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Executives

Ara K. Hovnanian – President, Chief Executive Officer & Director

J. Larry Sorsby – Chief Financial Officer, Executive Vice President & Director

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 Talbott McGrath – Barclays Capital

[Timothy Jones - Weselin & Associates]

Alex Barron – Agency Trading Group

[Joel Locker – FB&C Securities]

Lee Brading – Wachovia Securities

[Michael Lynn – Fairlawn]

Larry Taylor – Credit Suisse

Susan Berliner – JP Morgan

Hovnanian Enterprises, Inc.(HOV) F1Q09 Earnings Call March 11, 2009 11:00 AM ET

Operator

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 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 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 K. Hovnanian

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 shows 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 water mark 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 deliveries were down approximately 47% compared to a 66% decline for both deliveries and revenues with the ’08 Fort Myers 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 stockholders’ 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 decision 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-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 cash 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 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 as $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 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 ’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 we have taken on owned land. This is why we were such a 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.

Besides reducing staffing levels, we continue to look for ways to eliminate any non-essential costs. During the first quarter we took additional steps to lower our SG&A going forward, we suspended the company’s 401K matching contributions and have limited the potential bonus that any associate can get to no more than 50% of the already low ’08 levels. Neither of these decisions were reflected in our first quarter results nor were they easy to make from an associate retention point of view but they were necessary steps to ensure that we have the liquidity needed to get to the other side of this downturn.

It has been hard to cut SG&A as fast as our revenues have dropped. The sales pace we are achieving at a community level make this very challenging. It is unlikely that we will be able to get back to the historical percentages of SG&A to revenues until the sales pace per community returns to more normal levels. You can see on Slide 11 that the 2009 first quarter was slightly better than it was in last year’s first quarter in terms of net contracts per community but it’s still at very low levels compared to previous years.

The bottom line is that even though traffic and sales have exhibited some seasonal pick up, sales per community still remain near all time lows. I’ll turn it over to Larry to discuss our gross margin and the charges we took in the quarter as well as other topics.

J. Larry Sorsby

Let me start off by discussing our gross margin. As you can see on Slide 12 our gross margin has been in the single digits since the first quarter of 2008. Compared to the first quarter of 2008 our gross margin declined 100 basis points to 5.7% for the first quarter of 2009. However, gross margin increased sequentially by 100 basis points from the fourth quarter of 2008. This year-over-year decline is primarily the result of increased construction overhead as a percentage of home sales revenue.

Despite the almost 70% in staffing reductions we’ve made since 2006, construction overheads increased 470 basis points year-over-year primarily as the result of the lower sales volume. Our gross margin before overhead actually increased 370 basis points to 16.1% for the first quarter of 2009 compared to the first quarter of 2008.

During the first quarter of 2009 our home building cost of sales was reduced by $35.6 million from the reversal of impairments taken in prior periods. Turning to Slide 13 you can see our owned and optioned land supply broken out by our publically reported segments. There are some areas where we are more land heavy, these are generally the more supply constrained markets where we do a fair percentage of the land development ourselves, markets like New Jersey or California.

In other markets like Texas we almost exclusively contract for finished lots, take land down on a just in time basis and therefore generally keep less owned land on our books. While we still own almost three years worth of land, the good news is that we don’t own as much land as some of our peers do on a comparable basis.

Turning to Slide 14, you can see how our owned land position stacks up to those of our peers. It is sorted according to owned land supply based on trailing 12 month deliveries. This is what I call the raise to zero. Eve at a 2.8 year’s supply based on trailing four quarter deliveries, we still own more land than we would like to own right now but, compared to our peers we’re in relatively good shape.

The good news is that each quarter we work through more of our owned land and we will eventually get through all of it and be able to replenish our land supply with lower cost land at the bottom of the housing cycle. This will help our gross margins gradually increase back to normalized levels. I will now talk about the land related charges that we took during the first quarter.

We walked away from 2,390 lots in the first quarter and took a write off of $14.5 million related to these optioned lots. Turning to Slide 15, it shows the geographic breakout of these charges which represent the amount invested in these options through deposits and also any predevelopment dollars we had invested in getting this land through the approval process. Our remaining investment in option deposits was $55.6 million at January 31st ’09, $35.5 million in cash deposits and the other $20.1 million of deposits being held in letters of credit.

Additionally, we have another $72 million invested in pre-development expenses. The next category of pre-tax charges relates to impairments which is also shown on the same Slide. We incurred impairment charges of $95.7 million related to land and communities that we own in the first quarter. 56% of those impairments were on communities in our Northeast segment. We took additional impairments in the Northeast as the sales pace and pricing in this market have recently been impacted with all the turmoil on Wall Street.

We test all of our communities at the end of each quarter for impairments whether or not the community is open for sale. If home prices continue to deteriorate we will see additional impairments in future quarters. During the first quarter of 2009 we also recorded $21.8 million of write downs associated with our investments in two joint ventures in New Jersey. Looking at all our consolidated communities in the aggregate including mothballed communities we have an inventory book value of $1.9 billion net of $774 million of impairments which were recorded on 223 of our communities.

Turning to Slide 16, it shows our investment in inventory broken out in to two distinct categories sold and unsold homes which includes homes that are in backlog, started unsold homes and model homes as well as the land underneath those homes. The other category includes both finished lots and lots under development which are associated with all other owned lots that do not have sales contracts or vertical construction. We have reduced our total dollar investment in these two categories by 56% since our peak levels in July 2006 and we plan to make further progress in reducing our inventories during the remainder of 2009.

Turning to Slide 17, you can see that we continue to reduce the number of started and unsold homes. We ended the quarter with 1,142 started unsold homes which is a decline of 65% from the peak levels at July, 2006. This translates to about 4.7 started unsold homes per community. While the absolute number of started unsold homes made come down as our community count decreases in the future, the number of started unsold homes per community will likely stay in the range of four to five. This is consistent with the average of five started unsold homes per community on average over the past dozen years.

That leaves us with the last major areas of charges for the quarter which is related to taxes and the FAS 109 current and deferred tax asset evaluation allowance. We conclude that we should book an additional $79.4 million after tax non-cash tax asset valuation allowance during the first quarter. While our tax asset valuation charge was non-cash in nature, it did affect our net worth by the same $79.4 million during the quarter and increased our total valuation allowance to date to $754.9 million.

Now, let me update you on our mortgage markets and our mortgage finance operation. Turning to Slide 18, with average FICO scores of 726, our recent data indicates that our average credit quality of our mortgage customers remain strong.

Turning to Slide 19, we show a break out of all the various loan types originated by our mortgage operations during the first quarter of fiscal ’09 and compared it to all of fiscal ’08. During the first quarter FHAVA made up 44% of our volume as compared to 36% for all loan originations for FHAVA for all of fiscal 2008. We have very little exposure to jumbo mortgages which were only 1.9% and 2.5% of total loans for the first quarter of ’09 and the 2008 full year respectively.

The mortgage industry continues to be risk adverse and has once again embraced sound, reasonable lending practices. There are many loan products from which to choice and interest rates have never been better. Today’s mortgage customer will have no problem getting a loan but they need to meet the following requirements: first, a solid employment history; second, they need to be able to verify their income using paystubs, tax returns and written verifications from their employers; third, they need to have decent credit score, not perfect but decent; and lastly, they need to be able to document their source of funds to close.

The mortgage industry has become more black and white, one either meets the guidelines or one does not meet them. The practice of using compensating factors to get a marginal loan approved is gone. Another change is less reliance on automated underwriting and more reliance on the experienced underwriter’s manual review of all filed documentation. FHA, Fannie Mae and Freddie Mac have recently increased their loan limits due to the American Recovery and Reinvestment Act.

Since job security is often a concern of home buyers, Hovnanian and our mortgage company have partnered in a program to help ensure that mortgage payments will be made in the event of an involuntary loss of income. This along with interest rate buy downs are examples of the types of programs both internal and external we’re using to assist our home buyers in getting a mortgage loan.

Turning to the topic of our joint ventures, at January 31, 2009 we had $49.5 million invested in seven land development and 10 home building joint ventures. As a result of the cumulative affect of $273.3 million of impairments since 2006 within our joint ventures, you can see on Slide 20 that our debt to cap of all our joint ventures in the aggregate increased to 60%. We financed our joint ventures solely on a non-recourse basis. We’re now four years in to this downturn and because the loans are non-recourse we have not had any margins or capital calls on any of the debt associated with our joint ventures.

We ended the quarter with $843 million of cash as you can see on Slide 21 and do not have any significant debt maturities coming due over the next few years. Although we have no control over general economic conditions that could adversely impact the price and pace of our sales and deliveries, we will remain laser focused on generating positive cash flow from operations during the remaining three quarters of this year.

On Slide 22 you can see that our debt maturities are well structured and our first debt maturity is not until January, 2010 and that is an original face value of only $100 million. After that, nothing comes due until 2012 and even then it’s only $240 million of original face value. So, between the exchanges and the repurchases, we have reduced our debt by $406 million and have reduced our annual cash interest by $26 million.

In order to strengthen our balance sheet and to further reduce our debt we continue to explore debt exchanges and repurchases. However, we remain committed to the preservation of our cash balance and will be cautious about spending more cash to buy back debt. Now, I’ll turn it back over to Ara for some closing comments.

Ara K. Hovnanian

In February Congress passed stimulus plan, unfortunately the final stimulus plan was essentially a non-event from housing’s perspective. Several minor changes were made to the tax credit that was put in place July of ’08, it increased the tax credit by $500 to $8,000, it no longer needed to be paid back and was extended to December of ’09 however, it still limited the credit to first time home buyers only.

In some of our lower price communities, the $8,000 tax credit could be a significant percentage of the home price and could be more meaningful to someone who is undecided whether to purchase a home or not. Unfortunately, the overall dollar amount and the timing of the credit and the first time home buyer limitation significantly reduces the potential effectiveness of the tax credit.

While the recent actions to mitigate foreclosures are helpful, the housing industry was disappointed in the stimulus bill due to the lack of providing any meaningful demand stimulus for home buyers. The housing industry was also hopeful for a meaningful reduction in mortgage rates in this stimulus bill. As you can see on Slide 23, while the Federal Reserve has aggressively lowered the federal funds rate to stimulate business, you can see that mortgage rates to stimulate home buyers have not nearly kept pace with the federal fund rate reduction.

A meaningful tax credit and an interest rate buy down were key components of a stimulus package that the federal government used in 1975 to combat a difficult recession and housing market. Historically, the housing cycle has led us into and more important led us out of overall economic recessions. Unfortunately, our government has not taken similarly aggressive actions during this housing crisis so far.

This lack of action to date will mean that even more time is required before we see the housing markets stabilize. Ultimately, this failure to pass a more meaningful housing demand stimulus could be costly for the federal government as it continues to prop up the banking industry whose underlying problems are intricately linked to falling home prices.

Looking at the big picture we have seen the last two reported annual run rates for housing starts at record low levels. Slide 24 shows that the January annual run rate for housing is 466,000. If you adjust out the estimated 100,000 rental starts, for sale homes are now down to about 366,000 at an annualized rate down from about 1.8 million in 2005. New home production is clearly grinding to a halt.

This means that home builders have adjusted starts to match the recent visible demand levels. This should clearly help clear the markets of excess inventory once demand resumes to more reasonable levels but, as you can see on this Slide the current start rate is still well below the 1.6 million average annual starts we’ve seen for the last several decades.

Home building is a classic cyclical industry. We as an industry over produce in the good times and we need to absorb the excess supply that was created and under produce for some period of time as we’re doing now. While there is not much that is currently in the way of good news, long term demographics continue to bode well for the future of the industry. In short, the United States population continues to grow and grow at a slightly more rapid pace.

On Slide 25, you can see that household formations are expected to increase slightly from what they were during the last decades. [Inaudible] Institute and Moody’s have comparable estimates of household formations and long term demand for this decade. Over the long term based on household formations and the population growth, we have faith that equilibrium will be restored again.

Falling home prices and historically low interest rates make housing more affordable now than it has been for many, many decades. Current monthly mortgage payments are attractive from a home buyer’s perspective. However, potential home buyers now find themselves faced with growing uncertainty about their jobs and their ability to pay for the monthly mortgage. Today unemployment is a real factor in consumer’s decision making process.

But, as you can see on Slide 26, unemployment is also cyclical as you obviously know. Over time, on this Slide spikes in unemployment coincide fairly closely with the trough in housing starts. Although it’s counter intuitive history shows that the housing market can improve even while unemployment remains relatively high. 2009 will be another year of historically low starts across the country as we are now at an all time low for seasonally adjusted starts in January.

It is certainly possible that 2010 will see an increase in stars which in these past cycles has occurred as unemployment levels just begin to fall. Another unfortunate development for the economy but helpful to the surviving home builders it the demise of many previously solid competitors particularly among the private home builders. In fact a new website called www.BuilderImplode.com was initiated that tracks home builders that have stopped operations. It’s sadly growing every single week.

We have showed a portion of the list on Slide 27. To put the magnitude of these implosions in to perspective, in 2005 the dozen builders that are shown on this Slide delivered over 43,000 homes. When the economy and the housing market does return it is likely that half of the home builders will be gone making a much better environment that will remain.

As we look forward internally we don’t plan for a pickup in demand but we certainly believe that increased demand is an inevitable scenario that will play out at some point in the near future. Since we are no better at predicting when these outside influences will subside, we must continue taking steps to make certain that we survive this downturn. We believe that we’ve got the liquidity to ride through this difficult environment by sticking to our long term strategies of offering a broad product array and maintaining our presence in many markets that will once again present opportunities as the industry rebounds. We feel that we’ll be well positioned to participate in the eventual recovery.

That concludes my comments and we’ll be pleased to open up the floor to questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Michael Rehaut – JP Morgan.

Michael Rehaut – JP Morgan

The first question, we appreciate a lot the detail month-by-month that you gave on Slide Four in terms of the net contracts, I was hoping just for perspective from a year-over-year basis you could provide the last few months including February on the year ago basis on net orders and per community also?

J. Larry Sorsby

We don’t have that right at our finger tips, maybe by the end of the call or during the call we can gather that.

Michael Rehaut – JP Morgan

That would obviously be pretty helpful given that you also had mentioned in the press release that you still feel at this point the increase is seasonal so I just wanted to try and get a little more color on that. The second question guys and then I’ll get back in to the queue, I was hoping if you could just talk a little bit more about your expectations for cash flow certainly guidance is extremely challenging but, given the year-over-year decline in the cash flow ex the tax refund, I just wanted to know your thoughts about whether ’09 could be a positive year or a negative year as you kind of look out the next couple of quarters at least?

J. Larry Sorsby

Mike, it is challenging to make longer term projections on cash flow but looking at the first quarter Ara mentioned in his comments, you can’t just annualize the first quarter and assume that that is a meaningful number for any purpose. As he also said, we have negative cash flow in last year’s first quarter and then generated very strong cash flow for the full year. So, although I can understand why you’re focusing on this and wanting additional guidance I just don’t think anyone should go about trying to annualize our first quarter results.

Michael Rehaut – JP Morgan

No I definitely wasn’t implying that and we recognize the seasonality but just given the year-over-year comparison and the fact that the backlog is down so significantly, that’s more where I was coming from.

J. Larry Sorsby

I understand. We’re not going to give a specific projection other than to tell you that we’re laser focused on generating positive cash flow the remainder of this year. I mean, there’s a lot of things that are out of our control in terms of what’s going to happen, the pace, what’s going to happen to prices but we remain laser like focused on generating cash flow that really drives virtually every decision that we make as a company and I just can’t give you any guidance at this time beyond that.

Operator

Your next question comes from Carl Reichardt – Wachovia Securities.

Carl Reichardt – Wachovia Securities

Can you tell me a little bit about how your traffic per community has been trending during the quarter Larry? And, can you also define when you take a community out of the community count what’s your definition of doing that since different builders do it different ways?

J. Larry Sorsby

Our definition of doing that is I think there are 10 or less homes remaining to be sold. At the time that there’s less than 10 remaining in the community we take it out of our official count although as you well know since you track it from our website it will still be on the website because we still might have seven, or six, or five, or four homes to sell. But, that’s how we do it.

I mean traffic seasonally has picked up as well. I don’t have it right in front of me on a per community basis. I would say it’s probably following the same pattern – I’m going to try and give you the contract data that Mike asked for earlier and I think traffic has followed that same kind of pattern so we have had a pickup in traffic compared to what we were having in the fall.

Carl Reichardt – Wachovia Securities

So what you’d expect seasonally but is the traffic level changed much from the up sales per store place slightly has the slightly sort of increase similarly on a per store basis or greater than that?

J. Larry Sorsby

I think it’s probably a similar pace.

Carl Reichardt – Wachovia Securities

Last question, Ara you’ve talked the last couple of quarters a little bit about some of the additional avenues you’ve pursued for capital or joint investment and land in communities going forward, could you give us sort of an update on where you see that environment right now? The appetite for outsiders to invest in this business and anything you guys might be entertaining, if it’s changed?

Ara K. Hovnanian

There hasn’t been a lot of change. There continues to be an appetite, the real issue has been good investment opportunities so it becomes a little bit of the chicken or the egg. The good news is finally we are seeing land opportunities that make sense and for the first time in years other than Texas we have bid on a few parcels. We didn’t get any of those parcels but we were very close and the bids were at prices, all of them were from banks by the way, they were at prices dramatically below cost, I mean $0.15 to $0.17 on the dollar.

At those prices it makes sound economic sense in today’s environment. But, in any case as I’ve mentioned we haven’t landed any of them just yet. I am optimistic that we are going to see an increase in good opportunities. The opportunities we’ve seen all ready presented themselves in the last few months. It’s the first time in one or two years where we’ve seen any reasonable opportunities and I clearly get the sense that there are more coming up so that is good progress. Once we get the opportunities, that’s when we’ll put the full court press on finalizing deals with a partner.

J. Larry Sorsby

Before the next question I can answer Mike Rehaut’s question now, I’ve got the data by month for ’07 and I’m going to start, and this is on Slide Four for the monthly net contracts per community. For the month of November, 2007 we had .9 contracts per community compared to the 1.1 that we had in November of ’08. In December ’07 we had 1.4 net contracts per community compared to the 1.1 in ’08. In January of ’08 we had 1.3 net contracts per community compared to the 1.5 in January ’09. In February ’08 we had 1.8 net contracts per community compared to the 2.2 in February ’09.

Then starting with October of ’07 we had 226 contracts compared to the 231 in October ’08 but I will just tell you that ’07 was impacted to a large extent by the September ’07 deal of the century so we think we pulled some demand forward a year ago. In November of ’07 we had 386 net contracts compared to 284 in November ’08. In December of ’07 we had 582 net contracts compared to 304 in December ’08. In January of ’08 we had 543 net contracts compared to 373 in January of ’09. February of ’08 we had 804 net contracts compared to 506 in February ’09.

Ara K. Hovnanian

Obviously the absolute number of sales is more challenging because we’ve reduced the community count dramatically. But, as you can see by these comparisons the sales per community are showing an improved trend finally over last year.

Operator

Your next question comes from David Goldberg – UBS.

David Goldberg – UBS

First question is Ara, if we go back to your comments on the decision make process on building or not building and the recoverability test and how you guys think about that I’m wondering if you can kind of give us an idea what the range might be in terms of recoverability of current investment? What might be the low where you would decide to build through it and obviously, the max would be 100% but what might be the low and kind of some examples and just some more color around the actual decision making process?

I guess with that, not to go overly complex here but, with that how you think about what would have to happen to prices if you decide not to go ahead and build through, what the expectation for pricing to make it worthwhile to hold the communities or hold the land?

Ara K. Hovnanian

I mean the thinking varies a bit by community. If we’re in some parts of the market like a Bakersfield or a Fresno or parts of Florida that we feel are oversupplied then we’ll come down to low lot recoveries, $15,000 or $20,000 per lot. If we can recover that by building a house then we’ll continue to do that on the bottom end. In other examples if they are our prime locations with a shortage of land and markets just at the moment can’t justify the price then we might mothball a community or not to go forward if it generates substantially more cash flow per lot than that. But, that’s part of the thinking, it’s kind of tempered by what we perceive as the near or intermediate term future based on land supply there.

David Goldberg – UBS

Just to clarify that, the $15,000 or $20,000 on the low end, what would the finished lot cost be there? What percent of that would that be of the finished lot cost?

Ara K. Hovnanian

It’s all over the board. I mean it could be as low as 20% of the finished lot cost and obviously that’s why we’re generating some of the low margins that we’re generating or if you go down that far in price that’s why we’re booking the impairments in those cases.

David Goldberg – UBS

I guess the second question as opposed to the build or no build in open communities –

Ara K. Hovnanian

And by the way, the other positive of doing that in addition to generating cash flow is you build through our older valued lots so that we can make room to replenish our land supply at better valuations.

David Goldberg – UBS

I guess the second question, it’s along the same lines but it specifically relates to the mothballed communities and the $500 million plus land that you have in the mothballed communities, I guess I’m trying to figure out how much prices would have to go up from where we are to make that, or maybe sales base, if you can give us some sort of idea what would make those projects viable? Then, what goes in to the impairment analysis because you’ve written off at the masses right here about 36% of the original invested value in impairments in those communities and it seems like a low number given that we’re not at pricing now that would sustain opening up the communities?

Ara K. Hovnanian

The answer is all over the place. Obviously, it depends on the community and it depends on the status of land development and also when we put it in to mothball. But, there are clearly examples where it doesn’t take a lot of price appreciation or velocity. Remember, both of those are taken in to account. There are definitely cases where it wouldn’t take a lot to get it out of the mothball status for us. But, there’s not simple or easy answer. Clearly, prices have come down in many of our locations 40%, if we could recover 10% of that 40% there are many cases where it might justify reigniting a mothballed community.

Operator

Your next question comes from Dan Oppenheim – Credit Suisse.

Dan Oppenheim – Credit Suisse

I was wondering if you can talk about your comment on being very focused on cash flow at the expense of margins as it relates to the Northeast? Looking at the investment in lots in your K, and sort of adjusting for the impairments this quarter, it looks as though you’ve got in your planned communities $145,000 of investment per lot in the Northeast whereas every other region maxed out at about $40,000 per lot in the West. Given the weak demand in the Northeast, should we expect lower pricing and significant impairments to come on that?

Ara K. Hovnanian

Well, you’re comparing an apple and an orange. On the West most of our land holdings remain in very inexpensive areas, in the Inland Empire, in the outskirts of Sacramento and then Bakersfield where the land values are just very low. Conversely in the New Jersey market in the Northeast near the New York Metropolitan area or in the core areas of New Jersey, the values are dramatically higher. So, it’s a bit of an apple and an orange.

J. Larry Sorsby

Having said that, our impairments during the first quarter Dan were weighted towards the Northeast and specifically New Jersey because we have seen some price erosion based on what’s happened on Wall Street since September, so we make the analysis based on the facts at the time of each quarter end and make the adjustments accordingly.

Ara K. Hovnanian

If you also look as part of our release the average price in net contracts, I think it says that pretty well, in the West it was $166,000, in the Northeast it was $470,000, triple the price so that’s also part of the rationale.

Operator

Your next question comes from Nishu Sood – Deutsche Bank Securities.

Nishu Sood – Deutsche Bank Securities

I wanted to ask first about your debt repurchases which obviously stepped up in importance here. I wanted to get your thoughts, your kind of goals, your strategies that are guiding you here specifically I would like to understand how much cash you intend to allocate to the debt repurchases, how you’re altering your maturity structure, which maturities you’re targeting for repurchase and whether or not the repurchases you’re doing here are opportunistic, you know transactions that are coming to you or whether you’re going out and seeking them?

J. Larry Sorsby

I think really all we’re going to say about that is what we said in the script and that is that we gave the detail on what we have done very recently. We have a very limited amount of cash which I’m not going to define specifically as to how much more we’re willing to do but I can assure you that it’s limited because we need to preserve our liquidity and I think I’m just going to leave it at that.

Nishu Sood – Deutsche Bank Securities

Maybe you can give us just maybe your thoughts on the questions asked on what has happened to date already? Like, which maturities are you buying, whether they were opportunistic or whether they came to you? Just in terms of what has happened already.

J. Larry Sorsby

What’s actually happened already, we’ll put out incrementally more data when we file our 10Q later this afternoon, we’ll break it out between sub debt and senior debt but we’re just not giving any granularity on specifically what issue, what amount, that kind of thing.

Nishu Sood – Deutsche Bank Securities

The next question I wanted to ask was about gross margins, at this stage in the downturn, at this stage in the impairment cycle we’re seeing obviously a larger amount of previous impairments flow back through gross margins, you’re gross margins seem to have kind of stabilized in the let’s say the 5% to 7% range but your peers though generally have been coming in at about 11% to 13%. So, I was just wondering maybe if you could give us your thoughts on what the differential is there?

Ara K. Hovnanian

I think part of it could be related to the fact that we’ve got and have had a fair amount of activity in California and Florida which has some terrible margins. Part of it is also related to the fact that we are more focused on cash flow and more willing I think to accept lower margins in returns for sales velocity. You can see that by the fact that while our sales were dismal in the first quarter with a -36% it was the third best or fourth best in the industry when you look at the 12 or 13 public builders.

Part of the reason we were able to do that and not have our sales decline as much I suspect is that we were a little more aggressive and therefore were willing to take the pricing hits. As I mentioned with the California and Florida, we just have a greater portion of our assets in some of the very tough markets.

Operator

Your next question comes from Megan Talbott McGrath – Barclays Capital.

Megan Talbott McGrath – Barclays Capital

I just wanted to follow up a little bit more on the cash flow, Larry you mentioned – I realize that you don’t want to give guidance but you mentioned that you are going to be laser focused so I’m wondering if you can give us any more thoughts about what you can do? You talked about what’s out of your control but what are the things that are in your control? Did you have discretionary land spend this quarter that you can pull back? Does it make sense to be more aggressive on pricing over the next couple of quarters?

J. Larry Sorsby

Well, I think you’ve seen us be aggressive on pricing to the extent that we can still make a decent recovery of our current improved lot cost by selling a house. If we’ve got to discount the house and still can recover a decent amount of the lot cost as Ara defined a few minutes ago, we’ll continue to do that to the extent that the market dictates that we have to do that in order to sell homes. That’s been our strategy, it’s going to continue to be our strategy throughout this downturn.

The other thing that we continue to do is obviously monitor very carefully all of our overhead costs and you see every quarter although these decisions are extremely difficult to make but, as business slows down we have to continue to right size our business and you’ll see that happen as appropriate in individual markets as well. We’re just focused on preserving cash in every way that we can.

There’s a certain amount of land development work that we just have to do. In Texas, one of the better markets in the country, we have optioned finished lots so we’re selling well, we have decent margins there and we’ll continue to spend money on land as we sell homes on the lots that we currently own in specific communities so we can’t stop taking down land in a market where we’re getting a good return on our capital.

Megan Talbott McGrath – Barclays Capital

Ara, just to follow up, in your initial comments I think you very briefly mentioned that you took down some lots as part of a redesign of several communities. Is that something you’re doing firm wide?

Ara K. Hovnanian

No, what we were saying is if you simply took the lot purchases and compared it with the deliveries and lot sales, you couldn’t quite get to the number of lots we ended up with and that’s because on some existing lots that we own or land that we own, the product was redesigned giving us more lots without buying more land. I was just trying to explain that.

Operator

Your next question comes from [Timothy Jones - Weselin & Associates].

[Timothy Jones - Weselin & Associates]

Just a follow up first of all with what was asked to you on that buy back of debt, can you at least say has it been bought from debt holders or banks?

J. Larry Sorsby

I’m sorry has it been bought from who?

[Timothy Jones - Weselin & Associates]

Public debt holders or banks?

J. Larry Sorsby

They’ve all been from debt holders.

[Timothy Jones - Weselin & Associates]

Okay, the first question is on your covenants now what are your most stringent? Especially tangible net worth and debt to capital and does this $210 million gain in the second quarter, do the banks take it in full faith?

J. Larry Sorsby

We don’t have any tangible net worth covenants either on our bank debt or any of our public debt. We really don’t have any maintenance covenants such as a minimum net worth or fixed charge coverage on any of our debt.

Ara K. Hovnanian

Basically when we switched to a secure facility and reduced the amount, by the way we don’t have anything borrowed on our credit facility, but we exchanged that in return for very lenient covenants.

[Timothy Jones - Weselin & Associates]

But the banks will give you credit for this gain that you’ve got from buying back this debt early in the second quarter?

J. Larry Sorsby

There’s no covenant that’s related to it. They certainly count it as equity.

[Timothy Jones - Weselin & Associates]

The second one, you gave us the specs this year versus last year, can you give us either the total homes under construction including the specs and I can take the ones that are not spec out of it? Either non-specs or give me the total, either one it doesn’t make a difference.

J. Larry Sorsby

Clearly, I don’t have that number at our finger tips and it’s not something that we’ve ever given out before. Call me afterwards and we can talk about it Tim.

Operator

Your next question comes from Alex Barron – Agency Trading Group.

Alex Barron – Agency Trading Group

I was wondering if you could talk about your restrictive payments basket? I’m just trying to get a sense of is there some kind of max amount of debt you can repurchase?

J. Larry Sorsby

All the information regarding limitation on our restrictive payments you can find in the SEC filings for each of our debt issues. There are several different baskets with different kind of limitations that are available to us under the limitations. They are pretty complex and I think the important thing is that we remain in compliance of all those restrictive payment baskets and expect to continue to remain in compliance with all of our debt covenants. I think that’s what you need to understand.

Alex Barron – Agency Trading Group

My second question was you talk a little bit about I guess in some communities there are maintenance costs and taxes and so forth, do you have some estimate of what that amount is for this fiscal year?

Ara K. Hovnanian

No, we don’t break out that level of detail.

J. Larry Sorsby

I mean we have it built in to our models but we don’t have a break out of that to provide you.

Operator

Your next question will come from [Joel Locker – FB&C Securities].

[Joel Locker – FB&C Securities]

Just on the job or actually the 506 orders that you took in February, how many of the orders were taken with the mortgage in case you lose your jobs, six months per year or whatever it is?

J. Larry Sorsby

We only recently started offering that probably within the last three weeks, four weeks so I’m not sure how many of the 500 in February were that way but the program is getting some interest and it’s able to overcome the objection for some of the customers but I don’t think it’s a primary driver of why we got 506.

[Joel Locker – FB&C Securities]

How would that run through or which line item would you take a reserve immediately? Through COGS when you take an order?

J. Larry Sorsby

We go to a third party insurance provider to get that. We just pay an insurance premium so to speak so it doesn’t affect our ability to book the revenues or anything.

[Joel Locker – FB&C Securities]

And that would go through other expenses.

Paul W. Buchanan

The insurance premium itself would be in cost of sales as part of closing costs.

J. Larry Sorsby

It’s very modest.

Operator

Your next question comes from Lee Brading – Wachovia Securities.

Lee Brading – Wachovia Securities

I wanted to follow up on just the balancing act you’re doing on the land spend side because Ara one comment you made is that land is starting to make sense, you did a bid in Texas and Larry you made a comment it’s a race to zero yet it still looks like you have too much land that you own in general. What I kind of gather and looking at your Slide 13, I guess Texas would fall within that Southwest, a pretty low relative to your overall company in amount of years of lots owned. Is it very targeted geographically where you’re looking to buy land or is it broader than that?

Ara K. Hovnanian

It’s broader. First, just a clarification, the race to zero is on the land that we have on our books that was purchased at higher valuations. But, in terms of the current lot options that have been done, that’s been primarily focused in Texas and that’s been on an improved lot rolling take down basis. So, we’re basically buying two or three lots at a time if we get sales, then you buy another two or three lots and it turns relatively quickly with little exposure.

Regarding the overall larger picture for looking for land opportunities we’re looking really across all of our markets and as we’ve mentioned, our focus is to do that without using up a huge amount of our capital by finding joint venture partners. To the extent we already have a land supply obviously, we wouldn’t purchase the identical kind of parcel but there are many opportunities in many different geographies and many different products so even though we may have a larger land position than we’d like today based on old land holdings or old land purchases in DC, that doesn’t mean that we wouldn’t look at a new opportunity at a price that works today and generates a profit.

So, at the same time we’re continuing to sell some of our old land, we may have a new location or a new product, or perhaps our land is for 75 foot lots and we have a new product opportunity four towns over with 40 foot lots then we’d consider looking at those opportunities.

Lee Brading – Wachovia Securities

Then just on the interest expense side, just the timing of that, I know you disclosed interest occurred was about $50 million or so but if I was just looking at it I guess from the standpoint of the bond payments, you ended up making about $90 million in payments this past quarter, is that about right?

Ara K. Hovnanian

The bond payments are weighted towards the first and third quarters, they are dramatically higher, dramatically than the second and fourth quarters. As a clarification I think the bond interest payments was a little over $80 million in the first quarter and would be significantly less, significantly less in the second quarter.

Operator

Your next question comes from Michael Rehaut – JP Morgan.

Michael Rehaut – JP Morgan

I just had a quick follow up, more of a clarification from earlier, you had said that you mothballed 13 communities during the quarter and I wasn’t sure if the 531, I assumed that’s related to a larger number of communities and I was wondering if you could maybe give a little more color in terms of maybe geographic breakdown?

Paul W. Buchanan

65 total mothballed communities for that.

Michael Rehaut – JP Morgan

Any sense of geographically how that 531 breaks apart?

Ara K. Hovnanian

Not, we don’t break that out geographically.

Operator

Your next question comes from [Michael Lynn – Fairlawn].

[Michael Lynn – Fairlawn]

My question was what the amount of the RP basket was under the secured 11.5% notes pro forma for your buys?

J. Larry Sorsby

There are several different baskets so I don’t know, which one are you talking about?

[Michael Lynn – Fairlawn]

I guess the obvious question is you’ve spent $140 million on bonds in the open market under the 11.5% indenture which I assume would be the most restrictive, how much more could you spend if you wanted to?

J. Larry Sorsby

The answer is not that straight forward and I could just repeat the answer I gave earlier but it stands. If you want to really understand our restrictive payment baskets you probably ought to go look at the SEC filings. We remain in compliance with all of those baskets, it’s fairly complex and we intend to remain in compliance going forward as well.

Ara K. Hovnanian

In general it’s not unlimited by any stretch. We do have more opportunities. I would say our own internal caution would be the more restrictive factor right now than the basket. But, that basket does change over time and that’s why Larry mentioned it’s not a straight forward or a simple calculation.

Operator

Your next question comes from Larry Taylor – Credit Suisse.

Larry Taylor – Credit Suisse

I wonder if you guys could share, even if it’s not an exact number, give us some sense of the sort of level of cash that is your comfort level? I mean, you kept cash about flat during the quarter notwithstanding whatever happened with operations, you spent some on debt repurchase since, is there a level? Is it $500 million, is it $300 million, is it $700 million? Do you see where I’m going with that?

J. Larry Sorsby

Yes and that’s a difficult question to answer. Obviously, more is better and stating the obvious there but, how long is the downturn going to last? It would be easier to answer that question but we’re focused that the most important thing to our ability to weather this down turn is having sufficient liquidity which means sufficient cash. So, we’re very cautious on depleting that and I don’t think I can give you much more clarity than that Larry.

Operator

Your next question comes from Susan Berliner – JP Morgan.

Susan Berliner – JP Morgan

Larry, I guess if I could ask that question a little bit differently in trying to figure out the restrictive payment basket which I guess a lot of people are having difficulty. I guess when you guys look at the collateral package that secures the 11.5, I know you had gotten an appraisal, is there any way to give kind of an approximation of what the collateral is and should we include cash in that number as well? What kind of a cushion is there?

J. Larry Sorsby

You can include cash in the calculation and I’m just not going to be able to give you any specifics beyond that. But, I will tell you that cash is included.

Operator

At this time I see no further questions in queue. I would like to turn the call back over to Ara Hovnanian for closing remarks.

Ara K. Hovnanian

Thank you very much. It’s obviously a challenging environment. We wish we had even better news to give you but, we continue to work hard, focus on cash flow and we look forward to reporting to you next quarter.

Operator

Thank you for your participation in today’s conference. This concludes the conference. You may now disconnect. Good day.

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Source: Hovnanian Enterprises, Inc. F1Q09 (Qtr End 1/31/09) Earnings Call Transcript
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