Earnings Call Transcript - HOV Q3 2021

Operator, Operator

Good morning. And thank you for joining us today for the Hovnanian Enterprises Fiscal 2021, Third Quarter earnings conference call. An archive of the webcast will be available after the completion of the call and run for 12 months. This conference is being recorded for rebroadcast and all participants are currently in a listen-only mode. Management will make some opening remarks about the Third Quarter results and then open the line for questions. The Company will also be webcasting a slide presentation along with the opening comments from management. These slides are available on the investor's page on the Company's website at www.khov.com. Those listeners who would like to follow along should now log onto the website. I'll now turn the call over to Jeff O'Keefe, Vice President, Investor Relations. Jeff, please go ahead.

Jeff O'Keefe, Vice President, Investor Relations

Thank you, Jonathan. And thank you all for participating in this morning's call to review the results for our third quarter, which ended July 31st, 2021. All statements in this conference call 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 speak only as of the date they are made, are not guarantees of future performance or result, 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 section entitled risk factors and management discussion and analysis. Particularly the portion of NBNA and paid safe harbor statement in our annual report on Form 10-K for the fiscal year ended October 31st, 2020. And subsequent filings with the Securities and Exchange Commission. Except as otherwise required by applicable security 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 reasons. Joining me today are Ara Hovnanian Chairman, President and CEO, Larry Sorsby, Executive Vice President and CFO, and Brad O'Connor, Senior Vice President, Chief Accounting Officer and Treasurer. I will now turn the call over to our CEO. Ara, go ahead.

Ara Hovnanian, Chairman, President and CEO

Thanks, Jeff. I'm going to review our Third Quarter results and then address the current market environment. As usual, Larry Sorsby, our CFO, will follow me with more details and then we'll open it up for a little Q&A. On Slide 5, we compare our Third Quarter results to the guidance we gave on our last conference call. COVID-related supply chain disruption delayed the completion of some homes, resulting in slightly lower revenues. Nonetheless, our adjusted gross margin, SG&A ratio, adjusted EBITDA and adjusted pre-tax income were all better than the guidance range that we gave. During our second-quarter conference call we talked extensively about the impact of phantom stock expense on our SG&A. During the third quarter, our stock price declined, which resulted in a $6.7 million reduction in phantom stock expense. In the third column, we show what our results would have been without the benefit from the phantom stock expense reduction, and without that benefit, we still beat our guidance for SG&A, adjusted EBITDA and adjusted pre-tax profit. Gross margin was not affected. Moving on to Slide 6, we show year-over-year comparisons for our third quarter performance metrics. Given the supply chain disruptions and labor shortages we've all experienced as an industry, we're pleased with our strong performance in the third quarter. Starting in the upper left-hand portion of the slide, you can see that our total revenues for the third quarter increased 10% to $691 million. Moving to the upper right-hand portion of the slide, you can see that our adjusted gross margin increased 460 basis points to 22.1% this year, compared to 17.5% in last year's third quarter. This clearly illustrates that we've been able to raise home prices more than enough to offset the higher labor and material costs that we've incurred. Lumber prices have recently declined from the all-time highs they hit a few months ago. Given the significant decline in random land contracts, we expect our price for lumber will continue to decrease further in future months. While these lower lumber prices will not benefit margins on homes we delivered this quarter, starting in our Second Quarter of 22, we expect our gross margins to see an additional benefit from the significant reduction in our lumber costs. In the lower left-hand quadrant of the slide, you can see that our SG&A was 8.7% for the Third Quarter compared to 9.5% last year. If you ignore the benefit of the Phantom stock expense, it would have been 9.7% for this year. In the lower right-hand quadrant of the slide, we show that adjusted EBITDA increased 59% from $65 million in last year's third quarter to $103 million this year. On Slide 7, you can see that our adjusted pre-tax income improved to $63 million compared to $15 million of profit last year. On Slide 8, we show that our net income for the third quarter of '21 was $48 million compared to $15 million in the same quarter last year. Moving now to the sales environment. On the right-hand portion of slide 9, we show contracts per community for the Third Quarter in each of the last three years. You can see that our sales pace jumped 75% from a historically normal pace in 2019 to a white-hot pace in 2020. Remember, this was just after the March and April low in sales because of COVID and before we started to increase prices aggressively and began to meet our sales. Our contracts in this year's Third Quarter were better than 2019, but far below 2020. The sales pace we achieved in the summer of 2020 was unsustainable. We've been saying for some time now that comparisons would be very difficult because of the white-hot sales pace that we saw last year. Further to the left, we show that the average for the third quarter from 1997 through 2002 was 11.4. That was a time where there was neither a boom nor a bust for the housing industry. Our sales pace in the third quarter of '21 slowed to a more historically typical pace, but at significantly better margins than last year. This more typical pace is certainly more sustainable. As the industry sales pace returns to normal, it should also help contain labor and material cost pressures. On slide 10, we show contracts per community on a monthly basis from September through August. The most recent month is in dark green, the same month a year ago is in light blue and the same month two years ago is shown in gray. For the past 4 months, our contracts have been lower than last year's unsustainable pace. However, we compare favorably every month with 2019's more typical contract pace. It would be easy to become preoccupied with the sales pace this year compared to the higher COVID demand surge levels that we experienced in 2020. On slide 11, we focus on the increases in the most recent months compared to the same months in 2019 pre-COVID, when demand was closer to historical averages. It's clear from this trend that the COVID-19 sales frenzy has given way to a more rational sales pace. We think the new sales pace is healthy, slightly above-average, and much more sustainable. Let me take a moment to talk about increases in home prices. On the left side of slide 12, you can see that our average sales price on deliveries was up 13% year-over-year to $443,000 in the Third Quarter. On the right-hand portion of the slide, you can see that our average sales price on new contracts increased 27% from $396,000 last year to $503,000 in this year's Third Quarter. We believe these dramatically higher prices dampened the COVID sales frenzy that we experienced last year. And as I said a moment ago, we transitioned to a more sustainable sales pace that's in line with historical averages. You saw that the higher home prices in our deliveries have already increased our gross margins. We expect these higher home prices in our new contracts to generate further increases in our gross margins. The combination of higher gross margins along with our expected growth in community count should have a positive impact on our bottom line, more than offsetting the return to a more normal sales pace per community. On Slide 13, we show what our community count was at the end of every quarter over the last year. As you can see, primarily due to selling through communities that has significantly higher than normal pace, our community count has been declining each quarter up until the most recent quarter. We ended the third quarter of July 21 with 120 communities. This was up slightly from last quarter and is the first time we had a sequential increase in community count since the fourth quarter of 2019. Given no material changes in current market conditions, we expect our community count to grow to approximately 135 communities at the end of the fiscal year. This was at the same level of communities that we had at the beginning of this fiscal year. In fiscal 22, we expect further growth in our community count. Our community count is likely to fluctuate each quarter due to the opening of new communities and the timing of closing out of old communities. The combination of a return to a more rational sales pace per community with a reduction in community count certainly impacted our absolute level of contracts this quarter. Our upcoming community count growth should help that in the near future. Our contract dollars decreased to $609 million in the third quarter of fiscal 21, compared to $882 million in the same quarter last year. This was due to a number of factors including metering of sales in many of our communities, selling out of communities ahead of schedule, COVID-19 related delays for new community openings, and the unprecedented COVID-19 surge in demand last summer that made the comparisons very difficult. Much of our decline is related to community count. We're making excellent progress in our land position, but there's a lag between a land contract and the first home sales, and that certainly impacts our absolute level of contracts. As we will discuss later in our presentation, we project a return to last year's community year-end, and we've increased our lots controlled by 20% over the past year. We're pleased with our progress on land acquisition and we plan to grow our revenues in fiscal '22 and '23, even with today's more normalized sales pace per community. The supply chain disruptions along with shortages of labor have led to longer cycle times. The cycle time increases vary from market-to-market and product to product, but when you look at the average for the entire Company, cycle times have increased about 30 to 45 days. The average house that should take 4 months to build is now taking 5 to 5.5 months to build. But we've already built these new cycle times into our guidance. All signs indicate that fiscal '21 is expected to be an outstanding year for us, and fiscal '22 should improve further. I will now turn it over to Larry Sorsby, our Chief Financial Officer.

Larry Sorsby, Executive Vice President and CFO

Thanks, Ara. I'm going to start with the progress we've made in growing our lot position. Turning to Slide 14, we added 4,512 newly controlled consolidated lots during the third quarter. During that same quarter, we had 1,587 deliveries and lot sales, resulting in a net increase of 2,925 controlled lots. For the 12-month period ending July 31st, 2021, we added 11,594 newly-controlled lots and delivered 6,340 homes in lots, resulting in a net increase of 5,254 lots. For the trailing 12 months, this represents us controlling new lots at a rate of 183% of home deliveries, which bodes well for our expected future growth in community count and home deliveries. Our land acquisition teams continue to find new land positions for us. Our recent land acquisitions were underwritten with contract paces that match our current slower sales environment. That pace is consistent with the sales pace we achieved before the COVID surge in home demand. Additionally, we underwrote those recent acquisitions at significantly higher lumber costs in effect at the time. As a result of the recent declines in lumber prices, we now expect even higher margins on those land parcels. We continue to feel very good about the land acquisitions we've made over the last year. On the left-hand portion of Slide 15, we show our community count for the past five quarters. As Ara mentioned earlier, our community count has been going down each quarter. At the end of the third quarter of fiscal 2021, we finally changed the tide and now have achieved a sequential increase in community count. We expect another sequential increase in the fourth quarter that is large enough to grow our community count back to roughly the same level we had at the beginning of this fiscal year. On the right-hand portion of the slide, we show the lot count at the end of the same five quarters. For each quarter shown, our lot count has increased sequentially. Year-over-year, our lot count increased by over 5,000 lots or by 20%. We have been steadily increasing our lot position. Keep in mind there's a lag between when we control the lots and when we can open a community. The communities we put under control this quarter will be open for sale in 2022 and beyond. This is worth repeating: our ability to increase our lot supply clearly indicates the progress we've made towards growing community count in future periods. Virtually all of the land and communities necessary to achieve expected further growth and profits during fiscal 2022 are already under contract. Today, our land acquisition teams are primarily focused on obtaining control of land and communities for home deliveries in fiscal 2023 and beyond. Under the assumption of a more historically normal housing demand market going forward, we are controlling new lots and planning for further revenue growth in future years. Turning now to Slide 16. During the third quarter of Fiscal 2021, our land and land development spend was $178 million, a 9% increase over the same quarter a year ago. For the trailing 12 months, our land spend increased 36% to $761 million compared with $558 million during the same period last year. This further demonstrates that we're investing the money needed to grow our community count. Turning to Slide 17, even with that increase in land spend and paying off $111 million of 2022 notes early, we ended the third quarter with $308 million of liquidity, well above the high end of our liquidity targets. We continue to have excess liquidity, and our land teams are busy contracting additional land parcels across the country today. Turning to Slide 18, compared to our peers, you see that we still have one of the highest percentages of land controlled via options. We continue to use land options whenever possible in order to achieve high inventory turns, enhance our returns on capital, and reduce risk. We're pleased to control 66% of our land through options, which is up from 61% in the same quarter one year ago. Looking at our consolidated inventories in the aggregate, including the $98 million of inventory not owned, we have an inventory book value of $1.3 billion, net of $158 million of impairments. Turning now to Slide 19. Compared to our peers, we continue to have the second-highest inventory turnover rate for the trailing 12-month period. Our inventory turns were 20% higher than the next highest peer below us. High inventory turns are a key component of our overall strategy. Turning now to Slide 20, as we promised, now that we've achieved a sustainable level of higher profitability, we are now focused on repairing our balance sheet. On this slide, we show our debt maturity ladder at the end of the third quarter. On July 31st, 2021, we paid off in full, one year early, $111 million of our 10% senior secured notes due July 2022 at par. Additionally, on August 2, 2021, we paid off in full, 3 years early, $70 million of our 10.5% secured notes due July 2024, at the call price of 102 and 58. We believe that we should be able to refinance our currently undrawn revolving credit facility ahead of its maturity in the first quarter of fiscal 2023. This facility is at the very top of our capital structure. After that, we don't have any debt coming due until the first quarter of fiscal 2026. Given our $447 million deferred tax asset, we will not have to pay federal income taxes on approximately $1.8 billion of future pre-tax earnings. This tax benefit will generate significant cash flow in the years to come and will accelerate our progress in significantly improving our balance sheet. As we continue to post strong results, we believe we should be able to refinance our debt structure at lower rates and better terms. On Slide 21, we show that our total backlog, including domestic unconsolidated joint ventures at the end of the third quarter, increased 23% to 4,072 homes. You can also see that the dollar value of this backlog increased 44% to $1.99 billion. The strength of this backlog, including a solid expected gross margin, sets us up nicely for strong results over the remainder of this fiscal year and into fiscal 2022. Our financial guidance for both the fourth quarter and the full year for fiscal 2021 assumes no adverse changes in current market conditions and excludes further impacts to SG&A expense from phantom stock expenses related solely to stock price movements from the $104.39 stock price at the end of our Fiscal 2021 third quarter. However, our guidance for the quarter and for the year includes phantom stock impacts we already absorbed in the second and third quarters. For every $4 that our stock price increases or decreases, there is approximately a $1 million increase or decrease respectively of incremental phantom stock expense. On Slide 22, we provide guidance for the fourth quarter of Fiscal 2021. We expect to report total revenues for the fourth quarter of Fiscal 2021 to be between $830 and $880 million dollars. We also expect gross margins to be in the range of 21.5% to 22.5%, up substantially compared to the 20.2% in last year's fourth quarter. SG&A, as a percent of total revenues, is expected to be between 8.5% and 9.5% compared with 9.6% last year. Excluding land-related charges and gains or losses on extinguishment of debt, we expect adjusted EBITDA to be between $100 and $115 million. The high end of our guidance represents a 32% increase compared to the same quarter last year. Finally, we expect our adjusted pre-tax profit for the fourth quarter of Fiscal 2021 to grow to between $60 million and $75 million compared to a $45 million profit in the same period last year. Turning now to Slide 23, we are increasing our full-year guidance. We expect to report total revenues between $2.8 and $2.85 billion, up from $2.34 billion last year. We also expect gross margins to be in the range of 21% to 22% compared to 18.4% last year, and SG&A as a percentage of total revenues to be between 9.5% and 10.5% compared with 10.3% in the prior year. This includes the $10.8 million of incremental phantom expense from the second and third quarters. Excluding land-related charges and gains and losses on extinguishing debt, we expect adjusted EBITDA to be between $345 and $360 million, up between 47% and 54% compared to last year. Finally, we expect our adjusted pre-tax profit for fiscal 2021 to grow to between $175 and $190 million, up an amazing 243% to 273% compared to last year's earnings. This is an increase from our previous guidance of $150 to $170 million. Assuming a 25% tax rate similar to what we saw in the third quarter of fiscal 2021, our trailing 12-month PE ratio for the closing stock price of $93.83 yesterday was 5.2, significantly below the average fees for homebuilders of 8.7. Additionally, we're currently trading at 4.5 times our earnings guidance for this fiscal year. As we look forward to fiscal 2022, we expect that today's slower contract pace, which is more in line with historical norms, combined with higher home prices, higher gross margins, and increases in community count should lead to further growth in both total revenues and adjusted pre-tax profits in fiscal 2022. We expect to begin fiscal 22 with a very strong first quarter compared to the first quarter of last year, or really this year, fiscal 2021 especially with respect to improvements in our adjusted pre-tax profit. Turning now to Slide 24, here we illustrate the growth we've seen in adjusted EBITDA. On the left-hand portion of the slide, you can see that our fourth-quarter estimate for adjusted EBITDA is 23% more than the fourth quarter of 2020. On the right-hand portion of the slide, we show EBITDA for 2019, 2020, and our expectation for 2021. In 2020, we achieved a 35% growth in adjusted EBITDA. In 21, we now expect to achieve an additional 50% growth in EBITDA. These increases are representative of the progress we've made in materially improving our operating results. On Slide 25, you can see how our key credit metrics have improved over the past few years. Total debt to adjusted EBITDA has declined from 10.1 times in fiscal 2019 to 3.9 times projected for fiscal 2021. Net debt to adjusted EBITDA declined from 9.3 times in 2019 to 3.4 times projected for fiscal 2021. Adjusted EBITDA, the interest incurred, has more than doubled from 1 time in 2019 to 2.2 times projected for fiscal 2021. Assuming we hit the midpoint of our Fiscal 2021 guidance for pre-tax profit, our shareholders equity will grow by $661 million from 2019's fiscal year-end levels. Given our expectations to once again grow profits in Fiscal 2022, our book value will continue to grow rapidly. Both Moody's and S&P have recently recognized our improved performance with upgrades to a positive outlook, and Moody's also upgraded our credit rating by one notch. As we achieve our Fiscal 2021 guidance and continue to generate improvements in revenues and profits going forward, we expect further rating upgrades from both credit agencies. These improved credit statistics and rating upgrades should help us refinance our debt structure at lower rates and improved terms. Now I will turn it back over to Ara for some brief closing remarks.

Ara Hovnanian, Chairman, President and CEO

Thanks, Larry. As you just heard, we expect to close fiscal 21 with a solid fourth quarter, which would make the full year our most profitable year since 2006. We're pleased that we've been able to raise our full-year guidance. And more importantly, we expect further growth and profitability in fiscal 22. Heading into the COVID-19 frenzy that the entire home-building industry experienced, we clearly did not have enough new communities in our land pipeline to open fast enough to replace the communities we sold out much more rapidly than we expected. However, as we just illustrated with the 20% year-over-year increase in our lot count, community count growth is coming and it's coming soon. As we discussed, our margins are increasing. During the fourth quarter of fiscal '21, we have a large number of homes that will deliver, as well as a big slug of communities that will be opening for sale. There is always a possibility of further COVID-related delays during our fourth quarter. But we believe we factored in reasonable assumptions for the current environment into our guidance. I know that I can count on all of our associates to execute our plans for the fourth quarter, which should set us up nicely to be in an advantageous position to grow both revenues and adjusted pre-tax profits further in fiscal 22. I look forward to sharing our improved results in future periods. That concludes our formal remarks and we'll be happy to open up for Q&A.

Operator, Operator

The Company will now answer the questions. So that everyone has an opportunity to ask questions, participants will be limited to one question and one follow-up. After which, they will be able to get back into the queue to ask other questions. We will now open the call to questions. Our first question comes from the line of Alex Barron from Housing Research Center. Your question, please.

Alex Barron, Analyst

Hey, guys. Thanks for taking my question, and congratulations on the turnaround and everything that you guys have done to date.

Jeff O’Keefe, Vice President, Investor Relations

Thank you.

Alex Barron, Analyst

I wanted to ask about the prospects of refinancing some of your debt, which obviously right now is at very low rates for most other builders. I'm kind of wondering if that's something that's already in the works and if so, are you also planning potentially to raise equity as part of some transaction like that?

Ara Hovnanian, Chairman, President and CEO

Alex, we continue to explore the potential of refinancing our capital structure. We believe that we could do so today at lower rates than we have now. What we're struggling with as we continue to improve our results, we think we deserve even lower rates than what we think we could actually do today. So we're balancing the timing of when to do it concerning potentially issuing equity as a component of refinancing our debt structure. We've not ruled that out, and if we could issue a modest amount of equity to get a significantly lower rate and completely refinance our entire capital structure, I think it's something we would give serious consideration to.

Larry Sorsby, Executive Vice President and CFO

I'll just add that we're obviously forecasting very solid cash flow. And as we discussed, our debt maturity ladder gives us a long runway, so we don't have to rush in. We can play the market right and look for the right rate for us.

Alex Barron, Analyst

Yeah, I know that makes sense. I mean, your equity is obviously going in the right direction. I guess the other question I had was, your community count projection seems to imply a pretty big jump in the fourth quarter, and I'm just curious about a couple of things. One is, is that going to be more near-term or is that going to be more towards the end of the quarter? I guess what I'm trying to figure out is what impact it might have on orders. And the other thing related to orders is many other builders, including yourselves, I think have been withholding the level of orders or homes that you're willing to release to the market to kind of just the backlog and so forth. So do you guys feel that you are already past that adjustment period where you can start taking the foot off the brakes a little bit? Can you comment on that?

Ara Hovnanian, Chairman, President and CEO

Sure. First, I’d like to mention that we have returned to a more standard sales pace per community. We achieved this by balancing controlled releases and price increases. Last year during the third quarter, we experienced a significant surge in sales; however, after the events of March and April amid the COVID shutdown, we were understandably cautious, like many builders, about stopping the flow of sales, even though the sales volume was unsustainable. Currently, we believe we are in a good position. We are still managing some sales to align our capacity to start, sell, and deliver homes, which we think is a healthy approach, and we feel quite solid overall.

Alex Barron, Analyst

Okay. And on the timing of the communities, do you feel it's more back-end weighted or more nearer?

Ara Hovnanian, Chairman, President and CEO

I mean, we're halfway through the quarter, so we're not giving specific guidance, but we're comfortable we'll get there. We only have a month-and-a-half left to go. We feel like we're comfortable that we'll meet our numbers. Keep in mind, it is very difficult to be precise because if you sell a couple of too many in one community, that drops the community count once it falls below 10. If there is a two-week delay in opening a new community, it can throw it into the next quarter. So it's always very tricky.

Larry Sorsby, Executive Vice President and CFO

Alex, to try and give you a little clarity. If I were sitting in your shoes and we're not giving you specific guidance on this point, I would wait a little bit to the second half of the quarter as the first half.

Alex Barron, Analyst

Got it. If I could ask one more, obviously supply chain issues have been a big deal in the last few months. I'm just curious as to whether you guys think today, where you sit today, on supply chain problems and shortages and so forth, is it better, the same, or worse than 3 months ago?

Ara Hovnanian, Chairman, President and CEO

I'd say it depends; generally, it's a different problem with a different product in a different market every week. It's like the classic whack-a-mole problem. The different problem raises its head and we jump on it, that's been a major focus of our Company. So I'd say it's still kind of with us. We've tried to incorporate that into our guidance and projections. Our cycle time is still running higher as we mentioned earlier. We expect at some point, as all of the builders catch up on their starts and as sales for everyone start to return to normal levels, that some of the shortages and labor shortages as well as material shortages will come down and return to normal, and that will allow us to get back to regular cycle times.

Alex Barron, Analyst

Great, I'll get back in the queue. Thank you.

Larry Sorsby, Executive Vice President and CFO

Thank you.

Ara Hovnanian, Chairman, President and CEO

Thank you.

Operator, Operator

Once again, ladies and gentlemen, if you have a question at this time. And our next question comes from the line of Vincent Foley for Barclays. Your question, please.

Vincent Foley, Analyst

Morning, guys. So Larry, when we're talking about refinancing of the capital structure here, and you are sort of waiting on borrowing costs to come down, should we think about refinancing in the context of going from a secured to unsecured, or is it your priority right now, in a refinancing just interest savings? And then as a follow-on, can you give us a sense of how longer-term you think about a balance between secured debt and unsecured debt, and are you planning on a more plain vanilla capital structure over the longer-term?

Larry Sorsby, Executive Vice President and CFO

I'm going to address your last question first, and we definitely aim to establish a simpler capital structure. The last decade has been quite eventful, but we would prefer to return to more straightforward deals instead of complex or high-profile ones. Our main focus is on reducing rates. However, we believe that our enhanced performance allows us to refinance on an unsecured basis. We are weighing our options and are not completely discounting secured deals for the future. We expect to pursue fully unsecured refinancing, and if we can't achieve that right now, we may hold off until we can. It’s all about finding the best lower rate across various structures.

Vincent Foley, Analyst

One of the main questions we often receive is about the timing. Considering your slides and the reduction in leverage, with a six-turn decrease in the past two years, 2021 is set to be the best year in the company's history, and next year could potentially be even stronger. However, looking a year ahead, it's uncertain what the housing market, inflation, or the overall economy will be like. So, why not take action sooner rather than later to capitalize on exciting opportunities?

Larry Sorsby, Executive Vice President and CFO

I think we would do some investment enterprises later if we felt that we were getting a rate similar to peers that are certainly positioned to us, so it's not something we're ruling out at all. We're interested in refinancing at materially lower rates than what we have today. And as Ara mentioned, we don't have a gun pointed at our heads to have to do it right this second, but I understand the risk that you're pointing out that if we wait, the high yield market might run away from us, so we certainly are very conscious of the trade-offs that are out there in that regard. But we believe as we continue to post very strong results, including this third quarter, and now that the fourth quarter projection, the full-year is going up, that the debt market should be giving us additional credit. And as we see that additional credit come in the form of being able to do a deal at more attractive rates, we're not ruling that out at all. We may well do so. So it's just a matter of getting rates comparable to what we think similarly situated peers have today.

Ara Hovnanian, Chairman, President and CEO

I'll also add that our call premiums will drop substantially in the coming months, so that's certainly something that we look at as well.

Vincent Foley, Analyst

Great. Thanks very much.

Operator, Operator

Thank you. Our next question comes from the line of Alan Ratner from Zelman Associates. Your question, please.

Alan Ratner, Analyst

Hey guys, good morning. Thanks for taking my question. Just curious, moving away from the balance sheet a little bit, are you guys involved at all in the build for rent space? Several of your peers have announced either ventures in that area or are actively selling homes to single-family rental operators. So I'm curious if you're partaking and more broadly, what impact you're seeing from build for rent in your overall markets, either from competition on land, labor, and materials, demand, etc.

Ara Hovnanian, Chairman, President and CEO

We have one transaction that we're finalizing now of a couple of hundred homes. And that will be our first. It's not a primary focus. We feel like our capital is well-served right now in our primary business, and we're trying to stay focused on replenishing. I'm not saying we're ruling it out, and we're certainly dipping our toes in the water. But we're not ready to dive in full force just yet.

Larry Sorsby, Executive Vice President and CFO

I would just add one more thing, Alan. Certainly over the last year, demand from traditional sources has been very strong, which has been our main focus; we've experienced challenges in getting homes started as quickly as the demand has required. The rental market presents a good long-term opportunity, and if we could establish a long-term relationship, it would be something we would find interesting.

Alan Ratner, Analyst

Got it. Appreciate your comments there. Second, on pricing. Really strong increase in your average order price this quarter. I'm not sure how much of that 27% was like-for-like versus mix-driven. But just curious, when you are seeing a balance now with absorption pulling back to what you consider to be more normal levels, would you expect to take the foot off the gas a little bit on pushing price, or is that something where you still feel like there's an opportunity to drive price higher, given how strong demand is today?

Ara Hovnanian, Chairman, President and CEO

I'd say we're back to more normalized pricing reviews. There was a point in the last six months when we would need to raise prices every week or two or even every sale or two because lumber costs were going up, and that was really causing concern. I'd say right now we're back to a normal environment, so I don't think I would expect the kind of price increases that we've witnessed over the last year.

Alan Ratner, Analyst

On the flip side, are you starting to see any incentivizing going on in your markets from other builders? I know it's very early from that standpoint, but a few have mentioned that's a possibility as you get into the third and fourth quarters, which always happens this time of the year. It didn't happen last year, but just curious if you're starting to see any of that?

Ara Hovnanian, Chairman, President and CEO

We're seeing very little thus far, but we do not primarily expect builders; we're more than the majority built-to-order, so we're not as influenced by people doing end-of-the-year spec discounts. I'm sure it will return at some point to some normalcy in terms of concessions. And you would think that might hurt margins. On the other hand, our primary building material, lumber has been dropping, and will likely drop quite a bit more, so we feel pretty comfortable about margins given those two factors.

Alan Ratner, Analyst

Got it. Alright, thanks a lot. Appreciate it.

Operator, Operator

Thank you. Our next question is a follow-up from the line of Alex Barron from Housing Research Center. Your question, please.

Alex Barron, Analyst

Yes, thank you. I wanted to ask about the phantom stock issue. Will this accounting impact continue for many quarters, or is it limited to this year and then will be finished once it's resolved?

Ara Hovnanian, Chairman, President and CEO

The way it works is that after this fiscal year, the performance will be established, but the payment will occur over the next three years. Therefore, it will decrease over time. 60% of the amount will be paid in January, so a significant portion of the variability will be resolved in this upcoming January, followed by another 22% a year later, and then 20% in the subsequent year.

Alex Barron, Analyst

Okay, I understand. My other question is about your margins. It's clear that you've experienced a significant increase over the last few quarters, particularly in this quarter. Several other builders have shown confidence in the trend of margins, and it seems like you have as well. You mentioned that you anticipate further margin improvements by the second quarter, especially concerning lumber costs. However, some other builders have achieved even greater margin increases. Do you think there is more potential for improvement? Is there anything that might counterbalance lumber expenses and allow for better margins? I'd appreciate any insights you can share regarding margins.

Ara Hovnanian, Chairman, President and CEO

Yes, I think we're optimistic about the outlook for further margin growth. Part of it is driven by the lumber costs. Of course, that will be offset with some of the other materials that are in shortage, and sometimes you have to pay a premium for that. But as we pointed out, the price of our contracts was higher than the average price of our deliveries per home. So we feel good about what the margins in our backlog looked like compared to what we just delivered. Having said that, as you can appreciate, it's a very difficult market to project. There are supply chain issues popping up all over the place, and unfortunately, sometimes you have to deal with them by paying a high price, so we're not going to be too accurate or too specific in margin guidance, but we're feeling very comfortable right now that we will see some growth coming up.

Alex Barron, Analyst

Okay, great. I think that's it for me for now. Thank you.

Ara Hovnanian, Chairman, President and CEO

Okay.

Operator, Operator

Thank you. Our next question comes from the line of Brian from Emerson. Your question, please.

Brian Emerson, Analyst

Hi, everyone. It was a strong quarter with excellent execution. Thank you for taking my question. My first question is about any ESG initiatives you may be pursuing and when you plan to implement them. Additionally, I would like to clarify your multiples; I believe you’re presenting fully taxed multiples. Are you estimating around three times cash EPS for this year and next?

Ara Hovnanian, Chairman, President and CEO

We don't focus on cash multiples, but we do after-tax EPS, and that's the number we were referring to.

Brian Emerson, Analyst

After-tax EPS was the multiple you gave it, like four-ish, five-ish?

Ara Hovnanian, Chairman, President and CEO

Yeah.

Brian Emerson, Analyst

For next year's initiatives.

Ara Hovnanian, Chairman, President and CEO

Yeah.

Brian Emerson, Analyst

Given your tax yield, you reduced it by the tax base, so you're more like

Ara Hovnanian, Chairman, President and CEO

I understand where you're going. We haven't done that exact calc. But directionally you're correct. Yes, our cash flow is far higher than our after-tax income because we're not as burdened with heavy cash flows.

Larry Sorsby, Executive Vice President and CFO

As a proxy for what I call cash EPS, which is simply your pre-tax plus your tax rate, I estimate close to a 33% free cash flow yield. This shouldn't be interpreted as actual cash flow since you are actively growing communities and taking steps to expand the business, which will ultimately benefit shareholders. If you weren't focusing on growth, you would have the free cash flow, but with growth, you might see a decrease in free cash flow. That's how I perceive it.

Brian Emerson, Analyst

I think you're going to not hear us object to you saying that you think you've been cheaper than what we said on an after-tax basis. We do not believe the market on either side of the equity or the debt side is yet giving us credit for our dramatically improved performance. But I think as we continue to improve, we'll make believers out of both the debt and equity markets. And there's an upside.

Ara Hovnanian, Chairman, President and CEO

I will address two other points. One focus is on the price to book ratio. We have increased our projection for this year, which will raise our book value at year-end if we perform as expected. We are also guiding that we anticipate further improvement next year. To some extent, our book value will rise quickly due to the law of small numbers. By the time we finish this fiscal year, we believe we will present an opportunity from that perspective, given our $2 billion backlog. We are on track for fiscal 22. Do you have a second part to your question?

Brian Emerson, Analyst

Before we discuss ESG, I want to get straight to the point regarding present value. Prior to this quarter's report, it was challenging for me to identify a value below 150; however, based on your guidance, a value above 200 seems more reasonable, relying on various discount rates and moderate cash flow assumptions for the next three years. If everything holds up, I see a potential present value closer to 300, especially considering how much you've transformed over the last five years. Five years ago, when I visited, you had 2.5 billion in debt, and now it looks like you’ll be around 1.25 billion net by the end of October. Thank you for that. Regarding ESG, you are doing an excellent job. Given the current investor concerns about ESG, will you be discussing your initiatives in the future, and what might that entail, particularly with the green opportunities available to you?

Ara Hovnanian, Chairman, President and CEO

That's a well-timed question. It's actually something we're very focused on. It's on our agenda for the full board to discuss, and I think you'll be seeing a lot of information about our ESG efforts in this year's proxy, and soon in the near future as well on our website.

Brian Emerson, Analyst

Perfect. I'll get back in the queue for a follow-up unless you want to just take it off the cuff right now.

Ara Hovnanian, Chairman, President and CEO

You can follow up, we're good.

Brian Emerson, Analyst

The follow-up was about your clearance for rental partnerships and how your assets are ideally utilized at present. Given the high demand, it may be beneficial to find a significant investor like Blackrock to help backstop or refinance at a market rate, which is generally lower in terms of your debt interest. This could open up opportunities for a joint venture that might refinance or reduce debt over multiple years, ideally with a larger commitment of capital that wouldn’t strain your balance sheet. Land banking appears to be an intriguing option, especially since it seems there’s movement in that area, and with your team handling 120 communities, it raises a question about financing and potential partnerships.

Larry Sorsby, Executive Vice President and CFO

I think what you're referring to is our historical focus on land banking, which allows us to use less of our capital, enabling us to achieve more with the same investment and continue to grow. We haven't really considered a joint venture that would enhance our ability to refinance our debt at lower rates. However, if anyone is interested in discussing this with us, we would be eager to engage.

Brian Emerson, Analyst

Sounds great, guys. Thanks. Keep executing. Incredible quarter, and thanks for the guidance.

Ara Hovnanian, Chairman, President and CEO

You bet. Thank you.

Operator, Operator

This concludes our conference call for today. Thank you all for participating, and have a nice day. All participants may now disconnect.