Hovnanian Enterprises Inc (HOV) 2011 Q4 法說會逐字稿

Good morning, and thank you for joining us today for Hovnanian Enterprises fiscal 2011 fourth quarter and year-end 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 fourth 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 on the Company's website at www.khov.com. Those listeners who would like to follow along should log into the website at this time.

Before we begin, I would like to read the following forward-looking statements. All statements are made during this conference call that are not historical facts should be considered as forward-looking statements. 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 risks, uncertainties and other factors include, but are not limited to, changes in general and local economic and industry and business conditions and impacts of the sustained homebuilding downturn, adverse weather and other environmental conditions and natural disasters, changes in market conditions and seasonality of the Company's business, changes in home prices and sales activity in the markets where the Company builds homes, government regulation including regulations concerning development of land, the homebuilding, sales, and customer financing process, tax laws and the environment, fluctuations in interest rates and availability of mortgage financing, shortages and price fluctuations of raw materials and labor, the availability and cost of suitable land and improved lots, level of competition, availability of financing to the Company, utility shortages and outages or rate fluctuations, levels of indebtedness and restrictions on the Company's operations and activities imposed by the agreement governing the Company's outstanding indebtedness, the Company's sources of liquidity, changes in credit rating, availability of net operating loss carry forwards, operations through joint ventures with third parties, product liability litigation, warranty claims and claims by mortgage investors, successful identification and integration of acquisitions, significant influence of the Company's controlling stockholders, changes in tax laws affecting the after-tax costs of owning a home, geopolitical risks, terrorist attacks and other acts of war, and other factors described in detail in the Company's annual report on Form 10-K/A of the year ending October 31, 2010, and the Company's quarterly reports on Form 10-Q or 10-Q/A for the quarters ended January 31, 2011, April 30, 2011, and July 31, 2011. Except as otherwise required by applicable securities laws, we undertake no obligation to publicly update or revise any forward-looking statements whether as a result of new information, future events, changed circumstances, or any other reason. I would now like to turn the call over to Ara Hovnanian, Chairman, President and Chief Executive Officer of Hovnanian Enterprises. Ara, please go ahead.

Well, after that rousing introduction, good morning, and thank you for participating in today's call to review the results of our full year and fourth quarter ended October 31, 2011. Joining me today from the Company are Larry Sorsby, Executive Vice President and CFO; Brad O'Connor, Vice President, Chief Accounting Officer and Corporate Controller; David Valiaveedan, Vice President Finance and Treasurer; and Jeff O'Keefe, Vice President, Investor Relations.

On slide 3, you can see a brief summary of our full year results and comparisons to the prior year. For the first time since 2005 full year net contracts surpassed the prior year. Additionally, backlog increased 19% on a unit basis. Obviously, deliveries have not caught up yet as you can see on the slide, but we believe that will happen given the increase in sales and backlog. These nascent indicators of growth are primarily driven by a 5% year over year increase in communities.

We've achieved this community count growth through continued investment in new land parcels. As we have said in the past, part of our path back to profitability comes by gaining efficiencies through top line growth. Our internal projections for the next two years assume no improvement in market conditions, so any top line growth is driven by community count growth. Slide 4 shows 12 months of our net contract per community on a monthly basis, which was flat at 1.9 per month for all three months of our fourth quarter. The conditions in the fall weren't dramatically different than what we saw at the end of the summer.

If we were to annualize that number, we would have ended the year at approximately 23 net contracts per community for the full year, which was about where we were for 2009 and 2010. If you look at the absolute number of net contracts, as we do on slide 5, it shows that net contracts increased 3% in the fourth quarter of 2011 compared to last year. While November always begins our slowest sales season of the year, this year's November achieved a 31% increase in contracts over last year. These results were achieved with the same number of Sundays this year and last. Overall, the first six weeks of our new fiscal year has been better than our internal expectations. Going forward, we expect sales and traffic to show the typical seasonal slowdown until several week after the new year.

By the end of January, the spring selling season should begin to kick in. As you can see on slide 6, we ended the year at 21.3 net contracts per community, just slightly below the level of the past two years, with a slower beginning of the year and a better ending. For each of the past four years, our average sales per community per year is off by more than 50% compared to our historical normalized average pace of about 45 contracts per year. These low absorption rates make it more challenging to return to profitability. Nonetheless, we believe we can achieve profitability before sales pace returns to normalized levels.

Without the market improving a primary driver of efficiencies is growth through community count. We made some progress on this front in 2011. Year over year community count was up 5% as seen on slide 7. Although it's difficult to project future community count, we are continuing to look for new land parcels that meet our underwriting criteria in order to achieve future community count growth. As you can see on this slide, our mix of newly identified actively selling communities to total communities continues to rise. For all of 2011, about 44% of our deliveries were from new communities, this is up from 12% in 2010. Given the current mix of communities, we would expect that to increase further in 2012.

If you look at our cash flow from operations prior to land spend, it would have been positive $87 million, much higher than the levels we saw in the first three quarters of fiscal '11. Even after spending $95 million on land and land development, cash flow was just negative at $7.9 million, materially better than any of the periods since we began reporting this information five quarters ago. At the end of the fourth quarter, 72% of our wholly owned communities that were opened for sale were newly identified communities that we controlled after January of '09. However, only 44% of our consolidated 2011 deliveries were from newly identified land.

Since many of these newly identified communities were recently opened, they will not begin to deliver homes until 2012. As long as we see no changes in market conditions, particularly in home prices, this mix shift should cause our gross margins to improve in 2012. For the fourth quarter, our deliveries in homebuilding revenues were in line with our guidance. Our gross margin increased sequentially again in the fourth quarter, but clearly not as much as we had expected. We had been expecting a gross margin of about 16.8% in the fourth quarter, and actually achieved 15.5%.

Slide 8 shows the quarterly results for fiscal 2011 on the right hand side. Much of the fourth quarter shortfall was due to the need to add additional incentives to maintain sales pace. A little stability in pricing would help us achieve better returns in our newer purchases. Over the last two years, pricing has deteriorated slightly reducing the margins we expected on newer land purchases. Having said that, the land purchases were significantly better than sitting on our cash and investing in Treasuries.

During the fourth quarter of 2011, there were $19.1 million of impairment reversals compared to $35 million of impairment reversals in the fourth quarter of 2010. Margins are still below normalized levels, which were in the 20% range as shown on the left-hand side of this slide. Clearly, pricing pressures remain throughout the market challenging our margins. Our publicly traded peers are seeing this too, as eight of the 13 public peers that we track reported year over year declines in gross margins in their most recently reported quarters. We continue to make adjustments to our staffing levels based on current and expected deliveries. On the left-hand side of slide number 9, we show that staffing levels are down 78% from the peak in June of '06, and down 8% on a year over year basis.

On the right hand side of the slide, the bar shows that the absolute dollar amount of total SG&A is lower when compared to the fourth quarter of last year. When you look at total SG&A as a percentage of total revenues, as we have done, as we have shown underneath the bars on the right hand side of slide number 9, it is also improved from last year's fourth quarter. While SG&A has come down in both absolute terms and on a percentage basis, it is still much higher than our historical norm of 10% or 11%. These higher percentages remain despite steep reductions in our staffing levels.

Of note, the dollar amount of our fourth quarter homebuilding SG&A was $11.3 million higher than it was in the third quarter of 2011, due primarily to three unusually large charges. As we do every year in the fourth quarter, we conducted an actuarial study to determine if we have sufficient construction defect reserves. Over the last several years, the study resulted in no changes. However, this year the study resulted in an increase to our reserves of about $6.3 million. Keep in mind from a cash flow perspective, these reserves are used over an extended period of time, not necessarily at the time we make the charge.

Second, we had about $2.5 million net increase to legal reserves. Third, we had a $1 million charge for lease abandonments. We do not anticipate that charges of this magnitude will be recurring as we look forward to 2012. Therefore, we believe that the $47 million SG&A run rate we achieved in the third quarter of 2011 is more reflective of our expected 2012 average quarterly SG&A costs.

We are well aware of the need to achieve higher gross margins. Assuming no increases in incentives or home price concessions, we are confident that a better mix of deliveries in 2012 will result in higher gross margins. However, as is typical, improvements in deliveries and gross margins should be weighted to the second half of the year. Now, I'll turn it over to Larry, who will discuss our inventory, liquidity and mortgage operations, as well as a few other topics.

Thanks, Ara. Let me start with our efforts to reload our land position. Turning to slide 10, it shows the cumulative balance of new land parcels that we've controlled since January of 2009. So far, we have purchased or optioned approximately 16,900 lots. The land that we purchased or optioned met or exceeded our investment threshold of a 25% unlevered IRR based on the then current home selling prices and no change in sales pace for the next couple of years.

The intention with each and every one of these new land purchases is to get the community open for sale as soon as we can. On average, these wholly owned communities have 58 lots. Based on a current annual sales pace of about 21.3 per community, this equates to about a 2.7-year average selling life per community. Taking into account additional time for land development and permitting, we would expect on average to be out of most of these communities in less than four years. We continue to seek land opportunities in all of our markets and we've had success in finding new deals that made economic sense in most of our markets. However, the distribution of new land has been skewed to our operations in Texas and to a lesser extent in Washington, DC.

We remain true to our underwriting criteria and are not stretching for deals. This is evidenced by the fact that we walked away from 1,168 lots in 22 communities during the fourth quarter which includes about 350 legacy lots. As you can see on this slide, throughout fiscal 2011 if the original terms of an option deal no longer made economic sense and we were not able to renegotiate to more favorable terms, we were willing to walk away from those communities. During the fourth quarter, we optioned 1,700 new lots and walked away from 800 newly identified lots. The net result for the fourth quarter was that our total lots purchased or controlled since January of '09 increased by about 900 lots sequentially from the third quarter of 2011. In the fourth quarter, we purchased 420 newly identified lots in 74 communities. In addition, we purchased about 130 lots from legacy options. In total, we spent approximately $95 million of cash in the quarter to purchase approximately 550 lots and to develop land across the Company.

Turning to slide 11, you'll see our owned and optioned land position broken out by our publicly reported segments. Based on trailing 12-month deliveries, we own 4.8 years worth of land. However, if you exclude the 7,421 mothballed lots, we only own 2.8 years worth of land based on the low delivery rate of the past four quarters. Our owned and optioned lot positions decreased sequentially by 823 lots in the fourth quarter. We purchased approximately 550 lots during the fourth quarter, which was offset by 1,095 deliveries and 273 lots from land sales. On the optioned side of the equation, we walked away from 1,168 optioned lots, purchased about 550 optioned lots and signed new option contracts for additional 1,700 lots during the quarter. At the end of the fourth quarter, 70% of our optioned lots were newly identified lots, 26% of our owned lots were newly identified lots, and if you exclude mothballed lots, 43% of our own lots are newly acquired. When you combine our optioned and owned land together 41% of the total lots that we control today are newly identified lots or excluding mothballed lots, 56% are new.

Turning to slide 12, we show a breakdown of the 18,277 lots we owned at the end of the fourth quarter. Approximately 37% of these were 80% or more finished, 14% had 30% to 80% of the improvements already in place, and the remaining 49% have less than 30% of the improvement dollars spent. These percentages by category have remained relatively stable since the fourth quarter of 2010. While our primary focus is on purchasing improved lots, it's continuing to get more difficult in certain markets to find finished lots for sale at reasonable prices.

About 32% 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 continue to complete land development on sections of our legacy land as well. A year ago, we mentioned our desire to sell two parcels of land in New Jersey. One of those was located along the Hudson River at a site where we own four contiguous parcels. Although we were originally marketing one of the other contiguous sites that was valued at higher price, we ended up selling an adjacent site for $18 million in the fourth quarter. At this point, we're not marketing for sale any of the three remaining sites.

Now I'll turn to land-related charges which we can seen on slide 13. We booked $49.3 million of land impairments in 19 communities during the fourth quarter, $30 million, or 61% of those charges were in just three communities in New Jersey. There was also a community in California that accounted for most of the charges in the West. Two of these three communities in New Jersey were, where we triggered impairments was caused by us lowering our net selling prices to keep our sales pace on budget. And the third was related to the land sale. Because our aggregate investment in New Jersey is greater than our other markets and our individual community investments in New Jersey are also higher than our Company-wide average, downward pricing pressure in New Jersey will typically result in higher dollar amount of impairments. Additionally, during the third quarter, our walkaway charges were $10.6 million, which were spread across 22 communities throughout our markets, $7.8 million or 74% of these charges were associated with five communities in New Jersey.

Turning to slide 14, it shows the $39 billion of cumulative land-related charges that the public homebuilders have taken since the beginning of 2006. At $2.7 billion, we've taken our fair share of land charges but relative to our size our charges seem to be in line with the other builders. Our investment in land option deposits were $21.4 million at October 31, 2011, with $19.7 million in cash deposits and the other $1.7 million of deposits being held by letters of credit. Additionally, we have another $10.6 million invested in pre-development expenses.

Turning to slide 15, we show our mothballed lots broken out by geographic segment. In total, we have 7,421 mothballed lots within 59 communities that were mothballed as of October 31, and on this slide we break those lots out by geographic segment. The book value at the end of the fourth quarter for these remaining mothballed lots was $151 million, net of an impairment balance of $499 million. We are carrying these mothballed lots at 23% of their original value. Looking at all of our consolidated communities in the aggregate, including mothballed communities, we have an inventory book value of $968 million net of $787.2 million of impairments which were recorded on 150 of our communities. Of the properties that have been impaired, we're carrying them at 25% of their pre-impaired value.

Now turning to slide 16, primarily due to the increased community count, on a sequential and year over year basis the number of started unsold homes excluding models and unconsolidated joint ventures increased. We ended the fourth quarter with 811 started and unsold homes. This translates to 4.2 started and unsold homes per active selling community which is lower than our long-term average of about 4.8 unsold homes per community. Another area of discussion for the quarter is related to our current and deferred tax asset valuation allowance. At the end of the fourth quarter, the valuation allowance in the aggregate was $899 million. We view this as a very significant asset not currently reflected on our balance sheet and have taken steps to protect it. We expect to be able to reverse this allowance after we generate consecutive years of solid profitability and can continue to project solid profitability. When the reversal does occur, we expect the remaining allowance to be added back to our [shareholders] equity, further strengthening our balance sheet.

Today we could issue more than 125 million additional shares of common stock for cash without limiting our ability to utilize our NOLs. This has not changed from what we reported last quarter. We ended the fourth quarter with a total shareholders deficit of $497 million. If you add back the total valuation allowance, as we've done on slide 17, our total shareholders equity would be $402 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 from incurrence and we expect to utilize those tax loss carry forwards as we generate profits in the future. For the first $1.9 billion of pretax profits we generate, we will not have to pay federal income taxes.

Now let me update you briefly on the mortgage markets and our mortgage finance operation. We believe the mortgage underwriting pendulum has swung too far to the side of caution. We find ourselves in a position where excessively strict underwriting criteria is preventing someone who would have received a loan in the days prior to the advent of sub prime and Alt-A from getting a mortgage loan today. We believe that the mortgage industry needs to go back to a rational and responsible lending environment where lenders are not afraid to give a loan to someone with compensating factors.

In October, the conforming loan limits for FHA, VA, Fannie and Freddie Mac were reduced. Just before Thanksgiving, conforming loan limits for FHA were reinstated to a maximum $729,750. FHA's reinstatement is helpful in making sure that potential buyers can qualify for mortgages. We would have liked to have seen higher loan limits reinstated for Fannie Mae and Freddie Mac as well but given the state of affairs in DC we're happy that at least FHA loan limits were raised.

Turning to slide 18, you can see here the credit quality of our mortgage customers continues to be strong with an average FICO score of 736. For all of fiscal 2011 our mortgage Company captured 77% of our non-cash home buying customers. Turning to slide 19, here we show a breakout of all the various loan types originated by our mortgage operations in all of fiscal 2011 compared to all of fiscal 2010. 47.2% of our originations were FHA/VA during fiscal 2011, only slightly less than the 49.3% we saw during all of fiscal 2010. Let me update you quickly about what's happening with our loan repurchase requests we're receiving from various banks. We continue to believe that the vast majority of repurchase requests that we've received are unjustified.

On slide 20, you'll see our payments from fiscal 2008 through fiscal 2011. In 2011, our repayments were only $1 million. During the fourth quarter, we received only two repurchase inquiries. This brought the quarterly average for fiscal 2011 to 10 repurchase inquiries, which was much less than 2010's quarterly average of about 25 inquiries. It is our policy to estimate and reserve 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 year, our reserve loan repurchases and make whole requests were $5 million which we belief is adequate for our exposure. To date, repurchase has not been a significant problem, but we will continue to monitor this issue closely. Our cancellation rates remain at normal levels. Our cancellation rate for the fourth quarter was 21%. This was lower than the 24% we reported for last year's fourth quarter. If you look back on a quarterly basis to the beginning of 2003, as we've done on slide number 21, the 21% number that we've reported for the fourth quarter is fairly typical.

Turning to slide 22, it shows our debt maturity schedule pro forma for the debt exchange and the debt repurchases that we've made in the open market through the end of October. Subsequent to the end of our fourth quarter, we announced the successful completion of our exchange offer. $142 million of unsecured debt that originally matured in 2014 and 2015 was exchanged to a new 5% secured note that matures in 2021. And $53 million of unsecured debt that originally matured in 2016 and 2017 was exchanged into a new 2% secured note that matures also in 2021.

During the fourth quarter, we repurchased $25.6 million of our bonds for $14 million in cash, and paid $1.1 million for accrued interest. After making these repurchases and paying $14.2 million of cash consideration and $3.3 million for accrued interest as a component of our exchange offer, we have approximately $157 million of capacity left to repurchase additional bonds. If you combine the exchange offer and the repurchases we've made we have reduced our annual interest costs by $11.6 million. We felt comfortable with our liquidity before the exchange, and we feel even better about it now that it's done. Today, we only have $53 million of debt that matures through the end of 2014, and $137 million of debt that matures between now and the end of 2015.

At the end of October, after having spent approximately $95 million in cash in the fourth quarter to purchase 550 lots, and on land development across the Company, we ended the year with $302 million of cash including $57.7 million of homebuilding restricted cash used to collateralize letters of credit. The amount of homebuilding restricted cash used to collateralize letters of credit has steadily declined from about $135 million at the end of fiscal 2009 to the current level of $57.7 million. Our focus will remain at keeping a minimum total cash balance, cash balance at quarter end within our range of $170 million to $245 million, with no single quarter falling below $170 million. We believe that we have adequate liquidity to reinvest in sufficient land to increase our community count and deliveries, as well as repay the debt that matures between now and the end of 2015.

Additionally, we recognize the need to repair our balance sheet. As the homebuilding market recovers and we return to solid profitability, we should be able to issue equity at higher prices than today, reduce leverage and refinance our 2016 and 2017 maturities. I'll turn it back to Ara for some brief closing comments.

Thanks, Larry. I just wanted to reiterate a few highlights from the quarter. For starters, the combination of the debt exchange offer and the open market purchases that we have made have given us additional runway in terms of debt maturities and have also lowered our annual interest expenses by about $11.6 million. Both are meaningful improvements from where we were at the end of the third quarter. While not yet positive, we had a solid quarter from a cash flow perspective, at negative $7.9 million in our fourth quarter after spending $95 million on land and land development. We are working hard to improve cash flow further.

Finally, for the first time since the slowdown began, we had a slight, granted slight, increase in the number of net contracts for the full year. Recently, our trend in year over year contract is showing even higher gains. This increase in net contracts, coupled with a 19% increase in backlog indicates that we are about to turn the corner on the delivery and revenue side of the equation. We are hopeful that our continued growth in community count, and soon revenues, combined with improving gross margins will lead us back to profitability. That concludes our prepared remarks, and we'll be now glad to open it up for questions.

The Company will now answer questions. (Operator Instructions) Your first question comes from the line of Michael Rehaut with JPMorgan. Please proceed.

Thanks, good morning, everyone.

Good morning.

Good morning.

Just a little bit more on the gross margins if possible. As you said, you're expecting as of, I believe, it was as mid-September, as of your last call, 16.8% and it came in at 15.5%. That was still slightly better than the third quarter, and you pointed the big difference was just increased incentives or lower pricing, but on a sequential basis were you expecting less incentives to drive the improvement? Because, obviously, on a, sequentially, you did a little bit better, which on the surface might imply steady incentives. So I was wondering if you could kind of go maybe go a little bit more granular and were there particular geographic regions that really drove the shortfall or, I guess, you've had issues in New Jersey. Anything -- a little more detail would be helpful.

Sure. Well, first, as typically the case, it's never one item. It was certainly primarily driven by increased incentives, and I'd say that was fairly uniform. I guess maybe a little bit more in northern California and New Jersey. A little bit in DC. We also had, and we didn't mention it specifically, but there certainly have been some appraisal issues throughout the industry and we felt that in the fourth quarter, and what makes that challenging is a lot of that really only comes to light at the closing table, and that's particularly true with VA mortgages which continue to be our biggest problem on the appraisal side.

And largely mix also contributes. So we were disappointed by it. We were expecting a little bit more of a sequential gain. We certainly hope we'll make up some ground a little later in this current fiscal year of 2012.

So, but if incentives were up, or worse than you were looking for, but were they actually worse than the third quarter? Because, again, your gross margins did improve a little bit sequentially?

Yes, I'd say they increased a bit from the third quarter in general. It's hard to be really specific because, as you know, nothing is quite uniform, but overall we had more incidences of incentives in the third quarter than, excuse me, in the fourth quarter than the third.

All right.

Having said that, it does feel a lot stronger in the last six weeks or so of sales, maybe, I'm not sure, frankly, what I could attribute that to. It's not as though the news is particularly better, but we're, well, we saw it in our sales, that we released our November sales. It feels a little more resilient than it was and we haven't quite felt the pricing pressures. Having said that, it's only a month or six weeks or so and it's not a particularly robust time in terms of the quantity of sales. Nonetheless, we're pleased by the current feeling.

Great. And then there's the second question on land spend. Given the cash position and, I guess, still a little bit above your targeted number, can you give us a sense of what you're looking for, for 2012, and what type of community growth that can support?

Yes, we're not really giving a projection on what we intend to spend. I think the governor to our ability to continue to tie up land is going to be cash. I think we've made that very clear over the last year or so on a quarterly basis and the story isn't changing this quarter.

If we see opportunities and markets that meet our underwriting criteria based on the then current home selling prices and the then current home selling paces over the next couple of years we'll take advantage of those opportunities provided it doesn't cause us to get below our cash target. But we think we're also going to be generating cash coming in from home sale revenues, so it's both of those things coming into play, Michael.

Yes, overall, we do expect, barring changes in conditions, barring approval delays, et cetera, we do expect to be able to increase our delivery count in 2012 with the new communities and still stay within our cash targets.

Thank you.

Your next question comes from the line from Dan Oppenheim with Credit Suisse. Please proceed.

Hi, this is actually Will on for Dan. We've seen some companies exit metro areas. How do you look at this in the trade off between needing additional volume to generate cash as the [recovery] materializes versus current profitability?

Well, it is something we discuss regularly. The issue is really efficiency and would we get more efficiency, a better percentage of SG&A and, therefore, bottom line by dropping a market or two. At the moment, we don't think so. It's something we always, are continually evaluating, but at the moment we think the footprint is the right one and gives us the best opportunity for buying new land.

Okay. Got it. Thank you. And then one more question on the land. How competitive is the market for land nowadays? Has it been getting easier or more difficult since the last conference call?

I'd say about the same.

Okay. Thank you.

Your next question comes from the line of David Goldberg with UBS. Please proceed.

Thanks, good morning, everybody.

Good morning.

Good morning.

My first question was actually about the comments about November and some of the pick up that we saw. If I just do the back-of-the-envelope math here, right, it's 314 sales, 325 sales, excuse me, in 214 communities which is about 1.5 sales per community. So just to make sure I kind of understand, when you say that things have pick up a little bit, is that a sequential comment or is that versus normal seasonal trends? And does that kind of include traffic picking up or is it quality of traffic, maybe the same traffic level but the quality is coming up a little bit?

Well, it's really compared to seasonal trends. If you go back to slide 4, you kind of get the feeling of the seasonality. If you look, first of all, last year to the yellow bars, you see a significant drop-off from the August, September, October period in yellow to November --

Yes.

And that's a more typical seasonal pattern. We certainly did have a drop-off in November, but it just wasn't as significant. So that gives us a little positive feeling about it.

I'll just say from our perspective, November is a time that historically sales slow down. As we approach Thanksgiving, things slow down. And this year, we've not seen as dramatic a slowdown as we have seen in recent prior years, so from our perspective it feels pretty good. And I'll just tell you that we're kind of ahead of our internal expectations, so that's really where we're coming from saying that the market feels a little bit better than we would have expected.

And just with that, there's no change in the quality of those buyers? They're all, you're not worried about their ability to qualify when they eventually come to close on the home? They're all pretty good credit quality and --

We're always concerned.

Sure, you know what I'm saying. But no more concerned than you would normally be in this environment?

Credit quality is the same as it was. Having said that, mortgage qualification, particularly on the lower end continues to be a challenge and it is something we'd hope the administration and capitol hill can pay a little attention to because we do think there are qualified buyers that are being denied with the stringent rules in today's market.

Got it. And then just, my follow-up question was on the actuarial charge, the $6.3 million increase in the construction defect reserve, did that relate to any kind of specific problem that you guys could identify or was it more just kind of higher charges over a period of time generally, or is it something that we might see continue to increase?

It's just our overall claims history. It's not related to Chinese drywall or any particular defect. It's just the overall kind of claim history and how an actuarial guy kind of analyzed it. As we said in our comments, the past several years, in fact, I can probably go back even more than several and say that we've not had to take any charges so our methodologies have worked fine. For whatever reason, we had a few more instances of claims not related to any particular defect that caused us to take roughly a $6 million additional construction defect reserve.

Just to emphasize that, it's not a particular vintage either, it's not like homes built in (inaudible) here --

No. No.

All right. Perfect. Thank you.

Okay.

Your next question comes from the line of Alan Ratner with Zelman & Associates. Please proceed.

Good morning, guys, thanks for taking my questions. Expanding on Mike's point on the gross margin a little bit. I guess what was probably even more concerning to us, rather than the absolute level, was the fact that you did give that guidance on the gross margin almost halfway through your quarter and thinking about your deliveries you, obviously, had about six weeks' deliveries already to go off of plus you had a pretty good backlog, which even if the appraisal issues you highlighted were pretty significant, I wouldn't expect to see that big of a miss there relative to what you would have been expecting in September.

So I guess from a bigger picture standpoint, maybe you can comment a little bit or give us a little bit more comfort around your real time information from the corporate standpoint in communicating with the local divisions because, obviously, you're managing to a pretty tight cash flow guidance here and the need for real time information is pretty important in terms of how allocate your land spend, so to see that big of a miss kind of almost opens up the possibility that there's a lack of information flow between divisions and corporate. So I was hoping you could help alleviate some of those concerns and maybe comment a bit on that?

Well, first just to put it into perspective in terms of the effect on cash flow, a 1.5% miss, and it was a little less than that, on roughly $300 million of revenues is about $4.5 million of cash flow. So relative to the overall scheme of things, it didn't have a significant impact on our cash flow projections. It was more affected by deliveries which were within the range. Nonetheless, as I said, we're not happy of the shrinkage at the end, and going into the quarter we felt a little more confident.

Just to answer your question more specifically in terms of the real time nature of our information, we are in the middle of a systems conversion. Most of our Company is now converted. We've got a few divisions left to go. But the majority is on our new system which gives us a little better guidance in terms of gross margins for our anticipated closings. Generally speaking we focus on a monthly update, so when we are a month into the quarter we would have been using data just before the quarter began. But we really were just disappointed by the next few months of closings in terms of what it took to get the last minute sales and some of the appraisal issues that resulted in lower closing proceeds.

And I, one other issue is, gross margins by community vary widely, so if mix changes just a little bit, the amount of margin that we get on average can change more substantially than you might think. So mix by itself can move the margin. If we're getting more deliveries from community A and less from community B, so to speak, can have an impact as well. So it's a combination of things. We're very comfortable with the quality of our data.

We're very comfortable that we have real insight into what we can expect to have happen. As Ara mentioned, we refresh our projections with each our divisions on a bottom-up basis every month. So we have good trend data as well.

Great. Thank you. That's helpful. I appreciate it. Thank you.

Okay.

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

Thanks. This is actually Rob Hansen on for Nishu. We wanted to ask about your JV holdings entity, the one that was the issuer of the new 2% and 5% notes, and I think at one point you held somewhere around $130 million of cash in that entity, so I just wanted to get kind of an idea of what assets are held in that entity now and how much cash you have in there?

I don't think it, I don't think we actually put it in place until the beginning of our first quarter of 2012, so I think your assumption would be that there's $130 million of cash, roughly, and $50 million of equity interest in joint ventures, which is exactly what we said when we were out marketing the notes.

Okay. And then, and then just overall, how do you plan on managing the liquidity in terms of an operating cash burn perspective and land spend between the JV holdings entity and then the main operating subsidiaries?

Yes, well, the first thing I'm going to say is we're going to carefully manage it. But the real thing is we're going to balance cash and make sure that we have sufficient cash in both of our kind of walled off secured groups to take care of all of their needs, and we can do that by investing more or less in the old secured group or more or less in the new secured group which impacts their cash balance and the other one's cash balance. And we're looking at those numbers and very comfortable that we'll do that.

Initially, there's probably more cash in the new secured group than we feel is needed and you can expect over time for us to make investments using that cash to buy new communities or land parcels that we'll build houses on in the near term. As though investments generate cash, we'll decide to invest more in the new secured group, but at the same time we'll make investments in the old secured group as well. But the eye will be to kind of balance the cash as the cash needs are projected.

Okay. Thank you.

Your next question comes from the line of Andrew Casella with Imperial. Please proceed.

Hi, thanks for taking the question. If you look at your SG&A (inaudible)

Unfortunately, you're breaking up. I don't know if you have on a cell, but you're breaking up.

Hi, can you hear me?

Yes.

Yes.

Hi, sorry. Regarding your SG&A, I guess, how do you guys think about initial costs reduction efforts? I know it's down pretty significantly from the peak, but is there any room for further cost reductions going forward?

Well, I think we mentioned, clearly, we think our SG&A costs will be lower during the subsequent quarters in '12 than they were in the fourth quarter because of the unusual charges. Overall, though, as you saw, head counts continue to reduce as we work on our organizational structure and processes to get as efficient as possible with the volume of transactions.

All right. Great. Thank you.

Your next question comes from the line of Lee Brading with Wells Fargo Securities. Please proceed.

Hi, guys. I know you don't want to give any guidance per se on the land spend. But I was wondering, see if there's another way to think about. This past quarter you noted that you generated free cash flow and essentially offset that with the land spend. You'd mentioned also cash is a governor. But should we look at potentially that free cash flow as a governor on the land spend or is that going to vary from quarter to quarter?

Well, again, it's a combination of making sure -- and certainly free cash flow flows into this -- making sure that, A, we're not going to spend on land unless we find opportunities that meet our strict underwriting criteria. Frankly, we would have loved to have gotten down closer to our $245 million top end of our range rather than be higher than that. But we didn't find the opportunity that allowed us to do it. So that's the first governor is do we find opportunities that meet our underwriting criteria. Second governor, obviously, is cash, which, cash balance and, obviously, cash flow on a quarterly basis plays closely into that. I mean, they're interrelated, they're not something you can separate.

Overall, they're very related. Obviously, we look at the cash balance as the key governor and try to project closings we've got coming up. Try project the land spend we'd like to do, and just balance those all the time to make sure we've always got plenty of liquidity excess.

Got you. Thanks. And just for perspective, you bought back about $15 million in bonds and you mentioned that you have, I think, $157 million in capacity to purchase more bonds. Just going forward, how are you evaluating that, and was that more of a one-time kind of anomaly, or do you expect to continue to evaluate that going quarter-to-quarter here?

Well, certainly wouldn't call it a one-time anomaly given our track record on what we've done in terms of buying back debt over the past four or five years and been pretty regular at it. So we periodically evaluate it, and we will, if we see opportunities that we think make sense to buy back debt given our liquidity position at the time and cash balance, et cetera, we may buy some in the future or we may choose not to. But it is something we constantly evaluate and I think we have a pretty good track record of doing it periodically.

(Operator Instructions) Your next question is a follow-up question from line of Michael Rehaut with JPMorgan. Please proceed.

Thanks. Just getting back to the gross margins for a moment. Did you, and apologies if I didn't hear this, describe the differential between newer communities and older communities in terms of the gross margin generation?

We didn't describe it, and we just don't break it out that way.

Okay. Well, I guess, it kind of leads into the second question, which is just looking at the absolute level of overall gross margins being, I think, at the lower end of the peer group here and just trying to get a sense of why that might be. I think kind of related to that, when you look at the option walkaways in terms of the lots, it looks like throughout the different quarters you're walking away from anywhere from 50% to 90% of the net additions. And I'm just curious about the walkaways, if those are primarily more newly purchased, stuff that's been signed up in the last couple of years, and, because it just seems like there's a lot of turnover there --

Sure. I can address that. First, most of our walkaways occur during the investigation period before there's any dollars at risk. So a contract is signed, we report that immediately, but we typically have 45 days or so to investigate everything having to do with the property. Everything from entitlements to improvement costs, to fees, et cetera. And oftentimes during the investigation we find something that causes us not to proceed. That's where the overwhelming majority of the walkaways occur.

Regarding your first question on gross margins. First, it is important that you compare apples and apples cost categories. In our case, and this is slightly different from peer to peer, we deduct commissions, both internal and external commissions, as part of our cost of goods sold and, therefore, it lowers our gross margin. So when you compare to peers you have to check to see what their practice is.

That being said, we are disappointed in the gross margin. It's not quite as bad as it might appear before you do that adjustment, but we're certainly hoping that we're going to show better improvement. We showed sequential improvement for the last three quarters, but we hope we're going to show more sequential improvement during fiscal '12.

Okay. Thank you.

Okay.

Your next question comes from the line of Howard Weinberg with UBS.

Hi, guys.

Hi.

I was wondering if you could talk about land holdings? You guys provided great color on the amount of land you have by region. As we know, land spend is pretty local and where you sell the homes, making sure you have the homes in the right places. For your land spending that you're currently doing right now, how much of that land spend is for, to support 2012 and 2013 growth versus longer term?

We are definitely focused on shorter-term land positions. We don't think it's appropriate given the amount of capital we have to make investments in longer-term positions. We certainly have, and by the way, our average targeted absorption base on our purchases is about a two-year hold or holding period. It's about two years on average from when we start sales and deliveries. We'd like it to be even shorter.

We just have to balance that with the opportunities that are out in the marketplace. We certainly do have some older land holdings that are longer horizons, time horizons, but our focus today is shorter term and we think that's a critical component being able to allow us to grow with the capital we have in place. We need the higher inventory turnover and it certainly is a focus.

Great. Thanks. And then just a second question, did you make any bond purchases subsequent to quarter end?

We've not publicly disclosed what we've done since quarter end.

And we never do.

Okay. Thank you, guys.

Okay.

Your next follow-up question comes from the line of Andrew Casella with Imperial. Please proceed.

Hi. Thanks. Just going back to slide 12 where you break out your own lots as a percentage of development cost spend, if you're investing in, I guess, shorter-term projects, why haven't we seen, I guess, the 80% above developed bucket kind of increase versus from prior quarters?

Well, we still, even though they're shorter term, some of the purchases still require some land development.

The deliveries are coming out of that bucket. So that bucket gets depleted every quarter by the number of deliveries.

Yes. Having said that, overall, it's been relatively stable since the end of the prior year.

Okay. So I guess your acquisitions are the short-term projects but not necessarily fully developed where they would be classified in that bucket right away?

That's exactly right.

Okay. Great. Thanks.

Okay.

And at this time, I'd like to turn the presentation back over to Mr. Hovnanian for closing remarks.

Great. Well, thank you very much. We, as I said, we're pleased by a variety of aspects of our quarter. Certainly, we're not pleased with the gross margin. We hope to be making improvements on that front as well and we think the combination of some projected, or I should say, hoped for improvements in our gross margin with the projected increase in deliveries from the new communities should help our overall performance, and we'll look forward to reporting that in subsequent quarters. Thank you.

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