Income before income taxes $33,459 $(16,393 ) $49,852 $(21,688 ) $71,540
Homes delivered 1,866 (7 ) 1,873 (484 ) 2,357
Average sales price $336,121 $(4,278 ) $340,399 $(10,225 ) $350,624
West
Homebuilding revenue $425,516 $40,889 $384,627 $(45,919 ) $430,546
Income before income taxes $40,018 $(7,969 ) $47,987 $28,351 $19,636
Homes delivered 1,011 145 866 82 784
Average sales price $420,696 $(22,999 ) $443,695 $(101,602 ) $545,297 Homebuilding Results by Segment
Northeast - Homebuilding revenues increased 6.9% in fiscal 2019 compared to fiscal 2018 primarily due to a 7.9% increase in homes delivered and a 12.9% increase in average selling price, partially offset by a$12.8 million decrease in land sales and other revenue. 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 fiscal 2019 compared to certain communities delivering in fiscal 2018 that had lower priced, single family homes and townhomes in lower-end submarkets of the segment that are no longer delivering. Income before income taxes increased$0.1 million to$21.0 million , which was mainly due to the increase in homebuilding revenues discussed above and the increase in gross margin percentage before interest expense for fiscal 2019 compared to fiscal 2018. This increase was partially offset by a$1.0 million decrease in income from unconsolidated joint ventures and a$0.5 million increase in selling, general and administrative costs for fiscal 2019 compared to fiscal 2018. Homebuilding revenues decreased 44.5% in fiscal 2018 compared to fiscal 2017 primarily due to a 49.3% decrease in homes delivered, partially offset by a 13.5% increase in average selling price. The increase in average sales price was the result of some new communities delivering higher priced single family homes in higher-end submarkets of the segment in fiscal 2018 compared to certain communities delivering in fiscal 2017 that had lower priced single family homes in similar submarkets of the segment that are no longer delivering. Also impacting the increase in average sales price was higher option revenue and location premiums and the result of our ability to raise prices in fiscal 2018 in certain communities that were delivering homes during both periods. 48
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Income before income taxes increased$18.6 million to$20.9 million , which was mainly due a$24.6 million improvement in loss from unconsolidated joint ventures to income, along with a$10.6 million decrease in selling, general and administrative costs and a$2.8 million decrease in inventory impairment loss and land option write-offs. The increase was partially offset by the decrease in homebuilding revenues discussed above and the decrease in gross margin percentage before interest expense for fiscal 2018 compared to fiscal 2017. Mid-Atlantic - Homebuilding revenues increased 0.7% in fiscal 2019 compared to fiscal 2018 primarily due to a 3.8% increase in average sales price, partially offset by a 3.0% decrease in homes delivered. 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 fiscal 2019 compared to certain communities delivering in fiscal 2018 that had lower priced, single family homes and townhomes in mid to higher-end submarkets of the segment that are no longer delivering.
Income before income taxes decreased
Homebuilding revenues decreased 23.6% in fiscal 2018 compared to fiscal 2017 primarily due to a 21.5% decrease in homes delivered and a 2.6% decrease in average sales price. The decrease in average sales price was the result of new communities delivering lower priced, smaller single family homes in lower-end submarkets of the segment in fiscal 2018 compared to certain communities delivering in fiscal 2017 that had higher priced, larger single family homes in higher-end submarkets of the segment that are no longer delivering. Income before income taxes increased$1.6 million to$18.8 million , due mainly to a$2.3 million decrease in selling, general and administrative costs and a$1.9 million decrease in inventory impairment loss and land option write-offs and a slight increase in gross margin percentage before interest expense for fiscal 2018 compared to fiscal 2017. Midwest - Homebuilding revenues increased 4.0% in fiscal 2019 compared to fiscal 2018 primarily due to a 2.7% increase in homes delivered and a 1.0% 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 fiscal 2019 compared to certain communities delivering in fiscal 2018 that had lower priced, smaller single family homes in lower-end submarkets of the segment that are no longer delivering. Also impacting the increase in average sales price was higher option revenue in certain communities. Income before taxes decreased$2.2 million to a loss of$0.6 million . The decrease was primarily due to a$2.0 million increase in selling, general and administrative costs and a$2.1 million increase in inventory impairment loss and land option write-offs, while gross margin percentage before interest expense was flat for fiscal 2019 compared to fiscal 2018. Homebuilding revenues decreased 1.6% in fiscal 2018 compared to fiscal 2017. There was a 4.6% decrease in average sales price, partially offset by a 3.4% increase in homes delivered. The decrease in average sales price was the result of new communities delivering lower priced, smaller single family homes in lower-end submarkets of the segment in fiscal 2018 compared to certain communities delivering in fiscal 2017 that had higher priced, larger single family homes in higher-end submarkets of the segment that are no longer delivering. Loss before income taxes improved$2.7 million to income of$1.5 million . The improvement was primarily due to a$2.7 million decrease in selling, general and administrative costs and the$0.6 million decrease in loss from unconsolidated joint ventures, partially offset by a slight decrease in gross margin percentage before interest expense. Southeast - Homebuilding revenues decreased 8.9% in fiscal 2019 compared to fiscal 2018 primarily due to an 8.6% decrease in homes delivered, partially offset by a 1.0% increase in average sales price. The increase in average sales price was the result of new communities delivering higher priced, single family homes in higher-end submarkets of the segment in fiscal 2019 compared to certain communities delivering in fiscal 2018 that had lower priced, smaller single family homes and townhomes in lower-end submarkets of the segment that are no longer delivering. Also impacting the increase in average sales price was higher option revenue in certain communities. Loss before income taxes increased$0.1 million to a loss of$10.0 million due to the decrease in homebuilding revenue discussed above and a$1.2 million increase in selling, general and administrative costs, partially offset by a$0.6 million decrease in inventory impairment loss and land option write-offs, a$3.3 million improvement in loss from unconsolidated joint ventures to income and a slight increase in gross margin percentage before interest expense for fiscal 2019 compared to fiscal 2018. 49
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Homebuilding revenues decreased 7.2% in fiscal 2018 compared to fiscal 2017. The decrease was primarily due to a 2.9% decrease in homes delivered and a 4.6% decrease in average sales price. The decrease in average sales price was the result of new communities delivering lower priced, single family homes and townhomes in lower-end submarkets of the segment in fiscal 2018 compared to some communities delivering in fiscal 2017 that had higher priced, larger single family homes and townhomes in higher-end submarkets of the segment that are no longer delivering. Loss before income taxes increased$3.7 million to a loss of$9.9 million due to the decrease in homebuilding revenue discussed above, a$1.6 million increase in selling, general and administrative costs and a$2.9 million decrease in income from unconsolidated joint ventures to a loss, partially offset by a$7.3 million decrease in inventory impairment loss and land option write-offs. Additionally, the gross margin percentage before interest expense was flat for fiscal 2018 compared to fiscal 2017. Southwest - Homebuilding revenues decreased 1.4% in fiscal 2019 compared to fiscal 2018 primarily due to a 0.4% decrease in homes delivered and a 1.3% decrease in average sales price. The decrease in average sales price was the result of new communities delivering lower priced, smaller single family homes in lower-end submarkets of the segment in fiscal 2019 compared to some communities delivering in fiscal 2018 that had higher priced, larger single family homes in higher-end submarkets of the segment that are no longer delivering. Income before income taxes decreased$16.4 million to$33.5 million in fiscal 2019 mainly due to the decrease in homebuilding revenues discussed above and a decrease in gross margin percentage before interest expense for fiscal 2019 compared to fiscal 2018, partially offset by a$2.8 million increase in income from unconsolidated joint ventures and a$1.9 million decrease in selling, general and administrative costs. Homebuilding revenues decreased 22.9% in fiscal 2018 compared to fiscal 2017 primarily due to a 20.5% decrease in homes delivered and a 2.9% decrease in average sales price. The decrease in average sales price was the result of new communities delivering lower priced, smaller single family homes in lower-end submarkets of the segment in fiscal 2018 compared to some communities delivering in fiscal 2017 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 decreased$21.7 million to$49.9 million in fiscal 2018 mainly due to the decrease in homebuilding revenues discussed above, partially offset by a$5.5 million increase in income from unconsolidated joint ventures. Additionally, the gross margin percentage before interest expense was flat for fiscal 2018 compared to fiscal 2017. West - Homebuilding revenues increased 10.6% in fiscal 2019 compared to fiscal 2018 primarily due to a 16.7% increase in homes delivered, partially offset by a 5.2% decrease in average sales price. The decrease in average sales price was the result of new communities delivering lower priced, smaller single family homes in lower-end submarkets of the segment in fiscal 2019 compared to some communities delivering in fiscal 2018 that had higher priced, larger single family homes in higher-end submarkets of the segment that are no longer delivering. Income before income taxes decreased$8.0 million to$40.0 million in fiscal 2019 due mainly to a$4.1 million increase in selling, general and administrative costs, a$3.2 million decrease in income from unconsolidated joint ventures to a loss and a slight decrease in gross margin percentage before interest expense. Homebuilding revenues decreased 10.7% in fiscal 2018 compared to fiscal 2017 primarily due to an 18.6% decrease in average sales price and a$2.6 million decrease in land sales and other revenue, partially offset by 10.5% increase in homes delivered. The decrease in average sales price was the result of new communities delivering lower priced, single family homes in lower-end submarkets of the segment in fiscal 2018 compared to some communities delivering in fiscal 2017 that had higher priced, single family homes in higher-end submarkets of the segment that are no longer delivering. Partially offsetting the decrease in average sales price was the impact of price increases in certain communities within the segment. Income before income taxes increased$28.4 million to$48.0 million in fiscal 2018 due mainly to an increase in gross margin percentage before interest expense, along with a$3.6 million increase in income from unconsolidated joint ventures and a$1.8 million decrease in inventory impairment loss and land option write-offs. This increase in income was partially offset by a$4.7 million increase in selling, general and administrative costs. 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 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 years endedOctober 31, 2019 , 2018 and 2017, our conforming conventional loan originations as a percentage of our total loans were 65.8%, 69.8% and 69.0%, respectively. FHA/VA loans represented 29.8%, 24.6%, and 25.1%, respectively, of our total loans. The remaining 4.4%, 5.6% and 5.9% of our loan originations represent jumbo and/orUSDA loans. 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. 50
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During the years endedOctober 31, 2019 , 2018, and 2017, financial services provided a$17.6 million ,$18.2 million and$26.4 million pretax profit, respectively. In fiscal 2019, financial services pretax profit decreased$0.6 million primarily due to the geographic mix of title company activity within each period. In fiscal 2018, financial services pretax profit decreased$8.2 million compared to fiscal 2017 due to the decrease in homebuilding deliveries, and the decrease in the basis point spread between the loans originated and the implied rate from the sale of the loans as a result of the competitive financial services market and recent increases in mortgage rates. In the market areas served by our wholly owned mortgage banking subsidiaries, 70.9%, 72.4%, and 67.8% of our noncash home buyers obtained mortgages originated by these subsidiaries during the years endedOctober 31, 2019 , 2018, and 2017, respectively.
Corporate General and Administrative
Corporate general and administrative expenses include the operations at our headquarters inNew Jersey . These expenses include payroll, stock compensation, legal expenses, rent and facility costs and other costs associated with our executive offices, 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 decreased$3.3 million for the year endedOctober 31, 2019 compared to the year endedOctober 31, 2018 , and increased$10.3 million for the year endedOctober 31, 2018 compared to the year endedOctober 31, 2017 . The decrease in expense for fiscal 2019 was due to decreased legal fees (including litigation) related to financing transactions and higher costs for ongoing litigations involving the Company during fiscal 2018 which did not recur in fiscal 2019, along with a decrease in stock compensation expense, primarily due to the cancellation of certain stock awards that did not meet their performance criteria in fiscal 2019. Also impacting the decrease for fiscal 2019 is an increase in the adjustment to reserves for self-insured medical claims, which were reduced based on claim estimates. The increase in expense for fiscal 2018 was primarily due to increased legal (including litigation) fees related to our fiscal 2018 financing transactions and higher costs for ongoing litigations involving the Company. Also contributing to the increase in corporate general and administrative expenses was rent expense incurred during the year endedOctober 31, 2018 , related to (i) the sale and leaseback of our former corporate headquarters building for the period fromNovember 2017 toFebruary 2018 , and (ii) our new corporate headquarters building which we moved into inFebruary 2018 . Additionally impacting the increase was an increase in stock compensation expense in fiscal 2018, as a result of lower expense in fiscal 2017, resulting from the forfeiture of compensation under our long-term incentive plan due to the retirement of a senior executive, along with the cancellation of certain stock awards that did not meet their performance criteria. Other Interest Other interest decreased$13.2 million to$90.1 million for the year endedOctober 31, 2019 compared toOctober 31, 2018 , and increased$6.0 million to$103.3 million for the year endedOctober 31, 2018 compared toOctober 31, 2017 . Our assets that qualify for interest capitalization (inventory under development) are less than our debt, and therefore a portion of interest not covered by qualifying assets must be directly expensed. In fiscal 2019, the decrease was due to our assets that qualify for interest capitalization increasing by more than our debt, therefore the amount of directly expensed interest decreased. In fiscal 2018, the increase was attributed to more interest incurred as a result of the senior secured notes issued inJuly 2017 that have a higher interest rate than the senior secured notes which they refinanced and additional amounts outstanding under the term loan facility in fiscal 2018 compared to fiscal 2017.
Loss on Extinguishment of Debt
As a result of the 2019 Transactions we consummated onOctober 31, 2019 and discussed above under "- Capital Resources and Liquidity - Debt Transactions" and under Note 9 to the Consolidated Financial Statements. We incurred a$42.4 million loss on extinguishment of debt, a majority of which was non-cash. We incurred a$7.5 million loss on extinguishment of debt during the year endedOctober 31, 2018 due to several financing and refinancing transactions completed in fiscal 2018 as described in Note 9 to the Consolidated Financial Statements under " - Fiscal 2018." We incurred a$34.9 million loss on extinguishment of debt during the year endedOctober 31, 2017 due to three items that occurred during fiscal 2017. First, we repurchased in open market transactions$31.5 million aggregate principal amount of Senior Notes and 6,925 senior exchangeable note units representing$6.9 million stated amount of senior exchangeable note units. The aggregate purchase price for these transactions was$30.8 million , plus accrued and unpaid interest. These transactions resulted in a gain on extinguishment of debt of$7.8 million . Second, we incurred$0.4 million of costs associated with the Senior Secured Notes issued during the fourth quarter of fiscal 2016. Third, we completed certain refinancing transactions as described in Note 9 to the Consolidated Financial Statements under " - Fiscal 2017," which resulted in a loss on extinguishment of debt of$42.3 million . 51
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Income (Loss) from
Income (loss) from unconsolidated joint ventures consists of our share of the earnings or losses of our joint ventures. Income (loss) from unconsolidated joint ventures increased$4.9 million for the year endedOctober 31, 2019 from income of$24.0 million for the year endedOctober 31, 2018 to income of$28.9 million . The increase is due to our share of income from certain of our joint ventures delivering more homes resulting in increased profits for fiscal 2019 compared to fiscal 2018. Income (loss) from unconsolidated joint ventures increased$31.0 million for the year endedOctober 31, 2018 from a loss of$7.0 million for the year endedOctober 31, 2017 to income of$24.0 million . The increase is due to the recognition of our share of income from certain of our joint ventures delivering more homes and increased profits in the current fiscal year as compared to the prior fiscal year when they reported losses primarily due to startup costs. Total Taxes The total income tax expense of$2.4 million and$3.6 million for the years endedOctober 31, 2019 and 2018 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. The total income tax expense of$286.9 million for the year endedOctober 31, 2017 was primarily due to increasing our valuation allowance to fully reserve against our deferred tax assets ("DTAs"). In addition, the same years were also impacted by state tax expense from income generated in some states, which was not offset by tax benefits in other states that had losses for which we fully reserve the net operating losses. Deferred federal and state income tax assets primarily represent the deferred tax benefits arising from net operating loss ("NOL") carryforwards and temporary differences between book and tax income which will be recognized in future years as an offset against future taxable income. If the combination of future years' income (or loss) and the reversal of the timing differences results in a loss, such losses can be carried forward to future years. In accordance with ASC 740, we evaluate our deferred tax assets ("DTAs") quarterly to determine if valuation allowances are required. ASC 740 requires that companies assess whether valuation allowances should be established based on the consideration of all available evidence using a "more likely than not" standard. As ofOctober 31, 2019 , we considered all available positive and negative evidence to determine whether, based on the weight of that evidence, our valuation allowance for our DTAs was appropriate in accordance with ASC 740. As listed in Note 11 to the Consolidated Financial Statements, in order of the weighting of each factor, is the available positive and negative evidence that we considered in determining that it is more likely than not that all of our DTAs will not be realized. In analyzing these factors, overall the negative evidence, both objective and subjective, outweighed the positive evidence. Based on this analysis, we determined that the current valuation allowance for deferred taxes of$623.2 million as ofOctober 31, 2019 , which fully reserves for our DTAs, is appropriate. Off-Balance Sheet Financing In the ordinary course of business, we enter into land and lot option purchase contracts in order to procure land or lots for the construction of homes. Lot option contracts enable us to control significant lot positions with a minimal capital investment and substantially reduce the risks associated with land ownership and development. AtOctober 31, 2019 , we had$70.0 million in option deposits in cash and letters of credit to purchase land and lots with a total purchase price of$1.3 billion . Our financial exposure is generally limited to forfeiture of the nonrefundable deposits, letters of credit and other nonrefundable amounts incurred. We have no material third-party guarantees.Unconsolidated Joint Ventures As discussed in Note 20 - Investments inUnconsolidated Joint Ventures in the Notes to Consolidated Financial Statements, we have investments in unconsolidated joint ventures in various markets where our homebuilding operations are located. Our unconsolidated joint ventures had total combined assets of$539.7 million atOctober 31, 2019 and$602.0 million atOctober 31, 2018 . Our investments in unconsolidated joint ventures totaled$127.0 million atOctober 31, 2019 and$123.7 million atOctober 31, 2018 . As ofOctober 31, 2019 and 2018, our unconsolidated joint ventures had outstanding debt totaling$186.9 and$236.7 million , respectively, under separate construction loan agreements with different third-party lenders and affiliates of certain investment partners to finance their respective land development activities, with the outstanding debt secured by the corresponding underlying property and related project assets and non-recourse to us. While we and our unconsolidated joint venture partners provide certain guarantees and indemnities to the lender, we do not have a guaranty or any other obligation to repay our outstanding debt or to support the value of the collateral underlying the outstanding debt. We do not believe that our existing exposure under our guaranty and indemnity obligations related to the outstanding debt is material to our consolidated financial statements. As discussed in Note 19 - Variable Interest Entities in the Notes to Consolidated Financial Statements. We determined that none of our joint ventures atOctober 31, 2019 and 2018 were a variable interest entity. All our unconsolidated joint ventures were accounted for under the equity method because we did not have a controlling financial interest. 52
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Table of Contents Contractual Obligations The following summarizes our aggregate contractual commitments atOctober 31, 2019 . Payments Due by Period (1) Less than More than (In thousands) Total 1 year 1-3 years 3-5 years 5 years Long term debt (2)(3)(4)$2,391,127 $139,331 $492,180 $440,704 $1,318,912 Operating leases 30,833 9,785 14,722 4,572 1,754 Total$2,421,960 $149,116 $506,902 $445,276 $1,320,666
(1) Total contractual obligations exclude our accrual for uncertain tax positions
of
2019 because we were unable to make reasonable estimates as to the period of
cash settlement with the respective taxing authorities.
(2) Represents our senior unsecured term loan credit facility, senior secured and
senior notes and other notes payable and
payments for the life of such debt.
(3) Does not include
inventory. These mortgages have various maturities spread over the next two
to three years and are paid off as homes are delivered.
(4) Does not include the mortgage warehouse lines of credit made under our Master
Repurchase Agreements. See"- Capital Resources and Liquidity." Also does not
include our
borrowings outstanding as of October 31, 2019 .
We had outstanding letters of credit and performance bonds of $19.2 million and
$202.9 million , respectively, at October 31, 2019 , related principally to our
obligations to local governments to construct roads and other improvements in
various developments. We do not believe that any such letters of credit or bonds
are likely to be drawn upon.
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 54.0% of our homebuilding cost of sales for fiscal 2019.
Safe Harbor Statement
All statements in this Annual Report on Form 10-K 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:
? 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;
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? 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;? 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 this Annual Report on Form 10-K as updated by our subsequent filings with theSEC . 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 Annual Report on Form 10-K. 54
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