Hovnanian Enterprises Inc (HOVNP) 2012 Q1 法說會逐字稿

Good morning, and thank you for joining us today for Hovnanian Enterprises fiscal 2012 first quarter earnings conference call. An archive of the webcast will be available after the completion of the call and run for 12 months. This conference is being recorded for rebroadcast and all participants are currently in a listen-only mode. Management will make some opening remarks about the 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 of the Company's website at www.KHOV.com. Those listeners who would like to follow along should log onto the website at this time. Before we begin I would like to turn the call over to Jeff O'Keefe, Vice President Investor Relations. Jeff, please go ahead.

Thank you. Before I turn the call over to Ara I would like to read the following about forward-looking statements. All statements 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 economic and industry and business conditions and impacts of the sustained home building 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 home building, sales and customer financing processes. Tax laws and the environment, fluctuations in interest rates and availability of mortgage financing, shortages in and price fluctuations of raw materials and labor, the availability and cost of suitable land and improved lots, levels 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 agreements governing the Company's outstanding indebtedness. The Company's sources of liquidity, changes in credit ratings, 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, terrorists acts and other acts of war and other factors described in detail on the Company's annual report on the Form 10-K for the year ended October 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, our Chairman, President and Chief Executive Officer. Ara, please go ahead.

Good morning, and thank you for participating in today's call to review the results of our first quarter ended January 31, 2012. 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 of Investor Relations. On slide 3 you can see a brief summary of our first quarter results and comparisons to the prior year's first quarter. As you can see, our net contract, community count, net contracts per community, deliveries, backlog and total revenues all increased year-over-year in the first quarter of 2012. This is the first quarterly year-over-year increase in total revenues since the third quarter of 2006. After 21 straight quarters of decline, it feels good to reverse this trend. We are hopeful that our positive sales results will continue and drive additional revenue growth going forward. As we have said previously, our path to returning to profitability is very related on our ability to grow the top line.

Our net loss was less this quarter than it was in the year-ago period. From a macroeconomic perspective, things definitely feel better right now. There are more positive trends than negative trends grabbing the headlines. Mortgage rates remain low. The energy sector is booming. There are fewer discussions about fears of a double dip recession. Consumer confidence is improving and there is pent-up demand on the sidelines right now. The key to unlocking this pent-up demand is job growth and there is some evidence of a slight improvement in the labor market which bodes well for our industry, if it continues. With this economic backdrop, our net contracts have improved significantly.

If you turn to slide 4 you see that on an absolute basis, net contracts increased 27% in the first quarter to 1,079 homes, and the second quarter is off to an even better start. We signed 528 net contracts in February of '12, a 38% increase when compared to 384 net contracts in February a year ago, with the same number of weekends. In addition to our community count increase year-over-year, we also saw solid increases in net contract per community. Slide 5 shows monthly net contract per community for the past year. Each month in the first quarter posted similar year-over-year increases in net contract per community. 8 of the past 12 months have shown year-over-year increases in net contracts per community.

Slide 6 shows a 17% increase for the first quarter in net contracts per community, followed by February which registered an even stronger gain of 26%. Let me emphasize that there were no coordinated national sales promotions that led to this increased net contracts during the month of February. Many of our divisions did their typical seasonal local marketing campaigns, but these were not campaigns that reduced the net selling price or adversely affected our gross margins in our February contracts. During each of the past four months our sales results have exceeded our internal expectations. While we are pleased with how the spring selling season has kicked off, it's still too early to say how this is going to play out. We'll be watching sales closely as I know all in the industry will.

Our net sales per community increased 19% for the first four months of 2012. If we were to see that same increase for the entire year, that would put us on the pace of 25.3 contracts per community and you see that in the red bar on slide 7. This doesn't exactly catapult us to our historical normalized average pace of 45 contracts per year, which you see on the left hand side of this slide. However, 25.3 contracts per community per year would be the best sales pace we've experienced since 2006. During the first quarter, we were able to both increase our community count by 9% year-over-year, as you see on slide 8, and increase our sales pace per community by 17%. These are the type of results we need in order to continue to achieve our top line growth and return to profitability.

As we close out of legacy communities and open new communities, our mix of newly identified actively selling communities to total communities continues to rise. With the increased investment in communities in backlog it's not surprising that we ended the quarter with more capital deployed. Nonetheless, our cash position of $201.7 million including cash used collateralize letters of credit is around the mid-point of our cash target of $170 million to $245 million. Our future investment decisions will be made within the confines of this cash target range. Given the strong net contract trends and the growth in backlog, we expect to see our revenue increase in the future quarters, which should increase our ability to generate additional cash flow.

Turn now to slide 9 which shows our annual gross margin on the left hand side of the slide and quarterly gross margins on the right hand side of the slide. While our first quarter was down slightly compared to the same quarter last year, you can see on the right hand side that our quarterly gross margin has slowly moved up over the last three quarters including a 100 basis point sequential improvement from the fourth quarter of 2011, compared to the first quarter of 2012. Home prices remained stable throughout the first quarter and continued to hold in February. During the first quarter, the average price of our net contracts increased 3% including unconsolidated joint ventures and decreased 1% excluding unconsolidated joint ventures. In both cases, the price movements are related to product and geographic mix, rather than our ability to increase prices or our need to offer incentives. At the end of the first quarter, 76% of our wholly owned communities that were opened for sale were newly identified communities that we controlled after January of '09.

58% of our consolidated deliveries in the first quarter were from newly identified land, which is higher than the 44% of deliveries in fiscal '11 from new land. Given the current number of new communities, we would expect the mix for all of 2012 to be higher than it was in 2011. Since many of these newly identified communities were recently opened, they will not begin to deliver homes until 2012, later in 2012. As long as we see no adverse changes in the market conditions, particularly with respect to home prices, this mix should result in our gross margins increasing during 2012. During the first quarter of 2012, there were $16.9 million of impairment reversals related to home deliveries compared to $25.5 million of impairment reversals in the first quarter of 2011. While a gross margin of 16.5% is much improved over the last three quarters of fiscal '11, it is still well below normalized levels which were in the 20% range as shown on the left hand side of this slide.

On the right hand side of slide 10, the bar shows that the absolute dollar of total SG&A in the first quarter of 2012 declined 16.4% compared to the first quarter of last year. 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 this slide, it is improved from 21.9% during last year's first quarter to 17.1% during the first quarter this year. These gains are more meaningful because the first quarter is typically the weakest quarter with respect to operating leverage. Additionally, we expect further improvements in total SG&A as a percentage of total revenues during fiscal 2012. It's noteworthy that we were able to deliver 13% more homes during this year's first quarter with 4% fewer associates than we did in last year's first quarter. This further validates our strategy of gaining efficiency and top line growth. While SG&A has come down in both absolute terms and on a percentage basis, it's still much higher than our historical norm of 10% or 11%. These higher percentages remain despite steep reductions in our staffing levels. As our revenues increase we expect to leverage these SG&A expenses so that we gradually bring our SG&A ratio down to a normalized level. 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 11, 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 17,000 lots. The land that we purchased or optioned met or exceeded our investment threshold of a 25% unleverred IRR based on the then current home selling prices and no change in sales pace for the next couple of 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.

As you can see from slide 12, after seeing a steady flow of gross new land and lot purchase agreements throughout fiscal 2011, during the first quarter of fiscal 2012 we did experience a fall-off of new land and lot purchases. The figures aren't as dramatic on a net basis where we contracted for 200 home sites in both the first and second quarters of last year, compared to 100 home sites this year. However, we have noticed a very recent pick-up in new land and lot activity and are optimistic that we would return to net land and lot acquisition levels similar to what we experienced in 2011. During the first quarter, we optioned 450 new lots and walked away from about 350 newly identified lots. The net results for the first quarter was that our total lots purchased or controlled since January of 2009 increased by about 100 lots sequentially, from the fourth quarter of 2011. During the first quarter, we purchased 600 newly identified lots in 81 communities. In addition, we purchased about 90 lots from legacy options. In total, we spent approximately $74.1 million of cash in the quarter to purchase approximately 690 lots, and to develop land across the Company.

Turning to slide 13. You'll see our owned and optioned land position broken out by our publicly reported segments. Based on trailing 12 month deliveries we own 4.6 years worth of land. However, if you exclude the 7,094 mothballed lots, we own only 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 about 1,200 lots in the first quarter. We purchased approximately 690 lots during the first quarter, which was offset by 889 deliveries, by 100 lots from land sales and by a regulatory approval change that reduced the number of lots in one community by 140 home sites.

On the option side of the equation we walked away from 358 optioned lots, purchased about 690 optioned lots, signed new option contracts for an additional 470 lots during the quarter and reduced lots in one community by about 200 lots, due to site planning changes to optimize land values and obtain entitlements. We continue to be disciplined in only taking down option contracts that make economic sense. At the end of the first quarter, 70% of our optioned lots were newly identified lots. 27% of our owned lots were newly identified lots. And if you exclude mothballed lots, 44% of our owned 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. Excluding mothballed lots, 57% of our total lots are newly identified lots.

Turning to slide 14. We show a breakdown of the 17,866 lots we owned at the end of the first quarter. Approximately 39% of these were 80% or more finished, 13% had 30% to 80% of the improvements already in place and the remaining 48% 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 most of our markets to find finished lots for sale at reasonable prices. Therefore, more of our land acquisitions require that we complete land development. About 27% of the remaining newly identified lots we 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.

Now I'll turn to our land related charges which can be seen on slide 15. We booked $3.1 million of land impairments in 11 communities during the first quarter. Additionally, during the first quarter, our walk-away charges were only $200,000. Which were spread across seven communities throughout our markets. Our investment in land option deposits were $25.6 million at January 31, 2012, with $24.4 million in cash deposits and the other $1.2 million of deposits being held by letters of credit. Additionally, we have another $5.1 million invested in predevelopment expenses.

Turning to slide number 16. We show our mothballed lots broken out by geographic segment. In total we have 7,094 mothballed lots within 57 communities that were mothballed as of January 31, 2012. The book value at the end of the first quarter for these remaining mothballed lots was $138 million, net of an impairment balance of $494 million. We are carrying these mothballed lots at 22% of the original value. Eventually as the market recovery that we're beginning to feel gains some momentum we will be able to justify returning these mothballed lots into production. This would provide us with a rich supply of lots at a low cost basis. Looking at all of our consolidated communities in the aggregate including mothballed communities we have an inventory book value of $979 million net of $768.5 million of impairments which were recorded on 135 of our communities. Of the properties that have been impaired we're carrying them at 25% of their preimpaired value.

Now turning to slide 17. The number of started unsold homes excluding models and unconsolidated joint ventures decreased sequentially. We ended the first quarter with 779 started unsold homes. This translates to four started 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. The end of the first quarter the valuation allowance in the aggregate was $905.2 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 going forward. 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 first quarter with total shareholders deficit of $514 million. If you add back the total valuation allowance as we've done on slide 18, our total shareholders equity would be $391 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 our mortgage operations. Turning to slide 19. You can see here the credit quality of our mortgage customers continues to be strong with an average FICO score of 732. For the first quarter of fiscal 2012, our mortgage Company captured 79% of our non-cash home buying customers. Turning to slide 20. Here we show a breakout of all the various loan types originated by our mortgage operations in the first quarter of fiscal 2012 compared to all of fiscal 2011. 45.8% of our originations were FHA/VA during the first quarter of fiscal 2012, only slightly less than the 47.2% we saw during all of fiscal 2011. Regarding repurchase requests from various banks we continue to believe that the vast majority of requests that we've received are unjustified.

On slide 21 you'll see our payments from fiscal 2008 through the first quarter of fiscal 2012. In the first quarter of 2012, our repayments were only $0.4 million on two loans. During the first quarter of 2012 we received 13 repurchase inquiries which was slightly higher than the quarterly average of 10 repurchase inquiries for all of fiscal 2011. 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 first quarter our reserves for loan repurchases and make whole requests were $6.4 million which we believe is adequate for our exposure. To date mortgage repurchases have not been a significant problem but we will continue to monitor this issue closely.

Our cancellation rates remained at normal levels. Our cancellation rate for the first quarter was 21%. This was slightly lower than the 22% we reported for last year's first quarter. And identical to the 21% we reported for the fourth quarter of 2011. If you look back on a quarterly basis to the 2003, 2004 periods as we've done on slide 22, the 21% number that we've been -- that we've reported for the first quarter is fairly typical cancellation rate for us.

Turning to slide 23. It shows our debt maturity schedule through the end of January 2021 which takes into account the successful exchange offer and debt repurchase we completed early in the first quarter. As we reported in our 10-K we repurchased $44 million of our bonds for $20.5 million in cash including accrued interest during the first quarter. After making these repurchases and paying $14.2 million of cash consideration as a component of our exchange offer, we have approximately $138 million of restricted payment capacity left to repurchase additional bonds. We felt comfortable with our liquidity before the exchange and we feel even better about it now that it's completed. Today we have only $52 million of debt that matures before 2015 and additional $84 million of debt that matures before 2016.

The end of fiscal 2012, the first quarter after having spent approximately $74.1 million in cash during the quarter to purchase about 690 lots and on land development across the Company and spending $42.6 million to complete both the debt exchange offer and debt repurchases. We ended the quarter with $201.7 million of cash including $35.7 million of cash in home building restricted cash used to collateralize letters of credit. The amount of home building 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 $35.7 million. This reduction in restricted cash has obviously added to the productivity of our remaining cash balance. However, we do not expect restricted cash to decline as significantly in the future as it has declined over the past couple of years.

Our focus will remain at keeping a minimum total cash balance at quarter end within the range of $170 million to $245 million, with no single quarter falling below $170 million. However, due to the $22 million sequential decrease in restricted cash utilized for letters of credit we are much more comfortable at the lower end of that range which we've provided previously. We are just about at the midpoint of that range today as of the end of the first quarter and 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. Purchasing smaller land parcels resulting in faster inventory turns has been part of the formula that makes that achievable.

During the last week of February we had several small 3a9 exchanges of discounted bonds for Hovnanian Equity. These transactions were completed within a few percent of the bid side of market pricing on the bonds and the stock was priced at the weighted average daily price on the day that we agreed to terms for each transaction. In the aggregate we exchanged 1.2 million HOV shares for $4.8 million in the aggregate of our 2017, [8.625%] notes and our tangible equity unit amortizing notes. While our stock price has improved over the last couple of months and we are more willing to consider completing a few 3a9 exchanges, we are only considering opportunities at or near market prices. We continue to believe that as the home building market recovers and we can 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 a few closing comments.

Thanks, Larry. I know that many investors are concerned with our cash position. We have said for over a year now that we wanted to be fully invested in land and for the first time we've gotten to the point where we ended a quarter with our cash in our cash target range. These land investments resulted in our ability to increase community counts, deliveries and contracts during our first quarter, and assuming no change in market conditions, they set us up for additional growth this year. Keep in mind that the first quarter is typically our weakest in terms of cash flow because of the low seasonal deliveries. This year's first quarter was no exception. However, we are confident that deliveries and operating cash flow should improve in our later quarters, barring a significant change in the current market conditions.

Operating within the confines of our cash target range, we feel comfortable that we can continue to reinvest in land and grow our revenues as well as repay the debt that matures between now and the end of 2015. That gives us time to refinance the 2016 debt and issue additional equity in a better market as Larry mentioned. Our comfort is partially based on the fact that we are investing in new communities that generally have faster inventory turns. These new communities are now starting to return the cash initially invested as well as a profit and at the same time we continue to liquidate our slower turning legacy assets. We recognize that some will extrapolate the first quarter's cash flow and be concerned about our liquidity. Once again, our internal models show improved cash flow in subsequent quarters, particularly given our recent contract pace and deliveries from new communities that had consumed cash in the previous quarters. Our outlook has given us the confidence to continue to invest in new land purchases to position ourselves for growth. Further, we had sufficient confidence to spend part of our cash on repurchasing debt at a discount over the last quarter as we outlined. If the market changes and deteriorates further then there are a number of levers that we can pull to quickly increase our cash if we need to.

If you turn to the next slide, you see some of the options that we could have. We could delay or reduce land purchases or take-downs, we could sell excess land, we could enter into model sale leasebacks and we have many models out there. We could enter into joint ventures, both for new transactions and for some of our existing land deals. We could enter into land banking relationships on again, both new land transactions and some existing land. We could issue equity for cash or issue equity for debt much like the 3a9 exchanges that Larry mentioned that we executed last month. We could limit our started unsold homes or we could reduce land development spending. This is not a complete list but it's meant to give you an idea of some of the potential alternatives if we face the need to more quickly raise our cash position. Our recent upturn in contract pace has definitely given us further confidence that we are pursuing the correct strategy for our shareholders. We look forward to reporting further growth and progress in the coming quarters as well as making investors feel even more comfortable with our liquidity. That concludes our prepared remarks. And we'll now be happy to open up the floor for questions.

The Company will now answer questions. So that everyone has an opportunity to ask questions, participants will be limited to one question and a follow-up after which they will have to get back into the queue to ask another question. At this time we will open the call to questions.

(Operator Instructions)

Alan Ratner, Zellman & Associates.

Good morning, guys. Nice performance on the margin and the orders and Ara, and I guess Larry as well, I appreciate the kind of walking through the cash targets and some of the levers you can pull in a situation where maybe the market doesn't accelerate like we're seeing some signs that it's doing. But I guess I was hoping to ask the question kind of the other way and that's looking at your February orders and the 38% increase there.

Thinking about the cash that needs to go out the door to build up that backlog and assuming maybe the market is actually even stronger than the signs we've been seeing over the past couple of months. What would it get to the point in terms of order growth where you would maybe have to bring that cash position below the low end of that target, maybe on a short-term basis, but in order to build up that backlog? Or would you manage that target so strictly, where even if you're pretty sure that cash is going to be coming back in the door a quarter or two down the road you would still pull those levers to remain within that target?

Well, as you know, the increased orders work both sides in terms of cash generation. On one side it takes a little more cash to produce the width. On the other side, to the extent we're delivering homes on land that we own, it generates some significant cash flow and those two really work to counter each other. At this point, we're comfortable that we're going to stay within the targets even with the kind of pickup that we've seen.

Okay. I appreciate that. And then Larry, would you be able to provide the split on your unrestricted cash balance between I believe you have some cash within the unrestricted subsidiary that's back in the secured notes versus what's at the I guess the parent or at least the KHOV subsidiary.

That will be in the 10-Q. I think we have --

The cash amount that's in the, what we'll call the new secured group is $81million.

And how freely can you move the cash back and forth within those two buckets?

Cash is fungible. So obviously, as we're buying new land parcels we make a conscious decision whether we're going to buy the land in the new secured group or the old secured group. If we have more cash in one or the other we'll make that land decision to purchase it in the one that has more cash than we think that it needs to have. There's other levers that we pull, as well. But we're very comfortable that we can adequately manage the cash between the two secured groups.

Okay. Thanks a lot.

Andrew Cassella, Imperial Capital.

Hi. Thanks for taking my question. Larry, regarding the slide on your potential liquidity levers, can you quantify, I guess, the opportunities that exist in selling excess land, and model sale leasebacks, and kind of what investors could look forward to if you were to have to pull those levers, and what kind of cash that could generate?

We're really not making a public projection on how much we might do of each one of those particular categories. As Ara said, we have quite a number of models on the books. I think you can actually see that on one of the slides to give you a little bit of perspective of the number of models that we currently own. So, someone might be able to look that up as we go, since it's a publicly disclosed number.

217.

217 models as an example, but in terms of land sales and other things, whether we do land banking activities, et cetera, we can do that both on owned land, as well as new land. Those are not necessarily levers that we anticipate pulling. It's just it's kind of safety valves that are available to us if the market deteriorates, and just something we can look at, redeploying cash if we can get better returns doing something else with it.

And is there a priority as far as which one of these you would rather do, versus another option?

We would look at the opportunities at the time that we decided to do it and whatever we thought was the best opportunity at that time we would pursue first.

Okay. Great.

Clearly, we'd rather not defer land purchases since we like that for growth. So, some of the other alternatives would certainly be more attractive. Things like model leasebacks or joint ventures can be -- or land banking opportunities could be better sources of capital for us. We would prefer not to issue much equity at these prices because we feel pretty confident about the direction we're going in and would rather issue more equity at higher prices.

So, if forced to prioritize, I guess I'd say in that order, kind of land banking, model sales, et cetera, before some of the other choices. I will mention we have had a few model sale leasebacks, not many. But there have been small investors that are happy to basically earn a return equivalent to their mortgage payments and carrying costs and those are good opportunities for us, a fairly inexpensive source of capital right now.

I haven't added up the numbers, but Jeff mentioned we have about 217 models out there, I guess that we still own. So if you multiply that by our average price, somewhere around $300,000, I guess that's about $66 million on our average price. Our models tend to be slightly above our average price. So, that can be certainly can be a source of capital.

Great. Thanks. Just one quick follow-up. Larry, as far as the balance in the new secured group on the cash side, can you give us insight as to what constitutes excess cash in one box versus the other? Can we infer that the unrestricted group is now at $80 million, down from $120 million sequentially. Is that, I guess can we read into that number at all?

Not really. What we do is we look at the cash needs. Depends on what kind of investments we make in each secured group. For example, if we bought a raw piece of dirt in a new secured group and we were going to have to spend land development dollars on it in nearby quarters we would be able to project out what those cash needs were.

So, it just depends on what investments are in there and we understand what the cash needs are in each of the individual secured groups, and we're going to make sure that we have adequate cash in each one. As another example, there may come a time that we have only kind of producing communities in one group or the other, and they're going to be generating cash so we're comfortable with the cash balance being a lower number.

So, we manage the Company as one combined entity. We understand we have to wall off the two secured groups, and we've properly done so and we're going to manage the Company as a single entity, and that cash number may change from one quarter to the next as to how much is in each of the different secured groups.

Okay. Great. Thanks. I'll get back in the queue.

Nishu Sood, Deutsche Bank.

Thanks. It's actually Rob Hanson on for Nishu Have you guys look at if these current positive trends continue how much cash you would have to spend on land development this year, and I'm just kind of asking because you mentioned that you're going to have to do a little more land development but you also want to increase turns and buy these smaller plots of land and turn them into cash, as well. What's going to be more impactful this year for you?

We factored in the land development spend in our projections. Basically, in the boom days you think of a parcel of 150 lots and develop 100 at a time. Today, we're much more resourceful with our capital and we will develop lots in very small increments and basically turn that asset, even if it's an undeveloped land, much more quickly than we had in the past. So, right now it's factored in.

If we were to find opportunities that were large parcels that needed a lot more development dollars up front, for those we would and we have sought joint venture partners as long as the returns are sufficient. Having said that, we haven't seen as many of the large opportunities as the small opportunities and since we've got the cash position we've been doing those wholly owned in the recent periods. But we would be happy to bring some to our partners, and we've got some good experiences with them, if we found the right opportunities.

Okay. And then just in terms of the February sales data, how did it look excluding JVs and were there any parts of the country that significantly outperformed?

Have that at your fingertips, Jeff, or not?

Hold on one moment.

While Jeff is getting the without JVs and with JVs number, I assume that's what he's digging up right now I'll just comment that the pickup was pretty broad-based in terms of product type and geographies. If I had to pick on two markets that haven't quite joined in the resurgence as much as some of the others, I might say Tampa and parts of New Jersey. Other than that, we've seen a pretty broad-based pickup by geographies and product types.

Without JVs, we're up about 30% in the month of February.

All right. Thank you, guys. I appreciate it.

Michael Rehaut, JPMorgan.

Hi, this is actually Jason Marcus in for Mike. So, my first question is, regarding the sequential gross margin improvement, was wondering if you could give us a little bit more detail in terms of what the key drivers were there. And then also I think you mentioned that gross margin should improve year-over-year. I was just wondering if the level that it's at now do you think is sustainable or you think that it could potentially improve from here?

I guess I'll answer the second question first. I think we said pretty clearly, we expect gross margins to improve in 2012, so it wouldn't surprise me at all that it's going to improve above the level that we just reported. Larry, you want to take the first part of the question?

As always, it's a mix of everything, a mix of which communities are selling, a mix of the newer communities are helping a little bit, so it's really the overall mix. In general, we're weeding through some of our older legacy communities, we're weeding through some of the lower profit communities and feeling some strength in the marketplace. We also just haven't seen the pricing pressure that existed in prior quarters.

There are always anecdotal situations where you have to tweak concessions and that affects margins but we've also been having some anecdotal situations where we're raising prices. Not enough to say clearer trends but we're definitely seeing that a little more and that is clearly helping the overall gross margin situation.

Okay. And then the next question is just regarding new communities, was wondering if you could give us any color on how many net new communities you expect to add over the next several quarters.

That's just not something that we make public projections on. We kind of directionally tell you what we're expecting to have occur. It's a very difficult number to project because if we're selling faster than we had expected that will lead to less community count. It's just -- might have delays on openings. Just a very difficult number to project.

Okay. Thanks.

Megan McGrath, MKM Partners.

Good morning. Thanks so much. I guess first of all on the category of no good deed goes unpunished, I'm going to ask you about your liquidity levers again. Really just wanted to get manage expectations a little bit here about how you're forecasting, and when you talk about a deterioration in the market and when you could use these, can you give us a sense of what that really means.

Do we need to keep the pace? Do we need to just see growth, and you think that you can manage it? Does that mean that we start to see a year-over-year decline? When you think about a deterioration, what exactly does that mean?

I guess what we've very, very consistently said and reiterated time and time again is every time we run our own model, we're kind of assuming today's absorption pace, today's home prices and that things don't get better, they don't get worse. We run upsides and downsides but when we talk about our model publicly it's the model that kind of just assumes market conditions remain just as they are forever.

So, when we talk about deterioration, what we're saying is is the market materially gets worse than it is today i.e. the last time we kind of ran the model. That's kind of what we mean by -- it isn't just -- it's a tiny hiccup. It's something materially worsens.

And to be clear, we haven't run our model assuming February is what happens in every month.

Right.

Or even the first quarter. I'd say our models are run more conservatively than what we've experienced recently and we have -- we believe sufficient cash flow to buy land and hold our cash target in that scenario. It would have to decrease, home sales and prices would have to decrease from that position which was, again, more conservative than what we've just announced for the recent quarter and the month of February.

Okay. That's what I was getting at. Thank you. That's really helpful. And then could you drill down a little bit more if you could on your land base, you talked about buying new land that requires development.

This land that you're seeing, is it raw? Is it partially developed? How does that compare to, for example, your mothballed lots? Are your mothballed lots mostly undeveloped, and so when you talk about taking those out, and the low cost base of them, how much money are you going to have to put into those lots when you eventually bring them to market?

Mothballed lots first of all have both developed and undeveloped. We probably haven't looked at the exact breakdown but I think we have more undeveloped in a couple of parcels. But, we certainly have quite a few that are developed. On the ones that are undeveloped, there are a couple that would require more significant cash flow, cash investment to develop them.

Many of them, though, are able to be broken down into much smaller increments. So, I think we can get a reasonable blend between the ones that are already developed, some that can be broken down into very small land development increments and those that might require more significant investment, and perhaps for those, when they're ready, we might seek out a partner. But we've really got quite a mix.

In terms of what kind of undeveloped we're seeing, it really runs the gamut. We're -- immediately after this meeting we actually have a small land committee meeting, I'll give you an example of one. It's for a property in Chicago. It's a quasi in-fill, it's kind of on the beginning edge of the suburban fringe. And the streets on the outside are improved and land development that's necessary has to do more with drainage and sidewalk improvements, et cetera, not bringing the main utility there. In some cases -- and in that case, that's an older neighborhood and this was one of those overlooked parcels and we get those and they tend to have less development.

In other cases, we pick up where a land developer stopped and perhaps the bank got the property back. And they might have had the sewer and water lines done and stopped there. So, we have to go, complete perhaps the water and sewer or maybe just test it and then put in the final grading, do the roads, curbs, sidewalks, et cetera. And the third category is where we don't have anything there and we've got to do everything, A to Z.

We really have situations in all three categories all the time and that blend is pretty much -- we've kind of assumed the same blend of opportunities that we've been contracting over the last few quarters. We've assumed that's the same blend over the next few quarters. And that's how we calculate our capital needs.

Great. Thank you.

Kristen McDuffy, Goldman Sachs.

I understand that you can issue up to 125 million of shares for cash. Do you know how much equity you could issue in exchange for debt without limiting your ability to utilize your NOLs?

I think there's some fact specific stuff on that that it's difficult to make the estimate. It's some number somewhat lower than the 125 million, but I can't tell you what it is.

Okay. The cash that you're spending from your secured group, do you expect this to be spent mostly on wholly owned land or do you think that at points in the future you would invest into joint ventures?

We have two secured groups. Which one are you talking about?

The one for the twos and fives.

Okay. I mean, everything that we do in that secured group is actually in a joint venture. It's just a wholly owned joint venture. We could do additional unconsolidated -- excuse me, unconsolidated joint ventures in the future and it's something that we may choose to do.

As I think about investing cash in these joint ventures, how difficult is it to get that cash back? Does it take longer than, say, on a normal development to get cash back from a joint venture?

That's, again, fact specific as to what the exact terms of the joint venture structure is, but typically the cash comes back in a similar kind of flow as if we had it on a wholly-owned basis. We just don't put all the cash up. We're putting cash up along side of our investors, so it just takes less cash and the cash flows themselves are similar, if not identical.

So, we would get our pro rata share back, except for the fact that we get a promote. If we get into the promote stream, that promote portion may be delayed in terms of coming back to us because we've got to make sure we're over those thresholds. But that would have been cash we wouldn't have got if we did it on a wholly-owned basis, in terms of an extra IRR kind of return.

Okay. And it sounds like your focus is on purchasing finished lots, but I think conventional wisdom is that those are becoming more limited and difficult to find. How are you balancing that? What percentage of your lot purchases in the quarter are generally finished versus in need of development?

I'm not sure if I have that statistic off the top of my head. It varies to some extent from market-to-market. For example, in Houston and Dallas, almost 100% of our purchases are already developed and often are on a rolling option basis, where we buy X number of finished lots per quarter. In other markets, like let's say California or New Jersey, that's typically a little more difficult to achieve. But I just don't have the exact breakdown of our recent purchases of finished or undeveloped. Jeff, do you happen to have that handy?

No, I don't.

We don't track that.

Okay. Lastly, I wanted to talk about the land banking idea. I know you guys considered this a few years ago, a couple years ago and found it not to be the most attractive option. Was wondering what's changed, how much initial investment something like this would take, and how much of your land would you hope to purchase through such a thing if you chose that route?

I think the structure of a land banking arrangement is pretty much as follows. We as the home builder would put down a deposit. It would typically be between 10% and 20% of the purchase price. The land banker would fund the land development, also, if that's required. And then we would take down the lots on some preprescribed basis.

Typically, there's what's known as a skip provision, so that if there's a sales hiccup you can skip one quarter of lots, and you just add it to the overall pile. And the rates of return shift -- that's what shifts around at different times of the market cycle. I'd say from mid-teens to high teens is kind of the talk generally, and considering we buy land on an unlevered return of about 25%, plus, land banking arrangements with those kind of returns still make economic sense to us if they're large enough to warrant it.

Okay. Thank you.

Dan Oppenheim, Credit Suisse.

Thanks very much. Was wondering, if we think about the margins and such, and getting cash flow generation profitability isn't just about the volumes, but also having the margins coming through, margins even excluding the interest well below some of the peers, do you think that some of that speaks to the land that you're getting, or faster inventory turn, and so it's tougher, in terms of making the margins? Is it just fewer deals on the land right now? How do you look at that.

Part of it I think has to do that we don't all report margins the same way. When you're looking at our gross margin it's after sales commissions, and most of our peers do it before sales commissions. So, that may be why you're seeing -- we're still on the low side, but it's -- we move up the rank a bit when you make that apple-to-apple kind of adjustment.

Okay. Thanks.

Dave Goldberg, UBS.

Thanks. Almost good afternoon. I just wanted to make sure I kind of understood. In this recent debt for equity swap, I realize it was relatively small, but I just want the to think about that relative to the section 382 rules, and the change in ownership rules. Does it have an impact on your 382 and your ability to issue the 125 million shares? I know that was the same number you gave last quarter. Should we kind of assume there's no impact accordingly on the change of ownership rule.

We're not going to do an exchange with someone that's a 5% holder. This makes them a 5% holder. So as long as we stick to that kind of proposition it will have absolutely no impact on the 382.

Got it. And then I guess my follow-up question, it's kind of related to a question that was asked earlier about the cash flows in the joint venture. I want to think about that relative to the earnings stream, and how that might differ so we can obviously -- we can see the kind of earnings that come out of it from a unconsolidated basis, just kind of a single line item. I'm just thinking about how the cash flows would differ on, obviously, JVs. We are not fully consolidating them as we look forward.

I think earnings could exist before you get the cash flow, before either partner gets cash flow, because you may be plowing back the cash flow into WIP and subsequent land development sections. Even if we are into the promote, and believe we will be in the promote section, where we might get a disproportionate share of the income, we do not recognize that from a P&L standpoint, nor do we get the cash flow from that until the near the very end of the life, both, again, cash flow, nor that extra boost in P&L, we would not get until the end of that particular joint venture.

Got it. Can I just sneak one more in here quickly? If I look at the absorption pace in the joint ventures, it looks like it's higher than the joint ventures of the wholly-owned on balance sheet communities. Is that just related to the legacy communities that you still hold that have a slower absorption pace or is that something about product or location of what's in the JV versus on-balance sheet?

To be honest with you we haven't even analyzed that. My suspicion is it may have to do with some kind of tail end. I don't know whether we're counting the community counts that are 10 or fewer lots remaining or whether there is even any of those. It's not something we've analyzed. I don't think I can give you an off-the-cuff answer to that. They're generally larger communities that we've done in JVs. And in some instances that might impact absorption. It's just not something we've really done a lot of analysis on.

Is it fair to say quality wise there's no difference between what's in the JV in terms of location, A, B, C quality locations.

I think that's a safe bet. The primary reason we would do something in a JV is the size of the community rather than any other qualitative measure.

Got it. Appreciate it. Thank you.

Joshua Pollard, Goldman Sachs.

Hey. Thanks for taking my question. Most of what I wanted to know has been answered. But I'd love to understand what's the highest level of land you guys could bring on this year, now given that you're going to have to split your land spend much more between development and acquisition. It's something that I know you guys don't give community count targets, but I'm really just trying to understand how much slower you guys may have to grow the Business if land prices begin to make a march higher from here.

I guess the first comment, then I'll let Ara tag on if he has additional things to say is, we've been saying for quite a number of quarters and certainly throughout all of 2011 that we were doing land development and doing land development on newly identified lots, so this is not something new. And I don't think it's materially changed in the last quarter or two. So, we're not giving you clarity on specifically what our land spend is going to be, but I don't expect the fact that we are buying raw land or partially developed land, that really hadn't materially changed in the last six quarters, would be my reaction.

What was the split between development versus acquisition in '11?

I don't think we've ever publicly disclosed that.

Okay. My final question is you guys sort of announced the debt purchases that you did in the quarter in your K, and it doesn't look like you guys did much more beyond that into the rest of the quarter. Is there something that sort of signaled to you, Larry, you should slow down on the debt repurchase side, or how should we expect you guys to approach debt repurchasing for the balance of 2012?

The governor to our willingness to spend on land, to spend on debt repurchases, the final governor is really liquidity and managing to that cash target range that we continue to talk about. But when we're looking specifically, as am I going to invest in land, am I going to invest in debt repurchase, the price of the debt and where it's trading. So, we take all of those kind of factors into account. If we feel we have the liquidity to go out and make debt repurchases, we compare and contrast it to the potential yields we could get on land and do a balance, is really kind of how we think about it.

So is it right in assuming that the IRR, which you guys said were low to mid-20s for land purchases, that you guys are getting, you guys would expect lower returns on purchasing debt from December through January?

I think when we have purchased it, we were getting higher returns than we got on land. The transactions that we did do were very appealing from an IRR perspective.

Okay. Great. Thank you very much, Larry.

Alex Barron, Housing Research Center.

Thanks. I guess I am trying to balance a couple of thoughts and hoping you can help me. One is, you guys are obviously growing the orders at a pretty rapid and solid rate, 20%, 30% plus, and so, does that necessarily translate into your inventories are going to start to grow at that rate? And if so, how do you balance that against your cash position? Are you going to need to raise capital soon?

Some of that, as we tried to discuss on the call, some of that is really the fruit of investments that we've been making over the last few quarters, buying land. Some cases we were putting the development in. In other cases, just building the models and getting ready to open. So, as you've seen in some of the charts, our community count has been growing, which means we've bought the land. We've opened the communities, because we don't report it until it's open for sale.

And that typically means the big investments have preceded that and then the dollars that are necessary after that are pretty rapidly turning dollars. They're associated with the construction WHIP. So, if it takes you 90 or 120 days to build a house and you only have -- you pay the subcontractors 30 days later, that part of the asset can turn fairly quickly.

I mean, we can actually get proceeds from the customers closing the house before all of the bills have been received for that particular house. So, that component has pretty good turns and the land and land development component is typically preceded that community's opening.

Okay. I guess my -- thanks. My second question had to do with trying to understand the accounts payable, that portion dropped sequentially, I guess $30 million, $40 million. I was wondering, is that just a seasonal thing or is that going to bounce back?

That's just --

As the year progresses.

It's a seasonal thing, Alex. Fourth quarter's typically a big delivery and big deliveries right at the very end of the quarter and that led to higher accounts payable and there were just less in this quarter, and you'll see that same pattern if you go back and look historically at us, as well.

Okay. Thanks, Larry.

Susan Berliner, JPMorgan.

I'm sorry, my questions were answered. Thank you.

Okay. Thank you.

Joel Locke, FBN Securities.

Hi, guys. Just wanted to get I guess on the debt to equity swap, just what kind of -- how deep is that pool? Could you have done $12 million for $48 million, or maybe 20 fold that, just based on issuing shares at an equivalent of $4 a share doesn't seem like a bad play right here.

Well, I mean, we've been approached from time to time, and sometimes we're able to negotiate terms at market, and sometimes we're not able to negotiate terms at market. But as we mentioned in the script, to the extent that there's others that are interested in pursuing this. To the extent we can do them at roughly kind of market prices, it's something we would entertain.

All right. Thanks a lot, guys.

(Operator Instructions)

Andrew Cassella, Imperial Capital.

Hi, guys, thanks for taking my follow-up. If you could give us an update on your restricted payment basket in the old secured group, and then just talk about the ability to dividend money upstream from the new secured group, if you have that ability at all.

I think I mentioned the answer to the first question, we have roughly $138 million of restricted payment capacity left in that bucket from the old secured group. And then in terms of dividending cash, I mean, the cash is walled off with the exception of some limited propositions that I don't expect are going to be meaningful dollars. What really happens is, if we make money in the new secured group on the investments that we make, it adds for every $1 that we make, it adds another $1 to the collateral basket that I can do an additional secured $1 of debt. That's really the benefit.

Okay. Great. Thanks. And just secondly, on your incentives as a percent of the home sale price, can you talk a little about that in the quarter, and if you think that number can come down as we go through the year? It sounded like year-over-year February you guys weren't necessarily doing any additional incentive or promotional programs, so any color would be helpful.

First of all, we really focus on net pricing. Some situations, for a variety of reasons, a division in a location may decide to keep the base price higher and offer bigger incentives, and 10 miles away they may decide to offer no incentive and just have very low base prices. So, sometimes it can be -- the discussion can be confusing. All we focus on is net pricing, and overall, in spite of the fact that I saw the Case-Shiller Index did go down in a bunch of cities last month, I'd say the environment on pricing overall is holding steady.

All right. Great. Thanks.

Andy Schaeffer, Onex Credit Partners.

Can you describe what caused the change in your mothballed lots?

I don't think there's a big change. You're talking about sequentially?

Yes.

Go ahead, Brad.

We had one community that we sold, the property's reflected in our land sales, and the other community is now being reactivated. It's going to be opening for sales.

Unmothballed.

Unmothballed, basically. Then one other community had a change in it's map, basically for regulatory reasons so it reduced the number of lots.

Basically reduced the density, went with fewer but larger lots, and we thought that would better optimize the value of the land.

You commented Larry in your prepared remarks about unmothballing future lots going forward. What has to happen in terms of the market for you to unmothball those communities.

I think what basically has to happen is continued improvement in absorption pace, combined with at some level in certain communities an ability to increase home prices. So, our ability to get a better return on that investment to justify reopening that community, or opening it for the first time is basically what has to happen.

In some cases construction costs have come down enough to unmothball a couple of communities without the price going up. In some cases we've managed to change the product type or use type, and justify unmothballing a community. But generally speaking, Larry's response is right on. It would require a little more pricing or a little more velocity, or in some cases besides construction costs we have seen a few instances where the municipalities have lowered some of their fees, and that could justify unmothballing as well.

So we should -- any change there would be on the margin it sounds like.

Yes.

Until the market improves, that is what you're saying?

Going from here.

I would say -- I'm not sure what you mean by any changes, but as the market improves we fully expect over time to bring all of those lots back.

I guess --

We're about to unmothball another small parcel. In that case, almost every one of the changes were at play. The municipality did in fact reduce some of their fees by about $5,000. The market has picked up just a little bit in price and pace and we were able to redesign the product for something that's more cost efficient, yet still works with the entitlements, and when you add those three together, it justifies unmothballing, it's like 70 lots and will be a positive profit and cash contributor. So every situation is different.

I guess what I'm trying to get at, is this a seven-year process? Is it a five-year? Three-year? Trying to get a sense as to how quickly or slowly that could happen.

It's so dependent on those factors. I would say in general, I would not assume that we're going to unmothball everything in two years. I think more likely, it's just going to slowly evolve over time. The properties are in many different locations, so a neighborhood in Northern California may improve and firm up, just like the one I just mentioned in Florida did.

And frankly, we had no way to project when that would happen. All of a sudden we saw the pace pick up, prices pick up and some of the other factors and it was not in our projections at all. In fact, we assumed in our internal models that it would be mothballed for another four years and we just made the decision a week or two ago to unmothball it. It's one of those things that's hard to tell. There's just so many location-specific dynamics.

Okay. Thank you.

There are no further questions in the queue. I would now like to turn the call back over to Mr. Ara Hovnanian for closing comments.

Thank you. We'll try to work on the pronunciation in our future calls. We're obviously not spending enough money on radio advertising. In any case, appreciate your attention for the call. We are pleased with the results. We're not going to be ultimately pleased until we return to profitability and then start driving some good, solid numbers. We feel good about the growth prospects coming up and we look forward to reporting on them in the ensuing quarters. Thank you.

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