Hovnanian Enterprises Inc (HOV) 2011 Q3 法說會逐字稿

Good morning and thank you for joining us today for Hovnanian Enterprises fiscal 2011 third-quarter earnings conference call. An archive of the webcast will be available after the completion of the call and the run for 12 months. This conference is being recorded for rebroadcast and all participants are currently in a listen-only mode.

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

Before we begin I would like to read the following forward-looking statements. All statements made during this conference call that are not historical fact should be considered as forward-looking statements. Such statements involve known and unknown risks, uncertainties, and other factors that may cause actual results, performance, or achievements of the Company to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements.

Such risks, uncertainties and other factors include, but are not limited to -- changes in general and local economic and industry and business conditions and impact of the sustained homebuilding downturn; adverse weather and other environmental conditions and natural disasters; changes in market conditions and seasonality of the Company's business; changes in the home prices and sales activity in the market where the Company builds homes; government regulation including regulations concerning development of land, the homebuilding, sales and customer finance and processes, tax laws and the environment; fluctuations in interest rates and the availability of mortgage financing; shortages in and price fluctuations of raw materials and labor; the availability and cost of suitable land and improved lots; levels of competition; availability of financing to the Company; utility shortages and outages or rate fluctuations; levels of indebtedness and restrictions on the Company's operations and activities imposed by the agreements governing the Company's outstanding indebtedness; the Company's sources of liquidity; changes in credit ratings, availability of net operating loss carryforwards; operations through joint ventures with third parties; product liability litigation and warranty claims; successful identification and integration of acquisitions; significant influence of the Company's controlling stockholders, geopolitical risks, terrorists acts and other acts of war; and other factors described in detail in the Company's Annual Report on Form 10K-A for the year-ended October 31, 2010 and the Company's Quarterly Reports on Form 10-Q for the quarters ended January 31, 2011, April 30, 2011, and July 31, 2011, respectively.

Except as otherwise required by applicable security laws we undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, changed circumstances, or any other reason. I would now like to turn the conference call to Ara Hovnanian, Chairman, President and Chief Executive Officer of Hovnanian Enterprises. Ara, please go ahead.

Thank you. Well, after that exciting introduction, good morning, everyone. And based on her slight mispronunciation of our name, you can see that we've cut back on our advertising budgets as part of our SG&A attempts.

Good morning and thanks for participating on today's call to review the results of our 9-months and third quarter ended July 31 of 2011. Joining me today from the Company are Larry Sorsby, Executive Vice President and CFO; Brad O'Connor, Vice President, Chief Accounting Officer and Corporate Controller; David Valiaveedan, Vice President of Finance and Treasurer; and Jeff O'Keefe, Vice President of Investor Relations.

On slide 3, you can see a brief summary of our third-quarter results and the comparison to last year's third quarter. Of note, our net contracts and backlog both improved on a year-over-year basis. Additionally, our land-related charges and net loss were less this year.

Slide 4 shows a sequential comparison of our third-quarter results to our second-quarter results, as well as our guidance that we gave on our second-quarter conference call for deliveries, homebuilding revenues, and homebuilding gross margin. As you can see, we reported sequential increases and met our guidance for each of the 3 line items. Additionally, our net contracts and backlog increased on a sequential basis. More importantly, our losses were less in the third quarter.

Slide 5 shows our monthly net contracts through the month of August with this year in red and last year in yellow. You can clearly see the sales momentum leading up to the expiration of the tax credit last year on April 30 of 2010. As we all know, sales dropped dramatically in May of 2010 and continued to decline in June of 2010.

Fast forward to the third quarter of fiscal '11, net contracts improved each month with year-over-year increases of 28%, 30% and 42% for the months of May, June, and July, respectively. The pace of improvements lessened in August of 2011 when we reported 384 net contracts, which was slightly more than the 377 we had in August of 2010, but less than the 437 net contracts in July of 2011. There were several primary reasons for this shift.

First, during August of 2010, sales did start to increase from the dismal levels we saw in June and July last year after the tax credit expiration. However, during August this year, home buyer confidence was clearly affected by the extreme stark market, volatility, and the federal debt ceiling battle. Compounding the problem was Hurricane Irene, which impacted many of our markets. In fact our New Jersey division office did not regain power for about 5 days.

However, much of the year-over-year and sequential differential is due to the fact that August 2010 and July of 2011, those comparison months, had the benefit of 5 weekends compared to just 4 weekends in August of this year. Because the vast majority of our sales occur during the weekend, slide 6 illustrates the impact of the number of weekends in a month and how it can affect our sales level.

The left side of the page shows monthly sales. The right side shows weekly sales each month based on the number of Sundays. The monthly sales show more volatility than the weekly averages each month. The weekly averages were reasonably consistent throughout the third quarter and continued through August. That being said, August sales this year were short of our expectations and current market conditions do feel somewhat weaker than they did earlier in the quarter.

Slide number 7 shows similar monthly contract data, but broken out by contracts per community. While you can see that net contracts per community per month bounced around a little during the third quarter, all were increases of 20% or more over year-ago levels and sequentially, we are pleased that 2 of the 3 months were higher than what we saw for our second quarter. The sales per community were similarly affected by the number of weeks in each month.

Slide 8 puts all of this into perspective as it shows contracts per community on an annual basis. As we look at the reminder of the year, we expect to continue to bounce along the bottom and be somewhere around the 23 net contracts per community we've achieved for the past 2 years.

This means that we're still off by about 50% compared to the historic normalized pace of about 45 contracts per year and, obviously, much more compared to the peak years. With all of the economic turmoil, both domestic and international, there's not much that points to an improving housing market at any point in the near future. Our internal business plan assumes market conditions do not improve until late 2013 and even then, we only assume a modest sales pace improvement and no home price improvements.

Since we underwrite new land purchases based on today's home prices, as long as the housing market remains relatively stable, we can achieve higher gross margins without relying on an improved market. Assuming stable market conditions, as we continue to grow our community count both revenues and absolute levels of gross margin dollars should increase, which puts us on the path to returning to profitability.

Absent an increase in sales pace, we can still achieve improved operating efficiencies and revenue growth by increasing our community count. Year-over-year community count was up, as seen on slide number 9. However, we took a slight step backwards in the third quarter with a total community count dropping by 4 communities in the third quarter of 2011 compared to the second quarter. The shortfall is mainly due to delays in getting already owned communities up and open for sales. While we are not providing guidance on the exact number of communities for the end of the year, we do anticipate having more communities open than we had at the end of the third quarter.

Our mix of newly identified actively selling communities to total communities continues to rise. This increase should result in more deliveries from new communities in 2012. For all of 2010, about 12% of our deliveries came from new communities. In 2011 we expect it to be more than 40% and given the current mix of communities, we would expect a further increase in 2012.

Slide 10 shows the progress we have made in controlling new land parcels. Since January of '09, we have purchased or optioned approximately 16,000 lots. The land that we have purchased or optioned met or exceeded our investment threshold of a 25% IRR based on the then-current sales price and no change in sales pace for the next 2 years. We expect many of these communities to sell out in about 2 years from the start of deliveries, quickly turning the assets back into cash for reinvestment or repaying debt as it becomes due. Without a doubt, these purchases were better than sitting on our cash earning a few basis points on Treasuries, even with a slightly deteriorated performance since acquisition.

Of the 180 new communities that we've purchased since January of '09, 3 or about 2% have had performance deteriorate enough to warrant a writedown. Staying true to our underwriting criteria, when we experience a slowing sales pace or increased buyer concessions, we will attempt to renegotiate lot option agreements. If we're not successful we will walk away from our deposit and the lot option agreement.

During the third quarter we walked away from 1,380 lots under option in 19 communities. 480 were legacy option lots. 900 were lots optioned after January of '09. As you can see on the bottom right hand side of the slide, we optioned 1,500 new lots in the third quarter. The net result for the quarter was that our total lots purchased or controlled since January of '09 increased by about 600 lots sequentially from the second quarter of 2011, an improvement over our prior 2 quarters.

In the third quarter we purchased about 900 newly identified lots in 88 communities. In addition we purchased about 300 lots from legacy options. In total we spent about $105 million of cash in the quarter to purchase approximately 1,200 lots and to develop land across the Company.

Cash flow from operations after interest was positive by about $29 million prior to the investment in new land and land development. We continue to seek opportunities in all of our markets and we've had success in finding new deals that make sense in most of our markets, although not as rapidly as we would like.

At the end of the third quarter, 70% of our wholly owned communities that were open for sale were newly identified communities that we controlled after January of '09. However, only 43% of our consolidated third-quarter deliveries came from newly identified land. Since many of these newly identified communities were recently opened, they will not begin to deliver homes until the fourth quarter of 2011 and beyond.

As long as we see no changes in market conditions, this mix shift should cause our gross margins to improve in the fourth quarter, which is consistent with statements we've made on the past 3 quarterly calls. Our gross margins, while down on a year-over-year basis, did improve modestly in the third quarter compared to what we reported in the second quarter as seen on the right hand side of slide number 11. This sequential increase was consistent with the guidance we provided in the second-quarter call.

During the third quarter of 2011 there were $25 million of impairment reversals compared to $40 million of impairment reversals in the third quarter of 2010.

Margins are still below normalized levels. Clearly, pricing pressures remain throughout the market, challenging our margins. Incidentally, 9 of our 12 publicly-traded peers reported year-over-year decreases in margins in their most recent quarters.

On the right hand side of slide 12, the bars show the absolute dollar amount of total SG&A is lower when compared to both the third quarter of last year and the second quarter of 2011. When you look at the total SG&A as a percentage of total revenues, as we have shown underneath the bars on the right hand side of slide number 12, the 16.3% for the third quarter of fiscal '11 compared with 20.3% during the second quarter of 2011. It is still much higher than our historical norm. These high percentages occurred despite almost 80% reductions in our staffing levels, shown on the left-hand side of this chart.

The improvement in SG&A as a percentage of total revenues during the third quarter compared to the second quarter of 2011 illustrates both our continued cost saving measures and the leverage we can get from our existing SG&A by increasing deliveries and revenues.

As we have said in the past, in spite of our right-sizing efforts we still have some excess capacity at our divisional, regional and corporate offices. As we open new communities, incremental spending related to our community count will come almost exclusively at the community level. There, we typically need to add a construction supervisor and 1 sales associate per community.

Over time, the combination of further improvements in gross margin trending back to normalized gross margins in the 20% range, coupled with SG&A and interest leverage, as we grow our community count and increase revenues, will get us to the point where our homebuilding operations are once again profitable. We still have more work to do as we seek new land parcels that will bring us the types of returns that we need to continue to the path of profitability. We're making some progress there.

Our current backlog gives us some visibility over the next 3 months. Last quarter we gave guidance for the fourth quarter in terms of deliveries, homebuilding revenues and gross margin, which you can see on slide 13. Given the recent stock market turmoil and volatility, Hurricane Irene, and pricing pressures, we now expect to be either at or slightly less than the low end of the range for deliveries, revenues and gross margin.

While we are pleased that the third quarter was in line with the mid-range of our guidance and the fourth quarter should be close to the lower end of the range we initially gave, there's still quite a bit of uncertainty related to the longer-term cash flow guidance we provided during last quarter's call. While we did give some longer-term guidance during that 1 call, we did say we would not continue the practice and that we are making an exception that quarter.

The recent extreme stock market volatility and its effect on consumer confidence make it even more difficult to make projections over the long term. Additionally, the unknown impact of the upcoming loan limit reductions on October 1 adds to the uncertainty in making longer-term guidance.

We remain committed to maintaining adequate cash liquidity. If cash flow from operations does not meet the guidance we provided in our second-quarter call, we would reduce our land spend accordingly to ensure we maintain our targeted cash balance.

I'll now turn it over to Larry, who will discuss our inventory, liquidity and mortgage operations, as well as a few other topics.

Thanks, Ara. Let me start with discussing our current inventory from a couple of different perspectives. Turning to slide 14, you'll see our owned and optioned land position broken out by our publicly reported segments. Based on trailing 12-month deliveries, we own 4.8 years worth of land. However, if you exclude the 7,678 mothballed lots, we only own 2.9 years worth of land based on the low sales distortion rate of the past 4 quarters.

Our owned lot position increased sequentially in the third quarter, while the optioned lot position decreased. We purchased approximately 1,200 lots during the third quarter, which was offset by 993 deliveries. On the optioned side of the equation we walked away from 1,380 optioned lots and signed new option contracts for an additional 1,500 lots during the quarter. At the end of the third quarter, 65% of our optioned lots are newly identified lots and 25% of our owned lots were newly identified lots. When you combined our option and owned land together, 39% of the total lots that we control today are newly identified lots.

On slide 15 we show a breakdown of the 19,053 lots we owned at the end of the third quarter. Approximately 37% of these were 80% or more finished, 15% had 30% to 80% of the improvements already in place and the remaining 48% have less than 30% of the improvement dollars spent. While our primary focus is on purchasing improved lots, it's continuing to get more difficult in certain markets to find finished lots for sale at a reasonable price.

Where land development is required, we typically are able to break development down into many smaller phases, as small as 15 to 20 lots, minimizing our capital outlay and returning the expenditures into cash relatively quickly. About 28% of the remaining newly identified lots we've purchased or contracted to purchase are lots where it makes economic sense to do some level of land development and we continue to complete land development on sections of our legacy land as well.

Now, I'll turn to land-related charges, which can be seen on slide 16. We booked $5.1 million of land impairments in 13 communities during the third quarter. $3.2 million or 63% of those charges were in 2 newly identified communities in Northern California. Additionally, $1 million of our impairments was taken on 19 lots associated with walking away from 4 communities in the Carolinas. To date, including $3.2 million of the charges from the third quarter, we have taken $6.5 million of impairments on 3 newly identified communities, which are all located in Northern California. We have now taken impairments on 3 of the 180 newly-owned communities we've purchased since January 31, 2009.

During the third quarter, our walk away charges were $6.3 million, which were spread across 19 communities throughout our markets. $4 million or 63% of these charges were in either Maryland or Virginia. Bringing it down to the community level, $3.1 million of the charges were in just 3 communities. In total we booked $11.4 million of land-related impairment and walk away charges in the third quarter of fiscal 2011. Our investment and land option deposits was $22.2 million at July 31, 2011, with $20.5 million in cash deposits and the other $1.7 million of deposits being held by letters of credit. Additionally, we have another $15.1 million invested in pre-development expenses.

Turning to slide 17. We show that we have 7,678 lots within 57 communities that were mothballed as of July 31. And on this slide we break those lots out by geographic segment. The book value at the end of the third quarter for these remaining mothballed communities was $174 million net of an impairment balance of $556 million. We are carrying these mothballed lots at 24% of their original value.

Looking at all of our consolidated communities in the aggregate, including mothballed communities, we have an inventory book value of $1.025 billion net of $833.5 million of impairments, which were recorded on 146 of our communities. Of the properties that have been impaired, we're carrying them at 26% of their pre-impaired value.

Turning now to slide 18. On a sequential basis, the number of started unsold homes, excluding models and unconsolidated joint ventures, decreased slightly. We ended the third quarter with 742 started unsold homes. This translates to 4 started and unsold homes per active selling community, which is lower than our long-term average of about 4.9 unsold homes per community.

Another area of discussion for the quarter is related to our current and deferred tax asset valuation allowance. At the end of the third quarter, the valuation allowance in the aggregate was $859 million. We view this as a very significant asset not currently reflective on our balance sheet and have taken steps to protect it. We expect to be able to reverse this allowance after we generate consecutive years of solid profitability and can look forward and continue to project solid profitability. When reversal does occur, we expect the remaining allowance will be added back to our shareholders' equity and will further strengthen our balance sheet.

Today, we could issue more than 100 million additional shares of common stock for cash and as of October 2011, that increases to more than 125 million common shares without limiting our ability to utilize our NOLs. This has not changed from what we reported last quarter. We ended the third quarter with total shareholders deficit of $399 million. If you add back the total valuation allowance, as we've done on slide 19, our total shareholders equity would be $460 million.

Let me reiterate that tax asset valuation allowance is for GAAP purposes only. For tax purposes, our tax assets may be carried forward for 20 years from incurrence and we expect to utilize those tax loss carryforwards as we generate profits in the future. For the first $1.8 billion of pre-tax profits we generate, we will not have to pay federal income taxes.

Now let me update you briefly on the mortgage markets and our mortgage finance operation. We believe the mortgage underwriting pendulum has swung too far to the side of caution. We find ourselves in a position where excessively strict underwriting criteria is preventing someone who would have received a loan in the days prior to the advent of subprime and Alt-A loans from getting a mortgage today. The mortgage industry needs to go back to a rational and responsible lending environment where lenders are not afraid to give a loan to someone with compensating factors.

In October, the conforming loan limits for FHA, VA, Fannie and Freddie will be reduced. While less than 5% of our communities will be directly impacted, these loan limit reductions will affect the entire housing market, not just those needing a $729,000 mortgage. In many of our markets the conforming loan limits are much less than $729,000. You can see some examples from several of our markets on slide 20. For instance in Kent County, Delaware, FHA loan limits were reduced by $105,200. In Atlantic County, New Jersey, they came down by $137,500. In Maricopa County, Arizona it was decreased by $75,200.

We believe any pressure that is felt on the upper end of the market will adversely impact all home prices, but it is too early to know what the full extent will be. We believe that any reduction to demand at this point in the housing cycle is not good governmental policy. Obviously, we will be monitoring this situation very closely.

Turning to slide 21. You can see here the credit quality of our mortgage customers continues to be strong, with an average FICO score of 736. During the third quarter, our mortgage Company captured 78% of our non-cash home buying customers.

Turning to slide 22. Here we show a breakout of all the various loan types originated by our mortgage operations in the third quarter of fiscal 2011 compared to all of fiscal 2010. 46.1% of our originations were FHA/VA during the third quarter of fiscal 2011, similar to the 49.3% we saw during all of fiscal 2010.

Let me update you quickly about what's happening with our loan repurchase requests we're receiving from various banks. We continue to believe that the vast majority of repurchase requests that we've received are unjustified. On slide 23, you'll see our payments from fiscal 2008 through the first 9 months of fiscal 2011. So far in the first 9 months of 2011 our repayments were only $1 million.

Additionally, during the third quarter, we received only 6 repurchase inquiries, which was much less than last year's quarterly average of about 25 inquiries. It is our policy to estimate and reserve potential losses when we sell loans to investors. All of the above losses had been adequately reserved for in previous periods. At the end of the third quarter our reserve for loan repurchases and make-hold requests was $5.2 million, which we believe is adequate for our exposure. To date repurchase have not been a significant problem, but we will continue to monitor this issue closely.

Our cancellation rates remain at normal levels. Our cancellation rate for the third quarter was 18% lower than both the 20% we reported for this year's second quarter and the 23% cancellation rate that we reported for last year's third quarter when the tax credit was in place.

Turning to slide 24, it shows our debt maturity schedule as of the end of our third quarter. What you see very clearly is that we have only $68 million of debt coming due before 2015. Since the end of the third quarter, we have used $11 million of cash to repurchase $18 million face value of bonds maturing in 2014 and 2015. After making these purchases we have approximately $50 million of capacity left to repurchase additional bonds.

In spite of extending some of our debt maturities and issuing equity earlier this year, clearly having adequate liquidity for growth is a concern of many investors. As we've mentioned on our last conference call, we have run endless financial models using numerous scenarios and assumptions. We believe we have adequate liquidity and cash flow to return to profitability, meet our debt maturity payments through 2015, and position our balance sheet for refinancing options in 2016.

At the end of July, after spending approximately $105 million of cash to purchase 1,200 lots and on an overall new land development across the Company, we ended the quarter with $334 million of cash, including $60.8 million of homebuilding restricted cash used to collateralize letters of credit. The amount of homebuilding restricted cash used to collateralize letters of credit has steadily declined from about $135 million at the end of fiscal 2009 to the current level of $60.8 million.

Since we first gave out a targeted cash level in the fourth quarter of 2010, restricted cash used to collateralize letters of credit has reduced by $32 million. This $32 million reduction frees up an identical amount of cash to invest in our homebuilding operations. When we provided our original targeted cash level, we had $92 million of restricted cash used to collateralize letters of credit implying a homebuilding unrestricted cash target of $110 million to $185 million.

While we are not changing, I repeat, while we are not changing our homebuilding unrestricted cash target, since our restricted cash used to collateralize letters of credit has been reduced by $32 million, we are now reducing our targeted total cash to a range of $245 million to $170 million. Our focus will remain at keeping total cash at quarter end at the top end of our range or $245 million with no single quarter falling below $170 million. Our intention is to become fully invested in land as quickly as we find land opportunities that meet our underwriting criteria of a 25%-plus IRR based on current home sales, prices and absorption rates.

Some people believe that we should not be investing in land, but should just sit on the cash we have. We are comfortable targeting our projected level of cash because the bulk of our investments in wholly owned inventory will be in communities with shorter lives, regenerating into cash in the near-term. Investments in land are needed to grow our community count and in turn, our top line, which will eventually drive greater operating efficiencies and return us to profitability.

Keep in mind that we have discretion over the amount of investments we make in land and land development. We have the ability to reduce our land and land development spending based on actual cash flow compared to our internal projections. If needed to ensure we keep cash within our targeted range, we are prepared to adjust our land spend downward. We understand the market's concern with liquidity. It is something we continue to monitor closely as well. However, our internal financial models give us confidence that we have sufficient capital to grow our way back to profitability even in a flat non-recovering market.

While we cannot project when the housing market will recover, we do feel that our performance is at an inflection point. Sales dropped precipitously in last year's third and fourth quarters after the expiration of the tax credit. Our first 2 quarters of deliveries this year showed the effect of that. However, net contract comparisons to last year were positive in our third quarter and, given the current sales pace and growth in community count, should continue to show improvements in the fourth quarter.

Our gross margin should improve as our mix from newer communities improves. While this is not a direct proxy for cash flow, we do see our cash flow improving as well. Given that our large bond maturities are in 2016, we think that gives us sufficient time to improve our performance and our balance sheet to giving us further options on the capital front. That concludes our prepared remarks and now we'll be glad to open it up for questions.

(Operator Instructions) Dan Oppenheim with Credit Suisse.

I was wondering if you could talk about just overhead spending and such. It looked like it did well in the quarter despite having higher closings and such. Is there anything going on there? Is that just reflective of the cuts that you've been making? And do you think -- is that sort of where you are at this point in terms of overhead?

It's just been general tightening of the belt. No one specific thing, at all levels, corporate, divisional, spending at the communities as well.

And then you talked about sort of being flexible in terms of the land spending depending on the outlook and such which clearly makes sense. Is it going to really be driven by just the cash that you're sitting on? Are you going to be looking at it based on the order trends here? What would you need to see in terms of adjusting there?

I think the first thing is we got to find opportunities that hit our hurdle rate of a 25% plus IRR based on today's prices and absorption paces. As Ara mentioned in his comments, we've not seen as many opportunities as rapidly as we want, but the controlling factor obviously is our cash, projected cash balances at quarter end.

Having said that, we did make actually a little more progress in net land control position in the third quarter than we did in the first two quarters, so there are opportunities out there. We are also focused on land parcels that are shorter maturities. We're not looking to make long-term investments even if they beat our IRR hurdles because we want to maintain our flexibility. We want our investments to generate the profits and then turn back into cash fairly quickly in this environment. So, we're very focused on the right kinds of land opportunities out there. And the investment we're just going to gauge it very closely, as Larry said, based on our outlook for cash flow in future quarters.

Thanks very much.

Michael Rehaut with JPMorgan.

I guess the first question is, Ara, you'd mentioned I think in your prepared remarks that given all of the recent volatility in the market that, that probably has contributed to things slowing a little bit in August; and I think you also mentioned that, that does have the potential to create some variability to the cash flow projections. At the same time, Larry, in your comments you pointed to confidence that still you had orders up year-over-year in 3Q. It should be similar -- that you also are looking for gains in 4Q and you remain very comfortable with your guidance around cash flow and it being sufficient.

So, I was wondering if you could kind of reconcile those statements. Are the former statements just more hedging statements and over the next few months you still comfortable with your original projections or does this more just kind of speak to the lowering of the revenue guidance that towards the lower end of the range?

Yes, I would say that -- one thing I would point out is we're concerned about the macroeconomics that are going on and some of the things that Ara mentioned, stock market volatility, drives consumer confidence even if they are not big stock market investors, certainly settling the debt crisis that the US faced and so on has an impact on consumer confidence.

Having said that, during the month of August our weekly sales pace was equal to the weekly sales pace that we had been seeing in the prior two or three months during the quarter just ended. We are concerned about the impact that the lower loan limits may have, primarily on home prices rather than on sales pace. But I think overall, we're still pretty comfortable that because last year's fourth quarter still had some negative impact from the expiration of the tax credit a year ago, with the community count growth and kind of what our current sales pace has been even in spite of some of those macroeconomic events during the month of August, that we're still comfortable that we're going to show improvement.

I think our comment was meant to make clear that longer term projections in this environment are pretty difficult. We obviously are happy we met with the guidance in the third quarter. We think we'll be at or very close to the range of the guidance in our fourth quarter, but as you look out, obviously as we look out further, the crystal ball gets foggier. That's all we're trying to make clear.

Great. And then just going back to the SG&A for a second, you had about a $5 million decrease sequentially on the SG&A line in and of itself. How are we to think about projecting that? Is that a base that we can use and maybe just add a 4% variable on sales commissions? Or were there things that, that $5 million improvement in the quarter that were maybe one-time or temporary in nature?

Hold on a second. In general, we're just not going to give you crystal clear guidance, but I don't think there's anything too unusual about our SG&A expense during the quarter. So, sitting in your chair, the best you can do is assume that, that is kind of the current level of SG&A that we're running. Again, I don't think there's anything especially unusual in the quarter.

Yes, I mean--

We made progress from the first quarter to the second quarter and I think we were asked the same thing then. I don't think we quite reduced $5 million, but probably close to that and the same question was asked and we said then we're just continuing to tighten our belts all around.

Okay, thank you.

Megan McGrath with MKM Partners.

Just a quick follow-up in reconciling some of the sort of cash targets and things and land spend. Talk to us a little bit about you've walked away from some "new land", the 900 lots and your internal projections are showing, I think you said, no real growth until late 2013. Is there an argument in terms of the -- in market conditions late 2013, did I get that wrong?

Yes, we didn't say our internal growth. We do project our internal growth to occur. What we said is we did not project the market conditions to improve until late 2013, which meant the pace of sales per community in our internal projections we kept flat until toward the end, I think, second or third quarter of 2013. Third quarter, Larry, is --.

I'm saying fourth. We continue to say that there's no improvement in pace for two years and every quarter we push that out another quarter.

Yes and that's sales per community, as we've been saying along, we are planning to increase our community count and therefore, increase our revenues.

And given that thought in terms of the overall market, can you talk to us about conditions in the land market? Is there an argument that, look, if the overall market is flat these land prices are going to get even better six months from now, nine months from now? Or is it that the land that you're buying is such a quick turn that, that math doesn't work? Why buy now, why not wait six to nine months from now when things are flat and the sellers are going to be even more desperate?

Well, number 1, if we sit on -- number 1, we're not to buying long-term positions. We're buying short-terms, as you pointed out, so we want to churn through it. Number 2, we have fixed interest costs, to a large extent, and we do have some fixed overheads, although we've been making good progress. We are better off investing even if the yield ends up being slightly less than our 25% IRR, it's far better than a few basis points in Treasuries right now sitting on our excess cash. So, we have been anxious to deploy the excess cash above our targets. We would have liked to have done it even more rapidly and get down to our targets. We just haven't quite found the opportunities that we would like as rapidly as we would like, but we're making progress.

As long as we continue to underwrite, and it's our intention to do so, based on today's low sales prices and today's absorption paces and again, most of our communities are 2-years or less, so we don't assume any improvement in pace. Unless the market significantly weakens, it's a strong investment and we get to leverage our overheads, as well. And as Ara appropriately points out, the alternative investment is Treasuries earning a couple of basis points. So, we think it's a very compelling argument to make the land investment play.

Okay, thanks. And then a quick follow-up on the financing market and the FHA loan limits. We certainly heard that some banks are already not financing loans under the GSE limits, so I'm wondering if you've experienced that at all and any --.

What do you mean under the GSE limits?

Well, they are only doing it at the expected October 11 limit. So they've already sort of cutoff financing to anyone who's at the higher limit. I don't know if you've seen that at all or heard that.

We have seen some of that, but we have our own mortgage Company and they have taken appropriate actions and we are continuing to be able to originate loans today as long as they close prior to October 1 at the current loan limits. Obviously, we don't sell a lot of spec homes in every one of our markets. Some of our markets a few more than others. So, we couldn't start a home today and have it delivered by the end of September, so we are limited on what we can offer some of our current customers because we can't complete the home by that date.

Right, okay. Thanks very much.

Michael Kim with CRT Capital Group.

Just on the chart with the land positions by geographic segments, I was wondering, of the owned non-mothballed lots, how much land development spend is remaining to take this fully developed and just wondering if there's any regional concentration in terms of the stage of development away from what's in the backlog today?

It's just not information at that level of detail that we've made public. We do provide the three buckets that I talk through in my presentation, but we don't get anymore granular than that.

And I guess to think about your internal projections, when we think about the downside case, what are you assuming in terms of price, absorption rates, housing starts, return on equity, et cetera? Any color you could provide there?

In our internal downside case, we run multiple different downside cases so there isn't a particular one, but we do run stresses as well as upsides.

Okay. That's all I had. Thank you.

Alan Ratner with Zelman & Associates.

My first one was just on the land that you purchased during the quarter, the 1200 lots or so. Was curious what percentage, if any, of those are in communities that are active right now, so they would be kind of an additional phase of the community or just kind of acquiring more lots there that you have under control of option previously, versus lots that would be in communities that you would be opening in the future.

We don't, frankly, track it that way or break it out. From our perspective, if we've run out of lots and we're able to get another phase elsewhere in the community, I mean, we're really indifferent. All we care about is that we've gotten additional properties.

I think it's probably safe to say that we see more of that in a Houston or a Dallas than we do anywhere else.

Yes.

But we just don't track it in that particular order.

Outside of Houston or Dallas it just doesn't occur very often at all.

So, the majority of lots that you'd be buying today would be kind of in communities that you plan to open at some point in the future?

Outside of Houston.

Outside of those 2 markets.

We just don't track it that way internally.

And the second question just relates to another question on the mortgage market. I know there's been an announcement recently from Bank of America that they are exiting the correspondent business and I'm not sure how much of your mortgage sales have flowed through them in the past or currently, but just curious if you expect to see any impact from that or what you're hearing just in general about the future outlook of the correspondent lending business?

We have not been doing business with BofA for more than a year, so it won't impact us at all.

Who are you primarily selling your loans to today?

We sell to Chase, Wells Fargo, maybe a little bit to Citi.

Okay. Thanks, guys.

David Goldberg with UBS.

My first question, if we look at Slide 10 and I know there's been a couple references to the walk aways in the quarter, in the current quarter, but my question is I want to get an idea if we're thinking about this correctly. It seems to me that you've walked away from about 4300 lots in the last three quarters out of a total of 16,000 that you either purchased directly or put under option or kind of controlled through the joint venture since the beginning of '09, so about 25% of the lots. Is that the right way to think about the walk aways as a percentage of the total at this point given that there's still some, obviously, some lots under option and do you think that's an unusually high number?

That's basically right, except keep in mind that the 16,000 is what's left after you walked away. So, you'd have to gross up the 16,000 for the amount of walk aways to get your percentage calculation appropriate.

And keep in mind that some of walking away from an option is during our due diligence period. We had it under option probably with no money at risk for 90 days and during due diligence we found something that caused us to determine not to proceed or we attempted to negotiate a price reduction and the seller refused. So, again, it occurs and it's always occurred even before this downturn in that same kind of condition.

So is it fair to say that the percentage of walk aways relative to the total hasn't really changed that much?

Don't know the answer to that question.

But 20% is about the number, that wouldn't -- when you gross up the ones we've walked from--

Probably not an unusual.

Yes, it's not a shocking or surprising number to me.

Got it. And then my second question, with the understanding that when you're taking down some of these lots and communities that need some development work and they aren't necessarily finished lots and that you're doing them in chunks, smaller chunks of the actual cash turns a little bit faster, for the building of those lots specifically, I'm wondering if you could talk about the additional costs of development and kind of how that would look in terms of the overall obligation; because obviously, I would assume I should say that, that's not going to turn as quickly. You have to wait for the whole community for it to pull some of that cash out for the whole community to close out. So, can you talk about that generally?

No, no --

Well, first of all it varies dramatically from location to location. There are parts in Florida or Arizona where the incremental cost to put in the streets for 20 lots is just very nominal, but we'd put that investment in, get that cash back as you deliver those 20 lots and then we would be improving another 20 lots. So, you don't have to wait until the end of the community, but you've got your investment in 20 lots, let's say, turning at a time. Not everything you can do in increments of 20 lots. It just depends and if it's the first section it may entail more dollars, but the additional sections after the first section to get it started, we usually can break off into pretty small dollars.

Got it. Thank you.

Joel Locker with FBN Securities.

Just on the consolidated community count, I guess it's only up 1 or so year-over-year. And do you have a target for the end of fourth quarter and maybe at the end of 2012?

Not one that we've made public.

Yes, we do anticipate increasing and getting some growth again in the fourth quarter even though third quarter we lost a little bit on a sequential basis. We're still ahead of last year, but lost a little on a sequential basis. It's just hard to make really accurate projections. You think you're going to open models and then you get a hurricane or a flood or whatever it is or a permit delay- -

Or sales are better and you close down more than you expected. It's a very difficult number to project, but the trend should be upward.

Right. And then also on your joint ventures, what caused the $2.3 million loss? That's been a loss for the last three quarters now. And when do you expect that to reverse or normalize or at least get back to (inaudible)?

I'm sorry, what was it?

The $2.3 million loss on the joint venture?

That was mostly related to we entered into 5 more communities last quarter and we got a lot of start ups with those new communities.

When do you expect that to --?

We've got expenses and we don't have the deliveries happening yet. We're not forecasting --

precise times.

Precise performance on joint ventures, just like we are not giving detail for the overall Company (multiple speakers).

So the loss could last a couple more quarters just based on the start up costs?

No.

Make whatever assumption you want. I think we've answered this as much as we can answer.

All right, thanks a lot, guys.

Okay.

Nishu Sood with Deutsche Bank.

First question, Ara, I wanted to ask you about the loan limit reductions that are happening in a few weeks. There's been a couple different efforts in Congress to maybe try to get those extended. Obviously, they've run into headwinds from some of the parties in Washington. I just wanted to get your latest thoughts on that. Do you think there's any chance of success in any of those efforts? What are you seeing?

You know, I'd say at the moment, it's probably a long shot. It's not hopeless, but I'd call it a long shot, which is unfortunate. It's, frankly, ridiculous policy that at this stage of the housing cycle that they would allow the loan limits to reduce, but that's the way I'd handicap it.

And second question, Larry, you mentioned that you've lowered your cash target to the total of $245 million to $170 million and that in the near-term you are going to try to keep it towards the high end of that. I was a little surprised. I'm not sure if you meant the fourth quarter, because the fourth quarter is typically when we would expect you to have quite a strong cash flow performance. So, I was just wondering, since quarter end to today have cash flows been less than you expected, is that a result of less operating cash inflows, continued investment in land? So, what's the current status?

Current status is what we reported as of the end of the third quarter, but you shouldn't read anything into that comment beyond the fact, which we tried to make pretty clear, is the only reason we're reducing it is that we've been able to reduce the amount of restricted cash. So, we reduced the target for unrestricted cash by an amount equal to the reduction that we've made in restricted cash. And there's no meaning beyond that, that something different has happened during this quarter.

End of the fourth quarter even though we have great cash inflows because of high deliveries, if we find good opportunities to invest in land, we would be comfortable taking the cash down from where it was at the end of the third quarter. So, it's really a function of finding opportunities that meet or exceeds our hurdle rate so that we can make new investments.

And I think we did mention that we expect cash flow to be better in the fourth quarter, so I wouldn't try to misinterpret the comments we're making. I know it's a little confusing because of the restricted cash comment, but as the amount we have tied up that's unusable in the business basically reduces, and it's reduced a little better than we had projected, that means we have to keep less of that cushion because it's not tied up doing nothing.

Got it. So does that mean in the last month or so you've been, are you saying you've been finding a lot of good opportunities to invest in?

No, we haven't said anything about what's happened since the end of the third quarter, and we're not planning to do so, on this call.

Well, we've told you sales since the end of the first quarter.

Okay, great. Thanks a lot.

Okay.

(Operator Instructions) Adam Rudiger with Wells Fargo Securities.

If you look at your mothballed lots it didn't change overall substantially versus last quarter, but of the increase most of it was in the Northeast and a little bit in the Mid Atlantic and that's a little bit surprising to me because I think generally most people or other builders comment that those are among the better performing markets. So, I was wondering if you could explain the dynamics there, in particularly the Northeast where I think over 40% of your own lots are mothballed, just what's happening there and what it will take to get those lots un-mothballed?

Yes, it was primarily due in the Northeast to a land takedown. I think it was the last land takedown in a parcel that we've just decided it's not worth starting at this stage and it was a nominal increase. Overall increase in mothballed lots barely moved, but that's the reason why it did.

So you're buying land that you still want long term, but you just don't want to build on it in the near term?

Yes, on that -- in that particular case, it was the last section of a piece of property and we haven't developed the first two sections, but given that we had the first two sections we just thought it made economic sense in this case.

And secondly, could you comment on what your cash flow per delivery is right now, because I think you mentioned about 25% -- $25 million benefit from prior impairments and so if you consider that, I think your -- closer to a cash gross margin would be maybe closer around 6% and I recognize there's some timing issues with --.

Well, it matters greatly on where is the lot, okay? Because there are no lots created equal when you're comparing a Houston lot to a California lot to a New Jersey lot to a D.C. lot, so what's the average depth of the ocean? I'm not sure it makes any difference, so it's hard to answer that question.

And we don't mean to be quippy about it. It's just cash flow is an incredibly complex animal in housing when you've got a pretty broad geographic scope.

Okay, thank you.

Alex Barron with Housing Research Center.

I was hoping you could -- I guess this is more of a strategy question. Obviously, you guys reduced your SG&A this quarter and that's good. Just trying to figure out how you're kind of thinking about priorities between growing the top line versus reaching profitability. Are those two intertwined or if the market stays at current flat levels is there a plan, do you guys keep buying land anywhere or do you kind of stop?

Well, they are intertwined and we do feel we need to get the top line growth. We can't shrink our way back to profitability. That being said, with every purchase we look at the market conditions at that moment, we look at sales prices, then we look at the sales pace, we assume no improvement and if it still makes it 25% IRR and it meets all of the other conditions we talked about, it's not a long term investment, it can turn and turn relatively quickly to cash, then we move forward with that acquisition. But each time, as we mentioned before, we take an internal look at our cash flow, we make sure we're comfortable that we can still stay within our targeted excess cash cushion reserves that we talked about earlier and as long as we're there, then we make the acquisition and that's been the case thus far.

And if we could focus on Northern California, that was a market where you guys had a couple communities here impaired and 3 deals you walked away from. What changed since you guys entered into those deals? Was it the sales pace or was it the price? What kind of didn't hit your expectations?

Well first of all, the walk aways were from North Carolina not Northern California.

Oh.

But we did have, and they were all quite small, I think it was 4 separate deals.

19 lots.

Yes, but anyway, the Northern California there was -- there are pockets that are definitely having pricing challenges, particularly around the Sacramento area, some of the Modesto or Stockton areas and we look every single quarter at every community and if there is a -- if we had to drop our prices for competitive reasons, we reevaluate every community.

Got it. Okay, thanks.

Okay.

Susan Berliner with JPMorgan.

This is actually Rich for Sue. Just had a quick question with regards to land spend. Is the $100 million quarterly run rate guidance that you guys gave still a good number to use or have you guys revised down to a smaller run rate, at least in the near term? How should we look at that?

Yes, well, you might not have caught the earlier part of the presentation, but we kind of said look, in this environment longer term is just harder and harder to make projections. We don't know what's going to be the impact on the changed mortgage debt ceiling of the GSEs, et cetera. So, we said we're not going to -- we said it at the time we made the presentation, the guidance last quarter that we're not going to update it and we reiterated we're not going to give ongoing updates on the long term basis.

And then I guess just with regards to August orders. Can you guys comment on at all if you have -- you are seeing some increased incentives and cancellations since the end of July given the market fall off and what kind of margins you might expect to see on the August orders?

I don't know that we've seen anything significant in terms of increased incentives or concessions. There might be a community here or there that we've seen that just like we would have seen in June and July. So, it certainly hasn't come to a screeching halt of having to do incentives or concessions, but I can't say that there's been an overwhelming tidal wave of increase or anything along those lines. With respect to cancellation rates, we did look not on a calendar month basis, but I think on a trailing 4 or 5-week basis for the week ended the end of August and on a 4 or 5-week trailing basis, I think cancellation rates were around 16%. So, slightly lower than we had for the entire third quarter.

Thanks, guys.

Michael Rehaut with JPMorgan.

Just a follow-up. I think you started to address it in the last question, but I was wondering if you could just discuss pricing and incentive trends as they emerge throughout 3Q and then also again if you can just kind of give us any color in August and if there are any regions that on a regional basis anything that changed or is the stability that you have seen more in the first half of the year something that's broadly continued?

Well, I'd say I haven't -- I can't comment that there have been monthly changes. As I mentioned in my comments, I mean, in general in the third quarter we certainly felt pricing pressures, as have all the builders. 9 out of 12 are reported lower gross margins in their most recent quarters, so there are clearly pricing pressures that remain in the marketplace. I can't say it's getting sequentially worse each month. I can't say August was dramatically different. And every single case, it's really neighborhood specific anyway. It's hard to make generalizations even in a marketplace, you can be in one division and one neighborhood has got pricing pressures, the other one's raising prices. It's that localized. In general, while there's not a trend up or down, I'd say there's just continued pricing pressure overall and it's the same kind of pricing pressure that's been there for the whole quarter, including through August, not a change or directional difference.

Lee Brading with Wells Fargo Securities.

Wanted to talk a little bit more on the buying of lots and want to get a better feel for how hard is it to find lots that meet your hurdles and also looking at the 1200 lots that you purchased this past quarter, what was kind of the percent that was developed versus undeveloped?

I don't have the exact break down of developers as undeveloped. I'd say generally it was more on the developed side is my gut reaction and I'm not sure how to comment on the difficulty. We're trying to be as transparent as possible. We made a little more progress this quarter with basically 600 net more lots controlled during the quarter. The first two quarters the number was about 200 net additions. So, we've made some progress, but you have to go through it's just a lot of churning and due diligence and you've got to go through, whatever the expression is, kiss a lot of frogs to find the prince. It certainly is (multiple speakers).

Its always been difficult, I think would be one way to answer it and it continues to be difficult today. But we've always been successful ultimately finding some, but it's hard work and a lot of effort and we have land teams and virtually each one of our individual divisions that, that's all they do in life and many quarters they don't bring us any opportunities for a particular division. So, it isn't like there's a waterfall of deals and we just kind of stick a bucket out and they fall in. You got to really hunt hard for them and there's a lot of effort to make sure that they underwrite properly and ultimately every one of them comes to corporate to be approved.

It is interesting and we made this comment in the past. It's kind of a blessing and a curse. The banks did not decide to just fire sale and dump everything. On one hand it would have been nice, because we could have made a lot of purchases at low prices and that wasn't the case. The good thing is that, that's helped create a little bit of balance. And the other thing is it means that they still have inventories that just are being kind of dribbled out on a regular basis. So, we do find opportunities each quarter that just didn't exist a couple of quarters earlier. I can't say there's been a dramatic change one way or the other on our opportunities to find properties throughout the year.

If anything, again, this is my gut reaction, everybody may agree or may disagree, but I'd say if anything my gut is it's incrementally slowed in terms of deal flow, but it's not dramatic one way or the other.

And it doesn't sound like this will happen based on just kind of the discussion that's occurred, but if you were able to hit those targets and find all the land you could next quarter, would you be comfortable taking that cash target down to the $110 million to $185 area next quarter?

Well, we generally are targeting the larger number. However, what we recognize is there are quarter to quarter fluctuations, so we target the larger number and recognize that we can have quarters that would dip down. We would prefer not to target the lower number and let that have a quarter to quarter fluctuation.

But I think the answer would be is we would be comfortable taking it down to the top end of the range if we found especially smaller deals that we could return to cash within a couple of years that underwrote, the answer is probably yes, we would take it down to $185 million.

Frankly, we were hoping we would have gotten there sooner, but we haven't. We're trying to invest prudently and we haven't been able to get there yet.

Thanks very much.

Andy Casella with Imperial Capital.

Just real quick on your restricted cash, how do we think about that going forward as you embark on your land spend? Is that at all going to creep up or are we going to continue to see that decline and be released for you guys to use in your homebuilding cash?

It's hard to say.

We, frankly, had expected and this is why we didn't count on it shrinking as much. We expected more of our newer land deals to require more restricted cash, but it hasn't been the case. So, it's hard to project it for sure going forward and we're not giving specific guidance on projections, but we've been pleasantly surprised that the newer transactions do not require setting aside much restricted cash and LCs.

Is there a structural reason for that? Why would you guys kind of expected that and it end up not materializing. Just trying to get an idea of that.

Some of that relates to location of where we find a deal. Certain markets are tougher with respect to having to post letters of credits and bonds and those kinds of things and others are less tough about those kinds of things. And in some instances we're getting deals that already have them posted and we don't have to post them ourselves, so it's a combination.

The other part of it is some of the LCs were tied up in deposits on land acquisitions and the sellers are being a lot easier today because there just aren't a lot of buyers and they would rather get price than be tough on LC conditions. So that's been helpful.

And just a follow-up. As it relates to Irene in the Northeast, do you anticipate taking any charges in the quarter related to inventory damage, et cetera?

No, we really had minimal damage. The issue really is delays in terms of for a few days there, as Ara mentioned, our whole divisional office was without power. Some of our communities had power issues and we couldn't get some construction done. So, we're talking about a few days of delay in terms of construction, but I don't believe we had a single house that was materially damaged. There may have been a little bit of damage of some kind, but nothing material.

Okay, great. Thanks.

Michael Kim with CRT Capital Group.

I know it's early in September, but just wondering if you could provide us with any sort of update on sales pace or even traffic if there's going to be or have you seen or witnessed any benefit or improvement in traffic since Hurricane Irene?

Yes, not only is it early, but we just had a hurricane and Labor Day, so we just can't give anymore color than what we gave. I think we're one of the -- we are on the leading edge in that we released August data. I don't think every builder gives stuff that currently, but it's just too early to give a lot more color.

I actually think that the last week in August was the week that was directly impacted by the hurricane, so our August results clearly already showed the impact, at least, of the weekend that Hurricane Irene occurred and that impacted not just New Jersey. I mean, North Carolina, Virginia, Maryland, Delaware and New Jersey and New York for us.

Even Pennsylvania.

Even Pennsylvania, yes. So, you got some flavor of Irene in our August numbers.

And just to think about liquidity, is there any update on your potential land sales out there and if there's any way you could provide us with an updated unrestricted cash balance?

No update yet. We do have a couple of contracts, but you know how it is in this buying or selling environment, so no firm update at this stage.

Okay, understood. Great. Thank you.

Okay.

Ladies and gentlemen, this concludes the question and answer session for today's call. I would now like to hand the call over to Mr. Ara Hovnanian for closing remarks.

Well, thanks very much and we'll look forward to giving you our next report at our year-end. Thank you.

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