Hovnanian Enterprises, Inc. (HOV) Q1 2011 Earnings Report, Transcript and Summary

Good morning, and thank you for joining us today for Hovnanian Enterprises' Fiscal 2011 First Quarter Earnings Conference Call. [Operator Instructions]. Management will make some opening remarks about the first quarter results and then open up the line for questions. The company will also be webcasting a slide presentation along with the opening comments from management. The slides are available on the Investors Page of the company's website at www.khov.com. Those listeners who would like to follow along should log on to the website at this time. Before we begin, I would like to remind everyone that the cautionary language about forward-looking statements contained in the press release also applies to any comments made during this conference call and to the information in the slide presentation. I will now like to turn the conference call over Ara Hovananian, Chairman, President and Chief Executive Officer of Hovnanian Enterprises. Ara, please go ahead.

Thank you and good morning. Thanks for participating in today's call to review the results of our first quarter ended January of 2011. Joining me today from the company are Larry Sorsby, Executive Vice President and Chief Financial Officer; Paul Buchanan, Senior Vice President and Chief Accounting Officer; Brad O'Connor, Vice President and Corporate Controller; David Valiaveedan, Vice President of Finance and Treasurer; and Jeff O'Keefe, Vice President, Investor Relations. On Slide 3, you can see brief summary of our first quarter results. While our results are generally in line with our expectations and analysts' consensus projections, as we have said in the past there's still a lot of room for improvement. Slide 4 shows monthly net contracts per community. You can see that we experienced a seasonal shift, fall off in sales during November and December. This was followed by a typical seasonal rebound both in traffic and sales during January and February. However, even with the pickup in sales in January and February the sales pace per community is slightly below levels of a year ago, when the homebuyer’s tax credit was available. While we would have hoped for even stronger results in February, based on early sales and traffic results, we are feeling good about the spring selling season coming up. On Slide 5, you can see what contracts per community look like on an annual basis. The key takeaway from the slide is that even though the pace per community is not improving, the free fall that we experienced from 2004 to 2008 has stabilized during the past two years at 23 net contracts per community. There's a lot of upside from these low levels before we get back to more normalized levels like what we saw from 1997 to 2002, a period that was neither boom nor bust when we averaged at about 44 net contracts per community. The key component in seeing sales pace return to more normalized levels will be job growth and improvement in consumer confidence. We've begun to see some signs of improving consumer confidence as seen on Slide 6. This graph shows the consumer confidence index going back to the beginning of '95. Most recently, the February index at 70.4 was significantly higher than the trough of 25.3 that we saw in February of '09. While not yet normal, it’s clearly a step in the right direction. There's little that we can do to influence the direction of the economy, but we can remain focused on positioning our company to return to profitability and that's what we are doing. Two of the key drivers for us to get back to profitability are increasing the mix of deliveries from our newly identified communities versus our legacy communities and for us to grow our top line through increases in our community count. On average, deliveries from these newly identified communities are expected to generate about a 20% gross margin as we increase our mix of newly identified communities and shrink our mix of legacy communities, our consolidated margins should continue to improve. At the same time, growing our community count should grow our revenues allowing us to leverage our fixed overhead and interest costs. On slide 7, you can see that our community count, including joint ventures, increased from 189 to 201 year-over-year. While the holiday season is not normally a busy time to open new communities, during the first quarter we opened 20 new communities, many of them just on the pre-sales basis before models. At the same time, we sold out 23 existing communities. While it's difficult to project community count from quarter to quarter, as long as we continue to find new land opportunities that achieve our 25% plus IRR underwriting criteria, we expect our community count will continue to grow over time. At the end of the first quarter, 60% of the communities that were opened for sale were newly identified communities that we controlled after January 31, 2009. However, only 30% of the deliveries in the first quarter were from newly identified land. Since many of these newly identified communities are recently opened, they will not begin to deliver until the end of 2011. As long as we see no changes in market conditions this mix shift should cause our gross margins to have improved at the end of the year. While we don't have a specific target for community count that we're going to set today, we do expect to see the number of active selling communities increased during fiscal 2011. Slide 8 shows the progress we've made in purchasing or optioning new land parcels. From January of '09 to January of '11, we’ve purchased or optioned approximately 15,200 lots in 264 communities. As you can see on the bottom left-hand side of the slide, we optioned 1,850 new lots in the first quarter and bought about 50 new lots that weren't previously optioned. We then walked away from about 1,700 lots, 90% of which had virtually no cost as these lots were still in the initial due diligence period. We walked for a variety of reasons, including some slower absorption, paces, or in some cases, price declines that occurred after the property was put under option during investigation. The net result for the quarter is that our total lots purchased or controlled since January of '09 increased by about 200 lots. During the first quarter, we purchased about 550 newly identified lots in 60 communities. In addition, we purchased about 700 lots from legacy options. In total, we spent approximately $75 million of cash in the quarter to purchase 1,300 lots and to develop land across the country. Slide 9 shows gross margins. Annual margins are on the left side and quarterly margins are on the right side. The first quarter of 2011 marked the eighth consecutive quarter of year-over-year increases in gross margin. Even without $25.5 million of impairment reversals in the first quarter of 2011 and $49.2 million of impairment reversals in the first quarter of 2010, our margins would have shown a year-over-year improvement. As we have said in the past, gross margins have the potential to fluctuate from quarter to quarter. Sequentially, gross margin was flat this quarter. As we’ve said on the last conference call and assuming no change in market conditions, we continue to expect better gross margins toward the end of fiscal 2011. During the first quarter, our gross margin was 16.9%. This is still below our normalized gross margin, which for us is in the 20% to 21% range like those achieved in 2000 or 2001 fiscal years. In fiscal 2011, we continue to expect more than 40% of our deliveries will come from the newly identified land. So if home prices remain stable, our gross margin should continue to improve in 2011 even without a recovery. But we don't expect gross margins to get to the normal 20% range this year. On the right side of Slide 10, the bar shows the absolute dollar amount of total SG&A is lower when compared to the first quarter of last year and the fourth quarter of 2010. However, when you look at total SG&A as a percentage of total revenues, as we have shown underneath the bars on the right-hand side of Slide 10, the 21.9% for the first quarter of fiscal '11 is much higher than our historical norm. This increase has come despite continued reductions in our staffing levels. We incrementally reduced our staffing levels by another 5.4% or 88 associates during the past three months. Clearly, we needed a little more top line growth to get the efficiencies. In spite of our rightsizing efforts, we still have growth capacity at corporate and our divisional and regional offices. As we open new communities, we should not need to add associates to our corporate or divisional offices. Incremental spending related to increasing our community count will come at the community levels. Typically, we need to add a construction supervisor and at least one sales associate per new community. Over time, the combination of further improvements in gross margin trending back to normalized gross margins in the 20% range coupled with SG&A leverage as we grow our community count and increase revenues will get us to the point where home building operations are once again profitable. We have our work cut out for us to find new land parcels to invest in that will bring us the kind of returns that we need to continue down the path to profitability. Fortunately, deal flow remains steady as we continue to approve land acquisitions on a regular basis. I'll now turn it over to Larry who'll discuss our inventory liquidity and mortgage operations as well as a few additional areas.

Thanks, Ara. Let me start with the discussion of our current inventory from a couple of different perspectives. Turning to Slide 11, you'll see our owned and optioned land position broken out by our publicly reported segments. Based on trailing twelve-month deliveries, we own 4.2 years worth of land. Our owned lot position increased sequentially in the first quarter while our optioned lot position decreased. During the first quarter, we walked away from 2,600 lots, of which 1,700 were in just two communities. One with a 900 lot newly identified community that didn't make it past the initial due diligence period. And the other was an 800 lot legacy community that no longer met our performance hurdles. We purchased approximately 1,300 lots during the first quarter, which was offset by about 850 deliveries and the sale of about 200 lots. On the option side of the equation, we walked away from 2,600 optioned lots. Additionally, we signed new option contracts for an additional 1,600 lots during the quarter. At the end of the first quarter, 66% of our option lots are newly identified lots, and 21% of our owned lots were newly identified lots. When you combine our optioned and owned land, 39% of the total lots that we control today are newly identified lots. On Slide 12, we show a breakdown of the 18,711 lots we owned at the end of the first quarter. Approximately 38% of these were 80% or more finished, 12% had 30% to 80% of the improvements are already in place and the remaining 50% have less than 30% of the improvement dollars spent. While our primary focus is on purchasing improved lots, it is difficult to find finished lots for sale today at a reasonable price. About 35% of the remaining newly identified lots we've purchased or contracted to purchase are lots where it makes economic sense to do some level of land development. And we started to complete land development on sections of our legacy land as well. Now I'll turn briefly to land-related charges which can be seen on Slide 13. We booked $6.8 million of land impairments in four communities during the first quarter. $4.6 million of this was on one land parcel that we have an agreement to sell in New Jersey. Some newly identified communities from 2009 are no longer hitting hurdle rates because of slower absorption pace or pricing pressure. To date, we have impaired only one newly identified community. This was a $1.1 million impairment on a single community in California this quarter. During the first quarter, our walk away charges were $6.7 million with $6 million of the total charge split evenly between one community in California and one community in New Jersey. In total, we booked $13.5 million of land-related impairment and walk away charges in the first quarter of fiscal 2011. 79% of these charges were related to just three communities. Our investment and land option deposits was $28.4 million at January 31, 2011, with $25.3 million being in cash deposits and the other $3.1 million of deposits being held by letters of credit. Additionally, we have another $23.3 million invested in pre-development expenses. Turning to Slide 14. We show that we have 7,514 lots and 53 communities that were mothballed as of January 31, 2011. And on this slide, we break these lots out by geographic segment. The book value at the end of the first quarter for these communities was $167 million net of an impairment balance of $543 million. We are carrying these mothballed lots at 24% of their original value. Looking at our consolidated communities in the aggregate including mothballed communities, we have an inventory book value of $948 million, net of $860 million of impairments, which were recorded on 157 of our communities. Of the properties that have been impaired, we're carrying them at 27% of their pre-impaired value. Turning now to Slide 15. On a sequential basis, the number of started unsold homes, excluding models, continues to decrease. We ended the first quarter with 777 started unsold homes. This translates to 4.1 started and unsold homes per active selling community, unchanged from the end of the fourth quarter and lower than our long-term average of 4.9 unsold homes per community. Another area of discussion for the quarter is related to our current and deferred tax asset valuation allowance. During the first quarter, the tax asset valuation charged to earnings was $22 million. At the end of the first quarter, the valuation allowance in the aggregate was $833 million. We view this as a very significant asset not currently reflected on our balance sheet. We expect to be able to reverse this allowance after we generate consecutive years of profitability. When the reversal does occur, the remaining allowance will be added back to our shareholders' equity and will further strengthen our balance sheet. Pro forma for our recent capital markets transaction, we ended the quarter with a total shareholders' deficit of $279 million. If you add back the total valuation allowance as we've done on Slide 16, our total shareholders’ equity would be $554 million. Let me reiterate that the tax asset valuation allowance is for GAAP purposes only. For tax purposes, our tax assets may be carried forward for 20 years and we expect to utilize those tax loss carryforwards as we generate profits in the future. For the first $1.8 billion of pretax profits we generate, we will not have to pay any federal income taxes. Now let me update you briefly on the mortgage markets and our mortgage finance operations. Turning to Slide 17, you can see that the credit quality of our mortgage customers continues to be strong with an average FICO score of 736. During the first quarter, our mortgage company captured 78% of our non-cash home-buying customers. Turning to Slide 18, here we show a breakout of all of the various loan types originated by our mortgage operations during the first quarter of fiscal 2011 compared to all of fiscal 2010. 48.4% of our originations were FHA/VA during the first quarter of fiscal 2011, similar to the 49.3% we saw during all of fiscal 2010. There's a lot of discussion about how the federal government's involvement in the residential mortgage industry will change in the future. We are confident that the government will take cautious and appropriate steps to ensure that there is a valid mortgage market that can be accessed by individuals looking to purchase a home. What has been released so far has been pretty vague and nothing is likely to be implemented during the next several years. Needless to say, this is something we'll be keeping an eye on. Let me update you quickly about what's happening with loan repurchase requests. We continue to believe that the vast majority of repurchase request that we've received are unjustified. On Slide 19, you'll see our payments from fiscal 2008 through fiscal 2010 were relatively minimal. While we did not make any payments during the first quarter of 2011, we did receive 17 repurchase inquiries, which was a little less than last year's quarterly average of about 25 inquiries. It is our policy to estimate and reserve for potential losses when we sell loans to investors. All of the above losses have been adequately reserved for in previous periods. At the end of the first quarter, our reserve for loan repurchases and make whole request was $5.7 million, which we believe is adequate for our exposure. To date, repurchases have not been a significant problem, but we continue to closely monitor it. In general, mortgages are available today. However, lenders are asking for more evidence that the borrowers are creditworthy, so consumers have to provide more loan approval documentation than previously required. Although loan approval standards have not materially changed during the past three to six months, it is true that the file for loan applications today is much thicker than it has been in the past. Mortgages however, remain available today for creditworthy applicants. Our homebuilding contract cancellation rates continue to remain at normal levels. Our cancellation rate for the first quarter was 22%, similar to last year's first quarter of 21%, and 200 basis points lower than the 24% we had during our fourth quarter of 2010. Turning to Slide 20, it shows some details of the capital market transactions that we executed in early February of 2011. Including the exercise of the underwriters Green Shoe [ph] (29:53), we raised about $300 million through the common stock, tangible equity units and senior unsecured note offerings. And currently, we tendered for our senior and senior subordinated notes that matured in 2012 and 2013. 63% of these notes were tendered and the remainder have been called. The net result of these transactions assist us in strengthening our balance sheet by increasing our cash position by about $124 million net of fees and expenses, and clearing the deck of near-term maturities. Turning to Slide 21, it shows a debt maturity schedule pro forma for these transactions. What you see very clearly is that we have very little in the way of debt coming due through the end of 2014. Our cash position can be seen on Slide 22. At the end of January, after spending approximately $75 million of cash to purchase 1,300 lots and on overall new land development across the company, we had $399.3 million of homebuilding cash at quarter end. This cash position does not include $88.3 million of restricted cash used to collateralize letters of credit, which has declined from $135 million at the end of fiscal 2009. The final bar on this chart shows a pro forma cash balance of $523 million, which is our cash position at the end of the first quarter with additional cash from our debt and equity transactions that closed early in our second quarter. As we announced on our fourth quarter conference call, we closed a joint venture with GTIS [GoldenTree InSite] Partners in December of 2010. Looking forward, our strategy on joint ventures has not changed. We still intend to utilize joint ventures for larger land transactions. We're comfortable with our current liquidity position. The additional capital we raised gives us more drive power to invest in land. Investments in land is needed to grow our community count, and in turn, our top line, which will eventually drive greater operating efficiencies and return us to profitability. Now let me turn it back to Ara for some brief closing comments.

Well, needless to say, we are anxious to return to profitability. On Slide 23, we've developed some simplistic potential scenarios to illustrate what it would take for us to achieve break-even results. On the top of the slide, we assumed that our SG&A spending continues at levels similar to the first quarter of 2011. This would be an annual expense of about $220 million per year. While we include internal commissions and outside brokerage costs in cost of goods sold, which impacts our gross margin and not our selling costs, other general selling costs could increase with a higher volume, depending on things such as sales per community, advertising expenditures, number of communities, et cetera. However, for this simplistic analysis, we assumed that SG&A is flat at our most recent quarterly rate. We also noted our cash interest incurred of $155 million per year creating a total fixed cost in this simplistic scenario of $375 million per year. The middle of the slide shows the revenues and deliveries necessary at different gross margins to achieve break-even results assuming the above fixed costs. So if our gross margin stayed at 17%, we’d need revenues of $2.2 billion with 7,353 deliveries assuming our current average price of $300,000. If margins were more normalized at 20% levels, we'd need revenues of $1.875 billion or about 6,250 deliveries. Finally at the bottom of this slide, we showed the number of required communities based on different levels of deliveries per year per community. In this oversimplified model, if deliveries stayed at 23 per year with our current 17% gross margin, we’d need approximately 320 deliveries. If annual deliveries increased to 33 per community, still below our non-boom, normal times of 44, but increasing from our approximately two sales per month to 2.75 sales per month, and if margins also normalized at 20% then we'd need only 189 communities similar to the number of wholly-owned communities that are open for sale today. While these scenarios are oversimplifying the very complex situation, assuming fixed costs of $375 million, this does provide some perspective of the metrics we would need to achieve break-even results. We think these metrics are achievable and reasonably in the not too distant future. Before I turn it over to SG&A, I'd like to take a moment to comment on our upcoming change in our executive management team. After 30 years with our company, Paul Buchanan, Senior Vice President and Chief Accounting Officer, will be retiring this May. Paul joined our company in 1981 as Corporate Controller. And to put it into perspective, I believe the year Paul started, we had revenues somewhere around $50 million per year. Since then, Paul has served as a strong leader and trusted advisor as the company experienced significant growth and challenging market cycles. His contributions are far too many to list. Thank you, Paul. Brad O'Connor will be assuming Paul's responsibilities as Chief Accounting Officer. Brad has been in training with Paul for the last seven years, and has been preparing for a seamless and smooth transition. With that, I'll be pleased to open it up for questions.

[Operator Instructions] Our first question is coming from the line of David Goldberg from UBS.

This is actually Susan for David. Just wanted to get some more details in terms of the current order trends and what your thoughts are heading into the spring selling season. You did about one order per community in the last quarter per month. What do you think would be a good selling season, what do you -- do you have any kind of targets that you can talk to us about and sort of where you are relative to that?

I think if you can turn to Slide 4, it kind of puts it into basic perspective. Both what the current trend has been, which has been an upward direction since the trough in December of 2010, when we were at 1.2, we went to 1.8 in January '11 and then 1.9 in February '11. And you can see how that compares to last February and January as an indication when the sales -- or the homebuyer tax credit was in place, you can see that last year, we had a very similar increase from January to February of 0.1 net contracts per community identical to this year's 0.1 increase but we are below the absolute level when the homebuyer tax credit was in place. You can also see on this slide what happened in March and April of last year as well. So that just gives you some idea of what we're kind of looking to achieve going forward. Obviously, this is still nowhere near normalized spring selling seasons before this unprecedented downturn. But the trend's in the right direction and as Ara said, we're feeling good. We always would like to see more sales but we're feeling good.

Okay. And are you seeing, generally speaking, a lot of pricing discipline out there? And what are your thoughts about potentially having to increase incentives or lower prices or something along those lines in order to drive greater traffic, if you need to do that?

I'd say we saw pricing pressure, November and December, it was a slow time of the period -- of the selling season always, but there was definitely more pricing pressure. More recently, things definitely feel a little more stable in terms of pricing as well as velocity.

Your next question comes from the line of Dan Oppenheim from Crédit Suisse.

Hi, this is actually Mike Dahl on for Dan. Just a question on some of the comments you had on the more recent land purchases. You mentioned that some of the 2009 purchases aren't meeting hurdle rates anymore, but we've only see one of those communities impaired. I guess, why aren't we seeing more impairments on these communities? What should we expect going forward? And then presumably 2010, the land prices were generally increasing, so is it fair to say that the 2010 purchases are also not meeting hurdles?

Yes. First of all, while there has been deterioration, we haven't had enough deterioration to bring the overwhelming majority of our new purchases into a position of having to impair. That being said, there certainly has been pressure on pricing, as I've mentioned and we've mentioned on previous phone calls. And some of the -- it's been choppy I'd say. We certainly have many communities that are meeting or exceeding the hurdle rates, but we certainly have some that were purchased, particularly the ones earlier in '09, that are not achieving our hurdle rates. Nonetheless, they're performing at a rate that it’s -- that they don't require any impairment other than the small one that we discussed this quarter.

Got it. So, I mean, in terms of the -- if we think about the margins there, if you were underwriting to a 20% margin, I mean, what's the level that we're at on some of those, is it 15%, is it 18%?

I mean, on some of them we're above the 20%, we're above underwriting. On some we're below. There was only one that had deterioration either in or a combination of pace and/or price that caused a -- of an impairment. But these are all very fact-specific situations to a specific community. So I wouldn't take any broad-based conclusion that because we had one community that took an impairment, and we stated that there are some that we've gotten below the hurdle rate, that it’s the majority or anything close to the majority of what we've done. And also much of what we've controlled in 2010 we did in the last half of the year of 2010, the vast majority of our 2010 was in the last half of 2010 after the market had already slowed down so that we were able to take that into account in our underwriting criteria. So we're pleased at this point, given market conditions with the deals that we have done, and hopefully the market will stabilize or even improve from here. And we'll ultimately get even better returns on the properties that we’ve controlled since the end of January 2009.

Okay. That makes sense.

Your next question comes from the line of Michael Rehaut from JPMorgan. Michael Rehaut - JP Morgan Chase & Co: First question on the orders from new communities. I think you said that at this point in terms of your total communities open, 60% are new or newly purchased since '09, but what is the amount of percentage of orders that you're taking in as a percent of total from new and how does that compare to the last couple of quarters?

I don't think we have that detail at our fingertips, certainly don’t have it tracked that way. What we can say is that many of the communities that are newly identified that are now open for sale have recently opened for sale. And as Ara mentioned, some of them are kind of in pre-sale mode without models being completed yet. And therefore, the deliveries are going to be waited to the latter part of 2011 as we've got to get the models done. And then actually, build the homes that we're starting to sell on a pre-sell basis today, and then after grand opening obviously more. We just don't have that data available, Mike. Michael Rehaut - JP Morgan Chase & Co: Okay. So let me just ask it another way and I also just wanted to get one last question if I could. You have 30% of your closings today from new communities, does that mean that you could get to 50% or greater by the end of the year and then my second kind of separate question is on the break-even analysis, and I know that's kind of a rough, as Ara said, is kind of rough basic numbers, but I noticed you were using 300 ASP. And for the last several quarters, it's been pretty consistent around 280, so that's a 7% difference. Is that based on your newer communities and where you expect the ASP to shift towards? Or are you assuming an improvement in price or is that just kind of the rough analysis that you were doing?

Let me take a shot at it. First of all, what we've said for the full-year is that 40% of our deliveries, at least 40% we're expecting to be from newly identified communities. So you could -- it's going to be weighted towards the latter part of the year. So you can make whatever assumptions you want, but that's pretty clear guidance, I think, to provide you. With respect to the overly simplistic, as Ara described it, break-even analysis, you shouldn't read anything into the 300,000. It was just a nice round number to use in the calculation to give an illustration of what break-even results would be. If you want to change it to our current average sales prices, it's pretty easy to do. Michael Rehaut - JP Morgan Chase & Co: Okay.

I believe our average price of contracts for the quarter was about $293,000, so the very in-depth [ph] (35:36) was on our release. So pretty close to $300,000. We're just rounding it.

Your next question comes from the line of Carl Reichardt from Wells Fargo.

On the Slide 12 that you guys have included often with the percentage of lots and development stage, is there a concentration, geographically, of assets in either the lots that are under 30% developed or over 80% developed?

I'm kind of scanning the room to see whether any of my team members have a clue.

I think we have some concentration of the undeveloped in California, a little more than the other markets. That being said, it’s not a dramatic number. We probably have the highest concentration of developed lots in the Texas market.

Okay, I would assume so. And then the mothballed lots are included in there too, right Larry?

Yes. The mothballed are included and they're probably weighted towards the less than 30% developed and that's probably geographically-weighted California and New Jersey.

Okay. Super. And then, next question, Ara, has there been a change or maybe you can talk a little bit about the amount of time it's taking if you get a person new to attract from -- and you count them as traffic, how long is it taking them, if you convert them, before they sign? And has that time lapse between first visit and contract sign changed much? Maybe you can talk a little bit how that's evolved over the last year or two?

Yes. I don't think it's changed over the last year or two. Needless to say, in general, it's far greater than it was five years ago. Interestingly, it's a mix, it's really a polar mix. We've got some that make multiple, multiple decisions and it's strung out over a long period of time, particularly, as they wait to sell their homes. On the other hand, we have traffic that comes in, they finally sold their house, they weren't serious about looking until they sold it. And now, they need something right away. So it's really a mix, but I wouldn't say that there is a dramatic shift in that regard. I will say just from touring around our offices over the last month on the West Coast, out in Texas, in Florida, in general, we're definitely getting the sense that our sales people are getting increasingly enthusiastic about the traffic, the willingness and the interest of and the seriousness of the traffic that they're seeing out in the marketplace.

Right. I appreciate the color guys.

Your next question comes from the line of Jonathan Ellis from Bank of America Merrill Lynch.

My first question is related to margin, it's sort of a two-part question. First is can you give any update on the gross margin spread between newer land versus older land? I think in the past, you had said it's about a 500-basis-point spread. I'm wondering if that's still a good assumption to be using. And then, the second question on margins is, any insight you can give us into non-price based incentives? To what extent those are being ratcheted up? And if they're having success, one thing we've heard is that options and upgrades have become much more prevalent in the last month as a way to entice buyers, so any update on the use of incentives?

Well, when we talk about pricing, I always prefer the net pricing because it really doesn't matter where it comes from, more or less. And that's where I was saying, there was pricing pressure in November, December. Most recently, it’s definitely felt a little more stable. Generally, though I think your observation is correct, there has been more of a tendency among new home builders to do, other than the standard kind of closing costs approach, which is always helpful because it reduces the down payment requirement, there's definitely more emphasis on incentives that are used if they -- toward options and upgrades only. Generally speaking, that's a little less costly than outright price lowering obviously.

And then just a question on land, the gross margin spread between new and older land?

I don't know where you got the 500 basis points differential. I think what we said in the past is your best estimate of what the legacy margins were maybe at the end of the third or fourth quarter last year, I don't remember precisely when we might have said that, would have been what our total gross margin was because we didn't have a lot of deliveries from newly identified communities. And that's -- on average, the newly identified communities would average something close to 20%. It obviously depends on whether it's a Texas kind of community because we don't underwrite to a margin, we underwrite to an IRR. And in Texas where we're optioning finished lots on a just-in-time basis, the gross margin might be lower than 20%, but we get high inventory turns. And then in Washington DC, on a newly identified lot, the margin might be significantly higher than 20%, but it's a lower inventory turn to get to our 25-plus percent unlevered IRR, so it just depends on where the newly identified community is, as to what the margin is. But on average, it is around that 20% kind of number that we think that is normalized gross margins for Hovnanian.

Okay. Great. And then my second question, just on the financing side. I don't know if you have it available but obviously, a lot of talk about conforming loan limits and how those may be ratcheted down over time. Do you have any granularity you can share in terms of percentage of deliveries tied to mortgages or the principal balance between $625,000 and $730,000, and then, also within the sort of the traditional conforming level of $417 000 up to $625,000?

Not at my fingertips. I'm sure we have it at our mortgage company, but I don't have that data readily available. But our backlog average sales price and backlog today is $307,000, Paul? So we don't have a whole lot of our product that averages dramatically higher than that. So I don't think we're a big user of non-conforming, I mean, certainly we have some communities that use the higher loan limits but it's not a large percentage of what we do, but I just don't have the data at my fingertips to answer that.

Okay. I'll follow up.

Your next question comes from the line of Joel Locker from FBN Securities.

Just looking at your gross margins a little closer, if you say about 2/3 of your deliveries, like they'll be scheduled from new communities by the fourth quarter and if they’re throwing off a 20% gross margin versus the current 17% gross margin, which has been the run rate for legacy communities, would you say that by the fourth quarter, your gross margin should be at the 19% level using that weighting [ph] (53:29)?

We're just not going to make a projection on what our gross margin may or may not be at a particular point in time. We've given you about as much guidance as we can give you without making a specific projection.

Well, just assuming that pricing was flat, obviously, if it goes up or down it's going to be different?

Yes. I mean, you can make whatever assumptions you want, I'm just not going to -- just can't. Not willing to make an absolute projection on what our margins may or may not be even in a flat market by the end of the year.

Got you. And then just on the follow-up question on the consolidated February orders. What were they? I saw that the other -- that the chart on Slide 4 included a consolidate -- or joint ventures?

Probably not a whole lot.

We may be able to get that answer before we end the call. If we do, we'll tell you.

What was the number? I can't -- It's just hard to make out on the February total orders?

384.

All right.

Your next question comes from the line of Nishu Sood from Deutsche Bank.

Hey, this is Rob Hansen on for Nishu. You guys touched on traffic a little bit, and would you characterize traffic quality as better lately? And what's generally drawing traffic in your communities lately? Has it been just word-of-mouth or promotions, mortgage rates, what seemed to work to luring buyers into your communities?

Well, first of all, traffic quality is definitely better. It was definitely a lot slower in November, December. It's seasonally slow in November, December but it felt slower than the normal seasonal level there. I can't say that we're doing anything uniformly across the country in terms of our approach. We're fairly decentralized in our marketing approach. So some geographies are advertising on radio, some are really focus more on the internet and getting Google hits or Bing hits, you name it. It does vary dramatically. I can't say there is any one thing that we are doing. What I would say is there's just been a more positive attitude for consumer sentiment in general. And I'd like to tell you that the increase in traffic is just at our communities and the increase in sales, but as I'm doing my tours, I visit our competitors as well, we track what our competitors are doing and it definitely feels like there is strength for the overall industry and new homebuilders in general right now.

Okay. And just you -- you've kind of altered your maturity schedule and you've got some more breathing room, especially in the short term here. What's your preferred method of land spend? Outright land acquisition or are you going to be looking more to the JVs? And now that you have this additional cash, that cash is your kind of cash balance goal of $275 million changed at all or does that remain intact?

Yes. Our cash balance goals remain intact. It just gives us a little more firepower to grow. Generally, our ideal scenario is buying finished lots on a takedown basis, whether that's quarterly or monthly or annually, that's always the preferred route. If possible, we'd like our deposits to be equivalent of a Starbucks' Latte. But if we have to do a little more, we'd still prefer that. The second choice would be smaller, developed lots, there are 50 lots at a time, a year and a half worth, two years worth, that was more available earlier, it's a little bit more challenging to get the developed lots as much as we would like but we still find those opportunities. The third would be smaller undeveloped parcels. Again, small sites that we can get in and out of with relatively good inventory turns. And we are finding those opportunities around the country as well. Lastly, the joint ventures we’re pretty much trying to focus on those for the larger transactions where the site requires peak capital needs, approaching or over $20 million similar to what you saw with the GTIS transaction that we did two months ago on three sites, Northern California, Southern California and Washington.

All right.

Your next question comes from the line of Ivy Zelman from Zelman & Associates.

Your commentary on the spring or the beginnings of the selling season are obviously welcomed by the investment community. The questions we get a lot are within the various markets you're competing in. Is there a difference between the level of improvement in sales with respect to the first-time home buyer or the move-up buyer? And talking a little bit, if you could, maybe distinguishing between the buyer segments, if there's any discernible difference between the segments of your buyers? And any change that you'd see geographically. A lot of people assume the sand state which are more challenged with foreclosure overhang and higher unemployment levels, are those markets lagging, underperforming with respect to your improvement in sales or are you seeing a more consistent rebound off of lower bases maybe in those depressed markets where new construction has been arguably starved with no new products for a long time. So geographic and within the buyer mix side, please?

Sure. Just first, geographic, I'd say the notable slower locations would be all of the markets in Florida and a little slower in the greater Sacramento area, and to some extent Minneapolis. Those are the ones that come to mind. On the little stronger side, I'd say the DC area, parts of the San Francisco Bay Area, Houston has been solid, and surprisingly recently, Chicago has been very solid. I'd say surprisingly because if you technically look, they've got still an MLS about a 13- or 14-month overhang month supply of existing homes, they've got a reasonably high unemployment rate in the nine-plus percent, but sales seem to be quite perky there. So those are the notable differences from geographies. On the product type, I'd say we really seen reasonable demand at all the different segments. I can't say that there is a pattern of active adults or first time or first-time move up that's really discernible across the country. It's a little different in certain markets. In Dallas, the higher end is just a little slower, we're doing a little bit better in the middle end. In Houston, the first-time home buying niche has been tougher because there has been, particularly on the lower end, because there has been qualification challenges with some of those buyers. But I wouldn't say, by niche there’s been any discernible national trend.

Well, that's very helpful. I guess there's a lot of concern with interest rates moving up, and I don't know if you've got any commentary from your sales people and throughout the country, but is there a particular threshold of the mortgage rate that would concern your -- as long as it’s a steady sort of modest improvement or increase in rates. Just your views of is 6% the cut off for a 30-year fixed? Or is there resistance? Are people buying? Maybe your activities are improving because rates have moved up so you've gotten [indiscernible] (01:02:16). So just your perspective on what you think the magnitude of the rate increase can do to you? Or what the higher -- what rate will cut things off?

Sure, completely unscientific. I'd say a rapid rise over 6% would be a psychological hurdle, but it's very unscientific gut sense. You can take that for what it's worth. I'd say in general, a slow, gentle rising environment is not the worst in the world. And it could get people to not be sitting on the fences too long.

Ivy, I think we would trade above 6% 30-year fixed rates. If it came because the economy was doing better and we were creating jobs. I don't believe interest rates are the issue today. I mean, they're still at historical lows in spite of the increase that we've had that moved them up a little bit by any kind of longer-term historical perspective, it's just unbelievably affordable. What's preventing people from buying today isn't interest-rate related, it's really jobs, the economy, consumer confidence to make that purchase. And if rates go up, I think it might be good news, if it's related to the economy getting better and jobs being created.

I appreciate that. If I could sneak in one quick one, on your sensitivity, which was very helpful, in fact your slides, overall, were great. So Jeff, great job. Just in terms of the sensitivity, you show fixed cost with SG&A. What would be for community count growth? Is there a rule of thumb for each incremental community? How much of your G&A -- overall selling G&A would have to go up?

It's fairly de minimis, Ivy, because as I think we’ve said in the script, you're probably adding certainly a construction superintendent, a...

Which is not in SG&A, obviously, as we mentioned in the script, that's in the gross margins, but...

There's really not much that gets added as we increase. There's some incremental but it's not a big number.

Okay. Great.

And Ivy, just to remind you, and I know this is slightly different among the homebuilders, some homebuilders include commissions both inside and/or outside commissions, in selling costs, we do not. It's in our gross margin. And that's why we say we don't believe our SG&A has to increase very much as we increase our volume.

Great.

Your next question comes from the line of Michael Smith from JPM Securities (sic) [JMP Securities]

A couple of quick questions on land, if you don't mind. Could you detail a little bit where you've been purchasing the bulk of your land over the last quarter, say and into February?

Let me see, it has really -- I don't track it per se, but I'll just give you anecdotally. We've had, let's see, some transactions interestingly in Ohio, which has been slow in the past that we found more opportunities recently. They've been at pretty deep discounts from the banks there. We found very little in Minneapolis recently, we'd like to find more but that's been quiet. We found some transactions in Washington DC. Found some in Pennsylvania. Found several developed lot opportunities in Houston. Some small bulk transactions in Dallas. Those are the quick ones that come to mind over the last couple of months. It's fairly spread.

That's helpful. What, in general, is limiting to the extent that it is what you're able to go out and buy? Is it a lack of quality lots that you can find? Is it pricing that's above what you're willing to pay?

The challenge is our underwriting criteria is that it has to work at today's prices and today's pace. So when you take that discipline and you figure out what you can pay for the land, it's typically a fairly low number. So to find the opportunities that pencil-out at today's price and get us that average 20% gross margin, we have to turnover a lot of rocks.

In your markets in general as you're finding that even it doesn’t pencil-out there are plenty of A and B lots that you would want to take down available for you and you're just not willing to under -- they just don’t pencil-out the way you would want them to? Or are you finding that there's actually a lack of supply out there?

No. I mean, it's clearly a finite supply and there are clearly more C and D locations that we have no interest in. But there are As and Bs and it's a matter of timing either the sellers finally say, "Okay I'm tired of waiting." Or price or the pace firms up in that little sub-market such that you could justify the price they are looking for, or in some cases interestingly enough, construction costs come down just that extra little bit and it makes the hurdle rates work. Generally speaking, the financial institutions are not dumping the properties but it is steadily and regularly being doled out as their internal teams can deal with their problem assets. So that's kind of a good environment, we'd rather it be steady and stable.

Great, guys. I appreciate it.

Before the next question, I just want to respond to an earlier one on what was February's consolidated net contracts. The total net contracts including joint ventures was 384, 351 was the consolidated net contracts for whoever asked that question earlier.

And your next question will come from the line of Michael Kim from CRT Capital.

I guess, my first question is more for Larry. Touching on the remaining strategy for the capital structure, thinking about some of the call options, do you plan on exercising upcoming call options on the second and third lien notes to help assist in bringing down your fixed costs, just a touch? And I guess, how should we think about bond repurchases going forward as a way to delever for the capital structure?

I think, obviously we look at all of the flexibility and options that are available to us on the calls and we are obviously in the process of analyzing some of that, as some of that's callable in the next couple of months. So we've not made a final decision one way or the other. I don't think you should expect us to use much of our capital to go out and repurchase debt. We do have the flexibility to do that but we don't think it's our highest and best use of capital generally. There may be an exception here or there for some of the higher-cost debt that's out there. But in general, I think we would rather invest our capital in new land deals that need our hurdle rates of 25% plus unlevered IRR and grow the company rather than take our cash and use it to pay down debt right now.

Understood, and I guess as follow-up, I appreciate the slide on the potential break-even scenarios. Just curious, the deliveries per community per year, how is this computed? Is this based off the average active communities during the year and I guess you described...

If you go to -- let's see which slide it is. But we have our historical average annual deliveries, it's on -- or contracts, really it's Slide 5, okay? And the average during kind of normal times from a contract perspective, this isn't deliveries but obviously net contracts, deliveries would closely mirror is probably 44, 45 and the last couple of years we've been at 23. So one of the scenarios shows it at 23, and I think the highest one that Ara showed maybe got you to 33, still well below our kind of average norm of 44, 45.

Okay. And I guess, just in terms of the general trend over the past couple of years, how much has density changed for your communities? And I guess, with this metric in delivery per community per year, do you think you can reach some sort of inflection point in this metric over the next year, year and a half?

I'm not sure what you mean by density change?

You mean in terms of more multifamily or smaller lots, is that what you mean?

Yes, smaller lots, just thinking about the calculation of deliveries per community per year, I mean it's just --

I think it's more across...

I'm wondering if there's any sensitivity that could shift that metric given the change in density or...

I think it's more function of demand than any product type.

Yes. I mean, generally speaking, we do have greater velocity in the greater densities, whether they're townhouses or small lot singles. Generally, those have a little greater velocity sales pace. And we are seeing a little bit more opportunity and activity in that segment of the market than the larger estate lots. I mean, we're -- we tend to be more focused there anyway, but there's probably a little bit more of a shift and bias toward that end of the market.

[Operator Instructions] Your next question comes from the line of Tom Higbie from Deutsche Bank.

Quickly, what are you thinking for community count, any kind of targets you could provide for 2011, 2012, where should we think about the trajectory of community count going?

I think what we said very specifically was that assuming that we can find deals that underwrite based on today's price and today's absorption pace, the community count would grow but we've not at this stage given any guidance towards a particular number.

Okay. And also, when you look at traffic levels today versus traffic levels, where they were back when you were kind of 44 orders a year, how are traffic levels -- how much of the difference in today's pace is traffic and how much of it is closing that traffic? Meaning, is there any leverage that you can get out of today's traffic? Do you need to grow traffic significantly or can you actually get some leverage out of just closing current people walking through?

I would say, in general, our traffic levels are lower and it's just reflective of the same issues that are affecting sales. We need confidence to go up. We need employment numbers to get better. And I think, that'll attract traffic as well as customers.

Okay. So just a follow up on that. Is traffic down as hard as orders are? Or is traffic down something less than that and you're just closing a lower percentage?

Traffic is down every bit as much as orders are.

Okay.

Your next question comes from the line of Michael Rehaut from JPMorgan. Michael Rehaut - JP Morgan Chase & Co: Just a follow-up, and I don't know if you have this readily available, but maybe you can follow up later. Just wanted to get a sense with some of the recent discussions out there about risk retention by the banks in terms of underwriting anything that's, I think, less than a 20% down on the conforming loans. The banks would, at least in current discussions, have to retain a 5% piece of the mortgage. And you could see as a result, the conforming sub-20% down payment area become a little tighter. Do you have any sense of, I think, you said that your conforming loans right now are about 46%, do you have a sense of what the average down payment is for those loans?

No, I don't have it broken out by product type but the proposal you're talking about, I saw it for the first time yesterday afternoon. I think it's still in the proposal phase rather than anything that's been finalized. And I'd grouped it into the same comments I made during the script, that I think there's a lot of things being considered and nothing's been finalized. And then, I think the government's going to be very cautious about implementing something that somehow would limit the availability of mortgages to consumers across the country, especially in light of today's economic conditions. So certainly going to keep a close eye on that. Don't have the answer. We'll certainly get back to you, Michael. I think what you mean is conforming conventional, because FHA/VA is a big portion of our business today as well. Michael Rehaut - JP Morgan Chase & Co: Yes, just the conforming conventional. Exactly.

But I can certainly get back to you and tell you what our average down payment on conforming conventional is but my guess is it's probably not too far different than what our overall average loan to value is but I'll follow up with it. Jeff will find out and we'll give you a call. Michael Rehaut - JP Morgan Chase & Co: Great.

At this time, I'm showing no further questions in queue. I would like to turn the call back over to Mr. Ara Hovnanian for any closing remarks.

Great. Well, thank you very much. I know all of you are as curious as we are about the spring selling season. It feels good thus far, but we’ll look forward to give you more specific data on our next call. Thank you.

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