Hovnanian Enterprises Inc (HOV) 2007 Q1 法說會逐字稿

Good morning, and thank you for joining us today for Hovnanian Enterprises fiscal 2007 first quarter earnings conference call. By now you should have all received a copy of the earnings press release. However, if anyone is missing a copy and would like one, please contact Donna Roberts, at 732-383-2200. We will send you a copy of the release and ensure that you are on the Company's distribution list.

There will be a replay of today's call. This telephone replay will be available after the completion of the call and run for two weeks. The replay can be accessed by dialing 888-286-8010, pass code 52966380. An archive of the webcast slides will be available for twelve months. This conference is been recorded for rebroadcast and all participants are currently in a listen-only mode.

Management will make some opening remarks about the first quarter results and then open up the line for questions. The Company will also be webcasting a slide presentation along with the opening comments from management. The slides are available on the Investor's page of the Company's website at www.khov.com. Those listeners who would like to follow along should log onto the website at this time.

Before we begin, I would like to remind everyone that the cautionary language about forward-looking statements contained in the press release also applies to any comments made during this conference call and to the information in the slide presentation.

I would now like to turn to 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. 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; Brad O'Connor, Vice President and Associate Corporate Controller; and Jeff O'Keefe, Director of Investor Relations.

For those of you viewing our slides at www.khov.com, please turn to slide number one. Prior to the effect of charges related to our Fort Myers-Cape Coral operations, pretax earnings for the first quarter were $26.7 million, equivalent to $0.20 of net earnings per fully diluted common share. This is above our previous guidance of earnings between $0.05 and $0.10 per fully diluted share for the first quarter. This is based on deliveries for the quarter excluding unconsolidated joint venture deliveries of 3,266 homes, and we also delivered 289 homes in our unconsolidated joint ventures in the quarter.

During the quarter, we incurred $93 million of pretax charges related to the Company's Fort Myers operations due to a continued substantial decline in sales pace and general market conditions as well as increasing cancellation rates during the quarter. The charges consisted of $42 million in inventory impairments and a complete write-off of the remaining balance of intangibles associated with the acquisitions of Fort Myers, which occurred in August of 2005.

After these charges, we reported a net loss of $57 million for the first quarter of fiscal 2007, or $0.91 per fully diluted common share compared to earnings of $81.4 million, or $1.25 per fully diluted common share in last year's first quarter. In addition to the charges related to the Fort Myers operation, we incurred $4.6 million of impairment charges on land owned and $3 million in charges related to write-offs of predevelopment costs on option land during the first quarter.

When we announced our results for the fourth quarter of 2006, we said that if market conditions remained stable and did not decline further in terms of sales pace or pricing in our communities that we did not expect to incur any significant additional land related charges in 2007. However, we also stated that if market conditions continued to deteriorate further in any markets or locations, then we did remain exposed to potentially walking away from other options or additional land impairments. Well, market conditions continued to deteriorate significantly in the Fort Myers market during the first quarter.

As you can see on slide number three, the level of resale listings, the topline, has not continued on its torrid upward trend but is still creeping up, unlike most other markets that have already begun to decline. The lower line on this graph, which shows sales pace, is very concerning in this market today. It has continued to fall during October through January. The graph highlights the timing of our acquisitions, by the way, of Fort Myers, and as you can see, it was at the peak of the market right before the listings started to take off. In fact, we've joked about it, that it looks like it was within about two hours of the technical market peak.

Slide four shows the trend in cancellations for this market. Each month the cancellations continued to get worse and, in fact, for the quarter, we reported negative contracts for our Fort Myers operations. This led us to take further impairments. As I said, we took $42 million of impairments on inventory in Fort Myers. As of January 31, we have about 2,600 lots owned and a remaining inventory balance on those lots after all impairment charges of $47 million or $18,000 per lot.

In addition to the inventory impairment, we wrote off the remaining balance of the definite life intangibles that we carried on our balance sheet related to the acquisition. This balance was approximately $51 million.

If you turn to slide five, we went through the process of the intangible impairment calculation at the end of fiscal 2006, but at that time it did not trigger a charge.

Slide six shows the balance of our definite life intangibles that we have remaining on our balance sheet. As you can see, we are now down to $78 million, roughly where we were back in early 2004. By fiscal year end we expect to be down to about $60 million of remaining definite life intangibles with a normal amortization that's factored into our 2007 projections.

We feel comfortable with the geographic diversity in the balance of our definite life intangibles, as you see on slide number seven. It's quite spread and quite small among several other remaining acquisitions.

To reflect the impairment charges that we took in the first quarter and our current expectations for the remainder of the year, we are adjusting our projections -- slide number eight -- for 2007. We now expect total deliveries to be between 16,000 and 17,200 deliveries including 1,000 to 1,400 deliveries from unconsolidated joint ventures. This should lead to total revenues between $5.1 billion and $5.6 billion. Prior to the effect of the charges related to Fort Myers in the first quarter, this would equate to an earnings per share of between $1.10 to $1.50 per fully diluted share. After the first quarter charges, we expect EPS to be between breakeven and $0.40 per fully diluted common share.

For the second quarter, we expect a net loss of between $0.05 and $0.20 per fully diluted common share. Thus, the first two quarters could net out to breakeven before the effect of the Fort Myers charges and the $1.10 to $1.50 will be earned in the last two quarters with more than half in the final quarter. This is the result of greater volume of deliveries in the last two quarters consistent with prior years, but the effect is amplified during periods of lower volume and profits.

When we add the 3,266 homes we delivered in the first quarter to those in backlog that are scheduled to be delivered in the remainder of 2007, it accounts for approximately 68% of our forecasted deliveries for fiscal 2007. In most of our markets, other than Fort Myers, contract pace and pricing held up fairly well during our first quarter after factoring in seasonality compared to our forth quarter ended October 2006.

As shown on slide nine, excluding our Fort Myers operations, our net contracts for the first quarter were only down 2.3% and our cancellation rate dropped to 29% in the first quarter compared to our cancellation rate of 34% in the fourth quarter. Including our Fort Myers operations, our consolidated contracts for the first quarter were down 23%. For February, the first month in our second fiscal quarter, consolidated contracts were up 2.6% in units and 4.3% in dollars, including Fort Myers, compared with February of 2006.

Turn to slide 10. This is our first positive monthly comparison since the market began to slow down. However, because we had a 13% increase in communities year-over-year on a per community basis, our net contracts for February were down about 10%. Our cancellation rate for the first quarter was 36% including our Fort Myers operations.

If you turn to slide 11, you see that this is up slightly from our forth quarter rate of 2006. When calculated as a percentage of backlog, on slide 12, our cancellation rate decreased to 18% in the first quarter as compared to 20% during the fourth quarter of 2006. Our contract backlog at January 31, excluding joint ventures, was 7,800 homes.

Slide 13, you see that our backlog decreased 33% in dollar value to $2.7 billion.

Now I will talk about what we are seeing in the rest of our markets today, outside of the Fort Myers market. Selling conditions continue to be challenging in many of our markets, but we have seen stabilizing trends in several measurable areas that give us a level of cautious optimism. The true test will be if these signs of stabilization continue through the remainder of the second quarter, which is the bulk of our spring selling season. The phrase that best sums up the current environment is that it's not getting worse and it is slow but steady.

The freefall in pricing, which occurs throughout most of 2006 in the form of increases in incentives and concessions appears to have run its course. In most markets, the stabilization and pricing began in the early part of the first quarter and continued through February. However, our cancellation rates are still at higher than normal levels and we lowered prices in some of our communities in the beginning of the first quarter through additional incentives and concessions in order to maintain the pace of sales that we are targeting for those locations. The result is that our sales pace has shown signs of stabilization. Our contract pace in the first quarter held steady in most of our markets, with a pace we achieved in the fourth quarter of last year adjusted for normal seasonal factors.

While it is difficult to get a good read on contract pace in the seasonally slow period between Thanksgiving and Super Bowl, we are encouraged that the market conditions held up in the first quarter and this trend has continued through February. Pricing has generally stabilized since the reductions early in the quarter. However, those reductions led to lower margins in our backlog and our projected deliveries for later in 2007, so we are lowering our margin projections further in 2007, and Larry will chat about that a bit more in a moment.

Most of our markets have begun to show signs of stabilization, but we are not yet confident that we have found the bottom of the housing slowdown. We are saying instances of reducing our concessions and thus actually improving prices in some locations, only to be offset by other communities where we continue to increase incentives or lower prices. These situations are largely offsetting each other at this stage and the number of communities where prices are falling has been declining. Thus, we feel as if pricing is stabilizing overall.

In most of our locations we are holding prices fairly steady and achieving a steady pace of absorption in line with our budgets. To use a weather analogy, it is no longer a monsoon but it has been downgraded to scattered thundershowers.

As we would expect, in the beginning of the spring selling season, traffic began to improve. For the first four weeks through March 2007, traffic averaged 16 per community per week compared to traffic in our forth quarter, which averaged 14 per community per week. While we have not seen a huge spike in traffic as we begin the spring selling season, we have begun to experience and see its normal seasonal tick-up.

We are optimistic that the housing market will continue to stabilize and then remain in a steady pattern of absorption and pricing. We don't anticipate any quick improvements or upticks in pricing or sales. As shown on slide 14, we saw a steady decrease in the MLS listings through November, which then leveled off in January in markets like the DC market, in markets like Sacramento or Chicago as the sampling of markets that shows on this particular graph. Each of the three markets reported decreased MLS listings for about four months. The trends are cautiously optimistic and give us a little better sense for recovery. Levels are still high but the trends are getting better.

Consumer sentiment plummeted in 2006 to a level indicating that many potential buyers were waiting on the sideline. This indicator continues to improve as well, as you can see on slide number 15 that shows the University of Michigan's index on overall homebuying conditions. This index dipped just a bit in the most recent months, but it is up significantly from September.

Pricing, traffic, MLS listings and consumer confidence are very important data points, and the sense we get from the field is that conditions feel a little better today than in the summer or fall of 2006, when it seemed like we had to increase price incentives or lower our prices on a weekly basis. Again, the market seems to be slow but steady.

Turn to slide 16. Consequently, we are optimistic that the market may be near a bottom or could achieve a bottom sometime soon, perhaps near the sales pace and prices that we are experiencing. When we do find the bottom of this market downturn, we are not anticipating a V-shaped or even a U-shaped recovery; rather we believe the recovery is more likely to first exhibit a prolonged period of stabilization and fairly flat performance before turning up. I visualize this projected pattern of market improvement as being similar to the shape of a boat hull moving from the stern to bow, with the stern representing a recent sudden fall- off in the market and the bow representing the ultimate recovery with a more gradual smoother shape after a flat period in between.

What we don't know is whether the boat is an 18 foot whaler or a longer seagoing yacht. Regardless, the period of stabilization that we are currently feeling is much preferred to the period of falling home prices and slowing absorption pace that we experienced in most markets in 2006. Once it is clear that the market is not recovering rapidly, we are optimistic that land sellers will more fully adjust prices and we expect to be in a position to tie up new parcels of land.

Typically, land seller's behavior lags the market index by about six months to a year. Today, land sellers have lowered their asking price but not significantly enough to fully reflect the decline in conditions for selling homes; thus very few deals meet our return targets. As a result, our controlled land position -- if you turn to slide 17 -- has shrunk for the third quarter in a row. We ended the January quarter with 91,158 total lots controlled and optioned. Approximately 63% of those are controlled through options.

The total amount of lots controlled represents a 24% decline from the end of the first quarter of 2006. However, as you can see on the chart, the number of lots that we own has not been coming down as rapidly as the number of communities open for sale has been increasing. Although our total lots controlled declined 3.7% in the first quarter, the number of lots owned remained virtually unchanged. Together with the normal seasonal construction of homes in backlog, this led to an increase of about 2% in the total book value of inventories during the three-month period.

Slide 18 shows our aggregated option position or all of our lot options in the aggregate, the amount of deposits represents 9.5% of the average of the total lot purchases as of the end of January. During this period of stabilization we would anticipate the use of concessions and incentives to begin abating and cancellation rates to gradually improve.

With prices stabilizing, consumers will begin to lose their fear of the housing market sliding and will abandon the mindset that a lower price on a given home will be available in a couple of weeks or months. This should be evident in continued improvement in consumer confidence, particularly with respect to whether now is a good time to buy a home, and should lead to improved traffic at our communities, ultimately yielding positive net contract results. However, in each market we need to see higher levels of resell listings start to clear in a meaningful way to alleviate the current excess supply of homes available in the market. Although we are encouraged by current positive trends other than the normal seasonal pattern, we are not projecting any improvement in either our sales prices or pace in any of our communities.

I will now turn it over to Larry to discuss the financial performance for the first quarter and our guidance in greater detail.

Thank you, Ara. I'll walk through some specifics from the first quarter as well as provide you with more detail on our current projections for fiscal 2007. Our first quarter results are summarized on slide 19. One unusual aspect that I need to clarify is our effective tax rate for the quarter. Because of certain nuances of the charges and impairments related to Fort Myers, which were not all fully deductible for tax purposes, our effective tax rate during the first quarter was only 18%. Obviously, if our tax rate had been higher we would have reported a smaller loss.

For the balance of fiscal 2007, we expect our effective tax rate to be approximately 38% gross margins. The incentives and concessions we have offered have driven our margins to below normal levels, as shown on slide 20 which displays our homebuilding gross margins on a quarterly basis for the past several years. Homebuilding gross margins were 18% for the first quarter excluding interest, down 240 basis points sequentially from last year's fourth quarter and down 760 basis points [for] the first quarter of 2006.

Based on the homes that we plan to deliver [for] the remainder of 2007, we are projecting that our homebuilding gross margins, excluding interest, for the full-year in 2007 will be in the range of 17% to 17.5%, a further decline from the gross margin of 18% that we achieved in the first quarter.

While of our sales prices generally stabilized during the first quarter in most of our markets, we are lowering our projections for gross margins for the year about 100 basis points from our prior guidance. This is partially due to the decline in our projected price and margins in Fort Myers going forward. The decline in our projected gross margins is also attributable to additional incentives and discounts we have implemented in many of our community locations in order to achieve the stabilized pace of sales that we're now experiencing in those locations. Such pricing was generally in place early in our first quarter, but was not fully reflected in our prior projections, which were based on community level budgets pulled together prior to the end of our fiscal 2006 year.

As shown on slide 21, our projected gross margin for 2007 represents a decline of 560 to 610 basis points from our 2006 full-year gross margin. For the past several years through the end of 2005, our gross margin has been higher than normalized margins, which we estimate to be somewhere between 20% to 22%. The above normal margins were the result of significant price increases that we experienced in many of our markets over that period. We continue to renegotiate with our subcontractors on their cost and we're seeing varying degrees of success across all our markets. We expect between 5% to 8% of saving adjustments to our labor cost, the majority of which have already been negotiated and are included in our projections. These cost savings help to partially offset some of the margin pressure we're seeing in 2007.

SG&A. As we opened more communities throughout the quarter, we experienced an uptick in total SG&A as a percentage of total revenue, which was 13.3% for the first quarter versus 12.8% in last year's first quarter. In addition to expected relief from subcontractors, we have made headcount reductions of about 20% over the past three quarters. This percentage varies significantly by market depending on how much our sales pace has slowed. As market conditions dictate, we will continue to take appropriate steps to rightsize our organization.

We expect to see our total SG&A ratio increase again in 2007 in the range of 11.6% to 12.2% due primarily to challenges related to reducing overheads as rapidly as revenues are falling in 2007. Although many of our overhead costs are variable, some amount of advertising, selling and general administrative cost are fixed and we must continue to effectively staff the increased number of communities that we now have open for sale, despite the lower volume of activity per community.

2007 projections. The gross margin in SG&A projections are shown on slide 22, which also provides additional details that were factored into the revised breakeven to $0.40 EPS range that we're giving as our projection for fiscal 2007. The details of our summary projection for fiscal 2007 are also available on the financial information page of the Investor Relations section of our website at www.khov.com.

We anticipate that the average sales (technical difficulty) excluding unconsolidated joint ventures, will be between $331,000 and $346,000 in fiscal 2007, compared to $348,000 in the first quarter of fiscal 2007, and $329,000 for all of fiscal 2006. The year-over-year expected increase in average sales price in our markets is primarily the result of geographic and product mix of our deliveries rather than inability to increase home prices. This price range also takes into effect incentives offered on contracts in backlog and currently being offered for the homes we anticipate selling and delivering in 2007.

For fiscal 2007, we are also projecting total pretax land sale profits to be approximately $5 million compared to the $45 million of pretax profits from land sales in fiscal 2006.

I will now provide some additional clarification of our land related charges in the first quarter. Ara already commented on the $42 million land impairments that we took in Fort Myers operations and the $7.6 million of total land related charges in our other markets. These charges were offset by approximately $8 million of reversals of prior land charges. This reversal was the result of two deposits on land contracts that we walked away from in the fourth quarter. Portions of these two deposits were returned to us in the first quarter. As a result, the total amount of the line item on our income statement for inventory impairment loss and land option write-offs is equal to $41 million for the quarter, roughly matching the total impairments from Fort Myers.

As long as market conditions remain relatively stable and do not decline further in terms of sales pace and pricing in our communities, then we do not expect to incur material amounts of additional land related charges during fiscal 2007. Thus, we've not included any amount of such charges in our projections for the balance of fiscal 2007. However, if market conditions deteriorate further in certain markets or locations, then we may need to potentially walk away from other land options or incur additional land impairment charges. And even with current conditions holding up, I would not be surprised to see a small amount of impairment walkaway charges related to the nuances of specific community situations over the remainder of the year.

Joint ventures. For the first quarter we reported pretax income of $2 million from unconsolidated joint ventures, a decrease of 74% from the first quarter of fiscal 2006, primarily as a result of the wind-down of a couple of our joint ventures on individual communities along with the continued wind-down and thus, fall-off in deliveries and profits in our Hovstone joint venture with Blackstone.

Our investment and unconsolidated joint ventures increased modestly year-over-year to $206.2 million as of January 31, 2007 from $196.3 million at the end of last year's first quarter. We report significant details on the balance sheet, profits, debt structure and leverage levels of our joint ventures each quarter in our 10-Qs and 10-K. We are currently projecting total pretax income from unconsolidated joint ventures to be greater than $25 million in fiscal 2007 versus $15 million that we reported in fiscal 2006. While our joint venture with Blackstone continues to wind down, we have one midrise development in a joint venture where there are significant deliveries projected for our fourth quarter when the building is anticipated to be completed. Any slippage of the delivery of the midrise building into the first quarter of 2008 will negatively impact our 2007 earnings from joint ventures.

Now I will update you on financial services operations which continue to add to our overall earnings. If you will turn to slide number 23, our pretax earnings from financial services increased 48%, $8.5 million for the first quarter of 2007, compared to pretax earnings in the prior year's first quarter of $5.7 million. For fiscal 2007, we expect pretax earnings from financial services to be greater than $25 million.

Turning to slide 24. Our recent data indicates that our customers' credit quality remains very healthy. We experienced higher FICO scores in the first quarter of 2007 compared with last year, and we continued to see a declining use of adjustable-rate mortgages at 27% of our originations in the first quarter versus 32% for the full- year in fiscal 2006.

The subprime mortgage market has been in the news quite a bit lately. Due to the numerous questions we have been receiving recently on this topic, I will comment on how many of our customers chose to use these types of loans in the past.

Turning to slide 25, during fiscal 2006, our wholly-owned mortgage subsidiary originated and closed 8% of their volume and subprime loans. In addition, our mortgage company brokered another 10% of their volume in subprime loans to third-party mortgage lenders during 2006. Year- to-date fiscal 2007, our use of subprime products have declined to 6% originated in closed and an additional 8% brokered.

During prior down cycles in our industry, it was not uncommon to see mortgage underwriting criteria type. We are seeing that pattern repeat itself in this cycle. While we do not know the precise impact of tighter mortgage underwriting criteria, it is safe to say that the overall pool of qualified customers has shrunk.

I will now turn back to our balance sheet and credit statistics. For the first quarter, we generated adjusted EBITDA of over -- of $70 million; on a trailing 12 month basis, our adjusted EBITDA of $652 million, which covered interest 3.6 times. Due to the slowing velocity of deliveries in each of our open communities, our inventory turnover, and thus interest coverage, is declining in 2007. However, as we begin to bring our level of inventory investment into alignment with our lower revenues and profits, we expect coverage to stabilize and start to tick upward again.

For the full-year we are expecting EBITDA coverage to remain above two times and the ratio of total debt to EBITDA is expected to remain below six times as of the end of fiscal 2007. Adjusted EBITDA represents earnings before interest expense, income taxes, depreciation, amortization and land charges. A reconciliation of our Company's consolidated adjusted EBITDA to net income can be found as an attachment to our quarterly earnings release.

We ended the quarter with $225.7 million outstanding on our $1.5 billion unsecured revolving credit facility. The ratio of net recourse debt to capitalization as of January 31, 2007 was 54.8%. As we expected, our inventories grew 2% in the first quarter. We also expect inventories to grow modestly in the second quarter as we invest in new communities and associated land development and home construction. While we expect to be cash flow positive in our fourth quarter, we may not be cash flow positive for the full year due to our community cap growth in fiscal 2007.

We anticipate that our average ratio of net recourse debt to capitalization for the full-year of 2007 will be slightly in excess of our target of 50%. For the second quarter in a row we've brought down the number of spec homes per community slightly, as you can say on slide 26. This number of spec homes represents about a 2.2 month supply of started and completed and sold homes based on our February sales pace. This is a manageable level of spec inventories and is substantially lower than the industry average of 5.7 months supply of started and completed unsold homes.

At January 31, 2007, common stockholders equity was $1.7 billion or $28.22 per share. During the first quarter of 2007, we repurchased 200,000 shares. We anticipate continuing to repurchase shares but only at a measured pace, which more or less offsets the shares that are issued either through options or stock plans that many of our senior executives participate in. Although we believe our stock remains undervalued, we intend to maintain only the current pace of share repurchases at this time.

I will now turn it back to Ara for some closing comments.

I want to reiterate that we are not being overly optimistic in calling for a recovery. What we are talking about here is finding a bottom. The initial data that we have regarding the first four weeks of our spring selling season combined with the market data are showing some positive trends that we may be getting close to a bottom. Again, we also don't expect a quick recovery. We expect to remain in a range near the bottom for a bit.

Before I turn it over to questions, let may walk through a quick list of some of the markets that are relatively stronger or weaker than others. In terms of bad markets for us, the Fort Myers market is definitely our worst market today. It is followed closely by our operations on the East Coast of Florida in the greater West Palm Beach market. Our Southern California markets are still struggling, with some locations better than others, and most locations seeming to have at least found some price stabilization.

Houston and Dallas continue to hold up better than other markets and until recently we would have put North Carolina in that category, but they have generally gotten a little softer over the past couple of months. While the North Carolina markets are still doing relatively well, they continue to be highly competitive at all times.

We are seeing increasing strength in the DC market on both sides but particularly in Virginia, as well as certain locations in New Jersey. In these markets we are actually performing reasonably well and we are happy with the direction of the sales pace and pricing right now.

What we are looking for is stability in both pricing and absorptions. We have just started the selling season but I can say that the stabilizing trends experienced during our first quarter have remained fairly steady through the month of February. With the dollar value of net contracts up 4.3% in February, things are feeling a little better today than they did in mid to late 2006. I'm hoping we might be there right now but we will see over the next couple of months how this plays out.

Obviously every market is a little different. We're maintaining a conservative strategy in today's market given the uncertainties, but there are a couple of macroeconomic conditions that give me a little more comfort and confidence. To the point, we are at a very unusual time for a housing slowdown because we have a positive economic and low interest rates. By historical standards, these factors should work in our favor.

This concludes our formal comments and I will be pleased to open up the floor for questions.

(OPERATOR INSTRUCTIONS). Dave Goldberg, UBS.

This is actually Dave Goldberg on for Margaret. I was wondering if you could give us some more details on the communities that are going to open by the end of the year and where they are going to be and maybe the average tenure of how long you've controlled the land that's making up these communities?

We really don't have the new communities broken down by market at our fingertips. But I can tell you -- and obviously based -- your question regarding the tenure is trying to figure out what the margins or prices would look like. We have tried to incorporate our best guess and analysis as to what the margin and sales pace of those communities might be, and they're already baked into our projections.

Basically as we reviewed all of our options, we made what we refer to as go/no-go decisions. Based on the financial returns on those properties on a go-forward basis, we treated the existing cost as some cost and said okay, does the property make economic sense and satisfactory returns on a go-forward basis? Those that did not, we walked from and most of that occurred in the fourth quarter; and those that did, we're going forward with them. However, while it may make sense on a go-forward basis, if you go back and do include the subcost, the margins are obviously not what we would like and hence, that's part of the reason we're projecting a little more margin decline for this year.

Were you able to change the product offering in those communities at all? Maybe in smaller homes?

In many of them, we did. Typically we either reduced the specifications in our homes, reduced what we did as standard flooring or cabinets or appliances or other cases, we actually introduced new lower-priced smaller or more cost-efficient homes. In some cases that was practical; in other cases we were too far along and by the time you built models and went through the additional expenses it might not have made sense.

And then as a follow-up, I wonder if you could give more details on the reversal on the prior deposits you had expensed on the option deposits? I guess, do you have any other deposits that you think there might be reversals on in the future? What were the circumstances behind that?

No, we really don't. Those were a couple of very unusual situations to where there was a dispute on whether or not the deposit was refundable or not. We took it to arbitration and we ended up winning partial refunds in arbitration.

But there is not really any other cases like that outstanding?

Not that I know of.

We don't anticipate it.

Carl Reichardt, Wachovia Securities.

I'm not sure if I saw this in the release or not, what was your penetration rate for the mortgage company in Q1 and if you have it for last year?

I think both quarters, both last year and this quarter were roughly 70%.

So the 18% total originated and brokered is on the 70, so there's still 30 out there that could be also [prime] but probably aren't. The next technical question is just on the tax rate, is it a function of the write-off of the intangibles that creates the tax rate issue? Can you just give me a little more detail on that? And does that mean that assuming you have finished that obviously in Fort Myers, you don't have any more of your tax rate in Q2, even on the loss should be more normal?

That is correct. The intangible that we ended up putting on our books from the acquisition had to do with the fact that the seller had booked the lot sales for tax purposes already and it paid the taxes on those. But for GAAP purposes those profits should not have been recognized. As a result of putting that on their books, it was totally a GAAP adjustment, therefore as that intangible amortized from that GAAP entry, it was not deductible. Amortizing it over eight to ten years, it had a minimal effect on our effective tax rate as a permanent difference. Writing it off all at once had a substantial effect on our effective tax rate because the vast majority of the intangible write- off was a permanent difference for tax purposes.

Okay, that makes sense. I appreciate that. Thanks so much, guys.

Michael Rehaut, JPMorgan.

On the subprime also, I guess just following up with Carl, first just to understand the originated at the 6% and the brokered at 8%. That is, you kind of blend that together and get a feel for what your own capture rate, the mortgage that falls under your own capture rate. How do you think about the 30% that is not in that capture rate? I mean is that safe to assume that's a higher portion of subprime?

The real answer is we don't know for sure but it wouldn't surprise us if that 30% was more highly weighted towards subprime than our 70% was, but it's just a guess. We just don't keep that data. And the overall market's use of subprime, I have seen statistics around 20%, so my belief is that our use of subprime is not unlike the overall market [as] my expectation for what most people's use of it is. If you would have asked me two weeks ago, frankly we hadn't really focused on this a great deal and we would have been working under the premise that we were 5, 6, 7% use of subprime. But once we actually did the analysis and got the data put together, we're telling you what our mortgage company originated. We just don't know for sure what happened on that 30%. But I think it is a safe bet that it is slightly higher.

Appreciate that. Just obviously this has been unfolding very quickly over the last three, four months and continuing in terms of the turning off the spigot of credit in particular. Have you seen in some of your markets that have -- maybe two parts to this and then I will get back in the queue -- but which of your markets that you have seen higher levels of subprime, and in those markets over the last two, three months have you seen any particular changes in demand in those markets as the subprime financing has shrunk?

I think California has always been a user of the most exotic mortgages that you can find including the subprime. So of our 14% year-to-date, probably a disproportionate percentage of that in California because of the affordability factor. As we've increased incentives, lowered prices, affordability is coming into line a little bit better, but it is going to shrink the number of qualified customers in all of our markets, including in California. There is going to be some impact. I just don't know how to quantify it.

It is important to note that number one, I think we're at about 72% of our buyers are using plain vanilla fixed-rate mortgages, much more so than before; even just normal adjustables are much lower in usage given the rates. But the other thing that is important to note is that the subprime mortgage market has not gone away. They have just tightened the criteria. That clearly does shrink the pool of potential qualifying buyers, but that market has not gone away. Other questions?

Stephen Kim, Citigroup.

I was wondering if I could get a little clarity on the specific dollar amount that was written off in terms of the definite life intangibles this quarter and maybe if there was any in previous quarters?

I mean in the definite life intangible, was $51 million this quarter.

Could I get a couple of decimals on that?

Excuse me?

Can we get any more decimals on that?

Do you mean more precision than $51 million?

Yes.

Give us a few minutes.

Yes, if you can just come back to that, that will be great. The second question I had, in your guidance for the margins over the course of this year, what I'm trying to get a sense for what's embedded in that. First of all, I thought you had made some sort of an offhand remark about not being surprised if you needed to take additional write-offs and so forth. Would that comment be -- let's say you did take some additional write-offs. Would that be embedded in -- any portion of that embedded in your 17 to 70 math?

No, our assumption is that the market is stable and we won't take any more write-offs. What I said was in spite of that, there may be a community here or a community there, nothing on a material basis but it just wouldn't surprise us if there were some. We just didn't (indiscernible) in any of our projections.

The combination, intangible write-off and intangible amortization for Fort Myers for the first quarter -- so this is the amortization we had taken for November, December, January and then the write-off as of January 31, was $54,439,000. This is the first time we've ever written off an intangible associated with an acquisition, the definite life intangible associated with an acquisition that we made.

Of any material amount.

Of any material amount, any way. (multiple speakers). That number okay?

Yes, that's great. Thanks.

And the 54 obviously differs from the 51 in that we had had one quarter of normal amortization we were doing anyway.

Yes, no, I figured.

(OPERATOR INSTRUCTIONS).

Steve, we didn't tell her to say that.

Dan Oppenheim, Banc of America Securities.

Was wondering if you can talk about the order trends in February. Looking at your early slide on the Fort Myers market you showed a lot of cancellations there in December and January. How much of that then ended up being orders coming into February where you were discounting those homes to sell those? And what do you think the order trends would have been in February without that, if that did impact it?

I would say that February -- net contracts in February was an immaterial amount in Fort Myers. I mean they were positive but single digit, maybe double-digits in terms of absolute numbers. So very, very few net contracts in Fort Myers in February.

It happened to be a month where we cleaned out a lot of deposits in Fort Myers, so not a meaningful comparison date.

And then just one other question. I'm wondering about your outlook for some of the markets where your seeing signs of stabilization. As you see inventory coming down a bit, clearly some of that is seasonal. How do you look at that where we are seeing sales continue to fall but inventory falling? Is that a sign that sellers of homes are just not optimistic about selling it right now and do you have some concerns that we'll have more inventory coming to market once people do get a sense that there is stabilization out there?

Well, that is clearly a big question that no one knows the answer to. It is important to note that while we are seeing the level of listings are coming down, they're still way above the normal levels. So there is still a lot of oversupply in the markets.

As it comes down and prices stabilize, will other buyers say, okay, I'm going to list now? That certainly could happen. So it is definitely not yet time to break open the Champagne bottles.

Robert Manowitz, UBS.

I was wondering if you could talk a little bit more specifically about the book value of your inventory through the remainder of 2007, the peak level and how you envision year end?

In terms of inventories?

Yes.

I think inventories at year-end are going to be not materially changed versus the end of last year. So it is going to peak up on a normal seasonal basis. Our inventories typically probably peak in July and then fall off quite a bit in the fourth quarter.

And then as a follow-up to that and I'll play around after the call with the math on those comments, but could you help me understand the magnitude of that cash flow deficit for 2007?

I don't think it's going to be huge. We were hoping that it would be positive and it might still be a little bit positive. I'm just not as confident that it will be.

The fourth quarter itself will be very cash flow positive but as we mentioned and as Larry mentioned, we are growing our community count. I will emphasize this is not something we're doing now that the market is slow to try to counter that. We put a lot of those decisions into motion back in 2005. And if it continues to make economic sense on a go-forward basis as I said, we are proceeding with those investments.

In retrospect, obviously I wish we weren't quite as aggressive in 2005 for organic growth, but we are where we are and the investments do make economic sense on a go- forward basis. And that's part of the reason our inventories are not shrinking and we're not generating the surplus cash. Obviously, if the markets really deteriorated, we certainly have the ability to not go forward with option exercises, and then we would be generating more cash. At this point, those investments are warranted.

If it's all right I would like to sneak one last question in. That is that historically you guys have been a fairly large user of third-party capital in controlling land, and I was wondering if you could speak I guess somewhat generically to your understanding of the financial position of some of those partners and how they are faring? And I guess most importantly, how do you envision the cost of that type of capital evolving over the next two to three years?

Just to clarify your question, you're talking about on our existing joint ventures?

Yes, joint ventures and I imagine some of the off-balance sheet capital is directly with land bankers.

Okay, yes. We use options in general as a strategy. As you know, we have about 63% of our total lot control through options. Really I think we have about maybe a dozen, a dozen and a half properties out of 400 some odd that we could not get the seller to option them and therefore we went out and found a financial institution to option that for us. We have gone back in several cases and walked away from some of those options. And more often in those cases we have renegotiated with them. At this point we don't see any financial health issues with those [optionors]. They are usually representing significant institutions and have a pretty decent capital base.

With respect to using them on a go-forward basis, it would be our expectation that as land sellers adjust today to today's economic realities of a lower sales price and a lower sales pace that we have already seen them kind of loosen up the terms rather than wanting all-cash because there is bidding frenzies for every property. They've just not loosened up the terms and lowered the prices enough to make it attractive now. But my full expectations would be that there would be even less of a need going forward to use what you would call traditional land bankers as we find new deals just because I think the land sellers will adjust to be giving us -- take down 20% of it upon approval and then six months later take down another 20% so that it just takes less capital and no longer be demanding all-cash upon approval. So, I just think there's going to be less pressure on builders overall to try to go to land bankers.

And on the cost of that capital through the land bankers, is that yet heading higher? Or is it too early to tell?

Well, we've really not been renegotiating or trying to get new deals with them. Kevin, I don't know whether you have any feel for that.

I don't think we have had a sense that they are going to adjust pricing. I think it is a question of availability and we also haven't heard that they're completely out of the market although they are clearly dealing with their current portfolios now more than they are [doing the business].

Alex Barron, JMP Securities.

I need to ask about how many communities you guys impaired this quarter as well as how many lot options you walked away from?

We impaired three communities. The expenses regarding the option walkaways really were the predevelopment expenses. I think the option deposits were refundable at that stage but we had dollars expended in analyzing and researching the properties. And that is what was expensed.

And those three are all Fort Myers?

No, outside of Fort Myers.

Okay, how many were in Fort Myers?

Fort Myers we owned it so we impaired it but it really isn't a community because they're scattered lots. But the impairment we took in Fort Myers was on owned lots, they just weren't divided into communities so I can't answer the question with an answer of a community.

Right, sorry about that. And these three were in what markets?

I think they were primarily in Minnesota and New Jersey.

My second question here has to deal with again financing a little bit. I guess how would you break down -- what is your CLTV for the quarter and then what percentage of the loans are 80/20's, option arms, no dock/low dock, those kind of stuff?

We don't have all that data at our fingertips. We gave you -- what was it, 77% loan to value. That wasn't the combined loan to value (multiple speakers). The combined loan to value is probably in the mid-80s. (multiple speakers) so that is where the combined is. We don't break out the statistics and certainly don't have it anywhere in this room to give you how much we do of each one of the different kinds of loans, though, as more and more interest is there, we might begin to try to accumulate that data as well.

And as far as your guidance for next quarter, can you give me some break down like units, I guess margin. Are you implying any write-downs? I'm just trying to get to the $0.05 to $0.20 loss where you guys are getting that from.

Well, you know, I've given you as much guidance as we can give you. I mean our website has the full-year. We have told you that we're not going to make money. You can back into the numbers you want to back into.

Dennis McGill, Credit Suisse.

Just a question on the cash flow, Larry. Can you give us a sense of in 2006 and then your expectations for 2007 how much you've spent or are expecting to spend on the acquisition of land versus the development?

We just don't have that breakdown. That's not something we normally track.

Do you have the total spend?

Nobody sitting around this table is saying yes, so it's not something -- and we really track change in inventories, frankly, and project change in inventories. We don't break it down further than that.

To do that wouldn't you have to have the piece of how much you are acquiring?

No, we don't break down land acquisition. What we do, every single community does a projection for what its inventory will be by quarter. Sometimes the inventory growth is by land development, sometimes it is because we have got a big slew of homes under production, sometimes it is payment in fees, sometimes it's taking down more land. We do not analyze what part of that is in each of those components. What we do is we track every single community for the total capital that is laid out and we look at it that way.

I will mention that our incentive programs are based on return on investment for our divisions, so they are wary and try to focus on not spending more than they have to either on land or land development or fees, et cetera, and they try and monitor it tightly.

I look at it a different way than I would guess work in progress is coming down, particularly with spec coming down and with inventories up year-over-year, I guess that you would expect to be spending more on acquisition and development than you're selling through (technical difficulty) --

I think the real answer is because we are increasing our community count, therefore it is partially on land for those communities, models for those communities and work in process for those incremental new communities.

And putting land development in place.

Yes, land development. That's what's driving it.

Separate question. The average delivery price in the West seemed a little high relative to prior quarters and prior (indiscernible) versus the order rate. Is there something unique about the first quarter or is that the run-rate we should expect for the rest of the year?

I think the coastal area in Southern California might have had a higher proportion and they tend to have a higher average price.

I don't think I would imply that for the full-year.

Susan Berliner, Bear Stearns.

Can you give some details I guess on your incentives? Was that a lot of focus in the financial services business?

I'm not sure I understand.

What do you mean by --?

Well, I guess in terms of providing incentives or giving someone instead of a reduction in price any sort of benefit in the financial services business?

Not primarily. Oftentimes we will include any closing costs. Oftentimes we will tie an incentive to the mortgage company, but generally speaking the incentives have been more in upgrades and options that we provide at a better value or just an outright reduction of the purchase price.

Okay, that's helpful. And I'm sorry to beat this again on the subprime, I guess if the overall market is about 13% subprime based on originations, if things are going to be pulling back, at least for the short-term, what kind of impact overall? Is that a few percentage? Could it be higher? Any sort of additional outlook would be great.

We don't know how to quantify it. I mean some people, I mean clearly, as Ara mentioned, the subprime market's not going away, so the subprime market is going to get tighter by 5%, 25%, you know use what ever number you like and multiply that times our percentages and that is the impact. Now some of those people we can still qualify on some basis but it just shrinks the (indiscernible).

And then my last question, just following up on that on subprime, it seems with the added detail you guys are giving that your subprime exposure is higher, but with your product diversification than some of your peers, it seems rather unlikely. So is it apples to grapefruit comparisons? Or what's going on?

We don't necessarily think ours is higher than anybody else. We have just, frankly, it's nothing that we ever tracked before. It was never a big issue and as Larry mentioned, if you asked us a couple of weeks ago, we would have guessed it was a few percent, but we read the papers as well as everyone else and it's something that we're now focused on, and as we dove deeper, we got more of the data points that we shared with everyone today.

I mean it is possible that someone else is defining subprime differently than we define it. There's not a definition that is precise with respect to what a subprime loan is, but we went back and used credit scores between X and Y at different loan amounts and did the research that way. I'm not sure everybody else can track it in the same fashion that we do -- or did, but I just don't believe in my heart that we're a disproportionate higher user of subprime.

Now I would say that geographically someone that did not have a California operation, their subprime is going to be lower than ours, because California is a higher user of the subprime market. So there is specific geographies that are disproportionate users of subprime. I don't think that we are weighted dramatically towards that vis-a-vis our peers either, but who knows?

Steve Fockens, Lehman Brothers.

Just one question. Recognizing maybe that your timing wasn't as great as you would like on the Fort Myers acquisition, have you gone --

That's an understatement.

And I appreciate your honesty on that. Have you gone back and looked at that deal and found any factors, either in the marketplace or in the Company itself that with hindsight would have prevented you from doing the deal, and any plan to use that factor or look at that factor when you consider future deals?

Yes, I mean one of the things we do note is as we look back, there was a period of almost a year where resale listings equaled monthly sales. What that should have told us is hey, you have a market which is out of balance and overheated. And we should not have done our analysis based on that condition. But we had been eyeing that market and frankly, talking to this company for many, many months, and it continued and continued and continued, and finally we negotiated a transaction and of course, as it turns out in hindsight, it was just as it was about to end. But I'd say that's probably one thing we would really focus on a little bit more, that we never used to track.

And frankly, even if we're not making company acquisitions, we think that MLS data is something on our organic operations to track meticulously every month as well, that gives you a hint as to whether the market is getting better, getting worse. It might be a leading indicator. It is kind of a thesis we have at this point but clearly if supply and demand gets out of balance on used homes, it has a repercussion on new homes too.

So you would plan to use that kind of analysis more so than in the past?

Well, we didn't use it at all in the past.

Lee Brading, Wachovia Securities.

Thanks for the detail and going by the markets. I was wondering if I could drill down a little bit more in the mid-Atlantic from the order trends there that we saw this past quarter -- up 22%, average sales price down 16%. I was wondering what drove the growth. Was it incentive side or community count growth or if you're using positive comps in that market?

Well, in general we're saying a little more strength in that market. In Virginia, in particular, I guess they were -- Virginia was one of the first markets to slow down so it seems to be one of the first markets that hit the bottom. I don't want to get overly optimistic and use the recovery word, but that market is showing a little sign in recovery.

We are being aggressive in terms of the incentives that we need to do to keep product moving there. But on the whole, we have been much more pleased. It is one of our better performing areas today.

Absorption in the DC market really have exceeded our kind of own internal budgets in recent months. They certainly don't have pricing power to increase prices, but at the level that they are pricing now we have gotten a little more pace than we expect.

I would like to say it's just us; we're so brilliant, but I think that market in general is getting a little stronger.

That's helpful. Also I wanted to follow up on the free cash flow comment. Another way to look at it, should we expect debt levels by the end of the year to approach debt levels where you ended your fiscal 2006 year?

We don't anticipate a lot of change in debt levels during the year, just some minor fluctuations up and down. We do think our leverage should go down by the end of the year by the fact that we will make some equity in the following quarters and it will bring the ratio down in that way. And, again as we mentioned, the big burst in earnings is really going to go at the very tail end of the year in the fourth quarter.

(OPERATOR INSTRUCTIONS). [Joel Locker], SBM Securities.

I just wanted to get your take on the interest percentage of the homebuilding revenues. I see it's 3.1% as a projection of total interest but do you expect it to stay around the 2.4% range that was reported in the first quarter?

Yes.

So right around that? Also, how much total deposit dollars do you have from your customers on the --?

Customer deposits?

Yes.

Hold on. We will look that up.

I want to say about $140 million (multiple speakers)

$142 million, $143 million, something like that.

Hold on we will get the exact number. (multiple speakers) $143 million.

$143 million. And just on the trajectory of your debt to capital ratio, I mean how would you expect -- if you're modeling it out, how would you expect it to play out like at the end of the second and third and fourth quarters?

We gave you a pretty good hint that we're going to be a little bit above our target of 50%. We're above that right now. So I don't expect it to materially -- it's not going to be above roughly where it was in the end of January and then should come down a little bit by year end.

Stephen Kim, Citigroup.

Earlier in your presentation, Ara, I think you made two comments that I just wanted to follow-up on. One -- actually maybe this one was from Larry but -- you had talked about deliveries and I think that you had given numbers to try to help us triangulate it on what you thought deliveries might be for the second quarter. But I think I may have misheard you, so I was just wondering if you could sort of give us an idea of what we should look for in terms of closings for Q2?

We really didn't give any guidance on that.

I thought you said like first-half or something like that you would expect a certain percentage of your (multiple speakers) closings.

Here's what we said, is that the earnings were going to be negative in the second quarter and that therefore all the earnings were going to happen in the second half of the year, and more than half of the earnings in the second half of the year will be in the fourth quarter. So we said, weighted towards the fourth quarter.

Okay, so you were talking about earnings in other words you are saying, not the --? No, there was some comment you made, I thought, about closings. You had said a certain percentage of your deliveries like 28%, 38% or something like that in the first-half. I thought that you had said something like that. No?

I don't think so.

Okay, well, if you didn't, maybe I just completely misheard it. That's fine. That is certainly possible.

We will have to replay the webcast later.

All right, well, that's okay. No, I mean it's, that's fine. The second question I had related to, Ara, a comment you made about the longer-term gross margin. I believe you made a comment about something around 22% that you sort of felt was the long-term, sort of normal --?

What I said, that's the more normalized gross margin. Obviously we were above that for a good many years, 24, 25, and we're well below that right now. But I would say that's a more normalized. I will caution you, though, by saying we are IRR focused and sometimes we get that, as you know, with a lower margin and high turnover like buying developed lots on an option basis. Sometimes we get it through high margin, low turnover like when we have to develop our own parcels in land and larger parcels. So it is a mix. We don't focus specifically on gross margins.

And that is obviously a welcome change from let's say, 10 or 15 years ago as we covered at our conference. I guess I just wanted to sort of revisit, though, given what does matter, what do you think the normalized return on equity or the return on capital is?

I would say somewhere in the mid-20s on an after-tax return on equity with our debt targets of 50% debt to cap or slightly less. I mean, it should work backwards to at least that kind of level. I mean we underwrite specific communities to a 30% unlevered IRR. The only thing that doesn't include is an allocation for corporate overhead. But all of the other overhead and frankly, there is far more overhead in the divisions than there is at the corporate level, but if you took all those 30% IRR's and we [hid] them, we'd be slightly above the mid 20% for an after-tax ROE.

So you're basically basing that long-term sort of conversation about where normalized margins are with an assumption that eventually you will have the majority of your projects hit the intended IRR at the time of feasibility, basically?

Yes. You know we have been in excess of our IRR target for the last few years and obviously it's reversed [it], we're well under right now, but we'd expected our normal bases to be able to achieve our pro forma IRR.

And the move to adopt this IRR focus as you said sort of the genesis of that was somewhere around 96, 97, correct?

Right.

Alex Barron, JMP Securities.

I wanted to ask about SG&A. I guess in dollars it was kind of flat this quarter. So I wanted to understand how much in the way of headcount have you guys already done reduction? And I guess how should I think about SG&A going forward?

I don't know whether you maybe missed part of the presentation but in my part I said that we have already reduced headcounts in the past three quarters by 20%.

Okay, sorry, Larry.

What we're going to do going forward is as particular markets experience slower sales, we'll obviously rightsize the organizations market by market, and if they have great sales we won't have to make adjustments. So it is a market by market kind of decision.

Got it. In terms of your covenant's interest coverage leverage, what are those ratios?

Well, our revolving credit agreement does include a debt services coverage test. However, it only applies if our leverage ratio is substantially higher than where it is today, we don't anticipating allowing that leverage ratio to reach that level. However, we recognize that we need to increase cash flow, decrease debt levels during this period of a slower housing market to just provide an even bigger cushion. But right now with respect to our revolving credit facility, we are in fine shape.

But what is that ratio?

You're not going to be able to calculate it because it's adjusted debt levels and adjusted tangible net worth divided by adjusted debt. But just trust me, it's substantially higher than where it is today.

If things don't pick up in terms of sales pace, are you anticipating you're going to have to cut prices some in some regions, or how are you thinking about what is --?

We don't need prices -- I mean sales pace to pick up. We just want them to stay stable. And based on the last few weeks, it seems like they are stable. If sales pace drops, then absolutely, we would likely adjust our thinking by reducing prices further or adding concessions, and then we would reevaluate land options again, remaining land options. All of our discussions are really assuming that the most recent market environment continues. It doesn't get better and it doesn't get worse, and all of our projections assume flatness in the price and flatness in the pace.

And frankly, Alex, since the beginning of our -- since early in our first quarter, which began in November, at the very beginning of the quarter we did offer some additional incentives and concessions, but since that time we have really not had to -- other than a community here and there, we have not had to increase incentives and concessions. We have already kind of been feeling some stability for a number of months now in the aggregate across the country. I mean obviously there are some exceptions to that here and there but that's how it feels on average.

Great, but assuming the sales pace is stable, is that an acceptable sales pace to you guys? Or would you rather do something (multiple speakers) pace higher?

(multiple speakers) current sales pace.

I'd like triple that.

I don't know what the word acceptable means, but it's what we have incorporated into our forecast. Obviously we would love to do more. We want to raise prices and increase sales pace, but we have to balance everything with the market realities.

Stephen Kim, Citigroup.

I guess I wanted to follow up on your guidance on the margins with respect to your 17 to 17.5, I think is what you gave for the next three quarters. I was curious as to what you felt might be some potential drivers that could move that number, that could happen in time, to be able to move, let's say, your fourth or third quarter number up. We all know what could move it down. That's obviously been covered very well. But you had made some mention about efforts on your part to get your cost down with your suppliers. I was wondering how much, if any, was embedded in your, let's say, third and fourth quarter gross margin outlook from that particular area?

We have incorporated much of it of the savings we are getting, but not all of it yet. And keep in mind as, for example, new prices that we have negotiated in the last month or two, well, if it's a concrete person, well, homes we're delivering in the fourth quarter, we have already paid for that concrete because that's in the ground already. So it does get phased in. But in general, we feel like we have built in a lot of the cost savings we're getting. Frankly, margins might have been worse if it wasn't for the fact. Might there be a little more upside on the cost in terms of benefit for us with further cost reductions? A little bit, but we think we have captured a lot of it and built it in.

At this point we have, as we mentioned, 68% either delivered or in backlog. So we really only have price opportunities on -- up or down, I guess, in the remaining 32%. However, I will caution that I guess we have learned something we never really had to worry about before, that our old backlog does not necessarily close at the price they are contracted for. In some markets, and luckily it is quite isolated, but in some markets, we have had to offer concessions at the closing table, particularly if we have lowered prices in the community and it's at lower net prices on new houses in our backlog. So we have tried to build all of that into our best guess for today.

So that was where I was going to go with this. So, in other words that phenomenon which we know has been obviously impacting yours as well as many other people's margins in terms of your margin not being as good at the closing table as you thought it was when it was in backlog, you have already factored something for that over your remaining two or three quarters?

Yes. (multiple speakers) and obviously you don't really know until you get to the closing table, but we have taken our best guess of the market and tried to build that in.

So I guess where I'm going with this -- and again, I'm not trying to put words in your mouth or trying to make it seem like everything is starry-eyed and rosy, I'm just trying to understand we all know the downside. I'm trying to understand the upside. If your pricing environment stabilizes, or even slightly improves, and the impetus for buyers in your backlog or the strength they have to come to you at the closing table and demand such concessions, would not -- well, my guess would be it would probably not likely happen to the degree anywhere close to what you had seen over the last six months. So what you're saying is that since you factored something of that in your guidance, that could actually affect your gross margin realized even in the next two to three quarters? Is that correct?

I think I understand your question, and I guess that's correct, yes.

Because ordinarily people wouldn't think so. Someone would say, well, you're going to sell it, maybe you don't have to give as much concessions on it in, let's say, three to six months but that's not going to close until next fiscal year. And I'm saying that that dynamic of having pricing stabilizing or strengthening in your communities might actually affect your backlogs, margins being closer to what you think it is currently today. And if you factored in some allowance that it might be lower than that when you get to the closing table, then that portion of it could represent upside. That is what I'm getting at.

Yes, I guess it could. In this environment I just would be very cautious.

Sure well I -- yes, you shouldn't be embedding anything differently in your guidance. I'm just trying to understand it. Okay, I think that was it. Thanks very much.

[Basu Mulik], Neuberger Berman.

I have a quick question. Can you tell me what the $51 million of intangibles write-down, how would it flow through the income statement? And the other question is as I look at your backlog which shifts significantly from $6,000 in Southeast down and I look at the new contracts written as only very small percentage of the contracts, which is obvious from your Fort Myers write-off. How does that change the gross margin in net contracts that you're writing now?

The first question on intangibles, I did not hear all of it

My question is, you have seen tangibles, how did they impact the going forward gross margin of the Company or is it SG&A that flows through?

No, in the intangible amortization line on the income statement.

Okay, so that would impact $51 million? It would impact how much in pro forma 2007?

About $12 million a year.

And my next question is, if you look at the mix change as Southeast becomes much smaller on the net contracts in 2007 first quarter, how does that change your gross margin?

You mean as we -- (multiple speakers)

As you write the contracts.

(multiple speakers) quarter. As you write new contracts? Well, Fort Myers is just not a market that you can say much about right now so the margins are (multiple speakers) yes, nonexistent.

So if I took $5,800, which was in your backlog, right? And now it's $2,100, right?

$3,100, yes.

Right, so that's --

Not all of that is Fort Myers but a large portion is.

That's $2,700, right?

Yes. So we're getting -- I think your point [Basu] and you're right, is we're getting a very subfloor margin on any Fort Myers deliveries which are affecting our average margin.

So between the two, what kind of gross margin are you writing at in the net contract that you're writing, assuming that the Southeastern mostly was zero and that is coming down to nothing? In your 2006 net contracts you wrote this quarter?

How many -- I'm not sure I understood the question.

Once again, it's 2,600 homes you wrote this quarter, right?

Yes.

Out of that, only 144 is Southeast.

That is correct, yes.

Down from a year ago 1,015 out of 3,600.

Right.

So net-net, what happens to the gross margin now? I took 1,000 out of the 3,624 to 2,613.

Yes. Well, we don't look at gross margin (indiscernible) in a contract. We tend to look at it in backlog. We now have 8,600 total homes in backlog, as you said, with only 3,000 of those from the Southeast versus a higher percentage last year of 14,000 homes in backlog. We know that we're giving you guidance as we deliver that backlog. And sell another 30% of the homes as we need to sell still for this year. We expect to have gross margins that for this year will average 17 to 17.5 (multiple speakers).

And the Fort Myers is definitely substantially lower than that and the other market, which is dragging it down, so the other markets are obviously higher than that. But we don't give specific details on market in terms of --

But I think it is safe to say because of the Fort Myers impact that what we're selling on average because we're not selling anything in Fort Myers, the new contracts we're selling on average of higher margins perhaps than what we are going to be delivering in margins this year.

Which stands in sharp contrast to what you just reported in gross margin in your guidance for the rest of the year.

Except that it has impact because there's still stuff in backlog from --

Which is flowing through there?

Which is flowing through there, right.

Ladies and gentlemen, this now concludes the question and answer session. At this time I will turn the call over to Mr. Ara Hovnanian for closing remarks.

Thank you very much. It's obviously not as pleasant reporting in the last couple of quarters as it has been for the last five or ten years. But we have been through these ups and downs for many years, many times in our fifty-year history, and we are sure in the not too distant future we will be reporting some more positive results. Thank you very much and we look forward to giving you an update at the next quarter.

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