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Edited Transcript of HOV earnings conference call or presentation 5-Mar-20 4:00pm GMT

Q1 2020 Hovnanian Enterprises Inc Earnings Call

RED BANK Mar 27, 2020 (Thomson StreetEvents) -- Edited Transcript of Hovnanian Enterprises Inc earnings conference call or presentation Thursday, March 5, 2020 at 4:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Ara K. Hovnanian

Hovnanian Enterprises, Inc. - President, CEO & Chairman of the Board

* Brad G. O’Connor

Hovnanian Enterprises, Inc. - VP, CAO & Corporate Controller

* J. Larry Sorsby

Hovnanian Enterprises, Inc. - Executive VP, CFO & Director

* Jeffrey T. O'Keefe

Hovnanian Enterprises, Inc. - VP of IR

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Conference Call Participants

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* Alan S. Ratner

Zelman & Associates LLC - MD

* Alex Barrón

Housing Research Center, LLC - Founder and Senior Research Analyst

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Presentation

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Operator [1]

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Good morning, and thank you for joining us for Hovnanian Enterprises Fiscal 2020 1st Quarter Earnings Conference Call. An archive of the webcast would be available after the completion of the call and run for 12 months.

The conference is being recorded for rebroadcast, and all participants are currently in a listen-only mode.

Management will be making some opening remarks about the first quarter results and then opening the lines for questions. The companies will also be webcasting a slide presentation along with the opening comments from management. The slides are available on the investor page of the company's website at www.khov.com. Those listeners who would like to follow along should now log on to the website.

I would like to turn the call over to Jeff O'Keefe, Vice President, Investor Relations. Jeff, please go ahead.

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Jeffrey T. O'Keefe, Hovnanian Enterprises, Inc. - VP of IR [2]

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Thank you, Katherine, and thank you all for participating in the call this morning to review the results for our first quarter, which ended January 31, 2020.

All statements in this conference call that are not historical facts are considered 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 and/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 speak only as of date they are made, are not guarantees of future performance and results and are subject to risks, uncertainties and assumptions that are difficult to predict or quantify. Therefore, actual results could differ materially and adversely from those forward-looking statements as a result of a variety of factors.

Such risks, uncertainties and other factors are described in detail in the sections entitled Risk Factors in Management's Discussion and Analysis, particularly the portion of MD&A entitled Safe Harbor Statement in our annual report on Form 10-K for the fiscal year ended October 31, 2019, and subsequent filings with the Securities and Exchange Commission. 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.

Joining me today are Ara Hovnanian, Chairman, President and CEO; Larry Sorsby, Executive Vice President and CFO; Brad O'Connor, Vice President and Chief Accounting Officer and Controller; and David Bachstetter, Vice President, Finance and Treasurer.

I'll now turn the call over to Ara. Ara, please go ahead.

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Ara K. Hovnanian, Hovnanian Enterprises, Inc. - President, CEO & Chairman of the Board [3]

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Thanks, Jeff. I'm going to review the results of our first quarter, and as usual, Larry Sorsby will follow me with more detail.

On Slide 4, we compare year-over-year results for the first quarter. As you can see in the upper left-hand portion of the slide, total revenues grew 30% to $494 million during this year's first quarter. The growth was driven by a 28% increase in deliveries and a 4% increase in average sales price. We're pleased to see a more substantial increase in our revenues this quarter. This is in line with the increases we've seen in our contracts over the past 2 quarters.

Moving to the top right. You can see that our gross margin was 17.3% for the first quarter of 2020 compared to 17.8% during the first quarter of 2019. This was lower than we anticipated and is partially due to greater discounting to move through some of the spec inventory during the slower winter season. In recent weeks, as we have seen the market growing stronger, there has been far less discounting on specs.

In the lower left-hand portion of the slide, you can see that our total SG&A ratio was 12.2% for the first quarter of 2020 compared to 15.9% in last year's first quarter. Our total SG&A dollars were flat year-over-year at $60 million for the first quarter. Our increased levels of revenue and flat SG&A dollars resulted in a lower SG&A ratio for the first quarter. This certainly demonstrates the benefits of leveraging our SG&A expenses with higher revenues. As we continue to grow our consolidated revenues, we expect to be able to better leverage our cost and over time get our annual SG&A ratio back to a more normalized range of 10%.

In the lower right-hand quadrant of the slide, we show that adjusted EBITDA increased to $30 million this year compared to $17 million in last year's first quarter. This occurred despite an $8 million reduction in joint venture income in this year's first quarter. We did experience higher interest expense this quarter, which partially offset the improvement in EBITDA. Larry will talk about joint ventures and interest in greater detail in a moment.

On Slide 5, you can see that our pretax loss for the first quarter was $17 million. And for this year's first quarter, it was reduced to $7 million. If you ignore the gain on extinguishment of debt and any land-related charges, you can see on the right-hand portion of the slide that our adjusted pretax loss of $14 million this year was slightly less than the loss of $16 million last year. Again, our revenues, EBITDA and SG&A ratio all showed solid improvement this quarter. However, the improvements were partially offset by interest expense, resulting in a more moderate improvement in pretax income.

The strongest improvement in the quarter was in new contracts. On Slide 6, we show a very strong trend in quarterly consolidated contracts. We've seen 4 quarters of year-over-year increases that have progressed steadily higher each quarter. The second quarter was up 10%. It was followed by a 23% increase in the third quarter, a 34% increase in the fourth quarter and then a 42% year-over-year increase in this year's fourth quarter, which was the strongest quarter yet.

Slide 7 gives more granular detail with the number of consolidated contracts on a monthly basis for the quarter plus the month of February. During the first quarter, every month showed a strong increase in excess of 30% compared to the same month last year. In fact, we've had a year-over-year increase in contract every month for the last year. That positive trend continued in February of 2020, the first month of our second quarter. Contracts increased 44% year-over-year.

The previous slides relate to -- related to absolute contracts. Now I'll focus on contracts per community. On Slide 8, we show 3 years' worth of consolidated contracts per community for the first quarter. As you can see, this metric also improved, increasing 43% to 9.7 from 6.8 in last year's first quarter. Some may say that the strong increase was against an easy comparison last year. I'm pleased to say we were also up 33% compared to the first quarter of 2018. Additionally, our sales pace was the highest level of contracts per community for any first quarter since 2005. It's clear that the housing market is rebounding and demand for our homes continues to gain momentum.

On Slide 9, we give more granularity with monthly consolidated contracts per community for the last 12 months. The most recent month is in blue. The same month a year ago is in gray. 11 of the past 12 months, including the last 10 months in a row, have been equal to or better than the same month during the prior year. February '20 shows an improvement at 4.8 contracts per community compared to 3.2 contracts per community in February of '19 and '18. Clearly, each of the last 4-month sales pace is not only up over what some would say last year's easier comparison, but they're also up substantially to the same month 2 years ago as well.

If you turn to Slide 10, you can see another view of contracts per community with longer-term trends. On the left-hand side, we show our annual contracts per community from 1997 to 2002. We averaged 44 contracts per community during this period. And again, it was neither a boom nor a bust period for the housing industry. In the middle of the slide, you can see the steady growth in contracts per community for each of the past several years. On the right-hand side of the slide, we show that net contracts per community for the trailing 12 months ended January 2020 was 41 compared to 34.9 a year ago. While our contract pace has improved substantially over last year, we're still not quite at historical norms, let alone market peaks. However, it is the first time since 2005 that we're above 40 contracts per community on a trailing 12-month basis.

If you turn to Slide 11, you can see that our consolidated community count, shown in gray, was essentially flat with the community count at the end of last year's first quarter. This was due to selling through some communities faster than we anticipated. We also contributed 4 open and actively selling age-restricted Four Seasons communities to a new unconsolidated joint venture during the first quarter of 2020. Due to their resort-style amenity package, our Four Seasons active adult communities tend to be more capital-intensive than traditional market rate communities. That makes them prime candidates for joint ventures. We have 3 additional Four Seasons communities scheduled to open later this year, and we plan to place them into the same joint venture.

After taking into account our joint venture communities, our total community count increased 5% year-over-year to 160 communities at the end of our first quarter compared to 152 at the end of the same quarter last year. We're pleased to see our total community count is continuing to grow. Larry will talk more about the growth in our joint venture communities in just a moment. The growth in overall community count is the result of investments we've been making to our land position over the last few years. These investments have begun to produce higher levels of revenue, and ultimately, we expect them to result in higher levels of future profitability.

I'll turn it over to Larry Sorsby, our Executive Vice President and Chief Financial Officer.

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J. Larry Sorsby, Hovnanian Enterprises, Inc. - Executive VP, CFO & Director [4]

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Thanks, Ara. I'll start with a discussion about the year-over-year increase in our interest expense. As you can see on Slide 12, there was an $8 million year-over-year increase in cost of sales interest in the first quarter. Much of this increase was driven by higher delivery volumes. Cost of sales interest as a percent of homebuilding revenues was 3.8% in this year's first quarter, which is down slightly from the run rate of 4% for both the third and fourth quarters of fiscal 2019.

So while cost of sales, interest expense on a percentage basis was up compared to the first quarter last year, it was less than this year's first quarter than what we saw for the last half of the prior year.

Additionally, interest incurred increased $5 million year-over-year. Half of this increase was due to higher nonrecourse debt levels, and the other half was related to the debt exchanges that we completed in October and December of 2019. Other interest expense, which we show on the bottom of the slide, increased $3 million as this portion of the $5 million increase in interest incurred was expensed.

Turning to Slide 13. I'm going to update you on our unconsolidated joint venture activity. During fiscal 2018 and 2019, the number of domestic joint venture communities declined. In fiscal 2019, we opened 6 joint venture communities. And in the first quarter of fiscal 2020, we contributed 4 communities into the new age-restricted joint venture Ara mentioned earlier.

Total domestic joint venture communities increased from 15 to 24 year-over-year. As a result, we are once again beginning to see increases in our domestic joint venture contracts, which were up 29% in the most recent quarter. Primarily due to non-recurring income from our joint venture in Saudi Arabia in last year's first quarter, our income from joint ventures decreased $8 million year-over-year in the first quarter of fiscal 2020.

Next, I will talk about the most recent debt exchanges that we completed during the first quarter of fiscal 2020. This exchange offer focused on pushing out a portion of our remaining 2022 and 2024 debt maturities and capturing discounts on certain unsecured debt instruments.

On the top half of Slide 14, we show our debt maturity profile as it looked on October 31, 2019. And on the bottom half of the slide, it shows our maturity ladder as of January 31, 2020. We reduced our July of 2022 debt maturity by $23 million and reduced the July 2024 debt by $142 million. This $165 million of debt was exchanged into a new $159 million, 1.75 lien notes due November of 2025. Additionally, we exchanged $163 million of our unsecured term loan due February 2027 for an $81 million, 1.75 quarter lien term loan due February of 2028. This allowed us to reduce debt by $81 million.

For those of you that financially model our future performance, please note that these exchanges that we completed during the first quarter were treated as debt modifications in accordance with GAAP. As a result, the new $81 million, 1.75 lien term loan will have 0 P&L related interest expense for the life of the loan despite having 10% cash interest payments. Keep in mind that these most recent debt exchanges followed closely on the heels of us successfully extending our debt maturities by exchanging or refinancing over $800 million of debt in October 2019. The combination of all these transactions have improved our balance sheet, simplified our capital structure and extended the maturities on more than $1 billion of debt. We will continue to analyze and evaluate our capital structure and explore transactions to further strengthen our balance sheet.

Turning now to Slide 15. On the left half of the slide, you can see that the strong growth in our new orders has led to a 24% growth in consolidated contract backlog from 1,793 homes at the end of last year's first quarter to 2,221 homes at the end of this year's first quarter. On the right-hand side of the slide, we show a 20% increase in consolidated contract backlog dollars from $750 million at the end of last year's first quarter to $900 million on January 31, 2020. This is a leading indicator of the growth in revenues we expect to occur over the next few quarters.

Turning to Slide 16. Here, we show that for the first quarter, we added 2,026 newly controlled lots compared with 1,237 homes and lots we delivered. For the quarter, our newly controlled lots exceeded home deliveries by 789.

Turning to Slide '17. At the end of the quarter, we controlled 27,701 lots. Including modest growth assumptions for fiscal 2020, we control 100% of the lots required to meet our 2020 delivery forecast

Further, we already control approximately 95% of the lots needed to meet our more substantial growth in deliveries we're expecting during fiscal 2021. This is a significantly higher percentage of lots already under our control than we would typically have this far in advance of the following fiscal year. Our controlled lot supply remains strong.

We remain disciplined to our underwriting standards of using current home sales price, current home sales pace and current construction costs when controlling and/or purchasing new land parcels. We are not using optimistic rosy assumptions to stretch for land acquisitions. We continue to seek new land acquisition opportunities, and our land acquisition teams throughout the country remain busy. When we find the right opportunities, we seek to control those lots.

On Slide '18, compared to our peers, you can see that we had the second highest percent of land controlled via options. We continue to use land options as much as possible in order to achieve high inventory turns, enhance our returns on capital and reduce our land risk.

Looking at all our consolidated communities in the aggregate, including mothballed communities and the $205 million of inventory not owned, we have an inventory book value of $1.3 billion net of $200 million of impairments.

Turning now to Slide '19. Compared to our peers, you see that we have the second highest inventory turnover rate over the trailing 12 months. Although we lag NVR's industry-leading turnover number, our turns are 33% higher than the next highest peer below us. High inventory turns are a key component of our overall strategy.

Another area for discussion is related to our deferred tax asset. Our deferred tax asset is very significant, and because it is fully reserved for by valuation allowance, it is not currently reflected on our balance sheet. We've taken numerous steps to protect this asset. As of January 31, 2020, our deferred tax asset in the aggregate was $596 million. We will not have to pay federal cash income taxes on approximately $1.9 billion of future pretax earnings.

On Slide 20, we show that we ended the first quarter with the shareholders' deficit of $499 million. If you add back our valuation allowance, as we've done on this slide, then our shareholders' equity will be a positive $97 million.

Now let me comment on our current liquidity position. During the first quarter, we spent $118 million on land and land development.

As seen on Slide 21, we ended the first quarter with liquidity of $225 million, which is towards the upper end of our target liquidity range between $170 million and $245 million. Assuming no adverse changes in current market conditions, for the second quarter of fiscal 2020, we expect [Technical Difficulty] growth in revenues, a gross margin better than the 16.9% we had in last year's second quarter and meaningful improvement in pretax income before any land-related charges or gains or losses on extinguishment of debt. Similar to our historical trends, we expect to begin the year with weaker first half performance and end the year with stronger performance, particularly in our fourth quarter.

Before I turn it back to Ara for his final comments, I'm sure that many of you are wondering what impact the coronavirus will have on our industry. While nobody can accurately predict the potential impact of coronavirus on our industry, we are encouraged that last week, when the U.S. equity markets declined 12%, our weekly sales were up 38% year-over-year. In spite of coronavirus concerns, sales both last week and the 44% increase in contracts we reported for the month of February clearly continued the positive sales momentum we experienced during the first quarter. To date, we have not seen any disruption in our supply chain.

On Friday, Tim Cook, Apple's CEO, stated that their China factories are quickly returning to normal production. That is an encouraging sign that any supply chain impacts from China factories producing components for the U.S. housing industry may be of short duration as well. We remain cautious about any potential impact from the coronavirus, and we'll continue to carefully monitor this situation.

I'll now turn it back to Ara for some brief closing remarks.

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Ara K. Hovnanian, Hovnanian Enterprises, Inc. - President, CEO & Chairman of the Board [5]

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Thanks, Larry. The spring selling season is definitely off to a great start, and that's evident by our 42% increase in contracts in the first quarter and 44% increase in contracts in the month of February. The 4.8 contracts per community in February is the highest monthly sales pace we've achieved since May of 2005. These increases, along with less use of incentives, should bode well for the operating results over the next several quarters.

We expect our EBITDA performance will continue to improve. Signs -- given the signs of the strength we continue to see from the overall U.S. economy and more specifically the housing market, we will continue to take steps that lead us on our path to growing our revenues and getting back to higher levels of sustainable profitability.

That concludes our formal comments, and we're happy to open it up for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question comes from Alan Ratner with Zelman.

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Alan S. Ratner, Zelman & Associates LLC - MD [2]

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Nice order results, and thanks for the color on specifically the coronavirus. I think that's certainly on top of everybody's minds there. So good to hear. Yes, I guess, the question -- obviously, we don't know what impact these fears may ultimately have on either the economy or order activity, but I'm curious, very strong order numbers. You mentioned pulling back on some incentives as the quarter went on. As you sit here today, does the uncertainty surrounding coronavirus, does that change how you're thinking about the pricing side of the business at all. Are you thinking about maybe being a little bit less aggressive on pushing price or pulling back on those incentives, just given that we don't really know what's likely to come around the corner?

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Ara K. Hovnanian, Hovnanian Enterprises, Inc. - President, CEO & Chairman of the Board [3]

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We're not right now, Alan. Obviously, we're going to monitor sales every week in every community. And certainly, different communities and geographies warrant different actions. But right now, sales feel particularly and perhaps surprisingly steady and solid. So we'll continue on as we've been doing right now.

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Alan S. Ratner, Zelman & Associates LLC - MD [4]

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Great. That's good to hear. Second question, if we can dig in on the gross margin a little bit more, coming in a little bit lighter than you guys had expected. And I know you mentioned, obviously, incentives might have been a little bit higher when some of those homes were sold. But I would have presumed that you had that visibility when you gave the guidance a couple of months ago. So I'm curious exactly why that number came in a bit lighter. Was it homes that you sold intra-quarter or maybe just a mix impact that came in lower specs? And I guess, more broadly, as we think about the remainder of the year, should we expect a similar kind of ramp in the back half versus the first half that we've seen in the last couple of years in your gross margin?

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Ara K. Hovnanian, Hovnanian Enterprises, Inc. - President, CEO & Chairman of the Board [5]

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Alan, I'll take the first part first, and then perhaps Larry or Brad will tackle the second part. But we gave guidance last quarter, and the difference was we still had some specs to sell and the greater incentives really affected the specs that we sold and delivered that quarter. And it was just enough to make it a little lower than the guidance, not that significantly.

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J. Larry Sorsby, Hovnanian Enterprises, Inc. - Executive VP, CFO & Director [6]

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So Alan, we're certainly encouraged that we're able to claw back some of the incentives that Ara just mentioned and haven't been doing as heavily incenting spec sales. As I mentioned in my portion of the script, that's going to lead to margins being better in the second quarter this year than last year. And we just haven't made any projections for the second half of the year with respect to gross margins. But as long as we can continue to claw back incentives and raise prices, because demand is strong, I certainly think that gives you a hint as to what gross margins might do in the future.

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Brad G. O’Connor, Hovnanian Enterprises, Inc. - VP, CAO & Corporate Controller [7]

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Alan, I might comment. Just reflecting on this as you asked the questions about the coronavirus, it just brings to mind the horrific events of the World Trade Center terrorist attack a long time ago. And one would have thought then that you'd see a significant pullback on sales -- housing sales. But while there was a very brief hiccup, the housing market continued on a pretty strong basis. And that's what we're feeling so far right now with the coronavirus. So it's something you'd expect to have a widespread impact, but instead, it's really so far repeating the effect similar to the horrific events related to the World Trade Center a while ago.

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Alan S. Ratner, Zelman & Associates LLC - MD [8]

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Got it. And I appreciate that perspective. One last, just kind of housekeeping, just so I understand this margin impact. Larry, do you have the current spread on margin between specs and to-be-built, just to kind of maybe quantify what drag those extra sales in the quarter had on the margin?

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Brad G. O’Connor, Hovnanian Enterprises, Inc. - VP, CAO & Corporate Controller [9]

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This is Brad O'Connor. It was about 350 basis point spread between specs and to-be-built for the first quarter.

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Operator [10]

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(Operator Instructions) Our next question comes from Alex Barrón with Housing Research Center.

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Alex Barrón, Housing Research Center, LLC - Founder and Senior Research Analyst [11]

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Good job on the orders. I wanted to ask about the corporate SG&A portion. It was up a little bit versus all the quarters last year. Is there something that's onetime in nature? Is that taking to be more of a run rate for this year?

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Brad G. O’Connor, Hovnanian Enterprises, Inc. - VP, CAO & Corporate Controller [12]

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This year, we had a little bit higher expenses related to some cybersecurity work that we've been doing with some outside resources compared to the prior years. And also last year, stock compensation can vary depending on performance metrics being hit, et cetera. So what I would say is, I know it's a little higher this first quarter versus last year, it will probably trend higher than last year. But the best you probably can do is model it similar to what you see for the first quarter.

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Alex Barrón, Housing Research Center, LLC - Founder and Senior Research Analyst [13]

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Got it. Okay. That's helpful. And then the other question was, I guess, you went a little bit fast for me on the joint ventures. Can you elaborate a little bit more on why the income dropped this quarter and what we can expect going forward there versus last year?

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J. Larry Sorsby, Hovnanian Enterprises, Inc. - Executive VP, CFO & Director [14]

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Yes. It primarily related to -- we have a joint venture in Saudi Arabia. And last year's first quarter, we had a onetime nonrecurring property debt, what was it, Brad, again, $9 million $8 million?

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Brad G. O’Connor, Hovnanian Enterprises, Inc. - VP, CAO & Corporate Controller [15]

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About $6 million.

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J. Larry Sorsby, Hovnanian Enterprises, Inc. - Executive VP, CFO & Director [16]

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$6 million. $6 million of the $8 million was related to that. And as we're gearing joint ventures back up again, and we're certainly seeing that on the community counts and on the orders, ultimately, that will result in higher revenues, and once again, improving profitability in the future.

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Ara K. Hovnanian, Hovnanian Enterprises, Inc. - President, CEO & Chairman of the Board [17]

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But at the moment, the joint ventures are starting up and have some extra start-up costs associated.

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Alex Barrón, Housing Research Center, LLC - Founder and Senior Research Analyst [18]

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Okay. And so for the near term, I guess, we shouldn't go to look at last year as kind of a model for what to expect here?

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J. Larry Sorsby, Hovnanian Enterprises, Inc. - Executive VP, CFO & Director [19]

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Yes, we're just not giving specific guidance. But certainly, in your shoes, I would say that's worth looking at as you try to model it.

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Operator [20]

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And I'm showing no further questions at this time. I'd like to turn the call back to Ara for any closing remarks.

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Ara K. Hovnanian, Hovnanian Enterprises, Inc. - President, CEO & Chairman of the Board [21]

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Great. Thank you very much. We're pleased to report strong performance on many metrics. We look forward to giving you more positive updates in the quarters to come. And in the meantime, everyone stay safe and wash your hands a lot. Thank you.

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Operator [22]

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Ladies and gentlemen, this concludes today's conference call. Thank you for participating, and have a nice day. All parties may now disconnect.