Lennar Corp (LEN) 2006 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the Lennar Corporation fourth quarter earnings release. [OPERATOR INSTRUCTIONS].

Ladies and gentlemen, today's conference call may include forward-looking statements that are subject to risks and uncertainties relating to Lennar's future financial and business performance.

These forward-looking statements may include statements regarding our business, financial condition, results of operations, cash flows, strategies, and prospects.

Forward-looking statements represent the Company's estimates only on the date of this conference call, and are not intended to give any assurance as to actual future results.

Because forward-looking statements relate to matters that have not yet occurred, these statements are inherently subject to risks and uncertainties.

Many factors could cause our actual activities or results to differ materially from the activities and results anticipated in forward-looking statements.

These factors include those described under the caption, "Risk Factors Relating To Our Business", contained in our most recent annual report on form 10-K, which is on file with the Securities and Exchange Commission.

Please note that Lennar assumes no obligation to update any forward-looking statement from past or present filings and conference calls.

With that being said, I would like to turn the conference now to the Chief Executive Officer and President, Mr. Stuart Miller.

Please go ahead, sir.

Thank you.

Good morning, everybody, and thank you for joining us for our fourth quarter and year-end 2006 conference call.

We're very pleased to share with you our thoughts about market conditions and about our progress and focus for the upcoming year.

I'm joined this morning by Bruce Gross, our Chief Financial Officer, and Diane Bessette, our Vice President and Controller, who will both participate with some prepared remarks as we endeavor to give clarity to the numbers that we have reported, and as we give as much understanding as possible to the goals that we've set for the future.

Let me also note that this is our first conference call since the passing of our Chairman, Bob Strudler, and I would just say that his presence is sorely missed.

We as a group, always looked forward to getting a call from Bob after our conference call, and particularly in times like these, Bob would always be the source of a gentle reminder that we keep things in perspective, even as market conditions might wane.

As we look in particular at the market, let me begin by saying that market conditions have continued to be very difficult as we've completed our fiscal year 2006.

While it is not our custom to comment or update our view of the market in the middle of quarters, I will say that we have not yet seen improvement in market conditions to date, and this, as we've gone through the seasonally slowest time of the year.

We believe that as we move through the next six months of the year, we will begin to get the most credible reading of where the market actually is heading and how current market adjustments will resolve themselves.

In our decision-making, we do not try to predict the future heading of the market, and we continue to look very short-term, making all decisions based on the market conditions that currently exist.

We constantly remind ourselves that most predictions are wrong and there's never a consensus on the future.

Smart people are often at odds with each other and flawed decisions are often predicated on bad assumptions.

Our general guiding light consistently in all market conditions is that we are a balance sheet first-focused company.

We believe that the strength of our balance sheet will always provide a foundation from which we can propel our Company forward, finding opportunity and success in existing market conditions.

It is with this primary driver in mind that we address the market weakness that began to reveal itself at the beginning of 2006.

Our strategy for the past year has been to focus on our balance sheet by maintaining very low inventory levels, delivering our backlog of homes under construction and finished homesites, and reducing our land assets.

We highlighted early on in the year that we would price our product to market in order to achieve an even flow of deliveries to accomplish these goals, and we did exactly that.

We said that we would keep inventory very tightly managed as we built through our homes under construction.

In fact, as we went through the year, we maintained an approximate average of less than one homesite per community completed and not sold.

This enabled us to reduce our inventory from approximately $9 billion to $7.8 billion at year end.

We said that we would deliver developed homesites that were on what we called our construction conveyor belt, and in fact, we delivered a record 49,568 deliveries and revenues of $16.3 billion.

This enabled us to reduce our homesites owned and controlled from a peak at the end of the first quarter of 2006 of some 345,000 homesites to a year-end number of some 282,000 homesites, which is down approximately 18%.

We said that we would price to market in order to achieve balance sheet strength, and that resulted in a margin deterioration from a peak of approximately 25% to the current fourth quarter margin -- gross margin of 14.4% before impairment.

And we expect that margins will remain depressed as we deliver our backlog through the first half of the year.

We said that we would improve our balance sheet through the year as we executed our strategy and we accomplished -- and we accomplished that with a year-end homebuilding debt to total cap of 31.4% versus 33.1% at year end 2005.

We expect to continue to see balance sheet improvement into 2007 as we reduce our delivery expectations and continue to reduce our land and homes under construction.

We've also continued our strategy of paring down strategic assets as opportunities present themselves to do that.

Accordingly, we recently announced the LandSource transaction, whereby we and our partners, LNR Property Corporation, [agreed to have LandSource admit a partner for a] (corrected by Company following the call) 62% interest in what is primarily our Newhall land asset.

This transaction positions us extremely well to continue to participate in the ownership and buildout of this very strategic asset while we simultaneously reduce our investment and remain prepared and even better-positioned for future opportunities.

Also in the context of this transaction, we were able to recalibrate the pricing on some 4,000 homesites that we had under option.

Our strategy overall has been carefully crafted to prepare us for the future, when homebuilding markets begin a rebound and when new opportunities present themselves.

As we look ahead to 2007, we have set a goal of achieving flat earnings at $3.69 a share.

This goal, I underline this goal, clearly, is a little bit of scotch tape Band-Aid.

We simply can't see into the future, as I've already said.

There is no clarity.

And this is why we put forth a goal at this point and not guidance as we have in the past, per se.

That next year will be all about cost reduction, cost reductions that have not yet revealed themselves through our numbers.

It will be about product realignment, refocusing on what the market is looking for in current market conditions.

And it will be about further balance sheet improvement and focus while we reduce our deliveries by over 20%.

As we enter 2007, our challenge will continue to be to recalibrate to a new market condition.

We will continue to negotiate and renegotiate land pricing.

We will continue to adjust costs by rebidding subcontracts and materials.

We will continue to refine and redefine our product offering, meeting market desires and requests in the current market condition.

And we will reduce and right-size our overhead in order to meet restructured demands and deliveries.

The fundamentals that drive our business continue to be strong and continue to present opportunities for recovery within the industry.

While we have not yet seen that recovery, interest rates remain low, employment remains strong, and the overall economy remains strong, presenting opportunities for recovery in the future.

Our strategy has been to prepare for that future, and as we look ahead, we feel that we are uniquely positioned to be able to take advantage of opportunities that come up and to address market conditions as they exist.

With that, let me turn over to Bruce.

Thank you, Stuart, and good morning.

I'd like to touch on three topics.

First, I'd like to talk about the results of our balance sheet first strategy; second, I'd like to give a little bit more color on our fourth quarter results; and third, I'd like to give some details behind the goal that Stuart referred to as we rebuild profitability in 2007.

Starting with our balance sheet first strategy, in the first quarter of 2006, Stuart talked about a peak of 345,000 homesites owned and controlled.

As the market conditions began a significant pullback, we focused on a strategy of converting inventory into cash and repositioning our inventory to reflect the current market conditions by renegotiating our walking away from options or land purchases that no longer reflected current market pricing.

In managing this strategy, to understand it best, we divided the 345,000 homesites into three buckets.

Bucket number one are owned homesites, which had a balance of 106,000 in the first quarter of 2006.

Bucket number two, or option homesites from third parties, and had a balance of 134,000 in the first quarter of 2006.

And the third buckets are homesites optioned from joint ventures where Lennar has an equity interest and we had a balance of 105,000 homesites that we optioned from these joint ventures in the first quarter of 2006.

Those are the peak owned and controlled homesites that we experienced going back to the first quarter of 2006.

Now talking about each bucket, bucket number one, we receive 100% of the upside and 100% of the downside, of course, with homesites that we own.

Therefore, in a declining market, this is the bucket that we want to reduce exposure the fastest.

Our strategy for these owned homesites was to build out our construction and progress, which by the way includes finished homesites that were on the conveyor belt and ready to start construction, and then to price these homes to market and convert this inventory to cash quickly.

All of our homesites go through this bucket once they are purchased.

As a result, all of our deliveries come out of this bucket, and therefore by exceeding our delivery target in 2006, we did, in fact, reduce the greatest exposure in this declining market.

This bucket also received the largest portion of our valuation adjustment, which Diane Bessette, our Vice President and Controller, will talk about in a few minutes.

Now, at the end of 2006, this bucket was reduced to 92,000 owned homesites.

Bucket number two are options with third parties.

We reevaluated the options in this category to determine if it reflected today's realistic pricing.

If the options did not meet current market pricing, we either attempted to reprice to the current market conditions, or we were forced to walk away from the deposit.

We were successful in renegotiating the majority of these options.

However, we did walk away from $111 million of deposits, which represented approximately 9400 homesites.

As we ended 2006, the ending balance in this bucket was 95,000 homesites.

Bucket number three are homesite that is we optioned from joint ventures, which Lennar purchases at fair market value pricing.

The joint ventures have mitigated our downside risk as our Lennar investment in all of the joint ventures that we have in total is only 39% of the total equity in all the joint ventures that we are involved with.

Therefore, to the extent an asset in a joint venture is impaired, we are generally limited to our share of the investment and the joint venture.

In the fourth quarter, we recognized $110 million of valuation adjustments.

This bucket has now been reduced to 95,000 homesites at the end of 2006.

So when you look at it in total, as Stuart mentioned, the 345 ,000 homesites owned and controlled, which peaked in the first quarter of 2006, have been reduced to 282,000 and reflect land at current market pricing at year end.

As a result of this inventory reduction strategy, we generated significant cash flow and we finished the fiscal year with no short-term borrowings, either commercial paper issuances or borrowings under our $2.7 billion unsecured reinvolving credit facility, and additionally, we had over $660 million of cash on the balance sheet.

Our debt to total capital improved quarter over quarter, and year-over-year, improving 170 basis points year-over-year to 31.4%.

And our EBIT was $1.8 billion for 2006 and we have excluding the impact of the impairments from this number, since they are unusual in nature and noncash charges.

And our EBIT to interest coverage on this basis was 7.3 times and our debt to EBIT leverage was 1.4 times, both calculated on a rolling four quarter basis.

Additionally, during the fourth quarter, we retired at PAR $200 million of floating rate notes that were due to mature in August of 2007, and we repurchased over 500,000 shares of stock in the fourth quarter at an average price of $43.49, which brought the total number of shares repurchased in all of 2006 to 6.2 million shares.

As we have successfully executed our goal of building out our construction and progress and finished homesites on the conveyor belt, we tapered back starts in the fourth quarter by 29% compared to the prior year's fourth quarter, and we also significantly reduced new land purchases.

Construction and progress was managed very tightly as total wholly owned inventory under construction was reduced from 23,000 under construction to 17,000 under construction year-over-year.

Completed inventory unsold averaged one home per community at year end, and as a result of these strategies, we were successful in reducing our inventory balance from the peak in the first quarter of 2006 of $9 billion to $7.8 billion at year end.

Now to provide a little bit more color on our fourth quarter results, although our deliveries exceeded our estimates for the fourth quarter, our results reflect the change in pricing for new homes as sales incentives increase significantly and impairments were required when evaluating our inventory at November 30th of 2006.

Our 14% decrease in revenues from home sales is due to a 4% decrease in wholly owned deliveries and an 11% decrease in average sales price on wholly-owned homes from $338,000 to $302,000 year-over-year.

This decrease was a result of increased sales incentives from $11,000 per home in the prior year's fourth quarter to an average of $47,000 per home in the current year's fourth quarter.

The average sales price by region is detailed as follows: The east region was down 11% from $345,000 to $309,000.

Our central region was down 5% from 212 to $202,000, and our west region was down 10% to $445,000 from $492,000.

Our gross margin on home sales percentage before impairments decreased from 27% in the prior year to 14.4% in the current year's fourth quarter.

The gross margin percentage decreased in all of our operating regions, with the east at 14.4%,; the central at 14.4%; and the west at 16.4%.

This decline in margin was driven by the increased sales incentives from just over 3% in the prior year to 13.5% in the current year's quarter.

The sales incentives were broad-based, with increased in all of our regions.

However, generally the market set experience the highest gross margins in the last two years, also experienced the largest sales incentives.

Gross profit on land sales during the quarter was a loss of $119.9 million versus $58.2 million profit in the prior period.

This number is net of $111.1 million option deposit write-offs related to land the Company does not intend to purchase and $33.3 million of land valuation adjustments, which again Diane will talk about in a minute.

Our joint venture results decreased to a loss of $59.6 million from a profit of $79.1 million in the prior year's quarter.

This number is net of $109.7 million of valuation adjustments to certain investments and unconsolidated entities.

The SG&A percentage, as a percent of revenue from home sales increased 230 basis points to 12.1% versus 9.8% in the prior year.

This increase was primarily due to a 14% decrease in revenues and higher broker commissions and advertising, but partially offset by lower incentive compensation expenses.

We've been focused on reducing our head count to match the current environment and our associated head count is down approximately 10% from the peak level in 2006.

We incurred a $0.03 charge in the fourth quarter for expensing of stock options versus zero in the prior year.

And turning to financial services, our pretax income increased to $42.9 million versus $34.6 million in the prior year's fourth quarter.

Mortgage profit improved to $38.1 million from $21.6 million in the prior year.

And this was a result of an increase in our capture rate from 64% in the prior year to 70% in the current year, as well as a larger component of fixed rate mortgages, as that number is now up to 70%.

FICO scores did not change significantly from the prior year and remain in the low 700 range, and our title pretax decreased in the fourth quarter to $5.7 million from $13.9 million in the prior year, as volume and profit per transaction decreased due to the slowing housing market.

The actual share count at quarter end was 157.1 million shares, and due to a loss, the diluted share count is the same.

As discussed earlier, our new homeowners including joint ventures were down 6% year-over-year, and again the slowdown was broad-based and is being felt in all of our markets now.

Our cancellation rate was 33% during the quarter, including our joint ventures, versus 23% in the prior year.

Our backlog, as you noted in the press release, decreased 42% year-over-year.

Looking at dollar value, the average sales price in the backlog stayed at $333,000, which is down 9% from the prior year's fourth quarter.

However, I will note that with cancellations remaining at a high level, we do expect this average sales price and backlog to continue to decline.

The after-tax impairment charge in all of 2006 was $396 million, or approximately 6.5% of our ending shareholder's equity.

And the third topic I would like to talk about is our 2007 glimpse.

And with uncertain market conditions, it makes it difficult to provide a 2007 earnings goal.

However, we are hopeful that we will meet our exceed our 2006 earnings per share, as Stuart mentioned, of $3.69.

By focusing on carefully matching our starts to demand, we estimate deliveries will be lower in excess of 20% versus 2006 deliveries.

We will be focusing on rebuilding our margins in 2007.

However, since we know the margins in our backlog, we believe margins will improve each quarter, assuming a favorable homebuilding environment.

Our goal is to achieve a gross margin averaging in the high teens for the year.

However, starting lower in Q1, and improving each quarter throughout the year.

We expect the average sales price to be approximately $310,000 for the year, but starting at about $300,000 in Q1 and increasing each quarter throughout the year.

Our delivery goal is to be over 8500 deliveries in Q1 and increasing with each quarter, ending the fourth quarter, we hope to be over 10,500 deliveries.

And joint ventures and land combined, we expect to be 50 to $100 million of pretax, while management fees and others, we expect to be over $175 million of pretax.

And this includes an estimated profit from the closing of the LandSource transaction, which we still expect in the first quarter, and we still expect to be a pretax dollar amount of approximately $125 million.

As we indicated in our prior press release, we expect LandSource will result in deferred profit, to be recognized in future years of approximately $375 million, and we expect that to come in over the next five years.

We will continue to focus on managing our SG&A levels.

However, given our lower volumes, we expect SG&A as a percentage of revenues will be slightly higher than the actual percentage in 2006.

Our 2007 goal does not assume any additional impairments, and we are assuming a weighted average diluted share count of 158 million shares for 2007.

The market the conditions have been erratic, and therefore these goals are subject to change, dependent upon the homebuilding market.

With that, I would like to turn it over to Diane to discuss our process relative to the determine asset impairments.

Thank you, Bruce, and good morning.

During last quarter's conference call, we outlined for you one component of our balance sheet management program.

That is, we shared with you our regularly agitative approach to ensuring that our assets are properly stated.

For those of you that were not on last quarter's conference call, let me provide a quick summary of our approach.

We employ an orderly, regular, and comprehensive process for reviewing asset values, identifying impaired assets and assessing the recoverability of these assets.

This process is based on a quarterly corporate asset by asset review performed division by division.

Additionally, face-to-face operations reviews are held immediately after the end of each quarter.

During these operations reviews, the management team members of each homebuilding and land division meet with senior corporate management to review the performance and valuation of each asset.

The quarterly operations reviews provide connectivity between the knowledge embedded in our operational associates closest to the assets and markets, and corporate management's goal of ensuring that our conservative accounting policies are adhered to and our financial properties are properly stated.

Our process of identifying and evaluating underperforming assets is divided into three general categories: option deposits and preacquisition costs; wholly owned inventory; and investments in joint ventures.

Based on the approach I just summarized, let me provide you with the results of our fourth quarter valuation review of the assets in each of these categories.

The first category of assets we evaluated was option deposits and preacquisition costs.

We reviewed these deposits and costs on an option by option basis to determine if it is probable that we will walk away from the existing option contract.

For the fourth quarter of 2006, we wrote off approximately $111 million of option deposits and preacquisition costs, which represented approximately 9400 homesites.

The segment detail is as follows.

In the east segment, $73 million; west segment, $27 million; and other, $11 million.

There were immaterial dollars written off in the central segment.

The second category of assets we evaluated was wholly-owned inventory.

This review was performed on an asset by asset, division by division basis to determine potential impairment.

For the fourth quarter of 2006, we recorded approximately $273 million of valuation adjustments, split between homebuilding, which was $240 million, and land,which was $33 million.

The segment detail for the impact on the home building piece is as follows.

East segment, $139 million; central segment, $26 million; west segment, $60 million; and other, $15 million.

The segment detail for the impact on the land piece is as follows: east segment, $16 million; central segment, $4 million; and other $13 million.

There were no valuation adjustments recorded in the west segment.

The third category of assets we evaluated was our investments in joint ventures.

We have an entire corporate group dedicated to monitoring our joint venture investment to determine potential impairment.

For the fourth quarter of 2006, we recorded approximately $110 million of valuation adjustments.

The segment detail is as follows: east segment, $25 million; west segment, $78 million; and other, $7 million.

There were no valuation adjustments recorded in the central segment.

Based on the results of the comprehensive and orderly process I just described as well as our operating strategy as outlined by Stuart and Bruce, we were successful with the execution of our balance sheet management program that focused on decreasing our inventory balances in 2006.

From a peak of 345,000 homesites owned and controlled at February 28th, we decreased our total homesite count at 222,000 at November 30th.

Additionally, we pared down the inventory dollars reflected on our balance sheet from a peak of almost $9 billion at February 28th to $7.8 billion at November 30th.

This paredown was accomplished while ending the year with a homebuilding debt-to--total-capital ratio of 31.4% and $662 million of cash on hand, as has previously mentioned.

As we look ahead, we will remain focused on maintaining our inventory balance at properly-sized levels as we continue our strategy of matching starts with demand, delivering homes at completion dates, selling land as market conditions allow, and maintaining assets at properly stated value.

With that, I would like to turn it back to Stuart for some concluding remarks.

No concluding remarks.

Let me thank you, Diane, thank you, Bruce.

Let me say that in order to address as many as would like to ask questions, we're probably going to overshoot our traditional one hour.

I just wanted to let everybody know that that was our intention here.

We want to answer as many questions as possible.

So with that, we'd like to turn it over to question-and-answer.

[OPERATOR INSTRUCTIONS] First to the line of Ivy Zelman with Credit Suisse.

Please go ahead.

Hey guys, it's actually Dennis McGill.

The first question is, Bruce, if you can, given all the assumptions you laid out there, where is your expectations for first quarter excluding the potential gains from the JV sale?

We haven't broken that out, just given the erratic market conditions, Dennis.

We haven't actually broken out the numbers by quarter, but the numbers are increasing each quarter throughout the year.

So first quarter excluding LandSource, would be the low -- we expect to be the lowest number for the year as a result of the backlog that's in place.

And given the margins that are embedded in that backlog.

But we haven't actually given a range by quarter at this point.

Even though we're so deep into the quarter already?

Yeah.

Given high cancellations rates that have existed, Dennis, I think given what we've been through the last quarter or two, in particular, and the number of changes, we just think in this market it's more prudent not to pinpoint a very narrow range at this point.

So is it difficult, then, to put confidence around the full year, realizing that it sounds like a lot of the expectation is that the market starts to imply is the implication that the guidance suggests?

Dennis, this is Stuart.

As I said in my opening remarks, as we look ahead into 2007 and we taint our internal goal for 2007, I said that there's a little bit of scotch tape and Band-Aids involved in putting these numbers together.

Looking ahead in today's environment is filled with question marks.

All of the variables are subject to change, and we want to be very realistic about that.

We've been working in a very focused way for quite a number of months now on the cost side of the equation, and that's where we think the most substantial upside will come from.

But even within our own environment, we would say that the cost reductions are still unproven.

We need to see them start to flow through our bottom line numbers.

So from a realistic standpoint as we look ahead, all of the numbers that we would put on the table are subject to movement.

We think that there are some ups and some downs, and we want to be very clear to everybody that there's a lot of uncertainty as we move forward.

And as close as we are to the numbers, we recognize within our own shop that they are not predictable right now.

Is it safe to say in that goal that you are hoping the market gets better, or you're implying that you think it will get better?

I think as we -- as we look ahead, we can paint as many arguments for the market getting better as we can for the market perhaps staying the same, or even moving downward a little bit.

I think that the question surrounding inventory levels continue to remain a big question mark.

I think that there continue to be risks to the economy in general, and risks that perhaps foreclosures could peak up and present another four-month inventory problem.

We look at those as risks to the market.

At the same time, we recognize that interest rates are low, so they've been trending up a little bit recently.

We recognize that unemployment is low and looks like it's going to remain low.

The economy, overall, is strong.

These are generally ingredients for strength within homebuilding.

So there are really arguments on both sides.

And to try to cast a line on one side or the other, I think we have to remain agnostic to where we think the future is and just play out to the mark that exists right now.

Within our numbers, we are anticipating that there would be a seasonal pickup in demand and in sales and deliveries, but we are not expecting a big improvement in the marketplace, most of our expectations for margin improvement come from land positions and as well from cost reduction.

Okay.

Thanks a lot, Stuart.

That's helpful putting parameters around that.

Just one last question.

On the land side, on the cost side, as you brought up at the end there, of what you've repriced, if you looked at your own portfolio today, how much or what percentage of that would you say meets or exceeds return hurdles that you would set forth if you were buying the parcel today?

Well, I would say, Dennis, again, looking at the three buckets, the joint ventures we're buying at market.

What's in the option category from the third parties, we feel pretty comfortable that we've renegotiated the majority of those option deposits and those that did not meet our criteria today, those are typically the option deposits that we've walked away from.

So the majority of those we feel comfortable to meet today's hurdles.

The trickier part is the owned bucket, and that's why our strategy in 2006 of trying to move through that bucket as quickly as possible was a strategy we employed, because we wanted to convert that to cash.

Because those are the homesites that we have 100% of the exposure in the declining market.

So having exceeded the deliveries that we expected in 2006, we feel comfortable that we've mitigated a lot of that risk and then we've dealt with through impairments anything that was not at the current market pricing within that bucket.

Now, having said that, it doesn't mean that there isn't risk of future impairments or write-offs, again, depending how the market moves over the next number of months.

But we feel pretty comfortable that our strategy positioned our inventory to be realistic pricing as of the end of the year.

Do you feel like those 92,000 lots are priced at current market, assuming the market doesn't change from here?

Yes.

And assuming that as we look at the traditional sales period that we usually have in the spring, assuming that we feel that the pricing at year end was realistic.

And that's reflective in those 92,000 homesites.

Okay.

Thanks again, for the time, guys.

You bet.

Next to the line of Stephen Kim with Citigroup.

Please go ahead.

Thanks.

I wanted to clarify just once more your -- what's embedded in your expectations for the marketplace.

A read of what you said -- what you wrote in your release and listening to what you said here, it sounds like you're not really looking for demand -- you're not really embedding in an assumption that demand improves.

For instance, if you could have a seasonally adjusted measure of demand, not that one really exactly exists, but if you had such a measure and let's say it was 60 today or 60 over the last couple of months, your expectation of your goal of 369 were better is sort of an assumption that the index sort of stays at that sort of 60ish type seasonally adjusted level throughout the year.

Is that a way that I could sort of understand your outlook for what's embedded in your numbers?

Yes, I think that's exactly right, Steve.

Our view right now is to keep our thinking about the future tied to where the market conditions are right now.

You properly assessed the fact that we are expecting kind of a normalized seasonal adjustment as we go into the next month, but we are not -- we are not incorporating into our expectation a view that the market conditions materially improve.

Excellent, okay.

I thought that's what you were saying.

The second thing I wanted to understand was your cancellation rate.

Looks like it didn't really increase very much.

I have your can rate at about 31% last quarter.

Looks like it moved to 33.

So looks like the trajectory here has begun to diminish a little bit.

Can you talk, though, since you see these numbers in far greater detail than we can, is there anything embedded in those numbers in terms of regionally, or the kinds of cancellations that you saw this quarter versus previous quarters that either worries you, or, number two, makes you feel that perhaps the can rate is likely to stay high or go higher in the months and quarters ahead?

It's hard to certainly predict future cancellation rates, Steve, but I would say that the cancellation rates were broad-based.

The largest cancellation rates seem to match up more with the areas that have the greatest use of sales incentives.

And that would be the only correlation that I would probably say.

But it's very hard for us to see anything in these numbers that would cause us to make a comment about future trends.

The only thing that I would say, Steve, is that I know that everybody's looking for kind of that golden metric that's going to highlight to us when there's a bottom and when there's a turnaround, and a lot of focus is being brought to bear on cancellation rates.

It seems to me almost axiomatic that cancellation rates will come down as pricing becomes closer to market across the board.

I think the cancellations are a reflection of people's belief that what they bought yesterday is no longer at a fair market value.

I just think we're getting closer and closer to that.

So it would be my expectation that as a normal matter, even if the market is not materially improving, that through 2007 we will see cancellation rates start to come down.

Yes, I agree.

I agree.

And then, I guess lastly, you made obviously pretty important commentary -- part of your commentary here is the trend in margins.

One of the things you mentioned was that the initiatives you've taken to get your cost of goods sold down with some contractors, suppliers, and that sort of thing.

You said, it's been unproven.

And I think what you made for that, for observers such as ourselves, we have not been able to observe those improvements in your November reported figures.

I don't think you meant that you yourselves are uncertain as to whether in fact those improvements will be gleaned or not or gained or not.

Can you just, number one, confirm that is -- you actually do have a very good line on what you think your costs are going to be next year and that they are down.

And number two, maybe give us some sense for what the big chunks of that reduction -- those reduced costs might be?

Yeah.

Thanks for highlighting and giving us a chance to clarify that, because it's not easy to clarify.

Let me start by saying that both Jon Jaffe and Rick Beckwitt are spending a material amount of their personal time working on the negotiation of material costs.

I think as a starting point, we need to recognize that through 2004 and 2005 and in the wake of a market that was somewhat inflated and speculative and excited, costs moved up, perhaps even out of sync with where they should have gone.

And so there's opportunity to just bring costs back to a real zone.

But then on top of that, there's the opportunities to negotiate efficiency by creating efficiencies in the products that we're delivering through what you all know as our Everything's Included program, and then using that program as an opportunity to renegotiate for both purchases, with suppliers, subcontractors, both on the national and on the regional level.

And John and Rick have been primarily focused on two things, on renegotiating material and production costs, and then, of course, renegotiating land positions.

We believe that we're going to start to see, as we get into 2007, the benefit of those renegotiations coming through the cost side of the equation.

And it's not that those cost reductions are not proven.

We believe, or we have contracted for actually lower prices.

But as has been the case through many years and even decades, Steve, we as larger builders have said we're going to turn volume into cost reductions, and those cost reductions have been elusive.

I want to be properly cautionary by saying that we have not yet seen those cost reductions flow through the numbers, so we're going to take somewhat of a wait and see attitude as we watch those cost reductions start to flow through the cost side.

Can I tell you where the biggest chunks are?

I don't think that in our business we find big chunks of reduction.

What we do instead is it's a nickel here and a dime there that gets very actively and aggressively negotiated and then renegotiated.

And so we're not going to be able to put our finger on exactly where it's coming from.

And this is why I'm cautionary about these things.

I want to be very real realistic and not set expectations too high.

Okay, great.

Appreciate it.

Thanks very much, guys.

You're welcome.

Next to the line of Carl Reichardt with Wachovia Securities.

Please go ahead.

Hi, it's Darren for Carl.

Just a couple questions on LandSource.

First, I was just wondering, who approached who first about this transaction?

Well, there has been a relationship that, number one, existed with MWHP and Lennar over the last couple of years with the establishment of a land bank portfolio that we had with them.

Additionally, as we have continued to be involved with some interesting different transactions, there's been discussions of them possibly being involved in some of the other unique transactions we're involved with.

So it's something that evolved over time.

So admitting them as a partner to LandSource at this point is really an evolution that has occurred over time.

It's difficult to just put it very differently than that.

Okay.

I think that one of our fears was that people would look at this transactions and say, gee, this is one of those shotgun transactions at year end, or they kind of worked balance sheets and stuff like that.

The fact of the matter is that this transaction is a natural outflow of an evolution that's been in process for a long time.

We have a wonderful relationship with the McFarland Group, and it dates back, as Bruce said, quite a number of years.

There has been a hope and an expectation that we could do more things together as we move forward.

These are very smart people who understand fluctuations in real estate and recognize the opportunities that exist over longer periods of time in holding land assets that are strategically positioned.

This really wasn't a question of who approached who, it was more a situation where a natural evolution of a relationship kind of came to a head.

And we both saw opportunity in their financial prowess and staying power together with our ability and machinery to be able to harness, find and harness extraordinary opportunities.

In terms of their contribution, the $900 million that they're putting into LandSource, what's the split between land and cash on that?

The split will be determined at closing, of course, because some of the assets they're contributing might have changed slightly, depending on the closing date.

But the way I'd put it, it's a larger percentage that's related to the assets.

If you look at the two of them, there's several hundred million of cash, and then the balance would be assets.

But that number will be refined, depending on the exact closing date.

Okay, great.

Thanks, guys.

Our next question is from the line of Margaret Whelan with UBS.

Please go ahead.

Good morning, guys.

Good morning.

Can you give us an update at all on the first quarter, if you're seeing any stabilization in the can rate?

I'm sorry, in what, Margaret?

In the first quarter, to date, so December and half of January, are you seeing any improvement in your absorption rate or your can rate?

Historically, we really don't give inner quarter updates on the actual numbers.

But as I said, first of all, this is a seasonally slow time of the year, and as we've gone through this beginnings of our first quarter, we really haven't seen any significant movement in the marketplace.

In terms of Florida, where you're based, I imagine it was a lot easier in the fourth quarter this year than last year, just because you didn't have as much hurricane distractions?

So would you see that Florida's improving a little bit sequentially?

I think we've just had a different kind of hurricanes and distractions.

I think the Florida markets in general overall have been significantly impacted over the past year by market conditions.

And while it's easier to build, there's not as much -- there's not as much desire for things to be built.

The market has been very tough.

So without the extraneous distractions of hurricanes and other things, the market condition itself has really been very limiting here in Florida.

And to that point, you said in Bruce's prepared comments, you guys want to try and match your starts to demand.

When you say demands, are you thinking orders or deliveries at this point?

Well, let me say that we don't want to try to match starts to demand, and if we said it that way, I think we misspoke.

We have been consistently matching starts to demand as our low inventory indicates, and as we have operated through the past year.

What we've done is match starts to realtime kind of indications of demand through the sales pace and traffic count.

And it's a bit of an art as opposed to a science.

But I think it's been very effectively handled.

With the orders down so much on the delivery, in terms of the timing, it's going to be more of a real market this year?

I think what we're saying is it's a continuation of what we did in the past year, which is we'll look at the market as we go and we'll continue to match starts with what the demand is out there on a realtime basis.

And that's what we're looking at, market by market.

Now, if the market changes after you start homes, we'll still want to continue to deliver those homes.

But realtime will match starts and demands.

I guess what I'm trying to get at is that your prices come down much more than your peers because you're building more and discounting more and you're suggesting pricing power sequentially for '07 in your guidance?

I'm just trying to figure out, is that a change in your business model?

Is it because you have less homes in the orange, red area you described, or is it product mix or geographic mix?

Well, remember, market, we've been tapering back starts now for two or three quarters and as we said, our deliveries as we go into next year are going to be pulled back.

We are pricing our products basically to market, and although we might have pulled back a little bit too aggressively at certain points and certain marketplaces, the reality of market conditions are really being displayed by the pricing across the board in those markets, is really getting -- it's really getting closer to where we see and saw market pricing.

We are anticipating that there will be some seasonal stabilization in the marketplace.

In other words, the market will come back a little bit as it normally does through the season, and we think that will give a little bit of pricing power in the market as some of the supply of spec inventory is absorbed throughout these marketplaces.

The fact that we are so light on inventory right now, we think, is going to work very much to our benefit as we move ahead into 2007.

And we also think, and are looking forward to proving that costs are going to begin to work tour favor as well.

I agree with that.

The last question I have, you've been so focused on generating cash in the last 18 months, trying to figure out what you're planning to do with it.

I think Bruce mentioned that we should expect the share count to be flat in '07 versus '06.

I'm wondering, are you seeing any distress among the land holders and developers.

You and your peers are walking home with these options.

Do you anticipate buying more land?

Or just throwing more land to the options?

That's a great question.

The fact of the matter is that there really hasn't been distress generically among the land holders.

Of course, we can all speak to the isolated instances that are out there where there is a little bit of distress.

But the reality is that if you do some math, it looks like somewhere between 10 and $20 billion of land is back on the marketplace.

That doesn't necessarily present an opportunity for today.

But there's going to be a time where opportunity presents itself.

We're not sure in what form that will happen, but we know that from a historical experience, we know that having a very, very strong and liquid balance sheet, particularly in difficult times, enables us not only to act responsively, but also to do so with confidence that we're not compromising the future, even as the market conditions might not be clear ahead.

So it's really that foundation from which we have historically launched some of our best opportunities, and that's what we're positioning for going forward.

We simply don't believe that 2007 is going to be a record year for us, or frankly for anybody in the industry.

It's going to be in 2008 and 2009 that we start to see good strategies reveal themselves.

And can I imply from that that in 2007, if you don't think that these great opportunities will come up that you don't think that there's going to be a lot of distress among these land developers.

I guess the concern is that if there was, we can see another year of volatility?

I think that the stress among home -- among land owners is not dissimilar from the way it works in the stock market.

It very much has to do with their speculative feeling as to, number one, where they believe the market is headed.

If the market seems to be correcting, I don't think that there will be distress.

If it looks bleak ahead, they will feel distress, particularly as whatever debt they have on their land starts to create payments and out of pocket cash.

It's a really wild card right now.

I don't think anybody has a clear picture as to whether or not there will actually be distress in land, or whether the land owners have tremendous staying power and confidence.

Okay.

Thank you, guys.

You're welcome.

Our next question is from the line of Nishu Sood with Deutsche Bank.

Thanks, guys.

I also wanted to ask about your outlook and particularly the impact your strategy is having on your outlook.

You've done pretty well with your strategy of pricing to market, the even flow, reducing inventory and all.

One particular way the impact on your margins, for example, you mentioned that because you should be among the first builders to have your land position reflect current market pricing and current market reality sooner than your peers, that that should probably benefit your margin sequentially in '07.

So I guess there's just two numbers I was looking for.

If you were to look now at the projects where you have land at market pricing and home prices, the selling price at market levels, what kind of gross margins would that imply, and how does that contrast against the second number of gross margins applied in your backlog?

Well, I guess that underlying any response we give to that, we have to put a date to ish.

Which means our margins are clearly lower in the first and second quarter than they will be in later quarters.

Where do we see those margins?

I think Bruce highlighted that we see them moving towards the upper teens, and in large part, that is because of the land price positioning, and an expectation that home prices should stay, or in our view might stay where they are right now.

And again, that's an if.

And then, some of the uncertainty is how much and when will cost reductions start to flow through these margins and amplify the pricing that we have in the land.

So number one, we have a number of homes in backlogs that are already sold that are already contracted for from a cost standpoint that have land at a certain price, some of which has been written down.

And that will produce a lower margin.

And then as we go through the year, the beneficial land pricing together with changed cost structure and in some cases different product strategies should start to produce a higher teens margin.

And the way those numbers actually flow through will be a matter of timing and whether cancellation rates pick up, whether the market stabilizes or recovers, and a whole bunch of variables that we really cant map out right now.

Okay.

I understand all the caveats.

I was just thinking about your land position.

So assuming, for example, factoring out the rising cost issues, just focusing on land and assuming, let's say, a leveling of home prices, does that mean that the equal -- we should begin to see what we could call equilibrium level, where the land is matched to the price you're selling the home at in the back half of '07?

That's what we're hoping for.

But I have to throw all the caveats back out there, because the variables will move around exactly when -- which quarter we'll start to see that reflected and how it will actually flow through.

And I want to be clear about that.

And switching gears to the LandSource transactions.

Stuart, you mentioned that the transaction was consistent with your strategy of reducing exposure, reducing investment.

I can understand if you were talking about current communities in markets that have contracted quite a bit, but in the Newhall property, you're talking about the longer term project, and judging from the value that you realized on the transaction, it seems like it was a home run in terms of the value accretion.

So why take down your stake in a project that clearly has gone so well, even though the market there has turned down?

Well, it's exactly that is consistent with our history.

Frankly, the Newhall transaction would fit perfectly with the way that we've run our business over the past ten years, except for the fact that the market has trended down, which makes it so much of an anomaly.

And it stands out a lot.

You're absolutely right.

This transaction is a home run.

It's not a home run because of the transaction, it's a home run because the Newhall land position is a home run.

It's an excellently located parcel of land in a highly constrained market and everybody knows, everybody associated with the transaction and outside knows that over time this parcel of land is going to do exceptionally well.

But our strategy has been a disciplined strategy of making strategic purchases and even though we might be leaving money on the table, paring down our investment and still positioning ourselves to be able to be participatory and in both an upside in the land and as well the buildout of the community.

That's exactly what we've done here.

It's exactly consistent with what we did with El Toro and a number of other properties over the past years.

And it's very much the style in which we run the land side of our business.

Okay.

That makes sense.

And the final quick question, the land impairments you're taking, not the option deposit write-offs, are obviously going to reduce the basis on homes you're going to be delivering over the next couple of years.

Roughly how much dollar-wise impact will have that on '07 versus '08 versus '09?

Nishu, in terms of the land impairment, as you look at the different categories, we had a land impairment of only $33 million.

Is that the number you're referring to?

Well, I guess just the overall impact -- yeah, I guess looking at both the direct land impairments and also the joint venture.

Obviously that would provide a boost to the joint venture and company earnings.

Right.

Well, most of it flows through in '07 and '08.

So roughly, half/half, let's say?

Yes, again, as you think about our buckets, remember our longer term land positions tended to be either through joint ventures or some of the options.

So as we look at it, the area with more of the exposure is the owned bucket, the homesite in the owned bucket was a 2 to 2.5 year supply, and therefore as you look at the impairments to that bucket, most of those will -- most of those homesites will be delivered as homes in '07 and '08.

Okay.

Great, thanks a lot.

You're welcome.

Our next question is from the line of Michael Rehaut with JP Morgan.

Please go ahead.

Yes, hi, good morning.

Just a few questions here.

First on the '07 guidance, you talked about cost reductions, you talked about your hopefulness that pricing as the seasonality returns might improve a little bit.

I was hoping you could give just a little bit more color, I know you've kind of gone through it a little but, to the extent that you would rank those two big areas in terms of what is anchoring your view that gross margins should improve over the next, throughout the year, and if there's any way -- I know you said you haven't seen it flow through yet in terms of the cost reductions, but certainly you guys have to be baking in some type of level or range of actual savings from the cost of goods sold line and also the SG&A line , and I was hoping you could share some of those numbers with us.

I think that in terms of ranking, we would say that number one would be the change in land costs that is contributing to an improvement that would be contributing to improvement.

We clearly have a higher confidence level in that item.

We know what those dollars are.

Next would be the reduction in costs on the hard cost side of the equation.

We have a good sense of what those are, but they're still moving around a little bit.

Next would be reductions in SG&A.

And those numbers are still moving around a little bit as we go into 2007.

And then finally would be any level of confidence in an improvement in the market condition that would be our lowest level of confidence in terms of ranking and of minor consequence relative to our assessment of where the market or where our numbers will be for next year.

All right, that's helpful.

In terms of giving some broader type of range in terms of either on a percentage basis or on a dollar basis, what you're looking for in terms of savings from COGS and SG&A?

Well, again, from the SG&A standpoint, we indicated because the volume is coming down pretty significantly in '07 as a percentage of revenues we believe the percentage might actually be up slightly, even though we're saving significant dollars in the SG&A expense line.

So from a percentage standpoint, we're expecting that the gross margin percentage will be increasing and the SG&A percentage line will not likely improve from a percentage standpoint the same way.

But as you go from more volume to less volume, the natural tendency is for that SG&A percentage to get bigger, and I think that we're going to bring it -- be able to bring it down faster than it would naturally come down.

I think we've already made strides in that regard.

But I think Bruce raises a good point.

It's not going to be SG&A that increases our net margins at the end of the day.

It's just not going to deplete the savings and advances that we have in some other areas as much as it might naturally do.

Okay.

You also mentioned some improvement on the inventory line and getting the overall dollar number down to $7.8 billion and homes under construction.

I was wondering if you had goals for '07 with those numbers, given that closings are going to be down 20%, or in excess of 20% in your earlier take that you've shared.

And also with the homes under construction and the limiting of spec, if you are also trying to continue to take that down?

Yes, I think that the general notion here is that we're going to keep our inventory extremely tightly controlled.

And that's going to be a consistent theme throughout 2007 just as it has been throughout 2006.

We are a balance sheet first focused company, and that means that as we go forward, we're going to be continuing to work on bringing that inventory level down as our delivery numbers come down through the year.

So don't expect to see a buildup in inventory here, either on the land side or on the homebuilding side.

This is a very tightly focused upon area of our business.

Could that come down further, to like a $7 billion range, or below?

Given where you see closings going?

Yes, one of the big variables in there, Mike, is land purchases.

And again, depending on how the market evolves through 2007, and dependent if there are opportunities out there, that's one of the data points that are important as you're trying to figure out where inventory levels might be at the end of the year.

And because it's so hard to predict that, that's why we don't put out a goal for the inventory number.

But as Stuart said, our focus is to manage the homesites that we have very tightly and the other variable is how much land could be purchased throughout 2007.

Okay.

And as far as our homes under construction, one of the concerns, I think, that was out there is that with the even flow process, that there'd be a certain natural level of some type of level of spec building within the divisions.

I was wondering if you could address that, and if you plan to continue to keep spec low and where you see homes under construction going as well?

This whole area of spec building is somewhat of a market standpoint is a real confusing one to everybody.

I'm not sure what is a spec home and what isn't one.

What we've seen in the number of instances is homes are sold with maybe $1 down or $1,000 down.

I'm just not sure if that's sold homes or spec homes.

The fact is that we're tying very tightly together our deliveries with the demands for homes.

And that's why we've been able to keep our inventory level very low.

We are building homes in a very orderly process to deliver what we have under construction and to deliver land that we have that is still being worked through.

But as we've said, we've been tapering back that starts program so that we expect deliveries to be down more than 20% in 2007.

And while there will be some homes sold that are defined as spec, either because there's a small deposit or because the home isn't sold yet.

It is a very small percentage of our business.

As you've seen even flow get more implemented throughout your company, have you seen an improvement in days to build or any type of metrics that you could share with us in terms of construction efficiencies?

Yes.

Looking at things like that on a national level, numbers would lose their meaning.

The fact of the matter is in many of our divisions, we have seen a material improvement in days to build.

It has come down materially.

We have a far more efficient program on the ground than we had over the past year.

And part of that just has to do with market conditions.

As the market grows, subcontractor base becomes much more pliable, and focused on satisfying their customer, which is us.

But additionally, we think that the orderly process of deliveries and the lack of changes upgrades and options within our program are really worth the benefit.

And I think that's part of our cost improvement program.

Okay.

And just lastly, and I appreciate the time, with the write-downs that you've taken on the wholly owned land, the $240 million particularly on the homebuilding side, I was wondering if you could give us what that number represents as a percent of the overall cost basis, and after you wrote it down, what type of a gross margin level did you write it down to?

Did you write it down to an average over the last -- that you've been able to achieve over the last couple of years, or maybe a little bit below average?

If you can give us some color there.

Sure.

As it pertains to the homesites in that category that you're asking about, Mike, the $240 million, there we maybe can break it down.

We have backlog in place, where there are sales contracts and that is written down to essentially roughly a zero type of net margin.

So as you look at the gross less the SG&A, that gets you to basically about a zero gross margin.

And then with the remainder in that category, it depends on the length of time that the asset is there.

We looked at each one individually.

And again, as we look at that, we're looking at an adjustment to those to reflect current market pricing.

You'd likely see margins that are below our historical norm after we're done with those impairments.

So certainly the margins are lower as a result of the backlog, and then the remainder in that category, you're likely to see margins that are lower than we've actually been averaging over the last couple of years as a Company.

Great.

I appreciate the color there.

One last thing.

On LandSource, 4,000 homesites that you recalibrated, was this part of the $111 million of charges with the option walkaways, or was this part of, as you mentioned before, this general renegotiations that you didn't have to take charges on, and you were able to shift this into the new supply of land that LandSource will be drawing from?

Before I let Bruce answer this question, just one last thing, there are no more one last things for you.

That's it.

Go ahead, Bruce.

Just following up on some ten-question speakers before.

We're happy to answer this, Mike.

The MWHP portfolio had close to 4,000 homesites.

They are completely separate from the $111 million that we talked about, because there was no walkaway from this.

These are homesites that were renegotiated to today's current market pricing as they were contributed to LandSource as MWHP was admitted as a partner into LandSource .

And again, it was in the context of LandSource being a platform for additional growth, and therefore it made sense for those to be contributed.

So they're completely separate from the write-down that Diane was talking about earlier.

Great.

Thanks a lot.

You're welcome.

[OPERATOR INSTRUCTIONS] I'll go to Stephen East with SIG.

Please go ahead.

Thank you.

Just following up on Michael's question, maybe Bruce, this is for you.

On the option side of the write-down, the renegotiations that you take to get those prices where you want them, would the margins, the gross margins that you assume in those, are those similar to the gross margins that you were taking on your home building write-down that you were just talking about that you said's a little bit below historical norms?

When you look at the bucket number two, which are the options with third parties, and we wrote off $111 million, where we walked away from deposits.

As we renegotiated the options that we decided to continue with, our approach was to renegotiate those to today's current market pricing.

And if we were not able to get today's current market pricing, then we had to evaluate whether to walk away or whether it still made sense, depending on the level of deposit that was up and where we were in that community.

But our approach was to try to renegotiate all those to current market pricing.

Okay.

And then on the inventory write-downs that you take, the criteria to separate out between homebuilding and land, is it as simple as a foundation has started, so this goes to homebuilding, or what's involved there?

No, it's really whether or not we intend to build on that particular homesite.

As you know, we have land divisions and homebuilding divisions.

So where there's land in the land division that we intended to sell to a third party, the impairment related to that land was the $33 million we referred to.

All the other impairments in the homebuilding category, we intend to build on those homesites.

And and the last question, help me out here.

This is where I've really been struggling, Stuart, and maybe you can shed some light.

You all talked about the first bucket you want to get rid of the fastest is your land owned, et cetera.

But a big part of your conversion to cash is to take advantage of land that will be coming on to market.

You all believe that 10 to $20 billion.

I guess I struggle with the thought process, that the land you own, you're trying to get rid of that as quickly as you can to take care of possibilities looming down the road.

Why would your position of current land be less attractive than what you think will be coming on the market?

Well, Stephen, it's not so much -- that's a great question and I'm happy that we have the opportunity to clarify that a little bit.

Because I think a lot of people get confused on this.

It's not that we're trying to liquidate all of our land holdings.

We have some extraordinary land holdings, and they are extremely valuable.

But if you listen to every one of the builders, everybody recognizes the same thing -- excuse me, I'm sorry.

Everybody recognizes the same thing.

And that is, the land that was purchased in 2005, maybe late 2004, 2005, the beginning of '06, is land that was bought at retail at the height of a market.

And even though that land might be well positioned, well located, it is land that because of its pricing is definitionally not going to get -- it's not going to come into its own for quite some time.

Unless you believe that the market is going to recover as sharply as it went down, and in a very short period of time.

And so from our vantage point, you've really got one of two choices.

You can either write down that land in lump sums, and there is some of that, or you can deliver that land and turn it into cash and be positioned, not necessarily to buy new land parcels, because I don't know that the land that's out there that's coming on the market will be priced aggressively or won't be, but we believe -- and we have historically positioned ourselves for a better day, recognizing that with a strong balance sheet and parenthetically a land position that still positions us well to be able to move through the next couple of years at a delivery pace that's consistent with where we're going in 2007.

If we are well positioned with a strong balance sheet, while it might not be land or it might be land, while it might be M&A activity or it might be stock repurchase or a myriad of other things, it's the strength of our balance sheet that gives us the confidence to be able to pull the trigger on the next opportunity without feeling like we're compromising our future from that day going forward by taking -- by take down an opportunity.

So we feel that in troubled market conditions, unless you just have a strong belief, and we don't, that the market is going to recover as suddenly as it fell off, the single best thing that we can do is build through the land positions that were acquired at peak of market.

Not all of our land positions, but the ones that were acquired at retail, turn those positions into cash and be positioned, well positioned for a better day.

And if you look historically at the success and growth of our company, what we have done consistently is we've taken market conditions, market cyclicality, used it as an ally, not an adversary and we have been able to find counterintuitive, countercyclical kind of opportunities that have catapulted us to the next opportunity -- or to the next good market.

And that's exactly what we're preparing for today.

Where will that opportunity present itself?

We don't know right now.

But we know that our balance sheet is well prepared.

Okay, I appreciate it.

Thanks.

You bet.

And next to the line of Tim Jones with Wasserman and Associates.

Please go ahead.

Good afternoon.

First of all, I would just like to give my condolences on Bob and the 35 years we were great friends.

I have never heard one person ever say a thing against him.

Yes, he really viewed his relationship with you, Tim, as very special, and thank you for your nice thoughts.

Okay.

The first question, you've talked and I think you've been very forthright and so forth in trying to give a number out there.

The one thing that you have talked about is you expect this 10 to $20 billion of land that hasn't come down this much and expected to come down, and yet in your guidance, you have not taken any additional land impairments.

That doesn't seem to follow to me.

You're referring to any --

-- last year you've assumed no additional land impairments, but when you talk about the market and the overall land positions of the market, you thought that they were going to come down further?

Well, there are two things that I want to say here, Tim.

Number one -- As I said just a few minutes ago, the land that we bought at the highest prices, the land that we're moving through very methodically, so delivering that land and compromising our margins as we've been really obviates the need to be taking impairment in the future the land on our books that's a little bit older and lower priced, we don't think we're going to have impairments on.

But the other thing that I say is definitionally, if we think that there's an impairment out there, we should be taking it today.

And so it's just -- and this is why it's been so important for us to have Diane on these conference call, because our approach to impairments has been very focused and very realtime, very asset by asset driven to make sure that anything that we think we might be taking next quarter or the quarter after, we're actually taking right now.

Because we're incorporating a view of the market that is -- that revolves around market pricing.

We were very quick to go to market pricing on the sale of our homes, and we feel that that gave us, from the beginning, a very realistic perspective on where the market actually is, and those are the assumptions that are going into our land impairment on a realtime basis.

Definitionally, we can't and shouldn't be projecting impairments going forward, or unless we're making a statement that we think the market is going to fall off more, and we're looking at the market as where it is right now, and if we believe under current market conditions that there is an impairment in the future, we should be taking it today.

Okay.

And the second question is, if your goal is to get high teens gross margins, roughly, maybe 14, 15% in the first half and 19 to 20% in the second half.

That 5% change, can I imply that that is about what you intend to save with all these hard material labor and land cost savings that you've been working on?

I think that range that you put out there might be a little more narrow than that, Tim.

It might start off -- we hope to see it start off a little higher than that and maybe get up to the kind of level you're talking about at the end of the year.

So maybe a 4%.

But that would be mostly those savings, right?

They are not incorporating price increases or anything like that?

It's a couple of things that Stuart laid out.

It's reflective of the current market pricing on land.

There's some cost savings included in there as well.

And the traditional selling period that we'd normally see in the next couple of months developing, we expect, as well.

And you expect a little bit of firmer in prices there?

As traditionally you've seen.

As we come out of Super Bowl sun, give or take a couple weeks.

I've got my fingers crossed.

Me too.

Thanks, Tim.

Next to the line of Kenneth Zener with Merrill Lynch.

Afternoon.

Question, if your impairments reflect your view that you're early in the pricing trends, why wouldn't -- I'm just trying to get your understanding of how competitors would view their impairments in assets.

Would your actions create further deflation, especially since you've had a greater concentration of impairments now in Florida?

I don't think it's a chicken and egg, I'm just trying to understand your guy's perspective.

Say that one more time.

Since you were early to deflate the assets based upon your view of pricing, wouldn't that cause a repercussion in other builders' view of their assets, because the market is in fact going down, based upon your guy's now lower cost basis?

Look, I've heard a lot of the discussion about the fact that we've been the fastest and been ahead of everyone else and we've deflated the assets and deflated the market and all the other stuff.

Out in the marketplace, I'm not sure I see exactly that.

I'm not sure that others aren't pretty close to where we are also.

There's a range of a few percent one way or the other, but let me say this.

We're not hitting the leather off the ball in sales.

It doesn't come easy at the pricing that we're at.

We're not far different from the rest of the group.

I think that everybody's going to think responsible impairment charges reflective of market conditions.

I wasn't implying that -- I just wanted to see if one person prices down -- It appears if you have $270 million in inventory and land write-offs in the fourth quarter, I assume about two-thirds of that is going to hit in '07, in terms of a benefit of lower cost basis, using development cost of the land.

So it just gives you guys more opportunity.

That was the logic there.

Yeah, I think that everybody is going to end up with the a pretty responsible reflection of market conditions.

And the fact is, look, the change in the market conditions happens very suddenly.

And I don't think that there's necessarily one strategy that's going to prove perfect and another one that's going to prove poor.

I think a lot of strategies are going to work well.

The reality is that some waited to see a little bit longer than others.

There'll be some catch-up and some movement around and stuff like that, but I think overall, there are a lot of smart people in the industry, and the market condition will be profitably reflected by everyone.

No, I appreciate that, Stuart.

The last question is, what happened in given the strong increase in the east segment for impairments, which until now has been surprisingly absent from other builders.

Thank you very much.

You're welcome.

The east segment, the reason why that number is higher is because we did purchase more of the inventory in 2005 in that east area.

So as we talked about which period is leading us to some of the impairments, some of the 2005 purchases, or as you break down the 2005 purchases, there was a larger share coming from the east, and that's what's drove a larger impairment there.

Our next question is from Steve Fockens from Lehman Brothers.

Hi, guys.

Just two questions.

One to follow-up on some of the earlier ones.

Presuming that inventories are lower by the end of '07 and the net income you generate that you have some amount of cash through and by the end of '07 that you would look to redeploy, how would you rank order of the priorities for the use of that cash between first M&A and/or reinvestment, second, buybacks and/or dividends, third, debt repayment if it even applies, or fourth, just sitting on it and waiting for better opportunities?

I would rank as number one and only one the use of our capital cash balance sheet and everything will be sitting and waiting for the right opportunity to present itself.

And a lot of people will ask and have asked for color on what that means, exactly.

And the reality is that it's no clearer to us than it would be to anybody else right now.

It's about having our cork in the water and our confidence supported by the foundation of our balance sheet.

We have an attitude in this company that is edgy and entrepreneurial, and we're always looking for that next unique opportunity.

It's a lot like what we did with Newhall a couple of years ago.

We bought an asset that seemed to cut against the grain of the market.

We bought a strategic land asset and that's kind of what we do.

We look for inefficiencies in market conditions to define fundamental values that we think will work well over long periods of time.

And that's what we're going to use our capital for.

Thanks.

And then the second question is, I think you spoke about land purchased at retail from '05, that's the land you're moving through most aggressively.

Order of magnitude, how much of that is actually left at this point?

Maybe the way to look at it, Steve, is as the last person asked the question, I don't have an exact number for you there, but as far as the impairments that were applied and how quickly that will move through the system, they said about two-thirds of that will move through in 2007 and most of the remainder in 2008.

And that might be a good way to look at it.

Fair enough.

Thanks very much, guys.

You're welcome.

Next from the line of Alex Barron with JMP Securities.

Please go ahead.

Thanks, guys.

I guess I was hoping you could quantify for us how many communities were actually impaired in the quarter?

How many communities were impaired?

I don't have an exact number for you, Alex.

You know in the process that Diane talked about, we looked at every community, we don't have an exact number, though.

I guess I'm just trying to gauge, like, what percentage of the communities have been impaired or which percentage didn't quite make it to that threshold yet?

So in the owned category, bucket number one --

Right.

-- we'd probably estimate it was probably less than 10 or 20%.

Okay, got it.

I guess my follow-up question is, in your work in progress, I guess you guys said you were working it down.

What percentage or what number of that is sold versus unsold?

Hold on a second, we're looking it up.

Okay.

Yes, hey, Alex, just being consistent with prior periods, we don't give out an exact number, but there is a slightly larger percentage of that is unsold at this point than sold.

Slightly larger percentage, meaning greater than 50%, or --?

In terms of inventory under construction, over 50% is unsold, slightly higher than 50%.

And then in terms of completed inventory unsold, we indicated that that average is about one per community, which is in the 800-something range.

Okay.

Thanks, Bruce.

That's helpful.

Okay.

You're welcome.

We'll go to the line of Rick Murray with Raymond James.

Good afternoon, guys.

Bruce, I apologize if I missed this earlier, but did you disclose where your inventory balance is currently?

The year-end inventory balance in terms of dollars, we said, was about $7.8 billion.

Okay, thanks.

The other question I had was, could you just clarify a little bit if possible the motivations as you see it from the CalPERS and the other party's motivation for the LandSource transaction.

It seems to be decidedly in your favor.

We've had this question from other people.

The reality is that nothing's ever that planted when your dealing with smart people.

The fact is that LandSource and Newhall in particular represents a very unusual strategic opportunity for the future.

It's going to be a source of strong sale and pricing power for many years to come.

And while there might be a year or two of pullback, we think that the Newhall position is going to be just one of the strongest in California.

And I think that our partners believe that to be the case also.

Additionally, I think that the opportunities, particularly in a pulled back market condition, the opportunity for this partnership group that is Lennar with the residentialist expertise, LNR with the commercial expertise, and CalPERS or the McFarland Group with the financial background represents a very formidable group in terms of identifying and purchasing unique opportunities as they present themselves going forward.

So this is both an excellent investment for the MW Group at this time in a specific asset base, but it's also a springboard for more acquisitions and opportunities in what we all think is potentially a depressed market condition for acquisitions going forward.

So I think it's a great deal all the way around.

I was just curious, are there any liabilities or contingencies as it relates to your ongoing interest in terms of either corporate or debt guarantees or specific performance clauses as it relates to lot takedowns and et cetera?

The financing that we're planning to put in place, Rick, is planned to be nonrecourse financing.

However, if you remember, when we announced Newhall in 2003, based on the underwriting valuation, which was the original purchase price at our election, we did set up some specific performance options that have been in place since then.

And there are some specific performance takedowns in 2007 as well, which we believe reflect current market pricing.

So there's not an ongoing other liability that I would be concerned about relative to this new transaction.

Thank you.

Okay.

Perhaps this can be the last question.

Let's wrap it up, here.

That will be from Myron Kaplan with Kaplan, Nathan & Co. Please go ahead.

Hi, guys.

Hello, Myron.

I just say keep it up and make it easy.

My issues have been addressed and I wish you the best.

Keep up the good work, I guess.

Well, that's a perfect way to end it.

We really appreciate everybody's attention as we conclude 2006 and move into 2007.

We look forward to reporting back on our progress and market conditions at the end of our first quarter.

Thank you very much.

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