Hovnanian Enterprises, Inc (HOV)
Q1 2009 Earnings Call Transcript
March 11, 2009 11:00 a.m. ET

Executives

Ara K. Hovnanian – President, Chief Executive Officer.
J. Larry Sorsby – Chief Financial Officer, Executive Vice President.
Paul W. Buchanan – Senior Vice President & Chief Accounting Officer.
Brad O’Connor – Vice President and Corporate Controller.
David Valiaveedan – Vice President of Finance.
Jeffrey T. O’Keefe – Director of Investor Relations.

Analysts

Michael Rehaut – JP Morgan
Carl Reichardt – Wachovia Securities
David Goldberg – UBS
Dan Oppenheim – Credit Suisse
Nishu Sood – Deutsche Bank Securities
Megan McGrath – Barclays Capital
Timothy Jones - Wasserman & Associates
Alex Barron – Agency Trading Group
Joel Locker – FBN Securities
Lee Brading – Wachovia Securities
Michael Wynn (ph) – Fair Lawn
Larry Taylor – Credit Suisse
Susan Berliner – JP Morgan

Presentation

Operator

Good morning and thank you for joining us today for the Hovnanian Enterprises fiscal 2009 first quarter earnings conference call. By now you should have all received a copy of the earnings press release. However, if anyone is missing a copy and would like one please contact Donna Roberts at 732-383-2200. We will send you a copy of the release and ensure that you are on the company’s distribution list. There will be a replay of today’s call. This telephone replay will be available after the completion of the call and run for one week. The replay can be accessed by dialing 888-286-8010, pass code 90702453. Again, the replay number is 888-286-8010, pass code 90702453. An archive of the webcast slides will be available 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 first quarter results and then open up the lines for questions. The company will also be webcasting a slide presentation along with the opening comments from management. The slides are available on the investor’s page of the company’s website at www.khov.com. Those listeners who would like to follow along should log on to the website at this time. Before we begin I would like to remind everyone that the cautionary language about forward-looking statements contained in the press release also applies to any comments made during this conference call and the information in the slide presentation. I would now like to turn over the conference call to Ara Hovnanian, President and Chief Executive Officer of Hovnanian Enterprises. Ara, please go ahead.

Ara K. Hovnanian – Chief Executive Officer

Good morning and thank you for participating in today’s call to review the results of our first quarter ended January 31 ’09. Joining me today from the company are Larry Sorsby, Executive Vice President and CFO; Paul Buchanan, Senior Vice President and Chief Accounting Officer; Brad O’Conner, Vice President and Corporate Controller; David Valiaveedan, Vice President Finance; and Jeff O’Keefe, Director of Investor Relations. If you turn to slide three, you’ll see a brief summary of our first quarter results. We gave all this data and more in our press release which we issued yesterday. There are a few points on the slide worth a little further discussion. First, in the third line down if you look at net contracts per community during the first quarter it showed the first year-over-year increase in years. While hardly a cause for celebration, it is a shift in the right direction.

Second, you can see that our cancellation rate decreased during the first quarter of ’09 to 31%. This is solidly below the 38% for last year’s first quarter and well below the high watermark of 42% that we recorded in the fourth quarter of ’08. Third, deliveries in the first quarter of ’08 included about 1,345 homes delivered from our Fort Myers/Cape Coral operation because at that time we determined that we no longer had any further continuing involvement from these homes with construction perm mortgages. Excluding these deliveries our total revenues in the first quarter of ’09 were down 53% and our deliveries were down approximately 47% compared to a 66% decline for both deliveries and revenues with the ’08 Fort Myers deliveries included. Fourth, we purchased $53.2 million of face value of debt for $14.7 million in cash and we exchanged $71.4 million of unsecured notes for about $29.3 million of secured notes. These transactions resulted in just about an $80 million pre-tax gain from debt extinguishment. Since the end of our first quarter we purchased approximately $315 million of face value of debt for about $105 million in cash resulting in a $210 million pre-tax gain and a corresponding increase in stockholder’s equity.

Historically, our first quarter which runs from November 1st through January 31st is a tough time of the year to read much in the way of traffic and sales. Even in good economic times the period between Thanksgiving, and New Year’s and Super Bowl is a time of the year when most people put home buying decisions on hold. But, as the weeks roll of in January we typically see some seasonal increase in traffic and sales. On slide four we show you what our monthly net contracts were since September of ’08.

In February monthly sales exceeded 500 for the first time in six months. Additionally, our contracts per community for February were more than two times what they were in the months of October, November or December. Although we are rebounding sequentially from low levels for new net contracts since mid September when the deepening financial crisis entered the most recent stage of this recession, the year-over-year comparisons are still off significantly. What these recent trends really say is that there is some level of demand for new homes despite all of the uncertainty regarding the economy. Unfortunately, the sales come at the expense of home prices and margins. In general we are focused more on sales and cash flow generation than margin. While reporting that net contracts for the quarter are down 36% is nothing to brag about, compared to the most recent quarter of our peers, our results are somewhat favorable by comparison and you can see that on slide five.

We believe this relative out performance, if you can call it that, is partly the result of our emphasis on cash flow. Despite cash flow being the primary driver in almost every decision that’s made in our company today, we’re only slightly cash flow positive for the first quarter as seen in slide # six and that does include as we disclosed a $145 million tax refund that we received in January. Historically, the first quarter is the quarter when we use the most cash so the fact that our cash flow is -$109 million absent the tax refund and the debt repurchases was not surprising to us. Last year when we generated $368 million of cash flow for the full year we were a net user of $55 million of cash in our first quarter. Given the continued deterioration in the housing market, generating cash flow in the future is clearly going to be more challenging than it was recently. However, as the chart reflects, annualizing our first quarter cash flow results excluding the tax refund is not an accurate methodology to project our cash flow results for the remainder of the year.

In order to maximize our liquidity we will still move forward with projects when cash flow make sense. The way we make this determination is through a lot recovery analysis. We perform a lot recovery analysis to determine the amount of cash that we can generate by building and selling a home on an owned lot. If we are unable to obtain a reasonable recovery in our land cost relative to the perceived long-term value, we will mothball that community. We will save that land until such time as the market improves and we can generate higher returns for more meaningful cash flow. Through the end of the first quarter we have mothballed approximately 9,500 lots in 65 communities. 13 communities were mothballed during the most recent quarter. The book value at the end of the first quarter for these communities was $531 million net of an impairment balance of $305 million. With cash flow as a primary decision driver, we make sure the choice to take down an option lot makes sense from a cash flow perspective. When it doesn’t generate enough cash we try to negotiate the option either by reducing the price and extending or modifying the take down schedule. If it still doesn’t make sense then we walk away. We continued to walk away from deals. During the first quarter we walked away from 2,390 lots.

During the last couple of years, the Texas market is the only notable one where we have entered new lot purchase agreements typically structured with deminimus deposits. We continue to deliver houses and sell lots when it makes sense.

Slide seven shows the impact that these decisions have made on our owned and option lot position. As of January 31 ’09 our total lots were down 69% from the peak that we reached in April of ’06. During the first quarter we delivered approximately 1,200 homes and sold about 200 lots. Offsetting these reductions, we took down about 250 lots and the balance was an increase in the number of lots due to the redesign of several communities. Our option lot position has come down more substantially. Option lots are down 83% from the peak in April of ’06. The dollars we have written off from walking away from these options are only a fraction of the impairments that we have taken on owned land. This is why we were such big users of options in the past and will be in the future. As we move forward our focus is on reducing our owned land position.

On slide eight we show a breakdown of the 23,000 lots that we own at the end of the first quarter. Approximately 47% of these were 80% or more finished, 17% had 30% to 80% of the improvement costs already in place and the remaining 36% were less than 30% finished. While we are currently focused on reducing our consolidated land supply, we recognize that land deals will start making sense again. Land prices should follow a similar pattern to what we have recently seen with home prices, as banks aggressively lower the sales price of foreclosed homes to get them off their books. In addition to reducing our land supply we continue to make adjustments to staffing levels based on current levels of activity. If you turn to slide nine, you will see that through the end of February we have reduced our staffing levels by 69% from the peak level of associates in June of ’06. Our community count is down 45% from the peak and our pace per community is at historical low levels. So, the 69% reductions in staffing levels seem to make sense. As we move forward we will continue to right size our business based on the current activity that we’re generating in each of our markets.

We’ve done a good job in reducing our absolute dollars spent on SG&A. On the right hand side of slide 10 you will see that our total dollars are down 16% year-over-year during the first quarter. However, our total revenues are down 66% year-over-year in the first quarter. So the first quarter percentage of total SG&A to revenues jumped 27%, much higher than anything we’ve seen in many years. A portion of this however is due to a $12 million non-cash FAS 123 expense relating to stock options that were cancelled in December ’08 causing a blip in our corporate G&A expense. These cancelled options were granted from ’03 to ’06 to Larry Sorsby, our Board of Directors and to me. As you can see on this slide, when you exclude the $12 million from these cancelled options our total SG&A was $90 million at 26% year-over-year decline.