Jeffrey O'Keefe - VP, IR Ara Hovnanian - President, CEO & Chairman of the Board Larry Sorsby - EVP, CFO & Director.

Arjun Chandar - JPMorgan Chase & Co. Alex Barrón - Housing Research Center James Finnerty - Citigroup.

Good morning, and thank you for joining us today for Hovnanian Enterprises Fiscal 2018 First Quarter Earnings Conference Call. And archive of the webcast will be available after the completion of the call and run for 12 months. This conference is being recorded for a rebroadcast. [Operator Instructions].

Management will make some opening remarks about the first quarter results, and then open up the line for questions. The company will also be webcasting a slide presentation along with the opening comments from management. The slides are available on the Investors Page of the company's website at www.khov.com.

Those listeners who would like to follow along should log 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, Chelsey, and thank you for all participating this morning's call to review the results for our first quarter, which ended January 31, 2018.

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.

Such forward-looking statements include, but are not limited to, statements related to the company's goals and expectations with respect to its financial results for future financial periods.

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.

By their nature, forward-looking statements speak only as of date they are made, are not guarantees of future performance or results and are subject to risks, uncertainties and assumptions that are difficult to predict or quantify.

Therefore, actual results could differ materially and adversely from those forward-looking statements as a result of a variety of factors.

Such risks, uncertainties and others are described in detail in the sections, entitled Risk Factors and Management's Discussion and Analysis, particularly the portion of MD&A entitled Safe Harbor statement in our annual report on Form 10-K for the fiscal year ended October 31, 2017, and subsequent filings with the Securities and Exchange Commission.

Except as otherwise required by applicable security 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 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 Bachstetter, Vice President, Finance and Treasurer. I'll now turn the call over to Ara. Ara, go ahead..

Thanks, Jeff. As is typical, I'm going to review the operating results for the first quarter. I'll also discuss our current sales environment as well as our progress in land acquisition. Larry will follow me with more detail and discuss other items, including our liquidity position and our recent financing transactions.

I'd like to purpose my comments by reminding you about the impact from retiring rather than refinancing $320 million of debt in late '15 and '16 that was a turbulent time for the high-yield market. As a result, we are unable to replenish our land supply sufficiently at that time.

And this led to a reduction in our community count and revenues today, which obviously impacts our overall profitability. We're beginning to turn the corner regarding our land supply, and we will describe that more fully in a moment.

Our recent financings provided us with both the significantly enhanced maturity ladder and capital at favorable rates to invest in our core business. However, our first quarter deliveries, revenues and profitability were adversely impacted by decreases in our community count.

No place is as more evident than with respect to your revenues, which declined 24% during the first quarter from same quarter a year ago for all of the reasons I just stated. Turning to Slide 4. Here you can see that our adjusted gross margin was higher than last year at 17.9% compared to 17.2% a year ago.

Despite this increase, we and the industry continued to be challenged by increasing labor and material costs. Now turning to Slide 5. You can see the challenge with regard to rising material costs, primarily lumber and OSB prices. To put this in perspective, the left side of the slide shows that framing the lumber composite is up 23% from a year ago.

On the right-hand side, you can see that OSB is up 25% from a year ago. These meaningful increases are particularly relevant, because lumber and OSB make up about 15% of our typical home cost. Most of the lumber spike in '17 was driven by Canadian lumber import tariffs.

And the more recent spike in OSB was due to the loss of production mills from the hurricanes. Commodity prices are available, and they certainly have been fluctuating. These rising construction costs have and will continue to impact the gross margin on deliveries for land that we already own.

The higher lumber cost and labor costs are factored into all new land acquisitions that we're underwriting today, assuming no further cost increases in construction or any home price increases. On average, homes delivered on these new purchases are expected to generate normalized gross margins of about 20%.

The increases in labor and material costs are an issue that has affected our entire industry. On Slide 6, we show the trailing 12-month gross margin for 13 of our peers plus our own.

None of our peers reported year-over-year declines in gross margin, and one homebuilder reported flat gross margins Hovnanian and three other homebuilders reported small year-over-year increases. Gross margins are generally low at the current time for all homebuilders.

As demand for housing continues to increase, the market will adjust to the recent increases in labor and material cost, which should allow our gross margins to gradually return to normal levels, around 20% for us. On the top of Slide 7, we show our SG&A expenses increased slightly during the quarter from $60 million to $62 million.

This increase was primarily due to increases in corporate G&A related to legal expenses from our recent financings, rent on our corporate office as a result of a sale and temporary leaseback of our corporate office, Larry will talk more about that in a few moments, and the stock option expense credit in last year's first quarter that did not occur this year.

Without these unusual expenses, our SG&A would have been about $1 million less than last year, nonetheless, the drop in revenues - given the drop in revenues, our SG&A expense is still high, while we normally shrink our overhead further be in line with the lower revenues. We're working hard to return our revenues back to previous levels.

By fiscal '20, we expect to be much closer to our normalized SG&A levels of around 10%. In the lower left-hand corner of the slide, you can see that total interest expense was flat year-over-year at $41 million.

Despite lowering our interest expenses by paying off $56 million of maturing debt and using fewer nonrecourse mortgages, model sale leasebacks and land banking arrangements, the $840 million of refinancing of our secured debt last summer was at a much higher interest rate than the debt it replaced, which is added to our interest cost.

Larry will discuss in his recent - in his remarks that we expect to lower our interest expense by refinancing roughly half of that debt at lower rates in the summer of '19 when the noncall period expires.

And finally, in the lower right-hand corner of the slide, because of all the foregoing, we show that our loss before income taxes, land-related charges and gain on extinguishment of debt was $30 million compared to a loss of $4 million in last year's first quarter. Let me take a moment to comment briefly on our sales activity.

On Slide 8, we show our contracts per community on a monthly basis. Here, we show the most recent month in blue and the same month a year ago in red - in gray. For 11 of the last 12 months, contracts per community were equal to or better than the same month of the prior year. The month of February also had an increase in contracts per community.

So certainly appears that the spring selling season is already off to a good start. I've already mentioned the declines in our community count, but if you turn to Slide 9, you can see the trend in our community count since the beginning of 2016.

Our community count decreased sequentially each quarter through '16 and '17, primarily due to the steps we took in '16 to retire rather than refinance the $320 million of maturing debt as I mentioned earlier. Partially offsetting the impact of a declining community count is the fact that our sales per community have been steadily increasing.

On top of each quarter on this slide, we show an arrow with a year-over-year percentage increases in contracts per community for those same quarters. On the right-hand portion of the slide, we show our contracts per community increased again during the first quarter of '18, rising 3% over last year's first quarter.

We reported increases in contracts per community for each of the nine quarters shown on this slide. While we continue to make progress, contracts per community are still well below our normal levels. You can see this on Slide 10.

On the left, we show that our annual contracts per community averaged 44 from 1997 through 2002, a time that was neither a boom nor a bust in the housing market. On the right-hand side of this slide, you can clearly see the steady growth in contracts per community each year for the past several years.

We'd anticipate that as demand slowly returns to normal levels, and the supply of finished lots remains challenging as is typical during the recovery, contracts per community should return to normal levels.

While we did see a year-over-year decline in community count, the first quarter marked the first sequential increase in community count since the fourth quarter of '15. We're pleased to have seen growth in sequential community count. However, we don't anticipate sustaining this level of community count over the next several quarters.

Suffice it to say, we remain very focused on growing our community count. The first step is increasing our land control position, which we accomplished during the first quarter.

However, sustainable community count growth has proven more difficult than we originally thought, partially due to the longer lead time from land contract to community opening. Previously, we believe sustainable community count would begin in the second half of 2018.

We now believe it will occur a couple of quarters later in the early part of fiscal '19. We continue to work hard to replenish and grow our land supply, and our teams have been very busy throughout the country.

During the first quarter, we spent a $159 million on land and land development, which is higher than the average of $139 million that we spent during the previous four quarters. On the up of Slide 11, you can see that for the first quarter of 2018, we increased our net new options by 51% or 874 lots compared to first quarter of '17.

We remain disciplined to our underwriting standards. Our underwriting assumptions used current sales price, current sales pace and current costs. Typically, as we progress in the recovery, sales pace and sales price increased more than costs, however, our budgets don't assume that benefit.

We're not stretching for transactions that don't make sense based on the current conditions. Consistent with our strategy to maintain or improve our inventory turns, we look to control as much as possible through options when - where we purchased the land just before construction begins. Looking at the bottom of the slide.

You can see that in addition to optioning the lots, we're busy purchasing lots as well. And for the first quarter of fiscal '18, we purchased about 2,421 lots, that's 200 more or about 8% more than we purchased in the same quarter a year ago.

As we've said before, there is a significant lag from the initial contract to the time when the community opens for sale, and ultimately, when we can deliver homes. This time lag can vary from a few months in a market like Houston to 3 to 5 years in markets like California or New Jersey.

Once the community count begins to grow, delivery and revenue growth will follow a few quarters later. I'll now turn it over to Larry Sorsby, our Executive Vice President and Chief Financial Officer..

Thanks, Ara. I'm going to start by providing an update on our Houston operations. Turning to Slide 12. Despite the fact that we have had almost three years of significantly lower oil prices, our Houston operations continue to pose solid results. Here we show contracts per community for the trailing 12 months ending January 31, for the last four years.

As you can see, the 26.1 contracts for the most recent trailing 12 months is higher than both 2015 and 2016's levels, and just slightly less than 2017's level. Without the impact of Hurricane Harvey in the fourth quarter of last year, we suspect that our Houston contract results would have, once again, improved year-over-year. Turning to Slide 13.

For the first quarter of 2018, we had 5.4 contracts per community in Houston, which is identical to the pace we achieved in the first quarter of both 2014 and 2015, and up from the 5.0 pace we achieved in the first quarter of 2016. However, it is down a touch compared to the 5.6 contracts per community in last year's first quarter.

The fundamentals in the Houston market remain strong. Some of our peers have shifted their focus to the more affordable price points where we have been successfully operating for years. The overall market is continuing to recover from Hurricane Harvey.

We're seeing labor and material costs modestly trend up as trades are going to jobs repairing the hurricane damage where they will be paid more. Although, we have been able to raise prices, margins are under a bit of pressure in Houston as cost have gone up faster than home prices.

Houston remains an important market for us, and we have confidence in our local leadership team. However, we will continue to monitor this market very closely. If you turn to Slide 14. We show our land positions since the beginning of 2015.

For the first time since January 2016, we have achieved year-over-year increase in the total number of lots we control. At the end of the first quarter, we increased the number of wholly-owned lots we controlled to 27,183.

This was an increase both sequentially compared to 25,329 lots at October 31, 2017, and year-over-year from 26,234 lots at January 31, 2017. While we're pleased to report an increase in our lot supply, we remain focused on replenishing our land supply even further so we can return to growing our community count revenues and profitability.

Furthermore, we controlled 14,260 consolidated lots through optioned contracts. Many investors mistakenly believe that the majority of our land options are held by land banks, which certainly is not the case. Our land bank lots peaked at 16% of our total lot options at the end of the third quarter of fiscal 2016. As you can see on Slide 15.

This percentage has declined only 8% of our lot options by the end of January 2018 compared to 13% at the end of last year's first quarter.

Looking at all of our consolidated communities in the aggregate, including mothballed communities and the $94 million of inventory not owned, we have an inventory book value of $1.1 billion net of $313 million of impairments. We believe one of the key pure operating metrics for the homebuilding industry is EBIT-to-inventory.

This metric neutralizes the impact of debt. On Slide 16, we show the trailing 12-month adjusted EBIT-to-inventory for us and our peers. This ROI metric measures pure operating performance before interest expense. Despite our challenging community count, we remain in the top half when compared to our peers.

We, in the entire industry, are still not at normalized ROI levels yet, but we believe this will improve as we get further into the recovery. One of the ways we're able to achieve this is with a focus on inventory terms. Turning to Slide 17.

Compared to our peers, you see that we have the second-highest inventory turnover rate over the trailing 12 months. Although, we are below NVR's industry-leading turnover number, our turns are 67% higher than the next highest peer below us. This is a key component of our overall strategy.

Another area for discussion is related to our deferred tax asset valuation allowance. Our deferred tax asset is a very - very significant and not currently reflected on our balance sheet. We've taken numerous steps to protect it. The end of fiscal 2017, our valuation allowance in the aggregate was $918 million.

During the first quarter of 2018, we needed to take into account the new tax code that was passed at the end of December 2017. While we still will not have to pay cash federal income taxes on approximately $2.1 billion of future pretax earnings, we did have to reduce the valuation allowance to $661 million as a result of the lower federal tax rate.

On Slide 18, we show that we ended the first quarter with a total shareholders deficit of $491 million. If you add back our valuation allowance, as we did on this slide, then our shareholder's equity would be a positive $170 million.

Over time, we believe that we can repair our balance sheet and have no current intentions of issuing equity anytime soon. Before I talk about our liquidity, I want to comment on the sale of our corporate headquarters building. In the summer of 2017, we received an unsolicited offer for our corporate office.

We completed the sale on November 1, 2017, resulting in an annual net cost savings from this move of about $3 million. Additionally, after paying off the loans on the building, the transaction generated about $25 million of cash.

Contemporaneously with the sale, we entered into an agreement to lease back the building until we completed the move to our new location, which occurred on February 26. As I mentioned earlier, this temporary leaseback resulted in rent expense and corporate G&A that we did not have in the prior year.

Now that the move is complete, we will have ongoing rent expense for our new location, but we will save on operating and interest expenses related to our previously owned corporate office. Now let me comment on our current liquidity.

As seen on Slide 19, we ended the first quarter with liquidity of $292 million, which is in excess of our liquidity target between $170 million and $245 million. We spent $159 million on land and land development on the first quarter of 2018, higher than the average of $139 million we spent during the previous four quarters.

Even without increasing our use of alternative capital sources such as land banking and nonrecourse loans, we continue to have ample liquidity to increase our land spend. However, we remain disciplined in our approach to underwriting new land parcels.

We continue to use current sales price, construction cost and home price assumptions when underwriting new land deals. Our IRR hurdle rate for new land parcels remains at 20-plus percent. On Slide 20, we show the components of the recent financing transactions that we just completed. I'll walk through these step-by-step on the next several slides.

On the top of Slide 21, we show our maturity profile as it looked as of January 31, 2018. During the first quarter, we paid off the $56 million of exchangeable and amortizing notes that came due on December 1, 2017 with cash.

On the bottom of the slide, you see that in February 2018, we refinanced the 7% senior notes in their entirety with a 5% unsecured term loan that comes due in 2027 from GSO. The red dotted line shows how this refinancing enhances our maturity ladder.

Also in February 2018, on Slide 22, we accepted $170 million of the 8% senior notes due 2019, tendered in an exchange offer for the issuance of $91 million or 13.5% senior notes due 2026, $90 million or 5% senior notes due 2040, and $27 million of cash for the purchase of $26 million of tendered 8% senior notes.

An additional 5% unsecured term-loan commitment from GSO will be used to refinance $66 million of 8% senior notes that did not participate in the exchange. This illustrated - this is illustrated with the blue dotted line. Then if you turn to Slide 23 and focus on the green dotted line.

We have a commitment from GSO for a $125 million senior secured revolver/term loan, which we anticipate making the first draw in September 2018. We will use this to repay the $75 million superpriority secured term loan due in 2019, and the facility provides us with $50 million of incremental liquidity.

Furthermore, on Slide 24, GSO has committed to providing us in January 2019, with $25 million of additional liquidity via a tack-on purchase that approximately then current yields to our existing 10.5% senior secured notes due 2024. Assuming no change from today's trading levels, this price will be about 8%.

Finally, we received consent from our holders of our 10.5% senior secured notes due 2024 to eliminate restrictions on our ability to repurchase or acquire a unsecured debt.

We're very pleased to have successfully refinanced a $133 million of debt, exchange to $170 million of debt and to obtain commitments for $216 million of additional liquidity from GSO. We believe these financing transactions significantly enhanced our capital structure.

In the summer of 2019, the $440 million of 10% senior secured notes due 2024 become callable. Based on recent trades, the 2022 bonds are currently yielding approximately 7%.

Assuming this year remains unchanged, we would be looking at an annual interest savings of approximately $13 million per year if we were to call and refinance those notes at current yields next summer. Then in the summer of 2020, the $400 million, 10.5% senior secured notes due 2024 become callable.

Based on recent trades, the 2024 bonds are currently yielding approximately 8%. Assuming this year remains unchanged, we'll be looking at annual interest savings of approximately $11 million per year if we were to call and refinance those notes in the summer of 2020.

Assuming no change from today's yields, the combined annual interest savings from these two potential refinancings would be about $24 million per year. If we complete these refinancing transactions, the interim savings would significantly enhance future levels of our profitability.

We will continue to evaluate our capital structure and explore further ways to improve our financial position, including potential refinancing opportunities for a unsecured revolving credit facility due this summer. Now let me turn it back to Ara for some closing remarks..

Thanks, Larry. I want to close by emphasizing that our number one priority right now is increasing our land position and our community count. Our pure operating performance measured by homebuilding EBIT-to-inventory has been above median or near the very top of the competitors for a long period of time.

The recent financing transaction gives us the confidence and the stability to grow our land position and ultimately, our community count. This will eventually lead to growth in revenues, which should certainly enhance our performance dramatically.

We believe the worst quarter of fiscal '18 is behind us, and future quarters, this fiscal year should lead to better operating results as we continue to rebuild our company. This concludes our formal remarks. And I would like to open it up for questions..

[Operator Instructions]. And our first question comes from the line of Arjun Chandar with JP Morgan..

I wanted to start with land spend with inventory. So given the growth in community counts, consequentially from the fourth quarter of fiscal '17, how do we think about the cadence. And I know you made some comments in prepared remarks around the cadence of community count over the balance of the year.

But if I remember correctly from the middle of last year, you did say that this - the middle of fiscal '18 is when you expected kind of sustained positive inflection in community count.

Is that still the expectation going forward?.

Actually, we said towards the end of last half of '18. And in my comments, I mentioned, I think it will be couple of quarters later than that, could be the first half of '19. We're just seeing delays in the timing from when we contact the parcel, getting the finalized entitlements, getting the land development in place, getting the models open.

Everything is just running a little further behind in the marketplace in general, so we're pushing that time-out..

Got you.

And is there any minimal level of inventory at which time you consider yourself having to be little bit more aggressive in the land acquisition market as it relates to managing your liquidity balance?.

Well, it's a good question. I mean it's certainly something we are - we discussed from time to time. Right now, we think there are going to be enough opportunities that we shouldn't be more aggressive than our normal discipline and the normal rates of return that we look for. So far, that's our position now.

We will see how we do in the coming quarters on land acquisition..

And with regards to the refinancing transactions, the new secured superpriority revolver that's been put in place with GSO.

Is that secured by the same collateral that secures the all secure group?.

It's secured by the same collateral that secures the existing $75 million superpriority term loans, which is the old group..

[Operator Instructions]. And our next question comes from the line of Alex Barrón with Housing Research Center..

I was hoping you could discuss what your experience has been to date with the tick up in the interest rates? And what your expectation would be if interest rates were to go a bit higher? What your response would be there?.

Yes, this is certainly much discussed as well in the industry. The best and first response is, when I first started full time a couple of year - in the industry, a couple of years later mortgage rates went to 18%. And during that time there were more housing starts in the United States than there were last year.

So I think the market can adjust and has proven to adjust to higher rates. Needless to say, it would be most beneficial if the rate adjustment is gradual over time. And I think that's the more likely scenario.

What does happen as rates go up? People first scale back their options and selections, they may not get as higher level upgrade of cabinets or carpet or tile. They may not get the extra bonus room. Then later they may choose a smaller model within that community.

And then if rates go further yet beyond their affordability, they may think about a further out location or even a house - a different housing type, a smaller single-family home or a town house depending on where they are in income. So overall, I'm not very concerned regarding gradual rises in mortgage rates.

I think it's - we've certainly been through it many times in our 60-year history..

Got it.

And then can you discuss your current land - or your recent land positions? How are they different than what you've done in the last year or two? Are they further out, are they targeting smaller homes or cheaper homes? Or are they pretty much the same thing?.

I would say they are a mix of active adult communities, which is the same thing in type, but we've been more successful recently finding more geographies to develop a special niche we have. We build our active adult communities under the brand name of Four Seasons.

That is a - I think, a very important niche with the demographics of the aging baby boomer. That has been certainly one segment. I think we've seen a little bit more of an emphasis on town houses.

And that's partly because of the affordability, partly because you can sometimes get those in closer in-locations, which cater to a different demographic group, the millennials.

Otherwise, we have a mix of some properties that are a little further out for our most entry-level product that we call the Aspire line, and a variety of different move-up opportunities as well..

And I'm showing no further questions at this time. I'm sorry, we do have a question from the line of James Finnerty with Citi..

On the land spends, just want to make sure I get your latest thoughts on that. You said you've spent $155 million in the first quarter. And I guess previous comments were for year-over-year land spend growth.

That still the guidance? And any idea in terms of magnitude year-over-year?.

Yes, we still believe that we will have some year-over-year growth in land spend. We certainly have the liquidity to accomplish that. The land teams have been busy. We're seeing our land committee calendar getting even evermore booked. So yes, I think it will continue to be the case..

And in terms of community count, I guess you had 165 for the quarter, including 25 JV, but you're thinking the rest of the year, we should think of just from a modeling perspective, sequential declines on, I guess, from the 140 through the end of the year? Or is it - I just want to - just trying to think about how we should model it?.

Yes, I think you're on the right track. We don't believe the current level is sustainable for the next several quarters. And we won't really see growth until the first part of 2019. So I think you're on the right track..

So theoretically, first quarter '19, potentially higher than fourth quarter '18?.

Sometime in early 2019. I don't think we said first quarter, but we expect sometime early in 2019..

Yes, I mean as you know from everyone in the industry, the reason it's so difficult to project is the last details of entitlements before opening, but also that some community sell out a little faster or slower than projected.

And if you sell a few more homes than you thought in a quarter, all of a sudden your community count goes down, because once we're down to less than 10 homes remaining, we no longer count that as a community. So there are obviously many that could be on one side of the bubble or the other.

So it's just a very difficult number to be super accurate with..

And just in terms of the pushout in terms of the growth, would you say it's more due to selling out of communities quickly than anticipated? Or bringing on new communities at a slower pace?.

A little bit of both. As you see over the last year, our sales pace per community has continued to increase. And that certainly causes you to sell out a little faster. And it has been more challenging as I've mentioned, getting new communities, getting them on time and getting them all the way through the final entitlements and able to open on time..

Okay. And just one sort of detailed question about the revolver availability. It increased by several million quarter-over-quarter.

Just curious what drove that since it go from $8 million to $11 million availability?.

It's just the use of letter of credit that are also part of the revolver go down, which makes availability for cash to increase. The total revolver $75 million of course, which we used for letters of credit. But if our letter of credit use goes down, it increases the availability for cash..

I am sorry. We do have a follow-up question from the line of Alex Barrón with Housing Research Center..

Can you guys just discuss the dynamics going on in the Northeast and mid-Atlantic affecting the sales pace at the moment?.

It is a very location-specific. In general, in the mid-Atlantic, the Virginia market is doing well and is a little stronger than the Maryland market. There certainly were some concerns during the budget negotiations in Washington that affected that market. Overall, the New Jersey market has held strong.

It's just been a matter of getting sufficient communities online to get some growth in sales..

On a per committee count basis, I'll just turn it in here that the....

Community count itself..

What was sales per community, Jeff?.

Sales per community was down in both..

In both?.

In the quarter, yes..

Okay. Well, thank you very much. As we said, we feel good that this is the sub-quarter and it's behind us, and we look forward to giving you improved performance reports in future quarters. Thank you..

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