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).
Key Performance Indicators
The following key performance indicators are commonly used in the homebuilding industry and by management as a means to better understand our operating performance, trends affecting our business and compare our performance with the performance of other homebuilders. We believe these key performance indicators also provide useful information to investors in analyzing our performance:
? Net contracts is a volume indicator which represents the number of new
contracts executed during the period for the purchase of homes, less
cancellations of contracts in the same period. The dollar value of net
contracts represents the dollars associated with net contracts
executed in the period. These values are an indicator of potential
future revenues;
? Contract backlog is a volume indicator which represents the number of
homes that are under contract, but not yet delivered as of the stated
date. The dollar value of contract backlog represents the dollar
amount of the homes in contract backlog. These values are an indicator
of potential future revenues;
? Active selling communities is a volume indicator which represents the
number of communities which are open for sale with ten or more homesites available as of the end of a period. We identify communities
based on product type; therefore at times there are multiple
communities at one land site. These values are an indicator of
potential revenues;
? Net contracts per average active selling community is used to indicate
the pace at which homes are being sold (put into contract) in active
selling communities and is calculated by dividing the number of net
contracts in a period by the average number of active selling
communities in the same period. Sales pace is an indicator of market
strength and demand; and
? Contract cancellation rates is a volume indicator which represents the
number of sales contracts cancelled in the period divided by the
number of gross sales contracts executed during the period. Contract
cancellation rates as a percentage of backlog is calculated by
dividing the number of cancelled contracts in the period by the
contract backlog at the beginning of the period. Cancellation rates as
compared to prior periods can be an indicator of market strength or
weakness.
Overview
Market Conditions and COVID-19 Impact and Strategy
The demand for new and existing homes is dependent on a variety of demographic and economic factors, including job and wage growth, household formation, consumer confidence, mortgage financing, interest rates and overall housing affordability. In general, at the start of our fiscal year, factors including rising levels of household formation, a constrained supply of new and used homes, wage growth, strong employment conditions and mortgage rates that continue to be low by historical standards were contributing to improving conditions for new home sales. However, this year, overall economic conditions inthe United States have been, and continue to be, impacted negatively by the COVID-19 pandemic, which has resulted in, among other things, quarantines, "stay-at-home" or "shelter-in-place" orders, and similar mandates from national, state and local governments that have substantially restricted daily activities and caused many businesses to curtail or cease normal operations. Notwithstanding these developments, all of the state and local governments in the markets in which we operate have deemed housing to be an essential business, which has allowed us to continue with construction and sales of homes. Although most of the states in which we operate have begun to resume normal business operations,the United States continues to struggle with rolling outbreaks of the virus. Accordingly, we cannot predict the magnitude of either the near-term or long-term effects that the pandemic will have on our business. Earlier this year, in response to the pandemic, we actively took steps to navigate through this extraordinary period by placing our highest priority on helping to protect the health and safety of our associates, trade partners and customers. Among other measures, we implemented appropriate health and safety protocols so that our community construction and sales activities, wherever authorized, could continue operations. During the second quarter of fiscal 2020 and the initial impact of COVID-19, we experienced adverse business conditions, including a slowdown in customer traffic and sales pace and an increase in cancellations. To mitigate the adverse impacts, we implemented initiatives to maximize positive cash flow, retain a strong liquidity position and optimize our organization, which included focusing on closing homes in backlog and limiting cash expenditures, reducing or delaying certain land purchases and land development activity and beginning work on unsold homes and electing to draw in full the$125.0 million available under its Secured Credit Agreement (which was repaid in the third quarter of fiscal 2020). Further, inMay 2020 , we announced certain operational optimization measures including streamlining the organizational structure by: (1) transitioning from three homebuilding operational Groups to two; (2) consolidating several business units, resulting in the reduction of three Divisional offices; and (3) gradually phasing out of theChicago market as it sells through its existing communities. In addition, we took measures to reduce overhead expenses through a combination of furloughs, layoffs and other cost reduction measures, the implementation of which was completed in early fiscal 2021. We incurred costs of$2.9 million for severance and other related expenses in the third quarter of fiscal 2020 as a result of this restructuring. We expect the measures described above to reduce our annualized overhead expense by approximately$20 million beginning in fiscal 2021. However, the recent improved conditions in the homebuilding market have led to increases in other selling, general and administrative costs, including for example, stock compensation and bonuses based on profitability, which we expect will more than offset these annualized savings. 23
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While the broader economic recovery following the nationwide COVID-19 related shutdown is ongoing and there continues to be uncertainty surrounding the virus and various re-opening strategies, the homebuilding industry generally was only impacted from mid-March through April of 2020. Towards the end of April, economic conditions in our markets started to improve, and this improvement continued throughout our fiscal third and fourth quarters, due to what we believe is a combination of factors including low interest rates, low inventory levels of existing homes and a general desire for more indoor and outdoor space. During the third quarter and continuing through the fourth quarter of fiscal 2020, we returned to our normal activities with respect to land purchases, land development and resuming the construction of unsold homes. As a result, our operating metrics improved significantly as compared to fiscal 2019, as described below. Although many of our key metrics have improved since the end of the second quarter of fiscal 2020, the full magnitude and duration of the COVID-19 pandemic is unknown. We may experience material declines in our net contracts, deliveries, revenues, cash flow and/or profitability during fiscal 2021 and beyond, compared to the corresponding prior-year periods, and compared to our expectations at the beginning of our 2020 fiscal year. In addition, if conditions in the overall housing market or in a specific market worsen in the future beyond our current expectations, if future changes in our business strategy significantly affect any key assumptions used in our projections of future cash flows, or if there are material changes in any of the other items we consider in assessing recoverability, we may recognize charges in future periods for inventory impairments related to our current inventory assets or other reorganization activities. Any such charges could be material to our consolidated financial statements. Operating Results
We experienced overall positive operating results for the year ended
Our cash position allowed us to spend
Additional results for the year ended
? For the year endedOctober 31, 2020 , sale of homes revenues increased 15.5% as compared to the prior year, as a result of a 15.0% increase in deliveries, primarily due to our increased community count that occurred during fiscal 2019 and our 39.2% increase in sales absorption pace in fiscal 2020 as compared to fiscal 2019. ? Gross margin percentage increased from 14.2% for the year endedOctober 31, 2019 to 14.7% for the year endedOctober 31, 2020 , and gross margin percentage, before cost of sales interest expense and land charges, increased from 18.1% for the year endedOctober 31, 2019 to 18.4% for the year endedOctober 31, 2020 . The increases were primarily due to the mix of communities delivering compared to the prior year, along with increases in home prices in virtually all of our markets during the last half of fiscal 2020. ? Selling, general and administrative costs (including corporate general and administrative expenses) increased$8.7 million for the year endedOctober 31, 2020 as compared to the prior year, primarily as a result of our increased community count at the beginning of the year and our 15.0% increase in deliveries, along with a lower adjustment to our warranty reserves (as a result of our annual actuarial analysis) in fiscal 2020 as compared to fiscal 2019. However, as a percentage of total revenue, such costs decreased to 10.3% for the year endedOctober 31, 2020 compared to 11.6% for the year endedOctober 31, 2019 . ? Pre-tax income increased to$55.4 million for the year endedOctober 31, 2020 from a pre-tax loss of$39.7 million for the year endedOctober 31, 2019 . Net income increased to$50.9 million for the year endedOctober 31, 2020 from a net loss of$42.1 million for the year endedOctober 31, 2019 . Earnings per share, basic and diluted, increased to$7.48 and$7.03 , respectively, for the year endedOctober 31, 2020 compared to loss per share of$7.06 , both basic and diluted, for the year endedOctober 31, 2019 .
? Net contracts increased 30.2% for the year ended
? Net contracts per average active selling community increased to 54.3 for the year endedOctober 31, 2020 compared to 39.0 in the prior year. This increase represents our highest net contracts per average active selling community in over a decade. This strong absorption pace resulted in our active selling communities atOctober 31, 2020 decreasing by 17.7% compared toOctober 31, 2019 . ? Contract backlog increased from 2,191 homes atOctober 31, 2019 to 3,402 homes atOctober 31, 2020 , with a dollar value of$1.4 billion , representing a 61.3% increase in dollar value compared to the prior year. 24
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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, 2020 , the net book value associated with our 12 mothballed
communities was $11.4 million , net of impairment charges recorded in prior
periods of $122.2 million . We regularly review communities to determine if
mothballing is appropriate. During fiscal 2020, we did not mothball any
additional communities, or sell any previously mothballed communities, but
we re-activated one previously mothballed community and also re-activated a
portion of one previously mothballed community.
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, 2020 , inventory of
$48.8 million was recorded to "Consolidated inventory not owned," with a
corresponding amount of $47.2 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, 2020 , inventory of$133.4 million was recorded as "Consolidated inventory not owned," with a corresponding amount of$84.0 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.
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.
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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, 2018 toOctober 31, 2020 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$2.0 million of our total inventories atOctober 31, 2020 , 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 2020, we did not write down any of our unconsolidated joint venture investments. During fiscal 2019, we recorded a$0.9 million write down in our investment in one of our unconsolidated joint ventures in the West. 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 2020 and 2019, our deductible under our general liability insurance was a$20 million aggregate for construction defect and warranty claims. For bodily injury claims, our deductible per occurrence in fiscal 2020 and 2019 was$0.25 million , up to a$5 million limit. Our aggregate retention for construction defect, warranty and bodily injury claims was$20 million for fiscal 2020 and 2019. 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. 27
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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 total liquidity atOctober 31, 2020 was$399.1 million , including$262.5 million in homebuilding cash and cash equivalents and$125.0 million of borrowing capacity under our senior secured revolving credit facility. This was above our target liquidity range of$170.0 to$245.0 million . The unprecedented public health and governmental efforts to contain the COVID-19 pandemic have created significant uncertainty as to general economic and housing market conditions for fiscal 2021 and beyond. We believe that these sources of cash together with available borrowings on our senior secured revolving credit facility will be sufficient through fiscal 2021 to finance our working capital requirements. We spent$624.2 million on land and land development during fiscal 2020. After considering this land and land development and all other operating activities, including revenue received from deliveries, we had$292.8 million in cash provided from operations. During fiscal 2020, cash provided by investing activities was$2.1 million , primarily due to distributions from existing unconsolidated joint ventures, partially offset by an investment in a new unconsolidated joint venture. Cash used in financing activities was$167.8 million during fiscal 2020, which was primarily due to net payments made on our mortgage warehouse lines of credit, along with net payments for nonrecourse mortgage financings and also debt repurchases during the period. We intend to continue to use nonrecourse mortgage financings, model sale leaseback, joint ventures, and, subject to covenant restrictions in our debt instruments, land banking programs as our business needs dictate. Our cash uses during the years endedOctober 31, 2020 and 2019 were for operating expenses, land purchases, land deposits, land development, construction spending, state income taxes, interest payments, financing transaction costs, debt repurchases, litigation matters and investments in unconsolidated joint ventures. During these periods, we provided for our cash requirements from available cash on hand, housing and land sales, financing transactions, model sale leasebacks, land banking transactions, unconsolidated joint ventures, financial service revenues and other revenues. Our net income (loss) historically does not approximate cash flow from operating activities. The difference between net income (loss) and cash flow from operating activities is primarily caused by changes in inventory levels together with changes in receivables, prepaid and other assets, mortgage loans held for sale, interest and other accrued liabilities, deferred income taxes, accounts payable and other liabilities, noncash charges relating to depreciation and 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.
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, 2020 andOctober 31, 2019 , were as follows: October 31, October 31, (In thousands) 2020 2019 Senior Secured Notes: 10.0% Senior Secured Notes due July 15, 2022$ 111,214 $ 218,994 10.5% Senior Secured Notes due July 15, 2024 69,683
211,391
10.0% Senior Secured 1.75 Lien Notes due
-
7.75% Senior Secured 1.125 Lien Notes due
350,000 350,000
10.5% Senior Secured 1.25 Lien Notes due
282,322
11.25% Senior Secured 1.5 Lien Notes due
103,141
Total Senior Secured Notes$ 1,133,990 $ 1,165,848 Senior Notes: 8.0% Senior Notes due November 1, 2027 (1) $ - $ - 13.5% Senior Notes due February 1, 2026 90,590
90,590
5.0% Senior Notes dueFebruary 1, 2040 90,120
90,120
Total Senior Notes$ 180,710
$ 39,551
$ 81,498 $ - Senior Secured Revolving Credit Facility (2) $ - $ - Subtotal notes payable$ 1,435,749 $ 1,549,105 Net discounts and premiums$ 17,521 $ (49,145 ) Net debt issuance costs$ (22,160 ) $ (19,970 ) Total notes payable, net of discounts, premiums and debt issuance costs$ 1,431,110 $ 1,479,990
(1)
(2) At
Except forK. Hovnanian , the issuer of the notes and borrower under the Credit Facilities (as defined below), our home mortgage subsidiaries, certain of our title insurance subsidiaries, joint ventures and subsidiaries holding interests in our joint ventures, we and each of our subsidiaries are guarantors of the Credit Facilities, the senior secured notes (except that certain of the Notes Guarantors (defined below) do not guarantee the 10.5% Senior Secured Notes due 2024 as discussed in Note 9 to the Consolidated Financial Statements included elsewhere in this Annual Report on Form 10-K) and senior notes outstanding atOctober 31, 2020 (collectively, the "Notes Guarantors"). 29
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The credit agreements governing the Credit Facilities and the indentures governing the senior secured and senior notes (together, the "Debt Instruments") outstanding atOctober 31, 2020 do not contain any financial maintenance covenants, but do contain restrictive covenants that limit, among other things, the ability of HEI and certain of its subsidiaries, includingK. Hovnanian , to incur additional indebtedness (other than non-recourse indebtedness, certain permitted indebtedness and refinancing indebtedness), pay dividends and make distributions on common and preferred stock, repay certain indebtedness prior to its respective stated maturity, repurchase common and preferred stock, make other restricted payments (including investments), sell certain assets (including in certain land banking transactions), incur liens, consolidate, merge, sell or otherwise dispose of all or substantially all of their assets and enter into certain transactions with affiliates. The Debt Instruments also contain customary events of default which would permit the lenders or holders thereof to exercise remedies with respect to the collateral (as applicable), declare the loans made under the Unsecured Term Loan Facility (defined below) (the "Unsecured Term Loans"), loans made under the Secured Term Loan Facility (defined below) (the "Secured Term Loans") and loans made under the Secured Credit Agreement (as defined below) (the "Secured Revolving Loans") or notes to be immediately due and payable if not cured within applicable grace periods, including the failure to make timely payments on the Unsecured Term Loans, Secured Term Loans, Secured Revolving Loans or notes or other material indebtedness, cross default to other material indebtedness, the failure to comply with agreements and covenants and specified events of bankruptcy and insolvency, with respect to the Unsecured Term Loans, Secured Term Loans and Secured Revolving Loans, material inaccuracy of representations and warranties and with respect to the Unsecured Term Loans, Secured Term Loans and Secured Revolving Loans, a change of control, and, with respect to the Secured Term Loans, Secured Revolving Loans and senior secured notes, the failure of the documents granting security for the obligations under the secured Debt Instruments to be in full force and effect, and the failure of the liens on any material portion of the collateral securing the obligations under the secured Debt Instruments to be valid and perfected. As ofOctober 31, 2020 , 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. Under the terms of our Debt Instruments, we have the right to make certain redemptions and prepayments and, depending on market conditions and covenant restrictions, may do so from time to time. We also continue to actively analyze and evaluate our capital structure and explore transactions to simplify our capital structure and to strengthen our balance sheet, including those that reduce leverage and/or extend maturities, and will seek to do so with the right opportunity. We may also continue to make debt purchases and/or exchanges for debt or equity from time to time through tender offers, exchange offers, open market purchases, private transactions, or otherwise, or seek to raise additional debt or equity capital, depending on market conditions and covenant restrictions. Any liquidity-enhancing or other capital raising or refinancing transaction will depend on identifying counterparties, negotiation of documentation and applicable closing conditions and any required approvals. Due to covenant restrictions in our Debt Instruments, we are currently limited in the amount of debt we can incur that does not qualify as refinancing indebtedness (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. 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. 30
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Table of Contents Mortgages and Notes Payable We have nonrecourse mortgage loans for certain communities totaling$135.1 million and$203.6 million (net of debt issuance costs) atOctober 31, 2020 andOctober 31, 2019 , respectively, which are secured by the related real property, including any improvements, with an aggregate book value of$368.1 million and$410.2 million , respectively. The weighted-average interest rate on these obligations was 6.4% and 8.3% atOctober 31, 2020 andOctober 31, 2019 , respectively, and the mortgage loan payments on each community primarily correspond to home deliveries. Our wholly owned mortgage banking subsidiary,K. Hovnanian American Mortgage, LLC ("K. Hovnanian Mortgage"), originates mortgage loans primarily from the sale of our homes. Such mortgage loans and related servicing rights are sold in the secondary mortgage market within a short period of time. In certain instances, we retain the servicing rights for a small amount of loans. 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, 2020 and 2019, we had an aggregate of$87.2 million and$140.2 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 2020 or 2019. As ofOctober 31, 2020 , 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 2020, 2019 and 2018, 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, decreased$88.7 million during the year endedOctober 31, 2020 , fromOctober 31, 2019 . Total inventory, excluding consolidated inventory not owned, decreased in the Northeast by$24.8 million , in the Midwest by$2.6 million , in the Southeast by$44.0 million , and in the West by$33.5 million . These decreases were partially offset by increases in the Mid-Atlantic of$2.7 million and in the Southwest of$13.5 million . These inventory fluctuations were primarily attributable to home deliveries and land sales during the period, partially offset by new land purchases and land development. During the year endedOctober 31, 2020 , we had aggregate impairments in the amount of$2.0 million . We wrote-off costs in the aggregate amount of$6.8 million during the year endedOctober 31, 2020 related to land options that expired or that we terminated, as the communities' forecasted profitability was not projected to produce adequate returns on investment commensurate with the risk. In the last few years, we have been able to acquire new land parcels at prices that we believe will generate reasonable returns under current homebuilding market conditions. This trend may not continue in either the near or the long term. Substantially all homes under construction or completed and included in inventory atOctober 31, 2020 are expected to be closed during the next six to nine months. Consolidated inventory not owned decreased$8.1 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 decrease fromOctober 31, 2019 toOctober 31, 2020 was primarily due to a decrease in land banking transactions along with a decrease 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, 2020 , inventory of$133.4 million was recorded to "Consolidated inventory not owned," with a corresponding amount of$84.0 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, 2020 , inventory of$48.8 million was recorded to "Consolidated inventory not owned," with a corresponding amount of$47.2 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, 2020 , we had mothballed land in 12 communities. The book value associated with these communities atOctober 31, 2020 was$11.4 million , which was net of impairment charges recorded in prior periods of$122.2 million . We continually review communities to determine if mothballing is appropriate. During fiscal 2020, we did not mothball any additional communities, or sell any previously mothballed communities, but we re-activated one previously mothballed community and also re-activated a portion of one previously mothballed community. Inventories held for sale, which are land parcels where we have decided not to build homes, and are actively marketing the land for sale, represented$2.0 million of our total inventories held for sale atOctober 31, 2020 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. 31
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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, 2020 :
Northeast 3,043 130 2,913
Mid-Atlantic 5,928 557 5,371
Midwest 2,166 596 1,570
Southeast 3,071 298 2,773
Southwest 7,641 1,066 6,575
West 4,495 755 3,740
Consolidated total 26,344 3,402 22,942
Unconsolidated joint ventures 4,724 1,418 3,306
Owned 9,745 2,517 7,228
Optioned 16,304 590 15,714
Construction to permanent financing lots 295 295 -
Consolidated total 26,344 3,402 22,942
Lots controlled by unconsolidated joint ventures 4,724 1,418 3,306
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
The following table summarizes our started or completed unsold homes and models,
excluding unconsolidated joint ventures, in active and substantially completed
communities. The decrease in the total homes from October 31, 2019 to October
31, 2020 was primarily due to the increase in net contracts absorption pace
during the latter half of fiscal 2020.
October 31, 2020 October 31, 2019
Unsold Unsold
Homes Models Total Homes Models Total
Northeast 1 5 6 58 12 70
Mid-Atlantic 31 10 41 63 12 75
Midwest 11 8 19 31 10 41
Southeast 42 17 59 78 15 93
Southwest 174 16 190 320 12 332
West 14 19 33 213 19 232
Total 273 75 348 763 80 843
Started or completed unsold homes
and models per active selling
communities(1) 2.4 0.6 3.0 5.4 0.6 6.0
(1) Active selling communities (which are communities that are open for sale with
ten or more home sites available) were 116 and 141 at
2019, 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 decreased
Investments in and advances to unconsolidated joint ventures decreased$23.9 million during the fiscal year endedOctober 31, 2020 compared toOctober 31, 2019 . The decrease was primarily due to unconsolidated joint venture partner distributions during fiscal 2020, partially offset by new capital contributions for existing joint ventures and the formation of a new joint venture during fiscal 2020. As ofOctober 31, 2020 andOctober 31, 2019 , we had investments in ten unconsolidated homebuilding joint ventures 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. 32
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Receivables, deposits and notes, net decreased$11.2 million fromOctober 31, 2019 to$33.7 million atOctober 31, 2020 . The decrease was primarily due to the timing of home closings, along with the receipt of a receivable during the first quarter of fiscal 2020 related to the funding of the satisfaction and discharge of certain of our senior secured notes in the fourth quarter of fiscal 2019.
Prepaid expenses and other assets were as follows as of:
October 31, October 31,
(In thousands) 2020 2019 Dollar Change
Prepaid insurance $ 2,687 $ 2,061 $ 626
Prepaid project costs 28,549 32,015 (3,466 )
Other prepaids 7,022 10,808 (3,786 )
Other assets 431 820 (389 )
Lease right of use asset 20,016 - 20,016
Total $ 58,705 $ 45,704 $ 13,001
Prepaid insurance increased 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. The decrease in prepaid project
costs is directly related to our decreased community count, resulting from
delivering homes and closing out of communities at a faster pace than opening
new communities during the year. Other prepaids decreased primarily due to the
amortization of deferred financing costs and costs for certain software and
related services during the period. Lease right of use asset represents the net
present value of our operating leases which, in connection with the Company's
adoption of ASU 2016-02 on November 1, 2019 , are now required to be recorded as
an asset on our Consolidated Balance Sheets. See Note 4 to the Consolidated
Financial Statements for further information.
Financial services assets consist primarily of residential mortgages receivable
held for sale of which $101.8 million and $163.0 million at October 31, 2020 and
2019, respectively, were being temporarily warehoused and are awaiting sale in
the secondary mortgage market. The decrease in mortgage loans held for sale from
October 31, 2019 was primarily related to a decrease in the volume of loans
originated during the fourth quarter of fiscal 2020 compared to the fourth
quarter of fiscal 2019, partially offset by an increase in the average loan
value.
Nonrecourse mortgages secured by inventory decreased to
Accounts payable and other liabilities are as follows as of:
October 31, October 31,
(In thousands) 2020 2019 Dollar Change
Accounts payable $ 148,541 $ 141,667 $ 6,874
Reserves 89,985 92,083 (2,098 )
Lease liability 21,049 - 21,049
Accrued expenses 10,680 19,208 (8,528 )
Accrued compensation 68,641 53,157 15,484
Other liabilities 20,378 14,078 6,300
Total $ 359,274 $ 320,193 $ 39,081
The increase in accounts payable was primarily due to an increase in
construction spending in the fourth quarter of fiscal 2020 as compared to the
fourth quarter of fiscal 2019, and a corresponding increase in backlog at
October 31, 2020 from October 31, 2019 . 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. Lease liability represents the net present value of our
minimum lease obligations, which as discussed above, are required to be recorded
on our Consolidated Balance Sheets as a result of the Company's adoption of ASU
2016-02 on November 1, 2019 . Accrued expenses decreased primarily due to
accruals for legal fees associated with debt financing transactions accrued
at October 31, 2019 and paid in the first quarter of fiscal 2020. Accrued
compensation increased primarily due to increased bonuses related to increased
profitability in fiscal 2020 as compared to fiscal 2019. Other liabilities
increased primarily due to deferred payroll tax withholdings, partially offset
by the transfer of a municipal loan from a previously consolidated community to
a new unconsolidated joint venture formed in the first quarter of fiscal 2020.
Customers' deposits increased
Liabilities from inventory not owned decreased$9.8 million to$131.2 million atOctober 31, 2020 . The decrease was due to a decrease in land banking transactions during the period, along with a decrease in the sale and leaseback of certain model homes, both of which are accounted for as financing transactions as described above. Accrued interest increased$16.5 million to$35.6 million atOctober 31, 2020 . The increase was primarily due to the timing of new accruals as a result of the financing transactions completed inOctober 2019 , partially offset by payments during the year, along with slightly higher interest rates on our new senior secured notes issued in our financing transactions in fiscal 2020. Financial Services (liabilities) decreased$50.1 million from$169.1 million atOctober 31, 2019 , to$119.0 million atOctober 31, 2020 . The decrease was primarily due to a decrease in amounts outstanding under our mortgage warehouse lines of credit, and directly correlated to the decrease in the volume of mortgage loans held for sale during the year. 33
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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) 2020 2019 2018
Homebuilding:
Sale of homes $ 302,347 $ 43,454 $ (433,805 )
Land sales 7,694 (15,066 ) (24,319 )
Other revenues (1,066 ) (3,502 ) 3,080
Financial services 18,010 797 (5,388 )
Total change $ 326,985 $ 25,683 $ (460,432 )
Total revenues percent change 16.2 % 1.3 % (18.8 )%
Homebuilding
Sale of homes revenues increased $302.3 million , or 15.5%, for the year ended
October 31, 2020 , increased $43.5 million , or 2.3%, for the year ended October
31, 2019 , and decreased $433.8 million , or 18.5%, for the year ended October 31,
2018 as compared to the same period of the prior year. The increased revenues in
fiscal 2020 were primarily due to the number of home deliveries increasing
15.0%, and the average price per home increasing to $396,065 in fiscal 2020 from
$394,194 in fiscal 2019. The increase in deliveries in fiscal 2020 was primarily
due to increased demand for new home construction during the latter half of
fiscal 2020. 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 was 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 decrease in
fiscal 2018 deliveries was primarily the result of a reduction in community
count of 5.4%. The fluctuations in average prices for fiscal 2020, 2019, and
2018 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 further detail on changes in segment revenues see "Homebuilding
Operations by Segment" below. During the latter half of fiscal 2020, we saw an
increase in demand for new home construction and, as a result, were able to
increase home prices in virtually all of our markets. For further detail on land
sales and other revenue, see the section titled "Land Sales and Other Revenues"
below.
Information on homes delivered by segment is set forth below:
Year Ended
October 31, October 31, October 31,
(Housing Revenue in thousands) 2020 2019 2018
Northeast:
Housing revenues $ 175,627 $ 116,889 $ 96,012
Homes delivered 348 192 178
Average price $ 504,675 $ 608,797 $ 539,393
Mid-Atlantic:
Housing revenues $ 402,647 $ 356,674 $ 354,153
Homes delivered 755 652 672
Average price $ 533,307 $ 547,046 $ 527,013
Midwest:
Housing revenues $ 225,334 $ 203,734 $ 196,307
Homes delivered 727 680 662
Average price $ 309,950 $ 299,609 $ 296,536
Southeast:
Housing revenues $ 232,333 $ 219,860 $ 237,948
Homes delivered 548 545 596
Average price $ 423,965 $ 403,413 $ 399,242
Southwest:
Housing revenues $ 743,301 $ 627,201 $ 637,568
Homes delivered 2,233 1,866 1,873
Average price $ 332,871 $ 336,121 $ 340,399
West:
Housing revenues $ 472,786 $ 425,324 $ 384,240
Homes delivered 1,075 1,011 866
Average price $ 439,801 $ 420,696 $ 443,695
Consolidated total:
Housing revenues $ 2,252,028 $ 1,949,682 $ 1,906,228
Homes delivered 5,686 4,946 4,847
Average price $ 396,065 $ 394,194 $ 393,280
Unconsolidated joint ventures:(1)
Housing revenues $ 432,602 $ 485,324 $ 599,979
Homes delivered 728 774 984
Average price $ 594,234 $ 627,034 $ 609,735 (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.
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Table of Contents The increase in housing revenues during the year endedOctober 31, 2020 , as compared to the year endedOctober 31, 2019 , was primarily attributed to our increased deliveries, from the strong homebuilding market and high demand for new home construction, and by the increase in average sales price. Housing revenues in fiscal 2020 increased 15.5% on a combined basis across all of our homebuilding segments, and average sales price increased by 0.5% in all such segments combined, excluding unconsolidated joint ventures. In our homebuilding segments, homes delivered increased in fiscal 2020 as compared to fiscal 2019 by 81.3%, 15.8%, 6.9%, 0.6%, 19.7% and 6.3% in the Northeast, Mid-Atlantic, Midwest, Southeast, Southwest and West, respectively. Overall in fiscal 2020 as compared to fiscal 2019, homes delivered increased 15.0% across all our segments, excluding unconsolidated joint ventures. The increase in housing revenues during the year endedOctober 31, 2019 , as compared to the year endedOctober 31, 2018 , was primarily attributed to our increased deliveries, as our community count increased year over year, and due to the increase in average sales price. Housing revenues in fiscal 2019 increased 2.3% on a combined basis across all of our homebuilding segments, 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. Quarterly housing revenues and net sales contracts by segment, excluding unconsolidated joint ventures, for the years endedOctober 31, 2020 , 2019 and 2018 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) 2020 2020 2020 2020 Housing revenues: Northeast$ 42,218 $ 41,354 $ 46,791 $ 45,264 Mid-Atlantic 114,221 111,160 89,677 87,589 Midwest 59,498 62,901 56,543 46,392 Southeast 73,741 65,595 56,317 36,680 Southwest 194,505 214,608 170,485 163,703 West 159,332 110,315 103,534 99,605 Consolidated total$ 643,515 $ 605,933 $ 523,347 $ 479,233 Sales contracts (net of cancellations): Northeast$ 63,326 $ 51,586 $ 23,266 $ 33,003 Mid-Atlantic 135,364 152,511 128,652 93,702 Midwest 79,999 79,394 54,501 58,276 Southeast 74,765 79,846 48,508 67,158 Southwest 245,813 260,891 187,493 178,433 West 229,656 258,067 139,418 90,832 Consolidated total$ 828,923 $ 882,295 $ 581,838 $ 521,404 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 35
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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
Contracts per average active selling community in fiscal 2020 were 54.3 compared
to 39.0 in fiscal 2019. Our reported level of sales contracts (net of
cancellations) was positively impacted by an increase in the pace of sales in
all of the Company's segments during fiscal 2020. Cancellation rates represent
the number of cancelled contracts in the quarter divided by the number of gross
sales contracts executed in the quarter. For comparison, the following are
historical cancellation rates, excluding unconsolidated joint ventures:
Quarter 2020 2019 2018 2017 2016
First 19 % 24 % 18 % 19 % 20 %
Second 23 % 19 % 17 % 18 % 19 %
Third 18 % 19 % 19 % 19 % 21 %
Fourth 18 % 21 % 23 % 22 % 20 %
Another common and meaningful way to analyze our cancellation trends is to compare the number of contract cancellations as a percentage of the beginning backlog. The following table provides this historical comparison, excluding unconsolidated joint ventures.
Quarter 2020 2019 2018 2017 2016
First 14 % 16 % 12 % 12 % 13 %
Second 20 % 20 % 15 % 16 % 14 %
Third 21 % 16 % 14 % 13 % 12 %
Fourth 14 % 14 % 13 % 12 % 11 %
Most cancellations occur within the legal rescission period, which varies by
state but is generally less than two weeks after the signing of the contract.
Cancellations also occur as a result of a buyer's failure to qualify for a
mortgage, which generally occurs during the first few weeks after signing. As
shown in the tables above, contract cancellations over the past several years
have been within what we believe to be a normal range, although in the second
quarter of fiscal 2020 the number of contract cancellations increased and gross
sales contracts decreased due to the COVID-19 pandemic. However, in the third
quarter of fiscal 2020, contract cancellations as a percentage of gross sales
contracts decreased as gross sales rebounded and were very strong during the
period. In the third quarter of fiscal 2020, contract cancellations as a
percentage of beginning backlog increased further, primarily due to a lower
beginning backlog as a result of lower gross sales contracts in the second
quarter of fiscal 2020. In the fourth quarter of fiscal 2020, contract
cancellations decreased back to more normalized levels due to the increase in
beginning backlog in the third quarter as a result of strong gross sales during
the period. Market conditions and further impacts from COVID-19
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) 2020 2019 2018
Northeast:
Total contract backlog $ 82,111 $ 86,557 $ 30,496
Number of homes 130 152 51
Mid-Atlantic: (1)
Total contract backlog $ 291,115 $ 193,387 $ 180,546
Number of homes 557 343 296
Midwest:
Total contract backlog $ 169,517 $ 122,681 $ 107,149
Number of homes 596 450 394
Southeast:
Total contract backlog $ 146,971 $ 121,921 $ 108,137
Number of homes 298 282 251
Southwest:
Total contract backlog $ 360,225 $ 230,898 $ 180,854
Number of homes 1,066 663 523
West:
Total contract backlog $ 369,887 $ 124,700 $ 138,448
Number of homes 755 301 311
Totals: (1)
Total consolidated contract backlog $ 1,419,826 $ 880,144 $ 745,630
Number of homes 3,402 2,191 1,826
(1) Contract backlog as of
one of our joint ventures at the time of the joint venture formation.
Contract backlog dollars increased 61.3% as of October 31, 2020 compared to
October 31, 2019 , and the number of homes in backlog increased 55.3% for the
same period. The increase in backlog was driven by a 30.2% increase in net
contracts, despite a decrease in community count for the year ended October 31,
2020 compared to the prior fiscal year. In the second half of fiscal 2020, we
experienced an increase in our sales pace due to high demand for new home
construction, which has resulted in our highest sales pace in over a decade. In
the month of November 2020 , excluding unconsolidated joint ventures, we signed
an additional 493 net contracts amounting to $216.7 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.
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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.
Year Ended
October 31, October 31, October 31,
(Dollars in thousands) 2020 2019 2018
Sale of homes $ 2,252,029 $ 1,949,682 $ 1,906,228
Cost of sales, excluding interest expense and
land charges 1,837,332 1,596,237 1,555,894
Homebuilding gross margin, before cost of sales
interest expense and land charges 414,697 353,445 350,334
Cost of sales interest expense, excluding land
sales interest expense 74,174 70,520 56,588
Homebuilding gross margin, after cost of sales
interest expense, before land charges 340,523 282,925 293,746
Land charges 8,813 6,288 3,501
Homebuilding gross margin $ 331,710 $ 276,637 $ 290,245
Homebuilding gross margin percentage 14.7 % 14.2 % 15.2 %
Homebuilding gross margin percentage, before
cost of sales interest expense and land charges 18.4 % 18.1 % 18.4 %
Homebuilding gross margin percentage, after
cost of sales interest expense, before land
charges 15.1 % 14.5 % 15.4 %
Cost of sales expenses as a percentage of consolidated home sales revenues are
presented below:
Year Ended
October 31, October 31, October 31,
2020 2019 2018
Sale of homes 100 % 100 % 100 %
Cost of sales, excluding interest expense and
land charges:
Housing, land and development costs 72.1 % 72.1 % 71.9 %
Commissions 3.7 % 3.7 % 3.6 %
Financing concessions 1.4 % 1.4 % 1.2 %
Overheads 4.4 % 4.7 % 4.9 %
Total cost of sales, before interest expense
and land charges 81.6 % 81.9 % 81.6 %
Cost of sales interest 3.3 % 3.6 % 3.0 %
Land charges 0.4 % 0.3 % 0.2 %
Homebuilding gross margin percentage 14.7 % 14.2 % 15.2 %
Homebuilding gross margin percentage, before
cost of sales interest expense and land charges 18.4 % 18.1 % 18.4 %
Homebuilding gross margin percentage, after
cost of sales interest expense and before land
charges 15.1 % 14.5 % 15.4 %
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 increased to 14.7% for the year ended
October 31, 2020 compared to 14.2% for the prior year. This increase was
primarily due to the mix of communities delivering compared to the prior year,
along with increases in home prices in virtually all of our markets. Due to
significantly increased demand in June and July of 2020, we began increasing
home prices. We believe that these price increases should offset potential
material and labor cost increases related to increased demand and could also
result in improved gross margin as a percentage of revenues in future
quarters. Total homebuilding gross margin percentage decreased to 14.2% for the
year ended October 31, 2019 compared to 15.2% for the prior year. 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. 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.
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 $8.8 million , $6.3 million and $3.5 million during the years ended
October 31, 2020 , 2019 and 2018, respectively, to their estimated fair value.
See Note 12 to the Consolidated Financial Statements for an additional
discussion. During the years ended October 31, 2020 , 2019 and 2018, we wrote off
residential land options and approval and engineering costs totaling
$6.8 million , $3.6 million and $1.4 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 2020, 2019 and 2018. The
inventory impairments amounted to $2.0 million , $2.7 million and $2.1 million
for the years ended October 31, 2020 , 2019 and 2018, respectively. It is
difficult to predict impairment levels, and should it become necessary or
desirable to have additional land sales, further lower prices, or should the
estimates or expectations used in determining estimated cash flows or fair value
decrease or differ from current estimates in the future, we may need to
recognize additional impairments.
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Below is a breakdown of our lot option walk-aways and impairments by segment for fiscal 2020. In fiscal 2020, we walked away from 19.3% of all the lots we controlled under option contracts. The remaining 80.7% of our option lots are in communities that we believe remain economically feasible. The following table represents lot option walk-aways by segment for the year endedOctober 31, 2020 : Walk- Away Dollar Number of % of Lots as a Amount Walk- Walk- Total % of Total of Walk Away Away Option Option (Dollars in millions) Away Lots Lots Lots(1) Lots Northeast$ 1.5 261 6.7 % 2,934 8.9 % Mid-Atlantic - 102 2.6 % 3,994 2.6 % Midwest 3.5 1,807 46.3 % 2,634 68.6 % Southeast 0.8 968 24.8 % 3,049 31.7 % Southwest 0.6 458 11.8 % 5,984 7.7 % West 0.4 304 7.8 % 1,609 18.9 % Total$ 6.8 3,900 100.0 % 20,204 19.3 %
(1) Includes lots optioned at
walked away from in the year ended October 31, 2020 .
The following table represents impairments by segment for the year ended October
31, 2020 :
Dollar Pre- % of Pre-
Amount of % of Impairment Impairment
(In millions) Impairment Impairments Value(1) Value
Northeast $ - - % $ - - %
Mid-Atlantic - - % - - %
Midwest 2.0 100.0 % 4.8 41.7 %
Southeast - - % - - %
Southwest - - % - - %
West - - % - - %
Total $ 2.0 100.0 % $ 4.8 41.7 %
(1) Represents carrying value, net of prior period impairments, if any, at the
time of recording the applicable period's impairments.
Land Sales and Other Revenues
Land sales and other revenues consist primarily of land and lot sales. A breakout of land and lot sales is set forth below:
Year Ended
October 31, October 31, October 31,
(In thousands) 2020 2019 2018
Land and lot sales $ 16,905 $ 9,211 $ 24,277
Cost of sales, excluding interest 11,154 8,540 10,661
Land and lot sales gross margin, excluding interest 5,751 671 13,616
Land and lot sales interest expense 156 205 4,097
Land and lot sales gross margin, including interest
466 $ 9,519
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
seven land sales during the year ended October 31, 2020 , compared to six in
the prior year, resulting in a $7.7 million increase in land sales revenue.
There were six land sales in the year ended October 31, 2019 , compared to four
in the prior year. 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 a $15.1 million decrease in land sales revenue during fiscal
2019.
Land sales and other revenues increased $6.6 million for the year ended October
31, 2020 and decreased $18.6 million for the year ended October 31, 2019
compared to 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
increase from fiscal 2019 to fiscal 2020 and the decrease from fiscal 2018 to
fiscal 2019 was mainly due to the fluctuations in land sales revenue noted
above.
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Homebuilding Selling, General and Administrative
Homebuilding selling, general and administrative ("SGA") expenses decreased
$5.5 million to $161.3 million for the year ended October 31, 2020 as compared
to the year ended October 31, 2019 . The decrease was primarily attributed
to lower selling overhead and advertising costs, as a result of the reduction of
our community count and a reduced need for advertising as home sales have
improved. SGA expenses 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 unconsolidated 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.
Homebuilding Operations by Segment
Financial information relating to the Company's operations was as follows:
Segment Analysis (Dollars in thousands, except average sales price)
Year Ended October 31,
Variance Variance
2020 2019
Compared Compared
2020 to 2019 2019 to 2018 2018
Northeast
Homebuilding revenue $ 192,069 $ 67,697 $ 124,372 $ 8,076 $ 116,296
Income before income taxes $ 30,371 $ 9,417 $ 20,954 $ 85 $ 20,869
Homes delivered 348 156 192 14 178
Average sales price $ 504,675 $ (104,122 ) $ 608,797 $ 69,404 $ 539,393
Mid-Atlantic
Homebuilding revenue $ 403,669 $ 46,422 $ 357,247 $ 2,557 $ 354,690
Income before income taxes $ 34,570 $ 20,243 $ 14,327 $ (4,430 ) $ 18,757
Homes delivered 755 103 652 (20 ) 672
Average sales price $ 533,307 $ (13,739 ) $ 547,046 $ 20,033 $ 527,013
Midwest
Homebuilding revenue $ 225,718 $ 21,257 $ 204,461 $ 7,862 $ 196,599
(Loss) income before income taxes $ (1,805 ) $ (1,156 ) $ (649 ) $ (2,177 ) $ 1,528
Homes delivered 727 47 680 18 662
Average sales price $ 309,950 $ 10,341 $ 299,609 $ 3,073 $ 296,536
Southeast
Homebuilding revenue $ 232,730 $ 12,648 $ 220,082 $ (21,538 ) $ 241,620
Income (loss) before income taxes $ 1,355 $ 11,415 $ (10,060 ) $ (146 ) $ (9,914 )
Homes delivered 548 3 545 (51 ) 596
Average sales price $ 423,965 $ 20,552 $ 403,413 $ 4,171 $ 399,242
Southwest
Homebuilding revenue $ 744,197 $ 114,853 $ 629,344 $ (8,938 ) $ 638,282
Income before income taxes $ 68,184 $ 34,725 $ 33,459 $ (16,393 ) $ 49,852
Homes delivered 2,233 367 1,866 (7 ) 1,873
Average sales price $ 332,871 $ (3,250 ) $ 336,121 $ (4,278 ) $ 340,399
West
Homebuilding revenue $ 472,889 $ 47,373 $ 425,516 $ 40,889 $ 384,627
Income before income taxes $ 16,415 $ (23,603 ) $ 40,018 $ (7,969 ) $ 47,987
Homes delivered 1,075 64 1,011 145 866
Average sales price $ 439,801 $ 19,105 $ 420,696 $ (22,999 ) $ 443,695
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Homebuilding Results by Segment
Northeast - Homebuilding revenues increased 54.4% in fiscal 2020 compared to fiscal 2019 primarily due to an 81.3% increase in homes delivered and a$9.0 million increase in land sales and other revenue, partially offset by a 17.1% decrease in average selling price. The decrease in average sales price was the result of new communities delivering smaller single family homes, townhomes and affordable-housing homes in mid to higher-end submarkets of the segment in fiscal 2020 compared to some communities delivering in fiscal 2019 that had higher priced, single family homes in higher-end submarkets of the segment that are no longer delivering. Also impacting the decrease in average sales price was an increase in pricing concessions and a decrease in location premiums in certain communities. Income before income taxes increased$9.4 million to$30.4 million , which was mainly due to the increase in homebuilding revenues discussed above, a$0.5 million decrease in selling, general and administrative costs and a slight increase in gross margin percentage before interest expense for fiscal 2020 compared to fiscal 2019. This increase was partially offset by a$8.2 million decrease in income from unconsolidated joint ventures for fiscal 2020 compared to fiscal 2019. 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. Mid-Atlantic - Homebuilding revenues increased 13.0% in fiscal 2020 compared to fiscal 2019 primarily due to a 15.8% increase in homes delivered, partially offset by a 2.5% decrease in average sales price. The decrease in average sales price was the result of new communities delivering lower priced, smaller single family homes and townhomes in lower-end submarkets of the segment in fiscal 2020 compared to some communities delivering in fiscal 2019 that had higher priced, larger single family homes and townhomes in higher-end submarkets of the segment that are no longer delivering. Income before income taxes increased$20.2 million to$34.6 million , mainly due to the increase in homebuilding revenues discussed above, a$2.0 million decrease in selling, general and administrative costs, a$0.8 million decrease in inventory impairment loss and land option write-offs and an increase in gross margin percentage before interest expense for fiscal 2020 compared to fiscal 2019. 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
Midwest - Homebuilding revenues increased 10.4% in fiscal 2020 compared to fiscal 2019 primarily due to a 6.9% increase in homes delivered and a 3.5% increase in average sales price. The increase in average sales price was the result of new communities delivering higher priced, larger single family homes and townhomes in higher-end submarkets of the segment in fiscal 2020 compared to some communities delivering in fiscal 2019 that had lower priced, smaller single family homes in lower-end submarkets of the segment that are no longer delivering. Loss before income taxes increased$1.2 million to a loss of$1.8 million in fiscal 2020 compared to fiscal 2019. The increase was primarily due to a$3.2 million increase in inventory impairment loss and land option write-offs, while gross margin percentage before interest expense was flat for fiscal 2020 compared to fiscal 2019. 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 income taxes decreased$2.2 million to a loss of$0.6 million in fiscal 2019 compared to fiscal 2018. 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. Southeast - Homebuilding revenues increased 5.7% in fiscal 2020 compared to fiscal 2019 primarily due to a 0.6% increase in homes delivered and a 5.1% increase in average sales price. The increase in average sales price was the result of new communities delivering higher priced, larger single family homes in higher-end submarkets of the segment in fiscal 2020 compared to some communities delivering in fiscal 2019 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 price increases and higher location premium revenue in certain communities. Income before income taxes of$1.4 million in fiscal 2020 represented an$11.4 million improvement from the prior year due to the increase in homebuilding revenue discussed above, a$3.9 million decrease in selling, general and administrative costs and an increase in gross margin percentage before interest expense for fiscal 2020 compared to fiscal 2019. 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. 41
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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. Southwest - Homebuilding revenues increased 18.2% in fiscal 2020 compared to fiscal 2019 primarily due to a 19.7% increase in homes delivered, while average sales price was essentially flat with a 1.0% decrease in fiscal 2020. Income before income taxes increased$34.7 million to$68.2 million in fiscal 2020 mainly due to the increase in homebuilding revenues discussed above and an increase in gross margin percentage before interest expense for fiscal 2020 compared to fiscal 2019. 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. West - Homebuilding revenues increased 11.1% in fiscal 2020 compared to fiscal 2019 primarily due to a 6.3% increase in homes delivered and a 4.5% 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 2020 compared to some communities delivering in fiscal 2019 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 price increases in certain communities. Income before income taxes decreased$23.6 million to$16.4 million in fiscal 2020 compared to the prior year due mainly to a significant decrease in gross margin percentage before interest expense, partly as a result of increases in estimated land development costs in some of our communities in the segment. 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 compared to the prior year 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. 42
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Table of Contents 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, 2020 , 2019 and 2018, our conforming conventional loan originations as a percentage of our total loans were 69.1%, 65.8% and 69.8%, respectively. FHA/VA loans represented 29.8%, 29.8%, and 24.6%, respectively, of our total loans. The remaining 1.1%, 4.4% and 5.6% of our loan originations represent loans which exceed conforming conventions. Profits and losses relating to the sale of mortgage loans are recognized when legal control passes to the buyer of the mortgage and the sales price is collected. During the years endedOctober 31, 2020 , 2019 and 2018, financial services provided a$32.1 million ,$17.6 million and$18.2 million pretax profit, respectively. In fiscal 2020, financial services pretax profit increased$14.5 million from the prior year primarily due to the increase in homebuilding deliveries and an increase in the average price of the loans settled. Also impacting the increase in fiscal 2020 was the increase in the basis point spread between the loans originated and the implied rate from the sale of the loans. In fiscal 2019, financial services pretax profit decreased$0.6 million from the prior year primarily due to the geographic mix of title company activity within each period. In the market areas served by our wholly owned mortgage banking subsidiaries, 69.3%, 70.9%, and 72.4% of our noncash home buyers obtained mortgages originated by these subsidiaries during the years endedOctober 31, 2020 , 2019 and 2018, 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 increased$14.2 million for the year endedOctober 31, 2020 compared to the year endedOctober 31, 2019 and decreased$3.3 million for the year endedOctober 31, 2019 compared to the year endedOctober 31, 2018 . The increase in expense for fiscal 2020 was mainly due to an increase in stock compensation expense, primarily attributed to our long-term incentive plans achieving above target metrics for the plan years 2018 and 2019 as a result of current year profit. Also contributing to the increase in expense for fiscal 2020 were additional costs pertaining to software licenses and support fees for cybersecurity and monitoring services. 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 was an increase in the adjustment to reserves for self-insured medical claims, which were reduced based on claim estimates. Other Interest Other interest increased$13.7 million to$103.8 million for the year endedOctober 31, 2020 compared toOctober 31, 2019 , and decreased$13.2 million to$90.1 million for the year endedOctober 31, 2019 compared toOctober 31, 2018 . 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 2020, the increase was because we incurred more interest from our third-party inventory financing during fiscal 2020, and as a result of the financing transactions we completed in the fourth quarter of fiscal 2019 and first quarter of fiscal 2020. 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. 43
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Gain (Loss) on Extinguishment of Debt
OnDecember 10, 2019 ,K. Hovnanian entered into a credit agreement providing for$81.5 million of senior secured 1.75 lien term loans in exchange for$163.0 million of senior unsecured term loans. OnDecember 10, 2019 ,K. Hovnanian also issued$158.5 million of 10.0% Senior Secured 1.75 Lien Notes due 2025 in exchange for$23.2 million of 10.0% Senior Secured Notes due 2022 and$141.7 million 10.5% Senior Secured Notes due 2024. These transactions were accounted for in accordance with ASC 470-60, resulting in a net gain on extinguishment of debt of$9.2 million . During the year endedOctober 31, 2020 , the Company repurchased in open market transactions$25.5 million aggregate principal amount of 10.0% Senior Secured Notes due 2022. The aggregate purchase price for these repurchases was$21.4 million , which included accrued and unpaid interest. These repurchases resulted in a gain on extinguishment of debt of$4.1 million for the year endedOctober 31, 2020 , net of the write-off of unamortized financing costs and fees. The gains from the repurchases are included in the Consolidated Statement of Operations as "Gain (loss) on extinguishment of debt". As a result of the financing transactions we consummated onOctober 31, 2019 and discussed 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.
Income from
Income from unconsolidated joint ventures consists of our share of the earnings or losses of our joint ventures. Income from unconsolidated joint ventures decreased$12.3 million for the year endedOctober 31, 2020 from income of$28.9 million for the year endedOctober 31, 2019 to income of$16.6 million . The decrease was primarily due to the recognition of our share of income from certain of our joint ventures delivering fewer homes in fiscal 2020 as compared to the prior year. Also impacting the decrease was income recorded in the first quarter of fiscal 2019 related to the return of capital from an unconsolidated joint venture for which we had previously written-off our investment. Income 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. Total Taxes The total income tax expense of$4.5 million ,$2.4 million , and$3.6 million for the years endingOctober 31, 2020 , 2019 and 2018, respectively, was primarily related to state tax expense from income generated in states where we do not have net operating loss ("NOL") carryforwards to offset the current year income. In addition, the expense for the year endedOctober 31, 2020 was primarily related to state tax expense from the impact of a cancellation of debt income recorded for tax purposes but not for GAAP purposes, creating a permanent difference. Deferred federal and state income tax assets primarily represent the deferred tax benefits arising from 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, 2020 , 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$577.5 million as ofOctober 31, 2020 , which fully reserves for our DTAs, is appropriate. 44
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Table of Contents 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, 2020 , we had$88.9 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$540.2 million atOctober 31, 2020 and$539.7 million atOctober 31, 2019 . Our investments in unconsolidated joint ventures totaled$103.2 million atOctober 31, 2020 and$127.0 million atOctober 31, 2019 . As ofOctober 31, 2020 and 2019, our unconsolidated joint ventures had outstanding debt totaling$117.2 and$186.9 million , respectively, under separate construction loan agreements with different third-party lenders and affiliates of certain investment partners to finance their respective land development activities, with the outstanding debt secured by the corresponding underlying property and related project assets and non-recourse to us. While we and our unconsolidated joint venture partners provide certain guarantees and indemnities to the lender, we do not have a guaranty or any other obligation to repay our outstanding debt or to support the value of the collateral underlying the outstanding debt. We do not believe that our existing exposure under our guaranty and indemnity obligations related to the outstanding debt is material to our consolidated financial statements. See also Note 19 - Variable Interest Entities in the Notes to Consolidated Financial Statements. We determined that none of our joint ventures atOctober 31, 2020 and 2019 were a variable interest entity. All our unconsolidated joint ventures were accounted for under the equity method because we did not have a controlling financial interest. Contractual Obligations The following summarizes our aggregate contractual commitments atOctober 31, 2020 . Payments Due by Period (1) Less than More than (In thousands) Total 1 year 1-3 years 3-5 years 5 years Long term debt (2)(3)(4)$ 2,185,741 $ 136,175 $ 369,663 $ 310,645 $ 1,369,258 Operating leases 24,788 8,880 11,804 2,997 1,107 Total$ 2,210,529 $ 145,055 $ 381,467 $ 313,642 $ 1,370,365
(1) Total contractual obligations exclude our accrual for uncertain tax positions
of
2020 because we were unable to make reasonable estimates as to the period of
cash settlement with the respective taxing authorities.
(2) Represents our senior secured and unsecured term loan credit facilities,
senior secured and senior notes and other notes payable and
related interest 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, 2020 .
We had outstanding letters of credit and performance bonds of $11.3 million and
$194.4 million , respectively, at October 31, 2020 , 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.
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Table of Contents Inflation Inflation has a long-term effect, because increasing costs of land, materials and labor result in increasing sale prices of our homes. In general, these price increases have been commensurate with the general rate of inflation in our housing markets and have not had a significant adverse effect on the sale of our homes. A significant risk faced by the housing industry generally is that rising house construction costs, including land and interest costs, will substantially outpace increases in the income of potential purchasers and therefore limit our ability to raise home sale prices, which may result in lower gross margins. Inflation has a lesser short-term effect, because we generally negotiate fixed price contracts with many, but not all, of our subcontractors and material suppliers for the construction of our homes. These prices usually are applicable for a specified number of residential buildings or for a time period of between three to twelve months. Construction costs for residential buildings represent approximately 52.4% of our homebuilding cost of sales for fiscal 2020. 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:
? The outbreak and spread of COVID-19 and the measures that governments,
agencies, law enforcement and/or health authorities implement to address it;
? Changes in general and local economic, industry and business conditions and
impacts of a significant homebuilding downturn;
? Adverse weather and other environmental conditions and natural disasters;
? 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;
? Legal claims brought against us and not resolved in our favor, such as product
liability litigation, warranty claims and claims made by mortgage investors;
? Levels of competition; ? Utility shortages and outages or rate fluctuations; ? Information technology failures and data security breaches; ? Negative publicity;
? High leverage and restrictions on the Company's operations and activities
imposed by the agreements governing the Company's outstanding indebtedness;
? Availability and terms of financing to the Company;
? The Company's sources of liquidity;
? Changes in credit ratings;
? Government regulation, including regulations concerning development of land,
the home building, sales and customer financing processes, tax laws and the
environment;
? Operations through unconsolidated joint ventures with third parties;
? Significant influence of the Company's controlling stockholders;
? Availability of net operating loss carryforwards; and? Loss of key management personnel or failure to attract qualified personnel.
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. 46
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Table of Contents ITEM 7A
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