Hovnanian Enterprises Inc (HOVNP) 2010 Q3 法說會逐字稿

Good morning and thank you for joining us today for Hovnanian Enterprises' fiscal 2010 third quarter earnings conference call. An archive of the Webcast will be available after the completion of the call and run for 12 months. This conference is being recorded for rebroadcast, and all participants are currently in a listen-only mode. Management will make some opening remarks about the third quarter results, and then open up the line for questions. The Company will also be webcasting a slide presentation, along with the opening comments from management. The slides are available on the investor's page of the Company's website at www.khov.com.

Those listeners who would like to follow along should log onto the website at this time. Before we begin, I would like to remind everyone that the cautionary language about forward-looking statements contained in the press release also applies to any comments made during this conference call and to the information in the slide presentation. I would now like to turn the conference over to Ara Hovnanian, Chairman, President and Chief Executive Officer of Hovnanian Enterprises. Ara, please go ahead.

Good morning, and thank you for participating in today's call to review the results of our third quarter ended July 31, 2010. Joining me today from the Company are Larry Sorsby, Executive Vice President and CFO; Paul Buchanan, Senior Vice President and Chief Accounting Officer; Brad O'Connor, Vice President and Corporate Controller, David Valiaveedan, Vice President Finance and Treasurer and Jeff O'Keefe, Director of Investor Relations.

On slide three, you can see a brief summary of our third quarter results. Our third quarter was generally in line with our expectations, deliveries were strong, and net contracts were weak, both of which were impacted by the expiration of the federal home buyers tax credit. Due to the expiration of the home buyers tax credit in April, we expected our third quarter net contracts to be weak; however, the weakness was longer and more pronounced than we thought it would be and resulted in our net contracts for the quarter declining 37% on an absolute basis and down 33% on a per community basis compared to last year.

We believe that the recent slowdown in housing was caused not only by the expiration of the tax credit, but also by consumers being concerned about the health of the economy, the lack of job creation, sovereign debt crisis, the volatile stock market prices and the Gulf oil spill, just to name a few of the concerns on consumers' minds. These factors led to a downturn in consumer confidence. The bottom line is that a barrage of bad news set the US consumer on their heels.

On slide four, you can see a month by month analysis of sales over the last six months. Sales picked up in the last few months of the tax credit, and then dropped dramatically in May and June, partly due to the full-forward effect of the tax credit. The good news is that sales came back a little in July, and made an even bigger push forward in August.

However, turning to slide five, you can see that these improvements still don't get us back to the levels that we were at in 2009 for the same set of months. We are hopeful that our sales trends continue to improve in September and October. Frankly, it's hard to explain the improvements in contracts per community, given the media focus on the slowing economy and lots of bad news out there. Perhaps the pull-forward effect from the tax credit has worn off. Perhaps the record low mortgage rates have been a catalyst to drive some buyers back into the market. Thirty year fixed is available with no points at 4.5%, and a 15 year fixed is available at 3.875% today.

We're not certain at this point what seems to be driving some buyers back into the market. What we do know is that the increase was across virtually all geographies and, therefore, is not likely to be caused by local or isolated competitive issues. We also recognize that the improvements have not yet gotten us back to levels prior to the expiration of the tax credit.

Slide six shows our sales trends on a quarterly basis. After five consecutive quarters of year-over-year increases in net contracts per active selling community, the pace in the second quarter of 2010 was unchanged when compared to the same period a year ago. In our third quarter, the 2010 selling pace was slower than it was last year. Although August was better than June or July, it's still not as good as it was last year. It still feels like we're bouncing along the bottom with good months when there are bits of positive news and bad months when the news is more negative.

When looking at net contracts per community on an annual basis, as seen on slide seven, we see that we've reached the period of general stability after years of shrinking, but we're still a long way from the normal levels of absorption. The seasonally adjusted annual absorption pace in the first nine months of 2010 was 23, which is level with 2009. That was better than 2008, but still again, significantly below our average of 44 homes per active selling community between 1997 and 2002, a period generally described as more normal times.

As far as margins go, we saw some mixed signs during the third quarter. Let me begin with gross margins. The right side of slide eight illustrates the quarterly trends that we have seen in our gross margins since the beginning of 2009. Our gross margin has increased year-over-year for the sixth quarter in a row to 17.1% for the third quarter of 2010. Even without the $40 million of third quarter 2010 impairment reversals and a $50.6 million of third quarter 2009 impairment reversals, our margins would have shown a year-over-year improvement.

As we have said in the past, gross margins have the potential to fluctuate from quarter to quarter, sequentially margins took a small step backwards from 17.3% in the second quarter to the 17.1% we reported for our third quarter. But at this point, I would not read too much into that slight dip. As we have more deliveries from newly identified land parcels next year, we anticipate our gross margins will be higher for fiscal 2011 than they are this year, assuming net selling price stability.

As our mix of deliveries becomes more heavily weighted toward homes built on newly identified land, our gross margins should trend back to normalized levels, closer to the levels achieved in 2000 and 2001, that you can see on the left side of the slide. However, as I said earlier, quarterly gross margins can exhibit some choppiness due to product mix. The percentage of deliveries that we expect from newly acquired lots for all of 2010 is less than 10%.

In 2011, deliveries from newly identified lots are projected to account for about 40% of our deliveries. Assuming no changes in home prices, our gross margins should improve as we increase the percentage of our deliveries that come from newly identified land parcels. In order to achieve these targets, we need to continue to reinvest in new land parcels that make economic sense based on the current sales pace and sales prices. Fortunately, the deal flow remains steady as we continue to approve land acquisitions on a regular basis.

As you can see on slide nine, the positive trends in SG&A on a percentage of total revenues continued in the third quarter. Our total SG&A decreased by $14 million or 19% year-over-year during the third quarter, and $79 million or 31% for the first nine months of 2010. For the third quarter of 2010, total SG&A as a percentage of total sales was 15%, down sequentially from 17.8% in the second quarter of 2010, and 18.3%, in the third quarter of 2009. As our revenue grows, either through improved absorption levels or a rise in the number of communities, we expect to see further progress in getting our HG&A ratio into the historic normalized range of about 10%, shown on the left-hand side of the slide. Since deliveries are expected to be slightly less in the fourth quarter of fiscal 2010 than they were in our third quarter, partially due to the effect of the expiring tax credit, SG&A as a percentage of sales might rise slightly in the fourth quarter.

Finally, we continue to make progress in reloading our land position. As seen on slide 10, since January of 2009 we have contracted for or purchased a grand total of about 12,200 lots in 169 communities, an increase of 5,100 lots and 71 communities in just one quarter. We continue to seek out and evaluate new land deals for purchase in each of our markets. During the third quarter, we purchased 850 newly identified lots in 45 communities. In addition, we purchased 450 lots from preexisting options, bringing our total land and lot acquisitions for the quarter to 1,300, spending $70.3 million of cash.

Slide 11 shows recent trends in our community count. For the first time in 12 quarters, we are showing an increase in our community count. In order for us to have success in improving our gross margin and profits, we need to get more new communities opened for sales. As we continue to increase our community count, we'll be able to better leverage our fixed costs, and we'll begin to see our SG&A and interest costs as a percentage of total revenues inch closer to more normalized levels. By the end of our fiscal year, we project to have approximately 195 communities open for sale, reversing the downward trend of the past several years.

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

Thanks, Ara. Let me start with a discussion of our current inventory from a couple of different perspectives. Turn to slide 12, you'll see that our owned and optioned land position broken out by our publicly reported segments. Based on trailing 12 month deliveries, we own 3.6 years worth of land. 13% of the lots that we currently own are newly identified lots that have been purchased since January 2009. Over time, we are working through our older legacy land and replacing it with newly identified land parcels.

This should lead to sustainable gross margins back in the 20% range, assuming no changes in home prices. We do not need to have home price appreciation to see further improvements in our gross margin. Just a shift in the mix of lots that we own and deliver homes on, to be more heavily weighted to our newly acquired land parcels. While this will not happen overnight, we have started down the road to achieving this objective. As seen on slide 13, our owned lot position has increased during the third quarter of 2010, as we replenished our land supply with newly identified lots. As a matter of fact, it's increased by about 1200 lots during the first nine months of 2010, which is a step in the right direction.

An even more impressive gain comes from the optioned side of the equation. We saw sequential increases of about 3300 lots optioned during the third quarter. We walked away from about 550 legacy lots. We took down 1,100 lots that were previously optioned. And, we signed new option contracts for an additional 5,000 lots. At the end of the third quarter, 48% of our optioned lots are newly identified lots. When you combine our optioned and owned land, 29% of the total lots that we control today are newly identified lots that underwrote to a 25%-plus unlevered IRR based on the then current home prices and sales paces.

On slide 14, we show a breakdown of the 17,692 lots we owned at the end of the third quarter. Approximately 40% of these were 80% or more finished, 10% had 30% to 80% of the improvements already in place, and the remaining 50% have less than 30% of the improvement dollars spent. While our primary focus is on purchasing improved lots, we have recently purchased or contracted to purchase a number of land parcels where it makes economic sense to do land development. And, we started to complete land development on sections of our legacy land as well.

Now, I'll turn briefly to land-related charges. After two quarters of relatively low impairments, we booked $50 million of land impairments in the third quarter. 76%, or $38 million, of the land impairments this quarter were isolated to just five communities in fringe locations. Four of the communities were in Southern California, and one was in Southern New Jersey. Recently, each of these communities had been missing our expected sales pace, and we decided to lower net prices in order to achieve an improved sales pace.

If we find that we do not have to do any further discounting of home prices in order to pick up the sales pace, then we would not expect to see much in the way of material impairment charges, similar to what we experienced in the first six months of fiscal 2010; however, if home prices in any particular neighborhood falls further or incentives are increased like we saw in a few communities during the third quarter, our level of future impairments could rise. Our investment in land option deposits was $37.9 million at July 31, 2010, with $32.3 million in cash deposits and the other $5.6 million of deposits being held by letters of credit. Additionally, we have another $38.8 million invested in predevelopment expenses.

Turning to slide 15. We show that we have 7,866 lots in 61 communities that were mothballed as of July 31st and we break these lots out by geographic segment. The book value at the end of the third quarter for these communities was $235 million, net of an impairment balance of $543 million.

Even though we unmothballed two communities in the third quarter, our total number of mothballed lots increased by almost 300 lots during the quarter, because the plat map for one of our previously mothballed communities in California was recently reconfigured to add about 700 lots. So far this year, we have unmothballed a total of seven communities where we can now achieve acceptable cash flow from building homes on these lots. Looking at all of our consolidated communities in the aggregate, including mothballed communities, we have an inventory book value of $1.1 billion, net of $885.6 million of impairments which were recorded on 170 of our communities.

Turning to slide 16, it shows our investment in inventory broken out into two distinct categories. Sold and unsold homes, which includes homes that are in backlog, started unsold homes and model homes, as well as the land underneath those homes. Turning now to slide 17, on a sequential basis, the number of started unsold homes excluding the models has ticked up a bit. We ended the third quarter with 837 started unsold homes. This translates to 4.6 started unsold homes per active selling community, which is still below the 4.9 we have averaged since the beginning of 1997.

One more area of discussion for the quarter as related to our current and deferred tax asset valuation allowance. During the third quarter, the tax asset valuation charged to earnings was $33 million. At the end of the third quarter, the valuation allowance in aggregate was $746.6 million. We view this as a very significant asset, not currently reflected on our balance sheet. We expect to be able to reverse this allowance after we generate consecutive years of profitability. When the reversal does occur, the remaining allowance will be added back to our shareholders' equity and will further strengthen our balance sheet.

We ended the quarter with a total shareholder's deficit of $208 million. If you add back the total valuation allowance as we've done on slide 18, our total shareholders equity would be $539 million. Let me reiterate that the tax asset valuation allowance is for GAAP purposes only. For tax purposes, our tax assets may be carried forward for 20 years. We expect to utilize those tax loss carry-forwards as we generate profits in the future. For the first $1.6 billion of pretax profits we generate, we will not have to pay federal taxes.

Now let me update you briefly on the mortgage markets and our mortgage finance operations. Turning to slide 19. You can see here that the credit quality of our mortgage customers remains strong with average FICO scores above 730. Turn to slide 20. We show a breakout of all the various loan types originated by our mortgage operations during the third quarter of fiscal 2010 and compared it to all of fiscal 2009. 54.8% of our originations were FHA/VA during the third quarter, slightly higher than the 45.9% we saw during all of fiscal 2009.

We have received recent questions about exposure to repurchase claims made by investors who purchased loans from K. Hovnanian American Mortgage. On slide 21, you'll see that our losses during fiscal 2008, 2009, and 2010 year-to-date were relatively minimal. During 2008 and 2009, we either repurchased or settled investor repurchase claims on a total of 28 loans, each of those two years. The loss in 2008 and 2009 was relatively minimal at $2.6 million and $1.6 million respectively. During the first nine months of 2010, we paid claims on 15 loans totaling $1.6 million.

It is our policy to estimate and reserve for potential losses when we sell loans to investors. All of the above losses have been adequately reserved for in previous periods. Overall, the mortgage industry continues to exercise discipline, requiring that a prospective mortgage customer have a solid credit history and job history as well as a modest down payment. So mortgages are available today for those who are credit-worthy. We continue to offer competitive mortgage rates and loan programs, and we are leveraging our mortgage associates' knowledge and expertise to assist our home buyers in obtaining mortgage loans suited best to their needs and qualifications.

Turning to slide 22, it shows our debt maturity schedule as of July 31st, 2010. What you see very clearly is that we had very little in the way of debt coming due in the next several years. Through the end of calendar 2013, we have less than $160 million of debt maturing. During the third quarter we repurchased an additional $24.6 million face value of debt in the open market for approximately $19.3 million in cash.

We announced in an 8-K on March 4th, 2010 that we were considering a $40 million investment in a newly formed Company, Newco that would provide finished lots to Hovnanian as well as to other home builders. We have decided not to make this investment in Newco. In lieu of an investment in Newco, we are focusing our efforts on joint ventures, a strategy that has worked well for us historically including the two JVs we formed in the fall of 2009, one with Angelo Gordon and one with Golden Tree Insight Partners to purchase 1900 residential lots in Illinois and Florida. Our use of joint ventures with financial partners allows us to leverage our intellectual capital, and offers an opportunity for us to generate higher returns on capital due to receiving a higher percentage of the profits compared to our capital investment in the project when we hit certain return targets.

There is a lot of interest out in the investment community to purchase residential assets at or near the bottom of this housing cycle. Forming JVs with a Company such as ours is an efficient way for these firms to achieve their investment goals. The venture structure allows us to utilize our capital more efficiently to grow and an opportunity to achieve an enhanced return on our investment. In terms of cash, we believe that we have the liquidity we need to weather this downturn but also invest for the future. Forming joint ventures will allow us to leverage the cash we have across more communities.

Our cash position can be seen on slide 23. At the end of July, after spending $19.3 million to repurchase debt and $70.3 million on land during our third quarter, we had $492.4 million of home building cash at quarter end. This cash position does include $101.5 million of cash used to collateralize letters of credit. One more point I'd like to make before I turn it back to Ara. Although we did consider putting together a high level financial model to review on this call, given the general global economic uncertainties and the monthly volatility in housing activity, we don't believe it is prudent to publish the financial model.

Suffice it to say, we believe our path to profitability includes; one, obtaining operating efficiencies through growth in community count and home volumes and two, improving gross margins with a larger mix of deliveries from newly acquired land sites. Given the magnitude of the land opportunities out in the marketplace, we believe that we can optimize the use of our cash by higher utilization of finished lot option contracts, and joint ventures, both of which yield superior returns on capital.

By implementing these land investment strategies, we believe we should be able to sufficiently grow our community count and revenues. This top line growth and land investment strategy should allow us to more quickly return to profitability while meeting upcoming debt maturities over the next several years. Now I'll turn it back to Ara for some brief closing comments.

Thanks, Larry. Couple of quick points before we turn it over to questions. First, clearly, the market remains challenging, but late July and most of August have been encouraging versus June and early July as we have seen an improvement in net contracts. It does appear that we are bouncing along the bottom. With this year's industry starts on pace with last year's, at about 550,000 starts, we are significantly below the average for the past five decades. The average over the last five decades is about 1.5 million starts per year, with a post war low of 1 million starts.

Harvard just released its new State of the Housing report. The low end estimate from the Joint Center For Housing Studies at Harvard is 1.7 million new homes being built and needed on average, each year over the next 10 years, while at least one home building analyst is on the other side, calling for a much more modest 1.2 million starts on average each and every year over the same 10 years. Even the most conservative estimates would represent a very significant increase over the current state and rate of housing production. Who will be building these homes? Most of the private builders are either out of business or are working through their last parcels of land.

The vast majority of them do not have the equity to invest in new, and buying new lots for future communities and there's virtually no money being lent to these small builders by banks. The better capitalized private builders, and the public builders who either have capital or still have access to capital will be able to make disproportionate market share gains over this time period. Additionally, keep in mind that existing communities are finishing and closing more quickly than new communities are being opened. The number of new home communities continues to shrink, and the increase in demand should translate to significant increases in absorptions per community, further assisting operating efficiency and profitability. We have been very active in the land market and we plan to remain active in the land market, both with wholly-owned land, and with land that we purchase with joint venture partners. We expect to get our fair share of these market share gains and prosper in the inevitable housing rebound. Thanks, and we'll be glad to open it up now for questions.

Thank you. The Company will now answer questions. So that everyone has an opportunity to ask questions, participants will be limited to one question and a follow-up. After which they will have to get back into the queue to ask another question. At this time we will open the call to questions. (Operator Instructions). Your first question comes from the line of Nishu Sood with Deutsche Bank. You may proceed.

Hi. This is Rob Hansen on for Nishu, actually. In terms of your forecast for 40% of closings in new communities, what type of community count growth does this imply from here for next year?

We've not made a projection on community count growth beyond what we have told you the approximate 195 at year-end. So we're just not publishing a community count specific number, but suffice it to say, I think we gave you enough hints that we expect it to continue to grow.

Okay. And then in terms of the improvement in sales on a month over month basis this Summer, was this simply better conversion ratios or was traffic also up?

I think it's a combination of traffic and slight improvement in conversion rates. And again, as the data showed and Ara explained, we're very pleased to see the monthly sequential improvements, but we're not yet back to normalized levels, and not back even to the levels we achieved a year ago for the same months.

And your next question comes from the line of Dan Oppenheim with Credit Suisse. Please proceed.

Thanks very much. Wondering if you could talk a little bit about your thoughts on land. If we look at the owned land, less the mothballed communities, it's just a couple of years there, how do you think about that in terms of cash flow usage for 2011?

Overall, we're obviously quite comfortable enough with our cash flow usage. I mean, we're not only buying land. I mean, we were out last quarter buying $26 million of our debt back, and some of that debt was in maturities over the next several years. So, we're obviously comfortable that we have the necessary cash flow on the horizon to not just buy land, but to even accelerate early retirement of our debt through purchases.

Okay. Thanks. And then secondly, wondering in terms of -- you talked about the sales getting better as of late, (inaudible) where they were a year ago. What's the target for that? How do you look at that in terms of absorption, and in terms of getting back there, what would you be willing to do in terms of incentives and pricing?

I don't think we've done very much. We survey our competitors in nearby communities each and every week to see what kind of selling pace they have, and what they're doing in terms of incentives, and if they're selling and we're not, and sometimes it's difficult to ascertain what they are doing with incentives and concessions, we'll blind shop them to try to get the best data that we possibly can get. And for the most part, not in every situation, but for the most part, builders have not been increasing incentives or lowering sales prices on any kind of widespread basis. They may be repackaging how they market a particular incentive, but the dollars that they're offering end up being close to the same.

So we have not seen our competitors offering, on any kind of widespread basis, extra incentives or lowering sales prices, and therefore, we haven't done much of that ourselves. Now having said that, there's always a community here or there that you need to do something for, and we've done that, and we've seen some of our competitors do that as well.

And obviously, by the way, as we mentioned earlier, some of that -- the couple of isolated instances where we did make some price decreases and adjustments did result in the impairments this quarter, which we haven't seen much of over the last few quarters, but they were isolated.

And your next question comes from the line of Megan McGrath with Barclays Capital. Please proceed.

Hi. Thanks. Just wanted to follow up on that a little bit in terms of pace and pricing. Your comments about the communities that you impaired, you stated that the pace did get slower, so you decided to get a little bit more aggressive on the pricing side.

And I guess I'm wondering -- I realize there's no magic number for the whole Company, but sort of how much cushion do we have in the current pace before you think that you or other builders would start to get more aggressive? Do you feel pretty comfortable at these levels, or if we continue at this kind of pace, do you think in a couple of months that pricing could get more aggressive?

Well, I'd say if June had continued that kind of absorption levels, or we fall back to that kind of absorption levels, I'd guess that builders might get more aggressive. But as we pointed out, our sales pace improved in July. It improved yet again a little more significantly in August. So I think if that kind of environment holds, pricing may hold.

The other thing to keep in mind, and I mentioned it in my closing comments, generally speaking, in most of our markets we are seeing a decreasing community count. The number of store fronts from buyers to choose from is reducing. So to some extent, that helps mitigate the overall environment, and preserve some, both a little bit of sales pace and preserve a little bit of pricing.

If someone is interested in a new home, just over the last few years, there are just fewer and fewer choices out there. Builders have not been taking new, or developers, have not been taking many new land parcels through the entitlement process, so we've been using up what's out there. And that will help.

Thanks. That's helpful, and for my follow-up, similar on the same topic. I guess I've been a little bit surprised that you and other builders, frankly, haven't pulled back much in terms of the pace of land purchases in the most recent quarters, given the pull back in the overall market. So I'm wondering if you could sort of talk us through that. Is it because land prices have adjusted quickly, which we haven't really heard, or that this is just a longer term land purchase, so you're not really worried about temporary pull back in pace.

Both. First of all, we worry about everything. That's our job. But I'd say both -- many factors are really keeping that going. First and foremost, we are only buying parcels where we can make economic sense in the current selling environment. Now, that's getting tougher because sales pace has been off. But we're still finding parcels, even in the last quarter, that meet our return hurdles of about a 25% unleveraged IRR plus, even in this selling environment. Now, if it dips back much slower, or prices retreat, then you'll need even further lot price reductions to make economic sense.

The other thing is, it is important to maintain a certain amount of volume, and we are finishing some of our legacy communities. So it's critical to be out there, at a minimum, replacing communities, and hopefully, showing a net increase in communities. So we're monitoring it regularly. At the moment we're comfortable, if sales drop back to June levels for a couple of months, I'm certain we would hesitate a little bit more.

And your next question comes from the line of Ivy Zelman with Zelman & Associates. Please proceed.

Good morning, guys. First, I just wanted to compliment you on your disclosure. I think your slide deck, and the detail that you provide on the monthly trends, and detail on the mortgage Company, there's no other Company I've seen to provide that much transparency, so we greatly appreciate it.

Secondly, with respect to margins, you indicated on slide nine on the SG&A that you would expect in the fourth calendar quarter, I guess, I'm sorry, the next fiscal quarter, that we could see margins in the October quarter, your year-end, see SG&A as a percent of sales move higher slightly, due to the timing of closings that you've benefited from this quarter. Can you comment just near-term on gross margin, recognizing that, Ara, your comments were that gross margins would continue to improve with 40% of the closings coming from the newer communities next year, but nearer term as the backlog might be seeing some of the incentives or moving through legacy product that you had to reduce price. Are we going to see gross margins in the near term decline, or should we see it relatively stable, and I'd like a follow-up, please.

I think you can assume stable, Ivy, in terms of the next quarter.

Great. Thanks, Larry. And then just secondly on the impairments. You guys had -- we were a little surprised at the size of the impairments, given what you had been seeing in impairments. And I think with the sensitivity, I think Megan was trying to get at this, and maybe Dan and all of us are trying to understand, if pricing from here was to decline a few percent, 3% to 5%, what kind of sensitivities, Larry, should we expect to see on the impairment side?

You mentioned you had five communities that were generally the cause of those impairments, and you mentioned they were on the fringe. I would have anticipated that you would have already hit those projects if they were on the fringe, and why now would we see it if they previously should have been impaired? So, I'm just trying to understand where the sensitivity is, and what we should be expecting in future impairments.

Actually, I think several of those, if not all of those -- .

100% had been previously impaired.

Had been previously impaired. But, given that the absorption slowed a bit, as we pointed out last quarter, we felt it was most prudent to drop prices a little bit more. We don't have a lot of very large communities. The ones that impaired were larger or more expensive communities. And since they had a longer runway, we felt it would be more prudent to maintain the absorptions in those communities. But for all of them, then, it was the second dose of impairments, bringing the amounts down quite a bit.

Obviously, we don't maintain a tally of how many would trigger with another round, but I don't think off the top of my head, we have a lot that are right on the verge, but I can't say that with certainty. There's still a couple of other large ones out there that we'll just have to monitor closely.

And your next question comes from the line of Jon Ellis with Merrill Lynch. Please proceed.

Thank you. First question with respect to your community count, I believe last quarter you had given a year-end target of 200, now 195. Can you just help us understand, was there any difference in terms of perhaps the number of communities that you're planning to add versus the rate of close-outs. And sort of the related question there would be, do you have any expectation you can share with us in terms of community close-outs over the next few quarters?

Let me just say that, correct, we said there was going to be approximately 200 last time, and we're just refining it to a little more specificity this time. And it's a combination of, in certain instances, of getting through a few communities a little quicker than we had anticipated, and in other instances, not getting open as fast as we anticipated, which is probably more the case. The communities might be lagging a month or two, so they're not going to be open by the end of this fiscal year. You shouldn't read anything of substance into that minor change.

But to give you an idea on how difficult it is, and these are very approximate numbers. I think, I believe on the quarter, Brad, do you recall, how many we actually -- how many we closed out and how many new ones opened?

Yes, 54 new were opened during the quarter, 49 closed. So it's a lot of churn.

And that's what makes it very difficult to be very, very precise on the numbers. But that's a lot coming in and out each quarter, and it's hard to be exact on the projections.

Understood, but thank you, that's helpful. Second question, the started unsold homes figure of 837, do you have a number for how many of those are finished. And then the related question is, typically as you move in past Labor Day, can you give us a sense on, during normalized times, not obviously the past few years, but during more normalized times, what if any seasonal pick-up, do you tend to see in terms of traffic patterns post-Labor Day?

I'll take the finished question. Less than 10% of that 837 is finished. It might even be less than 5%. I just don't have it right in front of me, but it's a small percentage.

And regarding the secondary questions, I don't have the precise number, but as you might imagine, September is a better selling month than August. So normally the seasonal factors would pick up right now, and we certainly hope that's the case.

And your next question comes from the line of David Goldberg with UBS. Please proceed.

Thanks. Good morning, everybody.

Good morning.

First question is on -- I was hoping to get some more color on Newco, and the decision to not move forward with that transaction. A little bit surprising. Just wondering if you could give us some idea of what changed. Was it an ability to raise capital within the transaction? Was it just an absence of deals that you found appealing to go out and purchase. Just try to get some more color around it.

Basically, the deal terms in the end just didn't seem attractive enough compared to our traditional joint ventures. And we felt it just wasn't going to be worth the effort. And we could secure a better return on our capital with the traditional route. The part of it is, some of the smaller communities, we were just keeping those on a wholly owned basis, without a land banking effort on the small ones, or without a joint venture, and we have sufficient capital to do that. So we decided to change strategies just a bit, and focus more on working with our joint venture partners on some of the larger parcels only.

Got it. And then the follow-up question is just a little bit more theoretical. In the prepared remarks, and Ara, you've done this every quarter for a while now, talking about kind of the normalized start pace and historical start pace, and I'm wondering if you could give us some perspective, if you think that buyers' psychology around home ownership has changed.

In other words, maybe we're going to create 1.5 million starts on a normalized basis, but the home ownership rate fundamentally is going to be lower because people have been scarred by the period that we've gone through over the last couple of years. I'm just wondering about your perspective on that thought, and what that might mean for the mix of home ownership and new development as we move forward in this country.

It was interesting, but today on page 35 of the New York Times is a great op-ed piece by Karl Case, and he certainly is a significant author of these op-ed's. And his whole op-ed really revolved around the idea that a home is a dream after all, and that while some are suggesting that dream of home ownership is fading given the recent history, he argues just the opposite, and goes on to show a lot of reasons why that's the case.

Interestingly, among other things, he surveys a couple of thousand recent home buyers every year from around the country, and what was interesting, if you go back to 2005, among the many questions he asks them what they anticipate was going to happen with home prices, and back in 2005 that anticipation was that they would go up 9.5%. Well, that was obviously not reasonable. When you go to 2008, they anticipated a small drop, the recent buyers, and they still bought, interestingly, but showing how things changed. Last year, they anticipated a gain of 2.2%.

In the Spring, the home buyers are getting more optimistic. I guess the public over the long term, they're anticipating a 5.2% increase in home prices. So, I think the notion that what has happened recently, and this is certainly his point, will forever bias home buyers or the American consumers' attitude about home buying, I think that notion has been overplayed, and that's certainly the case he makes.

The second point, and I think this is a critical one as well, is that home ownership is not just a dollar and cents issue. I mean, there is something intangible, but very important to American homeowners, and interestingly, I might add, to immigrants that are now US Citizens, there's a very strong intangible drive to owning their own home, and having that control. It is a huge advantage that exists in the United States over other cultures, and both Americans that were born here and Americans that have moved here have that strong sense. So, while I think there will clearly be a short-term lingering effect from the recent period, I think that's going to change over the medium term.

One other interesting tidbit I'd say about his op-ed piece, because it was an interesting piece, he points out that when you do the math, and you take the average home and the mortgage rates, four years ago, the average home, $300,000, was a 6.6% mortgage, was $1,533 per month. Today, that's with a 20% down payment, with the same down payment, that home price has come down to -- with the same down payment percentage, the home price has come down to about $213,000 on average, and the mortgage rate, he used a 4.2% number because it had dipped just a bit the other day, the mortgage rate, the mortgage payment is $833 a month.

The point I'm trying to get to is, besides their long-term feelings, housing is so much more affordable now than it has been. That gives me some comfort that once we get past this negative psychology and confidence crisis, that we'll see some good home buying activity overall, vis-a-vis rentals.

I would like to clarify something I answered a question or two ago on how many communities we had opened and closed out this year. Rather than 54 opened and 49 closed during the quarter, that's actually the number for the nine months ended July. So, 54 were opened so far this year, and 49 closed.

And your next question comes from the line of Michael Rehaut with JPMorgan. Please proceed.

Hi, this is actually Jason Marcus in for Mike. I was just wondering if regionally you could comment on some of the trends throughout the quarter, and kind of what you've been seeing recently?

Well, I'd say overall, I'll comment on August. First of all, almost everywhere slowed down in June. Can't say there were any markets that showed particular strength.

Maybe even stronger weakness in June in Houston, Ara.

I think that's probably true, which is funny, because for us Houston has been decent. I think the tax credit expiration, seemed to have more of an effect on Houston in slowing things down.

I'd say in August, in most of August and the last couple of weeks in July, it also was fairly widespread in terms of the stronger markets, maybe a little bit more weakness in Phoenix, but generally speaking I'd say it was reasonably uniform. Most of the areas picked up over that period.

Okay. Thanks. And then you mentioned in the past that you expect to raise equity at some point. And I was just wondering if you could comment at all on the timing.

Well, I think as I mentioned the last call, our expectation to do that would be back when we're solidly profitable, and get a multiple of earnings, rather than some kind of option valuation on our equity. So, we haven't returned to profitability yet. So it's some ways off in the future.

Unfortunately, with our debt maturity schedule being fairly accommodating, we don't feel a lot of pressure to do so. In the long run, we think it's likely it will just improve our debt to equity ratios that much more quickly, and we think it will be the prudent thing, but it's not in our immediate horizon.

And your next question comes from the line of Michael Kim with CRT Capital Group. Please proceed.

Thanks for taking my question. Just curious about Newco, without the investment into Newco, thinking about the allocation of capital into more joint venture activity. Do you expect to invest in these vehicles on similar terms to existing JV agreements, and just I guess in terms of a 20% equity investment on an unlevered basis.

And just thinking about the capital requirement or projections of investments into these JV vehicles over the next year or so, and will they be with the existing strategic financial partners, or are you going to be opening this up to others. And just thinking about the leverage here, is there a point in time, near term or longer term, where you might elect to start entering into joint venture agreements on a levered basis?

Well, there are a few different questions I'll try to tackle the different ones. First, generally speaking, in terms of our total capital commitment, a joint venture, even where we contribute 20% of the equity unlevered, takes up less capital than a land banking relationship, which was part of the land stock or Newco model. So, with the switched joint ventures, we would actually have the capital to do even more ventures going forward. I've lost my train of thought.

The leverage, and I think the answer on leverage is, there's none available today for the most part. Banks just aren't lending to do acquisition development, even home construction is difficult to find bank debt. Having said that, initially we'd set the joint ventures up to do, based on 100% equity, and if debt became available at some future date while the joint venture was still in place, we would look at potentially putting leverage on, probably limiting the leverage to something around 30%.

And as we've done in the past, it would be on a pure non-recourse basis. Some of our peers did some recourse debt in the last cycle. We didn't do any recourse debt on any of our joint ventures in the last cycle, and we would continue to implement a philosophy of not doing recourse debt, if we were putting debt on joint ventures in the future.

Yes, the one thing I will add is, in the short -- well, our long-term target is very low leverage in joint ventures. Given the fact that we're fairly highly leveraged right now by mistake, it's possible, if our partners were wanting a little higher leverage than our long-term goal, for the short term we might accommodate that if it becomes available on good enough terms. But generally speaking, our immediate plans are 100% equity.

And that will be with existing strategic financial partners?

That was the other question. We are definitely having discussions with some of our past partners, and I think hopefully that will absolutely happen. Everyone has their preferences, of course. One may like Florida more. Another one may be bullish on northern California, et cetera. So you have to look at each particular opportunity.

Having said that, though, I'd say it's highly likely we would be also doing transactions with additional partners. Fortunately, there are many potential partners out there. We continue to get called regularly, and have conversations with many. So at this point, while we certainly want to be loyal to our partners, our recent partners, and the experience has been exceptional with them, we're very pleased, I think it's logical and prudent to continue to build relationships that we can count on for the future, too.

And your next question comes from the line of Joel Locker with FBN Securities. Please proceed.

Hello?

Yes, we're here.

Just one question on the customer deposits. They historically ran around 4% of backlog, and I noticed this quarter they dipped down around 2.7%, and was wondering, was there any change in policy or was that just a regional mix?

Has to be regional mix.

Yes, the regional mix can be significant. In Houston, the deposits, and California tend to be very low. In New Jersey, they tend to be very high. So just depends on mix at any particular point in time.

All right. Thanks. And just a follow-up on the debt to equity on your joint ventures currently.

Well, when we put them in place initially, they were 50% or less, and because we've written off some of the land values, it's increased -- hold on a second. We'll tell you what the number is.

Thanks.

62% debt to cap. And that's actually disclosed in our financial statements, 10-Qs every quarter as well, if you want to look back at it historically.

Right, all right, thanks a lot, guys.

And your next question comes from the line of Alex Barron with Housing Research Center. Please proceed.

Thanks. Good morning, guys. I wanted to ask you about your -- any plans that you have as far as reducing SG&A, that you could elaborate on, like are you guys planning on potentially exiting any markets to kind of shrink your footprint a little bit?

Frankly, we are not at the moment. We think while we're obviously doing all the things you might imagine, and we've already spoken in the past at length about the reductions in headcount, and other measures we've taken, we think ultimately, reaching our target levels of SG&A will take growth. Both growth in the number of deliveries, and growth in absorption per community, per month. The latter is a little bit more difficult for us to control. The former is more within our abilities, and we're working to do that. So, I'd suspect that that will be more of our path to SG&A reduction than reducing our footprint.

We need the growth to happen. And reducing our footprint, only makes it more difficult to do that. I'll add that in certain geographies where we have small current activity, like in southeast Florida or in Orlando, I mean, our division is down to a, literally about three or four people in the office. So we can manage that particular geography with fairly small local staffs, and doing more on a regional or a corporate-wide level.

Okay. And then I was wondering if you could also elaborate on your 25% IRR target, what does that mean in terms of like sales pace? What are kind of the ranges of sales pace and gross margins that make up the 25%?

We assume current sales pace, and current home prices when we're calculating that unlevered IRR out the next couple of years. I mean, if it's a really long-lived community, we still assumes today's sales price, but we might very modestly pick up pace in year three and beyond. But we're not doing too many communities that are that large to even have that phenomena come in. Our margins are different in different geographies, but average close to the normalized margins that we're talking about migrating back toward, which is the 20% to 21%.

To put perspective, sales pace at typical communities probably ranges between 1.75 a month and three per month. It just depends on the geography, the product type, the price range, et cetera. But that's the general range of absorption pace.

And it's based on what competitors are selling in nearby similar communities, or what we are selling in nearby similar communities, a combination thereof. But it's based on what the market is doing today in terms of pace, and what sales prices are net of all incentives, concessions today, so no improvement is assumed.

(Operator Instructions). Your next question comes from the line of Carl Reichardt with Wells Fargo Securities. Please proceed.

Hi, guys. Just on the impairments, Larry, I'm curious, what was the total number of lots in the five communities that were responsible for 75% of the impairments?

We don't have it right here, but we can call you back with that.

Okay.

If you're curious.

I am. And then on the remainder of the impairments, the $12 million to $13 million, do you know how many communities were impaired in that $12 million to $13 million left over?

Hold on just a second. We'll get back to you with that, too. We'll get back to you on both questions. We just don't have it at our fingertips.

Your next question comes from the line of Susan Berliner with JPMorgan. Please proceed.

Thank you. Larry, I guess a question for you. With regards to land spending, is there any set amount of minimum cash from unrestricted cash that would make you kind of pause and reduce the kind of $70 million clip of land purchases you've been doing?

Well, what we do is, we have one eye very focused on what our current cash balance is, and another eye very focused on what our debt maturities are, so to the extent I was investing cash today that was going to be returned to me before I have any debt maturities, and not only is that cash going to be returned, but I'm going to get an annual 30% return on that capital, I'm comfortable making that investment. But we want to make sure that in light of all the cash that we're investing, that we have sufficient cash remaining at the time that debt is coming due to pay off the near term debt maturities. So that's how we kind of look at it.

There's no magic number that I'm going to disclose on this call. Obviously, more is better in terms of having a cushion. But that's how we look at it.

Great, and then my second question is, I guess if you were to look to raise additional capital, I know we've talked about the equity market. Can you just talk about the bank lending market? Has that kind of reopened at all?

Not really, in my opinion, I mean, you might find a regional bank or a small bank here or there that might do something on home construction only. But I don't think it's anything widespread that's happening, and certainly not in mass quantities at this stage. I think at some point the banks may start to lend again. I think some of our peers may be talking to the banks right now about redoing their lines, and other than I guess MI homes, MI Schottenstein I think is the only one who has made any announcements to date. And I think they got theirs done, but it wasn't a large facility. So, I think all the banks are still trying to work through their existing loan portfolios in residential real estate, rather than make new loans today.

And with no further questions in queue, I would now like to turn the call over to Ara Hovnanian for closing remarks.

Well, thanks, appreciate the questions. There were some good ones. We're all obviously as anxious as you are to see what September and October sales brings, and we're hopeful that we'll continue to see some positive momentum in our sales trends. With that, we'll look forward to giving you an update in another quarter. Thank you.

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