Hovnanian Enterprises Inc (HOVNP) 2014 Q4 法說會逐字稿

Good morning, and thank you for joining us today for Hovnanian Enterprises FY14 Fourth-Quarter and year-end earnings Conference Call. An archive of 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 is also Webcasting a slide presentation along with the opening comments from Management. The slides are available on the investors page of the Company's website at www.khov.com. Those listeners who would like to follow along should log on to the website at this time.

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

Thank you, Operator, and thank you all for participating in this morning's call to review the results for our fourth quarter which ended October 31, 2014. Before we get started, I would like to quickly read through our forward-looking statements.

All statements in 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, achievements expressed or implied by the forward-looking statements.

Although we believe that our plans, intentions, and expectations reflected in or suggested by such forward-looking statements are reasonable, we can give no assurance that such plans, intentions, or expectations will be achieved. Such risks, uncertainties, and other factors include, but are not limited to, changes in general and local economic industry and business conditions and impacts of the sustained homebuilding downturn, adverse weather and other environmental conditions and natural disasters, 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, changes in market conditions and seasonality of the Company's business, the availability and cost of suitable land and improved lots, shortages in and price fluctuations of raw materials and labor, changes in home prices and sales activity in the markets where the Company builds homes, fluctuations in interest rates and the availability of mortgage financing, changes in tax laws affecting the after-tax cost of owning a home, operations through joint ventures with third parties, government regulation including regulations concerning development of land, the homebuilding sales and customer-financing processes, tax laws and the environment, product liability litigation, warranty claims and claims made by mortgage investors, levels of competition, availability of Financing to the Company, successful identification integration of acquisitions, significant influence of the Company's controlling stockholders, availability of net operating loss carryforwards, utility shortages and outages or rate fluctuations, geopolitical risks, terrorists acts, and other acts of war, and other factors described in detail on the Company's Annual Report on Form 10-K for the year ended October 31, 2013, and subsequent filings with the Securities and Exchange Commission.

Except as otherwise required by applicable securities laws, we undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, changed circumstances, or any other reason.

Joining me today from the Company are Ara Hovnanian, Chairman, President, and CEO, Larry Sorsby, Executive Vice President and CFO, Brad O'Connor, Vice President, Chief Accounting Officer and Controller, and David Valiaveedan, Vice President of Finance and Treasurer. I'll now turn the call over to Ara. Ara, go ahead.

Thanks, Jeff. Let me get started with our Fourth-Quarter results which can be found on slide 3.

Starting on the upper left-hand portion of the slide, you can see that our total revenues increased 18% year-over-year from the Fourth Quarter of FY13. Our revenue growth was driven by an increase in both deliveries and an increase in average sales price from $360,000 to $387,000.

I'd like to say that we raised home prices, but this increase in average sales price is primarily due to geographic and product mix changes. During FY14, we, along with almost the entire homebuilding industry, experienced a slower pace of sales per community compared to 2013. In addition, we saw our pricing power moderate from what we experienced in the prior year.

As projected on our last call, you can see in the upper right-hand portion of the slide that our homebuilding margin did in fact decline. Our Fourth-Quarter gross margin of 19.3% was slightly lower than our expectations due to the increased use of incentives since our last call primarily on spec homes.

Continuing clockwise, in the lower right-hand quadrant, we show that the dollar value of our backlog increased 12% year-over-year. Finally, in the lower left-hand quadrant, we show that our SG&A ratio decreased 130 basis points this quarter to 9.3% compared to last year's fourth quarter of 10.6%.

We also show that interest as a percentage of total revenues decreased 140 basis points to 5.3% compared to last year's Fourth Quarter of 6.7%. These year-over-year improvements demonstrate some of the efficiencies we achieved by growing our top line.

Going forward, we remain focused on generating further growth in revenues so that we can gain more efficiencies and return many of our operating metrics to normal levels. That obviously will drive increased profitability.

Slide 4 illustrates another view of the leverage we gain as we grow our revenues. As our top line increased throughout the year, we leveraged our fixed costs and returned to profitability during the second half of the year.

Starting in the upper left-hand corner of the slide, you can see that sequential quarterly growth in our revenues which typically peaked in the Fourth Quarter. Moving to the upper right-hand portion of the slide, our gross margin increased sequentially for the first three quarters of 2014 and then dropped off slightly to 19.3% during the Fourth Quarter.

In the lower left-hand quadrant, we show that our total SG&A and total interest expense as a percentage of total revenues improved sequentially each quarter during 2014. Our SG&A ratio improved from a high of 16.6% in the First Quarter to a low of 9.3% in the Fourth Quarter. Our interest expense ratio followed similar trends going from 9% in the beginning of the year to 5.3% during the last quarter.

The results of these improvements on our profitability can be seen in the lower right-hand portion of the slide where we show that we swung to a $15 million pretax profit during the third quarter and then to a larger $36 million pretax profit in the Fourth Quarter.

While we are profitable for the second consecutive year, there is still a lot of work to do. We're convinced that as we continue to generate increases in revenues, we will show further improvements in our SG&A and interest expense ratios. Over time, this will allow us to achieve higher levels of sustained profitability.

One goal we would like to achieve over the next several years is to even out our quarterly deliveries, so that we can be profitable in all four quarters. However, we don't anticipate being able to achieve this in FY15.

Turning now to the current sales environment on slide 5, we show the dollar amount of net contracts per month for the past 12 months. The most recent month is shown in blue, and the same month in the previous year is shown in yellow. We use green arrows to indicate year-over-year increases and red arrows to indicate year-over-year declines. Scanning across these colored arrows, it's an understatement to say that the past 12 months have been choppy.

The housing market this past year has been more challenging. In addition, the first 7 months of this 12-month period had much tougher comparisons. As such, from December, 2013 through June of 2014, we had only two months with positive year-over-year comparisons and five months with negative comparisons.

We saw more positive trends from July through November albeit with easier comparisons with only one negative monthly comparison and four positive monthly comparisons. In November, the final month we show on this slide and the beginning of our new Fiscal Year, we reported a 15% year-over-year increase in the dollar amount of net contracts including unconsolidated joint ventures and a 25% increase for the dollar amount of consolidated net contracts.

On slide 6, we show the number of monthly net contracts per community as opposed to the dollar amount on the previous slide. For the past 12 months, we have had only 3 months that showed year-over-year improvements. In November, we achieved 2 contracts per community compared to 1.8 during November of last year. We're happy to begin the first month of our Fiscal Year with a 10% increase. Hopefully, this will be the beginning of a positive trend for our FY15 year.

On slide 7, on the left-hand side, we show our quarterly net contracts per community for the past four years. The year-over-year comparisons turned negative in the third quarter of 2013 and remained that way through the third quarter of 2014.

In the Fourth Quarter of 2014, we posted a year-over-year increase. Not a big increase but a subtle shift. Hopefully, again, this will also prove to be the start of a more positive trend.

Unfortunately, the increase in the Fourth Quarter was not enough to show an improvement for the full year. On the right-hand side of the slide, you can see that we had 28.4 net contracts per community for all of FY14. This was less than 30.7 we had in 2013. This year-over-year decline in sales pace is not something we expected to see at this early stage of a housing recovery.

On slide 8, we try to put our sales per community into perspective with those public home builders that reported September quarter-end results. This slide shows the year-over-year change in net contracts per community for our peers and compares our results for the same three months ended in September.

While our performance was better than many, I suspect all of us were hoping for better sales results. Given the gains we have seen through 2014 in employment, we would have expected housing demand to be stronger than the low levels we're currently experiencing.

While sales pace per community was disappointing, an increase in community count lead to an increase in the absolute level of net contracts and dollar amount of net contracts for both the Fourth Quarter and the full year. We show on the left-hand side of slide 9 that the dollar amount of net contracts increased 15% to $512 million. On the right-hand side of the slide, we had the full-year results.

Due to a healthy increase in average sales price and an increase in community count, the dollar amount of net contracts increased 10% to just over $2.1 billion. This was achieved despite a slightly slower sales pace per community. Even if housing demand does not improve in 2015, we believe the increased community count we've achieved to date, combined with the additional communities we plan to open, will position us to achieve higher levels of home sales in 2015.

On slide 10, we show that our consolidated community count has grown steadily since the end of FY12. Increasing our community count is not an easy task. During FY14, we opened 98 new communities and closed out of 89 older ones.

At October 31 of 2014, our community count was up to 201 communities compared to 192 communities at the end of FY13. This was the first time since 2009 that our consolidated community count was above 200, and we expect additional growth in community count during FY15. Our new $250 million bond offering last month will allow us to grow our community count more rapidly in the future. Based on the growth in our community count, net contracts, and our average selling price, the dollar amount of our backlog has grown compared to last year.

On slide 11, we show the dollar amount of our backlog increased 12% to $856 million from $762 million at the end of last year. You can also see on the bottom of this slide that the number of homes in backlog grew to 2,229 up from 2,167 last year. This increase in backlog combined with the growth in community count gives us the confidence that we'll be able to continue to grow our top line as we head into next year.

Ultimately, demographics are in our favor, and consumers should buy homes at an increased rate in the future. Simply put, the population and number of households in the US is growing, and the nation is building fewer homes today than it needs to meet demand over the long-term. We positioned ourselves to take advantage of these trends. I'll now turn it over to Larry Sorsby, our Executive Vice President and CFO.

Thanks, Ara. Let me start with a discussion about our gross margin trends. As you can see on the left-hand side of slide 12, we show our annual gross margin percentage for the past four years. For both FY13 and FY14, we achieved what we consider to be a normalized gross margin for our Company. On the right-hand side of the slide, we show that for the first three quarters of FY14, we had sequential increases in gross margin.

As we forecasted during our Third-Quarter Analyst call, for the fourth quarter, our gross margin declined. During the Fourth Quarter, we experienced a more competitive environment in many of our Markets with broader use of incentives by our peers as well as increased competition from the sale of used homes.

As a result, primarily due to increased use of incentives on spec homes, our Fourth-Quarter gross margin of 19.3% was slightly less than we had anticipated. Assuming no change in current market conditions, we expect our gross margin for 2015 to be just below our normal historical range, similar to what we reported for the Fourth Quarter of 2014.

Turning to slide 13. You can see our total SG&A as a percent of total revenues decreased sequentially in each quarter of FY14 from a high of 16.6% in the First Quarter to a low of 9.3% in our Fourth Quarter.

On slide 14, we show our annual total SG&A expense as a percentage of total revenues going back to FY01. We consider approximately 10% as a normalized SG&A ratio. Primarily related to our efforts to grow our community count and the adverse impact of slower deliveries per community, our SG&A expense ratio increased slightly for the full year compared to FY13.

As we continue to generate future revenue growth and achieve more normalized sales pace per community, we expect to be able to leverage our fixed SG&A expenses further and get this ratio back to the normalized level of around 10%. This will not happen overnight, but we expect to be able to gradually work this number down each year during the next several years.

Despite the fact that we have given directional guidance for our community count, revenues, homebuilding gross margin, and SG&A expense ratio, the market remains too choppy to give specific profitability guidance for FY15 at this time. Furthermore, until the proceeds from the $250 million bond offering we closed in November are put to work purchasing new land deals and home deliveries start to occur from those land purchases, the incremental interest from that offering will negatively impact our profitability.

We are willing to sacrifice short-term performance in order to open more communities which we expect will ultimately result in longer term benefits from increased profitability. We remain convinced that this is the right thing to do.

Assuming no deterioration from current market conditions, we expect to be profitable for our full FY15. Similar to the past two years, we continue to expect the majority of our profits to come in the second half of the year.

Turning now to slide 15, you'll see our owned and option land position broken out by our publicly reported market segments. At the end of the fourth quarter, 92% of our optioned lots are newly identified lots we put under control since January, 2009. Excluding mothballed lots, 84% of our total lots are newly identified lots.

Our investment on land option deposits was $89 million on October 31, 2014 with $87 million in cash deposits and $2 million of deposits being held by letters of credit. Additionally, we have another $14 million invested in pre-development expenses.

Turning now to slide 16. We show our mothballed lots broken out by geographic segment. In total, we have 5,971 mothballed lots within 45 communities that were mothballed as of October 31, 2014. The book value at the end of the fourth quarter for these remaining mothballed lots was $103 million net of an impairment balance of $412 million. We're carrying these mothballed lots at 20% of the original value.

During the Fourth Quarter, we unmothballed one community in Florida. Since 2009, we've unmothballed approximately 4,100 lots within 68 communities. Every quarter, we review each of our mothballed communities to see if they are ready to be put back into production.

Assuming current market conditions remain steady, we anticipate unmothballing approximately 900 lots in FY15 in two locations. About 630 of those lots are in Natomas, California where a building moratorium due to levies and flooding issues expected to be resolved soon. The other 270 lots are in a parcel of land right on the Hudson River in New Jersey overlooking the Manhattan sky line where we plan to build a 14-story mid-rise which is likely to be completed with a joint venture partner.

Looking at all of our consolidated communities in the aggregate, including mothballed communities, we have an inventory book value of $1.3 billion net of $569 million of impairments. We've recorded those impairments on 72 of our communities. For the properties that have been impaired, we're carrying them at 19% of their pre-impaired value.

Another area of discussion for the quarter is related to our current deferred tax asset valuation allowance. During the fourth quarter, we've reversed $285 million of our current deferred tax valuation allowance. We will reverse some or all of the remaining valuation allowance when we begin to generate higher levels of sustained profitability.

At the end of the fourth quarter of FY14, the valuation allowance in the aggregate was $642 million. The remaining valuation allowance is a very significant asset not currently reflected on our balance sheet, and we've taken numerous steps to protect it. Although we will not have to pay cash federal income taxes on approximately $2 billion of pretax earnings, we will begin to report income tax expenses in FY15 on a GAAP basis.

On Slide 17, we show that we ended the fourth quarter with a total shareholders' deficit of $118 million. If you add back the remaining valuation allowance, as we've done on this slide, then our shareholders' equity would be a positive $524 million. Over time, we believe that we can repair our balance sheet by returning to profitability and have no intentions of issuing equity any time soon.

Now, let me update you on our mortgage operations. Turning to slide 18. You can see that the credit quality of our mortgage customers continues to remain strong with average FICO scores of 745. For all of FY14, our mortgage Company captured 65% of our non-cash home buying customers.

Turning to slide 19. We show a break out of all of the various loan types originated by our mortgage operations for all of FY14 compared to all of FY13. Our percentage of FHA loans was 15% in FY14.

At the top right-hand portion of this slide, we've shown that this is down from a high of 38% FHA originations in FY10. The steady decline in FHA originations is primarily due to both the recent lowering of FHA loan limits and the increases in FHA mortgage insurance costs. Borrowers that qualify have switched away from FHA loans to more affordable Fannie Mae and Freddie Mac conforming loans.

As seen on Slide 20, even after we spent $161 million on land and land development during our Fourth Quarter, we ended the Fiscal Year with $309 million of liquidity which includes $261 million of homebuilding cash and $48 million undrawn under our $75 million unsecured revolving line of credit. Subsequent to the end of the year, we successfully completed a $250 million debt offering which brings our pro forma liquidity up to $555 million.

Over the past year, we invested $586 million on land and land development. With the peak capital needs of already approved deals in front of us, combined with a healthy pipeline of new land deals proceeding through due diligence and the uncertainty of where interest rates are headed, we decided to tap into the debt Markets and raise our cash position in November. With this additional capital, we ended the year on a pro forma basis well in excess of our target liquidity range of $170 million to $245 million.

Now, turning to our debt maturity [letter] which can be found on slide 21. The red bars on this slide represent unsecured debt. We have a lot of runway in front of us before any material levels of debt come due.

We believe that we have the ability today to refinance all of our unsecured debt that matures between 2015 and 2017. However, we don't see enough benefit to pay [in] the high costs associated with make-whole provisions to refinance those bonds today. We are not likely to refinance or pay those bonds off until such time as we're closer to the maturity dates. Needless to say, we feel good about our liquidity position, and we'll continue with land purchases that meet our underwriting hurdle rates.

As you can see on slide 22, beginning in the second half of 2012, the number of net additions to our lot count has exceeded the number of deliveries by about 10,700 lots. In the fourth quarter, our net additions totaled 1,700 lots which is slightly less than the deliveries we had in the fourth quarter. This decrease is a testament to our discipline of sticking to current sales paces, current sales prices, and current cost to build homes when we're underwriting land deals.

We currently have all of the land we need for FY15 deliveries and 83% of our 2016 deliveries controlled today. Our estimates for 2015 and 2016 deliveries include assumptions that we will achieve year-over-year growth. Given the slower housing market we experienced in 2014, we recently reassessed the underwriting criteria that we use when evaluating new land deals.

We are remaining disciplined using current home price, current absorption pace and current cost to underwrite land but have decided to increase our hurdle rates until we see sustained evidence that the housing market is improving. Today, we are currently focused on land transactions for 2016 and beyond home deliveries. We have plenty of liquidity and our land acquisition teams continue to work hard across the country to identify new land parcels. However, we are being somewhat more selective.

We remain focused on controlling more land, opening more communities, and growing our top line in order to leverage our fixed cost. In light of the recent drop in oil prices, there have been a lot of investor interest in how home sales in Houston might be impacted.

To date, we have not seen any adverse impact. For our Fourth Quarter, we saw our net contracts per community in Houston increase 6%, and in the month of November, our net contracts per community increased 11%.

In spite of these recent improvements in Houston, we remain concerned about the potential impact further declines in oil prices may have and will continue to carefully monitor the situation. One housekeeping note. Due to scheduling conflicts, we will be issuing our First-Quarter results one week later than usual. That concludes our formal remarks, and we'll be happy to open it up for questions.

(Operator Instructions)

Your first question comes from the line of David Goldberg.

Thanks. Good morning, guys, and congrats on a good quarter in a tough environment.

Thank you.

My first question: I was wondering if you could give us some more visibility into the increase in the hurdle rates? And, specifically, if you tell us where you've moved them to, essentially? And maybe how much of that is on a local basis at this point given some individual market risk versus a more national decision?

It's really an across-the-board, national decision. We increased our hurdle rate on an unlevered IRR basis from 20% to 25%, and also tweaked up our profit contribution percentage hurdle rate as well. Our teams are able to continue to find land deals at that higher rate, and we just think that it's a prudent thing to do at this point in time.

I think that makes sense. Is there any -- as you look at Houston specifically, and obviously, it's a big market for you. And, Larry, I appreciate the comments. Is there any specific extra caution you're showing in that market, just given what's happened in oil prices? Is there anything you can do proactively to maybe lessen your exposure a little bit?

You know, it's interesting. Houston is our largest market, but it's far from -- very far from our largest investment, and that's because our strategy in Houston has been purchasing finished lots on a quarterly take-down basis. And, as such, frankly, our exposure and risk on the downside is not great. So, at this time, we are really not -- while we're being cautious and we're certainly keeping our eyes open, we are not really changing our strategy. And, thus far, everything feels pretty good.

Great, thank you.

By the way, I'll add that we don't tend to need much in the way of deposits in that market either.

Your next question comes from the line of Michael Rehaut from JPMorgan.

Good morning. It's actually Jason Marcus in for Mike. The first question is on the higher incentives that you talked about -- that impacted the gross margin during the quarter -- was hoping that you could provide a little bit more detail on the magnitude of the increased incentives, and which markets they are most prevalent in? And what the trend in the incentives was throughout the quarter -- if it increased as the quarter went on, or maybe it stabilized throughout -- towards the end of the quarter?

I'd say they were pretty stable. We just felt like we weren't getting enough traction in the market. I showed you the month by month that showed the choppiness overall, and sales pace per community; and pace per community is a critical component for us. It is a big driver of SG&A.

So, the incentives varied all over from, obviously, some locations with zero incentives, to those with more significant. As we mentioned in the commentary, they were primarily directed toward spec homes. We want to make sure that we drive first-quarter sales and deliveries, as well as meeting our quotas for the fourth quarter. Hopefully, the market will firm up a little bit, and we'll reduce it.

But you get an idea from the drop in gross margin, as to the magnitude. It wasn't huge, but a little adjustment was warranted.

Okay, thanks. And then, the next question: I think in the past you've talked about some increasing cycle times in certain markets due to shortages in labor and materials. I noticed that your backlog conversion actually improved in the fourth quarter. So, I'm just wondering if you could comment on what you're seeing on that front? And how we should think about backlog conversion going into 1Q 2015, and if that should maybe improve from last year or be flattish?

Yes, overall, we're still challenged by construction cycle times in most markets, and Houston continues to be one of those markets where we're feeling that challenge.

I'll turn it to Larry on the backlog conversion.

Again, backlog conversion -- understanding, in your chairs, it's one of the few data points you have to give you some insight as to cycle times. But I would caution you to use it as a direct correlation. It's not something we really track religiously, as we have a lot better data.

And Ara's comments about -- we continue to see elongation of cycle times, especially in Houston, but in a number of other markets as well. So, I don't think there's a correlation to conversion rate.

Other questions?

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

Thanks -- wanted to just dig into the gross margins a little bit. I wanted to understand: For the fourth quarter, the increase in incentives and the decline in gross margins -- was that more of a delayed tactical response to market weakness that has emerged during the year, or did it reflect more that things got noticeably worse in the fourth quarter?

The reason I'm asking the question is: You folks have been mentioning incentives for some time, but the gross margin trend was still pretty decent. I think you mentioned as far back as the beginning of 2014. And, plus, the market weakness, as the great data you guys show us, shows that absorptions have been challenged all year. So, was it just -- we need to readjust heading into 2015, or did things really get worse in the fourth quarter?

Yes, I think, in the fourth quarter, it is an indication the market slowed a bit more than we would have expected, combined with -- we just had a number of started unsold homes that were at a stage that we could actually deliver them in the fourth quarter. So, we were extra incented to actually get them to close; so, it took a little bit more incentive than perhaps it otherwise would have.

So, it's a combination of things. And as I mentioned in my portion of the earlier comments, I think, for modeling purposes, our margin trend right now for FY15 is running similar to what you saw in our fourth quarter.

If you go back to slide 6, it gives a month-by-month breakdown; that slide 6 only shows the number of net contracts. The previous slide shows dollar amount. But it's one of the gauges we look at.

In August, when we were -- just before we were chatting last on our conference call, we had an up month, and were feeling a little better. But then, it was followed by September and October were more challenging months. So, that's why we decided it was time to turn on a little incentive -- more incentives.

And we also were just checking our competitors. And I'd say it was certainly more prevalent during that period. So, could it be it's because of the end of the year, and all of us were anxious to not disappoint ourselves or all of you with the results? It could be. But the adjustments it took were not huge, and it did result in a good November for us. So, hopefully it's a good start.

Got it. Thanks; that's helpful.

And would 70% of your in-house mortgages being conforming; the new 3% down that was implemented yesterday by Fannie -- I'm sorry, two days ago -- and the discussions that seems to be ongoing and the momentum building towards actually easing the overlays -- all of the discussion that has been going on there as well. You probably haven't seen anything just yet, in terms of that entering the market, but are you optimistic as we head into the spring selling season that movement on that front could help you for next year?

Each of those steps by themselves is an incremental positive; aggregate them together, maybe they are better than an incremental positive. It is certainly in the right direction; hopefully be really helpful for the first-time home buyer, and I think that's one of the things that this market has been lacking.

So, we're encouraged by it. It's hard to gauge precisely what the impact is going to be because, as you say, it really hadn't come through yet. But each of them is a step in the right direction.

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

Yes, thank you for taking the question. Maybe you can talk to traffic levels, and recognizing that you have a weaker environment from a conversion and close -- and getting those contracts signed. Are you finding that people are coming in, and they actually want to buy, but then they just don't get approved for a mortgage? Maybe a little color, and then I'll come back with a second question, please.

Sure. I think traffic overall has been holding up, which is encouraging. I think there was less urgency in the last quarter, which was part of why we stepped up the incentive. I think that was more the issue in the last quarter versus any change in underwriting standards. That really hasn't gotten tighter in the last quarter, causing any more problems.

But in terms of approvals, generally it has been stable. But is that part of the issue in terms of the weakness in the market?

Yes.

Because if you think about -- yes. (multiple speakers)

Yes, undoubtedly. There are a lot of customers that don't even make it to the contract stage to get cancelled because we do pre-qualification. And there's no doubt that, even with the steps -- and hopefully the steps that were just announced will be more helpful.

But the mortgage industry, including our own mortgage company, are just being much tougher on underwriting. With all of the put-backs that have gone on, it's understandable that they've been overly cautious. Hopefully, soon, the market will just get back to normal, and that will definitely help the marketplace.

Great. That's my first question. I appreciate it.

Secondly, as you talk about gross margins, and realizing incentives had an impact, especially on the spec product -- thinking about 2015, is there risk if things don't get better and stay the status quo, that you're going to see even more margin pressure with labor costs up, and sticks-and-brick costs up, land prices are up? And if you can walk us through the math, I'd appreciate what the downside risk would be in a status-quo environment from the fourth quarter reported gross margin levels that you think are achievable in 2015. Is the situation -- more pressure likely? And maybe your broader thoughts about the industry, because I think everyone is looking at margins that are well above, as an industry, what historically they would be, given how much price was pulled forward, and now pricing is moderating.

Sure, it's a tough one, obviously, because there are a lot of moving parts. If the market did, in fact, slow, which I don't think further slowing is logical, but if it did, of course, there would be a little relief on cost pressures on all fronts. I think, like we saw throughout the whole downturn last time, as the market slowed down, the subs and suppliers got more competitive, and that was certainly helpful.

I also think, if things slowed, that we finally see a little bit of relief on the land price side. At the beginning, what happens typically is sellers just are resistant to selling because they don't like the new prices that are necessary for home builders to make a return, and you kind of see that in our land acquisitions last quarter. We just did not make as many deals, and we walked away from some deals that didn't continue to underwrite before closing. They typically -- we walked right before -- during the due diligence or just before close time. So, that would give a relief.

Overall, I just -- and maybe I'm a home-builder optimist, but it just seems like demographics have got to take over, and get the market with a little more solid feet. The last month for us, obviously, felt a lot better, as we indicated; so, hopefully that's the beginning of the trend.

And I agree with your views on the demographics and the constructive outlook. But in an environment -- maybe you can just elaborate on the costs easing? Have you seen easing on labor at all? Is that something that is starting to improve? And what are your costs on labor up year over year, and I'm sorry I snuck a second question and a third question.

Ivy, I think -- we saw cost pressure from the labor side really abate during 2014 compared to the cost pressure increases that we saw in 2013. They might have slightly gone up a bit year over year because the increases we put in place in 2013 were in place for the full year of 2014. But we certainly didn't hear our divisions complain about having to rob labor from our competitors, and pay higher prices in any significant way. It happened occasionally, but no significant way. So, I think that is in the rearview mirror, as the housing industry was really stable from a volume perspective year over year. So, I just don't think we saw much in the way of labor increases.

Yes, as you know, Ivy, 2013 -- that was the hot topic, because there was a big jump in sales, big jump in starts across the country, and labor wasn't there. So, everybody just raised their prices because they could, and they couldn't handle the work; and if they got the pricing, then they would figure out a way. But 2014 was a more lackluster year, so the pressure on construction cost just wasn't there.

Great, thanks. Good luck.

Thank you.

Your next question comes from the line of Eli Hackel from Goldman Sachs.

Thanks -- just first question on the specs, given maybe it took a little bit longer to sell them. Does that impact your view on specs for -- as you go into the spring selling season?

Not really. In the appendix of the slides -- I'll flip to it so I can get you to the right page. You can see our level of specs are still relatively modest; go to slide 30. We did increase our level of specs very consciously, and we have averaged 4.7 started unsold homes per community since 1997. As of October 31, we had 4.6. We're just returning back to our normal average level, and we think there's benefits to being at that level.

A lot of consumers wait to sell their home before they actually go out in the market and seek to buy another, so we need to have a few homes under construction at each of our communities. And that's really where we are. So, we're pretty comfortable with our current position, and I think it will be stabilized at that level.

Great; and then just one quick one. On the SG&A -- did a good job in the quarter there. Was there any benefit there from maybe lower bonus accruals or anything else like that? And how should we think about SG&A for next year?

And, quickly, what is the right GAAP tax rate for next year? Thanks.

Well, first of all, unfortunately, yes, we got a little help from bonus accruals.

Especially at the executive level.

Yes, but obviously, the volume is the bigger driver; a little more volume really leverages our costs.

Brad, do you want to comment on the tax rate?

I would say it would fall back to where we were in the years before we had the valuation allowance; so, high-30s% -- 38%, 39%, something like that.

Great. Thanks very much.

Okay.

Next question comes from the line of Adam Rudiger from Wells Fargo Securities.

Thank you. Ara, in your prepared remarks, you talked about being comfortable with some revenue growth next year due to community-count gains and higher backlog. I was wondering if you had any thoughts on the likelihood of absorption growth and what pricing -- potentially higher organic price increases, not mix-related ones?

Yes -- boy, I'm certainly hopeful -- certainly of absorption. I think that will likely come more -- closer to normal than pricing growth. I think absorption will lead the way.

As you can see on slide 7, which we mentioned, but I'll dig in a little deeper -- our average absorption during -- take out the boom and bust -- 1997 to 2002, we averaged 44 homes per community. During the boom years, we got to like 55, 56. Well, we're half of that right now. It's just abnormally low, and there are not -- it's not that there is huge growth in community counts.

So, with just a little bit more pickup in demand, we ought to see a good, steady progress toward getting to a better contract per community base. Maybe not 44 right away, but, boy, there's a lot of room between the current 28.4 sales per community and the 44 that's average. That will really help our SG&A. I think Larry mentioned that, obviously, growth in top line in total helps from certain SG&A factors, but sales per community really help a lot.

Okay, thanks. And then, sticking with what you were just talking about in terms of SG&A leverage and top line -- in the press release, you mentioned a focus in 2015 would be growing revenues to cover SG&A and interest. Does that suggest that is more of the focus than gross margin? Is pace to cover those two things more important, or are you -- other builders talk about optimizing the value of every single lot, and not emphasizing pace as much. Which camp are you in now, and is there any change to that?

Well, I think -- there's a constant balance, and it varies by community, between pace and price. I think the comment we were talking about is total revenue or total sales, and that's the one governor we can control a little bit more by making certain that we grow our community count. Because, even if we don't get improvement in pace, which would certainly be the most helpful, we can grow the top line and make our SG&As a little more efficient with growth in overall revenues.

Having said that, if you've got a community that's not selling -- we're far better off to test the market by increasing incentives slightly in order to get pace going. So, we would be in the market of taking some modest action to try to spur pace.

Makes sense; thanks for taking my questions.

Your next question comes from the line of Alex Barron from Housing Research Center.

Hi. Good morning. I was hoping you could talk a little bit about the nature of the incentives that you have found maybe as helping you get some traction now? Is it rate buy-downs, or is it just on options, or what are you finding that's getting consumers to step up?

We don't have a corporate strategy because we think it's more important that it be managed on the very micro level, at the divisions, and they look at it on a community-by-community basis.

Even a customer by customer -- some customer may need cash and, therefore, for closing costs or something, they'd rather have that. Somebody else might rather have a lower price. Somebody else might want to have 50% off on options. It's really packaging from a marketing perspective to the individual needs of that particular community -- or consumer at each community. And there isn't a one-size-fits-all. It's really buffet style for which -- whatever that particular customer wants.

Got it. And I guess, since you seem to emphasize that the incentives were more on specs, how does that change your approach to your spec strategy, if anything?

Well, it really doesn't right now. We focused on specs because we had them, and they were the quick sales. It certainly was helpful to the fourth quarter, and will be helpful for our first-quarter deliveries.

But, overall, as Larry indicated, our spec levels are pretty much at our normal historical level. So, we don't plan any huge variation; about 4 or so -- 4.5 per community, on average. We tend to try to do more specs in Houston, but that market, interestingly, has been so strong that they haven't been able to get specs out in front. So, we're actually doing fewer specs in that market than normal.

Markets like Virginia historically are the opposite. We hardly do any specs historically, other than townhouses when you start building when you have four out of six or seven sold; but single families, we rarely do specs. There were slightly more than normal. So, it really -- and that is just a conscious effort to help even out our delivery flow a little bit, and get more early deliveries in the year. We needed to have the homes ready to do that.

So, it's a slightly different story overall, but when you add it all up, we're pretty close to our normal levels right now, and we don't see changing that dramatically.

Got it. And then, if I could ask one more on the SG&A: I think it was a positive surprise that the home-building component was down, even sequentially, even though your sales were up. How are you able to maintain costs? Or what did you cut there? And is that a sustainable rate into next year?

Yes, I think -- not really familiar that we cut anything as a percentage. Brad, did it go down on a dollar basis?

Yes, it went from [$51 million] to $48 million.

Yes, part of it is true-up of accruals in the business units; bonuses; bonus accruals (multiple speakers)

Bonuses, that's probably it. (multiple speakers)

I would say the better way to go is to look at the overall number for the year, and consider that going forward. I don't think there's a meaningful shift from the third quarter to the fourth quarter that will continue.

Okay, thanks a lot.

Your next question comes from the line of Brendan Lynch from Sidoti.

Good morning. Thanks for taking my question. Ara, you mentioned that opening new communities should be aided by your recent bond offering. I had not really thought of your pace of community-count growth as being capital-constrained, but more a factor of subs availability and sales staff capacity and other factors like that. Can you just comment on what may potentially be the governor on getting the community count up over the next couple years?

Yes, well, frankly, we were underinvested for many, many quarters; so, from that perspective, capital was not a limiting governor. It was just a matter of finding deals that met our hurdle rates. But as you saw, we were having more success in community acquisitions and getting to our investment goals. But as we did that, we thought it would be helpful to get a little bit of extra boost.

On top of that, we've noticed -- which we anticipated -- but we noticed our newer acquisitions had a bigger mix of larger, undeveloped sites, rather than the smaller, developed sites. The smaller, developed sites tend to take less capital. The larger, undeveloped ones take a little more capital.

Now, in some cases, we're able to utilize land bankers, and, therefore, we're able to purchase the lots from them on the basis that we'd prefer, which is on a regular quarterly takedown, but that's not the case always. So, we just thought it would be a smart thing for us to do to get the excess capital right now.

And we also thought, since there was a little bit of uncertainty in the market, it would be a good and somewhat safer time to do a little land acquisition than when it was really growing steadily. In which cases, land prices tend to go up a little irrationally sometimes. So, hopefully there's a little more rationality in the market, and we thought a better time to get in a little early before the market gets too much momentum on the recovery.

Great, thank you for the color.

There are no more questions. I would like to turn the call over to Mr. Ara Hovnanian. Please proceed, sir.

Great, thank you very much. Well, we're pleased to report the quarter and some reasonable results. Needless to say, we're anxious and look forward to even improved results going forward. We've given a heads-up; unfortunately, we'll have lopsided quarterly revenues and earnings again, but we're continuing in our path to get growth, and we look forward to another good year of profitability. Thanks so much.

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