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Edited Transcript of HOV earnings conference call or presentation 5-Dec-19 4:00pm GMT

Q4 2019 Hovnanian Enterprises Inc Earnings Call

RED BANK Dec 6, 2019 (Thomson StreetEvents) -- Edited Transcript of Hovnanian Enterprises Inc earnings conference call or presentation Thursday, December 5, 2019 at 4:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Ara K. Hovnanian

Hovnanian Enterprises, Inc. - President, CEO & Chairman of the Board

* Brad G. O’Connor

Hovnanian Enterprises, Inc. - VP, CAO & Corporate Controller

* J. Larry Sorsby

Hovnanian Enterprises, Inc. - Executive VP, CFO & Director

* Jeffrey T. O'Keefe

Hovnanian Enterprises, Inc. - VP of IR

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Conference Call Participants

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* Alan S. Ratner

Zelman & Associates LLC - MD

* Alex Barrón

Housing Research Center, LLC - Founder and Senior Research Analyst

* Megan Talbott McGrath

The Buckingham Research Group Incorporated - Director

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Presentation

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Operator [1]

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Good morning, and thank you for joining us today for Hovnanian Enterprises Fiscal 2019 Fourth Quarter Earnings Conference Call. An archive of the webcast will be available after the completion of the call and run for 12 months. This conference is being recorded for rebroadcast. (Operator Instructions)

Management will make some opening remarks about the fourth quarter results and then open the line for questions. The company will also be webcasting a slide presentation along with the opening comments from management.

The slides are available on the Investors page of the company's website at www.khov.com. Those listeners who would like to follow along should now log on to the website.

I would like to turn the call over to Jeff O'Keefe, Vice President, Investor Relations. Jeff, please go ahead.

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Jeffrey T. O'Keefe, Hovnanian Enterprises, Inc. - VP of IR [2]

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Thank you, Liz, and thank you all for participating in this morning's call to review the results for our fourth quarter, which ended October 31, 2019.

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, statements related to the company's goals and expectations with respect to its financial results for future financial periods. Although we believe that our plans, intentions and expectations reflected in or suggested by such forward-looking statements are reasonable, we can give no assurance that such plans, intentions or expectations will be achieved.

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

Therefore, actual results could differ materially and adversely from those forward-looking statements as a result of a variety of factors. Such risks, uncertainties and other factors are described in detail in the sections entitled Risk Factors in management's discussion and analysis, particularly the portion of MD&A, entitled Safe Harbor Statement in our annual report on Form 10-K for the fiscal year ended October 31, 2018, and subsequent filings with the Securities and Exchange Commission.

Except as otherwise required by applicable security laws, we undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, changed circumstances or any other reason.

Joining me today are Ara Hovnanian, Chairman, President and CEO; Larry Sorsby, Executive Vice President and CFO; Brad O'Connor, Vice President, Chief Accounting Officer and Controller; and David Bachstetter, Vice President, Finance and Treasurer.

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

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Ara K. Hovnanian, Hovnanian Enterprises, Inc. - President, CEO & Chairman of the Board [3]

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Thanks, Jeff. I'm going to review the results of our fourth quarter. And as usual, Larry Sorsby will follow me with more detail.

Overall, we are pleased with the results, and our quarter was in line with our guidance.

Slide 4 shows the specific metrics we discussed on our last conference call. Our guidance for the gross margin for the fourth quarter was approximately 18.4%. Our actual results were slightly better, at 18.9%.

Second, we said that our adjusted pretax income for the fourth quarter would be enough that we would be profitable for the full year. That implied a pretax profit for the fourth quarter in excess of $40 million. Excluding the costs related to our early extinguishment of debt, which was $42 million related to our recent refinancing and excluding $3 million of land-related charges, our adjusted pretax income for the fourth quarter was $45 million. This exceeded consensus estimates, and for the full year, our adjusted pretax profit was $10 million.

Finally, we said that we expected our community count to increase in the fourth quarter and that we would exceed 160. We ended the year with 162 total communities, which increased sequentially and was up 14% compared to 142 communities in the fourth quarter last year.

On Slide 5, we compare year-over-year results for the fourth quarter. As you can see in the upper-left-hand quadrant, total revenues grew 16% from $615 million last year to $714 million during this year's fourth quarter.

The growth was driven by a 17% increase in deliveries and was offset slightly by a little lower average sales price. The increase in total revenues is a result of investments that we've been making in our land position over the last 2 years.

Moving to the top right, you can see that our gross margin was 18.9% for the fourth quarter of '19 compared to 19.2% during the fourth quarter of 2018.

While it was down compared to last year, just a bit, it was up sequentially from 18.4% in the third quarter and exceeded our guidance, as I said before.

In the lower left-hand portion of the slide, you can see that our total SG&A ratio was 7.6% for the fourth quarter of 2019 compared to 8.3% in last year's fourth quarter. Our increased level of revenues and the resultant lower SG&A ratio for the fourth quarter demonstrate the benefits of leveraging our SG&A expenses with higher revenues.

Our total SG&A dollars were up from $51 million last year to $54 million in this year's fourth quarter. Our 15% increase in consolidated communities certainly impacted our SG&A costs. However, for 5 quarters in a row, our SG&A per community decreased year-over-year.

For the fourth quarter, it decreased from $413,000 per community last year to $382,000 per community this year. As we started getting a greater number of -- excuse me, as we start getting a greater number of deliveries from our growing community count, we expect to be able to leverage our costs, and over time, get our annual SG&A ratio back to more normalized levels of -- in the 10% range.

In the bottom right-hand quadrant of the slide, in typical fashion, we had a particularly strong fourth quarter, with adjusted pretax income of $45 million, which exceeded consensus estimates.

Now let me talk about our sales environment. Our fourth quarter continued a very positive trend that began in February of this year and continued throughout the year.

On Slide 6, we show that consolidated contracts for the quarter increased 34% year-over-year to 1,345 contracts this year compared to 1,004 contracts a year ago.

Slide 7 gives more granular detail, with the number of consolidated contracts on a monthly basis. During the quarter, every month showed a strong increase compared to the same month last year. We've had a year-over-year increase in contracts every month since February of '19. The positive trend continued in November, the first month of fiscal '20, when contracts increased 42% year-over-year.

The previous 2 slides showed consolidated contracts on an absolute basis. On Slide 8, we show consolidated contracts per community for the fourth quarter of 2019. As you can see, this metric also improved, increasing 16% to 9.5 from 8.2 in last year's fourth quarter. It was one of the strongest quarters we've had in over a decade.

On Slide 9, we give more granularity, with monthly consolidated contracts per community for the past 12 months. The most recent month is in blue, and the same month a year ago is in gray. 9 of the past 12 months, including the last 7 months in a row, have been equal to or better than the same month during the prior year. November, again, the first month of fiscal '20, is also showing an improvement at 2.9 contracts per community compared to 2.2 contracts per community last year, and it was up even over the 2.7 that we had in November of 2017.

If you turn to Slide 10, you can see another view of contracts per community with longer-term trends. On the left-hand side of the slide, we show our annual contracts per community from '97 to 2002. We averaged 44 contracts per community during this time period, and again, that was neither a boom nor a bust for the housing industry, as we've said in the past.

On the remainder of the slide, you can clearly see the steady growth in contracts per community for each of the past several years. On the right-hand portion of the slide, we show that net contracts per community for all of 2019 was 38.9 compared to 36.0 a year ago.

While our contract pace has improved, we're still not at historical norms, let alone market peaks. Although we're currently in a very long recovery, this is one of the many metrics that suggest that we still remain far from the ninth inning. As we continue our gradual migration back to normal absorption levels, we expect our SG&A ratio will continue to improve.

If you turn to Slide 11, you can see that our total community count increased 14% to 162 communities at the end of the fourth quarter compared to 142 at the end of the same quarter last year. Again, the result -- this growth is a result of investments we've been making in our land position for a while. It certainly should lead to higher levels of revenues, and ultimately, to higher levels of profitability in the future.

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

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J. Larry Sorsby, Hovnanian Enterprises, Inc. - Executive VP, CFO & Director [4]

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Thanks, Ara.

I'll start by discussing the steps we took in the fourth quarter to significantly improve our capital structure and better position ourselves to execute on our growth strategy.

We successfully exchanged or refinanced over $800 million of debt. We eliminated all maturities until 2022 and pushed out over 50% of the debt coming due in '22 and 2024. Additionally, we simplified our capital structure by creating a single collateral pool for the benefits of all secured debt holders. The long-term benefits of extending our debt maturities far outweighed the short-term impact of the $42 million charge related to early extinguishment of debt.

On the top half of Slide 12, we show our maturity profile as it looked on July 31, 2019. And on the bottom half of the slide, it shows our maturity ladder after we closed the financing transactions on October 31, 2019.

In summary, we refinanced $270 million of debt maturing in 2020 and 2021, exchanged $435 million of debt that was coming due in 2022 and 2024 and extended all of those maturities to 2026. We also refinanced our $125 million revolving credit facility that was set to convert into a term loan later this month into a new 7.75% revolver maturing in 2023.

The financing transactions accomplished 3 main objectives: number one, it extended our debt maturity runway; number two, it simplified our capital structure into a single collateral pool for the benefit of all of our secured holders; and number three, it helps maintain our liquidity and allows us to continue to invest in land rather than use our liquidity to deal with near-term debt maturities.

Additionally, we have a pending exchange offer that is focused both on pushing out a portion of our remaining 2022 and 2024 maturities and capturing discounts on the exchange of certain debt instruments. We will continue to analyze and evaluate our capital structure and explore transactions to further strengthen our balance sheet.

As we stated on prior analyst calls, as we sold through some of the joint venture communities we set up in 2016, when we needed to raise liquidity by contributing wholly owned communities to joint ventures, we expected our joint venture activity to decline. In line with our guidance, our unconsolidated joint venture deliveries declined 34% in the fourth quarter. Our income from unconsolidated joint ventures decreased from $17 million in profit last -- in last year's fourth quarter to $8 million of profit in this year's fourth quarter.

Due to the community and geographic mix of homes we delivered this quarter, the decline in profit was greater than the decline in deliveries.

Looking forward, we expect unconsolidated joint venture income during the first quarter to be similar to last year's first quarter results.

Turning now to Slide 13. On the left half -- left portion of the slide, you can see that the strong growth in new orders has led to a 20% growth in consolidated contract backlog, from 1,826 homes at year-end last year to 2,191 homes at year-end this year.

On the right-hand side of the slide, we show an 18% increase in consolidated contract backlog dollars, from $746 million at the end of last year's fourth quarter to $880 million at October 31, 2019. This is a leading indicator of the growth in revenues we expect to occur in the near future.

Turning to Slide 14. As you can see on this slide, our lots controlled at year-end decreased a few percent compared to last year. However, including modest growth assumptions for fiscal 2020, we control 100% of the lots required to meet our 2020 delivery forecast. Further, we already control over 85% of the lots needed to meet the more substantial growth in deliveries we're expecting during fiscal 2021. This is a significantly higher percentage of lots already under our control than we would typically have this far in advance of the following fiscal year. During the fourth quarter, approximately 2,400 lots were put under option or acquired, and our controlled lot supply remained strong.

Turning to Slide 15. You can see our peers' supply of total lots controlled compared to ours. At 5.9 years of total lots controlled, we're above the median of our peers. We remain disciplined to our underwriting standards of using current home sales price, current sales pace and current construction cost when controlling and/or purchasing new land parcels. Specifically, we look at recent home sales prices, net of incentives of our competitors to determine current home prices.

Similarly, we look at our competitors' most recent 13-week sales pace, seasonally adjust them to determine current annual absorption pace. We are not using optimistic, rosy assumptions to stretch for future land acquisitions.

We continue to seek new land acquisition opportunities, and our land acquisition teams throughout the country remain busy. When we find the right opportunities, we seek to control those lots. We're pleased with the quality of our recent land acquisitions. We will continue to utilize options when available as we feel they mitigate risk and provide us with a built-in market hedge.

On Slide 16, compared to our peers, you can see that we had the second highest percent of land control via options. We continue to use land options as much as possible in order to achieve high inventory turns, enhance our returns on capital and reduce land risk.

Looking at all of our consolidated communities in the aggregate, including mothballed communities and the $190 million of inventory not owned, we have an inventory book value of $1.3 billion net of $209 million of impairments.

Turning now to Slide 17. Compared to our peers, you see that we have the second-highest inventory turnover rate over the trailing 12 months. Although we lag NVR's industry-leading turnover number, our turns are 33% higher than the next highest peer below us. High inventory turns are a key component of our overall strategy.

Another area for discussion is related to our deferred tax asset. Our deferred tax asset is very significant, and because it is fully reserved for by a valuation allowance, it is not currently reflected on our balance sheet. We've taken numerous steps to protect this asset. As of October 31, 2019, our deferred tax asset in the aggregate was $623 million. We will not have to pay federal cash income taxes on approximately $2 billion of future pretax earnings.

On Slide 18, we show that we ended the fourth quarter with a shareholders' deficit of $490 million. If you add back our valuation allowance as we've done on this slide, then our shareholders' equity would be a positive $133 million.

Now let me comment on our current liquidity position. During the fourth quarter, we spent $163 million on land and land development. As seen on Slide 19, we ended the fourth quarter with liquidity of $276 million, which is well above the $245 million high end of our targeted liquidity range. Assuming no adverse changes in current market conditions, for the first quarter of fiscal 2020, we expect year-over-year growth in revenues, a gross margin similar to the 17.8% we had in last year's first quarter and slightly better year-over-year performance and pretax profit before any land-related charges or gains or losses on extinguishment of debt.

Similar to our historical trends, we expect to begin the year with weaker first quarter performance and end the year with stronger performance in our fourth quarter.

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

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Ara K. Hovnanian, Hovnanian Enterprises, Inc. - President, CEO & Chairman of the Board [5]

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Thanks, Larry.

While we've been very focused on growing our top line and more recently on refinancing our debt, we've also been making investments in our associates and our systems. Here are just a few of the investments we've made over the past year.

We opened a new national Internet call center along with leading-edge software and processes. This enables us to enhance our interactions with potential customers in ways that are appropriate for today's digital world.

We've dramatically enhanced our in-house sales training with processes and sales management teams that together, with leveraging new technology, better prepares our sales associates to meet the needs of potential homebuyers, and obviously, to sell more homes.

We've launched new Extra Suite Plus floor plans across the country to meet the needs of multi-generational buyers. We have also continued to build a state-of-the-art national digital marketing team to address the ever-changing digital advertising landscape. This allows us to optimize the dollars we spend on digital advertising, including carefully managing by source cost per clicks, cost per site actions and cost per leads.

We've begun to develop dashboard reports using business intelligence software, combining -- combined with our integrated systems to enhance the monitoring and managing of all of our communities.

And finally, we've created a new, accelerated leadership development program, which includes experiential learning in a variety of roles in departmental functions. Our focus is on preparing our associates to become future division presidents.

I'm really excited about all the initiatives we've undertaken. These investments are very critical to our future successes. We're encouraged that the housing market remains strong, which is very evident in the recent sales success I just reported.

We feel that we're well-positioned to take advantage of demographic trends, especially given our focus on the entry-level homes through our Aspire offerings and empty nester homes through our Four Seasons active lifestyle communities.

Additionally, the U.S. economy remains strong, and mortgage rates are very attractive at these low levels.

We believe that given this backdrop, we're well positioned to execute on our growth strategies.

That concludes our formal remarks, and we're happy to open it up for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Megan McGrath with Buckingham Research.

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Megan Talbott McGrath, The Buckingham Research Group Incorporated - Director [2]

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I wanted to follow up on your conversation around your lots and land ownership and options. We've heard from some other builders, as we've worked through the last couple of months, that have also had really high rates of order growth some caution around their ability to maintain community count growth as they start to sell through these high orders. So I'd love to hear your comments on that looking into 2020 and the amount of finished lots that you have to kind of continue this pipeline?

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Ara K. Hovnanian, Hovnanian Enterprises, Inc. - President, CEO & Chairman of the Board [3]

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We feel pretty comfortable, Megan. I mean it's always a competitive environment. But I can't say that we've seen any significant decrease in opportunities from what we saw a year ago or 2 years ago. We continue to be disciplined, but we're finding opportunities across the country.

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J. Larry Sorsby, Hovnanian Enterprises, Inc. - Executive VP, CFO & Director [4]

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Yes. The only thing I would add is, obviously, just from a pure mathematical perspective, as you sell at a faster pace per community, it does make achieving growth in community count more difficult because you sell through them more quickly.

But obviously, what we're really after is growth in contracts, growth in revenues, which we're achieving by selling faster per community and get the benefit of some overhead reduction as well. So we'll take the faster pace, even if it does modify our ability to grow community count as fast as we otherwise would.

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Megan Talbott McGrath, The Buckingham Research Group Incorporated - Director [5]

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Okay. Great. That's what I was after. And then just to follow up a little bit on pricing. Your order ASP was down about 1.5 points. It looks like, although your individual regions were down more than that, so that's partially due to mix. So could you talk about that mix shift downward to a lower price point and what you're seeing there versus any pure pricing pressure?

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Ara K. Hovnanian, Hovnanian Enterprises, Inc. - President, CEO & Chairman of the Board [6]

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Yes, we have been trying to grow our Aspire line. Our Aspire line is our most affordable entry-level homes. So I'd say we're deemphasizing a little bit to move up homes, although it's not a huge segment, first-time homebuyers have always been a big part of our market. But we're pushing further on increasing the mix of our lowest price.

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Operator [7]

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Our next question comes from Alan Ratner with Zelman & Associates.

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Alan S. Ratner, Zelman & Associates LLC - MD [8]

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Congrats on a strong quarter and the debt refinancing. A couple of housekeeping questions first. First, on the SG&A, very impressive leverage. I think a year ago, you guys had kind of a onetime benefit in that number, maybe some reversal of some defect reserves. Was there any similar benefit this quarter that you can quantify?

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J. Larry Sorsby, Hovnanian Enterprises, Inc. - Executive VP, CFO & Director [9]

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Yes, Alan, thanks for the pat on the back on the good results. With respect to SG&A, last year, we had an actuarial analysis that we do for the year-end every year, and it resulted in a $10 million reversal of insurance reserves. I think that's what you're referring to. This year, we did that same actuarial analysis as we do every year, it resulted in a lower $6.5 million reversal this year. So if you take the $10 million out of last year's results and $6.5 million out of this year's results, the SG&A percent would have been 10.2% last year compared to 8.7% this year, ignoring that insurance reversal in both periods.

So it's 150 basis points improvement, ignoring -- if you want to call the insurance reversal onetime, I mean, it happened in both periods.

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Alan S. Ratner, Zelman & Associates LLC - MD [10]

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Got it. That's helpful, Larry. I appreciate that. Second, I want to just make sure I understood or heard you correctly. I think, Larry, you made a comment, just when you were talking about your lot supply and kind of controlling all of your expected deliveries in 2020, I thought you made a comment that you're expecting modest growth next year. And I guess I was a little surprised by that just given the fact that your backlog is up 20% entering the year, and it seems like the order activity is continuing quite strong so far into the beginning of the new fiscal year. So did I hear that correctly? And any additional commentary you could offer there?

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J. Larry Sorsby, Hovnanian Enterprises, Inc. - Executive VP, CFO & Director [11]

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I did say modest. I am a CFO, so maybe I'm a little more conservative than some. But we did say, in '21, which is really next year, and we are in '20 already this year, we expect more substantial growth.

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Alan S. Ratner, Zelman & Associates LLC - MD [12]

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Okay, understood. And then if I could sneak in one last one. The order trajectory is very encouraging. Just curious, we're hearing a lot about the entry-level kind of a resurgence across the industry, and you guys seem to be focusing on that as well. Within the last 3, 4, 5 months, and this really strong order growth, have you seen any improvement as well? Maybe the move up or higher price points or maybe some geographies that have been well publicized as maybe lagging earlier in the year, thinking about like California, for an example.

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Ara K. Hovnanian, Hovnanian Enterprises, Inc. - President, CEO & Chairman of the Board [13]

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I can't say we've noted any significant shift in the last 6 months, either in geographies or price points or target audiences. It's been fairly steady across the board.

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Operator [14]

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(Operator Instructions) Our next question comes from Alex Barrón with Housing Research Center.

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Alex Barrón, Housing Research Center, LLC - Founder and Senior Research Analyst [15]

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Great job in the quarter. I wanted to ask about whether you guys were going to offer any kind of guidance at this time since we're in the new year. Any estimate on what you think you're going to try to do for revenues or orders or anything like that?

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J. Larry Sorsby, Hovnanian Enterprises, Inc. - Executive VP, CFO & Director [16]

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Yes, we did provide some color with respect to the first quarter in my formal remarks. We are not prepared to provide any formal guidance for the full year.

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Alex Barrón, Housing Research Center, LLC - Founder and Senior Research Analyst [17]

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Okay. And then in terms of the DTA, what are the rules or what would it take, Larry, for you guys to be able to put that back on the balance sheet now that you're profitable?

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J. Larry Sorsby, Hovnanian Enterprises, Inc. - Executive VP, CFO & Director [18]

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Yes, we need to be profitable on a 3-year cumulative basis and be able to look forward with our internal projections and believe that we can continue to be solidly profitable. Those are the rules. I get that right, Brad?

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Brad G. O’Connor, Hovnanian Enterprises, Inc. - VP, CAO & Corporate Controller [19]

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Yes. The only thing to make note of is that profit that we looked at is after everything. So the loss on debt counts on that. So if you're thinking that we're no longer a 3-year cume because you're doing our adjusted profit, it doesn't work that way. So I'll just point that out.

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Alex Barrón, Housing Research Center, LLC - Founder and Senior Research Analyst [20]

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Got it. So it's a trailing thing...

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Brad G. O’Connor, Hovnanian Enterprises, Inc. - VP, CAO & Corporate Controller [21]

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Trailing 3 years.

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Alex Barrón, Housing Research Center, LLC - Founder and Senior Research Analyst [22]

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Okay. Got it. Okay. And then, I guess, given that you guys have fixed the balance sheet quite a bit, any thoughts on -- or is there any restriction why you couldn't either buy back some of the bonds that are trading at a big discount or your stock given where it's at right now?

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J. Larry Sorsby, Hovnanian Enterprises, Inc. - Executive VP, CFO & Director [23]

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Well, it's a complicated answer to that question. There are certain restrictions on certain debt securities, being able to buy those early, on others, there aren't restrictions. From a cash usage perspective, we think it's probably more important to us in terms of using our cash to really focus on executing our growth plans. At this point, we're trying to grow our community count and grow our revenues, get to a higher level of sustainable profitability. Once we reach those higher levels of sustainable profitability is when we'll begin to really focus on further repairing the balance sheet and trying to reduce debt.

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Alex Barrón, Housing Research Center, LLC - Founder and Senior Research Analyst [24]

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Got it. And if I could ask one last one. I think last quarter, you guys mentioned the target of SG&A, trying to get back towards 10%. So should we expect that you'll see some SG&A leverage this year, now that the top line seems to be growing again?

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J. Larry Sorsby, Hovnanian Enterprises, Inc. - Executive VP, CFO & Director [25]

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Yes. I think as the top line grows, there should be SG&A leverage that comes along with that. I mean we actually just went over some results for the fourth quarter that kind of showed that. So as revenues grow, we expect to leverage the SG&A ratio down.

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Operator [26]

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I'm showing no further questions in queue at this time. I'd like to turn the call back to Mr. Hovnanian for closing remarks.

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Ara K. Hovnanian, Hovnanian Enterprises, Inc. - President, CEO & Chairman of the Board [27]

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Great. Thank you very much. We were pleased with the results for the year and the quarter, and we'll look forward to giving you more good news as 2020 unfolds. Thank you.

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Operator [28]

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