Hovnanian Enterprises Inc (HOVNP) 2007 Q2 法說會逐字稿

Good morning, and thank you for joining us today for Hovnanian Enterprises fiscal 2007 second 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 in the Company's distribution list. There will be a replay of today's call. This telephone replay will be available after the completion of the call and run for one week. The replay can be accessed by dialing 888-286-8010, passcode 44220838. Again, the replay number is 888-286-8010 passcode 442208. An archive of the Webcast live will be available 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 second quarter results and then open up the line for questions. The Company will also be webcasting a slide presentation along with the opening comments from management. The slides are available on the investor's 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'd like to remind everyone the cautionary language about forward-looking statements contained in the press release also applies to any comments made during this conference call and to the information in the slide presentation. I would now like to turn the call over to the host, Ara Hovnanian, President and Chief Executive of Hovnanian Enterprises. Ara, please go ahead.

Thank you very much. Boy, I think our first order of business is to make sure our next Operator can pronounce the name fast and properly. Good morning, and thank you for participating in today's call to review the results of our second quarter ended April. Joining me today from the Company are Larry Sorsby, Executive Vice President, and CFO, Paul Buchanan, Senior Vice President and Corporate Controller, Brad O'Connor, Vice President and Associate Corporate Controller and Jeff O'Keefe, Director of Investor Relations.

Overall, the housing market remains very challenging. If you turn to slide one, you see that for the second quarter of '07, we reported total revenues of $1.1 billion, down quite a bit from last year and a significantly lower gross margin of 16.3%. Our pre-tax loss prior to land related charges was $7 million, and we took a $34 million pre-tax charge for land related items. This netted out to a loss for the second quarter of $0.49 per fully diluted common share. Before land related charges, our loss was $0.12 per fully diluted share. As you may know, adding insult to injury, when you report losses, you utilize the basic number of shares versus the fully diluted shares in calculating earnings per share.

On an operating basis, these results are moderately better than the initial indication we gave on March 4, but the amount of land related impairment and walk away charges was a bit higher than we had expected, the net result being about the same. We delivered 3150 homes on a consolidated basis, that's down 31% compared to the deliveries, of 4555 in the second quarter of '06. These numbers exclude home deliveries, in our unconsolidated joint ventures compared with the 612 homes in the second quarter of fiscal '06. It's frustrating to report these poor operating margins and a loss for the quarter. What is even more frustrating is reporting that the housing market continues to slip further in many locations in terms of both sales pace and sales price, but that is what has occurred in the latter part of the second quarter and slower conditions have continued into May.

If you turn to slide two, you see that for the quarter, we reported net contracts down 21% compared to the second quarter of '06, and a cancellation rate of 32%. The cancellation rate is equal to the rate in the second quarter a year ago, but remains higher than our typical rate in the second quarter as you can also see on the slide, which shows five years of second quarter cancellation rates. Once again, we saw a difficult market conditions in our Fort Myers operation. If you exclude Fort Myers operations, we reported net contracts down 17% and a 30% cancellation rate for the second quarter, a little better than the consolidated results would be with them but still difficult.

These sales results are disappointing, especially after we experienced a level of stabilization in many of our markets and community locations during the period from November last year through February of this year. This of course is a slow period during the year for housing sales and is difficult to fully gauge the market. When we reported our first quarter results in the beginning of March, we had seen some signs of stabilization in many of our markets, even posting a monthly year-over-year increase in net contracts in February, but the markets did not pick up as they usually do in March and April, and remained at a contract pace similar to February which is substantially below the pace in March and April last year and even further off the strong pace of a spring selling season in prior years.

As you can see on slide three, sales in February were actually up 3% compared with '06, but we experienced a 29% decline in March versus the prior year and a 33% decline in April. Cancellation rates, also shown on this slide, followed a similar negative pattern and spiked up in March and April. May sales have not shown any improvements, unfortunately. Through the end of the second quarter, traffic is off but not as much as net contracts for the second quarter, traffic averaged 14 per community per week compared to 18 per community per week in last year's second quarter. Of note, we did not see the typical seasonal increase in traffic from the first to the second quarter as our traffic was flat on a sequential basis.

So the fall off in our contract pace is a result of the combination of a decline in traffic patterns and a slower conversion rate than the spring season a year ago. This indicates that weak consumer confidence continues to overhang the market. These more recent negative trends led us to further use of incentives on new contracts signed as well as on homes that close during the quarter. In many cases, we continued to offer additional incentives on homes scheduled to close in order to avoid further cancellation. The result is further compression of margins in the quarter.

We believe that the further slippage in housing demand in many locations was largely linked to the tightening of mortgage lending standards, particularly in the subprime market. That seemed to kick in just as the housing markets appeared to be getting their feet under them. We felt the impact most directly in those communities that relied on subprime buyers, obviously, such buyers are clearly finding it more difficult to qualify for a mortgage. In other cases, our buyers may not need a subprime mortgage, but they need to sell an existing home and somewhere in the food chain, the pool of qualified buyers for their home has shrunk based on mortgage qualifications. In addition, the psychology of potential home buyers has been dented again via renewed negative press and the chatter around office water coolers about subprime mortgages, foreclosures, and further declines in housing prices. Any intent to buy has been replaced by a continued attitude of hesitation, just waiting to see what happens in the marketplace.

On a longer term basis, we think the tighter mortgage standards will prove to be a healthy part of the correction and may limit future activity from investors and speculators, but the short-term impact has been a pull back in housing demand. The further declines in pace and pricing in some of our locations led to further land impairments and lot option walk away charges in the second quarter. During the second quarter, we reported $34 million of pre-tax charges related to land impairments and write-offs of pre-development costs and land deposits.

The impairments were quite spread geographically. This amount was slightly higher than our original expectation given on March 4th. Part of the reason for the higher charges again related to Fort Myers which resulted in about $8 million of the $34 million in pre-tax land charges for the quarter. We identified a buyer for half of our remaining lots in that market and have them under contract for sale. We're not abandoning the market, but there's not likely going to be the need for a lot of brand new houses in the near future, and we feel we can replenish the supply of land when we need to.

We are recognizing the loss related to the bulk sale this quarter, even though the transaction is not anticipated to close until the fourth quarter. The sale price on the lots was moderately lower than the basis at which we were carrying these lots. In addition, we reported an impairment on the other half of the lots based on a recent offer to buy these lots in bulk. While we have not signed a contract for the second half of the lots, we did book the impairment as the sale or some sale is likely. When we earlier did the impairment, we hadn't anticipated a bulk sale.

We'll continue to monitor conditions in all of our markets and if the weakness seen in the first few weeks of the third quarter continues, then we may have additional impairments in future quarters. Similarly, we regularly review our option contracts for further renegotiation and consider walking away if we can't obtain further concessions to make future development of communities that remain under our option reach our return hurdles. We've walked away from more than 25% of our peak land positions held under option, and we continue to review the remaining options on a regular basis. By walking away from some of our options and not replenishing all of our lots that we have taken down and delivered, we've reduced the total amount of option land position by 40% since its peak in the second quarter of '06. Many of the remaining options have been renegotiated, although changing market conditions require constant reevaluation and potentially require further concessions from land sellers if we're going to move forward with the community.

We've always controlled the majority of our future land through options. It was and is a fundamental component of our operating strategy. We've kept it in place during the good years because throughout at the almost 50 year history of this Company, we knew that there were housing cycles and that when things inevitably slowed down, as they certainly have, land options would give us the flexibility to either renegotiate or walk away. We think it's a critical component of our strategy not to own too much land. The simplest renegotiation on land option contracts is to slowdown the take down of lots or to defer the next take down of a phase of lots entirely. In some cases, without a price escalation, which in effect is a price reduction. This allows us to continually manage our balance sheet investment in inventory, not with 100% flexibility but with a significant amount of flexibility on the dollars we're spending. Some communities also require direct price renegotiation and we have had success in these instances as well.

In some cases, it has been necessary to walk away from an option only to find that the seller wanted to reoption the property back to us at more appropriate valuations after trying to shop the land to another buyer or other buyers and not able to find others willing to pay unrealistic prices either. In some cases, where land development has not begun on land that we already own, we are considering postponing improvements and the community opening and the corresponding investments until the market improves. This ability to manage our balance sheet and forgo additional expenditures on land gives us the confidence in our ability to manage our way through the current downturn and generate positive cash flow even with poor margins and net losses. We will continue to use this positive cash flow to repay debt and bring our leverage back in line with our goals.

You turn to slide four, you see a list of tactics and our slowdowns during this marketplace and many of these we've talked about before and i'm not going to spend a lot of time on them at this point but i'll only add that we are watching our costs very carefully as well, and we're very focused on the reduction of overheads, but our main emphasis today is on managing the balance sheet and making sure we're generating cash flow. Turn to slide five. This shows that in '05, even as we generated almost $1 billion in EBITDA, we reported almost $500 million in negative cash flow. We continue the negative cash flow for the full year in '06. The negative cash flow in these years is a result of the investments we are making additional land inventory and construction, in line with the equity and earnings growth that we were achieving. Over the past year as the market has turned, we have dramatically scaled back our investments in new properties.

As a result, we're on the cusp of becoming cash flow positive. In the second half of this year, we expect to generate about 175 to $250 million of cash, most of that occurring in the fourth quarter. This still leaves us with an aggregate negative cash flow for the full year of about 175 to $250 million. Next year, in fiscal '08, we expect to generate positive operating cash flow for the full year in the range of 100 to $400 million. As you see on slide six, during the period from 2000 through 2006, we were growing our inventory investments in line with the 30 to 40% annual growth inequity we were achieving. Our growth in stockholders equity and earnings during this period was among the highest in the industry.

Our land position was factoring in continued organic growth, although we controlled nearly 70% of this future land position through option contracts in order to maintain flexibility. Unfortunately, planning our investments in new communities requires reasonably long lead times, particularly in certain markets, because of the time required to design the communities and the homes, and in some cases to obtain entitlements while the land is under option and to develop the ground into buildable lots. As a result, when we experience a slowdown, we are not able to reduce our investment levels and generate cash flow as rapidly as we would like; however, over a period of several quarters, we can turn around our investment levels and begin to generate positive cash flow as we expect to do in the latter half of this year.

By walking away from a big slice of our option position, renegotiating and slowing down takes on other land -- large land positions and slowing down development expenditures overall, we are now reaching that flux point in managing our inventory investment so that we can generate positive cash flow. What you'll also see on slide six is that at the same time we were growing at significant rates, we were actually able to maintain and even improve our debt-to-capitalization ratios, thanks to the strong earnings and returns we were generating, and thanks to the fact that we were not paying dividends but reinvesting the capital back in the Company. We have flattened out the growth in our average inventory this year to be less than 5% and for '08, we expect our average inventories to be down.

We evaluate every land option regularly. We renegotiate them regularly, if needed, and walk away if the go forward returns are not above our target thresholds. If conditions worsen further or our balance sheet becomes more stretched, we can walk away from more contracts and generate more cash by reducing inventories more rapidly. However, it's been challenging to slow down our takedowns under land options rapidly enough to generate positive cash flow sooner, as many of the communities that we had committed to before still make financial sense on a go forward basis if you ignore the sum cost that you'd lose if you walked away anyway even at today's lower pace and pricing. Therefore, it would not always be sensible on an economic basis to walk from many of these options.

We are not out today looking to aggressively acquire new land parcels. We don't generally see enough opportunities out there today that make sense, based on today's level of sales pace and price. We ended the quarter with $412 million outstanding on our $1.5 billion unsecured revolving line of credit. The ratio of net recourse debt-to-capitalization at the end of the quarter was 56.9%. We anticipate that our average ratio for the full year will be above our target of 50% and that we'll end the year with an average closer to 55%. This average ratio for '07 is higher than our target and thus we are highly focused on taking additional steps to improve this ratio. We expect to reduce debt further in '08 and to reduce our debt-to-cap ratio for the full year. While it's early to project accurately, we are targeting an average ratio of less than 50% for the full year '08.

I'll now turn it over to Larry Sorsby to discuss our financial performance and projections in greater detail.

Thank you, Ara. I'll walk through some specifics from the second quarter and first half of 2007 as well as provide you with our delivery and revenue projections for the remainder of this year. If you'll turn to slide seven, it shows our updated projections for deliveries, and revenues for '07. As we stated in our press release, due to uncertain market conditions, we've pulled our previously issued earnings guidance and we are not issuing new earnings guidance at this time. However, we expect total deliveries to be between 13,200 to 14,200 homes, excluding deliveries from unconsolidated joint ventures. This would result in total revenues between 4.5 and $5 billion. The incentives and concessions we've offered have driven our margins below normal levels.

Slide eight displays our homebuilding gross margins on an annual basis for the past several years. In 2000 & 2001, before the rapid price appreciation we saw in many markets, we posted more normalized gross margins of 20%. We posted abnormally high gross margins in '03, '04, and '05 of at least 25.5%, and in the last two quarters, which are seen in the far right of the graph, we have posted abnormally low gross margins. Homebuilding gross margin was 16.3% for the second quarter, below the 18% we posted in the first quarter of '07. This reduction is due to the difficult operating environment we were experiencing throughout many of our markets which has forced us to lower home prices through increased use of concessions and incentives. Also impacting this gross margin is our Fort Myers Cape Coral operations, which have continued to weaken, and is operating pre-impairment at a negative gross margin level and post-impairment at roughly a breakeven gross margin level based at current sales prices. Given these lower than normal levels for gross margins, we are even more conscious of controlling costs where possible.

In our efforts to reduce overhead expenses, we have consolidated a number of business units. Through these efforts we reduced staffing, overhead, and office cost. The end result is a lower cost structure in place going forward. More broadly, we've continued to make headcount reductions when the level of staffing exceeds production expectations, at the local level. The number of associates at the end of January '07 was down 16% from the peak number back in June 2006, and at the end of April, it was down 21%, a further 5% reduction from that we achieved as of January '07.

Going forward, we will make additional headcount adjustments based on business levels in each of our individual markets. Our investment in unconsolidated joint ventures was roughly flat at $216 million as of April 30, 2007 compared to $212 million at the end of last year's second quarter. As in the past, we have maintained low leverage in our joint ventures. At quarter end, our debt-to-cap and our joint venture was 39%, one of the lowest JV leverage levels in the industry. The debt at the joint venture level is non-recourse beyond the assets of the venture; however in some of our joint ventures, Hovnanian Enterprises provides a limited environmental indemnification, completion guarantee and standard warranty and rep against fraud, misrepresentations and other similar actions including it bankruptcy. We report significant details on the balance sheet and profits of our unconsolidated joint ventures in our 10-Q's.

I'll now update you on our Financial Services operations. If you'll turn to slide nine, our pre-tax earnings from Financial Services decreased 6% to $6.3 million for the second quarter compared to $6.7 million for the same quarter last year, while our six-month results came in at $14.7 million, up 19% versus last year. Turning to slide ten, our recent data indicates that our customers credit quality remains very healthy. We experienced higher FICO scores in the second quarter of '07 than we did last year and we continue to see a declining use of adjustable rate mortgages at 15% of our originations in the Second Quarter compared to 32% for the full fiscal 06 year.

Turning to Slide 11, we've provided updated and corrected information on the amount of subprime business, our wholly owned mortgage company generated during fiscal 2006 and for the first two quarters of fiscal 2007. As underwriting criteria for subprime mortgages tighten, our level of subprime business contracted as well. The amount of subprime mortgages generated by our mortgage company has declined from 12.1% during fiscal 2006 to 9.3% in the first quarter of '07 and most recently declined to 3% of their total loan volume during the second quarter of '07. The tightening of lending standards is evidenced in a reduced level of subprime originations during our second quarter.

Our contract cancellation rate was impacted by the fall out from subprime loans in our backlog that could no longer qualify during the second quarter as the underwriting criteria tightened. We continue to renegotiate land deals, reducing prices, delaying takes or reducing the number of lots to be taken down. As such, we expect to have fewer communities open by the end of the year than we predicted three months ago.

Our number of spec homes picked up slightly, as you can see on Slide 12. For almost the past ten years, we've averaged approximately five started unsold homes per community. We ended the April quarter with 6.1 started unsold homes per community, above our average but not dramatically higher. The number of started unsold homes represents about a 2.8 month supply of started and completed unsold homes based on our April sales pace. Even at such a slow sales pace this represents a manageable level of spec inventories and is substantially lower than the industry average of 5.5 month supply of started and completed unsold homes.

Although we're working to generate positive cash flow by reducing our inventories, the EBITDA that we're generating has been declining in line with our profits. For the second quarter we generated adjusted EBITDA of $40 million, down from adjusted EBITDA of $206 million in last year's second quarter. Adjusted EBITDA represents earnings before interest expense, income taxes, depreciation, amortization and land charges, a reconciliation of our Company's consolidated adjusted EBITDA to net income can be found as an attachment to our quarterly earnings release.

Due to the slowing velocity of deliveries, in each of our open communities, our inventory turnover and thus our interest coverage is declining in fiscal '07. However, as we begin to bring our inventory investment into alignment with our lower revenues and profits, we expect coverage to stabilize and to start to tick upward again. Our revolving credit agreement does include a debt service coverage test; however, it only applies if our leverage ratio is substantially higher than where it is today. We do not anticipate allowing that leverage ratio to reach that level; however, we recognize that we need to increase cash flow, decrease debt levels during the slowdown to provide an even larger cushion.

Despite the current conditions in the housing industry and the net losses we reported for the past three quarters, after taking aggregate land related charges of 403 million over the trailing 12 months, at April 30, 2007, we have common equity of $1.7 billion or $27.73 per share, and total equity including our preferred shares was about $1.9 billion. During the second quarter of '07, we did not repurchase any stock, although we believe our stock remains undervalued, we remain committed to bringing our debt-to-cap back to our stated goal of less than 50% and do not anticipate buying back shares at this time.

I'll turn it back to Ara for some closing comments.

Thanks, Larry.

I wish I could give you better news but unfortunately, it's a challenging market. I'm providing you with as frank and comprehensive an analysis of current conditions as possible. The levels of existing home inventories, some of which are new homes that have never been occupied, is just too high. We need to see this inventory clear the market before we can expect to realize sustainable year-over-year increases in net contracts and positive momentum in home pricing. We also need a more positive buyer psyche. We thought we had seen signs of stabilization at the end of the first quarter but our second quarter ended with weak trends in net contracts as the subprime issues became the focus of the market. So, it seems that we've got more work to do.

On the positive side, first, the economy is still creating jobs, not as many as it had been but jobs are being created, unlike the past downturns we've had to deal with where there were job losses. Second, our interest rates are near record lows by historical standards, again unlike what we had to deal with in '81 or '91. Third, the recent price corrections, while painful, when combined with the current low rates have dramatically helped affordability, which was part of the problem that caused the slowdown in the first place, and fourth, permits have remained constrained relative to past cycles in the highly regulated markets.

As a Company, we are almost 50 years old, and have successfully operated through numerous cycles. Although this downturn is a little different than what we've experienced in the past, we do know how to handle it. We focus on balance sheet and cash flow and make the corrections in the field as we need to, week by week. As we get further into the correction, financially sensible opportunities in land & Companies will arise that will help propel the growth in profits that always follow these market corrections for those that have the capital to take advantage of the opportunities. The market will soon play right into our core strengths, land and Company acquisitions. We plan to prosper after this correction as we have in all corrections in the past. The long term demand for housing is stronger than ever, and we know we just have to hunker down and weather the current period to prepare for the inevitable upturn.

With that, I conclude my comments for today and I'll be pleased to open up the floor for questions.

Thank you, sir. The Company will now answer questions. So that everyone has an opportunity to ask a questions, participants will be limited one question and a follow-up after which they have to get back into queue to ask another question. At this time we will open the call to questions. (OPERATOR INSTRUCTIONS).

We'll just wait a moment for questions to populate. Your first question is from the line of Stephen Kim of Citigroup.

Thanks, guys. Two questions for you. First of all, could you talk about your inventory. I know that you guys provide, I think you gave $3.6 billion in sold and unsold homes and lot development. I was hoping you could break out or some sense as to what the land portion embedded in that $3.6 billion was?

No. We don't provide that level of detail, Steve.

Is that something you think you might, well forget that. I'll count that as my second question. I wish you would.

Duly noted. We understand.

Good. Second question relates to, where is it? Okay, my second question related to your cash flow. I was wondering whether I could get the components of operating cash, cash from investments, cash from financing.

The cash flow we're referring to are before financing. It's just purely from operations.

Oh, I'm not talking about the guidance figures. I'm talking about just simply do you have the components at the end of the second quarter?

We'll let Brad answer that. If you want to tie it to what's in the 10-Q, what you're looking for?

Yes, that's great.

Cash flow from operations, cash flow from investing activities and then exclude or subtract the change in mortgage notes receivable line, if in the operating section of the cash flow statement?

Okay, got it. Great. Thanks.

Thanks, Steve.

Your next question is from the line of Michael Rehaut of JPMorgan.

Hi, thanks. Good morning.

Good morning.

The first question I have i,s I was wondering if you could describe a little bit more in terms of the incentives that you saw, that you mention you had to increase during the quarter and perhaps where you were on an average in terms of percent of sales price of home at the beginning of the quarter and where you ended towards the end of the quarter and then I have a follow-up.

Sure. Well, first of all, as you know, it's extremely situationally isolated. I would say in the most recent quarter, we certainly saw a broader use of incentives. In the Southern California, inland empire market, Riverside and San Bernadino Counties, and also in the Sacramento market, interestingly enough, along the coastal Southern California area, we really didn't change our incentives at all. That was the market that slowed down first, and that's showing a little more sign of stability.

The Riverside San Bernadino area slowed down later, and that is still going through more of a correction. To give you an idea on the magnitude, in those areas, certainly we've seen 5% concession increases, about $20,000 let's say on a $400,000 house. That's just a typical example. That's just all over the place depending on the pricing so I guess the best way to answer it is I can't give a uniform answer. They'revery different in different parts of the market. Obviously in the Texas market as you know those have been stronger. We haven't had to resort to concessions but certainly there are other parts where we have and the examples could be anywhere from a few thousand dollars to $50,000 on higher end homes.

Thanks very much, Ara, for that detail. The second question I guess is related and given that you have seen this increase in incentives and weakening of prices during the quarter, I guess I was surprised that you didn't take more in terms of land impairments of only $34 million and first if you could just fine tune it that $34 million was all land impairments or if there's some option walk aways, but what was the process in terms of I assume that you determine those charges at the end of the quarter. You saw the prices weakening substantially, and maybe you could give us some insight as to why there weren't a larger level of charges or is that something that we're just going to have to wait and see and could kind of hit us in a larger degree next quarter?

Sure. Well, first of all, unfortunately, as you know, we have taken substantial land impairments already, and we've tried to do a good job of making sure we cover communities that were on the cusp as well, but it's something we have to do regularly. As I did mention as well, not every geographic area was affected, so we just have to look community by community, and we'll continue to do that on a regular basis. I would say if the market continues as we've seen the first few weeks of May, then it's likely we will have additional impairments, but frankly the analysis is significant.

It takes some time, and we'll be spending a lot of time this quarter analyzing if there are additional sites that warrant the impairments. I don't, at this stage, I wouldn't anticipate the kind of impairment levels that we did in the fourth quarter of '06, but short of saying that I don't anticipate them of that magnitude, I'll say that we haven't completed the analysis, and it will be ongoing. The other part of your question is part of the charges did have to do with walk aways. Brad, would you happen to have that number at your finger tips?

Yes, it was $5 million of the number was walk aways.

So $5 million in walk aways, about 29 in impairments.

And where were those impairments largely?

They were fairly spread out, some in California, some on the East Coast. They were fairly spread out, Minneapolis, I think, had one.

Great. Thanks very much.

Sure.

Your next question is from the line of Carl Reichardt of Wachovia Securities.

Good morning, guys. How are you?

Good morning.

Just one question actually. When you're looking at your community count for a year-end '07, Larry, can you tell me what you're expecting to add and then the number of communities you're expecting to close to get to your year-end community count?

Well we haven't refreshed the year-end community count. That would be the first point that I'd make. We just said it was going to be less than what we had previously told you last quarter, so we're just not prepared to give any detail on that.

And is it your sense that is that a function of a slowdown in the number of communities you expect to close or a slowdown in the number you expect to open?

Well, it's probably a combination of all of the above, in order to get to a total so it's for being driven up by, it's not closing them as rapidly and driven down by not opening some, so it's a combination.

Thanks, guys.

Yes.

Your next question is from the line of Dan Oppenheim of Banc of America.

Thanks very much. Was wondering, as you talk about to the managing in a long term slower environment, but working down inventory and generating cash flow, it seems to suggest much more of a focus on absorption. Can you talk about sort of what your goals are for absorption relative to what you're seeing in terms of absorption right now?

Yes. Absorption, as you know, Dan, is very different in different parts of the market. To give you an example, in Northern California and Sacramento, in the very good parts of the market let's say in '05, a typical community in that geography was absorbing 6 to 7 homes per month. Things have slowed down to the point of those that have got some good absorption, let's say two homes per month. We probably would like to see that tweaked up to three homes per month as an example. We don't expect to have absorption get back to the pace of '05.

We think that was abnormally high, but we do want in many cases, not all cases, but in many cases, we would rather see the absorption go a little higher than we're talking about now, so in some communities where it's two, we would like to get it to three and in others where it's four, it may be fine. And yet other communities, if it's five, we may want it to get it to six. In some cases frankly, we've had hardly any absorption and we've got to do more price reductions to start getting on the radar screen in absorption so it's really all over the place, but in general, we're now just shifting the pendulum a little more toward absorption and worrying a little less about margin.

Thanks very much and I guess a quick follow-up, in terms of thinking about that where you're looking to increase the absorption there, when, have you started sort of to adjust sort of with that new tactic or was that something you started in May, is it something that's starting right now?

No. It's been a gradual process and I'd suspect we're going to gradually try to continue to increase that.

Sorry, just last question. Do you worry about sort of just fighting for a larger share of a smaller pie with other builders that I think is generally a focus on absorption from many of the builders?

I wouldn't say that we're fighting for market share per se, Dan. I mean, it's that what we do is we budget based on recent sales trends and then we try to anywhere that we've got communities that aren't meeting their current budget they have to take action, whether it be step up the sales and marketing effort or change the salespeople or increase incentives, we just want to keep on track. I mean, we're budgeting at what I would call ten year low absorption paces, and we just don't want to fall to 100 year low absorption paces so we just want to keep some absorption and weep the blood flowing.

Okay, thanks very much.

Sure. With all of them, by the way, it's not fire sale prices, get rid of it at any price. We're really looking at our inventory by category and situationally. If it's a spec home which is finished and as Larry mentioned , our spec home level is always slightly higher than our ten year average, but if it's finished, chances are we'll be a little more aggressive. If it's a developed land scenario, we'll be aggressive but not as aggressive. If it's land that we haven't developed, well then in some cases, we may not want to be very aggressive at all and we may be better off postponing the community. Basically, we do an analysis on what kind of land investment recovery can we get, and if it gets to the point where we have to get concessions so low that we're just not getting enough return of the dollars we have invested, then we're better off postponing the community and just waiting for the market to clear a little bit. In some areas, in Southern Florida, in Palm Beach County, in those places, we're better off letting the market clear a little bit because there's just so much overhang that it's not worth chasing the concessions to move the inventory, so it's not a one size fits all strategy right now. We have to look at every situation and really fight the market

And your next question is from the line of Lee Brading of Wachovia Securities.

Hi, guys.

Hello.

You mentioned earlier that your, I guess the bulk sale in Fort Myers, I know you probably don't want to say specifically who's buying but just on a broad standpoint across your market, who is looking to buy? Are you seeing developers, private builders, some of the other big production guys?

I'm seeing generally it's not the big public, it's not really developers. I think Fort Myers kind of a special situation. I'd call it more of an investor speculator than anything else in that particular case, but for the most part, there's not many land sellers that are adjusting the price of land to today's market realities and therefore, there's not a bunch of buyers of land out there.

Yes, there is just not transaction activity. The land sale market is just really slowed to a complete trickle with very few buyers of any type out there, and that's part of the reason why you do see many home builders resorting to selling spec homes because there's really a way of liquidating the land portfolio. It's easier to sell land by popping a house on it than it is to sell land because there are just not many buyers out there.

Great. That's helpful. And then on the subprime comment, that it's only 3% exposure in Q2, I imagine it's a combination of customers not showing up and a tighter lending standard as well. Could you give some examples or details on how you've tightened your standards? I did see the FICO scores are up. Is it there or a few different items you're tweaking?

Well it's really an industry wide, mortgage industry wide tightening of criteria. We didn't make those loans and hold them. We under wrote them to the criteria that the end buyer of that loan dictated, and what's really happened is that FICO scores requirements have increased in order to qualify for some of the subprime and therefore it's just taken the bottom of the pyramid out of the arena of being able to qualify for a mortgage, because they don't have a high enough credit score, so that's really what's happening.

Can you quantify how much you seen an increase, for a couple of FICO scores?

I think it was, what was it? 60 points, 40 to 60 points. I forget what the exact tightening was, but it was quite significant in terms of credit worthiness had increased substantially.

That's helpful. Thanks.

Your next question is from the line of Joel Locker of FTN Securities.

Hi, guys. Just was wondering about your capital investment inland options, just noticed it's gone from 362 million to 392 million in the last six months, and just wondered if you could elaborate on that increase in investment?

I don't have that number off the top of my head, but I'd suspect some of them, I did mention in some cases we had walked away from options so you saw the number go down, only to find that after the seller tried to market it to others had no success and came back to us at substantially reduced option prices, and then we did have to put up another deposit, but on much more improved terms.

Ara, I think the other thing that it's not just land options, that category is land & land options so it's certain inactive communities that we now own that are also in that category and my suspicion is although there may be minor impact from increase in the deposit that probably though have not done the analysis, probably the bulk of it is a community or two that is just inactive that's in that category that we took down.

Right. And then just on the impairment reversals. Like how many did you have this quarter and what do you expect for say the rest of fiscal '07 and fiscal '08?

Well, I mean, you can not really project impairments, so --

Impairment reversals. I'm saying you've impaired about $200 million worth of land owned. How many of that will go through the income statement in the next six quarters and how many went through the second quarter?

Brad? Do you have it?

Yes.

Go ahead, please.

For the second quarter, it was roughly $13 million and for the six months it was $27 million, so it's been running 13 to $14 million a quarter. I don't have a projection though because we don't get the projection that way.

We wouldn't give it to him if we had it.

Right. All right, thanks a lot.

Okay.

And you have a follow-up from the line of Stephen Kim of Citigroup.

Hi. You guys made mention of the land sale that you made in Fort Myers, I think you indicated that you took a slight loss on it.

Well, Steve, just for clarification, we just entered a land contract. The sale hasn't been consummated yet. We anticipate that in the fourth quarter if all goes well, but it's simply an option contract at this stage.

Okay, that was, because you had sort of talked about two halves to the land so I was getting a little confused there.

Let me try to clarify. There are two interested parties, one that's an interested party in the land at Cape Coral, and that one is actually a signed contract, but it's still at the investigation period although they have a substantial deposit. The other one, I believe is in Lehigh Acres in the area, and that's in active negotiation, but not yet a signed contract, but neither of those transactions have obviously closed yet.

Right, but you have taken impairments you had said I thought on both of them?

We did. We thought it would be most prudent to impair both of them, both of the areas as though they were going to be sold in bulk. If you were going to build through them in theory, the impairment would not be triggered and we reserve sufficiently but we did not reserve for a bulk sale.

I see, okay, got it. And in terms of but you said I think that you had indicated that the price was slightly below your carrying basis?

Yes, that's right.

Okay, and had that basis been reduced since the time you initially entered, since you had initially taken ownership of that land?

Substantially.

That's what I thought. Can you give us a sense for maybe what magnitude it was lower than you had initially paid?

Oh, well, we didn't buy all of that land in one transaction. These are, if you remember, scattered lots in that area, so they were literally bought in small increments on a regular basis, but, I mean, to give you an idea on how significantly that market corrected, at the peak, lot transactions happened in one of the areas at about $80,000 a piece. The market continued to come all the way down. We wrote it down, not all of ours by the way was purchased at $85,000, but that's where it was at the peak. We wrote down the values to the low 20s and I think the contract amount off the top of my head came in just slightly below that level.

Okay, got it. Thank you. That's kind of what I was looking for. Thanks a lot.

Sure.

Your next question is from the line of Robert Manowitz of UBS Greenwich Capital.

Good morning. I just wanted to go back to your comments on your covenants and make sure I fully understand your plans here and what the underlying message was. I guess what I interpreted was that you expect that the two times coverage ratio could be challenging in the near term but you're comfortable that the leverage trigger won't be met. Is that kind of what you were trying to tell us?

We don't have a straight interest coverage and I never mentioned two times for anything with respect to our bank revolver, but the point is as long as our leverage doesn't increase significantly from where it is now, we don't have to deal with a interest coverage test in our revolver agreement, and we're going to certainly do everything in our power not only to not let the leverage go up but to actually decrease it in order to provide even a larger cushion, so we just have a unique covenant with respect to the way the interest coverage covenant works in our bank revolver.

Understood and that ratio is not two times is what you're telling me?

I don't remember precisely what it is.

Okay. Well, let me ask you this, a follow-up to that then. Does it make sense to give yourself some incremental wiggle room at this point?

We agree, we should give ourselves, well, we're not going to give ourselves wiggle room by going back to loosen the covenants. We think we're in good shape. We would rather give ourselves the wiggle room if you will by reducing our inventories further and focusing even more on cash flow.

Great, okay. That leads me into my next question, which ties to your comments on the absorption versus margin shift that is now starting to take place.

Yes.

How should we think about your gross margins and your backlog today versus the gross margins that we saw in your income statement in the second quarter of this year? Obviously excluding the land charges?

That's a good way to try to figure out if we'll give you a projection, and we're just not comfortable giving all of the uncertainties that we're faced within the individual markets of really giving you clarity or projections on margins at this point.

And your next question is from Ivy Zelman of Credit Suisse.

Good morning. This is Justin Speer for Ivy. Just a couple questions. From a higher level, have you seen competitors continue the restraint on starts across their markets here recently, be it public or private?

Well, it really depends. What we have seen is there are some builders whose strategy is that they will start a group of spec homes and then as soon as they sell those spec homes in a community they will start another batch of spec homes, sell those and start another batch, so I think they are acting in a disciplined fashion in that they aren't saying we're starting ten homes a month no matter what. That would be dangerous, because that could cause a rapid build up of inventory, and we're not seeing in the new home area at our competitors a growth in that inventory but we certainly are seeing builders that are continually starting new specs as they sell the ones they have on hand.

So do you expect potentially this may be or lead to a catalyst that will result in maybe prices coming down further?

No, I think what Ara is saying is that the new home builders in the aggregate are being prudent and disciplined and in fact controlling the inventory level of unsold homes at very reasonable levels. No one is building up a lot of spec inventory. Frankly, the concern on inventory levels is more pointed, frankly, at the used home market. That's where we see the problem of inventories much more so than we do on the new home front. And unfortunately, some of the MLS listings are not used homes in a traditional sense. Some are still investor purchases of brand new homes.

So do you think what will be the catalyst, I mean, do you think there's a certain level of pricing that will get the buyer motivated, do you think?

It really changes. Back in December, January, and February, even though that was not the hot time of the marketplace, it just felt like the buyers psychology was shifting. There was not a big change in supplier inventory but the psychology was shifting and people were finally starting to think, well, the prices have come down enough, this may be the time to get into the market, and prices were starting to stabilize, and just about then, the subprime issues really came out and that changed the dynamics again.

In a low activity market, it doesn't take a lot to throw it slightly off of equilibrium, but I can say that there is a set point. It just changes. We had reached that set point and then there was a new factor into the market that modified it. Now, the good news is there is still job growth, interest rates are still good. A lot of the issue is psychological and good news about that , well part of the issue is inventory overhang. Part of it is the psychological attitude of buyers, and the good news about that psychology is just like we saw it shifting fairly quickly in December-January-February, it could shift back again to a more positive mood.

This is what's different and unusual is this is not a slowdown like we had to deal within 81 and 82 or 91 and 92 where you had to hope that employment grew and you actually had jobs and people were not being laid off in masses as they were, that's not the situation here. We have job growth, the economy is decent, a little slower but decent, so we just got this two pronged issue of a little excess inventory both in MLS and new homes, and buyer psychology and the buyer psychology has been rattled and it's been rattled recently by the whole subprime and foreclosure news that we see in the media every single day. You can't open up the paper any day without an article about it, and it affects the

People are delaying their home purchase decisions because of the uncertainty in the markets. I think there's actually pent-up demand out there for whenever the catalyst ends up being, whether it's more positive press or some demand that get publicized in a particular set of communities or people get convinced the prices aren't going to be lowering further. Whatever the catalyst ends up being, once that occurs there's some pent-up demand, I'm not suggesting that I think there's going to be a run on housing or that we'll have long lines of people or anything. I just think there's solid demand out there that is just waiting for the right opportunity and the right signal to come back into the market.

Your next question is a follow-up from the line of Michael Rehaut of JPMorgan.

Hi, thanks. Larry, you'd mentioned earlier some detail on the JV debt-to-cap, and some details on the debt and I was wondering if you could just kind of further go over in what instances are you on the hook, maybe not as much from the environmental completion but overall the maintenance guarantees. What would trigger that?

We never do maintenance guarantees

Sorry?

We never provide a maintenance guarantee to where we're injecting equity. We don't do that.

Okay. So what are the instances where you do have certain completion guarantees that would and how would they be triggered?

Well the completion guarantee is if we decide we're not moving forward with the project with us and our partner, we agree to complete the project, provided that the lender give us the money to complete it and pay the overheads. That's what the completion guarantee is.

Okay, and to the extent that you're familiar with it and I know that a lot of these JV agreements are different, but is there any detail you can give on how your JVs are different from the whole Technical Olympic troubles?

I'm just not familiar enough with Technical Olympic to comment on it.

What I can tell you on that that is number one, the one huge area of difference is in leverage. I believe the leverage was --

80%.

80% debt-to-cap. Ours is 39% debt-to-cap, about half. That is the fundamental difference in the leverage and that's what really separates us. We specifically went out to say we're going to manage our joint ventures on a low risk profile. This is not a way to, well, I'll leave it at that comment. So, that's the big fundamental driver.

But I think really, Mike's question there was with respect to the completion guarantee and Mike, if you'll call me off line, I'll speculate on what happened with respect to Technical Olympic. I just don't want to do it publicly but we have not done what I believe Technical Olympic did to trigger some of their issues. So I'm not going to speculate publicly.

I appreciate that and Ara's point is very fair in terms of the leverage going in, I think is very different. The other question I had was just going back to your revolver and if you care to or if you're able to go over, what is the actual leverage ratio that would trigger the covenants on the revolver and on your core debt, fixed or the debt issues that you have outstanding, aside from the revolver, what are the covenant triggers either if those do have interest coverage, or do those have leverage ratio coverage or both?

Let me first speak to the revolver. First, if I gave you the number, you can't calculate it, because of the way the revolver doesn't just take equity, gas equity, it's an adjusted tangible net number, so I'm not going to tell you exactly what it is because it's just not something you could ever tie it to or calculate to. I'll just tell you that it's leverage substantially higher than where we are today. We don't intend to get there and we're taking steps to even provide more of a cushion by deleveraging and therefore we're not concerned about that particular issue and our revolver, we don't think there's any other covenants inside the revolver that concern us. With respect to agreements outside of the revolver, every senior and subordinated notes have a debt occurrence test that does have a coverage component or covenant to it, but there's all kinds of buckets to solve that particular problem and we don't believe we're close on that with respect to that issue either.

Okay, thank you.

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

Thanks, guys. Can you talk about your impairments like in a little more detail like how many communities you impaired and what was the dollar break down by region?

Hold on and we'll give you a little color. It was spread out geographically. Brad, do you want to pull that up?

It's about ten communities and Ara kind of gave you the locations before. It will take me a few minutes to give it to you by public segment. I don't have it here.

So, it is spread out geographically ten different communities.

The bigger places were California, there was a community in Minnesota, Pennsylvania, and then Fort Myers that we talked about. That's basically where they are.

Okay, so the bulk I guess was in California then?

Well, that's not what he said. He told you the four different places that the bulk of it came from.

Okay.

Minnesota, Pennsylvania, Florida, and California.

How about do you guys have your pre-tax income break down by region?

No, we don't have that yet. It will be in the 10-Q.

Okay, got it. Thanks a lot.

You bet.

(OPERATOR INSTRUCTIONS). Our next one is from the line of Susan Berliner of Bear Stearns.

I know you said that thus far the first quarter the few weeks have been weak as well and I was wondering if going sequentially, I know you how had given a good color about orders and cancellation rates deteriorating throughout the quarter if you seen continuing deterioration thus far in the third quarter?

I think we just want to say that it's continued to be weak rather than try to make a judgment on whether it is weaker or slightly better. I mean, it continues to be weak.

Okay, and if I could just ask, have you seen anything on the Alt-A, and if you can give any details on your Alt-A lending at this point versus last year?

Alt-A has also had a tighter underwriting criteria applied to it. It is generally very creditworthy customers with even higher credit FICO scores required this year than last year and our use of Alt-A has increased some. I'll give you an extreme example and as someone that's highly qualified recently bought a second home that makes great income and a great credit score, the mortgage Company would rather do that as an Alt-A. There's not even a penalty from the rate perspective, just to not have to go through the trouble of verifying all of the documentation and so on and so forth, so Alt A by itself does not mean there's a stigma or anything close to subprime and I think the pricing of the Alt A product being almost on top of prime product is the best indication of that.

Great. And just one other question. Can you update us on what's going on in the Washington D.C. market, if it's still stabilizing or incentives are increasing there as well?

It's interesting. The DC market both Virginia and Maryland side, for us, had been fairly steady and decent, obviously nothing like what it was, but was steady and decent. In the last, I would say, month or two, it has weakened just a bit, and we have taken some steps in incentives or pricing to bolster that. But the DC market for us is not nearly as challenging as markets like Florida or parts of California.

Great. Thanks very much.

As there are no further questions in queue, I'd like to turn the call back over to Mr. Hovnanian for closing remarks.

Great. Well, thank you very much. I wish I could give you better news, but as I said in my prepared comments, we just try to be as forthright and comprehensive as possible. We continue to maneuver through these markets. We've been through these cycles many times before and as we have in the past, we'll bounce through and come out stronger than before. Thank you very much and we look forward to giving you continued news in the next quarter's release. Thank you.

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