Jeff O’Keefe - Vice President, Investor Relations Ara Hovnanian - Chairman, President and Chief Executive Officer Larry Sorsby - Executive Vice President and Chief Financial Officer.
Jason Marcus - JPMorgan Sam McGovern - Credit Suisse Megan McGrath - MKM Partners Nishu Sood - Deutsche Bank Alan Ratner - Zelman Susan Berliner - JPMorgan Petr Grishchenko - Imperial Capital Melissa Tan - R. W. Pressprich Alex Barron - Housing Research Center James Finnerty - Citi.
Good morning and thank you for joining us today for the Hovnanian Enterprises Fiscal 2016 First Quarter Earnings Conference Call. An archive of this 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 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 Investors page of the company's website at www.khov.com.
Those listeners who would like to follow along should log onto the website at this time. Before we begin, I would like to turn the call over to Jeff O'Keefe, Vice President, Investor Relations. Jeff, please go ahead..
Thank you, operator, and thank you all for participating in this morning's call to review the results of our first quarter, which ended January 31, 2016.
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 provision 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 the statements related to the company's goals and expectations with respect to its financial results for the current or future financial period, including total revenues and adjusted pre-tax profit.
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 the date they’re 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 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 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 in terms of financing to the company; successful identification and 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, terrorist acts and other acts of war; increases in cancellations of agreements of sales; loss of key management personnel or failure to attract qualified personnel, information technology failures and data security breaches, legal claims brought against us and not revolved in our favor and other 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, 2015, 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, change in 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 Bachstetter, Vice President-Finance, and Treasurer. I'll now turn the call over to Ara Hovnanian. Ara, go ahead..
Thanks, Jeff. This morning we're going to share our results for the first quarter and then we're going to update you with regard to an acceleration of our plans to delever and improve our credit statistics. First, regarding the quarter, we made progress on almost all metrics. Let me begin with net contracts, which can be found on Slide 3.
On the left-hand side, we show the dollar amount of net contracts including unconsolidated joint ventures. These increased 28% to $668 million during the first quarter while the number of net contracts we signed increased 17%.
If you look at consolidated net contracts, as we've done on the right-hand side, we had a 25% increase in dollars to $629 million and a 16% increase in the number of net contracts.
Our community count including unconsolidated joint ventures was 228 at the end of the first quarter, an increase of 10%, while consolidated active communities increased 9% to 217. Our sales per community also improved for the quarter.
On Slide 4, we show that our consolidated net contracts per community increased from 6.6 to 7.1 during the first quarter. While net contracts per community including unconsolidated joint ventures increased from 6.6 in last year's first quarter to 7.0 during the first quarter of this year. Our backlog growth was even greater.
On Slide 5, we show on the left side the dollar amount of our contract backlog, including unconsolidated joint ventures, increased 49% to $1.4 billion while the number of homes in backlog increased 30%. Consolidated net contract backlog shown on the right half of the slide increased 39% year-over-year to $1.3 billion at the end of the first quarter.
Our consolidated backlog units increased from 2,399 homes to 3,014 homes, up 26% year-over-year. This positive momentum in sales pace and the growth in our quarter end contract backlog gives us the confidence that we will be able to significantly grow our revenues and achieve our projection for profitability for fiscal 2016. Turning to Slide 6.
We experienced strong revenue growth in our first quarter. In the top left-hand quadrant of this slide, we show that our total revenues increased 29% to $576 million during the first quarter, compared with $446 million in last year's first quarter.
This increase was due to a 4% increase in our average sales price and a 24% increase in the number of deliveries. The upper right-hand portion of the slide shows that our gross margin for the first quarter decreased 160 basis points year-over-year to 16.6%. This is the only metric on the slide that didn't improve.
Larry will discuss this a little more fully in a moment. Moving to the lower left-hand quadrant, you see that our SG&A decreased by 340 basis points to 11.1%, happens to be the lowest first quarter since 2005.
On the lower right-hand portion of the slide, we show that our adjusted EBITDA increased 83% from $21 million in last year's first quarter to $39 million this year. Turning to Slide 7.
In addition to these improvements, our interest expense ratio, which can be seen on the left-hand side of the slide improved as well, shrinking from 8.2% last year to 6.6% this year. The improvement in our total SG&A and interest expense ratios more than made up for the decline in our gross margin in the first quarter.
Pretax performance on the right-hand side of this slide improved substantially compared to last year. Keep in mind, our first quarter is always our most challenging quarter, particularly during periods of growth like we're experiencing this year.
On the right-hand side of this slide you can see that our pretax loss before land related charges improved from a loss of $17 million in the first quarter last year to just below breakeven with a loss of $1.5 million for the first quarter of this year. Needless to say, we expect continued quarterly improvement throughout the year. Turning to Slide 8.
On the left-hand portion of the slide, we show our annual SG&A expense as a percentage of revenues going all the way back to 2001. We consider 10% to be a normalized SG&A ratio.
On the right-hand portion of the slide, you can see that our first quarter SG&A ratio declined 340 basis points to 11.1%, a significant improvement over the 14.5% we had in the first quarter of last year.
The improvement resulted from our 29% growth in revenues while at the same time reducing our total SG&A spend from $65 million in the first quarter last year to $64 million in the first quarter this year. We're pleased with the progress we made with respect to this ratio during the first quarter of 2016.
Throughout 2016, we expect our increases in deliveries and revenues to grow much faster than the incremental increases to our SG&A expense and as such, we anticipate our SG&A ratio will approach our normalized 10% level for the full year in fiscal 2016, a level we haven't seen since 2005.
For a number of years we've been explaining to investors that in order to return to sustainable profitability, we needed to grow our top line in order to achieve fixed cost operating leverage. To prepare for that growth from 2012 to 2015, we grew our inventories by 71% from $891 million to over $1.5 billion.
The hard work of our land teams over the last few years is paying off and we expect to grow revenues to a range of $2.7 billion to $3.1 billion for all of fiscal 2016, up from $2.1 billion last year.
During the first quarter, our 29% revenue growth allowed us to decrease our SG&A and interest expense ratios by 500 basis points as we gain operating leverage. Although our operating leverage for the first quarter improved significantly, many investors remain concerned about our liquidity.
Given the volatility in the stock market, the low price of oil, and overall uncertainty regarding global economy, the high yield market continues to be extremely challenging, especially to triple-C credits like ourselves.
As we discussed in prior quarters, we do have additional liquidity levers that we could expect to utilize including land banking, joint ventures, model sale leasebacks and project specific nonrecourse debt, all of which we used during the first quarter.
These steps help build our cash reserves to pay $173 million of bonds that matured in January and to begin to build up cash to pay our $87 million of bonds maturing in May of this year.
Given the uncertainties in the financial markets, combined with the fact that during 2016 we expect to grow our revenues to a level where we can achieve increased operating leverage, we believe a shift in our strategy is appropriate.
For the next couple of years, we are now planning to focus on deleveraging our balance sheet and maximizing our profitability instead of focusing on additional revenue growth beyond 2016. We believe that while deleveraging our balance sheet we can generate the revenues we need to leverage our fixed operating costs and achieve solid profits.
Assuming current market conditions, we should be able to you achieve our goals of increasing profitability annually while paying off the bonds that mature in May of this year and the bonds that mature in January and December of next year without significantly tapping our liquidity levers.
Halting top line growth coupled with higher inventory turnover certainly helps and the recent land banking transactions certainly help boost our inventory turnover. This provides us flexibility rather than being required to rely on third-party additional capital.
However, to gain additional financial flexibility, we may still utilize joint ventures and land banking for certain larger transactions or other liquidity measure as our needs dictate.
After much analysis of our more challenging divisions and our desire to be a more significant player in our markets with better performance, we have decided to exit Minneapolis, Raleigh and Tampa. Our plan is to exit Minneapolis and Raleigh via a bulk sale and to exit Tampa via a wind down as we deliver out our existing communities.
We have a signed LOI for the sale of the Minneapolis land portfolio and we've just begun to market the Raleigh operations with strong preliminary interest from a number of builders.
Furthermore, given the frothy market conditions in the San Francisco Bay area, which are resulting in lofty, almost speculative land prices and given that we are a relatively small player in that market and we prefer to be a larger player in some of our other markets, we've decided to focus our efforts in Northern California to the Sacramento market area where we already have a larger presence.
We'll wind down our operations in the Bay area in Northern California by selling and delivering the homes in our existing communities. These steps will provide us the additional capital to both pay off debt and to invest more in our remaining markets where we believe we can achieve economies and powers of scale.
We have many good associates in these markets that we're exiting that have been with us for a while and I want to thank them all for what they've done for our company.
These have not been easy decisions to make, but based on a variety of factors, we felt that they were the necessary steps in order for our company to succeed and produce solid financial results. I'll now turn it over to Larry Sorsby, our Executive Vice President and Chief Financial Officer..
Thanks, Ara. Let me start with the $11.7 million of land-related charges we took during the first quarter. Our decision to sell our land position in our Minnesota market resulted in an impairment of $9.7 million.
Additionally, primarily during the due diligence period, we walked away from 1,256 lots spread across a number of our markets for a $2 million charge. We are staying disciplined in our underwriting approach and making sure that the communities we go forward with are ones that will further our goals of maintaining strong levels of profitability.
Based on what we discovered in due diligence, we felt the communities that we walked away from this quarter yielded too low a gross margin and total return. On Slide 9, we show our gross margin for the prior five quarters. In a typical year, we report our weakest gross margin during the first quarter.
This weakness is partially a result of certain fixed indirect overhead costs that are a component of our cost of sales. These fixed period costs primarily consist of construction overheads, service cost and property taxes, which are spread over the lower delivery volumes we typically see in the first quarter.
As our delivery volumes increased in the remaining quarters of 2016, our revenues are expected to grow and we should gain efficiencies with respect to these indirect overheads and our gross margin percentage in the second half of the year should increase. We remain comfortable with our full year gross margin guidance of 16.8% to 18%.
We are not the only builder that has felt the pressures on its gross margin. If you turn to Slide 10, we show a comparison of our gross margins in blue for the most recent quarter and in yellow for 12 of our public peers. At the top of each bar's and arrow, which indicates the year-over-year change in gross margin for each of the builders.
A green arrow indicates an increase in gross margin and a red arrow represents the decline in gross margin. 10 of the 13 builder's reported year-over-year declines in gross margin, while the other three reported slight increases.
Although it does not make us feel better about our year-over-year decline in gross margin it is clear that this was an industry-wide phenomenon that impacted the vast majority of our peer as well.
However, we feel that this is effectively a hangover from the 2013, 2014 land buying period and as more homes deliver from more recent land acquisitions for us and for the industry, margins will improve once again. Let me update you on our specs on Slide 11.
They've fallen from 4.7 at the end of the fourth quarter of 2014 to 3.9 per community at the end of the first quarter of fiscal 2016. The percentage of deliveries from spec homes decreased once again in the first quarter to 39%, which is lower than the 46% of total which we had in last year's first quarter and 41% during last year's fourth quarter.
Let’s now look at our net contract performance on a monthly basis. On slide 12, 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. Sales trends for this 12 month period have been strong. 11 of the past 12 months have year-over-year increases.
Over the trailing 12 months, our net contract dollars, including unconsolidated joint ventures were up 23%. Our most recent quarter generated extremely strong net contract performance and the moment continued into the month of February when the dollar amount of net contracts increased 28%.
While Slide 12 showed the dollar amount of net contracts, Slide 13 shows the number of monthly net contracts per community. We have reported year-over-year increases for eight months consecutively and 10 of the last 11 months showed year-over-year gains as well.
On Slide 14, we show our net contract results restacked as if we had a December quarter end so that we could compare our results to nine of our public peers who report results for December quarter end. The year-over-year results for the three month period range from a decline of 5% to an increase of 23%.
As you can see, with an 18% increase in net contracts, we have the second highest year-over-year increase in this three month period. On Slide 15, we show a slightly longer period of time. This has our net contract results restack for a six month period ending December 31, 2015, compared to nine of our public peers who report calendar quarter ends.
The year-over-year results for the six month period range from a decline of 2% to an increase of 18% with an 18% increase in net contracts we had the highest year-over-year increase over this six month time period.
Achieving top line growth and critical mass is a priority for 2016 for us and we are clearly well on our way to you a achieving that goal. Another area where we compare favorably to our peers is inventory turns.
On Slide 16 you can see that we have the second highest inventory turns over the trailing 12 months as compared to our peers, achieving high inventory turns will continue to be a focus for us going forward. Houston remains a hot topic within our industry.
Rather than give the same data points we have over the past several quarters, I want to provide a briefer update on what we are seeing in that market. During the first quarter of 2016 we saw the absolute number of net contracts in Houston increase by 2% year-over-year.
We continue to believe our strong performance in Houston is due to our focus on lower average price points, not participating in any of the highly competitive master planned communities and having less exposure to communities in the energy corridor in Houston than our peers.
After more than a year of significantly lower oil prices, our margins and profitability levels in Houston remain strong. We have an exceptional management team in Houston and as we noted last quarter, John burns pointed out we have the least exposure to the Houston energy corridor of any of the public builders.
In 2016, our dependence on Houston from both a profitability and volume perspective is expected to decrease as other parts of our operations are expected to grow significantly, while Houston is expected to level off.
Despite another solid profitable quarter for our Houston operations, we remain cautious about the impact of lower oil prices on the Houston economy. We continue to keep a close eye on the market and will take appropriate actions should any further developments arise.
Moving back to our overall company on Slide 17, it shows that our consolidated community count has grown steadily over the past two years. There's a lot of activity that goes into an increase of 18 communities that we saw in the last 12 months.
During the last 12 months, we opened 102 new communities and closed out of 84 older communities, growing our community count from 199 to 217. Needless to say, our future community count will decline due to our decision to shrink our geographic footprint as discussed earlier.
Going forward, we're not focused on community count and growth as we are now focused on reaping efficiencies and repairing our balance sheet sooner rather than being focused on top line growth. Turning to Slide 18, you will see our owned and optioned land positions broken out by our publically reported market segments.
Our investment in land option deposits was $86 million as of January 31, 2016. Additionally, we have another $15 million invested in predevelopment expenses. Looking at all of our consolidated communities in the aggregate including mothballed communities, we have an inventory book value of $1.7 billion net of $503 million of impairments.
Another area of discussion for the quarter is related to our deferred tax asset valuation allowance. During the fourth quarter of fiscal 2014, we reversed $285 million of a deferred tax asset valuation allowance. We should reverse the remaining valuation allowance when we begin generating sustained profitability levels higher than recent years.
At the end of the first quarter of fiscal 2016, our valuation allowance in the aggregate was $635 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.
We will not have to pay cash federal income taxes on approximately $2 billion of future pre-tax earnings. On Slide 19, we show that we ended the first quarter with a total shareholders’ deficit of $143 million. You add back the remaining valuation allowance as we've done on this slide then our shareholders equity would be a positive $492 million.
If you look at this on a per share basis, it's $3.34 per share, which means that at yesterday's closing stock price of $1.76 per share our stock is trading at a 47% discount to our adjusted tangible book value per share. Over time, we believe that we can repair our balance sheet and have no current intentions of issuing equity anytime soon.
As seen on Slide 20, after spending $117 million on land and land development in the first quarter, paying off $234 million of bonds that matured between October 2015 and January 2016, we ended the first quarter with $152 million of liquidity, just slightly under our liquidity target of between $170 million and $245 million.
On Slide 21, we show our maturity ladder.
Given the liquidity levers we have previously discussed on calls along with our decision to shrink our geographic footprint, we believe we have sufficient sources of liquidity to pay the $87 million principal amount of notes maturing in May and the $121 million principal amount of notes maturing in January of 2017, and the $85 million of principal amount of exchangeable notes maturing in December 2017.
Turning to Slide 22, I would now like to reiterate our expectations for all of fiscal 2016. I'll go back to - turning to Slide 22, I'd like to now reiterate our expectations for all of fiscal 2016. Again, assuming no changes in current market conditions, we expect to report total revenues between $2.7 billion and $3.1 billion for all of fiscal 2016.
We expect our gross margin for all of fiscal 2016 to be between 16.8% and 18%.
Additionally, we expect total SG&A as a percentage of our total revenues for all of fiscal 2016 to be between 9.8% and 10.2%, excluding any land related charges, gains or losses on extinguishment of debt and other nonrecurring items such as legal settlements, we expect the pretax profit for all of fiscal 2016 to be between $40 million and $100 million.
I will now turn it back to Ara for some closing comments..
Thanks, Larry. Back in September of 2015 we shared various illustrative models and these models showed that we could grow our revenue significantly through 2018 and then level off our revenues at that point and shift our focus to harvesting cash and repairing our balance sheet.
The scenarios assumed we refinanced our near term debt maturities, which to date have not occurred. Unfortunately, the high yield market changed and continues to be extremely challenging.
Therefore, we utilized land banking and various other liquidity levers that we've described during prior analyst calls and we paid off $61 million of our notes that matured in October of 2015 and $173 million of notes that matured in January of 2016.
After much thought and analysis, we've concluded that rather than continuing to aggressively purchase see these liquidity levers so we could continue to grow we'd be better served to shift our focus from top line growth and immediately start to harvest cash and improve our credit statistics.
As Larry mentioned, this change in strategy doesn't adversely impact our guidance for 2016.
However, given the strategic decisions to sell our Minnesota and North Carolina divisions and wind down our Tampa and Bay area divisions and assuming the retirement of debt at maturity through 2018, we now expect to see a slight dip in our revenues and inventory levels during 2017 and 2018 as compared to this year's levels of 2016.
By 2019, we expect our other divisions to grow more significantly and we expect total revenues by 2020 to be similar to the 2016 levels once again.
In spite of a slight revenue decline in 2017, because of the anticipated reductions in interest expense and a very modest improvement in our gross margin, we continue to believe that our profitability in 2017 can improve from the $40 million to $100 million level of profits that we expect to earn this year.
Keep in mind that due to our deferred tax asset, we won't be paying federal taxes on roughly $2 billion of future profits and that allows us to reinvest virtually all of our pretax earnings back into inventory. As we harvest cash and pay down debt between now and 2018, we will focus more on operational excellence rather than revenue growth.
We expect our bottom line focus and some of our more recent land purchases will help us return our gross margin back to more normalized levels by 2019. Keep in mind, we're at normal 20% gross margin levels in both fiscal 2013 and fiscal 2014.
Over the past few years, we've aggressively invested in growing our land inventory to position us for more meaningful growth of revenues and profitability. We've achieved and are achieving a lot of that growth.
While we now plan to level off our revenues and to delever our balance sheet sooner than we had had previously anticipated, we believe we can still achieve year-over-year increases in profitability going forward due in part to lower interest expenses and also due to a smaller, more efficient and productive footprint.We feel like we're in a position to once again deliver solid performance metrics and we look forward to delevering and delivering continued improving results for this year.
That concludes our formal remarks and we'd like to turn it over for questions..
The company will now answer questions. [Operator Instructions] Our first question comes from the line of Michael Rehaut with JPMorgan. Your line is open..
Good morning. It's actually Jason Marcus in for Mike.
First question, just discussing further about the markets that you're exiting, wanted to see if you could give a little bit more color on the number of communities that you had in each of those markets and then also in terms of the gross margin that you're most recently seeing in those markets, how did those compare to the company average? And then lastly I guess, with other markets that you evaluated when you were making this decision and is it possible that you'll exit further markets in the future?.
The first point is, I’ll address your last question. We really looked across the whole company and we do not plan to exit any additional markets. We decided that we'd make all the changes in one move, rather than have associates guessing at what's going to happen. We took a lot of moves earlier and all at one time.
We feel good about our remaining footprint and we've dealt with some of the divisions that just weren't contributing sufficiently in terms of return on investment to our overall operation..
So with respect to community count, in Minnesota there's six active selling communities. In North Carolina, Raleigh, there's five active selling communities. And Tampa, Florida there are nine active selling communities and we don't have it broken out right in front of us, but I think it's two or three in the San Francisco Bay area..
And how are the margins on those communities relative to the company average?.
I haven't actually run the numbers to see, but I think it's a safe assumption to just assume it's a reasonable blended margin across all of that, similar - not dissimilar to our consolidated..
Generally speaking, the performance in those markets were weaker in terms of ROI..
Okay.
And then the second question is, should we expect any additional impairments related to the exit of any of these communities?.
We don't have a current expectation of additional impairments, but until we actually finalize offers and have final offers, we can't be positive..
But keep in mind Tampa and Bay area is being exited just by delivering out our inventories. So it shouldn't be any impairments associated with that. And the Raleigh market seems like it's quite strong, so hopefully we'll exit there without any impairment..
Okay. Thanks..
Thank you. Our next question comes from the line of Sam McGovern with Credit Suisse. Your line is open..
Hi, guys, thanks for taking my questions. Just on the land banking, I wanted to understand just a couple things. I think on the call, on the prepared remarks you guys said that you guys expected to be able to pay off the near term maturities without significantly tapping additional other liquidity levers. I just want to confirm that.
And then secondly, just in terms of when I look at the balance sheet, the consolidated inventory not owned increase by about 215,000.
Is that the cash you guys received, roughly about $215 million, sorry, and that implies that you guys would get another $85 million coming in from the land banking agreements that you guys already signed? Am I reading that right?.
Let me take a shot at your questions and if I forget one, you can re-ask it. With respect to the $215 million, that's with respect to the inventory being shifted related to the land banks, not necessarily the cash proceeds from land bank because the deposits, et cetera.
So it's not a cash number, but it is related to the inventory shifting to inventory not owned due to land banking relationships. So, I've already forgotten the other question. So ask again..
Just in terms of how much additional proceeds you guys expect to receive after this quarter from the land banking and then if I heard you guys correctly I think you guys said that the near term maturities you guys hope to be able to pay off without significantly tapping the other liquidity levers that you guys signed..
Yes, we do believe on a longer term basis that we can deal with the maturities in May of this year, January and December of next year without significantly tapping those liquidity levers. We will tap them to some degree, but not in order to deal with each and every one of those.
We're now rather than focusing on growth, which is one of the reasons that we needed to kind of tap those liquidity levers, we're focused on really improving the profitability and operational excellence.
So, we won't tap it as aggressively as we otherwise would have, but there will be some tapping of it and I don't think we've publicly disclosed how much more may be coming in land banking activities. There have been a couple after the first quarter ended, so there is some that have occurred, not a tremendous amount..
Okay. Great. Thanks. I'll pass it on..
Thank you. Our next question comes from the line of Megan McGrath with MKM Partners. Your line is open..
Hi, good morning.
Could you help us a little bit in terms of the timing of the exit of the markets for Minneapolis and Raleigh, is that something you expect to be completed in the next quarter or so? And then on Tampa and San Francisco, the markets that you're sort of exiting through attrition for lack of a better word, are there land holdings you have there that you haven't opened communities on that you would be selling as well?.
First, Minneapolis and North Carolina, yes, we would expect to complete those transactions in the next quarter or so. And in the San Francisco Bay area, no, we don't anticipate selling anything or just winding down and delivering. And in Tampa it's possible we'll entertain a parcel or two, but it's not significant.
Primary exit will be via delivering out of our communities..
Okay, thanks. That's helpful. And then just a quick follow-up on sort of current activity in the market, in terms of your level of spec, it's certainly lower than it was last year how did it end to the spring selling season. Was that purposeful? I know that March last year was a little bit of a disappointment.
How do you feel about how you're setting yourself up? Do you feel you're sort of conservative headed into the season in terms of the level of spec that you have?.
Generally, yes, I'd say we feel like we're conservatively positioned. If you look at our long-term spec average we're actually at a lower level than we've been in most of our recent history, excluding this short period over the last year. So, I think we're well positioned and conservatively positioned..
Great. Thanks..
Thank you. Our next question comes from the line of Nishu Sood with Deutsche Bank. Your line is open..
Thank you and going back to the market exits, I wanted to understand the level of inventory dollar exposure to those markets as we think about what you might be able to derive in terms of debt pay down from winding down or selling.
Just more broadly on it, it was not that long ago you laid out pretty effectively I thought an elaborate detail your strategy for paying down debt through on a more operational basis. If anything financial conditions have improved slightly, perhaps and I can't say I disagree with the strategy.
Obviously with the risk of potentially recession rising here, but what prompted your change in thinking? I was just wondering if you had to - just the dollars, what prompted your change in thinking here?.
I think what you're referring to is the illustrative model scenarios that we published in September and what changed is, is when we published those scenarios it was predicated upon us being able to refinance debt as it matured and that just has not proven to be possible, given kind of the extremely challenging high yield market today.
So, it has actually caused us to kind of revisit our strategy and make the determination that rather than wait until 2018, which was the strategy back in September, to harvest cash and focus on repairing the balance sheet that we would accelerate the harvesting of cash and paying down debt to now and just get into better shape earlier.
And as a result, we won't continue to grow revenues for the next couple of years as we're paying down a significant amount of debt at least as of right now the high yield market is not allowing us to refinance..
Just as oil prices dropped the summer, the high yield market went from shaky to basically shut down very quickly for triple C credits and that happened just after we reduced some of those models. So that prompted the change in strategy..
Got it.
And in these targeted markets what is the dollar exposure on your balance sheet?.
I don't think we have it right at our fingertips. That may be something we'll put out later, because I'm sure it's interesting data point for others that are trying to adjust their models. So we just don't have it right at our fingertips..
Got it. My second question was your order trends and we appreciate as always the monthly detail, and January and February looked quite strong, a continuation of the pace of order gains that you had in the prior quarter.
Now, recognizing that you laid out that you've been at the high end of the range amongst your peers, the other public builders, I was just wondering if you could walk you us through qualitatively, given where we sit now here in the early stages of the spring selling season, maybe some color by markets where you're seeing strength and not and importantly also your overall characterization of how demand has been going.
Clearly people will be wondering whether there's been any incentivizing going on, just your commentary if you could about the demand trends, where we sit in the spring selling season..
Sure. Obviously hopefully we've given some pretty good granularity with detailed January and February results. But overall, we'd say they're solid. In general, it hasn't been a rocking recovery. It's been a steady, gradual recovery and the year-after-year and the spring selling season really continues that trend.
Geographically, it's been fairly evenly distributed. Texas market definitely remains very strong. Houston surprisingly has been solid. Again, in our case, we've avoided the competitive master plans, especially the high end. We operate at one of the lowest price points in our company in Houston. Dallas has been very solid.
Up in Northern California as I've mentioned the Bay area is just white hot, but that's not necessarily a good thing in two ways. One, the new land market got very frothy. Number two, it's so hot that it's really difficult to build there right now. There have been delays, expanded construction cycles, a lot of cost pressures.
Having said that, the Sacramento area has been very solid as well, not frothy at all but just a solid recovery. I think those are the standout markets in my mind. Maybe the Southeast Florida we're just seeing a lot of strength there and we're about to open several communities with models there in the coming quarter..
Thanks. Appreciate the comments..
Thank you. Our next question comes from the line of Alan Ratner with Zelman. Your line is open..
Hey, guys, good morning. Thanks for taking my question. I was hoping just to circle back on the balance sheet and get a little bit more detail if you have it. So, you made the comment you that believe you could pay off it's roughly $300 million of maturities that you've got coming due over the next two years.
If we look at the balance sheet today you've got $150 million of cash. That's at the low end of where you'd like to be ideally from a liquidity standpoint and presumably you want to stay around that level at a minimum.
So seems to imply you're pretty comfortable that you can find a way to generate about that $300 million of cash through some sort of operations, land sales, exiting these markets and I guess to a much lesser extent pulling the levers that you've pulled in the past.
So, I guess if you could break that down a little bit more to give us some confidence in how you see that playing out it would be helpful.
You mentioned you didn't have inventory dollars on-hand for the four markets you're exiting, but how much cash do you expect that to ultimately bring in the door either through selling off that inventory or land sales and then where do you see the cash flow from operations over the next 18 months. Thank you..
Alan I think the easiest way for you to think about it is if you have a home builder that's growing, it takes additional inventory dollars in order to fuel that growth. If you have a home builder that is either staying the same or shrinking, they're a cash machine and they generate a lot of cash every time they close a house.
So, what our strategy shift has taken place is that rather than growing revenues in 2017 and 2018 and then tapping the brake and leveling off growth and harvesting cash, we are going to see inventory levels and revenue levels decline a minor part due to exiting the two markets and winding down the other two markets, but more significantly we're just consciously slowing down growth and we're going to see inventory levels decline a bit from the growth prospects that we had before and that's going to generate sufficient amount of cash in order to pay off the debt that is coming due on the maturity dates that we've already kind of outlined.
So, I think that's how you need to kind of think through it..
I guess - I appreciate that, Larry, but I guess where I struggle with that a little bit is, if we go back to 2010 to 2012 for you guys, your inventory balance really didn't move a whole lot. You weren't growing the businesses from a lot count perspective yet you weren't generating cash back then because of the higher interest expense.
So, maybe you get a little bit of a lift there as you pay off the debt and you save some on the interest side, but unless you're talking about a pretty significant contraction in inventory it's hard to see that level of cash flow generation based on what you've done in the past..
Just the reduction in the markets that we've described, they're not insignificant amounts of inventory. We don't have the numbers at our fingertips and we'll get it to you, but it's not insignificant. And certainly provides that extra liquidity I think that you're searching for.
At the same time, doesn't have a material effect on our pretax because as I mentioned these were more challenging markets for us. So that's a big driver.
We also looked around at some of our land holdings and in some cases where we've got some larger mothballed assets that we're not planning to use right now that have not been in our financial models and in other places we've got a longer land position than we need for the next few years, those provide us with some additional opportunities as well.
So, when you consider exiting basically four markets and those markets not having much pain from the profit standpoint and then a few land parcels, we think that provides us with that extra liquidity we need. We're talking about the next two years here. So, the last maturity we're talking through is December of 2017.
So, it gives us quite a bit of time to generate some of that cash..
Got it. I appreciate that. I think if you could dig you up that inventory balance it would be very helpful. Thanks a lot, guys..
Okay..
Thank you. Our next question comes from the line of Susan Berliner with JPMorgan. Your line is open..
Hi, good morning..
Hi, Susan..
I wanted to I guess delve back into the liquidity again and I think Sam asked the question with regards to the roughly $300 million of land banking that came in from DW and GSO, what amount was closed in the first quarter? Because I think we were thinking there was going to be more cash and we're assuming a lower amount closed than clearly that $300 million.
Was it $200 million? Was it $250 million? I think we're all trying to figure out where the liquidity is going to go? If we don’t know what you can sell the markets for, maybe it would be helpful just knowing what else is coming in land banking..
I think your question is how much cash was generated by the land banking activity we did in the first quarter?.
Yeah..
$138 million cash..
So if we go back to the $300 million that you talked about with those two transactions, and I think you said $50 million may not be the typical sale, that implies there's another $100 million coming in, is that correct?.
I mean there is other cash that comes in later than – I mean I already said there's a couple of transactions that closed in the first quarter. But in addition to that, the land development activity on some of the stuff that we've already closed will happen in future quarters.
So all that cash we never anticipated that it was all going to happen all upfront. Just the way land banking works. And then there was another bucket of to be identified parcels that haven't all closed at this point in time..
So is there any way to help us with what should be coming in at least in 2016 additional?.
Let us reflect on that and see if we can come back with a little more granularity. We thought we spelled it out fairly well, but let us reflect, see if we can come back with a little more granularity..
Great.
And then I guess just on land spend, you spent 116, 117 this quarter, how should we think about that for the rest of the year as well as into 2017?.
Land spend, I think, clearly we've said we're not going to continue to focus on growth. So you're not going to see us have the same kind of land spend that you've seen us have in the last six, eight quarters.
So I think it's safe for you to assume in your modeling that our land and land development spends is going to be more modest, a combination of the markets that we are exiting combined with the less aggressive growth targets that we've talked about. So it will be a smaller land spend going forward..
As we mentioned, we really ramped up our land purchases over the last two years and got a lot of growth in inventory.
We feel that that's sufficient to carry us over for a while and that's part of how we can generate more cash too without having to – because we bought so much already, we're not having to invest as much each quarter as we did over the last few years. So that definitely contributes to our liquidity..
So is it fair to say that it will be a lower land spend even than this past quarter?.
I think it's fair to say it will be lower than last year. I don't think we're giving quarterly spend numbers..
Okay. Thank you..
Thank you. Our next question comes from the line of Petr Grishchenko with Imperial Capital. Your line is open..
Hi, guys and thanks a lot for taking my question.
Can you please provide me with color on the inventory backing the collateral 7.25 notes, like what portion is land versus homes, active/inactive, or like finished/semi-finished? And does the 7.25 have [indiscernible] all that inventory you're showing in slide 25?.
You want a breakout of the inventory by status on slide 25? Is that what you're asking?.
Yeah, yes, you have – you're showing $6.8 million..
We certainly don't have that at our fingertips..
Okay..
It is all perfected or in the process of being perfected..
It's all perfected..
Yeah, it was all perfected, so all of it is perfected as of the end of the quarter..
Perfect.
And I wanted to confirm that the inventory sold in land banking that all came are from the old collateral group, right?.
The impact was all to the old collateral group; that's correct..
Got it and just trying to reconcile the cash and inventory. I heard prior callers asking this questions. The $128 million of cash you guys received in the first quarter from land banking, you also mentioned [indiscernible] change in inventory not owned.
And then I think it was some – you kind of alluded to receiving additional, let’s call it, like $100 million or something like that in 2016. I’m just trying to understand the movement of cash and inventory here if you could provide some more color..
One, you're talking about a cash number and the other you're talking about an inventory number and the land banking activity, although we would have transferred from wholly owned inventory to inventory not owned when we land banked something, not all of that turned to cash when we made the transfer because you leave a deposit with land banker in order to get the option to buy back the lots that we sold to him on a just in time basis kind of tied into our expected sales pace.
So it's a little bit of an apple and an orange..
Right. So you said if I look at the inventory you sort of managed the land banking of $250 million. That was a change from owned to not owned and the cash received that implies roughly $77 million difference.
That difference I'm trying to understand, that was related to like the options and so forth?.
Basically deposits, but….
Deposits..
…a 100% of that is all just land banking, might have been some other transaction or two. But that's the bulk of it..
Okay. Got it. Thanks a lot and I'll get back in the queue..
Okay..
Thank you. Our next question comes from the line of Melissa Tan with R. W. Pressprich. Your line is open..
Thanks for taking my question. Just a follow-up to the previous caller. I want to ask a little bit differently about the collateral for your first lien and second lien notes.
It's great that you're trying to deleverage some of the near-term maturity, but some investors are concerned about basically their collateral being stripped as the company's strategy now has kind of shifting to will be shrinking either via land banking or exiting some of the markets.
So I just want to hear the management's comment on that and in addition to that I understand from the presentation that you laid out the assets backing it's only $600 million and if you add the other $200 million back in the 2021 notes that's still short of the inventory that's actually on your books.
So I'm trying to understand the remaining inventory, are they considered unencumbered assets or they could actually act be as collateral for these 2020 notes, given for example over-collateralization from some of the mortgages. Thank you..
Well, with respect to the question about the inventory from the two groups that's not been equal to the total on the balance sheet, there are some – some of the inventory is not yet perfected mortgages. So as we buy new property, we have a certain amount of time to get the mortgages in place so that's under way for some of the inventory.
And then some of the inventory is mortgaged for the nonrecourse project level financings that you'll see as a liability on the balance sheet. So those are not mortgages part of the security for these notes. That's what makes up the difference between the sum of the two slides and the total inventory.
And there's also option dollars that we talked about on land option reflected in inventory. Those are kind of the big components that reconcile the differences..
Okay. Thank you.
And so for the unperfected lots, I guess at some point with the process it could become collateral for these notes?.
Correct..
Will become collateral in ordinary course..
And what's the proportion of that unperfected inventory in the discrepancy, for example, I think it's about like $300 million?.
Yeah, I think the nonrecourse mortgage component is the largest component of that $300 million. Give me a minute, I'll find it..
We'll respond before the call is over on that..
Okay. Thank you.
And what about just any general commentary about management's strategies – and some of the bond holder concerns of their collateral?.
I think everybody should understand that the first priority is to make sure that we deal with any debt that is maturing. I mean the last thing any bondholders want to see and certainly that the company would want to see is any kind of default.
So our first priority is to make sure that we have sufficient liquidity to pay off debt as it's maturing and that's what we've very consistently been saying that we're going to do and the way the covenants are drafted the collateral on the first and second liens due 2020 is not adversely impacted by paying off any of the unsecured debt that comes due before it, but the collateral pool on the notes that come due the other first and second lien notes does get reduced by some of the things that we've discussed and you can even see some of the reduction in that cryo pool that took place between October 31, 2015 and January 31, 2016..
Back to the earlier question. The inventory from the two collateral groups on the slides is about $800 million. The nonrecourse mortgage property is a little over $300 million and there is about almost $100 million of option dollars. So the remaining difference between the inventory and those amounts is remaining to be perfected..
Okay. And part of a that $340 million I believe is overcollateralized, that the liability is less than the….
Liability is less, that's correct. $130million of liability, that's correct..
Okay..
So there's value in that..
Okay, great, thank you..
Absolutely..
Thank you. Our next question comes from the line of Alex Barron with Housing Research Center. Your line is open..
Yeah, hey, guys. How you doing? I wanted to ask you, I heard a comment about the strength in South Florida. But I'm not sure if I missed any comments on Tampa area or why you decided to exit that market..
Of our Florida markets, the Tampa area is the least vibrant and our performance has just not been up to our expectations. So that's what caused our decision there and to focus on our other two markets of Orlando and Southeast Florida..
Okay.
And then I guess as you guys are thinking of basically staying, without growing for the next couple years, what are your thoughts regarding Houston in that context? Are you also going to try to stay flat or are you going to just kind of shrink those communities [indiscernible]?.
Houston, at this point, we're just staying level. We're not growing and we're not shrinking. Our land position there is fairly low risk.
We're primarily buyers of finished lots and we have nominal deposits, much lower than in most parts of the country, so we adjust there relatively quickly if market conditions change, but at this point our returns there are solid. We've got an excellent management team and we're planning to continue at a steady level..
Okay. Great. Well, I wish you good luck and I think you guys are following the right strategy..
Thank you..
[Operator Instructions] Our next question comes from the line of James Finnerty with Citi. Your line is open..
Hi, good morning. Most of my questions have been asked and answered. Just one sort of broader strategic question.
If the high yield market were to become more accessible to you, being a triple-C credit, would your strategy change to growth in the out years relative to shrinking as you're currently viewing it?.
I think that we would probably modify our strategy somewhat, but I think you would still overall see us be focused on reducing debt and improving the balance sheet and our credit statistics.
We think that's the right strategy to do, but if the market was available, we still might just from a pure liquidity perspective look at if the terms were reasonable refinancing some of the debt and easing some of the pressure..
And I'm not sure if this was asked.
On the liquidity front, is there – do you have a target or a range that you think you're going to be remain in for the year, on a quarterly basis?.
Target for what, I'm sorry..
Liquidity..
We haven't changed our liquidity target. We've fallen just below, but at this point we've not changed our liquidity target. Obviously it's more challenging as we're paying off substantive amount of debt as we've been paying off, but we still believe that the low end of that range is an appropriate liquidity target for us to have..
Okay.
And just going through the year, I would imagine you'd finish the year at a higher liquidity number than the end of the year?.
Some cash to pay off the [indiscernible] of 2017, so, yes..
Yeah, we'll likely end the year at the high end or above our liquidity target right now..
Okay, thank you so much..
Thank you. Our next question comes from the line of Susan Berliner with JPMorgan. Your line is open..
Hi, Larry. Just had a follow-up question with regards to last quarter you had said additional inventory available for land banking was $500 million and I'm not sure if I missed it before.
Did you guys give that updated number?.
No, we didn't give an updated number on that. I don't think it would have changed dramatically from that, but we did not refresh that number..
Great. Thank you..
Thank you. I'm showing no further questions at this time. I'd like to turn the call back to Ara Hovnanian for closing remarks..
Thank you. As we mentioned, we had a lot of good performance metrics during the quarter, particularly revolving around sales and increased revenues. So that sets us up nicely for this year to execute on achieving our guidance.
We think the steps we've taken in regard to exiting certain markets, getting a little more efficient footprint makes a lot of sense for us and focusing on de-levering and we feel good about the prospects of improving profitability at the same time that we're improving our balance sheet.
So we'll look forward to reporting our progress as the year proceeds. Thank you..
This concludes our conference call for today. Thank you all for participating and have a nice day. All parties may now disconnect..