Hovnanian Enterprises Inc (HOV) 2006 Q1 法說會逐字稿

Thank you for joining us today at Hovnanian Enterprises's fiscal 2006 first-quarter earnings conference call. By now you should have received a copy of the earnings press release; however, if anybody is missing a copy and would like one, please contact Donna [Tesche] at 732-747-7800. We'll send you a copy of the release and ensure that you are on the company's distribution list. There will will a replay of today's call, this replay will be available after the completion of the call, and run for 12 months. The replay can be accessed by dialing 888-286-8010, pass code, 21410219. Again, the replay number is 888-286-8010, pass code, 21410219. This conference is being recorded for rebroadcast, and all participants are currently in a listen-only mode.

Management will make opening remarks about the first quarter results, and open up the line for questions. The company will also be webcasting the slide presentation along with the opening comments from management. The slides are available on the Investors page of company's website at www.khov.com. Those listeners who would like to follow along should logon to the website at this time. Before we begin, I would like to remind everyone this 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 conference call over to Ara Hovnanian, President and Chief Executive Officer of Hovnanian Enterprises. Ara, please go ahead.

Thank you. Good morning, and thanks for participating in today's call to review the results of our first quarter ended January 31. Joining me today from the company are Larry Sorsby, Executive Vice President and CFO, Paul Buchanan, Senior Vice President, and Corporate Controller, Kevin Hake, Senior Vice President and Treasurer, and Brad O'Connor, Vice President and Associate Corporate Controller. We are pleased to report another strong quarter. I'll review the financial highlights, comment on our operations and provide an outlook for the remainder of fiscal '06. Larry Sorsby will then spend some more time reviewing our financial performance in greater depth. We reported earnings of $1.25 per fully diluted common share for the first quarter of '06. This is at the very top of guidance range we had projected for the quarter.

We had projected an essentially flat quarter compared to last year, due largely to the negative impact of Hurricane Wilma's landfall on Florida, in October of last year, and the subsequent delays that we've incurred in permitting, along with shortfalls in both materials and labor in Florida, as well as several other markets. For those of you that are reviewing the slides on the Investor page of our website, you can now turn to slide 3. We are continuing to expect healthy year-over-year growth in earnings in '06, but it will occur at the end of our fiscal year as a result of many of the delays I just spoke of . As you can see on this slide, first quarter earnings have not been a large part of our full year EPS over the past few years, as certainly the case this year. We are well positioned for achieving our projected '06 deliveries based on our strong backlog.

On slide 4, you can see substantial growth in our contract backlog at January 31, which reached 14,125 homes with a sales volume of $4.9 billion. Our sales and backlog have remained healthy, but delays in our ability to get the homes delivered have led to a very back-ended fiscal year. When we add the 4,430 homes delivered in the first quarter to those in backlog that are scheduled to be delivered in the remainder of '06, it accounts for about 70% of our projected deliveries for the full fiscal year. This includes deliveries from unconsolidated joint ventures. We obviously, still have some more homes for -- to sell for fiscal '06 deliveries, but we are in great position for this time of year.

For the trailing 12 months, we posted an after-tax return on beginning common equity of 36.7%, and an after-tax return on beginning capital of 21.1%. These rates of returns stack up very well against our peers, and our entire industry continues to outperform most other industry. As you can see from slide number 5, our average return on equity of 31.1% for the last 12 months compared very favorably with the average return on equity of the S & P 500 which stood at about 16.5% at the end of December '05. If you turn to slide 6, total revenues for the first quarter of '06 increased 21%, to $1.3 billion, up from $1.1 billion in the prior year's first quarter, continuing a very positive trend and setting another record in revenues for the quarter. Top line growth is definitely happening.

Slide 7, total deliveries including unconsolidated joint ventures, increased 35% in the first quarter of '06, to 4,430 homes, another record in spite of -- of the delays I mentioned earlier. Turning to slide 8, the dollar value of net contracts for the first quarter ended January 31, '06, including unconsolidated joint ventures, increased by 22% from the first quarter of '05. The number of net contracts for the quarter, 3,624, increased 12% compared to the 3,240 in last year's first quarter. Given the slowing market conditions that we are experiencing, this is a strong indication of our ability to grow and capture additional market share. Now, while we are pleased with all of the positive news for the quarter's performance I've just announced, clearly, the market has slowed from the white-hot conditions that existed over the prior years. In spite of the 22% increase in the dollar value of our contract, we were expecting a slightly greater increase. Further, we have seen some competitors increasing their use of incentives in many of our markets. Fortunately, the use of incentives is focused primarily on selling standing inventory and generating a little more traffic rather than across the board reductions on all homes.

We commented on a slower sales environment in early December when we reported our year-end results. While conditions in these markets have improved from the period between Thanksgiving and the end of January, a traditionally slow period, they remain more moderate than they were during the comparable time frame a year ago. Our first quarter cancellation rates were up modestly compared to last year's 30 % versus 27% last year. First quarter is historically higher in cancellation rates given the seasonally lower growth sales. For the full year, last year's average cancellation rate was 24% , and we anticipate slightly higher rates than that for fiscal '06, but frankly, that's not the big challenge in the sales environment today.

In general, some of the more highly regulated markets, California, Florida, and Washington, DC, which earlier saw substantial price appreciation are now showing greater incentives, as they seek to sell standing inventory and correct some of the over pricing that occurred in the hot marketplace. We are projecting a lower absolute number of home deliveries from our highly profitable California operation in our '06 budget. At the same time, we are projecting an increase in home deliveries from Florida and Washington, DC. The Florida increases are largely the result of acquisitions, while the Washington increases are the result of organic growth. Both markets are highly profitable, and help offset the decrease in California.

While there's been a lot of discussion about the challenges of the Washington, DC market, as the number 2 builder there, we are continuing to see growth in that market, primarily due to increasing our community count. Even after the incentives that have appeared in the Washington, DC market, with our solid land position, we are yielding some excellent returns. Virginia is a little more challenging, and Maryland is a little stronger, but on the whole, the market is yielding excellent results. Interestingly, some of the less restricted markets like Dallas, Houston, and North Carolina, are actually strengthening. On the basis of our sales backlog and the current market conditions, we are reaffirming our EPS projection for fiscal '06 of between $8.05 and $8.40 per fully diluted share.

It turn to slide number 9. This projection would represent a 12% to 17% increase from fiscal '05 record earnings of $7.16 per share. The projection of income in fiscal '06 is after approximately $87 million of noncash pretax expense related to acquisition premiums of companies. It is also after $13.4 million expense of noncash stock option expenses, a new GAAP expense calculation that didn't exist in '05, and is after a full year of preferred dividends of $10.7 million after only one quarter of such dividends in our '05 costs. We expect revenues in fiscal '06 to increase more than 28% to between $6.8 billion and $7 billion on deliveries of 19,500 and 20,200 homes. As I said, top line growth is not an issue. This excludes deliveries from unconsolidated joint ventures in which we expect to deliver more than 2000 homes this year, bringing our total deliveries to 21 -- , to greater than 21,500 homes.

Based on the current expectations of geographic and product mix, as well as today's levels of home prices and costs, we are confirming our earlier projections for gross margins, without interest, to be in the range of 24.5% to 25% for the full year. Now, this does represent a reduction from last year's full fiscal year gross margin of 26.4%, and the first quarter's margin that we are just reporting of 25.6%.

If you turn to slide 10, you can see what the trend in gross margins has been for the last few years, along with this year's current margin and again, you can see what I just discussed this year. We are projecting margins to be lower than we have had for the last few years, not quite the levels that we were at -- had been achieving in -- achieved in '02, but lower than what we've recently achieved. Overall, we expect our -- to grow our earnings per share in fiscal '06, with a decreasing gross margin, offset by higher deliveries and revenues and higher land sale profits, all of which Larry will explain in greater detail in just a moment. Although it's too early for a formal EPS projection for fiscal '07, we expect to see a similar trend to what we are projecting this year, further reductions in gross margins offset by yet further gains in deliveries and revenues resulting in an increased EPS.

If you turn to slide 11, we believe we will increase our community count this year to more than 440 consolidated communities by year end, as well as an additional community count of more than 30 communities in unconsolidated joint ventures. Even if our deliveries per community drop from their current levels, our growth in community count should lead to a growth in revenues in '07. However, predicting the precise timing of permits, and therefore community grand openings and community count growth accurately in today's restrictive regulatory environment, continues to be difficult and is always one of the challenges in projecting.

At the end of the first quarter, we had 371 active selling communities, excluding the communities in the joint ventures. This is an increase of 27% over the 293 communities that we had opened up at the end of the first quarter of fiscal '05. At the -- at our year end, with our projection of 440 communities, this -- we project an additional 19% increase in communities over the next nine months. Much of our future growth will be the result of delivering homes in these communities already opened for sale as well as through our strong pipeline of new communities scheduled to open during '06. Clearly, our pretax margins, ROI, and ROE are likely to decline from the record levels of the past few years. There aren't many industries that for several years in a row can generate 40% after-tax returns on equity.

Nonetheless, even if gross margins return to levels achieved in '02, 440 basis points lower than last year, and prior to the benefits of the last few years of high home price appreciation, we believe we can continue to grow EPS and post returns in ROE and ROI that would compare very favorably to other industries. It's also likely that material and labor costs, which have worked against us over the last several years could trend in the other direction, if the market continues to slow. Our projections maintain currents levels of material costs and labor costs. Details of our summary projections for fiscal '06 will be available later today on the Financial Information page of the Investor Relations section of our website at www.khov.com. I'll now turn it over to Larry Sorsby to discuss our financial performance in a little greater detail.

Thank you, Ara. I will go into more detail pertaining to the first quarter and some specifics behind our expectations for the remainder of fiscal 2006. If you'll now turn to slide 12, the average sales price for homes delivered companywide, excluding unconsolidated joint ventures, for the first quarter was approximately $324,000, a 4% increase from the average sales price of approximately $311,000 in the prior year's first quarter. The increase in average sales price in our markets is primarily the result of a geographic and product mix of our deliveries.

We expect that the average sales price per home excluding unconsolidated joint ventures will be between $335,000, and $338,000 in fiscal '06, reflecting a modest shift in geographic and product mix. Turning to slide 13, for the first quarter, the company's consolidated home building gross margin, excluding land sales and prior to deducting cost of sales interest, was 25.6%, a slight increase from 25.5% last year. However, we are continuing to project that our consolidated gross margins for the full fiscal 2006 year will decline from 2005's levels, in the range of 140 to 190 basis points of decline. This is based on the homes we have in backlog for delivery through the end of fiscal '06, and the mix of homes that we anticipate selling and delivering in the remaining three quarters of the year and assumes no further price increases from today's levels.

While we expect our gross margin to decline to the range of 24.5% to 25% for the year, down from the super-charged gross margin of 26.4% that we reported in fiscal '05, this is still a very healthy level. During '06, our margins are expected to fluctuate quarter by quarter due to shifts in our geographic and product mix. I can also give you a bit more color on how we see the year unfolding from a quarterly perspective. Our fiscal '06 projection includes earnings in the second quarter of approximately $1.55 to $1.80 per fully diluted common share, representing only 19% to 21% of our full '06 earnings projections,.

Due primarily to adverse impacts of Hurricane Wilma and the timing of new community openings, as well as regulatory delays in California, and construction delays caused by labor and material shortages in Arizona and Florida, we will lose a bit of ground in '06 on our efforts to smooth out quarters, and thus, '06 will again be more back-end-loaded, with the first quarter being our weakest quarter and the fourth quarter being our strongest quarter, as has nearly always been the case for our company. A particularly large number of our deliveries are projected to occur in fourth quarter this year, in the range of 30% to 33% of total deliveries for the year.

As a result, we are not comfortable that we'll be able to achieve the current analyst consensus of $2.20 per share in fully diluted earnings through our third quarter. This is our initial guidance for our second quarter and the first indication we have provided on our expected third and fourth quarter delivery and profit trends. We strongly encourage analysts to revise their projections for our third quarter earnings downward and shift some profits from the third quarter to the fourth quarter. While we recognize that achieving such a significant portion of our full year profits in the fourth quarter is not desirable or comfortable, we have demonstrated the ability to achieve this year after year.

Profits from land sales in our first quarter were significantly less than they were in the first quarter of fiscal '05. Pretax profits from lands sales were $2.23 million in the quarter, compared with $8.6 million in net profits in last year's first quarter. Although the amount of land sale profits vary from year to year, and quarter to quarter, some amount of land sale profits are typically recognized by the company each year, in a normal course of operations. Such land sale revenues and profits are generally included in our budgeting and projections because they usually occur in specific locations where we anticipate selling a block of lots or lands to another builder.

For fiscal 2006, we are now anticipating that total after-tax land sale profits will be up to a range between $31 million and $37 million, compared to $21 million of after-tax profits from land sales in fiscal '05. This projected amount of land sale profits is included in our fiscal '06 projections. The amount of land we are planning to sell has not changed significantly, but fortunately, the prices we are currently negotiating are higher than they were -- than we were anticipating earlier. The increase in land sale profits has to do with a few larger developments that we have undertaken, where we have strategically decided at the outset to sell some portion of the community to one or more other builders. These are typically locations with higher land costs so the sales proceeds are becoming slightly more significant. Although we budget land sales, the specific quarterly timing of the closing of these sales is often hard to predict.

Our second quarter is a good example this year. We have projected several land sales to occur in the second quarter, totaling approximately $12 million in after-tax profits, or about $0.19 per fully diluted common share in the net earnings out of the $1.55 to $1.80 in EPS that we are projecting for the quarter. Although we don't anticipate it will impact our full year results, if some or all of these lands sales slipped to later quarters it, will have an adverse impact on our second quarter earnings.

Now, if you'll turn to slide 14. You can see the total selling, general, and administrative expense, including corporate expense, as a percent of total revenues, was 12.8% in the first quarter of '06, compared with 10.7% in last year's first quarter. The increase in total SG&A is due to a combination of factors. Increases in profession fees, including Sarbanes-Oxley compliance costs, stock option expenses under the newly implemented FASB rules, and increased selling, overhead, and advertising expense, some of which is associated with launching new community openings, and some of which is in reaction to slower market conditions.

In addition, we have experienced a change in the timing of the charges for stock that is it issued under our corporate bonus programs, all of which to be expensed in our fourth quarter, but is now expensed as the shares vest. These expenses account for a significant amount of the increase in the first quarter versus the prior year's first quarter.

Total SG&A is expected to increase in nominal dollars but decrease as a percent of revenues in each quarter this year, similar to the pattern exhibited last year and will be at its lowest ratio as a percentage of total revenues in our fourth quarter. We anticipate that our total SG&A expense, including corporate overhead as a percent of total revenues, will be in the range of 9.8% to 10.2% of total revenues for the full year in fiscal '06, compared with 10% in fiscal 2005, and will be lower as a percentage of revenues for each of the remaining fiscal quarter than the 12.8% ratio of total SG&A expense incurred in the first quarter.

Our effective tax rate for the first quarter was 37.8%. This was below our effective tax rate of 39.6% for fiscal '05, primarily due to a tax benefit associated with the Job Creation Act. For the remainder of 2006, we now expect our effective tax rate to be approximately 38%. I will now shift gears and talk about our earnings from joint ventures.

We've been attempting to provide investors and analysts with additional clarity around our joint venture activity, since that activity has been increasing for the past several years, particularly in conjunction with our acquisition of Town & Country Homes, and a joint venture with the Blackstone group in March of last year. For the 2006 first quarter, our income from unconsolidated joint ventures was $7.6 million, compared with $1.4 million in last year's first quarter, primarily due to income from the Town & Country joint venture which didn't exist in the 2005 first quarter, and from the wind-down of significant joint venture community in New Jersey. Our investment and advances to unconsolidated joint ventures increased modestly in the first quarter to $196 million, from $187 million on October 31, 2005. We remain committed to providing significant transparency into our joint venture activities through disclosures in our financial statements and our footnotes. We believe they are the strongest of any home builder out there. I strongly encourage each of you to read our joint venture footnote in our recently published 10-K for fiscal 2005. Due to the increased significance of our joint venture income, we're also adding a separate line item projection of that income to our detailed website projections going forward for 2006. And we are continuing to provide projections of joint venture deliveries for 2006 on our website projections also.

This will also avoid distorting our reported margins. While a good deal of our reported net contracts and deliveries in our unconsolidated joint ventures for the quarter came from our Town & Country joint venture with Blackstone, we have also had some significant individual community joint ventures, including certain high-rise and mid-rise developments that have lumpy deliveries that will all occur in one or two quarters, and could thus cause significant variations in profits from one quarter to another. One such community is expected to deliver more than 100 homes during the second quarter of fiscal 2006.

On the other hand, one particularly highly profitable joint venture with significant deliveries in fiscal 2005 has largely delivered out and is thus having less of an impact on our fiscal 2006 results. As a result, we are projecting total pretax income from unconsolidated joint ventures to be in the range of $25 million to $30 million, in fiscal '06, versus the $35 million we reported in fiscal '05, even though the profits from the Town & Country joint venture are increasing in 2006 and are thus helping to offset the decline from a single community joint venture that is now largely completed.

Our financial services operations continue to add to earnings of our overall performance. If you'll turn to slide 15. For the year, our pretax earnings from financial services increased 34% to $5.7 million in the first quarter of '06, compared to pretax earnings in the prior year's first quarter, $4.3 million. We are currently originating mortgages in all of our markets except Tampa and Cleveland, as well as the markets where our Town & Country acquisitions operate, including Chicago, Minneapolis, and West Palm Beach, and Fort Lauderdale, Florida. In Orlando and Fort Myers, Florida, we originate mortgages through a JV mortgage company that were in place prior to our acquisition of Cambridge Homes and First Home Builders in Florida.

Turning to slide 16, our recent data indicate that our customers' credit quality remains quite healthy. Our average loan-to-value ratio was 77% for the first quarter of fiscal '06, compared with 75% for all of fiscal '05. For the first quarter of '06, our average FICO score was 710, compared to fiscal 2005's FICO score of 712, virtually unchanged. Our average FICO score for customers that utilize an adjustable rate mortgage during the first quarter was 699, compared to 704 for all of fiscal '05. We believe that our customers' FICO scores are above mortgage industry average. Recently, we've seen the percentage of home buyers using adjustable rate mortgages decrease, which, in fact, is logical as the yields curve is now inverted. In the first quarter, adjustable rate mortgages represented 36% of all of our origination volumes, down from the 40% of originations for all of fiscal '05. Less than 6% of our mortgage originations in the first quarter of fiscal '06 included adjustable rate mortgages where the rates adjust in the first year. Our mortgage capture rate increased slightly during the first quarter to 69% compared to 67% for all of fiscal '05.

Our balance sheet and credit statistics remain very healthy. For the quarter, EBITDA increased modestly to $168 million, from $162 million in the first quarter of '05. EBITDA represents earnings before interest expense, income taxes, depreciation and amortization. A reconciliation of our company's consolidated EBITDA to net income can be found as an attachment to our quarterly earnings release.

In this year's first quarter, we covered interest by 5.4 times, and we expect to cover interest by more than 7.0 times in fiscal '06. The ratio of total debt to EBITDA is expected to be less than 2.0 times, as of the end of fiscal '06. We ended the quarter with a ratio of net recourse debt to capitalization of 47.3%. Even with the $300 million note offering that we completed last week, we anticipate that our average ratio of net recourse debt to capitalization will be below 50% on average for the full year of '06, in line with our targeted leverage goals. In short, all of our credit statistics remain at very attractive levels.

At January 31st, '06, as you'll see on slide 17, common shareholders' equity was $1.7 billion, a 37% increase from the $1.3 billion at the end of the first quarter of '05, continuing a very healthy growth trend. Based on our current projection for fiscal '06, we expect common stockholders' equity to grow to approximately $2.2 billion by the end of October 31, 2006.

Our current land position represents more thana five year supply, based on our '06 projected deliveries, providing us with excellent visibility for our forward projections of deliveries and earnings. At January 31st, 2006, as slide 18 indicates, we controlled, on a consolidated basis, 120,336 lots in our various home-building markets for future developments. This excludes 9,032 lots that we controlled through our unconsolidated joints ventures. Roughly 72% of our lots controlled are under option contract, which minimizes our risk exposure to any significant decrease in the value of land. Out of all of large public builders, we have one of highest percentages of land controlled through options. This strategy gives us tremendous competitive advantage of being able to renegotiate lot or phase take-downs with the sellers, if we are not achieving the sales pace or pricing that we anticipated in a particular community. Although we have not had to utilize this tactic much in recent years, we have employed it successfully in the past, particularly when the markets slowed down in the early 1990's.

If the currents sales pace continues to slow down further in certain markets, we have the flexibility to renegotiate a large portion of these option contracts, and thereby protect a significant amount of our return and profits in the developments of these communities. The renegotiation may be in the form of stretching out the timing of take-down, or in the lowering of the purchase price for lots, or both. In order to execute this strategy successfully, it is important that we stay focussed on minimizing the amount of our deposits on our land and lot option contracts. This allows us to have stronger negotiating position and the potential to walk away from some option take-downs if land values decline.

Turning to slide 19, it shows our average -- excuse me, our aggregated option position for all of our lot options and the amount of aggregate deposits, which are only 8.1% on average of the total purchase of the lots.. We believe that a deposit less than 10% gives us significant flexibility in renegotiating with land sellers to modify take-down schedules of absorption rates or pricing change adversely. Even deposits on certain transactions up to 20% give us greater flexibility than owning the land outright. Excluding model homes, we had 2,568 started and unsold homes at the end of January. Based on our recent sales pace, this represents only about a seven-week supply of started and unsold homes, and completed and unsold homes is a tiny fraction of that seven weeks.

We repurchased 150,000 shares of common stock during the first quarter of '06, and have approximately 1.34 million common shares left to buy back under the current authorization which has been in place since 2001. We believe that buying back shares can, at times, be an appropriate use of our cash, depending not only on stock price, but also on our capital needs for growth and current opportunities available to us to deploy capital in our on-going business that achieves our targeted levels of return on investment. Going forward, we expect that we will continue to buy back shares, but we do not anticipate that you will see a material increase in our activity under our current authorization. We target our current land acquisitions to yield after-tax returns on equity in the high 20% range. This is higher than the short term effect of buying back stock even at the current lower valuation of our shares.

Our first quarter of 2006 results include approximately $20 million of noncash expenses related to the amortization of definite life intangibles and to stepped-up inventory from company acquisitions. At the end of the quarter, our total remaining definite life intangibles are $212 million. We expect definite life intangibles to be below $172 million by the end of fiscal '06, assuming no further additional company acquisitions during '06. Our earnings projections for '06 includes more than $87 million of noncash pre-tax charges related to acquisition premiums, which are split between stepped-up inventory and amortization of definite life intangibles. Let me clarify this a little further.

During '06 we expect to expense approximately $50 million of definite life intangibles, and roughly $37 million of Inventory step-up related to our prior company acquisitions. The combined $87 million charge is a noncash expense to Hovnanian. Despite the negative impact on our margins in the short run, we continue to believe that our conservative approach to purchase accounting which amortizes 100% of any purchase premium is among the most conservative in the industry, and is the most appropriate way to represent our financial results on our balance sheet.

We did not book any goodwill in conjunction with our recent acquisitions. And at January 31, 2006, we only had $32.7 million of goodwill on our balance sheet, which is related to acquisitions we completed prior to the change in the goodwill accounting rules. I'll now turn it back to Ara for some closing comments.

Thanks, Larry. We are proud of the continued strength of our financial performance, and we're pleased with our recent sales activity. As the heavily regulated markets return to more normalized levels, the efforts of our talented associates need to be and will be even more focused on execution. We believe we've got the right strategies in place to continue to grow our market share, even if U.S. housing starts fall over the next several years as many are expecting. Under this scenario, we will not be able to grow our earnings at the 57% compounded annual growth rates that we have over the last five years, but we still expect to grow earnings, albeit, at a more measured pace, and earn returns on equity well above the S & P 500 as we've been doing for many years. Our updated projections for fiscal '06, take into account the selling environment and slower market conditions that we've been experiencing. As a result, they include 140 to 190 basis points projected decline in our consolidated home-building gross margins. As Larry clarified, they also include lower projected deliveries from California than we achieved in '05. Yet, our return on beginning equity in '06 at these lower levels of profitability is still projected to exceed 30%, almost double the S & P 500 in a weaker environment.

The reduced demand from investors that have exited the marketplace is exacerbated by the increased supply of homes that have come to market as investors have put their homes up for sale. It will take some time for this oversupply to work its way through the markets. What gives us comfort is that in some of our more highly regulated markets, the same ones that saw the most investor activity, this regulatory environment keeps the supply of new homes at artificially low levels. As you can see in slide 20, the permit activity in New Jersey is down approximately 40% from the levels in the mid 80's. And in Southern California, an important market for us, if you turn to slide 21, you see an even larger contrast as current permit activity decreased more than 60% off the activity we saw in the mid 80's.

We are basically producing, instead of 140,000 permits in this key area in Southern California, we are producing a little over 50,000. We're just not able to meet the supply, and if you look in both New Jersey and in Southern California, the two examples I just gave, the last five or six years, the permit activity has been flat. They have not, in spite of strong conditions, been able to get more product to the market, and that's why we've been seeing this big price appreciation.

Turning to slide 22, we see here recent example of investor inventory working its way through the market. This shows resale listings in Southern California and Orange County and what the trends were from the fall of '04, as some of the earlier investors took some profit-taking. It did take about 60 to 120 days to work off that excess inventory, and it did affect sales and pricing, but once it did, that market returned to more normalized levels of selling after a short period, , and has remained a consistently good contributor to our returns.

While the housing markets are clearly cooling and returning to more normal levels, the demographic trends in economic outlook support the fundamentals that allow me to be confident about our future. Most forecasters are predicting that, as a country, we will need to build between 1.8 and 2 million new homes each and every year over this next decade. This outlook bodes well for our continued success, but even with the fallout from these levels of national activity, our geographic, product, and price diversity, as well as our size and financial strength, allow us to continue for grow market share and perform well.

We are also well positioned for achieving our earnings targets for the remainder of '06, with a $4.9 billion contract backlog as we begin the second quarter. The major challenges for achieving out '06 projections relate primarily to the construction of homes that are already in backlog, and that has definitely been more challenging than the past, particularly in Florida, where we expect to deliver about 20% of our homes in '06, the production delays that we are experiencing in those markets continue. Believe it or not, we still have some homes waiting for roofs since November, and production delays exist throughout Southern California -- excuse me, throughout southern Florida. We are also focused -- at the same time that we are worried about and focused on production in '06, we are focused on sales for '07 deliveries.

While we expect margins on new sales to be lower as many markets return to a more normal sales environment, and we don't have the benefit of the price appreciation that definitely benefited our margins over the last several years, we do not see any evidence of a bubble bursting. Most importantly, we are continuing to take total market share and, as evidenced by the growth in our sales contract, and the increasing number of active communities. As a result, we believe we are going to be able to continue to grow revenues and profits in fiscal '07, even if the sales pace per community continues to -- at a slower pace, and gross margins continue to decline to more normalized levels.

Since we need land out in front of us, in order to achieve our objectives of opening up more and more communities, we will continue to fuel our pipeline with both company acquisitions and land acquisitions, although we will be a little more cautious. We target our land acquisitions to yield an after-tax return on equity in the high 20% range. While we accept slightly lower returns on company acquisitions, due primarily to purchase accounting, over time we are comfortable and confident that we'll achieve strong returns in markets we enter through company acquisitions. By remaining focused on high returns on land deals that we acquire, we will continue to grow our profitability and maintain healthy returns on our invested capital, we return a 20% unlevered IRR on each land parcel that we acquire with a normal sales pace in current market conditions.

As an example, just yesterday, I approved a large acquisition in Southern California. However, instead of using an 8-to-9 home-per-month absorption pace, which we had been achieving, we scaled it back to 6 or 7 homes per month, which is more reflective of what we are seeing in the marketplace. And we priced it to current market, net of any discounts or incentives. This has still yielded an unlevered return in the low 30% range on IRR's. Now, this is lower than the high 30% range we were achieving earlier, but definitely rock solid returns that would yield great returns on equity.

We are confident that through the consistent discipline and execution of our business strategy, in an industry with increasing advantages for the large homebuilders, we will accomplish our long term goals for growth and profitability. And with that I conclude our comments today, and will be pleased to open up the floor for questions.

[OPERATOR INSTRUCTIONS] And we'll take a question from Michael Rehaut. Please proceed.

Hi. Good morning. It's Mike Rehaut, JP Morgan.

Good morning.

Just a question, you had some commentary in the press release about some improving trends in some of the markets that had been slower in December, January, such as Florida or California, DC, but still, down year-over-year in terms of perhaps absorption rates or other metrics. I wonder if you could kind of give us a little color on how much perhaps some of those markets have come back since the end of January, and is that trend something that you expect to continue as the excess inventory is being burnt off?

Sure. We only have four weeks of sales, and we're releasing sales on a quarterly basis. I can't be too specific, and we don't have a big trend line right now, but in general, we have seen a bit of strengthening. It's a little different in some markets than other parts of the marketplace, but we are projecting clearly that we're not expecting the market to recover to what it was last year post this normal slow season. If I was to take a guess at how long in certain markets it's going to take to work off some of the -- this excess investor inventory, I don't know, I guess I'd have to say about a six-month period or so. It was a little less than that in the Orange County example, so it's hard to say exactly. As I did mention, in some of our markets where we didn't have this investor overhang, the Carolinas, Houston, Dallas, we had very little investor activity there. They didn't see the big price run-ups, so it didn't force people to jump into the marketplace. Those markets are, in fact, strengthening right now, so kind of an interesting dichotomy between the heavily regulated markets and the unregulated markets. Even with that, however, there. However, and even with some of the incentives in slower markets, generally speaking the higher regulated markets are still yielding better returns.

Great, thanks. And just one follow-up, on the guidance that you gave out before, it appears that the revenues are a little bit higher than what you gave out last time, and also perhaps, you have a little bit higher contribution slightly higher from land sale gains and, I just want to understand where the offset to that was, since you overall reiterated EPS range.

Yeah, the big area -- Actually SG&A is pretty much in line. Kevin, you want to address that question?

Yeah. I think our deliveries are down a little bit, but average sales price is up a little bit, so our revenues are, you're accurate, are up just slightly in our guidance from the last guidance we gave. Most other factors, you are correct on the land sale income being up, which we, I think, clarified and gave you a good number on, and our tax rate for the year, little bit lower than what we anticipated, given the tax credit that we are now getting that we didn't know the magnitude of that when we gave our last guidance.

Yeah, I mean, overall, really, I mean, the change in revenue was basically about a rounding error. Our projections are, all in all, pretty much right in line with what what we gave you last quarter.

Okay. It just seems like there's a couple things where you've moved up a little bit, and perhaps that, in my mind, suggests perhaps a slight increase cushion in terms of potential conservatism.

I wouldn't anticipate anything we did as increasing any consumption or increase in any conservatism, Mike, I think we are trying to give you pretty straightforward guidance, and similar to us coming in within the range that we projected for the first quarter, which was much lower than what the consensus was when we put out our release in December. You really just need to trust us on this. We are not building a bunch of conservatism into these numbers.

No, I'm not saying that. I'm just saying that you are tweaking up a couple of line items here and here, and most of these tweaks are in the positive direction, yet you've reiterated the EPS guidance, so that just kind of prompted the comment.

No, I mean, the tweaks are literally about rounding errors. I mean it's pretty much dead on where we were.

Okay. Thank you.

Okay.

And we'll take our next question from Steven Kim. Please proceed.

Thanks, guys. First I want to say just thanks for the clarity on your guidance. I think your presentation was really exemplary, so thanks for that.

You're welcome.

I guess -- my first question relates to gross margins and my second one relates to land options. Both of these are fairly common things that I encounter when I talk to folks about you, and other companies. The question that I have in my mind about gross margins is where do you anticipate the normalized longer term gross margin for your company, in particular, might reside, and what gave rise to that question is, that your comment was that in '06, you expect the gross margin to be down versus next year, which I would agree with, and in '07, you expect it to be down perhaps as well from '06 which I also agree with, but I just want to make sure we're on the same page for how much.

Sure. Well, Steve, as you know, our real focus is return on investment, more than gross margin, and we achieve that in a number of different ways. Some markets, like Houston and Dallas, have lower margins and much higher inventory turns because we have lower land costs and buy developed lots, and other markets have higher margins, lower turns, so it's not our primary focus. However, to answer your question, what we might anticipate as more normalized, our earlier slide showed you -- an earlier slide showed you our trend over the last few years. If you go back to '02, about four years ago, we averaged a 22% gross margin in that year, and that was before a lot of the real run-up in '03, '04, and '05 in pricing, where it drove it up quite high. The 22% by the way, translated for us to about -- well, in excess of a 30% after tax ROE. The year before that, going back to 2001, about five years ago, we had a gross margin of about 20%, a little in excess of 20%. That translated in that year, again, slightly different turn conditions, but that translated to an after-tax return on beginning equity, to a little bit in excess of 20%. So, I don't know. I suppose somewhere in ex -- between those numbers I might consider a normalized area.

Could we have a couple of quarters of sales where some markets go through some corrections that are a little less than that?. I suppose so. We are not experiencing that at this moment. We're actually achieving higher than the '02 numbers at this moment. We told you our first quarter, we were about 25.6% as we reported. Obviously, if we are projecting to average about 24.5% to 25%, the latter three quarters are a little lower than that number, to get that average, so that's not where we were back in '02. But I'd have to say somewhere around those levels. I mean, if you took the IRR of properties we are acquiring, it's an unlevered IRR of 30%, that would translate to the very high 20% range at our current structure for our company in terms of after-tax return on equity. Obviously, the last few years, we bought at 30% IRR. We had price appreciation, even net of the cost of appreciation we did better than that. It's possible some of the properties we bought a year ago may generate IRR's less than the 30% we thought, so they could bring our ROE's down in the lower 20s, but on the whole, that's what we generally purchased for, a 30% unlevered IRR. We're continuing to see those opportunities, and that would translate to ROE's in the very high 20's, just touching 30% after tax.

That's a very complete answer. I guess that also doesn't assume though, what you were articulating before, that perhaps getting some concessions from suppliers and being able to wield your size to your benefit better, right? That doesn't assume that -- cash. That's right.

We always make our projections, and feasibilities for new properties. We hold house prices constant. We hold absorptions constant to what they were in the immediate preceding period, the prior month or two or three, and we hold all material costs and labor costs as if they are static as well, and in reality, all of those move around a little bit.

The other thing I would add, although Ara already gave a lengthy answer, is that as you said, we are much more focused in a tight range on where we are looking for returns. But our gross margins that we are targeting on a community by community basis, or market by market, can vary significantly. We pro forma new communities, with gross margins in the high 20s, or even into the low 30s. In many cases, where we are in a highly regulated market, or we're doing more land development, or we're having to take down more land up front, and we have a lower inventory turnover, in that case. In other markets, Texas markets being a good example, we are buying finished lots on a rolling take-down, we may have gross margins that are in the high teens --

But actually ---

-- We are achieving excellent returns on the basis of turn over. So, it makes it very challenging to project very much long term where will our net gross margin average out to. It has had noise in the past as we've made acquisitions in places like Houston, and it may have noise in the future as we grow unequally and do more land development or do more options -- finished lot options. So I just wanted to clarify that and the number that we are giving you for '06 is based on a community-by-community build-up budget, so we feel we have a pretty good idea where that's going to average out but, even then, if our mix of deliveries in more highly regulated markets would slip or grow, it could shift that number around a little bit this year, particularly quarter by quarter.

What's interesting is even in the same markets, our diversity of product and land acquisition approaches can achieve the same ROI or IRR with very different gross margins For example, on our mid-rise and high-rise, we have to generate a higher gross margin because the capital is typically out there longer, so to reach our IRR hurdle in the same market, we have to generate a higher return and in the same market, if we get a more favorable land deal with many takes versus an all cash, we'll generate lower, and that's part of the reason why you can see quarter-to-quarter fluctuations in our gross margin. You likely will this year, because we've had a little lumpy distribution from mid-rises and high-rises in some quarters versus others, and that the geographic mix does make a difference.

Great, that was a great answer. My second question relates to land options. One of the things that you alluded to was how, when things get tougher, you can always renegotiate the land options, and you talked about how important land options are as a part of your overall strategy. One of the things that I frequently find people don't fully understand well is why on earth any land seller over the last few years would be willing to write an option for such a low deposit amount to a public builder. I was wondering if perhaps you might take the opportunity to sort of in some way that can maybe -- maybe withhold names to protect the innocent, but in some way, can give us a flavor for what you're seeing out there on the ground that enables you to get such -- what apparently are attractive sort of unilaterally positive arrangements.

Sure. Well, they're not just unilaterally positive. First of all, there are two broad classes of options that are quite different. The one broad class is an option which is subject to entitlements. And in those cases, -- and that would -- is in markets where we tend to process the property all the way through the entitlement stage. The Northeast or the DC market, we do a lot of that, and the reason the sellers are willing to do that is, number one, they recognize we can literally spend millions on an entitlement for just one property, so they take into account the option dollars that we give them, and the option dollars that we spend, so that's part of it, and number 2, they recognize that we bring a value add to their property. It's like a diamond in the rough, a raw diamond is not nearly as valuable as a polished cut diamond, and we are very good at bringing these lands to the polished cut phase, which adds value to those holders. That's the second reason. They value our value-add. And the third reason is we have a strong track record. We are typically the very large builders in the markets. We've got a great track record on executing on the deposits. It is not common when, for us to walk or have to renegotiate, it's an exception, and if we do have to go back to the land seller, they know that it's not just our company that is underperforming. If we have to talk to them about stretching out take-downs or re-looking at escalators, it's because the whole market is changing, and they recognize that.

Great. Thanks a lot. Keep up the good work, guys

Thank you.

We'll take our next question from Carl Reichardt. Please proceed.

Good morning, guys. How are you?

Good, Thanks.

I have a question back on the IRR's. In the past periods, Ara, where you've seen IRR's fall, I guess we can go back to the mid-90's or maybe there's some other time frame, did you tend to chase them down or where was the tipping point where you decided we're going to either conserve capital or start to repurchase stock? And how do you look at that in this environment, currently?

In all of them, we're basically applying the same discipline. So we are -- we have -- we look at every new property. We try to really gauge the current absorption, and really try to understand the current incentives that are offered. And, if, after applying that test, and I mentioned the example from yesterday in Southern California, it was in the Inland Empire area, if after achieving that test, we can meet our threshold IRR's, we'll move forward. We don't consider it chasing. Now, it's conceivable that prices could deteriorate from where they are even now, or absorption could slow even more, and therefore, the property won't yield the 30%, but we're buying land all the time. We're replenishing a couple of billion dollars of land that we're burning through every year, so we're in the market, and sometimes we'll be a little higher, sometimes a little lower, and all the markets are a little bit different.

We don't anticipate, Carl, lowering our hurdle rate in order to make more land deals. I think what you'll see happen, if we can't find deals that pencil at today's lower absorption rates or at lower margin levels because of market conditions, we won't approve the deals, and therefore we'll have more cash available. If we have more cash available, I think we'll likely pay down debt and then consider, after we pay down debt, potentially buying back stock or paying dividends or just conserving cash for future investments, but your question really was, when will we kind of lower our rate to make stuff happen? We are not going to lower our hurdle rate.

That's that answer.

At this point, we really don't feel the need to. We're particularly comfortable because with the communities we have in place, as we stated in our presentation, we already have positions to grow our community count significantly which will set us up nicely for '07, it's not like we have to rapidly fill in some slots that we are missing. We're in pretty good shape, and we can be picky and choosy in our acquisitions right now.

Great. Okay and my followup is to do with Q4 and the back-end load. What are you guys doing tactically right now to ensure that you will get to those delivery numbers? Is it -- do you start earlier so you -- or you may --

Working hard.

Yeah.

Anything more specific than that? I figured that.

Unfortunately, and this is not something we're particularly proud of, we have had a -- we have been a company that's been a big fourth quarter company, so we have been through this drill before. And I wish I could say it's something we can plan for. First of all, I wish we could smooth it out better than we have been. Unfortunately, the hurricane season really made -- already a big fourth en -- fourth quarter condition even worse. What we are trying to do is be more anticipatory in terms of staffing. We're being a-- a little more liberal in trying to bring staffing early, and we're trying to make sure we are staffed appropriately for that crunch at the end. At this point, sadly, our subcontractors know us well. They know the crunch we've got at the year end, and they start doing some of the same things.

And raising their prices, too, I would think?

No, our prices don't change from quarter to quarter with most of our subs and suppliers. Other than commodity prices, obviously, for lumber and cement and so forth, but most of our labor is priced uniformly throughout the year. There's no change for seasonality.

Okay. And then, I'm sorry, it's one quick number. Do you guys just have orders for First Homes for the quarter?

We don't publicly give out specific quarters by acquisitions that we've made or even by state, so it's just not something we provide.

But, I will say this. First Homes has -- actually, I'll say a couple of things. We gave the growth in our community count. First Homes in that market in Fort Myers, we are building a couple thousand homes. We have no community, so it distorts some of that. We only closed on them in August, so really only had a fourth quarter benefit last year. We'll have a full year's benefit this year. But the point I was getting at, they -- when we acquired them, they had a huge backlog, about a year-and-a-half-plus's worth of backlog. We don't like to manage with quite as much of a backlog. We are absolutely still selling homes there every week, and we continue to be astounded at the strength of that marketplace, but we are tempering their sales. That's one of the few markets where I can honestly say we're trying to temper sales. In most markets, we are trying to boost them up. There, we've just got such a big market, such a big backlog, that we're not overly anxious to sell too many homes too far in advance. .

It helps, because their orders were a little lower than we thought, I think that's the reason. .

Okay. Hey, I appreciate it, guys. Thanks very much.

Okay

We'll take our next question from Ivy Zelman. Please proceed.

Hi guys, actually Dennis McGill on. You were kind of just touching on what I was going to ask on the First Homebuilder situation. When you first did the transaction, you had said you really weren't worried about continuing to take orders at the same pace as they were selling, but it sounds like you have pulled back in that area?

Yes, I would say we have. I mean, what we really have done is tried not to try and absorb the same pace, and if we wanted to, we might have done a concession or two, but we've got a very healthy pace. So right now, we've got -- we have backlog going well into '07 for First Homebuilders. I'd rather bring that down to a six-month or nine-month backlog so -- but at the same time, we, obviously don't want to cut off sales. That would be unhealthy. Our whole sales staff would revolt, so, we're just not trying to be overreactive, We're not trying to stimulate sales, no special deals. And we're plugging away nicely adding sales every week, and delivering homes every week, and our goal would be to bring the length of backlog down a little bit. I wish I could say we want to just step up production to meet it, and keep sales at the pace, but we just can't down there. Florida, Southern Florida is really tough on construction. It's been plaguing us, not just in Fort Myers. We're seeing it in Tampa. We're seeing it in West Palm. We're even seeing it in Orlando. It's just one of the toughest markets in production. It's s rare. I mean, I can't remember over the last five years saying construction is an issue, but in Southern Florida, it's tough right now.

Have you been successful in bringing the backlog down, and have you run into any cost pressures on the backlog that is extended?

We have been successful in bringing the backlog down a bit. We are delivering a little bit more than we are selling right now, so that's a good thing. And yeah, we're definitely seeing cost pressures. And that's part of what we factored into our projections. The cost pressures, as we're seeing everywhere. The good thing is, the shortage of materials, roofers, roofing materials, in particular, the market is not reacting by trying to gouge thankfully so, that's helping us a bit. Normally, with that kind of shortage, you would expect some price gouging. It hasn't been that bad, so we are just kind of seeing price increases that are similar to what we see in other markets.

Okay, and just one more technical one on that transaction. When the buyer enters into a contract, does it go into backlog when they sign on the land parcel, or is there a contract that signs before? Is there any inbetween time between when they would sign for the home and take the parcel down and give you the cash for that?

They -- well, we put it into backlog. It's kind of a simultaneous contract for the land and the house, but they close on the land parcel early, which is a beautiful thing. I think about, I don't know, 70% or 80% off the top of my head, of their backlog, the customers have already bought the land from us, and by the way, it's at a profit, but we do not book that profit. We don't recognize that profit until the home delivers. So it is about the most solid backlog you can imagine. Since they've already bought the land, they're not very apt to try and cancel at that point.

Okay, so only 20% or 30%, roughly have not closed, is what you said.

Yes.

Okay.

And that's typically, the most recent sales activity. It just takes a month or two to get that to happen. I will mention one other thing you may remember about our First Home operation. They are unusual in that, in First Homebuilders in our market, we are our own distributor for many, many materials, so we buy direct from the manufacturers, which make us less susceptible to gouger that might happen if you're buying from market distributors, and secondly, in several of the trades, concrete, framing, cabinetry, et cetera, we actually are our own laborers as well. We don't use subcontractors. So, that's also part of the reason why we -- pricing has not been a big, big problem. What the other thing that has been a problem causing some of the delays in Florida and certainly in Fort Myers, since we're talking about it, is inspection delays. The reason is, if you've been driving around Florida at all, that actually is really bad on the east coast but exists on the west coast.. You see a lot of blue tarp on roofs, and that's because the roofs have blown out. There are windows that are still blown out, and there are inspectors that are going out all over Florida to inspect people that are repairing damage on work, so it's really strained the inspection staff, and it's put us way behind because there's a lot of -- lots of -- there's a lot of priority given to existing homeowners that have to fix their house. And sometimes they give new home builders lower priority. So that's also part of the challenge we have here.

Thank you, Ara.

Yep.

And we'll take our next question from Alex Barron.

Great, thank you very much. Wanted to focus a little bit on your community count, and hoping you could at least give us some directional guidance of which of the regions, I guess, is expected to grow more than others?

I don't believe, Kevin, we don't give community count information by market. Is that correct?

I think we give it in our Q and K by --

We give actuals -- he's talking about projections.

But we don't give projections by --

Alex, gosh I wish we could. It's the most difficult thing we have to project. We're one of the few builders that continues to give community count, much less project community count. we just can't get more granular to tell you what regions.

I can tell you at high levels. As I mentioned earlier, in Southern California, we're projecting actually lowering our earnings -- our deliveries in '06, compared to '05. In Washington we're increasing -- and by the way, you can pretty much correlate that. We're are probably decreasing community count a bit in Southern California. Hopefully, that's going to correct itself toward the very end of the year, beginning of '07. In Washington, we are going the other way. We're increasing the community count there. Florida, we are obviously increasing dramatically, but it's distorted because of acquisitions, so it's really a little bit all over.

Okay. Great. I know you guys don't break it out by specific acquisition, but I was wondering if as a whole, you could break out your orders for this quarter that did come from acquisitions? .

We don't provide that.

Yeah, we don't provide that detailed break out.

Or lastly, there's been a lot of press, and I've seen advertisements of strong discounts and incentives by some of your -- the top five builders. I'm kind of wondering how that's affecting you guys, and in what ways are you responding? Like what kind of discounts or incentives are you guys having to give?

Sure. Well, it definitely affect the marketplace overall. It's part of the reason why we are projecting lower gross margins. Fortunately, as I mentioned earlier, a lot of it is related to standing inventory. I mean there's , lot of talk about the Centex, one or two day huge discount blowouts. They were very -- when you dig down, it was very much geared towards standing inventory for their fiscal year end in March. I'm not suggesting anybody's doing a bait-and-switch, but they're clearly targeting the discounting towards certain locations, certain lots that are -- have been problems.But, no. In many cases, we've absolutely had to step up to the plate, and offer more concessions or discounts than we were doing earlier. I'm fairly -- and by the way, where we do -- where we've seen a slowing because competitors offer discounts, if we've had to go to matching some discounts, we've seen absorption return again. If you remember about, I don't know, I think it was a year and a half ago, there was a lot of publicity about Las Vegas, I think at that time it was Pulte, in several communities did a lot of discounting, and everybody made a big hullabaloo about it. The reality is they were hugely overpriced. Prices had just gotten out of control. They corrected. It forced some of the other builders to correct. They kind of worked through the situation a little bit, and then Las Vegas went on to be a very good market. Frankly, we're not there, and even with all the bad publicity, I wish we were there. It's proven to be, even with the concessions and correction they went through, it proved to be a very solid market. And that's pretty much what we are seeing. It's definitely affecting margins, and we have to react, but it's very tactically applied. Nowhere are we doing across-the-board, big discounts that are beyond kind of our normal discounts or concessions, and that really varies from market to market. On the whole, we're pretty comfortable with where we are right now.

Okay. Along those lines, what percentage of your homes that you start are without a buyer?

It varies dramatically, I think at the moment, I think we mentioned, we've got a little over 2,000 homes that are started without a -- they are not finished -- that is a much smaller number, but they're started without a customer. In certain parts of Houston, in one of our two divisions in Houston, it's probably 80%. You go to New Jersey or Washington, it's probably 10%. It varies dramatically from market to market, but across the whole company, we are just a little in excess of 2,000 homes that are started at this moment. And hat compares to 21,000 or so that we'll deliver this year.

And, Alex, that's something we put in the 10-Q and 10-K every quarter, so you can track that, and if you look at it on a per-community basis, it's been roughly the same on a per-community basis for every quarter last four or five years. And one of the things that drives that number a little bit is as we do attached homes, whether they be low-rise, or mid-rise, or high-rise construction, we typically want to have 40% or 50% of the homes sold in a building before we start it, but de facto when we start it with only 40% or 50% sold, it increases the number of started unsold, but having it at only a 7- , 6-, 7-week supply at our current sales pace, it's a very modest level.

Understood. I appreciate it. Thanks.

Okay. Thank you.

And we'll take our next question from Craig Kucera. Please proceed.

Hi. Good morning and thanks for all the detail on the call. I just wanted to ask you, some of the comments you had about SG&A. You said that your SG&A during the quarter was up because you were reacting to slowing market conditions. Is that -- is that mostly an increase in advertising, or are you pushing some of your incentives through that line item?

No -- go ahead, Larry.

It's advertising. Incentives would not come through that line item.

So incentives would go through cost of sales?

Yes.

That's correct.

Okay. Thanks a lot. That's my only question.

Okay. Any other questions?

We'll take our next question from Michael Wood. Please proceed.

Hi. It's actually Dan Oppenheim, here, B of A. I just had a quick question, if you could elaborate more on the margins. You talked about how there's a negative impact from the geographic mix shift out of California and also the negative impact of the step-up of inventory, and intangibles from the acquisitions. How much of these [inaudible] declining margins is coming from a slower market and maybe it would be helpful also just to -- to look at it in terms of current orders, relative to looking at closings in '06?

Well, first of all, just a clarification. Intangibles do not affect the gross margin. They're below the line. The step-up does. I can't say that we break it out that way. But it's a little of everything. It is a little bit of geographic shift. We are definitely, because of market conditions within the same markets, seeing a lower gross margins as there are more pricing pressures, and as we come to market with more recent land acquisitions, which are typically, obviously, higher priced than our older land acquisitions. It's a little built of everything.

Keep in mind that we've not changed our margin projection for the year from what we said last quarter. We projected at the beginning of the 2006 year that our margins would decline 140, 190 basis points. We're maintaining that this quarter, and it's not really rocket science. I know some of our peers aren't quite candid as we were on this point, but the homes that we closed today have a lower land basis under them than the homes that I'm starting today. That's the primary driver for the projected margin decline.

Okay. Thanks, and wondering about the comments on acquisitions. You said you were more cautious in looking at those now. Is that based on the performance of recent acquisitions, or is that more just on the sort of greater uncertainty in the market at this point?

It's more on the greater uncertainty. We're pretty pleased with the performance of our recent acquisitions in general. And even though you are seeing more incentives in places like Florida, our acquisitions there have been excellent, and we're very pleased.

Perfect. Thanks very much.

And we'll take our next question from [Steve Sockins].

Hi guys. Just one question. In some of your comments about incentives, you saw -- your mentioned some competitors in select markets maybe being more aggressive. As you see it it from the land buying perspective, and, as you mentioned, you haven't really -- you have not at all changed your hurdle rates, have you seen any evidence of competitors public or private being more aggressive in your mind from a land buying perspective such that you think they may be, in fact, lower hurdle rates?

No. Actually, the one benefit is we are seeing the complete opposite,particularly from the private home builders . Many of the commercial banks which are the primary funding mechanism for mid- and smaller private builders that still make up 75% of the marketplace. Many of them are getting much more cautious. The smaller builders are more highly levered, and so the banks are being very cautious, and they are being much more cautious because of that. So that's been a benefit, However, I'll say that land sales prices are always sticky on the way down. They're pretty fast on the way up, but they're sticky on the way down, and a lot of the sellers are not super quick to reduce pricing. What's interesting, is over the last two years, I think we saw the tougher part of the land transaction where that the terms of the transaction became more and more difficult, requiring more cash up front, maybe earlier in the approval process where we -- where you don't have absolute final approval. Where you might have the preliminary approvals, and the risk is gone, but you have to sit and wait for six more months. My suspicion is that we'll probably see a little softening of the terms first. We're just beginning to get little hints of that in the marketplace now. I think that will be the first thing to ease, which is good. We'll be pleased with that. It won't affect our margins but it'll affect our investment levels and thus our returns on investment. And then only later will we hope to see some reductions in the land prices. We haven't seen a lot of the big builders being overly aggressive in land parcels, or company acquisitions for that matter. I think everybody is just taking a little more cautious stance. We were acquisitive a year ago. I don't think we've acquired anybody since August of last year, which is a longer period for us, and we're not seeing as much competition in the company acquisition arena either, so that's a good thing.

Great. Thanks so much for your comments.

And we'll take our next question from Susan Berliner. Please proceed.

Hi, thanks so much. I was wondering if you had any feedback regarding the rating agencies, I guess specifically S & P, in terms of a potential upgrade, and if you can comment on your discussions with them regarding your joint ventures and your options since this seems to be a hot button by them.

We've not had any specific feedback from S & P. We meet with them on a regular basis, and we continue to believe that our credit statistics will someday convince them to upgrade us. We've been there with a positive outlook for quite some time. We've provided S & P with a -- a lot of clarity on our joint venture activity. Kevin, I don't know if you have a different recollection. I don't recall any concerns that they've had on the joint venture activity at all. As you might recall, and if you read the footnote to our financial statement, it's very clear, unlike some of our peers, we limit the leverage on our joint ventures in the aggregate to the same kind of debt-to-cap that we limit the company at which is a 50% net debt-to-cap number. So if we ever consolidated all of our joint venture activity onto Hovnanian's books, it wouldn't have any adverse impact on our overall leverage. We also do not provide any maintenance guarantees or other types of financial guarantees other than very limited environmental guarantees, so I don't believe that either of the major rating agencies or any of the three major rating agencies have any great concerns about our joint venture activity, and we, again, are working very hard so that everybody understands what we are doing with a very transparent footnote.

Yeah. We -- we're excited about the limited amount of joint venture activity we do participate in. The returns are very good. They're are not good because we leverage higher. They are good because a lot of the equity, a disproportionate amount of the equity, is put in by financial partners as opposed to our company, and then on the other side, we get a disproportionate amount of the back-end profits.

Okay, and one comment, just , a followup, I guess, on the leverage, and I think Larry, you recently said that you are still comfortable with a 50% target; however, if the environment changes, you may reconsider that. What type of environment would you reconsider that in?

It's really not an environment. It's really just us deciding that we want to become even more conservative. We've noted that some of our peers have lower debt-to-caps than 50%. When we set that target in 1997, if you were a homebuilder and achieved a 50% debt-to-cap, you could get investment grade rating. And we've seen builders at 50% debt-to-cap recently, be investment grade, so it's still possible. It's just that we may decide to get a little more conservative. We've had some hallway conversations with -- inside the company about that, and it wouldn't surprise me if over the next few years, we do tweak down our goals. We're just not positioned and ready to do that at this point.

Great. And just one follow up question. I think in the last two calls, you guys had commented about 90% of your growth coming organically? I was wondering if you could comment this time.

In terms of the quarter, we didn't have any growth. So, can't make that comment.

Okay. Nice try. Thank you.

Zero of our growth came from new acquisitions. Other questions?

And we'll take our next question from [William Nobler].

Hi. I want to go back to the $87 million of noncash charge amortization and step-up.

Okay.

Am I correct if you should, or one could use your 38% tax rate and come to the conclusion that your reported EPS would be penalized this year by over $50 million?

Yes. That's about right, yes.

So that would be something like $0.75, $0.80 per fully diluted share?

That's correct.

No. No. It's $50 million after tax. -- yeah, that's correct. You're right.

Over $0.80 a share.

Okay. Do you have a guesstimate, if you don't do any acquisitions, which I think is becoming increasingly possible, do you have any guesstimate of what next year's charge would drop to? If everything remains the same?

Paul or Brad, do you all have a guesstimate?

I'll be right back.

There are two components of that, as you recall. One part is intangible. One is a step-up. The intangible part will not vary dramatically next year. The intangible component was about $50 million, so there won't be as much runoff there. You will see the step-up reduced, because a lot of First Homes had step-up and a lot of that is delivering out this year, so that -- that will go, and, Paul just went to try to get the numbers, do you have it handy, Paul?

I don't have the step-up portion of that The intangible portion will go down about 15%, And I would suspect the step-up would go down even more, because the step-up runs off quicker than intangible does. So maybe 20% left.

20% of the total 87?

Correct.

So it could be and I understand how difficult this is, but it could be $70 million, which, I guess -- so $17 million, that would be, I guess about a $0.15 a share pick up from that source.

That's probably right. Yes.

Right.

Again, that's assuming no further acquisitions.

Yeah, yeah. That's all it can do.

I wouldn't say while we are definitely being more conservative and we don't have any hot transactions in the way, on the way or at the moment, you know, I certainly would not rule it out.

Right. In this environment going back to your comments a few second ago, why wouldn't you lower your goal of debt-to-cap, recognizes it's gone from a red-hot sellers market to a more normal buy market?

Our goal of 50% debt-to-cap was set before the red-hot market. We are comfortable with it in the red-hot market. We are comfortable with it in a slowing market. We do consider to see -- continue to see opportunities there. We are in a consolidating industry and we want to continue to gain market share within the industry as long as we can find good financial returns in our new investments, and we still have much of the country that, in spite of a $7 billion-dollar size, there's still much of the country where we are not yet operating, and we desire to be operating. It's particularly important because the number of reasonably sized private builders is dwindling, and so when there are markets where we are desirous of entering, and a good private builder becomes available, and they may be one of only two in the top fifteen that are private in that given marketplace, we don't want to sit on the sidelines as long as we can negotiate a good transaction. So, all in all, we're very comfortable that we can operate safely with a 50% debt-to-cap, particularly when you combine it with the fact that we operate with a substantial amount of land options, which gives us the flexibility to adjust our balance sheet fairly quickly, and we are also comfortable because of diversification as well, and finally, we always keep hand a large amount of our unsecured credit facility undrawn so that if we really did need to draw upon it because the market slowed more than we thought, and for whatever reason we didn't reduce our assets as we would normally expect in a slowing market, we've got the fina -- the access to capital we need, so we are comfortable in that range.

All right. Well, just as a last comment, but your cost of capital in terms of the preferred you issued and even the debt you recently issued, is higher because of your more leveraged position, and while I fully recognize you and the family own 43% of the company, considering that, plus the six-multiple that the industry and Hovnanian sells at, I would think that you would take all of this into consideration, and I think Larry sort of suggested that is a possibility. But thanks a lot.

Okay. Thank you.

Thanks for the comment.

And we'll talk our next question from Timothy Jones.

Good morning. First of all, I'd like that table that you put out on your options. And you imply you had roughly $58,000 cost of the per lot in there. That comes out to about under 19% of your average sales price right now. Most single family builders, that number is 22% to 24%. Is it because you have more multifamily units? Or secondly, are you including all costs including fees for the lots?

It really depends on geographic mix. In certain markets, like Carolinas, cost of the developed lot may only be 15% or 16% of the sales price. In expensive markets like the Northeast or coastal California, it can approach 40% of the developed lot. And in high-rise and mid rise, it tends to be a lower percentage, the land development, because construction tends to be a higher percentage, so it varies dramatically by product mix and by geographic mix.

That's the finished lot price what you're looking at here. Some of these are options to purchase ground that we still have to spend money on to develop after --

It's not the -- it's not the entire finished product.

It's a mix. Yes.

That's where it is.

Houston and Dallas, they may be finished lots, and in the New Jersey or Washington, they may be raw lots.

That's the answer. And secondly, the 8.1%. Now, I applaud you having over 70% of your land in options, believe me, but that seems high compared to most builders with the number's about 5%. Is that because you are just simply being more aggressive on getting some of these good pieces and willing to get the turnover into returns inherent on [inaudible] lands?

Again, that does vary by market, and in Houston and Dallas, it will tend to be a few percent. In other markets, it tends to be a higher percent, 10% to 15%. So the 8.1% is a blended average.

You'll be happy to know in Boca Raton, that brokers are coming out of the wall now after not being around for about three months.

Okay. Good.

We are glad to hear that.

They are, they are coming to buy every day.

Good deal.

And we'll take our next question from Joel Locker.

Hi, guys. Just kind of wanted to talk to you about the second quarter orders. Just noticed you were anniversarying the Cambridge and the Town & Country acquisitions in early March, and just wondered if that was going to affect second quarter orders with a more difficult comparison?

It will from a comparison perspective, for obvious reasons. But it won't affect the absolute number of orders.

Right, not the absolute number, but I'm saying, just to on a percentage basis, could they, with them in the numbers in the first quarter being up 22% on a dollar basis, I mean --

We would not expect orders to be up the same percentage that they were in the first quarter and the second quarter for precisely the reason you suggest.

But, I'm just thinking they might even possibly be negative just based on trends and without -- .

We won't know that answer for a while.

But -- Trying to get geared toward it. And I guess, Ara, you mentioned an acquisition that you guys made in Southern California the other day? About 30% ROE?

It was a land acquisition.

Right. Land acquisition.

30%, it was actually an IRR, but yes.

30% IRR and that's used in 6 or 7 absorption versus 8 or 9. Just wondering if we went back to 2005, February/March levels for home prices in Southern California, meaning just retracted back down about 12% or so, what would the IRR be on those deals in on those deals , or on that particular deal?

Lower.

I mean, have you guys done a sensitivity analysis on that at all?

Generally, when we do the analyses, we do an upside and downside, and the -- on the upside -- well, on both cases we vary both the gross margins and the sales absorption assumption and we stress test them in both directions and, again, it depends on the assumption you use, that deal structure you use, but often times when we stress on the downside margins and absorptions, we get down to a 20% IRR. And on the upside, we shoot up to 40% IRR. It's kind of a typical swing we will see when we stress test sensitivity.

Right. So even if you use March '05 prices being down about 12%, you would still come out with a 20% --

No. I really don't know. We didn't -- we don't look at historic and do it that way. We just -- kind of just take a ballpark reduction based on the gut feel of possibilities of a slowing environment. We don't track it to a specific price point.

The way we adjust for changing market conditions is to use today's home prices, including any incentives, concessions that have a negative impact on margins, and we adjust as the market goes up, then prices increase, we adjust as the prices go down. If you look long term at the last 35 years, the medium price of new homes in America on average go up 6.9% per year over that 35-year period of time. Yes, there are individual markets that you've seen decline from time to time. Houston comes to mind in the mid- 1980s when I lived there, so I've got a lot of experience in that, and we've operated in a number of markets that from time to time might have a decline. So, we know how to operate in those kinds of conditions, but we're not smart enough to know precisely what 's going to happen and when it's going to happen in each market, but the trends on the long term basis is that home prices go up.

All right. Got you. And just the purchase accounting for the Florida acquisitions. Are those almost runoff, or how long should we expect that to --

No. It's typically the step-up portion of it, takes on average maybe three years, maybe four, and the amortization of intangibles is longer in the four to six year range..

Four to six years. All right. Thanks a lot.

[OPERATOR INSTRUCTIONS] and we'll take a question from Gary Freeman.

Thanks guys. Thanks for your time. Just wanted to go back to a comment you made earlier on the call, about gross margins in '01, and '02, which I think you referenced were in the 20% to 22% range. Can you just give us a sense of what age of your profits the Northeastern California contributed back then, and how that compares to now and what you expect sort of for '07?

California was almost very small in 2001. We hadn't done the Forecast Homes acquisition if I'm remembering the dates correctly. And the Northeast would have been a huge percentage of our overall profits.

Yeah, we don't give specific geographic break downs of profits, but back in '01, when margins -- gross margins were closer to 20%, we were still largely a New Jersey company. I think we had just acquired Washington Homes, really, and Dallas and had just began the broader geographic diversification. Today, we are dramatically more diversified geographically in terms of our profit sources.

So is that really an apples-to-apples comparison to compare margins sort of back then to today when, I'm assuming Northeast back then still would have been one of your much better performs margin geographies?

Margins were lower then than they are now, so I think on a relative basis, it's as apples-to-apples as we can give you.

Yeah. I mean gross margins in Washington, California, and the Northeast do not -- are not very different frankly. Comparable.

I guess what I'm suggesting is, you're sort of speaking to 20%as a trough, if you were diversified back then as you are today, perhaps you would have been looking at something less than 20%.

It would have been the other way around, I'd think. But again, there is not -- it just so happens in the markets we are talking about, Washington, California, and New Jersey, some of the big ones, there's not a meaningful difference in the gross margins. Today in that marketplace, I don't know, because I wasn't overly active in all three of them then, but we were active in them then. We were in Southern California. We were in Washington. And I can't say that there was a big huge difference in the gross margins. The difference was we just had more activity in New Jersey than we did in the other two markets, but the margins and the patterns were quite similar in those markets.

Okay. Thanks. That's helpful. The other question I wanted to ask you was looking at your '07 EPS growth expectation for '07, it seems largely predicated on some pretty significant revenue growth. I'm just curious in terms of strategy, if the market weakness persists longer than you expect, are you likely to meet the market in terms of pricing, or would you more likely ratchet back on your volume expectations?

You know, I think we probably ratchet back pricing, certainly for the communities that we are committed to. Turning inventory is important to us, so if we have assets there, we don't want them to be stale, and we would more likely, reduce pricing to continue absorption there. On the other hand, regarding new acquisitions, we would again look at new absorptions and new pricing, and if we couldn't find opportunities that met our 30% IRR, we would ratchet back new acquisitions and therefore would have slower absorption.

Understood, and then lastly, can you just give us a sense of on the same -- Land prices per lot increases that you expect to sort of flow through the P&L, that's over the next 12-18 months, more particularly in the coastal regions, what per-lot increases are we likely to see on a sort of same-unit basis?

Just not something we track. We have so much variation in product from a condo to a town house to a single family to a high end to, high density. It's not something we track I really can't comment on it. More important, I can just tell you what we do look at after factoring in all the changes of prices, land costs, land development costs, home materials costs, et cetera, the best guidance I can give you is what we're showing in gross margin, which is the net of all those things, and we are projecting that down, I would say, as I said in the 24.5% to the 25% range, which means remaining sales are probably a little lower than that in order to meet that average since our first quarter was higher.

What's your hunch in terms of land price increases on the coast versus what you were seeing a year or two ago?

Well I think the easiest way to answer that question is on a more macro level, and that is, is our hurdle rates for new land deals, assuming zero home price appreciation and the costs that were in place at the time we tied the land up would generate a high 20% range of ROE. We've been achieving returns on beginning equity that approach 40% the last couple of years. The delta between the 30% and high 30% is really been the wind in our back in terms of home price appreciation, or land value increases that were inherited in our backlog, so with zero land appreciation, we are going to be getting high 20% kind of returns on equities instead of the 35% to38% kind of returns on equities that we've been generating. And that's about the best answer we can give you.

I mean, in general, I'd say the last six or nine months, land prices have flattened. We would like to see decreasing land prices. That hasn't happened, but they have flattened. Now, product we are bringing to market today, some of it we optioned and put under contract and took to entitlements five years ago, so those are at very favorable prices. Some of it we bought twelve months ago, it's possible that those are going to earn under a 30% IRR. We've given you blending everything, the best projections we possibly could with the growth margin info we gave you.

Okay. Thanks, that's helpful.

And we'll take our next question from Wayne Cooperman.

Hey guys. How are you? On the build it on your lot business, are you providing the financing? How does that work? Because I know like Walter has a big finance business.

We provide financing for all our different businesses through our own mortgage company. We capture just under 70% of our home deliveries, so we have a very active mortgage finance operation as well as titles.

Is that the same, do you just sell those off?

Yeah, we sell them off, we don't hold the mortgages, we don't --

No installment sales?

No, we're not doing any of that.

I got you. Okay, great. Thanks.

Other questions?

And we'll take our last question from [Myron Kaplan.]

Hello?

Yes.

This is a little off the beaten path so to speak, but could you tell us a little bit about your redevelopment efforts in Westchester County, and, in Yonkers? Urban in fill, let's say?

I will be honest and tell you we have 450 or so different communities in planning across the country. I am not up to speed with that particular community, and the senior management that would be more up to speed is -- is just not on this call. If you are curious, if you follow up with our Investor Relations department afterwards, we might be able to get you more color on that specific community.

Thank you.

Okay.

This concludes our conference call for today. Thank you for participating. And have a nice day. I'll turn the call back over to the presenters for all closing remarks.

Thank you very much. Again, we are pleased with the results we've just reported. We recognized the market is more challenging than it was. We've tried to build all of the current market conditions into our projections. All in all, what that's yielding is lower gross margins, a little lower absorption per community, a little growth in revenues, yielding the growth in EPS that we've talked about, 12% to 17%, more back-end loaded than we would like, definitely tougher quarterly comparisons. But on the whole, we feel quite good about our outlook, and we look forward to continuing to give you updates and good news in the quarters to come. Thank you very much.

Ladies and gentlemen. Thank you for joining us on the call. You may now disconnect. Have a great day.