Hovnanian Enterprises Inc (HOVNP) 2015 Q2 法說會逐字稿

Good morning, and thank you for joining us today for Hovnanian Enterprise FY15 second-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 second-quarter results and then open the lines for questions.

The Company will also be webcasting a slide presentation along with opening comments from Management. The slides are available on the investor's page and 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'd like to turn the call over to Jeff O'Keefe, Vice President, Investor Relations. Jeff, please go ahead.

Thank you, Amanda, and thank you for participating in this morning's call to review the results for our second quarter, which ended April 30, 2015. All statements in this conference call that are not historical facts should be considered as forward-looking statements within the meaning of the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Such statements involve known and unknown risks, uncertainties, and other factors that may cause actual results, performance, or achievements of the Company to be materially different from any future results, performance, or achievements expressed or implied by the forward-looking statements.

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; regional and local economic factors, including dependency on certain sectors of the economy and employment levels affecting home prices and sales activity in the markets where the Company builds homes.

Fluctuations in interest rates and availability of mortgage financing; changes in the tax laws affecting the after-cost tax 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 and integration of acquisitions; significant influence of the Company's controlling stockholders; availability of net operating loss carry-forward; utility shortages and outages or rate fluctuations; geopolitical risks, terrorist acts, and other acts of war; and certain risks, uncertainties, and other factors described in detail in the Company's annual report on Form 10-K for the fiscal year ended October 31, 2014, 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 for the Company are Ara Hovnanian, Chairman, President, and Chief Executive Officer; Larry Sorsby, Executive Vice President and CFO; Brad O'Connor, Vice President, Chief Accounting Officer, and Controller.

I'll now turn the call over to Ara. Ara, go ahead.

Thanks, Jeff. Let me get started with our second-quarter results, which can be found on slide 3. Our net contract dollars increased 5%, despite a slight decline in the number of net contracts we signed. This is due to a higher average sales price primarily as a result of product mix. We successfully opened up more communities during the quarter, and as a result, our active communities grew 6% year over year; however, our net contracts per community declined 5% year over year, negating the benefit of the increased community count.

Our contract backlog was stronger at the end of the second quarter, growing to $1.171 billion. The dollar amount of backlog increased 12%, and the number of homes in backlog increased 6%. This growth in backlog gives us confidence that we'll be able to continue to grow our top line in the second half of FY15 and improve our performance.

Our total revenues grew by 4%. This growth was driven by a 5% increase in average sales price, which was offset by a 1% decline in deliveries. Similar to what we have experienced in other recent quarters, the increase in the average sales price is primarily due to geographic and product mix changes and not related to our ability to raise prices on our homes.

Unfortunately, our second-quarter gross margin declined by 410 basis points, and our total SG&A as a percentage of total revenues increased by 80 basis points. I'll go into more detail about these metrics in just a moment. While we began the year with a year-over-year improvement in our first-quarter results, we took a step backwards during the second quarter of FY15, and our loss increased in the second quarter compared to a year ago.

The second quarter of FY15 was challenging for us. As we move forward, we are very focused on generating further growth in revenues so that we can gain more efficiencies. In addition, we are very focused on improving the results of our weaker divisions, and thereby returning our operating metrics to more normal levels.

Let me go into a little more detail about our gross margin and SG&A. As you can see on the left-hand slide of slide 4, we show our annual gross margin percentage for the last four years. We are pleased that we made solid progress from 2011 to 2012 to 2013, returning to more normalize gross margin levels of roughly 20% in both FY13 and FY14.

However, we've taken a step back in FY15. On the right-hand side of this slide, you see that we reported a 16.1% gross margin for the second quarter, 410 basis points less than last year's second quarter. As we discussed last quarter, we expected the second-quarter gross margin to be weak because of offering more incentives and concessions on started, unsold homes commonly, referred to as spec homes.

We're not the only home builder that recently felt pressure on its gross margin. On slide 5, we show all nine of the public builders that reported March quarter-end results. All of them had year-over-year declines in gross margin. Five of them had margin declines in excess of 200 basis points, and one was similar to our decline. Nonetheless, it doesn't make us feel great about our decline.

On slide 6, we show a trend of increasing the number of specs per community from the second quarter of 2014 to the fourth quarter 2014. As we explained during our analyst call last quarter, we believe we were too aggressive in our spec starts, especially in certain geographies and communities. We took action to reduce our specs with special incentives and concessions. Unfortunately, as you would expect, that took a toll on our margins.

However, we made progress on our goal of reduction. The number of specs per community declined to 4.1 at the end of the second quarter of FY15, which is below the recent peak of 4.7 specs per community at the end of the fourth quarter of FY14. Let me explain the negative impact that specs had on our gross margin during the second quarter and why we think the gross margin will improve during the remainder of FY15.

Turn to slide 7. Our gross margin during the second quarter of 2015 was less than we thought, primarily because of additional incentives and concessions, as I said earlier, that we offered on specs. The following numbers exclude Houston, where our gross margins continued to improve during the second quarter.

Margins in our to-be-built homes declined 220 basis points during the second quarter of FY15 compared to last year's second quarter. Relative to our peers' margin declines, our decline in gross margins on to-be-built homes would've put us in the middle of the pack. However, margins on our spec homes declined 2 times that amount, or 450 basis points, over the same time period.

You can clearly see from these numbers that the bulk of the pressure on gross margin was from spec home deliveries. Furthermore the percentage of deliveries from spec homes in the second quarter increased to 52% in this year's second quarter from 42% in last year's second quarter. It's typical for spec homes to be sold with lower gross margins than to-be-built homes, but the increased incentives we offered over the last six months exacerbated the typical spread.

Because 25% of the deliveries were specs sold during the quarter, the impact was greater than we anticipated when we provided guidance during our first-quarter conference call. Spec deliveries in the second quarter of FY15 increased to 52% of our total deliveries, from 46% in the first quarter. Given the current level of specs and our expectations for specs per community going forward, we believe the percentage of quarterly spec deliveries will gravitate back to the low 40% range over the next several quarters.

Turning to slide 8, we show that the discount on spec homes compared to to-be-built homes was 250 basis points during the second quarter of 2014 and that we increased the discount on spec homes compared with to-be-built homes to 480 basis points during the second quarter of 2015. The discount on specs compared to to-be-built homes appears to have peaked this quarter. It was 230 basis points higher than it was in the second quarter a year ago. Clearly, you can see we are aggressive in taking action to bring our spec position into better balance by geography and by community.

Last quarter, we warned you that we were increasing incentives on our specs. Now I'm happier to say that we are scaling back our incentives and concessions that we're offering on spec homes, and we've already begun to see the spread trending toward normalized levels. The trend of fewer specs as a percentage of total deliveries and a more normal spread between specs and to-be-built homes should lead to sequential improvements in gross margin in the final two quarters in FY15. It should also lead to an improved gross margin in FY16.

Now, turning to slide 9, you can see that our SG&A as a percentage of total revenues increased year over year during the second quarter of 2015 to 14.7% from 13.9% in last year's second quarter. The majority of this increase was related to our efforts to grow our community count, including higher compensation costs related to increased staffing and increased architectural expenses. Once these new communities begin to deliver, we expect to further leverage our fixed SG&A expenses. Our SG&A ratio for the full FY15 year should be similar to last year and should decline in 2016.

On slide 10, we show our annual total SG&A expense as a percentage of total revenues going back to 2001. We consider about 10% as a normalized SG&A ratio.

As we continue to generate further revenue growth and achieve more normalized sales pace per community, we expect to be able to leverage our fixed SG&A leverage expenses further and get this ratio back to normalized levels of 10%. As we have said in the past, it's not point to happen overnight, but we will continue to make progress to bring this number down over time.

I'll now turn it over to Larry Sorsby, our Executive Vice President and Chief Financial Officer.

Thanks, Ara. Turning now to our current sales environment on slide 11, we show the dollar amount of our consolidated net contracts per month for each of the past 12 months. The most recent month is shown in blue, the same month of the previous year is shown in yellow, and we use green arrows pointing up to indicate an increase and down red arrows to indicate a decrease.

Driven by the combination of increased community counts, and more recently, stronger sales results, 10 of the past 12 months have had year-over-year increases. In May, the first month of our third quarter, we saw an increase of 18.6% in the dollar amount of net contracts.

While slide 10 showed the dollar amount of net contracts, slide 12 shows the number of monthly net contracts per community. While there have been more positive than negative monthly comparisons recently, the market still seems a bit choppy.

If you take a step back and recall the steps that we took in the spring selling season of 2014, some of the fluctuations for us make sense. In March, 2014, we did a national sales promotion called Big Deal Days. It was highly successful, and we had 3.4 contracts per community during the month of March, 2014, making it a very tough year-over-year comparison.

But it likely pulled demand forward, because we fell to 2.9 contracts per community in April, 2014, which created an easier comparison for the same month this year. So it should not be a surprise that net contracts per community declined year over year in March, 2015, and increased in April, 2015. But sales promotion or no sales promotion, the market still feels a bit tentative right now.

On slide 13, we try to put the current sales situation into perspective with a longer-term view. The dark blue bar shows the average net contracts per community for 1997 through 2002, a period of neither boom nor bust times.

Then in yellow, we show net contracts per community bottoming in 2011, followed by two years of improvements in 2012 and 2013. Surprisingly, we in the homebuilding industry took a step backwards in sales pace per community in 2014.

Looking at the light blue bar, it shows that the seasonally-adjusted trailing 12-month net contracts per community increased to 30.4 and is approaching the 30.7 contract per community level we saw in 2013. This is certainly a step in the right direction and will hopefully continue or improving the back half of this year.

I want to provide a brief update on what we are seeing in Houston. Our profitability in Houston remains solid, with gross margins and revenues expected to increase over last year. The margins that we currently have in our backlog remain solid, and we continued to have pricing power in Houston.

Turning to slide 14, you can see our quarterly net contracts per community in Houston for 2013, 2014, and 2015. With net contracts increasing to and 9.1 per community in the second quarter of 2014, you can clearly see how white hot the Houston market was in the second quarter last year. While we do not believe it's related to declining oil prices, our sales pace during the second quarter of this year cooled to 6.9 net contracts per community.

The decline in our second-quarter sales pace was due to a combination of factors, including a very difficult year-over-year comparison and the fact that we intentionally slowed down or stopped selling homes in certain communities where our land developers were significantly delayed in delivering us finished lots. Due to these longer cycle times, we were unwilling to guarantee a fixed home price to our customers when we could not lock in our construction cost. We remain cautious about the impact of lower oil prices on the Houston economy and will continue to keep a close eye on the market and any further developments we see there.

On slide 15, we show that the dollar amount of consolidated net contracts increased 5% year over year to $701 million during the second quarter. Assuming no changes in market conditions, given the growth in our community count plus the additional communities that we expect to open in the second half of 2015, we believe that we will be able to grow our revenues significantly in FY16. This gives us confidence that 2016 will be a solidly profitable, and we will break out of our string of low- or no-profit performance years.

Turning to slide 16, it shows that our consolidated community count has grown steadily over the past two years. There is a lot of activity that goes into a net increase of 11 communities that we saw in the last year. During the last 12 months, we opened 97 new communities and closed out of 86 older ones. We expect to see continued community count growth as we move forward.

Based on the growth in our community count and average selling price, the dollar amount of our backlog has grown compared to last year. On slide 17, we show the dollar amount of our backlog increased 12% to $1.17 billion, from $1.05 billion at the end of last year's second quarter.

You can also see on the bottom of this slide that the number of homes in backlog grew to 2,972, up from 2,797 last year. This increase in backlog, combined with the community count growth, provides further evidence that we'll be able to continue to grow our top line throughout the remainder of this year, which we expect to result in sequentially improved quarterly performance.

Turning to slide 18, you'll see our owned and optioned land positions broken out by a publicly reported market segments. Our investment in land option deposits was $87 million on April 30, 2015, with $86 million in cash deposits of $1 million of deposits being held by letters of credit. Additionally, we have another $22 million invested in pre-development expenses.

Assuming current market conditions remain steady, we continue to anticipate unmothballing approximately 900 lots in FY15 in two locations. One in Natomas, California, and the other along the Hudson River waterfront in New Jersey. As the housing market improves, additional communities will be unmothballed in future periods.

Looking at all of our consolidated communities in the aggregate, including mothballed communities, we have an inventory book value of $1.5 billion, net of $559 million of impairments. We've recorded those impairments on 71 of our communities. For the properties that have been impaired, we're caring at 22% of their pre-impaired value.

Another area of discussion for the quarter is related to our deferred tax asset valuation allowance. During the fourth quarter of FY14, we reversed $285 million of our deferred tax asset valuation allowance. We will reverse the remaining valuation allowance when we begin to generate higher levels of sustained profitability.

Back when we had a valuation allowance covering the full value of our deferred tax assets, other than minor amounts related to federal or state tax reserves, any income tax benefit or expense was offset by adjustments in the valuation allowance, resulting in no income tax benefit or expense on the income statement. Now that we've reversed a portion of the valuation allowance, income tax benefit or expense is reflected in the income statement, consistent with how we've reported taxes prior to having a valuation allowance.

At the end of the second quarter of FY15, our valuation allowance in the aggregate was $643 million. The remaining valuation allowance is a very significant asset not currently reflected on our balance sheet, and we have taken numerous steps to protect it. Will not have to pay cash federal income taxes on approximately $2 billion of pretax earnings.

On slide 19, we show that we ended the second quarter with a total shareholders' deficit of $146 million. If you add back the remaining valuation allowance, as we have done on this slide, then our shareholders' equity would be a positive $497 million. Over time, we believe that we can repair our balance sheet by returning to higher levels of profitability and have no intentions of issuing equity any time soon.

As seen on slide 20, after spending $108 million on land and land development during the second quarter, we still ended the second quarter with $312 million of liquidity, which includes $259 million of homebuilding cash and $53 million undrawn under our $75-million unsecured revolving line of credit. We once again ended the quarter in excess of our target liquidity range of $170 million to $245 million.

Now, turning to our debt maturity ladder, which can be found on slide 21. The red bars on this slide represent unsecured debt.

We continue to believe we have the ability today to refinance all of our unsecured debt that matures between 2015 and 2017. However, in order to reduce the high cost associated with the make-whole provisions, we have waited to refinance those bonds until we were closer to the maturity dates. I expect that we will likely refinance the 2015s and at least the early-dated 2016s sometime this summer.

Because of the financial constraints that we had earlier in the cycle, we had less capital to spend on land, and therefore, were less aggressive on investing in land than some of our peers. But as you can see on slide 22, over the past 12 quarters, we have gained control of about 10,000 more lots than we actually delivered homes on, and our land acquisition teams across the country continue to work hard to identify new land parcels to purchase today.

We know the general timing of when these investments are going to come online as active selling communities. We are finally at the point where we will be opening up a lot of communities, which gives us confidence in our ability to build revenues and profitability in 2016.

With respect to the walk aways shown on this slide, our option deposits are typically fully refundable during the due diligence period. The walk aways from the second quarter of 2015 resulted in only modest charges, primarily consisting of investigative expenses incurred during the due diligence period. We feel good about our liquidity position and will continue with land purchases that meet our 25%-plus unlevered underwriting hurdle rates based on today's construction costs, today's home prices, and today's absorption rates.

Turning to slide 23, I would now like to discuss our expectations for the remainder of FY15. Assuming no change in market conditions, we expect to report total revenues between $2.2 billion and $2.3 billion for all of FY15. We expect our full-year gross margin for all of FY15 to be between 17.4% and 17.8%. We expect total SG&A as a percentage of our total revenues for all of FY15 to be between 12.1% and 12.4%.

While we sill feel good about our ability to grow the top line during FY15 and still expect to generate a solid profit during the fourth quarter, we do not expect it to be sufficient to offset the losses in the beginning of the year, including a loss in the third quarter. We expect the pretax loss for the full year to be between $15 million and $30 million. This is due to this year's decline in gross margin and the relatively high level of SG&A related to preparing for greater top-line growth.

I'll now turn it back to Ara for some closing comments.

We're not happy about the step backwards we've taken in 2015. As much as I'm disappointed in our results in 2015 thus far, we are expecting dramatically better results in our fourth quarter, which begins in August, and continuing through 2016, which begins in less than five months.

We're planning some aggressive growth for 2016. We believe we are well-positioned for this growth based on our land position. We are growing our community count.

Additionally, we are taking steps to improve the operating results of some of our weaker divisions. The steps include recent management changes, whittling down some of our older communities, and new communities coming online with better financial metrics.

We believe the seeds we have been planting are going to pay off for us in 2016, which is why we're calling for a breakout year in deliveries, revenues, and profitability. Any benefits we get from an improvement in the housing market will only accelerate our top- and bottom-line growth.

That concludes our formal remarks, and I'm happy to turn it open for questions.

(Operator Instructions)

Susan Maklari, UBS

Good morning.

Good morning.

In terms of the spec level, I know that you commented that you expect it -- it's already started to come down, and you expect that to further come down. Can you give us some sense of how we should be thinking out a normalized level in terms of the number of homes per community?

We actually don't expect it to come down much further from where we are right now. The issue was not so much the absolute level of specs per community, but our distribution. Normally, in markets like Houston, we ran higher specs per community, but that market has been quite strong, and we've been selling the homes early, so we have actually fewer specs there.

I think some of the mistakes we made, we had specs in areas that we don't customarily have spec homes. That would be markets like Virginia or Maryland or New Jersey, and there, the market was not used to as many specs. The market is not particularly strong, and that's where we had to take some steep discounts to adjust it.

That's a long-winded way to say that the issue is not the number of specs in absolute sense, but the balance and distribution between geographies and product lines. We also started a few specs more than we should have in retrospect on some of our higher-end communities as well. We think the key is more bringing it in balance than reducing the number further.

Okay, that's helpful. Thanks. And then my second question is, you noted that in Houston things continue to be strong, but that you have had to slow sales down where lot deliveries have been delayed. Given the recent weather down there with the flooding and that situation, could that potentially get pushed further out and have further impacts for that market?

Sure. They had extremely wet spring, and then they had the flooding that occurred, and it's still fairly rainy. That's not helpful when you're trying to develop lots. The lots were already delayed, and certainly, the weather has caused further delays for developers across Houston as well.

Obviously, we're hoping the weather gets a little bit better so the developers can catch up and get our land developed and delivered to us. In Houston, we are primarily a buyer of finished developed lots.

Okay. Thank you.

Megan McGrath, MKM Partners

Good morning. Thanks for taking my question. Some followup from the gross margin. Just wanted to make sure that -- when I look at your guidance for the full year, it looks like that implies, if I'm doing correct math, about 200 basis points in improvement by the end of the year. Is that about right? And do you expect that to come gradually, or are we going to see a big bump in the 4Q gross margin?

I think you are in the ballpark in terms of your math. Certainly, the fourth quarter is going to be stronger than the third quarter. You will see is sequential increases in the margins is how it's going to occur.

Great. And I wanted to follow up on your detail on the to-be-built margin differential that you broke out. When we heard from a lot of other builders, their commentary was that this was a reflection of the weak market at the end of 2014 rather than a commentary on the existing market. Would you agree with that, and are you expecting to see that margin improve as we go through the end of the year?

You mean on to-be-builts? Is that the question?

Yes, on to-be-builts.

Yes, I would say that the to-be-built margins did decline in the latter half of 2014. That was a result of the slower sales pace that us and the whole industry was experiencing as compared to the better sales pace per community that we experienced in 2013. So builders were trying to get a disproportionate share, and the way they did that was offer incentives and concessions.

I'd say that's been mitigated for the most part this year as the market has shown some strength. So I think most of the decline in margins related to to-be-built homes is probably either in backlog or already been delivered and that we're seeing slightly stronger to-be-built margins as we move forward.

Okay thanks very much.

Michael Rehaut, JPMorgan

Hi, good morning. It's actually Jason Marcus in for Mike. The first question was hoping you could talk a little bit more about the overall demand environment. I know you talked about gross margins being below your expectations, but in terms of sales pace, obviously, it declined about 4% or 5% during the quarter, and I just wanted to see how that compared to your expectations as you look across the different regions throughout the Company? And then furthermore, as you look into 3Q, if you could talk about how you are balanced on price versus pace?

I think, again, as I tried to explain when I talked in the script about the sales pace, it's partially impacted by the tougher comparison we created for ourself last year when we did our national sales promotion, so that's part of the answer. But in terms of expectations, I think the candid answer is, we really thought leading into January sales, or all the way through January, monthly year-over-year net contracts per community had shown a positive trend [four] months in a row, and that gave us great optimism that the spring selling season would continue that kind of pattern.

So we were disappointed when February showed a decline. I think we talked about that a little bit during last quarter's conference call. March, that decline didn't surprise us quite as much, but expectations, being optimist, probably were still that even March would show at least even, if not a slight improvement year over year. So I don't know if that is responsive enough to your question, but that's my macro view of it.

Just overall adding to that tone, in the first quarter, the actual first-quarter months, November, December, and January, as you may recall back on slide 12, our contracts per community were up every single month, but we did report the first month of the next quarter, February, which was down. As it turns out, as you know now from the results, February and March were down, but the good news is, unlike last quarter where we began with a negative month, this time, we ended the quarter in April positively, and we began with a very strong May. So we're optimistic that this is more of a trend in the positive direction.

However, as you can obviously see, for us, we've seen the market being choppy overall in our markets. We're hoping some of that choppiness ends, but it's hard to tell. We didn't expect in February and March to the extent that we had the downward comparisons, but we're pleased that April and May are up strongly.

As we mentioned in dollar amount of net contracts in May, it was particularly strong, with $213 million compared to last year's $179 million. Our recent results we are very pleased with.

Okay, great. And then next question, quickly, on the land market, if you could talk about what you were seeing there in terms of the competition and pricing from a regional perspective, and if you've had to adjust your underwriting criteria.

No. The underwriting criteria is about the same, and I can't say there has been any great change in competitiveness on the land deals. As you can see, we really have to do our due diligence. You saw on one of the slides, many of our initial options don't withstand the due diligence process. You have to be extremely careful in this environment. And we're remaining true to our discipline and trying to be very analytical in our new acquisitions, which are critical.

But on the whole, I would say the market is balanced. We're finding opportunities as we need them. 2016 is basically all purchased, or at least optioned and controlled and in contract, so we are today, just working to build our 2017, and that includes counting on significant growth for 2016.

Okay, thanks.

Nishu Sood, Deutsche Bank

Hi, good morning. This is actually Kanika Goyal on for Nishu. My first question is regarding gross margin. Can you shed some light on why you consider 20% to be a normalized gross margin, and do you need pricing power to get there?

The reason we consider 20% to be a normalized gross margin is -- we showed some longer-term history of our gross margin, and I'm not sure exactly which slide it is. Jeff will look it up as I am speaking. But between 1997 and 2002 when it wasn't a boom market or a bust market, we averaged just around 20%, 21% gross margin. We consider that a normalized gross margin.

We actually achieved that gross margin in 2013 and 2014, so we don't really need pricing power per se. We just need our communities -- our new communities coming online should be averaging in that regard. We need the market to hold up to where builders aren't offering as much incentives and concessions as they did in 2014. So I think we'll get back to that 20% over time.

I will add that, obviously, during the stronger markets we have registered gross margins far in excess of that. In fact, I think in 2004 and 2005, we had 25% and 26% gross margin. So certainly is capable of exceeding 20%, which is about where we consider normalized. Right now, we're just anxious to get back to our normal levels.

Okay, thank you. And my next question is, can you shed some more light on your backlog and why you are confident that you will see higher margins in the back half of the year? What factors are going to drive those?

We can see the numbers as we sell each house, what the margin is, and we can see what our margin is, actually, in backlog across the country, and we know what month those are expected to close in. So we have pretty good visibility and transparency, and that's what's gives us confidence to make the statement we did about margins improving throughout the rest of this year.

The one caveat is that we do sell typically about 25% of each quarter's deliveries during that quarter. Those are specs. And last quarter, as we had announced, we were planning to discount the specs, and ended up, we discounted more than we planned, so we came in a little lower in our gross margin than we had anticipated.

At this time, we are seeing the spreads narrow on our specs, so we're feeling better about that trend. Still, we haven't sold all of the specs, as we typically don't, for the quarter deliveries, but we just don't anticipate any negative surprises this time based on the current environment.

Got it. Thanks.

(Operator Instructions)

Alan Ratner, Zelman & Associates

Good morning. Thanks for taking my question. Ara, as I listen to your commentary, I definitely hear the frustration in your voice about the recent performance. And I think while all builders agree the recovery hasn't been as robust as we would've expected a few years ago, I think it is fair to say the market is in a materially better position today than back in, say, 2012. Yet your metrics are pretty similar now versus when they were back then.

So my-bigger picture question to you is, as you sit here today and you think about Hovnanian's outlook, I was curious if there's any consideration being paid by Management and the Board to a more material strategy shakeup? You mentioned the recent management changes at the local level, but was curious, is there any consideration to exit weaker-performing markets, sell off some land to shrink the balance sheet, even bringing in an outside consultant to help craft that longer-term vision of the Company as some other builders have done over the last few years?

Appreciate the comment, and yes, you do correctly hear frustration in my voice, but we think we see the path to improvement and we think it's upon us. If we don't meet the positive fourth quarter that we believe we've got with dramatically better results, and if we don't kick off FY16 with positive results, then I think we'd look at something more significant.

But really, we are employing the same strategies in general in how we manage that led us to industry-leading performance in the last up cycle. In 2004 and 2005, with largely the same Senior Management Team in place, we not only outperformed almost every single public builder in those two years, but we actually were number two on the Fortune 500 performance in terms of return on equity and growth in profit.

So we think we know what we need to do, and we don't think the fundamentals have changed that much. Obviously, we were hampered by the mistakes that were made before the downturn, and we have been saddled with some of those mistakes that haven't given us the same flexibility that some of our competitors have had, but we have gotten through that.

We weren't able to quite do the land purchases we would have liked or that some of our competitors did, but we have made some great progress. We've got a lot of communities opening, and we think that performance should be turning around shortly. We look forward to reporting much better results, particularly beginning in the fourth quarter and going on from there. It's only a few months away.

Great. I appreciate it. Thanks very much.

Susan Berliner, JPMorgan

Hi. Good morning.

Good morning.

I want to start with land spend. I was wondering, in light of the upcoming debt maturities, if you may be looking to reduce land spend? I know if you go back to FY11 and FY12, you guys were closer to $400 million instead of the $600 million last year.

Sue, if you will recall on last quarter's call, we discussed after raising $250 million of debt in the first quarter that we took some near-term steps in order to more fully deploy that cash. Those steps allowed us to avoid that negative arbitrage of paying interest both on our new debt and interest on items such as non-recourse mortgages, model sale lease backs, land banking arrangements, et cetera. And we also said we would reactivate those programs when we decided to increase our liquidity or deploy additional cash to grow our land positioning further.

And actually, in the second quarter, towards the end of the second quarter, we've reactivated some of those programs so the $108 million land spend is artificially low, and the land spend that we had in the first quarter -- I don't recall exactly what it was -- was probably a little bit high. So if you average our spend over those two quarters, that's what our quarterly spend has been without the white noise of some of those actions we took to reduce interest costs. We've really been steady on our land spend is what I'm really trying to convey.

Okay. And then if I could turn to markets because I'm still a little confused on the slowdown and absorption pace,. And I know you had some in Houston, and I was wondering if you could talk about some of your other large markets, whether it be DC, New Jersey, Chicago, et cetera.

Sure. The strong markets overall for us continue to be, in addition to Texas, the Northern California, Silicon Valley suburbs where we've got communities there -- a particular community, a large one with two product lines, where we have people camp out, and we literally sell out the morning we release the homes. That market has been particularly strong. And we're about to open another new and large community there as well, so we think that's going to be beneficial.

The DC market overall has been sluggish compared to where we'd expect it to be at this time in the cycle. Clearly, sequestering is taking its toll, and employment has not been as vigorous as it used to be. So that is not giving us the punch that we normally have.

In the Northeast, that market has just not recovered as vigorously as other markets have. However, some of our newer communities that we were able to purchase at a solid basis have performed very well. So we're anxious as we continue to open new communities to get a bigger mix of our new communities compared to the old legacy ones in the Northeast, and we think that alone will improve our performance.

And finally, in Florida, in Southeast, and Orlando in particular, they are very strong markets. We've got several communities underway with land development. We're just anxious to get the models open and open for sale there. We think that will be very helpful. We've got some good properties at a good basis, and we're just anxious to get land development done and models built to open up.

Great. Thanks very much.

At this time, I'd like to turn the call back over to Mr. Hovnanian for any closing remarks.

Thanks very much. Listen, we understand disappointment in the results. We're disappointed, but we look forward to reporting better results in the very near future. Thank you.

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