HOVNANIAN ENTERPRISES, INC. 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 netcontracts represents the dollars associated with net contracts executed in the
period. These values are an indicator of potential future revenues;
? Contract backlog is a volume indicator which represents the number of homes
that are under contract, but not yet delivered as of the stated date. The
dollar value of contract backlog represents the dollar amount of the homes in
contract backlog. These values are an indicator of potential future revenues;
? Active selling communities is a volume indicator which represents the number
of communities which are open for sale with ten or more home sites available
as of the end of a period. We identify communities based on product type,
therefore at times there are multiple communities at one land site. These
values are an indicator of potential revenues;
? Net contracts per average active selling community is used to indicate the
pace at which homes are being sold (put into contract) in active selling
communities and is calculated by dividing the number of net contracts in a
period by the average number of active selling communities in the same period.
Sales pace is an indicator of market strength and demand; and
? Contract cancellation rates is a volume indicator which represents the number
of sales contracts cancelled in the period divided by the number of gross
sales contracts executed during the period. Contract cancellation rates as a
percentage of backlog is calculated by dividing the number of cancelled
contracts in the period by the contract backlog at the beginning of the
period. Cancellation rates as compared to prior periods can be an indicator of
market strength or weakness.
Overview
Our strategy over the past several years has been to grow through increased open
for sale communities. While our community count grew throughout fiscal 2019, our
community count decreased 3.5% from 141 communities at October 31, 2019 to
136 at January 31, 2020 and was relatively flat year-over-year as compared to
137 communities at January 31, 2019 , due to selling through communities faster
than anticipated, as well as transferring four previously owned communities to a
new unconsolidated joint venture in the first quarter of fiscal 2020. Despite
the recent decrease, the increases in community count through the past year have
resulted in increased year-over-year contract and delivery growth, as discussed
further below. As our recently opened communities continue delivering homes, we
believe it should lead to additional delivery and revenue growth, and in turn
profitability in future periods, absent adverse market factors. We plan to
continue to make land acquisitions to replenish inventory as communities sell
out.
Our cash position enabled us to spend $117.9 million on land purchases and land
development during the first quarter of fiscal 2020, and still have total
liquidity of $224.9 million , including $81.4 million of homebuilding cash and
cash equivalents as of January 31, 2020 . We continue to see opportunities to
purchase land at prices that make economic sense in light of our current sales
prices, sales pace and construction costs and plan to continue actively pursuing
such land acquisitions. New land purchases at pricing that we believe will
generate appropriate investment returns and drive greater operating efficiencies
are needed to return to sustained profitability; however, we remain cautious and
are carefully evaluating market conditions when pursuing new land acquisitions.
Additional results for the first quarter of fiscal 2020 were as follows:
? For the three months endedJanuary 31, 2020 , sale of homes revenues increased 32.3% as compared to the same period of the prior year, as a result of a 27.8% increase in deliveries, primarily due to our increased community count that occurred during fiscal 2019. ? Gross margin percentage decreased from 14.8% for the three months endedJanuary 31, 2019 to 12.9% for the three months endedJanuary 31, 2020 . This decrease was primarily due to the increase in cost of sales interest and greater discounts on started unsold homes ("spec homes") and was also the result of the mix of communities delivering in each period. Gross margin percentage, before cost of sales interest expense and land charges, decreased slightly from 17.8% for the three months endedJanuary 31, 2019 to 17.3% for the three months endedJanuary 31, 2020 , due to the mix of communities delivering, along with greater discounts on spec homes. ? Selling, general and administrative costs (including corporate general and administrative expenses) remained flat at$60.4 million for the three months endedJanuary 31, 2020 as compared to the same period of the prior year. As a percentage of total revenue, such costs decreased from 15.9% for the three months endedJanuary 31, 2019 to 12.2% for the three months endedJanuary 31, 2020 . ? Active selling communities atJanuary 31, 2020 decreased slightly by 0.7% over last year's first quarter. Net contracts increased 41.5% for the three months endedJanuary 31, 2020 , compared to the same period of the prior year. ? Net contracts per average active selling community increased to 9.7 for the three months endedJanuary 31, 2020 compared to 6.8 in the same period of the prior year. This is the highest net contracts per average active selling community for the first fiscal quarter since fiscal 2005. ? Contract backlog increased from 1,793 homes atJanuary 31, 2019 to 2,221 homes atJanuary 31, 2020 , with a dollar value of$899.6 million , representing a 20.0% increase in dollar value compared to the prior year. 32
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Table of Contents CRITICAL ACCOUNTING POLICIES As disclosed in our annual report on Form 10-K for the fiscal year endedOctober 31, 2019 , our most critical accounting policies relate to income recognition from mortgage loans; inventories; unconsolidated joint ventures; and warranty and construction defect reserves. SinceOctober 31, 2019 , there have been no significant changes to those critical accounting policies.
CAPITAL RESOURCES AND LIQUIDITY
Our operations consist primarily of residential housing development and sales in the Northeast (New Jersey andPennsylvania ), the Mid-Atlantic (Delaware ,Maryland ,Virginia ,Washington D.C. andWest Virginia ), the Midwest (Illinois andOhio ), the Southeast (Florida ,Georgia andSouth Carolina ), the Southwest (Arizona andTexas ) and the West (California ). In addition, we provide certain financial services to our homebuilding customers. We have historically funded our homebuilding and financial services operations with cash flows from operating activities, borrowings under our credit facilities, the issuance of new debt and equity securities and other financing activities. Due to covenant restrictions in our debt instruments, we are currently limited in the amount of debt we can incur that does not qualify as refinancing indebtedness with certain maturity requirements (a limitation that we expect to continue for the foreseeable future), even if market conditions would otherwise be favorable, which could also impact our ability to grow our business.
Operating, Investing and Financing Activities - Overview
Our homebuilding cash balance atJanuary 31, 2020 decreased$49.6 million fromOctober 31, 2019 . We spent$117.9 million on land and land development during the period. After considering this land and land development and all other operating activities, including revenue received from deliveries, we had$27.6 million of cash provided from operations. However, as ofJanuary 31, 2020 , we had$125.0 million of borrowing capacity under our Secured Credit Facility (defined below), and therefore, our total liquidity atJanuary 31, 2020 was$224.9 million , which is within our target liquidity range of$170.0 to$245.0 million . During the first quarter of fiscal 2020, cash used in investing activities was$16.8 million , primarily due to an investment in a new unconsolidated joint venture, partially offset by distributions from existing unconsolidated joint ventures. Cash used in financing activities was$65.2 million during the first quarter of fiscal 2020, which was primarily due to a$67.2 million reduction in the use of mortgage warehouse lines of credit. 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 three months endedJanuary 31, 2020 and 2019 were for operating expenses, land purchases, land deposits, land development, construction spending, state income taxes, interest payments, financing transaction costs, 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. We believe that these sources of cash together with available borrowings on our senior secured revolving credit facility will be sufficient through fiscal 2020 to finance our working capital requirements. Our net income (loss) historically does not approximate cash flow from operating activities. The difference between net income (loss) and cash flow from operating activities is primarily caused by changes in inventory levels together with changes in receivables, prepaid and other assets, mortgage loans held for sale, interest and other accrued liabilities, deferred income taxes, accounts payable and other liabilities, and noncash charges relating to depreciation, stock compensation awards and impairment losses for inventory. When we are expanding our operations, inventory levels, prepaids and other assets increase causing cash flow from operating activities to decrease. Certain liabilities also increase as operations expand and partially offset the negative effect on cash flow from operations caused by the increase in inventory levels, prepaids and other assets. Similarly, as our mortgage operations expand, net income from these operations increases, but for cash flow purposes, net income is partially offset by the net change in mortgage assets and liabilities. The opposite is true as our investment in new land purchases and development of new communities decrease, causing us to generate positive cash flow from operations. In the first quarters of fiscal 2020 and 2019, with continued spending on land purchases and land development, we used cash from operations. As we continue to actively seek land investment opportunities, we will also remain focused on liquidity. 33
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Table of Contents Debt Transactions Senior notes and credit facilities balances as ofJanuary 31, 2020 andOctober 31, 2019 , were as follows: January 31, October 31, (In thousands) 2020 2019 Senior Secured Notes: 10.0% Senior Secured Notes due July 15, 2022$195,842
10.5% Senior Secured Notes dueJuly 15, 2024 69,683
211,391
7.75% Senior Secured 1.125 Lien Notes due
350,000 350,000
10.5% Senior Secured 1.25 Lien Notes due
282,322 282,322
11.25% Senior Secured 1.5 Lien Notes due
103,141 103,141
10.0% Senior Secured 1.75 Lien Notes due November 15, 2025 158,502 - Total Senior Secured Notes$1,159,490 $1,165,848 Senior Notes: 8.0% Senior Notes due November 1, 2027 (1) $-
$-
13.5% Senior Notes dueFebruary 1, 2026 90,590
90,590
5.0% Senior Notes dueFebruary 1, 2040 90,120
90,120
Total Senior Notes$180,710
Senior Unsecured Term Loan Credit Facility due
$39,551
Senior Secured 1.75 Lien Term Loan Credit Facility due
$81,498
$-
Senior Secured Revolving Credit Facility (2) $- $- Net discounts and premiums$23,503 $(49,145 ) Net debt issuance costs$(24,552 ) $(19,970 ) Total Senior Notes and Credit Facilities, net of discount, premium and debt issuance costs$1,460,200 $1,479,990 (1)$26.0 million of 8.0% Senior Notes are owned by a wholly-owned consolidated subsidiary of HEI. Therefore, in accordance with GAAP, such notes are not reflected on the Condensed Consolidated Balance Sheets of HEI. OnNovember 1, 2019 , the maturity of the 8.0% Senior Notes was extended toNovember 1, 2027 .
(2) At
Except forK. Hovnanian , the issuer of the notes and borrower under the Credit Facilities (as defined below), our home mortgage subsidiaries, certain of our title insurance subsidiaries, joint ventures and subsidiaries holding interests in our joint ventures, we and each of our subsidiaries are guarantors of the Credit Facilities, the senior secured notes and senior notes outstanding atJanuary 31, 2020 (collectively, the "Notes Guarantors"). The credit agreements governing the Credit Facilities and the indentures governing the senior secured and senior notes (together, the "Debt Instruments") outstanding atJanuary 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 ofJanuary 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 with certain maturity requirements as discussed above (a limitation that we expect to continue for the foreseeable future), even if market conditions would otherwise be favorable, which could also impact our ability to grow our business. 34
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We have certain stand-alone cash collateralized letter of credit agreements and facilities under which there was a total of$17.8 million and$19.2 million letters of credit outstanding atJanuary 31, 2020 andOctober 31, 2019 , respectively. These agreements and facilities require us to maintain specified amounts of cash as collateral in segregated accounts to support the letters of credit issued thereunder, which will affect the amount of cash we have available for other uses. AtJanuary 31, 2020 andOctober 31, 2019 , the amount of cash collateral in these segregated accounts was$18.5 million and$19.9 million , respectively, which is reflected in "Restricted cash and cash equivalents" on the Condensed Consolidated Balance Sheets.
See Note 12 to the Condensed Consolidated Financial Statements included
elsewhere in this Quarterly Report on Form 10-Q for a discussion of the
Unsecured Term Loans, the Secured Term Loans and Secured Revolving Loans and
Mortgages and Notes Payable We have nonrecourse mortgage loans for certain communities totaling$205.8 million and$203.6 million (net of debt issuance costs) atJanuary 31, 2020 andOctober 31, 2019 , respectively, which are secured by the related real property, including any improvements, with an aggregate book value of$422.2 million and$410.2 million , respectively. The weighted-average interest rate on these obligations was 8.2% and 8.3% atJanuary 31, 2020 andOctober 31, 2019 , respectively, and the mortgage loan payments on each community primarily correspond to home deliveries. Our wholly owned mortgage banking subsidiary,K. Hovnanian American Mortgage, LLC ("K. Hovnanian Mortgage"), originates mortgage loans primarily from the sale of our homes. Such mortgage loans and related servicing rights are sold in the secondary mortgage market within a short period of time. In certain instances, we retain the servicing rights for a small amount of loans.K. Hovnanian Mortgage finances the origination of mortgage loans through various master repurchase agreements, which are recorded in financial services liabilities on the Condensed Consolidated Balance Sheets. The loans are secured by the mortgages held for sale and are repaid when we sell the underlying mortgage loans to permanent investors. As ofJanuary 31, 2020 andOctober 31, 2019 , we had an aggregate of$73.0 million and$140.2 million , respectively, outstanding under several ofK. Hovnanian Mortgage's short-term borrowing facilities.
See Note 11 to the Condensed Consolidated Financial Statements for a discussion of these agreements.
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Table of Contents Inventory Activities Total inventory, excluding consolidated inventory not owned, decreased$11.7 million during the three months endedJanuary 31, 2020 fromOctober 31, 2019 . Total inventory, excluding consolidated inventory not owned, decreased in the Northeast by$6.0 million , in the Mid-Atlantic by$4.1 million , in the Southeast by$8.7 million and in the West by$8.4 million . The decrease was partially offset by increases in the Midwest of$6.7 million and in the Southwest of$8.8 million . The net decrease was primarily attributable to home deliveries during the period, partially offset by new land purchases and land development. During the three months endedJanuary 31, 2020 , we wrote-off costs in the amount of$2.8 million related to land options that expired or that we terminated, as the communities' forecasted profitability was not projected to produce adequate returns on investment commensurate with the risk. In the last few years, we have been able to acquire new land parcels at prices that we believe will generate reasonable returns under current homebuilding market conditions. This trend may not continue in either the near or the long term. Substantially all homes under construction or completed and included in inventory atJanuary 31, 2020 are expected to be delivered during the next six to nine months. Consolidated inventory not owned increased$14.9 million . Consolidated inventory not owned consists of options related to land banking and model financing transactions that were added to our Condensed Consolidated Balance Sheet in accordance with US GAAP. The increase fromOctober 31, 2019 toJanuary 31, 2020 was primarily due to an increase in land banking transactions, partially offset by 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 Condensed Consolidated Balance Sheet, atJanuary 31, 2020 , inventory of$156.7 million was recorded to "Consolidated inventory not owned," with a corresponding amount of$105.9 million (net of debt issuance costs) recorded to "Liabilities from inventory not owned" for the amount of net cash received from the transactions. In addition, we sell and lease back certain of our model homes with the right to participate in the potential profit when each home is sold to a third party at the end of the respective lease. As a result of our continued involvement, for accounting purposes in accordance with ASC 606-10-55-68, these sale and leaseback transactions are considered a financing rather than a sale. Therefore, for purposes of our Condensed Consolidated Balance Sheet, atJanuary 31, 2020 , inventory of$48.5 million was recorded to "Consolidated inventory not owned," with a corresponding amount of$46.3 million (net of debt issuance costs) recorded to "Liabilities from inventory not owned" for the amount of net cash received from the transactions. When possible, we option property for development prior to acquisition. By optioning property, we are only subject to the loss of the cost of the option and predevelopment costs if we choose not to exercise the option. As a result, our commitment for major land acquisitions is reduced. The costs associated with optioned properties are included in "Land and land options held for future development or sale" on the Condensed Consolidated Balance Sheets. Also included in "Land and land options held for future development or sale" are amounts associated with inventory in mothballed communities. We mothball (or stop development on) certain communities when we determine the current performance does not justify further investment at the time. That is, we believe we will generate higher returns if we decide against spending money to improve land today and save the raw land until such time as the markets improve or we determine to sell the property. As ofJanuary 31, 2020 , we had mothballed land in 13 communities. The book value associated with these communities atJanuary 31, 2020 was$13.8 million , which was net of impairment charges recorded in prior periods of$138.1 million . We continually review communities to determine if mothballing is appropriate. During the first quarter of fiscal 2020, we did not mothball any additional communities, or sell any previously mothballed communities, but we re-activated a portion of one previously mothballed community. Inventories held for sale, which are land parcels where we have decided not to build homes and are actively marketing the land for sale, are reported at the lower of carrying amount or fair value less costs to sell. At bothJanuary 31, 2020 andOctober 31, 2019 , there were no inventories held for sale. In determining fair value for land held for sale, management considers, among other things, prices for land in recent comparable sale transactions, market analysis studies, which include the estimated price a willing buyer would pay for the land (other than in a forced liquidation sale) and recent bona fide offers received from outside third parties. 36
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The following tables summarize home sites included in our total residential real estate. The decrease in total home sites available atJanuary 31, 2020 compared toOctober 31, 2019 is attributable to delivering homes and terminating certain option agreements, as well as contributing eight previously owned communities, including four active communities, to a new unconsolidated joint venture in the first quarter of fiscal 2020, partially offset by signing new land option agreements and acquiring new land parcels. Active Proposed Active Communities Developable Total Communities(1) Homes Homes HomesJanuary 31, 2020 : Northeast 5 418 2,798 3,216 Mid-Atlantic 18 2,118 3,186 5,304 Midwest 16 1,657 1,609 3,266 Southeast 16 2,082 1,801 3,883 Southwest 59 4,642 2,599 7,241 West 22 2,520 2,535 5,055 Consolidated total 136 13,437 14,528 27,965 Unconsolidated joint ventures (2) 25 5,305 - 5,305 Owned 7,156 3,510 10,666 Optioned 6,017 11,018 17,035 Controlled lots 13,173 14,528 27,701 Construction to permanent financing lots 264 - 264 Consolidated total 13,437 14,528 27,965
(1) Active communities are open for sale communities with ten or more home
sites available. We identify communities based on product type. Therefore,
at times there are multiple communities at one land site.
(2) Represents active communities and home sites for our unconsolidated
homebuilding joint ventures for the period. We provide this data as a
supplement to our consolidated results as an indicator of the volumemanaged in our unconsolidated joint ventures. See Note 18 to the Condensed
Consolidated Financial Statements for a further discussion of our
unconsolidated joint ventures.
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Active Proposed
Active Communities Developable Total
Communities(1) Homes Homes Homes
October 31, 2019 :
Northeast 6 499 2,798 3,297
Mid-Atlantic 25 2,281 3,016 5,297
Midwest 16 1,758 2,140 3,898
Southeast 17 2,628 2,065 4,693
Southwest 58 4,487 2,701 7,188
West 19 2,465 2,795 5,260
Consolidated total 141 14,118 15,515 29,633
Unconsolidated joint ventures (2) 22 4,226 - 4,226
Owned 7,522 3,852 11,374
Optioned 6,341 11,663 18,004
Controlled lots 13,863 15,515 29,378
Construction to permanent financing lots 255 - 255
Consolidated total 14,118 15,515 29,633
(1) Active communities are open for sale communities with ten or more home sites
available. We identify communities based on product type. Therefore, at
times there are multiple communities at one land site.
(2) Represents active communities and home sites for our unconsolidated
homebuilding joint ventures for the period. We provide this data as asupplement to our consolidated results as an indicator of the volume managed
in our unconsolidated joint ventures. See Note 18 to the Condensed
Consolidated Financial Statements for a further discussion of our
unconsolidated joint ventures.
The following table summarizes our started or completed unsold homes and models,
excluding unconsolidated joint ventures, in active and substantially completed
communities.
January 31, 2020 October 31, 2019
Unsold Unsold
Homes Models Total Homes Models Total
Northeast 68 10 78 58 12 70
Mid-Atlantic 74 15 89 63 12 75
Midwest 33 9 42 31 10 41
Southeast 72 16 88 78 15 93
Southwest 363 14 377 320 12 332
West 180 21 201 213 19 232
Total 790 85 875 763 80 843
Started or completed unsold
homes and models per active
selling communities (1) 5.8 0.6 6.4 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 136 and 141 at
completed communities, which are communities with less than ten home sites
available.
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Other Balance Sheet Activities
Investments in and advances to unconsolidated joint ventures increased$8.3 million to$135.3 million atJanuary 31, 2020 compared toOctober 31, 2019 . The increase was primarily due to a new unconsolidated joint venture entered into in the first quarter of fiscal 2020, partially offset by unconsolidated joint venture partner distributions during the period. As ofJanuary 31, 2020 andOctober 31, 2019 , we had investments in 11 and ten unconsolidated homebuilding joint ventures, respectively, and one unconsolidated land development joint venture for both periods. We have no guarantees associated with our unconsolidated joint ventures, other than guarantees limited only to performance and completion of development, environmental indemnification and standard warranty and representation against fraud, misrepresentation and similar actions, including a voluntary bankruptcy. Receivables, deposits and notes, net increased$4.3 million fromOctober 31, 2019 to$49.2 million atJanuary 31, 2020 . The increase was primarily due to a new receivable related to a land banking arrangement in our West segment, partially offset by the receipt of a receivable during the period related to the funding of the satisfaction and discharge of certain of our senior secured notes in the fourth quarter of fiscal 2019.
Prepaid expenses and other assets were as follows as of:
January 31, October 31, Dollar
(In thousands) 2020 2019 Change
Prepaid insurance $3,244 $2,061 $1,183
Prepaid project costs 31,887 32,015 (128 )
Other prepaids 13,012 10,808 2,204
Other assets 874 820 54
Lease right of use asset 22,267 - 22,267
Total $71,284 $45,704 $25,580
Prepaid insurance increased during the three months ended January 31, 2020 due
to the timing of premium payments. These costs are amortized over the life of
the associated insurance policy, which can be one to three years. Prepaid
project costs consist of community specific expenditures that are used over the
life of the community. Such prepaid costs are expensed as homes are delivered.
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, 2020 , are now required to be recorded as an asset on our Condensed
Consolidated Balance Sheets. See Note 9 to the Condensed Consolidated Financial
Statements for further information. Other prepaids increased mainly due to new
premiums for the renewal of certain software and related services during the
period, partially offset by amortization of these costs.
Financial services assets consist primarily of residential mortgages receivable
held for sale of which $87.6 million and $163.0 million at January 31, 2020 and
October 31, 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 is related to a decrease in the volume of
loans originated during the first quarter of 2020 compared to the fourth quarter
of 2019, primarily due to the decrease in deliveries, partially offset by an
increase in the average loan value. Also contributing to the decrease in
financial services other assets was a decrease in restricted cash due to the
timing of home closings at the end of the fourth quarter of fiscal 2019 compared
to the end of the first quarter of fiscal 2020.
Nonrecourse mortgages secured by inventory increased to $205.8 million at
January 31, 2020 from $203.6 million at October 31, 2019 . The increase was
primarily due to additional loan borrowings on existing mortgages, along with
new mortgages for communities in our Southwest and West segments obtained during
the three months ended January 31, 2020 , partially offset by the payment of
existing mortgages.
Accounts payable and other liabilities are as follows as of:
January 31, October 31, Dollar
(In thousands) 2020 2019 Change
Accounts payable $136,864 $141,667 $(4,803 )
Reserves 92,738 92,083 655
Lease liability 23,306 - 23,306
Accrued expenses 16,410 19,208 (2,798 )
Accrued compensation 24,601 53,157 (28,556 )
Other liabilities 12,640 14,078 (1,438 )
Total $306,559 $320,193 $(13,634 )
The decrease in accounts payable was primarily due to the lower volume of
deliveries in the first quarter of fiscal 2020 compared to the fourth quarter of
fiscal 2019. Lease liability represents the net present value of our minimum
lease obligations, which as discussed above, are required to be recorded on our
Condensed Consolidated Balance Sheets as a result of the Company's adoption of
ASU 2016-02 on November 1, 2020 . Accrued expenses decreased primarily due to the
timing of property tax payments, along with the timing of certain accruals for
legal fees associated with debt financing transactions during fiscal 2019. The
decrease in accrued compensation was primarily due to the payment of our fiscal
year 2019 bonuses during the first quarter of fiscal 2020, partially offset by
the accrual of fiscal 2020 bonuses in the first quarter of fiscal 2020. Other
liabilities decreased primarily due to 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, partially offset by an increase related to
the timing of hospitalization claims and payments during the period.
Liabilities from inventory not owned increased $11.2 million to $152.2 million
at January 31, 2020 . The increase was primarily due to an increase in land
banking activity during the period, partially offset by a decrease in the sale
and leaseback of certain model homes, both accounted for as financing
transactions as described above.
Financial Services (liabilities) decreased $73.0 million from $169.1 million at
October 31, 2019 , to $96.1 million at January 31, 2020 . The decrease is
primarily due to a decrease in amounts outstanding under our mortgage warehouse
lines of credit, and directly correlates to the decrease in the volume of
mortgage loans held for sale during the period.
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RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED
Total Revenues
Compared to the same prior period, revenues increased as follows:
Three Months Ended
January 31, January 31, Dollar Percentage
(Dollars in thousands) 2020 2019 Change Change
Homebuilding:
Sale of homes $479,233 $362,135 $117,098 32.3 %
Land sales and other revenues 809 8,851 (8,042 ) (90.9 )%
Financial services 14,014 9,608 4,406 45.9 %
Total revenues $494,056 $380,594 $113,462 29.8 %
Homebuilding
For the three months ended January 31, 2020 , sale of homes revenues increased
$117.1 million , or 32.3%, as compared to the same period of the prior year. This
increase was due to the number of home deliveries increasing 27.8% for the three
months ended January 31, 2020 compared to the three months ended January 31,
2019 , along with a 3.5% increase in the average price per home. The average
price per home increased to $387,729 in the three months ended January 31, 2020
from $374,493 in the three months ended January 31, 2019 . The increase in
average price was the result of the geographic and community mix of our
deliveries. Land sales are ancillary to our homebuilding operations and are
expected to continue in the future but may significantly fluctuate up or
down. For further details on the decrease in land sales and other revenues, see
the section titled "Land Sales and Other Revenues" below.
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Information on homes delivered by segment is set forth below:
Three Months Ended January 31,
(Dollars in thousands) 2020 2019 % Change
Northeast:
Dollars $45,264 $12,505 262.0 %
Homes 81 22 268.2 %
Mid-Atlantic:
Dollars $87,589 $53,179 64.7 %
Homes 155 111 39.6 %
Midwest:
Dollars $46,392 $44,889 3.3 %
Homes 159 149 6.7 %
Southeast:
Dollars $36,680 $43,883 (16.4 )%
Homes 97 108 (10.2 )%
Southwest:
Dollars $163,703 $117,863 38.9 %
Homes 493 365 35.1 %
West:
Dollars $99,605 $89,816 10.9 %
Homes 251 212 18.4 %
Consolidated total:
Dollars $479,233 $362,135 32.3 %
Homes 1,236 967 27.8 %
Unconsolidated joint ventures (1)
Dollars $86,349 $95,027 (9.1 )%
Homes 149 152 (2.0 )%
(1) Represents housing revenues and home deliveries for our unconsolidated homebuilding joint ventures for the period. We provide this data as a supplement to our consolidated results as an indicator of the volume managed in our unconsolidated joint ventures. See Note 18 to the Condensed Consolidated Financial Statements for a further discussion of our unconsolidated joint ventures.
As discussed above, the overall increase in consolidated housing revenues during the three months endedJanuary 31, 2020 as compared to the same period of the prior year was attributed to an increase in deliveries, along with an increase in average sales price. 41
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An important indicator of our future results are recently signed contracts and
our home contract backlog for future deliveries. Our sales contracts and homes
in contract backlog by segment are set forth below:
Net Contracts (1) for the
Three Months Ended Contract Backlog as of
January 31 , January 31 ,(Dollars in thousands) 2020 2019 2020 2019 Northeast: Dollars$33,003 $34,950 $74,296 $52,941 Homes 63 52 134 81 Mid-Atlantic: Dollars$93,702 $81,514 $189,646 $208,881 Homes 183 151 350 336 Midwest: Dollars$58,276 $37,046 $134,566 $99,306 Homes 187 127 478 372 Southeast: Dollars$67,158 $40,460 $139,505 $104,714 Homes 155 95 305 238 Southwest: Dollars$178,433 $115,338 $245,627 $178,329 Homes 528 362 698 520 West: Dollars$90,832 $57,018 $115,927 $105,650 Homes 206 147 256 246 Consolidated total: Dollars$521,404 $366,326 $899,567 $749,821 Homes 1,322 934 2,221 1,793 Unconsolidated joint ventures:(2) Dollars $121,758 $85,569 $252,279 $222,223 Homes 265 134 633 348
(1) Net contracts are defined as new contracts executed during the period for the purchase of homes, less cancellations of contracts in the same period.
(2) Represents net contract dollars, net contract homes and contract backlog dollars and homes for our unconsolidated homebuilding joint ventures for the period. We provide this data as a supplement to our consolidated results as an indicator of the volume managed in our unconsolidated joint ventures. See Note 18 to the Condensed Consolidated Financial Statements for a further discussion of our unconsolidated joint ventures. In the first quarter of 2020, our open for sale community count decreased to 136 from 141 atOctober 31, 2019 , which is the net result of opening 16 new communities, closing 17 communities and contributing four communities to an unconsolidated joint venture since the beginning of fiscal 2020. Our reported level of sales contracts (net of cancellations) has been impacted by an increase in sales pace per community in the first quarter of fiscal 2020 as compared to the same period of the prior year. Net contracts per average active selling community for the three months endedJanuary 31, 2020 increased to 9.7 compared to 6.8 for the same period in the prior year. This is the highest net contracts per average active selling community for the first fiscal quarter since fiscal 2005. 42
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Cancellation rates represent the number of cancelled contracts in the quarter divided by the number of gross sales contracts executed in the quarter. For comparison, the following are historical cancellation rates, excluding unconsolidated joint ventures:
Quarter 2020 2019 2018 2017 2016 First 19 % 24 % 18 % 19 % 20 % Second 19 % 17 % 18 % 19 % Third 19 % 19 % 19 % 21 % Fourth 21 % 23 % 22 % 20 %
Another common and meaningful way to analyze our cancellation trends is to compare the number of contract cancellations as a percentage of the beginning backlog. The following table provides this historical comparison, excluding unconsolidated joint ventures:
Quarter 2020 2019 2018 2017 2016
First 14 % 16 % 12 % 12 % 13 %
Second 20 % 15 % 16 % 14 %
Third 16 % 14 % 13 % 12 %
Fourth 14 % 13 % 12 % 11 %
Most cancellations occur within the legal rescission period, which varies by
state but is generally less than two weeks after the signing of the contract.
Cancellations also occur as a result of a buyer's failure to qualify for a
mortgage, which generally occurs during the first few weeks after signing. As
shown in the tables above, contract cancellations over the past several years
have been within what we believe to be a normal range. However, market
conditions remain uncertain and it is difficult to predict what cancellation
rates will be in the future.
Total cost of sales on our Condensed Consolidated Statements of Operations
includes expenses for consolidated housing and land and lot sales, including
inventory impairment loss and land option write-offs (defined as "land charges"
in the tables below). A breakout of such expenses for housing sales and
homebuilding gross margin is set forth below.
Homebuilding gross margin before cost of sales interest expense and land charges
is a non-GAAP financial measure. This measure should not be considered as an
alternative to homebuilding gross margin determined in accordance with GAAP as
an indicator of operating performance.
Management believes this non-GAAP measure enables investors to better understand
our operating performance. This measure is also useful internally, helping
management evaluate our operating results on a consolidated basis and relative
to other companies in our industry. In particular, the magnitude and volatility
of land charges for the Company, and for other homebuilders, have been
significant and, as such, have made financial analysis of our industry more
difficult. Homebuilding metrics excluding land charges, as well as interest
amortized to cost of sales, and other similar presentations prepared by analysts
and other companies are frequently used to assist investors in understanding and
comparing the operating characteristics of homebuilding activities by
eliminating many of the differences in companies' respective level of
impairments and levels of debt.
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Three Months Ended
January 31,
(Dollars in thousands) 2020 2019
Sale of homes $479,233 $362,135 Cost of sales, excluding interest expense and land charges
396,318 297,570
Homebuilding gross margin, before cost of sales interest expense and land charges
82,915 64,565
Cost of sales interest expense, excluding land sales interest expense
18,136 10,242
Homebuilding gross margin, after cost of sales interest expense, before land charges 64,779 54,323 Land charges 2,828 704 Homebuilding gross margin$61,951 $53,619 Gross margin percentage 12.9 % 14.8 %
Gross margin percentage, before cost of sales interest expense and land charges
17.3 % 17.8 %
Gross margin percentage, after cost of sales interest
expense, before land charges 13.5 % 15.0 %
Cost of sales expenses as a percentage of consolidated home sales revenues are
presented below:
Three Months Ended
January 31,
2020 2019
Sale of homes 100.0 % 100.0 %
Cost of sales, excluding interest expense and land charges: Housing, land and development costs
72.7 % 71.8 %
Commissions 3.5 % 3.5 %
Financing concessions 1.4 % 1.3 %
Overheads 5.1 % 5.6 %
Total cost of sales, before interest expense and land
charges 82.7 % 82.2 %
Cost of sales interest 3.8 % 2.8 %
Land charges 0.6 % 0.2 %
Gross margin percentage 12.9 % 14.8 % Gross margin percentage, before cost of sales interest expense and land charges
17.3 % 17.8 % Gross margin percentage, after cost of sales interest expense and before land charges
13.5 % 15.0 %
We sell a variety of home types in various communities, each yielding a
different gross margin. As a result, depending on the mix of communities
delivering homes, consolidated gross margin may fluctuate up or down. Total
homebuilding gross margin percentage decreased to 12.9% during the three months
ended January 31, 2020 compared to 14.8% for the same period last year. This
decrease was primarily attributed to an increase in cost of sales interest, as
well as the impact of additional incentives on spec homes delivered in the first
quarter of fiscal 2020 and also the result of the mix of communities delivering
in each period. Gross margin percentage, before cost of sales interest expense
and land charges decreased slightly from 17.8% for the three months ended
January 31, 2019 to 17.3% for the three months ended January 31, 2020 , primarily
due to the impact of additional incentives on spec homes delivered in the first
quarter of fiscal 2020.
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Reflected as inventory impairment loss and land option write-offs in cost of sales, we have written-off or written-down certain inventories totaling$2.8 million and$0.7 million during the three months endedJanuary 31, 2020 and 2019, respectively, to their estimated fair value. During the three months endedJanuary 31, 2020 , we wrote-off residential land options and approval and engineering costs amounting to$2.8 million compared to$0.7 million for the three months endedJanuary 31, 2019 , which are included in the total land charges discussed above. Option, approval and engineering costs are written-off when a community's pro forma profitability is not projected to produce adequate returns on the investment commensurate with the risk and when we believe it is probable we will cancel the option or when a community is redesigned engineering costs related to the initial design are written-off. Such write-offs were located in the Midwest and Southeast segments in the first quarter of fiscal 2020, and in all of our segments, except our Midwest segment in the first quarter of fiscal 2019. We did not record any inventory impairments during the three months endedJanuary 31, 2020 . We recorded an inventory impairment of less than$0.1 million during the three months endedJanuary 31, 2019 , which was related to one community in the Northeast. It is difficult to predict impairment levels, and should it become necessary or desirable to have additional land sales, further lower prices, or should the estimates or expectations used in determining estimated cash flows or fair value decrease or differ from current estimates in the future, we may need to recognize additional impairments.
Land Sales and Other Revenues
Land sales and other revenues consist primarily of land and lot sales. A breakout of land and lot sales is set forth below:
Three Months Ended
January 31,
(In thousands) 2020 2019
Land and lot sales $25 $7,508
Cost of sales, excluding interest 37 7,357
Land and lot sales gross margin, excluding interest (12 ) 151 Land and lot sales interest expense
- -
Land and lot sales gross margin, including interest
Land sales are ancillary to our residential homebuilding operations and are expected to continue in the future but may significantly fluctuate up or down. Although we budget land sales, they are often dependent upon receiving approvals and entitlements, the timing of which can be uncertain. As a result, projecting the amount and timing of land sales is difficult. Revenue associated with land sales can vary significantly due to the mix of land parcels sold. There was one land sale in the first quarter of fiscal 2020 compared to four land sales in the same period of the prior year, resulting in a decrease of$7.5 million in land sales revenues. Land sales and other revenues decreased$8.0 million for the three months endedJanuary 31, 2020 compared to the same period in the prior year. Other revenues include income from contract cancellations where the deposit has been forfeited due to contract terminations, interest income, cash discounts and miscellaneous one-time receipts. The decrease for the three months endedJanuary 31, 2020 , compared to the three months endedJanuary 31, 2019 , was mainly due to the decrease in land sales discussed above.
Homebuilding Selling, General and Administrative
Homebuilding selling, general and administrative ("SGA") expenses decreased
$2.1 million to $40.7 million for the three months ended January 31, 2020
compared to the same period last year. The decrease can be attributed to the
reduction of our community count and the increase of unconsolidated joint
venture management fees received, which offset general and administrative
expenses, from contingent management fees received in the current fiscal quarter
from our land development joint venture. SGA expenses as a percentage of
homebuilding revenues decreased to 8.5% for the three months ended January 31,
2020 compared to 11.5% for the three months ended January 31, 2019 , as a result
of the 29.4% increase in homebuilding revenue for the first fiscal quarter
compared to the prior year period.
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HOMEBUILDING OPERATIONS BY SEGMENT
Segment Analysis
Three Months Ended January 31,
(Dollars in thousands, except average sales
price) 2020 2019 Variance Variance %
Northeast
Homebuilding revenue $45,276 $19,941 $25,335 127.0 %
Income before income taxes $5,741 $5,879 $(138 ) (2.3 )%
Homes delivered 81 22 59 268.2 %
Average sales price $558,815 $568,387
Mid-
Homebuilding revenue$87,759 $53,430 $34,329 64.3 % Income (loss) before income taxes$4,058 $(7 ) $4,065 58,071.4 % Homes delivered 155 111 44 39.6 % Average sales price$565,090 $479,091 $85,999 18.0 % Midwest Homebuilding revenue$46,444 $44,921 $1,523 3.4 % Loss before income taxes$(3,443 ) $(849 ) $(2,594 ) (305.5 )% Homes delivered 159 149 10 6.7 % Average sales price$291,774 $301,272 $(9,498 ) (3.2 )% Southeast Homebuilding revenue$36,774 $43,991 $(7,217 ) (16.4 )% Loss before income taxes$(4,311 ) $(2,929 ) $(1,382 ) (47.2 )% Homes delivered 97 108 (11 ) (10.2 )% Average sales price$378,144 $406,327 $(28,183 ) (6.9 )% Southwest Homebuilding revenue$163,899 $118,199 $45,700 38.7 % Income before income taxes$8,620 $2,386 $6,234 261.3 % Homes delivered 493 365 128 35.1 % Average sales price$332,055 $322,911 $9,144 2.8 % West Homebuilding revenue$99,621 $89,901 $9,720 10.8 % Income before income taxes$1,611 $11,705 $(10,094 ) (86.2 )% Homes delivered 251 212 39 18.4 % Average sales price$396,833 $423,662 $(26,829 ) (6.3 )%
Homebuilding Results by Segment
Northeast - Homebuilding revenues increased 127.0% for the three months endedJanuary 31, 2020 compared to the same period of the prior year. The increase for the three months endedJanuary 31, 2020 was attributed to a 268.2% increase in homes delivered, partially offset by a 1.7% decrease in average sales price. The decrease in average sales price was the result of new communities delivering smaller single family homes, townhomes and affordable-housing homes in mid to higher-end submarkets of the segment in the three months endedJanuary 31, 2020 compared to some communities delivering in the three months endedJanuary 31, 2019 that had higher priced, single family homes in higher-end submarkets of the segment that are no longer delivering. Also impacting the decrease in average sales price is an increase in pricing concessions and a decrease in location premiums in certain communities. Income before income taxes decreased$0.1 million to$5.7 million for the three months endedJanuary 31, 2020 as compared to the prior year. While profit for the segment was relatively flat, volume increased generating a$25.3 million increase in homebuilding revenue. However, the additional profit from the increase in homebuilding revenue was offset by a decrease of$6.0 million in income from unconsolidated joint ventures. 46
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Mid-Atlantic - Homebuilding revenues increased 64.3% for the three months endedJanuary 31, 2020 compared to the same period in the prior year. The increase was primarily due to a 39.6% increase in homes delivered and an 18.0% increase in average sales price for the three months endedJanuary 31, 2020 compared to the same period in the prior year. The increase in average sales price was the result of new communities delivering higher priced, larger single family homes and townhomes in higher-end submarkets of the segment in the three months endedJanuary 31, 2020 compared to some communities delivering in the three months endedJanuary 31, 2019 that had lower priced, smaller single family homes and townhomes in lower-end submarkets of the segment that are no longer delivering. Loss before income taxes improved$4.1 million to income of$4.1 million for the three months endedJanuary 31, 2020 compared to the same period in the prior year, which was primarily due to the increase in homebuilding revenue discussed above and a slight increase in gross margin percentage before interest expense for the period compared to the same period of the prior year. Midwest - Homebuilding revenues increased 3.4% for the three months endedJanuary 31, 2020 compared to the same period in the prior year. The increase was due to a 6.7% increase in homes delivered, partially offset by a 3.2% decrease in the 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 the three months endedJanuary 31, 2020 compared to some communities delivering in the three months endedJanuary 31, 2019 that had higher priced, single family homes and townhomes in higher-end submarkets of the segment that are no longer delivering. Loss before income taxes increased$2.6 million to$3.4 million for the three months endedJanuary 31, 2020 compared to the same period in the prior year. The increase was primarily due to a$2.6 million increase in inventory impairment loss and land option write-offs. Gross margin percentage before interest expense was flat for the three months endedJanuary 31, 2020 compared to the same period of the prior year. Southeast - Homebuilding revenues decreased 16.4% for the three months endedJanuary 31, 2020 compared to the same period in the prior year. The decrease was due to an 10.2% decrease in homes delivered and a 6.9% decrease in average sales price. The decrease in deliveries was primarily due to the number of communities winding down as compared to new communities not yet delivering homes during the three months endedJanuary 31, 2020 as compared the same period of the prior year. The decrease in average sales price was the result of new communities delivering lower priced, smaller single family homes in lower-end submarkets of the segment in the three months endedJanuary 31, 2020 compared to some communities delivering in the three months endedJanuary 31, 2019 that had higher priced, larger single family homes in higher-end submarkets of the segment that are no longer delivering. Loss before income taxes increased$1.4 million to$4.3 million for the three months endedJanuary 31, 2020 primarily due to the decrease in homebuilding revenue discussed above and a slight decrease in gross margin percentage before interest expense for the period compared to the same period of the prior year. Southwest - Homebuilding revenues increased 38.7% for the three months endedJanuary 31, 2020 compared to the same period in the prior year. The increase in homebuilding revenues was primarily due to a 35.1% increase in homes delivered and a 2.8% increase in average sales price for the three months endedJanuary 31, 2020 . The increase in average sales price was the result of new communities delivering higher priced, larger single family homes in mid to higher-end submarkets of the segment in the three months endedJanuary 31, 2020 compared to some communities delivering in the three months endedJanuary 31, 2019 that had lower priced, smaller single family homes in lower-end submarkets of the segment that are no longer delivering. Income before income taxes increased$6.2 million to$8.6 million for the three months endedJanuary 31, 2020 compared to the same period in the prior year. The increase was primarily due to the increase in homebuilding revenue discussed above and an increase in gross margin percentage before interest expense for the three months endedJanuary 31, 2020 compared to the same period of the prior year. West - Homebuilding revenues increased 10.8% for the three months endedJanuary 31, 2020 compared to the same period in the prior year. The increase for the three months endedJanuary 31, 2020 was primarily attributed to an 18.4% increase in homes delivered, partially offset by a 6.3% 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 the three months endedJanuary 31, 2020 compared to some communities delivering in the three months endedJanuary 31, 2019 that had higher priced, larger single family homes and townhomes in higher-end submarkets of the segment that are no longer delivering. Income before income taxes decreased$10.1 million to$1.6 million for the three months endedJanuary 31, 2020 . The decrease for the three months endedJanuary 31, 2020 was primarily due to a significant decrease in gross margin percentage before interest expense for the period compared to the same period of the prior year. 47
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Financial Services
Financial services consist primarily of originating mortgages from our home
buyers, selling such mortgages in the secondary market, and title insurance
activities. We use mandatory investor commitments and forward sales of
mortgage-backed securities ("MBS") to hedge our mortgage-related interest rate
exposure on agency and government loans. These instruments involve, to varying
degrees, elements of credit and interest rate risk. Credit risk associated with
MBS forward commitments and loan sales transactions is managed by limiting our
counterparties to investment banks, federally regulated bank affiliates and
other investors meeting our credit standards. Our risk, in the event of default
by the purchaser, is the difference between the contract price and fair value of
the MBS forward commitments. For the first quarters of fiscal 2020 and 2019,
Federal Housing Administration and Veterans Administration ("FHA/VA ") loans
represented 33.2% and 26.7%, respectively, of our total loans. The origination
of FHA/VA loans increased from the first quarter of fiscal 2019 to the first
quarter of fiscal 2020 and our conforming conventional loan originations as a
percentage of our total loans decreased from 69.8% to 64.4% for these periods,
respectively. The origination of loans which exceed conforming conventions
decreased from 3.5% for the first quarter of fiscal 2019 to 2.4% for the first
quarter of fiscal 2020. Profits and losses relating to the sale of mortgage
loans are recognized when legal control passes to the buyer of the mortgage and
the sales price is collected.
During the three months ended January 31, 2020 , financial services provided a
$4.5 million pretax profit compared to $1.1 million of pretax profit for the
same period of fiscal 2019. This increase in pretax profit is attributed to the
increase in the homebuilding deliveries and the increase in the basis point
spread between the loans originated and the implied rate from the sale of the
loans, as well as an increase in the average price of the loans settled. In the
market areas served by our wholly owned mortgage banking subsidiaries, 68.1% and
70.5% of our noncash homebuyers obtained mortgages originated by these
subsidiaries during the three months ended January 31, 2020 and 2019,
respectively.
Corporate General and Administrative
Corporate general and administrative expenses include the operations at our headquarters inNew Jersey . These expenses include payroll, stock compensation, facility costs and rent and other costs associated with our executive offices, legal expenses, information services, human resources, corporate accounting, training, treasury, process redesign, internal audit, national and digital marketing, construction services and administration of insurance, quality and safety. Corporate general and administrative expenses increased to$19.7 million for the three months endedJanuary 31, 2020 compared to$17.7 million for the three months endedJanuary 31, 2019 , primarily due to additional costs pertaining to software licenses and support fees for cybersecurity and monitoring services. Other Interest Other interest increased$2.7 million for the three months endedJanuary 31, 2020 compared to the three months endedJanuary 31, 2019 . Our assets that qualify for interest capitalization (inventory under development) are less than our debt, and therefore the portion of interest not covered by qualifying assets is directly expensed. Other interest increased for the three months endedJanuary 31, 2020 compared to the three months endedJanuary 31, 2019 because we incurred more interest as a result of the increase in nonrecourse mortgages atJanuary 31, 2020 compared toJanuary 31, 2019 , and as a result of the debt exchange in the fourth quarter of fiscal 2019.
Gain on Extinguishment of Debt
OnDecember 10, 2019 , the Company entered into a credit agreement providing for$81.5 million of senior secured 1.75 lien term loans in exchange for$163.0 million of senior unsecured term loans. OnDecember 10, 2019 , the Company also issued$158.5 million of 10.0% Senior Secured 1.75 Lien Notes due 2025 in exchange for$23.2 million of 10.0% Senior Secured Notes due 2022 and$141.7 million 10.5% Senior Secured Notes due 2024. These transactions were accounted for in accordance with ASC 470-60, resulting in a gain on extinguishment of debt of$9.5 million for the three months endedJanuary 31, 2020 .
Income from
Income from unconsolidated joint ventures consists of our share of the earnings or losses of our unconsolidated joint ventures. Income from unconsolidated joint ventures decreased$8.0 million to$1.5 million for the three months endedJanuary 31, 2020 compared to the same period of the prior year. The decrease was primarily due to the income recorded in the first quarter of fiscal 2019 related to the return of capital from an unconsolidated joint venture in which we had previously written-off our investment. 48
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Table of Contents Total Taxes The total income tax expense of$1.7 million recognized for the three months endedJanuary 31, 2020 was primarily related to state tax expense from the impact of the cancellation of debt income recorded for tax purposes but not for GAAP purposes, creating a permanent difference. The total income tax expense of$0.3 million recognized for the three months endedJanuary 31, 2019 was primarily related to state tax expense from income generated that was not offset by tax benefits in states where we fully reserve the tax benefit from net operating losses. 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 53.1% of our homebuilding cost of sales for the three months endedJanuary 31, 2020 . Safe Harbor Statement All statements in this Quarterly Report on Form 10-Q that are not historical facts should be considered as "Forward-Looking Statements" within the meaning of the "Safe Harbor" provisions of the Private Securities Litigation Reform Act of 1995. Such statements involve known and unknown risks, uncertainties and other factors that may cause actual results, performance or achievements of the Company to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. Such forward-looking statements include but are not limited to statements related to the Company's goals and expectations with respect to its financial results for future financial periods. Although we believe that our plans, intentions and expectations reflected in, or suggested by, such forward-looking statements are reasonable, we can give no assurance that such plans, intentions or expectations will be achieved. By their nature, forward-looking statements: (i) speak only as of the date they are made, (ii) are not guarantees of future performance or results and (iii) are subject to risks, uncertainties and assumptions that are difficult to predict or quantify. Therefore, actual results could differ materially and adversely from those forward-looking statements as result of a variety of factors. Such risks, uncertainties and other factors include, but are not limited to:
? Changes in general and local economic, industry and business conditions and
impacts of a significant homebuilding downturn;
? Adverse weather and other environmental conditions and natural disasters;
? High leverage and restrictions on the Company's operations and activities
imposed by the agreements governing the Company's outstanding indebtedness;
? Availability and terms of financing to the Company; ? The Company's sources of liquidity; ? Changes in credit ratings; ? The seasonality of the Company's business;
? The availability and cost of suitable land and improved lots and sufficient
liquidity to invest in such land and lots;
? Shortages in, and price fluctuations of, raw materials and labor, including
due to changes in trade policies, including the imposition of tariffs and
duties on homebuilding materials and products and related trade disputes with
and retaliatory measures taken by other countries;
? Reliance on, and the performance of, subcontractors;
? Regional and local economic factors, including dependency on certain sectors
of the economy, and employment levels affecting home prices and sales
activity in the markets where the Company builds homes;
? Increases in cancellations of agreements of sale;
? Fluctuations in interest rates and the availability of mortgage financing;
? Changes in tax laws affecting the after-tax costs of owning a home;
? Operations through unconsolidated joint ventures with third parties;
? Government regulation, including regulations concerning development of land,
the home building, sales and customer financing processes, tax laws and the
environment;
? Legal claims brought against us and not resolved in our favor, such as
product liability litigation, warranty claims and claims made by mortgage
investors;
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Table of Contents ? Levels of competition; ? Successful identification and integration of acquisitions; ? Significant influence of the Company's controlling stockholders; ? Availability of net operating loss carryforwards; ? Utility shortages and outages or rate fluctuations; ? Geopolitical risks, terrorist acts and other acts of war; ? Diseases, pandemics or other severe public health events;
? Loss of key management personnel or failure to attract qualified personnel;
? Information technology failures and data security breaches; and ? Negative publicity. Certain risks, uncertainties and other factors are described in detail in Part I, Item 1 "Business" and Part I, Item 1A "Risk Factors" in our Annual Report on Form 10-K for the fiscal year endedOctober 31, 2019 . Except as otherwise required by applicable securities laws, we undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, changed circumstances or any other reason after the date of this Quarterly Report on Form 10-Q.
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