Hovnanian Enterprises Inc (HOVNP) 2006 Q3 法說會逐字稿

Good morning, and thank you for joining us today for Hovnanian Enterprises fiscal 2006 third 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 replay will be available after the completion of the call, and run for 12 months. The replay can be accessed by dialing 888-286-8010, passcode 83553743. Again, the replay number is 888-286-8010, passcode 83553743. 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 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 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 over the conference call 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 third quarter. 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. We reported net earnings of $74.4 million or $1.15 per fully diluted common share for the third quarter ended July 31. For the trailing 12 months that ended July 31, we posted an after-tax return on beginning common equity of 28.3% and an after-tax return on beginning capital of 17.5%. Despite a slowing housing market, we have continued to generate strong returns. I wish I could say I see those same returns continuing for the next 2 years. I do not. But the returns have been very strong quite far into the market slowdown.

Slide 1, total deliveries excluding unconsolidated joint ventures, increased 17% in the third quarter to 4,623 homes. Slide 2, our contract backlog at July 31, again, excluding joint ventures, was 10,313 homes, up 14.2% from a year earlier. Backlog increased 12.5% in dollar value to $3.6 billion. Based on our current backlog and projected delivery schedules for many of these homes in our fourth quarter, we are reaffirming our guidance for the remainder of '06 with full year EPS projected in the range of $5 to $5.75 per fully diluted common share. We are also reaffirming our projection of consolidated deliveries of about 18,000 homes in fiscal '06, yielding total revenues of about $6.2 billion. We expect more than 2,000 additional home deliveries in unconsolidated joint ventures, bringing our total deliveries to over 20,000 homes. Due to continued fluctuations in the sales pace and pricing in many of our markets, we are not making a projection of deliveries or profits for fiscal '07, which will start on November 1. However, I'll update you on our markets and what we are doing to compete under our current market conditions. Then I'll turn it over to Larry to go through some more details in our results and our projections for the rest of the year.

Slide 3. Our net contracts for the quarter, excluding unconsolidated joint ventures, declined 19.2% compared with Q3 in '05 to 3,349 homes. Net contracts were down approximately 26% including joint ventures. Our net contracts for the quarter in unconsolidated joint ventures were down more than 65% to 249 homes. As a result, our backlog in the unconsolidated joint ventures declined 32.7% to 1,548 homes. Our level of activity in unconsolidated joint ventures has been declining primarily as a result of our large joint venture with the Blackstone Group that we created in conjunction with the Town and Country acquisition 18 months ago.

The Town and Country venture experienced significant sales in several communities in the third quarter a year ago, particularly in the Southeast Florida operation, and these communities were no longer actively selling this year. In addition, the pace of sales in those communities that are still selling are down. And in Southeast Florida, they are down significantly, as I'll talk about more in a moment. Furthermore, this venture has begun to wind down a bit as a result of its liquidating structure, whereby new communities in the 3 markets of Chicago, Minneapolis, and Southeast Florida are generally being acquired and developed on a wholly owned basis by us. We also had another separate joint venture on an individual community in New Jersey with significant sales and backlog in the third quarter last year, and that community is sold out now, thus leading to declines in the comparison for this year's third quarter.

While our consolidated pace of net sales was down 19% for the quarter, the number of new contracts indicates that there are a large number of consumers that are still buying new homes over the past 3 months. The overall new housing market is substantially slower, but it's far from dead. That said, sales pace and pricing continue to be a challenge. In certain markets, the sales pace may increase to desired levels after we offer new sales incentives, only to slow again when other builders offer similar or better incentives, thereby requiring further price cuts to spur sales velocity again. Due to this punch-counterpunch activity in the more challenging markets, I'd say the overall sales environment has not stabilized yet.

As you can see on slide 4, we ended the quarter with 436 communities, and expect to add a few more before the end of the year to more than 440 communities open at year end, which represents a 20% increase over year end of '05. In a minute I'll discuss our current strategy toward land acquisitions and take-downs, and why the number of communities had continued to grow. But it is clear that the significant decline in our pace of net contracts per community has been partially offset by our growth in communities, which has kept our absolute number of sales from falling more substantially and, thus, is helping to buffer the decline in our projected consolidated deliveries and earnings performance over the next 6 to 12 months.

Slide 5, on a per-community basis, our net contracts for the quarter, excluding unconsolidated joint ventures, was 7.7, a 39.8% decline from last year's third quarter contracts of 12.8 per community, and the lowest level of contracts per community during the last 10 years. We believe that once the buyer sentiment returns to more normalized levels, that our sales per community will rebound from the current low levels to a number closer to what we've experienced on average over the last decade. As a reminder, we report our contracts on a net basis, which means gross orders net of cancellations for the period. A significant part of the reason for our decline in new contracts -- in net contracts is the spike in cancellations that we've been experiencing. Our gross orders are actually not as far off as the net orders, down 8% for the quarter versus the third quarter last year, excluding JVs. Again, there is a level of demand out there in most of these markets. They are not completely dead.

If you look at slide 6, our cancellation rate for the third quarter was 33%, just a notch higher than the second quarter rate of 32%, but significantly higher than the 24% in last year's third quarter. In some markets we are experiencing cancellations at the closing table, making projections a challenge. To further aggravate the situation, the same homes are typically resold with added concessions later. On a regional basis, cancellation rates have ticked up the most over the past 6 to 9 months in Florida, Arizona, and California. Markets like North Carolina and Texas are experiencing below average cancellations and have not shown a noticeable uptick in the recent quarters. Generally, our sales performance in North Carolina and Texas has been holding up pretty well during the last few quarters, and this continued in the latest quarter. These markets did not experience the accelerated growth in pricing that attracted speculative investors and led to the current excess in resale inventories that is negatively impacting new home sales in the more heavily regulated markets, like Florida, California, Washington, D.C., and New Jersey.

On a regional basis, the decline in our sales has been the greatest in the West region, which is comprised of our California markets. Despite a 24% increase in actively selling communities, consolidated net contracts in the West were down 31.8% for the quarter, compared with last year. Consolidated net contracts in the Northeast only declined 4.1% for the quarter. However, we doubled the number of active communities in that region. This was helped a bit by the acquisition of Oster Homes in Cleveland. Consolidated net contracts in the Southeast declined 16.2% as a result of significant declines in the Florida market, somewhat smaller declines in Maryland and Virginia, and decent performance in North Carolina. Net contracts were down slightly in North Carolina, but only at a rate equivalent to the modest decrease in communities that we experienced in that state year-over-year. We are able to hold pricing fairly firm in our North Carolina markets, while we utilized incentives to spur current activity in contracts in Florida, Virginia, and Maryland.

Third quarter consolidated contracts in the Southeast also benefited marginally from our acquisition earlier this year of CraftBuilt Homes in South Carolina, and a full quarter of contracts from First Homes operation in Fort Myers, which occurred in the fourth quarter of '05. Consolidated contracts in the Southwest fell 21.3% for the third quarter, although this was largely a result of the falloff in our Arizona markets, as our Texas operations in Dallas and Houston performed slightly better. Consolidated contracts were down about 15% year-over-year in these Texas markets, with a flat community count in Dallas, and about a 22% increase in communities in Houston. Similar to North Carolina, we were generally able to hold pricing fairly firm in the Texas markets. The current slowdown is less noticeable in the less regulated markets, like Texas and North Carolina, that were more competitive over the past few years and experienced less price appreciation over that time frame, thus keeping speculators and flippers from coming into the market and messing up the supply/demand balance.

In most of our markets the growth in new home inventories appears to be the result of higher than usual cancellation rates, rather than builders starting higher levels of unsold homes. With respect to Hovnanian, we have 3,292 started and -- started and unsold homes at the end of July, excluding our models. As you can see on slide 7, our number of started, unsold homes per community has ticked up recently. At the end of April, we had 7.2 homes per community. At the end of July, it's up slightly to 7.6 homes. The increases are mainly due to cancellations on contracts where we had already begun the production of the home, and not due to a conscious decision to build more spec housing. Based on the recent sales pace, this represents about a 2.9 month supply of started and unsold homes, below the recent national average of a 5.3 month supply, which is based on completed, unsold homes. Despite more cancellations late in the process, very few of our unstarted -- started, unsold homes are actually completed.

We are unsure how long it will take to work through the overhang of resale listings in the more regulated markets, but slide 8 shows examples of the spikeup that has occurred over the past 12 months in resale listings for 4 of these more regulated markets. And in West Palm Beach, an extreme example, the inventory level is now equal to a 38 month supply versus the most recent market absorption pace. It likely needs to return to a 6 or 8 month supply that the -- that most realtors consider normal, before both the new home market and the resale market return to normal supply/demand balance. Will it actually take 38 months to work through the inventory? That's unlikely. First, the new sales are at an unusually low pace at the moment, partly due to buyer psychology. A return to what it was just a few quarters ago would dramatically reduce the number of months supply. Number 2, some owners will decide to wait for the market to firm up and delist their homes. And number 3, some investors will decide to rent until the market firms up.

The second factor which is compounding the slowdown further is a decline in overall consumer confidence, and particularly with regard to a decision to buy a home. The latest University of Michigan data that was released in August indicated a confidence index of 82%, near the lowest level since 1994. In July, only 57% of consumers thought it was a good time to buy a home. While still more than half, it is the lowest percentage since 1990, and well below the historical average. On a more positive note, 3.4% of families that responded in July said that they were considering buying a home in the next 6 months, which is in line with the historical average, and has actually trended up modestly over the past few months. The problem is that the price cutting and incentives being offered in the market and broadcast through aggressive advertising by many of the home builders, along with a steady diet of negative press on the declining housing market, has kept a large number of potential buyers on the sidelines, so they could see what's going on in this fluctuating housing market. Thus, they are postponing their purchase decisions. Essentially, they are holding out to see what kind of incentives they will get from a builder down the street, or if the incentives will continue to increase if they wait another month or 2.

Home builders have generally been surprised by the speed with which conditions have changed, and by the breadth of the slowdown in terms of the number of markets that have been impacted. What has made the slowdown surprising to builders is the broader economic backdrop is still very positive in terms of job growth and the relatively low mortgage rate environment. If you only view the macroeconomic factors today with the second quarter GDP growth up 2.9%, you would expect that the US housing industry would be much stronger than the conditions we are currently experiencing. Regardless, we are running our business today as if we are in a prolonged downturn.

On the cost side, we are addressing subcontractor construction costs and overhead as aggressively as we can in each of the markets that have been impacted by the downturn. Larry will elaborate more on this in a moment. We are setting our pricing strategy in each market based on the particular market conditions for each individual community. In some cases, we may offer more aggressive incentives and discounts. In other cases, we may choose to stay firmer on pricing and operate with a slower pace of absorption in order to maximize our returns, particularly if we are able to slow down our land takes under an option contract. In each case, we remain focused on competitively pricing our homes on a community-by-community basis to balance our margins and sales pace at an optimal level relative to market conditions.

Most importantly, we are reviewing our pipeline of land option contracts even more regularly and aggressively than we normally do. For our existing land option contracts, we are reevaluating the economics of each transaction and renegotiating wherever it is appropriate, based on the revised market absorption pace or pricing. We have achieved some success in renegotiating a number of contracts, but we've also walked away from some contracts that we could not renegotiate to a take-down schedule and price that made sense to us. Most of these transactions that we've renegotiated within -- excuse me, most of these are transaction that's we've renegotiated within the last 12 or 24 months, and thus the original option terms do not reflect today's market realities. We have found most land sellers beginning to understand the market conditions have deteriorated, and are working with us to renegotiate terms that allow us to move forward with the transaction. For our new land transactions that are under consideration, we are applying current net prices, sales pace, and costs. If it meets our IRR hurdles, subject to these more stringent, due diligence tests, we will proceed. But we are making no bets on a market recovery. Each land deal must work based on the continuation of today's slower selling environment.

We always use current sales prices, absorptions, and construction costs, based on trailing 10 or 12 weeks of time. In many of our markets today, the net sales prices are lower, due to the increased use of incentives and concessions, and the sales pace has slowed down. Construction costs are also higher in many locations, although I'm hopeful this condition will change soon. Nonetheless, this creates a situation where it becomes harder and harder to find land acquisition opportunities that pencil to our target rate. We do not have a corporate mandate in place that precludes us, or any of our divisions, from buying land. If they are able to find opportunities that meet our return requirements, we will proceed, and we do find opportunities. We maintain a disciplined approach, and continue to target an unleveraged 30% IRR on the acquisition of any new land parcel. While this is a high hurdle rate, it keeps us disciplined in good times and in bad times to ensure that we're not paying too much for land in the current environment.

As a result of the challenge in finding new land parcels that pencil to our hurdle rate for new land acquisitions, we experienced a 5% sequential reduction in the total number of lots controlled from the end of the quarter. As you turn to slide 9, you see that our land owned increased by about 1,800 lots, but the options were reduced by 8,500 lots over the last quarter. The renegotiation of land contracts has impacted our financials through increased write-offs of option deposits and some costs, as well as a modest increase in write-downs of owned properties. Over the last 5 years, we have averaged about $6 million per year in total charge-offs and inventory impairments. So far this year through 9 months, we have walked away from $18.6 million in options and predevelopment costs, and we've incurred another $2.4 million in land write-off impairments. This is obviously up dramatically from what we have experienced historically. Only $828,000 of the impairment charges were incurred in the third quarter, but $11.4 million of the option charge-offs were taken in the third quarter.

During the third quarter, we walked away from approximately 3,400 lots, which were spread across several of our markets. These charges have a negative impact on our current earnings, but the flexibility to renegotiate or walk away when the returns diminish is exactly why we enter option contracts in the first place. I'd rather walk away from a 10% deposit, than continue to own land that is devalued by 20%. Our strategy is to reallocate the capital to areas where we expect to produce superior returns. Approximately 68% of our lots were controlled under option contracts at the quarter end. This ratio is down a bit from the mid 70s level over the past few quarters due to the combined effects of 2 factors. 1, we are continuing to take down option land with high RRs thus moving them to the owned category, while walking away from options that no longer make economic sense. And 2, we have slowed down the pipeline of tying up land under new options to replace these contracts, thus leading to a fall-off in our percentage of land under options. However, our strategy is to continue to control land primarily through options. We believe this strategy gives us a tremendous competitive advantage of being able to renegotiate the timing of take-down schedules, the purchase price on land, or other terms, if we are not able to achieve the sales pace or pricing that we anticipated in the particular community.

Turning to slide number 10, you see that our aggregated option position for all of our lot options and the amount of aggregate deposit, which represents 8.9% on average of the total purchase of the lot. A lower amount of deposit at risk in a land option obviously gives us a better ability to renegotiate or walk away. There seems to be a lot of confusion and worry in the capital markets about the risk of inventory impairment charges for home builders. I can tell you that at this time, we do not expect to have significant write-downs or impairment charges on land positions that we own. Based on the accounting rules for such impairments to be recorded, a community's profit must decline from healthy and even super-healthy levels all the way down through all levels of mediocre profit margins to a level of break-even or loss, after ignoring go-forward interest expense and ignoring the vast majority of SG&A costs in order to qualify for an impairment charge. As a result, the vast majority of the charges we have taken this year are from walk away costs related to option deposits and predevelopment costs. We've only had to write-down land through impairment charges in the amount of $2.4 million year-to-date, despite the market slowdown.

Investors should understand that some builders will not necessarily be able to take impairment charges to the extend that they own land at prices that were contracted over the past year or so, but instead will be building through communities at lower levels of profit margins and returns for the next several years. That's exactly why we prefer the option strategy. We intend to renegotiate aggressively any such options that were contracted at prices which no longer pencil out, and we will walk away where we are unsuccessful in improving the returns back to reasonable levels. The charge-offs that we do incur on option deposits are small, relative to the implicit cost of building through hundred of millions of dollars of capital at mediocre returns. We plan instead to position the Company to be able to generate our threshold targeted returns again as soon as possible, even if market conditions remain as they are today. And our option strategy will largely enable us to do that. I'll now turn it over to Larry Sorsby to discuss financial performance and projections in greater detail.

Thank you, Ara. We've provided a fair amount of detail on our third quarter results in our press release and our detailed guidance as it is provided on our website. So I'm not going to spend a lot of time going through each of the specifics. Our third quarter results are summarized on slide number 11. Despite an 18% increase in total revenues, our third quarter earning per share declined 35% due primarily to lower home building gross margins, which were 23.4% for third quarter excluding interest, compared to a very strong 27.1% in last year's third quarter. Reduced margins in our higher priced, more heavily regulated markets due to the greater use of incentives, have reduced our gross margins for the Company as a whole. We are addressing subcontractor construction costs and overheads as aggressively as we can in each of the markets that have been impacted by the slowdown. We are seeing some success in negotiating with our subcontractors. In some cases, gaining only a 1% to 2% adjustment to contracted amounts. But in other markets where sales pace is more -- is off more significantly, we anticipate getting reductions in excess of 5% and, perhaps, as much as even 8%. While it's still too early to quantify what the total impact will be, we believe that we will get some relief, which should help offset some of the margin pressures next year.

As we opened more communities and increased advertising costs, we experienced an uptick in total SG&A as a percentage of total revenues, which was 11.7% in the third quarter, versus 10.3% in last year's third quarter. We realize that we need to hold over overhead expenses in line with our future production needs, and we're focused on reductions wherever possible. However, one of our primary goals is to deliver quality and value to our home buyers. In order to achieve this goal, we need to have the right number of capable and trained associates deliver the homes that we have in backlog. While we have had some surgical layoffs in certain markets, in the aggregate, our headcount has remained relatively steady, due to our significant community count growth. Much of our overhead spending, whether it's related to payroll, advertising, or other general expenses, happens at the community level. Even with our community growth, however, we expect our total SG&A ratio to stay in the range of 11.3% to 11.7% for the full year, and we will manage it carefully as we enter fiscal 2007.

If you'll now turn to slide 12, I'll make some additional comments on our projections for fiscal 2006, providing you with the details that were factored into the $5 to $5.75 earnings per share range that we are reaffirming as our projection for this year. The details of our summary projections for fiscal '06 are also available on the financial information page of the investor relations section of our website, at khov.com. We anticipate that the average sales price per community, excluding unconsolidated joint ventures, will be between $330,000 and $335,000 in fiscal '06, compared with $318,000 last year. The expected increase in average sales price in our markets is primarily the result of geographic and product mix in our deliveries, rather than an ability 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 the remaining 3 months of the year.

Based on the homes that we plan to deliver between now and October 31st, our home building gross margin should be in the range of 23% to 23.6% for the full year, excluding interest. This would represent a decline of 280 to 340 basis points from our 2005 gross margin. With our initial guidance for 2006, which we provided in December, 2005, we've projected the decline in gross margins to 140 to 190 basis points. The lower current expectations are due to the more prevalent use of incentives and increases in construction costs, land development, and other costs since the start of the year. In addition, our higher cancellation rates have meant that some of the higher margin homes that were in backlog earlier this year did not close, and had to be resold at lower margins.

For our fourth quarter, we expect deliveries in the range of 4,575 to 5,175 homes, and earnings of approximately $1.05 to $1.80 per fully diluted common share. While this may seem like a wide range of projected earnings for 1 quarter ahead, we are exposed to significant variations with regard to the amount of charge-offs we may incur in the fourth quarter as we continue to renegotiate a number of our land option contracts. We are likely to incur additional walk away costs in conjunction with some of these situations, and a certain amount of such costs is factored into our guidance for the fourth quarter. However, we cannot quantify the exact amount or reserve for them, until each land option contracts renegotiation is finalized, thus creating an additional variable in our forecast for the quarter.

For fiscal 2006, we're now projecting the total after-tax land sale profits to be approximately $27 million, compared $21 million of after-tax profits from land sales in fiscal 2005. These land sales are from a few large parcels where we strategically decided at the outset to sell some portion of the community. We still have 1 such land sale to complete during the fourth quarter. Our fourth quarter projection, which also includes a couple of smaller land sales, includes total after-tax land sale profits of approximately $13.7 million, or about $0.21 per fully diluted common share of net earnings. This large transaction is expected to close over the next 2 months. But if it slipped a month or 2, it will have an adverse impact on our fourth quarter earnings. For the remainder of '06, we continue to expect our effective tax rate to be approximately 38%, which will bring our tax rate for the full year into the range of 37% to 37.5%. The lower tax rate this year is due to a larger percentage of sales in Florida and Texas, which have lower state tax rates.

For the 2006 third quarter, we reported a loss of $3.2 million from unconsolidated joint ventures. This loss is primarily attributed to our investment in a large joint venture that is incurring costs, but not yet delivering homes, and a write-off of definite life intangibles in our Blackstone joint venture resulting from our decision to discontinue the use of the Town and Country trade name in Florida. This loss contrasts with a $13.9 million gain in last year's third quarter. This was a tough comparison, since we had a very profitable joint venture that delivered the bulk of its homes in last year's third quarter. Our investment in unconsolidated joint ventures increased modestly in the third quarter to $217 million as of July 31st, '06, from $212 million at April 30th, '06. Even as the joint venture with Blackstone begins to wind down, we have additional investments in joint ventures that we expect will generate significant deliveries and strong deliveries in future years. Due to the write-off of the trade name in Florida, we are now projecting total pretax income from unconsolidated joint ventures to be in the range of $22 million to $25 million in fiscal '06, versus $35 million that we reported in fiscal '05.

Our Financial Services operations continue to add to overall earnings. If you'll turn to slide 13, our pretax earnings from Financial Services increased 30% to $19.9 million in the first 9 months of '06 compared to pretax earnings in the prior year's first 9 months of $15.3 million. For the full year, we expect pretax earnings from Financial Services to be greater than $25 million. Turning to slide 14, our recent data indicates that our customers credit quality remains quite healthy. We experienced slightly higher FICO scores in the third quarter at 715, compared with a FICO score of 712 for all of fiscal '05. And we saw declining use of adjustable rate mortgages at 32% of total originations versus 40% for the full year fiscal '05.

I'll now turn to our balance sheet and credit statistics, which remain healthy. In this year's third quarter, we generated EBITDA of $165.4 million, which covered interest 4 times. And for the first 9 months of the year, we covered interest by 4.9 times. The ratio of total debt to EBITDA is expected to be less than 3.2 times as of the end of fiscal '06. EBITDA represents earnings before interest expense, income taxes, depreciation, and amortization. A reconciliation of our Company's consolidated EBITDA to net income can be found as an attachment to our quarterly earnings release. We ended the quarter with a ratio of net recourse debt to capitalization of 52.7%. It's not unusual for the April and July quarters to be near our seasonal peak for our leverage ratio. We anticipate that our average ratio of net recourse debt to capitalization will be close to 50% for the full year of '06. This level is in line with our targeted leverage goals and keeps us well positioned for the current market slowdown.

Recently a couple of equity analysts have published reports regarding stock option grants in the home building industry. After these reports were published, we decided to undertake a review our option grants over the past 10 years. It's still early in the review process, and no conclusions have been reached. If anything material is discovered in our review, we will inform you. Now I'm going to turn it back over to Ara for some closing comments.

Thanks, Larry. Before I wrap up, I'd like to take a few moments to talk about our allocations of capital as we go forward in this current slower housing market. As I said before, our land pipeline of new opportunities is slowing down. At some point in the future, if our growth rate for new communities remains slower, we'll begin to generate excess cash, which would be available to reduce nominal levels of debt, pay dividends, or repurchase shares. We still have a number of communities in planning that have been tied up years ago, and the current economics on those communities still make sense. As we commit the remaining capital to take down this land, our investments in land will remain at or above current levels, and total inventories are likely to increase through at least the next few quarters. But if current market conditions persist, you can expect to see our cash generation increase toward the middle or end of '07. We'd like to deleverage our balance sheet a bit further so that we can build up some dry powder to use for future acquisitions of land parcels, of land portfolios, or outright acquisition of other home building companies.

While we remain extremely cautious in our M&A activity today, we recognize that acquisition opportunities are likely to present themselves in the current environment more than in the boom times. Moreover, when they do, we want to be in a strong enough position so that we can move on them if they are a viable, strategic fit for our Company, and are priced to make good returns for our Company. As a wise philosopher once said, I see all of these wonderful opportunities cleverly disguised as problems. These are the times when opportunities arise. For the time being, we will continue to repurchase shares only at a measured pace, which more or less offsets the shares that are issued, either through stock -- through stock options or stock plans that many of our senior executives participate in. Although our stock is severely undervalued, we intend to maintain only the current pace of share repurchases at this time. We bought back 375,000 shares of class A common shares during the third quarter, bringing our total year-to-date to 675,000 shares. This leaves our current authorization for repurchasing at 813,000 shares.

At July 31, '06, as shown on slide 15, common shareholders' equity was $1.92 billion, a 29% increase from the $1.49 billion at the end of the third quarter of '05, continuing a very healthy growth trend. Based on current projections for fiscal '06, we expect common shareholders equity to grow to approximately $2 billion by October 31, '06, which is equivalent to about $32 of book value per common share. Our shares are currently trading well below our projected year-end book value, as you can see on slide 16.

In conclusion, conditions in most markets have not improved, and buyer sentiment remains poor. We've been vigilant to ensure that we are prepared for the future. We're redoubling our sales efforts through increased advertising and through further training of our sales associates. We are proactively negotiating with our subcontractors to have them absorb some of the burden in this slowdown. And we remain disciplined in our efforts to acquire new land parcels that meet our stringent return requirements. I'm confident that the lessons we have learned over the past 47 years that we have been in business will serve us well, and that Hovnanian will exit the current slowdown in a stronger position, as we have done in the past down cycles. That concludes our formal comments. And I'll be glad to open up the floor for questions.

[OPERATOR INSTRUCTIONS] Margaret Whelan, UBS.

Actually, it's Dave Bogert on for Margaret. My question -- my initial question was on cancellation rates, and kind of how they fared over the quarter. Where you guys think cancellation rates are going to plateau. And what's driving the increase? I mean, is it people who can't sell homes? Are there still speculators there? And how frequently you're kind of capturing the deposits of these buyers.

Yes, well, I mean, the positive news is we're starting to see a flattening of the cancellation rate. We were at 32% last quarter. We're at 33% this quarter. So it is definitely flattening. And what we are seeing is most of the cancellations are some of the older buyers. In some cases, they're the older investors. In some cases, they're older buyers that see price are coming down. In some cases, they can't sell their current homes for what they anticipated selling them for. And that causes them an issue. So it's all over the place. But if I were to guess, I'd say we're going to see that cancellation rate leveling off.

And in terms of the amount of the deposit that you're capturing -- ?

They vary all over, from a high of 10% in the Northeast, to 3% in California. It really varies market by market.

I think the question might have been, how -- what percent of time do we keep them.

Exactly, Larry.

Virtually 100% of the time we keep the deposits.

Yes.

Okay. And then my follow-up question was really about -- Ara, you talked about this kind of downward spiral, where you go out and you give price cuts, and then that works to increase sales pace. And then everyone else in the market does the same thing, so you have to cut again. I guess, if you could give us an idea how you operate, and how you think about, you know, when you're in a market where that's going on, how do you react long term, since you realize it's a downward spiral? And then just kind of drawing off your historical experiences, how -- when does that reverse? How does that stop?

You know, every situation is different. And I don't want to give this -- give the impression that this is going on in every different geography. It depends on how many lots builders are holding. Are they just trying to -- in some cases, for example, if we know they're reducing pricing or increasing incentives because they want to get out of the last 10 or 15 homes, then we may be patient, and wait for them and not do anything. Wait for them to finish, and let that little market stabilize a bit. If they've got a fairly large inventory, but we don't, then we may get aggressive, and just finish ours up and move on. Every situation is really quite different. The one fortunate thing is we do not hold a big land-owned position, and that's one thing we just keep coming back to. If you are long land and values come down, you have no choice but to continue to discount and really work through your inventory. In our case, we'd rather write-off the options, free up our capital, and hopefully repurchase the land, potentially at a lower value a little later. So the answer is, I can't answer it. Every situation is very different.

Okay. Thank you. I'll requeue.

Larry Taylor.

I wonder if you could elaborate a little more on the amount that you think the balance sheet may grow. And as your investing in these communities over the next several quarters, how you're likely to balance the -- keeping the balance sheet strong versus investing in these communities.

Generally speaking, we're still adhering to our internal target of net recourse debt to cap of 50%. And even with these conditions, we don't particularly see that changing. I'd like that to come down a little bit. Some of that depends on what we do with some of the options we're renegotiating on. Do we -- if we walk from a little greater percentage than we planned, we'll come down further under the 50%. Could we tweak up above it a little bit for a couple of quarters? That's possible. But generally speaking, we're pretty much planning to adhere to our own internal target.

But I guess maybe thinking about it another way, I'm trying to reconcile the incremental investment in community growth and in land in the face of what looks like significant declines in order levels.

Some of the investment that we're making is on land that we optioned years ago, that continue, even in today's pretty draconian sales environment, to generate strong returns. So we're taking that investment down and, therefore, investing dollars going out the door in inventory. But only where it generates acceptable return. So that's kind of how we look at it. In terms of what Ara was talking about in terms of tying up new land, it's the same kind of theory. Taking recent, very low, by historical averages, sales paces. Today's lower sales prices, including incentives and concessions, and higher construction costs, and if we can tie up a parcel of land and generate a 30%-plus internal rate of return on it, we still think it's a wise investment. This is a cycle, and we're going to come out of it, we're going to be well positioned when we do come out of it. We're not going to overleverage to tie up too much. But if we can find great investments, we're going to make them.

And you're confident that the assumptions you're using now reflect current market conditions and how things are unfolding?

Absolutely. Not only today, but they always have.

Okay. Thank you.

Now, current market conditions are obviously changing, and they're different this quarter than they were last quarter. But, we look at -- whereas in the past we'd look like back 6 weeks -- excuse me, 6 months, or even a year to get absorption pace and pricing, now we're looking much more currently at a 10 to 12 week history.

Okay. Thank you.

Stephen Kim.

I wanted to follow-up a little bit on the cancellation rate issue. You -- I guess from your commentary, it seems to suggest that you haven't seen, in the last month or so, a meaningful departure from the kind of cancellation rate that you reported this quarter. Is that a fair statement?

Yes.

Okay. Now, that means that there's been a bit of a divergence between yourselves and at least 2 of your peers, at least the last 6 weeks. So I wanted to go into that a little bit. Can you talk to us about how you handle the order taking process, perhaps to ensure that you are not exposing yourself to folks who may be canceling in the future? Do you have any -- is there anything that a builder can do to protect itself perhaps from the kind of buyer who may be more prone to cancel on you in the future? Can you just talk to us about how you handle that?

Well obviously, in certain markets we have a sizable deposit. And once they get through the mortgage qualification, their deposit is at risk. There aren't a lot of buyers that are buying today that aren't serious buyers. There aren't many investors at all in the marketplace today. So, I'd say the new buyers that are coming in are pretty serious buyers. A good indication, by the way, is once they sign a contract, then they go to our design home gallery. And if they go to that step, and they're recent buyers, they're probably pretty serious. And we're seeing pretty good trends in that regard.

When you mean a significant deposit, can you give us a sense for roughly what kind of a deposit you hold?

Well, again, as I mentioned in an earlier question, Steve, in the Northeast, it's 10%. In California, by state law it's only 3%.

Right.

And some markets, in some of the Texas markets, it could be less than that. So -- .

So de facto in that example, it's easier in California for someone to walk away, than it is in a D.C., or a Florida, or New Jersey, because we have more meaningful deposits. So, it's just a risk of the business from that perspective, because they're statutorially driven.

Sure. And what's interesting, though, is of course you have a significant exposure to California. You have a big business there in your cancellation rate, which was somewhat similar to Beezer and KB's last quarter. Looks like theirs went up to about 50. And yours has sort of stayed sort of in the level that it was.

I will tell you that in California, our cancellation rates are meaningfully higher than our average.

Sure. Sure.

Okay? So -- .

It seems to me that the big driver to cancellations, isn't, as you said, is not speculators. But it seems to be basically folks who are finding that they can't sell their home. And I think a critical tenet to the idea that cancellation rates will decline in the future, would be that buyers today are altering their behavior in the way they are handling the sales process for their own home. In other words, maybe 6 months ago or a year ago, they may have chosen to buy from you, and then wait until the very last second to put their house on the market to capture all the gain. And now, because they recognize it's a more tough proposition, they don't want to lose a deposit, they begin that process earlier. Do you have any evidence to suggest that that change in behavior of marketing their own home is actually happening, or is there anything that you can do to help make that happen?

Well, we are doing things. There are outside realtors that will come in, give them a fair appraisal, and do guarantees at certain prices, and so forth. The other thing that is occurring besides the buyers doing a little different process, is their expectation for what they can get in the sale is changing a bit. I think 9 months ago, they were expecting X, and today they're now expecting .9 X. That helps. And secondly, I think they're taking that lower expectation, and calculating what they can afford. So based on the lower expectation of their current home, they're saying, "Gee, I really wanted that 3,700 square foot house with the granite countertops. I'm now going to have to settle for the 3,400 square foot house, and I'll just go for Corian and stick with the American cabinets, rather than the fancy Euros." That kind of more rational process is going on right now.

Got it. Okay. Thanks very much, guys.

Ivy Zelman.

Actually, Dennis on for Ivy. Just my first question has to do with the comments Ara, you made about the potential for write-downs. I'm thinking about some of the acquisitions that were done within the last, say, 12 to 18 months. Do you see any risks there, aside from maybe the brand names if you pursue a rep similar to Town and Country?

No. What -- first of all, we do not, and have not, since they changed the accounting rules to disallow amortization of goodwill. We don't book anything -- any of the premiums to goodwill. So that helps mitigate the risk dramatically. Instead, most of our premiums in the past have been assigned to either stepped up land assets, which we've been amortizing regularly, much of which has been expensed, or definite life intangibles, which amortize regularly each quarter. What happened in the Town and Country transaction in Florida, we decided to change -- part of the definite life intangible was the value of the trade name. But unlike most of the places where we leave the trade name in place for a while, in southeast Florida, for a variety of reasons, we decided to convert there, and Minneapolis, we decided to convert to the Hovnanian name. And therefore had to accelerate that amortization. We don't really anticipate a lot of other changes in that regard at this moment.

You believe the assets themselves, are safe?

Yes, we do.

Okay. And then looking back to, I guess it was 1997, you guys wrote-off, I think the equivalent of maybe 15% of the book value. What has changed in the way that you approach the land underwriting business today versus then, that you feel that that type of write-down isn't a potential?

One thing you need to keep in mind on that '97 since you brought it up, is I believe that is the year that we exited our income producing property business, and a substantial portion that write-down had to do with exiting building retail strip centers, flex office buildings, and that kind of thing. So I don't think it was reflective of our residential home building operation.

Okay. Fair enough. If I could just ask one quick one on the comments you made in Texas and Carolina, with regards to the demand not seeming to be driven by investors. The data, whether it's new homes, it's probably more on the existing side, reflects the opposite. What do -- what are you doing as far the capital allocation in those markets to make sure that Texas and Carolina don't turn into what we're seeing in a lot of other markets, 6 or 12 months from now?

Well, I'm not sure why you would say the data indicates otherwise. But generally speaking, Texas and North Carolina are some of the safer markets from the land perspective, because the land we build in both of those markets primarily on optioned, developed lots that have a minimal deposit amount. So the land risk and land development risk, land deposit risk, is probably the lowest of any of our markets in those particular markets.

Okay. But if the buyer ends up changing their attitude like they have in other markets, it could still impact absorptions, which seems to be the driver in some -- .

Sure. And if that happened, we'd have to walk away from the deposits. If the community didn't make any economic sense. I'm just saying, that's easier to do in those markets than anywhere. But keep in mind, there hasn't been the big price run-up in those markets. So there's just a little less fear in those markets. The housing prices have been fairly stable there.

Okay. Fair enough. Thanks again.

Dan Oppenheim.

Wanted to ask one question in terms of the underwriting on new land investments. It seems when you're talking about the sort of during the stronger times, you'd look at the past 6 months of sales activity, would seem to be conservative since you're using lower prices. But now, if you're using the past 10 to 12 months, that's still likely to be higher -- .

No, 10 to 12 months. 10 to 12 weeks.

Sorry, 10 to 12 weeks. But still higher, given that you said that we haven't had unstabilization yet. Why would you not use something that would be sort of more conservative than what we've seen over the past couple of months?

Dan, what we have done, because we do believe that the market is not yet stabilized and, therefore, there's likelihood of continued slower absorptions and potentially lower sales prices, what we've said is to our divisions is it has to achieve higher than our hurdle rate, rather than just our hurdle rate. So we're trying to buy land today at tomorrow's prices. And if we can find deals that pencil on that basis, we'll do it. So we do kind of factor that in, just not on a basis that we think that home prices are going to decline another blank percent, or absorption is going to change another X percent. We're not smart enough to figure out how much of that may or may not be. We just increased our hurdle rate.

And specifically, our hurdle rate's the same, it's 30%. Up until recently, it just hit 30, that was fine. We're edging it up. And we say, okay, our hurdle rate's 30. But we'd really rather see land deals that are at the 34% range plus, and that gives us a little wiggle room if it does slow down further.

All right. Thanks. One question then, in terms of the spec homes. If we look at that in terms of 2.9 months right now, at what level would that have to be before you would say to the people in the field, really go out there and make sure that the buyers buy one of the spec homes, rather than starting something new, just to sort of minimize your risk on that front?

Dan, I think many of our divisions are making those kinds of decisions each and every day. Those aren't mandates coming from corporate, across the country. It's market specific. We've got very bright individual group presidents, area division and region presidents out there making the right business decisions each and every day. Much of the increase in the started unsold, as we mentioned in the script, was associated with the high cancellation rate, rather than a conscious decision to go start more homes. So we're very focused today on selling the started, unsold homes in each of our markets. But there's not going to be a corporate mandate, as you suggest.

But keep in mind, first of all, it's 2.9 months of started unsold. As soon as we put a stick up, we call that a spec. So it's really not a very big level of completed homes. But number 2, we charge all of our divisions internally 12% per year, so they're very focused on the -- their cost of carrying a spec. And third, their bonuses are determined by a return on investment. So not only do they get the interest charge, but their investment levels blow up. So, without us policing every single spec, they have a lot of self-motivation to keep their spec levels at a minimal level.

Thanks. Just -- do you think, should we expect that 2.9, though, to then go down, say, during the fourth quarter of the year, the first quarter? Or at least stabilize?

It really depends on what happens to cancellation rates. If cancellation rates would decline, you'll see that start to come down. But if cancellation rates continue at the current high level, we're starting homes today thinking we have a buyer, and if later they cancel out, that turns into an unsold spec.

But generally speaking, we would anticipate those levels coming down a bit.

Okay. Thanks very much.

Alex Baring.

I was hoping -- this one's more, I guess, a strategic question. How are you guys handling markets where a lot of your competitors are basically spec building entire communities, and you guys are saying you're trying not to do that? How are you competing in those markets? And how do you think about that?

Well, I mean, we do that all the time. That hasn't changed. There are advantages to not building, or not buying a spec home from the customer's standpoint. They can make their own selections. In some cases, it gives them time while we are building the house for them, to sell their own home, make their own moving plans, and so forth. So, we've always found a market to compete with builders that are primarily spec home builders.

So you don't believe in the theory of trying to liquidate the land ASAP by spec building?

Not particularly. We really haven't changed our -- I mean, some of our divisions have the latitude. One of our 2 divisions in Houston typically uses specs as its normal methodology of selling homes. And in California in some places, they tend to do it a little more. They build a phase at a time, not necessarily always have it presold. But whatever that strategy is for a particular division, that has not changed to try to liquidate land at this point.

In the aggregate and on the whole, Alex, as indicative by our lower than national average month supply of started unsold, we're not a big believer in build them, and they will come. We prefer the "sell them and then build them to order" kind of model. We think there's less risk involved in that rather than sinking more money in, and then having to take even steeper discounts. But there isn't a one-size-that-fits-all even within our own Company. But that's our general flavor.

Got it. Thanks. And when you say started but unsold, you said you don't put a stick up, or when you put a stick up. How exactly do you design a spec home? Is it when you put a slab down, when you pull a permit? I mean, what -- ?

No, it's once we go beyond a slab. The first stick in the air, it's got to be vertical.

Okay. Got it. And my second question has to do with your joint ventures. Just wanted to clarify. You said you took some sort of write-off for the brand name this quarter. So what would have the earnings been without that write-off? I'm just trying to get a sense for what the margins are in the stand-alone business or -- ?

It -- we only have a percentage. It's in the joint venture that actually took the impairment. It's not on our books, is the first point I'd like to clarify. But the impact to us of the impairment that the joint venture took was about $6 million pretax reduction in earnings from joint ventures.

Okay. So if I just back that out, I can sort of get a stab at it?

Yes.

Okay. Thanks a lot.

Michael Rehaut.

Thanks for the call. Just wanted to ask a question about the acquisition comments that you made before. You had mentioned that you could see some consolidation likely, maybe not in the near term. But how do you go about that in terms of valuation? Right now with your valuation at below book value, would you be looking at other assets, either private or public? I mean most of the other public comps are probably on a book value basis higher than your Company. So what goes into the decision making process either on a public or private side from that perspective?

Well, generally speaking, we really -- book value is an interesting component. But we really look at a return on investment, and in some cases IRR on our investment. Frankly, the challenge at this moment, and the reason why we really have not been active recently, is the absorption and sales pace has simply not stabilized in most markets. So it's okay on an individual land opportunity to take a little bit of risk, particularly because we just try to exceed our hurdle rates and it gives us a little cushion. But I wouldn't want to take a larger transaction and make that bet at the moment until we feel like the market or a given market has hit the bottom and bounced along the bottom a little bit. And then we can say, okay, the market has stabilized. The house -- housing for this type of housing sells for this much a foot net of all concessions, and it's been at that level for 4, 5, 6 months. And the absorption now has been steady for 5, 6 months. It has -- it doesn't keep dropping or fluctuating. We'd really want those conditions to exist before we get active in the M&A area again. But what -- this is a good time still, to look at opportunities, to understand companies. So that once those environmental conditions return that I just described, that we'd be able to act on some great companies.

Great. Thank you. And just -- on the follow-up, I was wondering if you could give any color of the trends during the quarter, as I think it was mentioned earlier by another person on the queue, that other builders have seen conditions worsen markedly over the last 2 to 3 months. Was there a change -- I mean, how did it progress in terms of the order trends. And was there a point during the quarter where you became more aggressive on the pricing or the incentives to perhaps jerk back a possible weakening during the quarter of trends, if that was the case?

Let me just first clarify that the question was, did our cancellation trends change.

I think -- I'm kind of referring to both order trends and can -- ?

I know. I'm just trying to clarify what we've already answered. And what we said on cancellation is we didn't see it change materially in August. With respect to sales pace, I think our sense of the markets - and every market is kind of different - is that many of them have weakened somewhat during the quarter as the quarter progressed. We've not really seen the market stabilize in any particular individual market, especially the higher regulated. Pricing concessions, probably pricing down concessions are up in the month of August, would be kind of our observation, as well as this kind of punch, counterpunch environment that Ara mentioned in the call, persists in many markets.

Great. And that would include D.C.?

Yes.

Great. Thank you.

Susan Berliner.

2 questions really, I guess are related. I think you guys had talked a little bit about starting to generate free cash flow in the mid to late '07. Is that correct?

Well, depending on what happens in the market, we think that that's -- if the market remains slow, that that's likely to occur in mid to late '07. Just depends on what happens in the market.

Now, Larry, does that, I guess in light of you having about $273 million on your bank line, I guess if you can tell me how you're going to address that, if we can assume at your end it would be much lower than that. And then how you would go about debt repayment. Is it just looking at your maturities?

Yes, I think the way you need to think about it is what we've been very consistent in saying for the past 5 or 6 years, which is we target a debt-to-capital ratio of 50% net of cash on the balance sheet. We believe that we're going to be right around that 50% level at year end. So you can back into what you think might be on our revolver at that point in time. Going forward, as we earn $1 of equity, we'll match it with $1 of debt, if we can find good investments to invest it in. If we can't find good investments, we will be generating excess cash. That excess cash first, we'll use to pay down the revolver. We might after that opportunistically buy back some of our public debt, if we can find it. We may just have cash on the balance sheet waiting for great opportunities for a while. But we don't have a preset, absolute plan on how we're going to put it to work.

Okay. That's helpful. Any sort of kind of targeted free cash flow for '07?

Nothing that we're going to make public at this point.

Okay. Thanks very much.

Carl Reichardt.

Just on the renegotiation of the option contracts, Larry, are those renegotiations all lot price takedown? Or are they pushout of takedown timing?

Both.

Is there a quantification you can give me, maybe, Ara, on what percentage would be one or the other?

No. Some of them have both. No. Every -- it's just impossible to really track it. And it's not relevant for us. All we care about is whether it's through extended takes or through price or a combination, that we can get to our targeted IRRs.

On an extended take, I'm assuming that the option holders can ask for more deposit, though, right?

They can ask for a lot of things. Doesn't mean they're going to get a lot of things. And we have to weigh every individual situation. And if we don't have a lot of deposit up, they can ask all they want. And we'll consider walking, if that makes more sense. If we have a bigger deposit, then we may consider it.

Okay. And then 2 other quick ones. Do you have your traffic count for this quarter, relative to third quarter last year?

Not at my fingertips. But maybe I can get back with you later today on that one, Carl.

Okay. Fine. And then just, if you're looking at deliveries, let's say for fiscal '06, what's your guess as to percentage attached versus detached for you guys?

Again, not something we'd have at our fingertips. We could follow up -- .

We don't even track it on a quarterly basis that way. We don't really -- we don't pay attention to whether it's attached or detached in our internal reporting data.

Okay. Thanks, guys. Appreciate it.

Steve Fockens.

Just 1 question. I certainly understand that taking on what looks to be older land with attractive return hurdles makes sense. But if I step back and look at your historic firm-wide average return on invested capital, let's say over the last 10 years, is around 15%. The last 5 years, around 20%. Both very attractive. But if you take your current balance sheet and assume it's the same at year end, your year end or your '06 return on capital is going to look like about 10%, or maybe half the level of the last 5 years. So how do I reconcile the math on that. Is it the new projects that you're bringing on are actually offsetting even weaker returns at the older ones? Or is it just a lag when you expect returns to pick up? How should we think about that?

We've not been able to isolate ourselves from the downturn that the whole industry is experiencing. And as evidenced by our decline in profitability year-over-year -- .

Nonetheless, I'm confused by your comment that our return on capital is the lowest in 10 years for '06. We absolutely -- .

17% on the trailing 12 months.

Yes, I mean, it's actually very high for our industry. And it's not the lowest. So maybe I could suggest after the call if you follow-up with Jeff O'Keefe, he can work through your numbers, because I would guess there seems to be an error.

Well, I mean, your invested capital currently is going to be 50% higher than a year ago. I'm looking on the average, not a beginning period. Maybe that's some of it. But -- .

That could be it. And again, I think it would be best, rather than go through the formulas right at this moment, if you handle it post-call.

Fair enough. But maybe the better question to ask is, maybe what are the assumptions over the next sort of 2 to 3 years for the outlook of the business as a whole to get returns back up to where you'd like them? Because conceivably if you keep, let's say, aggregate investment in the business flat the next 2 to 3 years to get back to where you've been recently, at least on an average basis, you'd have to see a big jump in income. Is that -- are you -- ?

I would say the returns on equity and returns on capital that the industry saw over the last couple of years are not sustainable levels. And I don't think investors should look at those as targets to return to.

We actually said that at the time.

Yes. I mean, we had numerous years of 30%-plus after-tax returns on equity. I mean, that's way, way above the S&P 500. Those are just not sustainable, normal levels. But can the industry generate very reasonable returns, better than average of the S&P 500, maybe at a 15% to 20% ROE on an after-tax basis? Yes, I think that is very doable. It may not happen over the next year or 2. But I think as the market corrects, as land prices come down, as a variety of costs get in line, I think that will happen.

And as demand normalizes, the buyers come back into the market that are fence sitting right now, I think that will have an impact, as well.

Okay. Fair enough. Thanks.

Tim Millway.

I'm particularly interested in the Florida market. Can you tell me what the average deposit is in Florida? And do you have any information as far as lots option contracts that you may have walked away from in that state?

We have walked from some.

We did in the second quarter, one significant parcel in West Palm Beach. I mean, in general, that Florida market, especially the southeastern portion of the state, is -- if it's not the worst market in the country, it's one of the top couple of worst markets in the country. Florida in general has been hit harder than many other markets throughout the country. Deposit-wise, anybody in the room -- ?

About 6%.

About 6% in Florida for deposits. That answer all the questions?

Yes, thanks, guys.

Bernie Casey.

I'm looking at your backlog, I guess at year end, was about 14,900. Now, your backlog is 10,300. So it seems like things in the backlog at year end, most of those should have been delivered, inventory built, they were delivered, it seems, if you think 9 months to a year. I'm just curious, why has your -- your inventory is up a billion over that same period? Will it decrease a billion if sales rates stay the same over the next 12 months? Or when is inventory really going to become a source of cash?

Well, we've tried to answer that a couple of times. And I'm going to stay with the same response that we said in the script, and on a couple of questions subsequent, is that we think that if market conditions continue to be at slow levels, and we're not able to reinvest current excess cash that we're generating and the new deals that generates superior returns, at that point, we would begin to spin off cash that we could do other things with. Best guess on that is, the latter half of '07, if the market continues to be weak.

But what are you doing with this -- it seems like right -- ?

Well we increased our community count from 323 at the end of last year's third quarter, to 436. So that's 113 additional communities that we built model homes in, we take down land in. That's where the inventory went.

Yes, I mean, interestingly, you could say, well, that was a good thing or a bad thing. 2 of our peers reported their last quarter's contracts today. One was down 48%, one was down 43%. We reported, and we were down 19%. Now, part of the reason for that is we happened to open more storefronts. And that's where our inventory dollars are. One might say that might be a brilliant move. One might say it might be a dumb move. But it's the move that we made. And it's helping us in new sales. I'm quite certain our sales would be less had we not invested any additional inventory in new communities, because our sales pace per community is down.

And I can assure you we wouldn't open a new community on land that we controlled by option if we didn't think that it was generating an acceptable return on capital at the time we were taking the land down. So we have the luxury of making that decision since 70% of our land is controlled by option on a community-by-community basis. And that's exactly the analysis we're going through very rigorously each and every day here.

You guys had given us the number on unsold homes, but you didn't give us model homes. How many model homes are there now?

Hold on a second. We'll tell you that. I mean, we publish this data in our Q every quarter. I think it's around 300. Hold on, and we'll tell you the number.

And I guess while you're looking at that, what other -- I mean, I know -- I'm just curious, what's the dollar amount of, I guess, investment in those incremental communities?

350 models.

I guess besides the actual model homes, I mean, what's the dollar amount of other incremental investment for -- ?

Well, like land would be one of them. And depending on whether we had to take the entire parcel down, or whether we only took down 25% of it, or 50% of it. You have to put in streets.

-- Specs maybe, the dollar invested -- .

No, I guess if you guys have to build like. I don't know, lakes or common areas, or -- I'm assuming things like -- ?

Depends on the community, but the answer can be yes or no to each one of the things that you'll tick off, depending on where the community is, and what's planned for it.

Thanks.

[OPERATOR INSTRUCTIONS] Dan Oppenheim.

Just 1 quick question. was wondering about just how I should think about the fourth quarter in terms of order trends, and how many orders you had in the fourth quarter of '05 related to First Home Builders after that was -- after that acquisition was completed at the start of the fourth quarter last year?

Dan, as I think you know, we don't publish individual data for any of the acquisitions that we make. So I can't answer your question with respect to what we did in the fourth quarter last year with respect to First Homes. What of the other part of your question?

That was it. Thanks.

[OPERATOR INSTRUCTIONS] Bernie Casey.

I guess out of that -- the options, if you have about 500 million in options on the balance sheet now, what percentage of that would you consider is in the money? Or does it -- would not -- would be economical to exercise right now?

You mean how many of those -- what percentage would be generating acceptable returns that we would take the land down? Is that kind of your question?

Yes.

You know, we -- I think the majority, the vast majority of it is at this point in time. But I'm not going to give you a precise percentage. But the vast majority of it we still think generates acceptable returns.

And the ones that are not, we are having good success renegotiating them. Many have been renegotiated already. And we're having good success renegotiating the others going forward. The good thing about land options, the sellers are not blind. They read the newspapers, too. They know that other builders' appetites have changed. Their valuations have changed. And if we're not buying, or at least if we feel the values are lower, chances are our competitors feel the values are lower, as well. So they're getting more and more willing to talk and renegotiate.

Thanks.

Joel Locker.

Just wanted to get the percentage commission that you're paying outside brokers currently.

It varies by market. Sometimes we really don't have a co-proposition at all. And sometimes, 40%, 50% of the homes that we sell in a market have participating brokers. And it ranges, I don't know, Ara -- ?

2% to 3% is typical. Occasionally, to move a particular community, there may be a [inaudible] to bring it to 4% or even a full 6%, which is a normal full commission. But in that range. We have heard very isolated cases where there are extreme commissions being paid by our competitors. I've even heard 10% bantered about. But they're extremely isolated, and we're not doing anything of that magnitude.

But as a company average versus 12 months ago, are -- would you say they're similar, or up like a 1.5%, or -- ?

I'd say maybe up a very small percent. Not much at all.

Not even a percent? A full percent?

Probably not.

Yes, probably not. You know, in some markets, like the Northeast, we barely use outside brokers. So on average, probably a little less than 1%. But, I'm just shooting from the hip. It's just not a major strategic thrust, and not one we're pushing as a general tool.

Right. And just your noncontingent buyers, maybe your borderline, like 650 FICO scores, are they having any more difficulty getting outside loans for actually just because default rates are a lot higher than they were a year ago?

No, I don't think -- there's been some underwriting criteria tightening on what I'll call the exotic mortgages that has been going on the last 12 months or so, interest only, adjustables kind of stuff. But other than that, there's really not been any significant change in underwriting, and no difficulty getting them loans than it was a year ago.

Right. And just the last question on the material prices. Just especially like on the gypsum and cement front, do you see any price breaks coming in the fourth quarter? Maybe the first quarter of fiscal '07?

I wish I had a crystal ball that told us those things.

The good news is, lumber, at least, has been a lot more kind. And that certainly is a very high component of our costs.

Right. But as of right now, no price breaks on gypsum or cement?

Not that I'm aware of. But to be honest, I just don't track every commodity week by week. So I couldn't tell you.

All right. Thanks a lot.

This now concludes our Q&A session. So I will now turn over the call to management for closing remarks.

Thank you very much. As you know all too well, it is a challenging marketplace that's in transition. We're proud of the results that we are generating. And we look forward to continuing to give you good reports in future quarters, considering the marketplace. Thank you.

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