Hovnanian Enterprises, Inc. (HOV) Q3 2009 Earnings Report, Transcript and Summary

Good morning and thank you for joining us today for the Hovnanian Enterprise fiscal 2009 third quarter earnings conference call. An archive of the webcast will be available after the completion of the call and run for 12 months. (Operator Instructions) Management will make some opening remarks about the second quarter results and then open up the line for questions. The company will also be webcasting a slide presentation along with the opening comments from management. The slides are available on the investors page of the company’s website at www.khov.com. Those listeners who would like to follow along should log onto 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 to the information in the slide presentation. I would now like to turn the call over to Ara Hovnanian, President and Chief Executive Officer of Hovnanian Enterprises. Ara, please go ahead.

Good morning and thanks for participating in today’s call to review the results of our third quarter and nine months ended July of ’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’Connor, Vice President and Corporate Controller; David Valiaveedan, Vice President of Finance; and Jeff O’Keefe, Director of Investor Relations. On slide three, you will see a brief summary of our third quarter results. As usual, we give this data and more in our press release, which we issued yesterday. Disappointingly, the losses continued in our third quarter but there are a few indications on this slide that the market may be seeking a bottom. For starters, it’s good to see our cancellation rates settling into a more normalized pattern. Our cancellation rate was 23% for the third quarter, as seen on line number four. This is the second quarter in a row that cancellation rates were back to our typical low 20% range, which for us is a more normalized cancellation rate. You have to go back four years to the third and fourth quarter of ’05 to find the last time when we had back-to-back quarters with cancellation rates at levels like this. Another interesting note is that even though our backlog units were down 34% year over year, which you see in line six, sequentially our backlog increased from 1,858 homes at the end of the April quarter to 1,978 homes at the end of our July quarter. This is the second quarter in a row that our backlog grew sequentially, which means that we sold more homes than we delivered. It feels a lot better to see our backlog growing after watching it shrink 14 quarters in a row. Another trend on this slide makes me think we may be starting to work our way through this downturn is our recent net contract performance. Our net contracts were down 19% for the quarter year over year as you can see on the first line. However, given the 44% reduction in active communities, which you see on line two, our net contracts per community for the quarter were up 62%. If you turn to slide number four, you will see a recent history of our quarterly contracts per community going back to 2006. After 15 quarters in a row of shrinking net contracts per community, we are finally seeing the trend reverse. For the first quarter of ’09, we reported a 5% increase in net contracts per community. For the second quarter of ’09, we posted a 25% increase and now as I just mentioned in our third quarter, our net contracts per community were up 62%. Not only was the sales pace in the third quarter better than last year but it’s approaching ’06 levels. For the first nine months of the year, we already sold more homes per community than we sold per community for all of fiscal ’08. Although our sales pace has improved and we may now be bouncing off a bottom, it’s important to put the data into perspective. Slide 5 shows that even though the annualized sales pace in ’09 is better than it was in ’08, it is still significantly lower than our 14-year average of 42 net contracts per community. Improvements in our absorption rates per community are one of the necessary components for us to return to profitability. Although we still need more improvements in absorption, combined with increased margin in order to return to profitability, at least the trends are headed in the right direction now. On slide 6, we show the net contracts per community for the third quarter of ’09 and ’08 for our publicly reported segments, as well as the percentage change from last year. While contract pace is up in some geographies more than others, it’s important to note that year over year, it is improved everywhere. Typical of normal seasonal trends, on a monthly basis absolute sales slowed down somewhat as we headed into the summer months but on a per community basis, each month during the third quarter this year was significantly better than it was during the previous year, which can be seen on slide number seven. As we look back on previous downturns, sales pace typically improved before pricing. We now have nine of 10 months of improved sales pace per community. Hopefully price improvement is not too far off it the future. In general, we have seen more price stability as of late. We still have communities with price declines but they are fewer in number and where we are seeing declines, prices are falling at a slower rate than we have seen in previous quarters. Additionally, we have even been able to either raise prices or reduce incentives in some communities. These increases have been modest, certainly compared to the decreases but they are increases nonetheless. Finally, after a couple of years of expecting it to happen, the land market is slowly starting to thaw. We have begun to see new land deals that we can actually underwrite and purchase based on current sales prices and current sales pace. While it started as a slow trickle of deals last quarter, the pace of opportunities is certainly picking up. Most of the opportunities are owned by banks that are ready to sell their REO or non-performing loans. Our recent transactions underwrite to an unleveraged IRR in the mid to high 20% range based on today’s home prices and absorption levels. While we are not budgeting any increases to sales prices, if prices were to move in our favor, plus an additional pick-up in velocity, returns could be even more significant. This is precisely what occurred with our acquisitions at the bottom of the market in the early 80s and the early 90s. During our third quarter, we purchased and entered into option contracts for approximately 1,200 lots in brand new deals. Additionally, we have purchased one note from a bank for 160 lots and optioned another note for approximately 1,800 lots in several different communities. In most cases, we are buying the finished lots at a discount to the development cost with the land essentially free. In Delaware, we bought land in a joint venture in the second quarter and we have already begun selling homes in this community. So far our sales pace is on target and our margins are in the low- to mid-20s. In Houston, we have begun selling homes on some finished lots that we purchased on a wholly-owned basis early this year. So far the sales pace here is also on target and the margins in these communities are in the 20% range. We are seeing opportunities for land deals in three broad categories. Let me describe them. The first category is a just-in-time finished lot take-down program. Here we purchased a certain number of improved lots per quarter that is typically tied to a projected sales pace. These just-in-time deals minimize the amount of up-front and ongoing capital, so we are comfortable doing these deals on a wholly-owned basis. The gross margin on these deals is around 20%. Because of the higher turnovers associated with this land purchase strategy, we are able to easily meet our IRR hurdle rates. The second kind of deal is for small bulk take-downs of finished or almost finished lots. These deals are typically for 40 to 60 lots at closing with gross margins in the mid 20% range. Because the capital requirement is not very significant, we are comfortable taking these lots down also on a wholly-owned basis, although we are exploring the concept of packaging some of these smaller communities into a joint venture. The third category is for larger bulk transactions that require us to take down more lots up-front with larger capital requirements. They have higher gross margins in the 30% range. Because of the larger capital requirements, these deals are better suited for our joint venture partners. We already closed two joint venture deals and we are in negotiations for a third joint venture. Further, we continue to generate interest from multiple potential joint venture partners on each opportunity that we have presented. Both of the joint ventures we have completed were done without any leverage. If in the future debt financing becomes available, returns to us and our joint venture partners will be even better. With respect to the improving market conditions, we opened two previously mothballed communities recently. While it’s too early to call this a trend, it’s interesting because in both cases, we were not expecting to open these communities for several years. We opened one community in Southern California and another one in Arizona. The sales pace and price in those areas had improved to a reasonable enough level that we were able to generate sufficient cash today to justify the re-opening, rather than postponing it further. Several signals of a housing industry bottom have become apparent and we are currently running a national advertising campaign that highlights increased sales paces, home prices beginning to firm up, and the recent upward trends in interest rates to inform the public that this may be their last opportunity to buy homes at rock bottom prices while obtaining favorable mortgage interest rates. We call the campaign Pounce Before the Bounce. Some of the graphics from the campaign can be seen on slide 8. These ads have just begun to run and while it’s too early to judge the impact of the campaign, it does seem to be driving more traffic to our communities. Hopefully the trends that we are seeing throughout our fiscal ’09 will continue and even pick up more momentum as we move forward. However, the results of our current quarter remind us there are further steps that we need to take to deal with the reality of today’s depressed levels of activity. Our gross margin was up both year over year and sequentially for the second quarter of ’09. The right-hand side of slide number 9 shows the improvements that we have made each quarter this year. However, our gross margins remain at extremely depressed levels when compared to our normalized historical levels on the left-hand side of the slide. We continue to focus on generation cash which often comes at the expense of margin. While we may continue to see some slight improvements in gross margin in the near term, our gross margin is likely to remain relatively low until housing demand increases and our ability to increase home prices return. Reloading our land supply based on today’s home prices and pace will help our margins in the future. I spoke about new land deals earlier and the impact they will have on profitability. On slide 10, we show how significantly different the gross margin is on the new land deals compared to what we reported for the most recent quarter. However, it will be some time before we start delivering a significant portion of our total deliveries from these new land deals. During the third quarter, our home building cost of sales was reduced by $50 million from the reversal of impairments slightly more than last quarter. At the same time that our gross margin is improving but still low, our SG&A as a percentage of total revenues is improving but still high. This has not happened because we’ve sat idly by as the market slowed. We have taken considerable costs out of our business but it is difficult to keep pace with the declines in our revenues. On slide 11, you can see that our staffing reductions have been significant. Staffing levels are down 72% since the peak levels we reached in June of ’06. Unfortunately, we continue to take steps to right-size the company and our staffing levels are down 33% since the beginning of our fiscal year alone. For the first nine months of this year, our total SG&A, which includes home-building SG&A and corporate G&A, has been reduced by almost $100 million, or 28% as you can see on slide number 12. We also show a significant reduction for the third quarter on this slide. Unfortunately, it’s been hard to cut SG&A as fast as our revenues have dropped. As such, our total SG&A expenses as a percentage of total revenues was still 18.3% for the third quarter. This is down from the first quarter and the second quarter but still not where we need it to be. However, we are about in the middle of the pack when compared to our peers total SG&A as a percentage of total revenues and you can see that on slide 13. In order for us to get back to profitability, we will need to see SG&A costs decrease as a percentage of revenues and gross margins increase. In the meantime, cash flow remains our top priority. Today we are less concerned with margins and more concerned with the cash we will generate by building and delivering a home. We were a user of cash in the third quarter as you can see on slide 14. The cash flow this quarter was affected by two factors -- first, our cash interest payments are higher in the first and third quarters, each representing about 40% of the full year’s cash payments. In fact, our cash interest payment in the third quarter was $61 million higher than it was in the second quarter because of the timing of bond interest payments. In our fourth quarter, we only expect to pay about $5 million in cash interest payments, so significant swings. Secondly, our land purchases including the new deals, some of the new deals I just described, were at $37 million this quarter. This is higher than previous quarters. I will now turn it over to Larry who will discuss our inventory and the charges we took in the quarter, as well as other topics.

Thanks, Ara. Let me start by talking about some of the components of our inventory. If you will turn to slide 15, we show the progress we made in reducing our active selling community count from 354 at the end of last year’s third quarter to 198 at the end of our 2009 third quarter. This represents a 44% decline. Reducing the number of active selling communities is an important step in generating cash flow by lowering the amount of our capital invested in these communities and by lowering our overheads. Likewise, our lot count continues to decline. If you turn to slide 16, it shows our owned and optioned land supply broken out by our publicly reported segments. Based on the trailing 12 month delivery basis, we own slightly more than three years worth of land. On a relative basis, this compares well to the owned land position of our peers, which can be seen on slide 17. The good news is that each quarter we work through more of the land we purchased in high prices during the housing boom and we will eventually get through all of it. We have already begun to replenish our land supply with lower cost land at the bottom of the housing cycle. Over time, this sale of older land combined with purchasing new land at current market prices will cause our gross margins to gradually increase back to normalized levels. Of course, if the market improves and we can raise prices, the timeframe to return to normalized margins will shorten. Our owned lot position decreased by about 2,300 lots. We delivered approximately 1,300 homes and sold 500 lots. Offsetting these reductions, we took down 600 lots that were under option. The balance of the net change was a decrease in the number of lots due to the redesign of communities. As we move forward, we still need to reduce our owned lot supply further. On slide 18, we show a breakdown of the 19,541 lots we owned at the end of the third quarter. Approximately 47% of these were 80% or more finished; 12% had 30% to 80% of the improvements already in place, and the remaining 41% had less than 31% of the improvement dollars spent. I will now talk about the land related charges that we took during the third quarter. We continued to walk away from land options when they don’t make economic sense. During the third quarter, we walked away from 425 lots and took a write-off of $6.5 million related to those auctioned lots. Turning to slide 19, it shows how these charges were broken out between our various segments. Our remaining investment in land option deposits was $41 million at July 31, 2009, with $30 million in cash deposits and the other $11 million of deposits being held by letters of credit. Additionally, we have another $56 million invested in pre-development expenses. The next category of pretax charges relates to impairments, which is also shown on the same slide 19. We incurred impairment charges of $95 million related to land and communities that we owned in the third quarter. Many of the charges were isolated to a few communities where we took large impairments. Land impairments were the highest in California, wherein some of the fringe locations we needed to further reduce prices in order to maintain a reasonable sales absorption pace. In particular, there were two large communities that made up 65% of the charges in the west and 34% of our total consolidated impairments. In the northeast, a market that held up better than most until last fall, 95% of the impairments were from three communities. This was 20% of our total impairment charges for the quarter. More than half of the impairment charges were concentrated in a handful of communities. The balance of the $43 million of impairments was spread throughout 46 other communities, so the average was less than $1 million per community. Many of these charges were due to our lowering the price on the remaining homes in certain under-performing communities that were almost finished and where we wanted to expedite our close-out. We test all of our communities, including communities not open for sales at the end of each quarter for impairments. If home prices continued to deteriorate, we will see additional impairments in future quarters, even if the deterioration is isolated to only a handful of communities. During the third quarter of 2009, we also recorded $4.6 million of write-downs associated with our investment in joint ventures, which shows up on the loss from unconsolidated joint ventures line in our income statement. On slide 20, we show that we have 8,687 lots that were mothballed as of July 31st and we break these lots out by our segments. Book value at the end of the third quarter for these communities was $376 million, net of an impairment balance of more than $500 million. Looking at all of our consolidated communities in the aggregate, including mothballed communities, we have an inventory book value of $1.3 billion net of $1 billion of impairments which were recorded on 226 of our communities. Turning to slide 21, it shows our investment in inventory broken out into two distinct categories, sold and unsold homes, which includes homes which 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 69% since our peak levels in July 2006 and we plan to make further progress in reducing our inventories during the remainder of 2009. Turning now to slide 22, you can see that we continued to reduce the number of started and unsold homes excluding models. We ended the quarter with 793 started and unsold homes, which is a decline of 76% from the peak levels of July 31, 2006. This translates to four started and unsold homes per active selling community. While the absolute number of started unsold homes may 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 and unsold homes per community we’ve averaged over the past dozen years or so, as seen on slide 23. One more area of charges for the quarter is related to taxes and the FAS-109 current and deferred tax asset valuation allowance. We concluded we should book an additional $76.7 billion after tax non-cash tax asset valuation allowance during the third quarter. While our tax asset valuation allowance charge was non-cash in nature, it did affect our net worth by the same dollar amount during the quarter and increased our total valuation allowance to date to $873.8 million. Let me reiterate that the FAS-109 tax asset valuation allowance is for GAAP purposes only. For tax purposes, our tax asset may be carried forward for 20 years and we expect to utilize those tax loss carry-forwards as we generate profits in the future. We ended our third quarter with a total stockholders deficit of $105 million. If you add back the total valuation allowance as we’ve done on slide 24, our total stockholders equity would be $769 million. Now let me update you on our mortgage markets and our mortgage finance operation. Turning to slide 25, with our average FICO scores at 737, our recent data indicates that our average credit quality of mortgage customers remains strong. Turning to slide 26, we show a breakout of all of the various loan types originated by our mortgage operations during the third quarter of fiscal 2009 and compared it to all of fiscal 2008. During the third quarter, FHAVA loans made up 48% of our volume as compared to 36% for government loan originations throughout all of fiscal ’08 and only 8% for all of fiscal 2007. We continued to have very little exposure to jumbo mortgages, which were only 1.9% and 2.5% of the total loans for the third quarter of ’09 and 2008 full year respectively. The mortgage industry continues to be risk averse and has embraced sound reasonable lending practices. We continue to offer competitive mortgage rates, including great buy-downs and we are leveraging our mortgage associates knowledge and expertise to assist our home buyers in obtaining mortgage loans. I will now discuss our joint venture activity. At July 31st 09, after cumulative charges we had $35.6 million invested in seven land development and eight home building joint ventures. As a result of the cumulative effect of $364 million in impairments of our joint venture investments since 2006, you can see on slide 27 that our debt to cap of all of our joint ventures in the aggregate increased to 78%. Historically we have financed our joint ventures solely on a non-recourse basis. The most recent joint ventures we initiated during the third quarter are all equity deals and therefore have no debt. We are now more than four years into this downturn and because the loans on our JVs are non-recourse, we have not had any margin or capital calls on any of the debt associated with our joint ventures. Considering the $219 million reduction in debt during our most recent quarter, it should not be surprising that our cash position has decreased. We ended the quarter with $546 million of cash, as you can see on slide 28. During the third quarter, we successfully completed a tender offer that allowed us to repurchase and retire $119 million of our debt at an average price of 68%, and we paid down $100 million on our credit facility. Additionally during the third quarter, we made an $80 million cash interest payment, which as Ara mentioned earlier, is one of our largest quarterly interest payments. As shown on slide 29, we further reduced or near-term debt maturities. Our first debt maturity is not until January 2010 and there’s only $11 million of face value remaining on that issue. After that, nothing comes due until April 2012 and even then, it’s only $112 million of face amount that matures. Between the exchanges and repurchases to date, we have reduced our debt by approximately $740 million and reduced our annual cash interest by almost $50 million. Our debt covenants do continue to limit the amount of additional debt we may repurchase. We recognize that we are still left with a large maturity in 2013 which we are not taking lightly. We still have a long runway ahead of us and feel that there will be many options to deal with this maturity between now and 2013. Now I will turn it back to Ara for some closing comments.

Thanks, Larry. Let me make some brief comments about the environment we are facing today before turning it over to questions. Home building is the poster child for cyclical industries. This is clearly illustrated on slide number 30. This chart shows you housing starts for the past century. The red bar on the right shows you projected annual starts based on the first half of the year. In the worst of the housing downturn since World War II, the housing market bottomed at about a million housing starts. This year, we are on track to start half of those historic lows, about 500,000 new homes. Keep in mind our population has doubled from WWII to where we are now, and we are producing about half of the lowest of the low. We are producing housing at rates that we achieved during World War I, World War II, and the Great Depression, and before that you have to go back to the 1800s to find housing levels this low. Now we did just come off of a peak in production in 05 but frankly as you see on the chart, that peak was not very dissimilar to other peaks that we’ve had post World War II, yet the trough we are experiencing is about half and again, we have a much greater population. Clearly the market has over-corrected during this downturn, certainly based on raw demographics projecting housing demand. We’ve been in business for 50 years now and have been through five downturns previous to this one. In each case, there were opportunities to buy land at extremely low prices. Some we bought in the past, some we passed on. Looking back, we can say that we always wish we had bought more. When we under-write land today, we don’t do it with the hope that the market will recover. We have begun buying land because for the first time in three years, you can make an economic return based on the lousy current prices and the lousy current sales pace. So if we can just make the pro forma returns on our acquisitions, which as I described earlier, we have on some of our new acquisitions already, we will be selling homes on land that produced dramatically better gross margins than what we just recently posted. And if the market improves, then obviously margins will get only better. One of the results of the current downturn is that the number of homebuilders is shrinking, particularly among the ranks of the private homebuilders. Some of these builders were formidable competitors for many years but the declines in land values have driven them out of business. Others are in a position where they can’t get the financing to buy that next land parcel. While this is happening in many parts of the country, one good example of this is a market that we have seen tremendous fall-off in competition, Chicago. As seen on slide 31, seven major builders are no longer building in Chicago. Some have filed for bankruptcy, others have closed their doors, and some of the larger public builders have made the strategic decision to leave the marketplace. These competitors built over 4300 homes in 2005 and were significant players in that market. When the demand picks up in a market like Chicago, there are going to be far fewer builders out there meeting that demand. Another development that is playing out across the country is that the number of communities that are open for sale has shrunk considerably. On slide 32, you see that at the beginning of calendar ’08, there were 3,789 communities open for sale among the 12 publicly traded builders that report the data. In only a year-and-a-half, that number has been reduced by 36%. Again, when demand returns, there are going to be fewer choices for the home buyers due to the significant decline in new communities offered by the public home builders. So there are fewer competitors and of those that remain, they have fewer communities open today. But the one thing that has not stopped is household formation. Even during recessions, babies are born, people get married and divorced, and we are still seeing people immigrate to this country. Families can make short-term decisions to stay in a home that they have recently outgrown or in the case of the empty nester, a house that is too big for their needs. Families can double up or even triple up because of the economic reasons. But at some point, there will be an unbundling of these households and a decision to put off moving to that next home will become too burdensome. The underlying demographics are expected to create some 1.4 million households every year this decade. That translates to housing demand of about 1.9 million homes per year, again every single year this decade, about four times the average rate of production and about two times last year’s rate of production. The demand for new homes is going to rise and it should rise significantly to make up for this shortfall. So when the economy and the housing market does return, there should be a much better environment for those of us that remain. In the short-term, we recognize that risks remain. The expiration of the California and federal tax credit, continued job losses, and the pending threat of increased foreclosures could affect housing demand and prices. For now, we need to remain focused on cash flow. We will opportunistically purchase land when it’s in the right markets for the right price, but we need to remain disciplined. Getting to the other side of this downturn with as much cash as practical, as little debt as practical, and having the right land parcels is at the top of our priority list. That concludes my comments and we’ll be pleased to open up the floor for questions.

(Operator Instructions) Your first question comes from the line of Carl Reichardt of Wells Fargo.

I had a question about mothballing the 8,700 lots. I’m just trying to get a sense of what scenario would have to unfold for those lots to come back to market. In other words, is the mothballing due to the fact that you can’t bring them to market today at positive gross margins? Or due to the amount of capital they need to get to the market? I’m just trying to decide also how you get to normalized margins when your interest coupons are going to be so much higher than it’s been in the past, so can you kind of work through that with me, Ara?

Sure. We mothball for a variety of reasons but I mean generally speaking, we mothball when we can't generate a sufficient cash flow by building new houses. As I mentioned in two conditions, both on the West Coast, in those micro markets around those particular communities the prices have crept up just a bit, the sales pace has crept up just a bit and it was enough -- the combination was enough to say you know, it now should generate sufficient cash flow and it’s time to un-mothball these communities. It happened ahead of our projections and that was obviously a positive event. Hopefully we’ll see that trend continue in other markets. What was interesting is part of what caused that is that other communities were closing in those markets and there was no other location to get supply to the market so those that were there had good demand relative to the smaller supply and that picked up the pace and price. I see that kind of phenomenon happening everywhere. There’s builders are closing communities, they are not replenishing them, so community count is going down. That should help us get to an environment of un-mothballing more communities.

Okay. And then secondarily, you mentioned that 37% of the apps to the mortgage company are first-time entry level buyers. Is that comparable to what you are seeing in terms of what you are selling right now? And are the can rates higher on the first-time buyers?

It is comparable to what we are selling. I mean, the mortgage company is providing 85% of our mortgages, so it’s pretty representative. That number, by the way, has been growing a bit each of the last three quarters for us, presumably the first time home buyer credit has had something to do with that, as well as a little bit of a shift in focus toward that marketplace. But no, we don’t really see a greater cancellation pace there. That market is growing for us and our overall cancellation rate has been coming down.

Okay, thanks. I appreciate it.

Your next question is from David Goldberg of UBS.

The first question I had was about some of the land deals that you bid on, Ara, and the lots that you were able to put under terms or to buy outright. And what I am trying to understand is what do you think, and I realize it’s kind of a vague question, but what do you think is different? Because we know a lot of your builder competitors and maybe even some others outside of the homebuilding industry certainly are out there bidding on lots too and I am just trying to understand what you think is different about your bid or you guys when sellers think about Hovnanian that makes it so you can secure these lots, maybe in front of some other competitors, who have fairly similar models for trying to determine pro forma land and see if it works for them.

I don’t think really there’s anything substantially different. I mean, we’ve all been buying land for decades and we all compete against each other and different companies get different parcels of land. So it just -- it depends on who has the particular insight or an inside track on a piece of property. Many times they are complicated. These are not straightforward land deals. We’re talking about REOs. In some cases we acquire them through a non-performing loan, so they are not straightforward deals and it just depends. But in general, there are not a lot of active buyers out in the marketplace. It is stepping up, without a doubt and we are seeing more people out there looking but there should be plenty and increasing amounts of opportunities out there.

And I think one other point, David, is that several of these parcels we’re doing with financial partners so just as you mentioned, they are out there, financial partners are out there looking to buy deals on their own and they have exhaustive underwriting criteria of their own, slightly different from ours and we are able to match up both our underwriting and a large financial partner’s underwriting criteria and make the deals work.

Got it. The follow-up question, actually, Larry was on the same lines and maybe you guys can address this -- Ara, in your comments you talked about the kind of third type of joint venture deal or land deals that you are looking at right with larger bulk take-downs, where it makes more sense to be with the JV partners. When you guys have looked at JV deals before with financial partners, it’s been -- my understanding has always been more that it would be -- you know, you would contribute maybe land to the joint venture as opposed to capital. Has that changed? Are these joint ventures in these larger bulk acquisitions, you guys are putting cash in? Is it management expertise? Maybe you can just give us a little bit more color on how those deals are being structured.

The structures are actually quite similar to the ones that we did when the market was very strong. I mean typically, we put in 10% to 20% of the capital, the partner puts in 80% to 90% of the capital. One variation is in the past, we’d seek 50% leverage. Now we are doing them with zero leverage. It’s 100% equity, and then we build them out, we share pro rata on the profitability up to certain levels of returns and then as the returns outperform those initial what they refer to as waterfall levels, we get a higher and higher proportion of the profitability. So that’s part of what intrigued us to team up with financial partners even when the market was very good and we were flush with capital. If properties perform, we have the opportunity to get a disproportionate share of the profit relative to the capital that we put in, yet there is plenty remaining to give some great returns for our financial partners. There’s a lot of interest out there in teaming up with companies like ourselves to buy these assets at the bottom of the marketplace.

Your next question is from Michael Rehaut of JPMorgan.

This is Ray on for Mike. The first question on the absorption pace in orders, it looks like they sell throughout the quarter. I guess that was more in line with seasonal trends. I’m wondering if you guys can give an update on what absorption in traffic and orders have done through August -- are we kind of expecting a continued seasonal decline or do you think you guys can sustain that kind of seven orders per community pace?

We don’t have specific numbers to release. I can just tell you the selling environment has remained very solid. It’s just a very good selling environment right now -- even in August, which is traditionally of the summer months one of the slower months, it remains solid right now.

Okay, and then just a follow-up question on that -- it looks like the Midwest was pretty strong this quarter, the west looked a little bit weaker. I was wondering if you could get more granular in terms of which markets outperformed your expectations, which ones were a little bit weaker.

To be honest, we’ve been pretty pleased everywhere. I mean, part of it depends on the community offerings and how many you have compared to last year and so forth but I can tell you everywhere is doing solidly and every market for us is exceeding our internal budgets, so we are pretty pleased.

Okay, and then just lastly, where do you guys think community count can go by by the end of the year and also, in terms of the un-mothballing, have you guys started looking at other regions? You know, you talked about Southern California and Arizona -- are there any other communities or mothballed communities on the radar screen right now?

Let me take the community count -- we just don’t make public projections of where our community count is going to be at any point in time but I think the trend of going lower will probably continue at least incrementally until these new communities that we are starting to tie up begin to open and it takes some time before that will occur. I’ll let you take the second half of this.

Yeah, I mean the mothballing, we just look regularly and do the evaluation periodically and do the evaluation periodically so I wouldn’t say we have any specific ones on the burner at the moment but conditions really depend on what's happening in a particular micro-market. I mean, a five mile radius of a particular location can be very different from a location just 10 or 15 miles away. So we look at each situation specifically. I wouldn’t be surprised to see more of that happening this year but I can't be more specific than that.

Okay. Thanks, guys.

Your next question is from Megan McGrath with Barclays Capital.

Good morning, thanks. Just a follow-up on the question about pace throughout the quarter and what you have seen -- you mentioned in your remarks, Ara, that one of the potential headwinds is the loss of the tax credit in California but it sounds like from what you are saying that you haven’t actually seen a significant drop-off in the market since it essentially expired in July. Is that a fair comment or have you seen the impact of the loss of that credit?

I would say thus far, keep in mind it’s only been a few weeks, we haven’t seen a huge impact, so we are pleased with that. Part of that could be driven by the federal credit and that expires at the end of November, so you know, it’s hard to know what the impact of losing both of them will be and it’s hard to know what the impact will be after a greater period of time in California. But based on the first few weeks, thus far things seem to be holding.

Okay, great. And then also a follow-up on the land deal in that market -- can you rank for me in terms of why they are pricing a little bit better now? Is it more that the banks are re-pricing these assets finally or that pricing has stabilized in the market and pace is looking a little bit better, so your returns in the models start looking better, even if the banks are re-pricing?

No, it’s really that the banks are properly pricing and are just marketing more of the deals. For a long while, it took a bit of time for them to even make the opportunities available. They are finally getting organized, getting their REO groups and their non-performing groups to get the properties to the market and we are seeing more of them and those that we saw are pricing properly and realistically, so that is what is primarily driving it. And then on our side, we are getting a little more confident to bid on some of these because we are seeing stability in the marketplace in terms of pricing and an improvement in pace.

Great. Thank you very much.

Your next question is from Steven Kim of Alpine Woods.

I just have two quick questions for you -- if I could follow-up on Megan’s question regarding the impact of the various tax credits, it’s true that the federal tax credit expires in November but I would venture to guess that homes that are sort of built to order at this point are probably not going to make that deadline, so I was curious as to whether or not you’ve seen the -- a change in the activity of sales on homes that are not spec, or not even started at all but truly built to suit as we approach the point where you could no longer guarantee delivery in time for the credit?

Steve, I can't say that we’ve analyzed that in detail. I can say to you that just in general, the sense that we may be at the bottom and the improved media outlook is trumping the potential offset from the loss in credit. I mean, that’s just a gut feeling I have but it’s a huge difference in picking up the newspaper today, whether it’s the New York Times or BusinessWeek or watching any of the news channels, there’s just a huge difference in what they are saying and reporting and obviously just the sheer fact that we’ve actually had a few months of medium price increases, we’ve had a few months of absolute increases in sales, both existing and new homes, that is a factor that is not lost upon consumers. So that is giving a little bit of a boost right now. Now, later on, if that wanes, that could be different but at the moment, that means a lot. Psychology is part of what drove us into this slow-down and that could really feed upon itself on the downside. Luckily the correlary is also true, that the positive psychology can feed on itself on the upside and so far it’s looking good.

Yeah, no, that’s great -- that’s great to hear. The second question I had relates to drywall. I noticed that a number of your peers have taken drywall charges, I think the largest was Lenar so far, about $40 million. And I know that you have a pretty large presence, or had a large presence in Fort Meyers, which is where a lot of the activity seemed to center. I was curious as to whether or not you’ve analyzed that, do you feel to your full satisfaction yet, whether you took a charge in the quarter and whether that is something that you are still looking into?

Thanks for asking the question, especially in light of the article in yesterday’s journal. Our exposure to Chinese Drywall really has not been material. We didn’t take any additional charges in the quarter related to drywall. To date, we’ve agreed to repair a whopping total of about five homes that we’ve confirmed were built with Chinese drywall across our Tampa, West Palm Beach, Orlando, and Fort Meyers Florida markets and we continue to believe our exposure to Chinese drywall is de minimis.

That’s great. Thanks very much, guys.

Your next question is from Alex Barron of Agency Trading Group.

Good morning, guys. I wanted to ask you, as you guys look forward over the next couple of years, what do you think the path to profitability looks like? Is it that you might have to impair the land a little bit further to get the margins to go back up or is it just going to be cutting SG&A further or is it more -- getting into more new land deals like the ones you were talking about?

It’s all of the above, really. Clearly we have to work through the land that we have that is not as well-priced as what we are now buying in the market place. Clearly velocity has to continue to pick up because velocity per community is a big driver of our overhead efficiency. Clearly we need pricing to stabilize and certainly it would be very, very helpful if that even improves, which we would anticipate it will do at some point. And in the meantime, we are continuing to right-size the organization and look for every opportunity to get SG&A low. SG&A will get low by both making absolute cuts but also increasing our activity which would make our overhead per home produced lower. So we have to get many of these things to work, the same that we’ve done for every correction and every down cycle that we’ve experienced over the 50 years. We’re basically doing the same things in spite of the fact that this one was clearly a more severe housing downturn than in the past. The steps we are taking are really the same and the pattern we are seeing is very much the same pattern that we’ve seen in other slowdowns. With the velocity really picking up first and as we reported, it’s now been nine out of 10 months for us that we’ve seen velocity pick up. That is typically the first stage of the important recovery. The next will be for us to see pricing pick up. We are seeing prices stabilize, which I guess is the precursor and hopefully that will follow with prices picking up. So that’s a long-winded answer to your question. It’s all of the above to get back to profitability.

Okay, my other question has to do with your covenants. Can you help me understand in those covenants, do you guys add back the deferred tax asset valuation allowance as part of the equity calculation? Can you talk a little bit in more detail of how much debt you are allowed to buy and also how much equity you can put into JVs based on those covenants?

We have no covenant that’s tied to our tangible net worth, so we don’t add anything back because we don’t have a covenant that deals with it. With respect to how much debt we can buy back, similar to previous quarters, we’re not going to provide specific detail but all of the information regarding the limitations on restricted payments can be found in our SEC filings for each of our various debt issues. There are several baskets that are available to us under these limitations on restricted payments and we remain in compliance and expect to remain in compliance with all of our debt covenants and again, there’s no maintenance covenants associated with any of the bonds.

And as far as JVs, are you limited as to how much you can put into those?

That’s again part of the restricted payment baskets, and I’ll just refer you back to the same SEC filings with respect to that.

Yeah but in general, I can tell you certainly for the next few years, we don’t see that as a limitation. I mean, we feel we’ve got plenty of room in the basket to do all of the JVs that we think are reasonable for us to budget going forward.

Okay, thanks.

Your next question is from Dan Oppenheim of Credit Suisse.

Thanks very much. Larry, you talked about having fewer communities going forward. I was just wondering how you think about reducing SG&A as a percentage of revenue while having fewer communities, just the difficult with that but also doesn’t it mean that with -- if you are opening fewer communities, you would have a higher proportion of communities in the less strong areas and a lower percentage in the stronger areas as you sort of burn through the communities in the better markets right now?

I mean really, our focus on reducing communities, and we’ve made great progress on that to date, has really been more about cash generation and lowering overhead. And now that kind of we are seeing sales per community pick up, it’s actually helpful to have fewer communities that are actually doing more per community than having more communities doing fewer per community, so we’ve gotten rid of some of the underperformers along that process as well. Having said that, Dan, it’s true that as revenues shrink, it’s harder to shrink our overhead in certain areas, corporate being one example of that. But it is something that we continue to monitor to closely and take appropriate steps to as Ara mentioned, right-size our business. I wish I could say that that was behind us but I don’t think it is.

Thanks, and then second question, wondering about the owned lots, you said that it would be helpful to reduce the number of owned lots there and if we think about the lots that are mothballed right now, a lot of that land is raw but you are able to buy for less than the cost of development, is there a way really to reduce that number of owned lots, aside from just selling homes and doing it that way?

Well first of all, some of the mothballed land is at least partially improved so the improvement costs are not as great as they would be with raw land. But in general, right now the best way to sell some of the mothballed land is to build a house on them. Having said that -- and the primary reason is there’s not much of a land market to speak of and certainly not at very good prices. Having said that, we have sold some of our mothballed properties, so we are doing a little bit of a mix but at the moment, we like most of our mothballed properties and we are going to be holding on to them to have the land as the market recovers.

Thanks very much.

Your next question is from Joel Locker of FBN Securities.

Just on -- I was wondering on the income taxes payable, is there a specific timeframe where that’s going to be paid?

A specific timeframe -- you know, what it’s related to is we reported an accrual for federal taxes and related interest for a change in estimate of certain temporary timing differences amounting to $19.3 million, so yeah, it’s possible that it will be paid and then we will get it back over time.

Right. And the other thing on the -- I guess the balance sheet value of the 30% of the lots that are less than 30% developed, do you have a number for those? I think it’s around 8,000 lots.

No, we don’t have a specific lot number, no.

And then just a last question, you guys I guess in the last conference call or a year ago, you updated August orders. Do you have any -- I mean, can you comment on the August orders too?

Yeah, I don’t have it right in front of me but as Ara mentioned, we’ve been pleased. We’ve not seen any significant difference in August sales as compared to July sales. I mean, things continue and it continues to be at the same kind of levels that we saw in the summer.

All right. Thanks a lot, guys.

Your next question is from Alan [Retna] of Zelman & Associates. Alan Retna - Zelman & Associates: Larry, first I just wanted to touch on -- I know in the covenants you had the restricted payment there but is there anything that would restrict a debt for equity exchange?

I don’t believe so. Alan Retna - Zelman & Associates: Okay, and then secondly, I was kind of hoping to expand on Alex’s question a little bit with regard to your return to profitability. Ara, you highlighted that you still have a ways to go to get back to your normal level of gross margins but you have seen now three quarters of improvement and was just curious kind of when you look into your current backlog if you are seeing additional benefits there on the gross margin side. And then kind of secondly, what percentage of closings you might see in 2010 that come from your new land projects at higher gross margin?

I think what you are really trying to do is get us to project the gross margins and Alan, we’re just not in a position to do that. It’s not rocket science. As home prices improve, gross margins will go up. As we bring in more of the newer communities, and I will tell you that that’s certainly not a 2009 proposition, and probably a de minimis impact on 2010, just because of the number of new lots compared to the number of old lots -- it’s just going to take a while to move the needle, so to speak. But I think we’ve got to work through the old land, which has under-performed from a margin perspective, have more new land come in and hopefully get a little wind at our back from the market before you see us get back to normalized margins. Alan Retna - Zelman & Associates: Right, well I mean, you’ve had roughly 400 basis points of improvement from your lows in 4Q and that’s been without any significant price appreciation, so I am just trying to get a handle on whether you’ve taken impairments on kind of closings coming down the pipe that you would expect that trend to continue?

Well, I mean, you see us take impairments every quarter and as you take impairments, the impairment reversals increase. We show you detail on that every quarter as it occurs, so you can draw your own conclusions but you know, impairments lead to impairment reversals which help margins. Alan Retna - Zelman & Associates: Okay. Thanks a lot.

Your next question is from Timothy Jones of Wasserman & Associates. Timothy Jones - Wasserman & Associates: First of all, good job, Jeff, on those charts. Okay, the first question is you paid off your revolving line of credit -- is it still available and if so, how much do you have available?

Yeah, it’s a $300 million facility, of which $200 million is set aside for letters of credit and $100 million is set aside to borrow cash but the $100 million that we paid back is fully available to draw down again. Timothy Jones - Wasserman & Associates: Is the full 300 available? What is --

Three-hundred million is available and what did we get, 100 --

We just have barely over $100 million of it used for LCs, so there’s still about half of the capacity is unused on the LC side and 100% of the capacity is available on the cash side. Timothy Jones - Wasserman & Associates: Okay. So you try to -- I was going to ask some more questions about the gross margin but you -- I don’t think you are going to answer them. I mean, there is a difference, you know, between 3.5% and 20%. We can’t hold it in any closer than that?

Well, hopefully over time it migrates upward for the reasons we previously -- Timothy Jones - Wasserman & Associates: Well, I mean, I know that. Okay, now the second quarter, your cash flow was negative by $43 million. Obviously as you start with your expected improvement in business, you are going to have to start building homes at least, even if you hold your land purchases down. So do you have a projection for cash flow for the rest of the year and for next year, operating cash flow or are you going to stay away from that one?

We don’t make a public projection.

Frankly, I don’t think there are many public homebuilders that would today. Timothy Jones - Wasserman & Associates: Well, they were when they were going well and they were cutting margins. I think they will stop pretty soon. Thank you.

Your next question is from Tom [Hagby] of Deutsche Bank.

I wanted to ask quickly about the land spend -- I believe you used the number $37 million. I wanted to get a sense for how much of that is from straight spend, how much of that is part of a JV acquisition or an option deposit? Can you break that out?

It’s all land.

And all of it is wholly-owned land. That excluded land spends on JVs. And it also excluded deposits. That was actually just a pure land spend.

Okay. Would you mind disclosing what you spent on new JVs or on options?

We just don’t have those dollars handy but they are not that overly significant.

Okay. That’s good for now. My other question was answered. Thanks, guys.

(Operator Instructions) Your next question is from Andy [Shefra] of Onyx Credit.

Two questions -- if the Chinese drywall issue were to become more significant, how would that be treated, or what type of insurance would you have to cover any remediation costs? And then the second question is it sounds like you guys purchased land and also entered and purchased land in joint ventures after the quarter end. If you could give us a sense for the significance of that in terms of dollars as well.

Well, I hate speculating on Chinese drywall. We really think that if there was going to be anything more material, we’d know about it by now. I mean, as you probably read in various articles, the symptom of Chinese drywall is a very noxious odor and you would think that if we sold a house that has a noxious odor, somebody would have actually contacted us by now, so I don’t think we have anything and if something does pop up, we do have insurance. With respect to what we have invested in joint ventures subsequent to quarter end, I think we will just wait until next quarter. I don’t think it’s a big number at this point but I think we will wait until next quarter to disclose precisely what it is.

Suffice it to say that it’s not significant and remember, we only typically in a typical structure put up 10% to 20% of the equity anyway, so it’s just not a big number.

I guess to ask it a different way, during the quarter and then subsequent to the quarter, if you looked at what the joint venture, whether or not it’s your share, would have spent on land acquisition -- is it $100 million spent during the quarter and something similar after? I’m just trying to --

The combination of [inaudible] plus the joint venture?

Correct.

No, it’s -- the joint ventures spent far less than that.

Okay. Thank you.

And you have a question from the line of Alex Barron of Agency Trading Group.

Thanks. Larry, I don’t know if you mentioned it but did I miss the benefit from previous impairments to the gross margin?

Yes, you missed it.

$50.6 million, just slightly more than prior quarter.

Okay, and so the last quarter, do you have that handy?

Give us a moment, we might be able to get it.

$49.3 million.

49.3? Okay.

Yeah, so it increased about $1 million.

Okay. My second question was I was looking at your sales pace over the last couple of months and it seems like it is kind of holding up I guess relative to the peak you saw in April, May but it’s still slightly down sequentially. The government figure said national sales were up 9% I think it was last month. Do you think their numbers are wrong or what do you think accounts for that?

Theirs may be seasonally adjusted and we’re not seasonally adjusting ours. I think the best way to look at it is looking at the sales per community, which I think is also on that slide. And if you compare those year over year, do we have that on there, Jeff, year-over-year comparison?

Yes.

You can see that they continue to grow year over year, so I think that’s about as granular data we can give you.

Okay. Now you mentioned like, for example, in Chicago several competitors have left that market. Have you guys seen a noticeable improvement in market share or sales base because of that?

Not substantial -- I mean, again, we’ve seen pick-up in a lot of markets but in Chicago at the moment, frankly, we’re quite shy on land. One of the new joint ventures we are about to do would substantially change that and dramatically increase our land position there.

Okay, great. Thanks.

At this time, I would like to turn the call back over to Ara Hovnanian for closing remarks.

Great. Well, thank you very much. As we started the phone call, I mentioned it’s disappointing to have a continued losses -- on the other hand, there were many positive signs that we are at the bottom and perhaps beginning the recovery, so we look forward to continuing to report the results and hopefully the positive results as we get further into this recovery. Thank you.

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