Lennar Corp (LEN) 2007 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the Lennar Corporation second quarter earnings call.

For the conference, all the participant lines will be in a listen-only mode.

However, there will be an opportunity for your questions, and instructions will be given at that time.

(OPERATOR INSTRUCTIONS).

As a reminder, today's call is being recorded.

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 intend to do 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 & Exchange Commission.

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

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

Stuart Miller.

Thank you, John.

Good morning, everyone.

Thank you for joining us for our second quarter 2007 update.

In the context of what continues to be difficult market conditions, we would like to share with you our thoughts on both the state of the home-building industry in general and the progress and performance of Lennar in particular.

I am joined this morning by Bruce Gross, our Chief Financial Officer, who will provide additional detail on our numbers and Diane Bessette, our Vice President and Controller, who will also participate with an update on our asset reviews.

I know there are a lot of questions this morning.

Accordingly, I would like to request, as usual, that in our question and answer period that you please limit to just one question and one follow-up so that we can be as fair as possible to all of our participants.

We welcome you to rejoin the queue if you have additional questions, and we'll attempt to answer as many questions as possible in the hour, more or less, that we've allotted for the call.

Let me begin by saying that these continue to be very difficult times for the home-building industry.

As we began 2007, we were hopeful that we would begin to see some stabilization in the market as we came into the spring selling season.

When we reported our first quarter, that stabilization had not yet materialized, and since our first quarter call in March, the market, in fact, has continued to deteriorate.

Whereas in the beginning of this year, we set an internal goal of maintaining profitability in line with last year, market conditions have eroded so much over the past six months, that we are now focused on limiting the loss for the year.

With each additional downturn in the market, a re-examination of our impairment charges reveals the need for further charges.

Certain assets that were underwritten to a positive margin last quarter require an additional charge this quarter to keep up with the market slowdown.

Just over a week ago we completed our quarterly operations reviews with our division management team.

In those reviews, we meet with each division management team, we review market conditions, we review their performance for the quarter, and we review the asset strategy for each asset that they own in their market.

The overriding sentiment in these reviews was that the market is becoming more and more competitive as inventories are managed, and there is a great deal of downward pricing pressure through the use of incentives, price reductions and brokerage fees.

Most of the competitive sales are of standing inventory homes, which resulted from either cancellations or prior purchasers putting their homes on the market.

All of these with very quick closings available.

In most markets, there is a very big push to reduce standing inventory across the industry.

In addition to the standing inventories of new homes, it is apparent that there is a growing backlog of existing homes that are not selling at yesterday's prices, and they will soon be repriced in order to sell.

Overall, the supply of homes to sell continues to climb in many markets, and we are not yet able to get a good reading on how quickly this inventory will be absorbed.

Simply stated, the supply of homes available for purchase has continued to climb while at the same time, demand has been sharply reduced.

On the demand side, the investor/purchaser part of the demand is now long gone.

Primary purchasers are either on the sidelines or demanding better pricing before purchasing.

Consumer psychology has been affected by the steep drop in market -- in the market, and consumer confidence in the home purchase process has waned.

And because of the continued deterioration of the subprime lending market, an additional component of demand has been sidelined because of the inability of customers to qualify for a mortgage or because the purchaser of a customer's home needed for closing cannot qualify.

What is clear is that supply and demand are continuing to shift in many markets, More rapidly than expected, and three things will have to happen before we see a stabilization and recovery in the market.

They are as follows: Number one, inventories of both new and existing homes will have to stabilize first and then be absorbed.

Number two, the mortgage markets will need to settle, especially relative to the subprime market and the subprime business will need to be replaced so that many first-time purchasers can have access to the homeownership market.

We would expect to see FHA loans to continue a trend that has already begun, and that is to absorb a big portion of this demand.

Number three and finally, consumer confidence is going to have to be restored, so that purchasers once again believe in the ultimate value of their home.

The leading indicators and timing of a recovery have proven thus far to be elusive, and I would suspect that we will not know that a recovery is coming until it is already upon us.

Before we see a recovery, it is unclear today whether there is another shoe to drop.

Thus far, the home-building market has fallen while the economy has remained relatively strong.

Unemployment has remained low, interest rates have remained reasonable although trending higher recently, and there is tremendous liquidity at this in the market.

Questions remain as to whether the economy will weaken in a housing-led slowdown.

While there are risks, the liquidity that exists in today's financial markets is a real wild card and could be a critical mitigating factor alleviating negative market forces and restoring balance.

Lennar's strategy has been certain and consistent as we've seen these market conditions unfold over the past year-and-a-half.

Our overriding strategy is defined by our focus on our balance sheet.

Our company has intensified the focus on generating cash flow at the expense of maintaining margin.

We have rigorously pursued this objective by using incentives and price reductions to sell homes and to back fill cancellations.

The best way to generate cash flow is to deliver our inventory, that is, completed homes, homes under construction, and developed land, by reducing prices to market pricing, and converting inventory to cash.

While margins have eroded, our balance sheet continues to improve, with inventories remaining low while homes currently under construction have declined from the prior year.

Additionally, we have strategically and materially tapered back production to meet the reduced demand levels in the market.

In fact, our starts year-over-year are now down over 50%.

While our results for the second quarter are disappointing, they are reflective of our strategy for dealing with these market conditions.

We have continued to deliver our backlog while we have reduced our start pace to reflect the sales pace in the marketplace.

While revenues for the quarter were down 37% to $2.9 billion, our balance sheet continues to improve with our debt to total capital improving to 31.6% from 33.5% last year.

And while we have recorded a loss of approximately $244 million, it is reflective of our aggressive reassessment each quarter of every land position, every joint venture, and every deal under option or contract within the Company in light of current market conditions and current margins.

We have consistently focused primarily on protecting our balance sheet first and foremost.

As a management team, we have also maintained day by day focus on our business operations.

We've continued to refine our business model in each of our markets, and we have mapped out a strategy to regain margins when the market stabilizes.

We've reviewed our business plan with each division, considering sales, starts, closing, inventory and asset base, and we have adjusted production levels so they are tailor to do each division's unique position.

Within each Lennar division, there is a daily morning meeting where sales, starts, closings, inventory and asset base are carefully reviewed, and this review dovetails with a daily executive management meeting where the same elements are reviewed on a companywide basis.

Our strategy overall is recalibrated every day.

From our quarterly operations reviews to our daily plant meetings in each division to our daily corporate call, we're focused on what we call the four legs of re-engineering margin.

It starts with salesmanship, driving our sales force to shift from order taking to going out and finding sales and driving sales base.

In reality, it is a long road back from the days of lines out the door of people waiting to purchase to a more regular environment of having to earn each and every sale.

Over the past quarters, we have revamped both our sales effort and our marketing programs.

Next, we have been and continue to rebid our construction costs.

Inasmuch as we're coming off of strong market conditions, intensity is required if we really want to get costs in line with current market expectations and affordability.

Central to this effort is what many of you know as Lennar's Everything's Included business model.

We are refining and redefining our product offering and making sure that we include the 20% of the options that 80% of the customer base really wants and really needs.

We simply include those features.

We have also materially reduced the number of floor plans offered and the number of SKUs that we purchase.

This creates simplicity in the production process and enables us to gain cost advantages relative to a well defined spec sheet.

It just seems logical to us, especially with cancellations running so high, that if we can research, choose the most popular specs, include them and breed simplicity in the field, we'll be able to gain the best cost advantages and deliver the best value to our customers.

As a third part of our program, we've been reducing and right-sizing our overhead in order to meet restructured demand.

Every division in our corporate office as well has been challenged regularly to reconsider all elements of overhead as we shrink our business.

Often on daily calls overhead items are dissected and compared to the divisions can have the benefit of pure comparisons and best practices.

Finally, we're also negotiating and renegotiating every land deal both on the books and in the pipeline.

Along with the reevaluation process, we have reconsidered and renegotiated every land contract and option on our books.

Some we have reworked numerous times in order to have them properly priced for the declining market condition.

We have also strategically restricted all new land acquisitions across the country with new land deals underwritten to new market metrics and subject to a very different risk profile evaluation.

In conclusion, let me say that we are working towards a better day.

Our quarterly results on their face are disappointing.

Nevertheless, we're focused on the strength of our balance sheet as a foundation for defining both stability in a difficult market and also future opportunities and growth as the market returns, and it will return.

In the meantime, we will continue to renegotiate land pricing, rebid subcontracts and materials, refine and redefine product offerings, and review overhead in order to meet a restructured demand and reclaim an acceptable margin when market conditions do finally stabilize.

With a strong financial position, a lean inventory position, and refined operations, Lennar will be positioned to change and adapt to meet the opportunities and challenges of a new, and at some point, recovered market.

With that, let me turn it over to Bruce.

Thank you, Stuart, and good morning.

I am going to discuss our balance sheet and our second quarter results this morning, and as Stuart mentioned, we've been very consistent with our balance sheet first strategy.

As a result of carefully managing inventory levels, we were successful at converting inventory to cash, enabling us to further improve balance sheet leverage and liquidity.

Leverage improves as our debt to total capital improved to 31.6% from 33.5% in the prior year while this quarter's net debt to total capital which is net of cash, was 29.6%.

Additionally, we continue to generate strong cash flow and continue to pay down debt.

We called for the early retirement of our $300 million floating rate notes due to mature in 2009.

This note was repaid after the quarter ended on June 19th.

In addition to paying down debt, we maintain ample liquidity.

There were no outstanding borrowings on our $2.7 billion revolving credit facility at quarter end, and additionally, we had $234 million of cash.

The revolving credit facility was increased from 2.7 billion to 3.1 billion right after the end of the quarter, and additionally, there were no stock repurchases during the quarter.

Our EBITDA to interest coverage ratio for the trailing four quarters was 4.5 times coverage, and our debt to EBIT leverage was 2.8.

These calculations exclude the impact of impairments, as they are noncash items.

We've been consistently engaged in an aggressive asset management strategy since the beginning of 2006.

We have reduced inventory from $8.9 billion to $7.7 billion year-over-year for the second quarter.

We have continued to manage starts every day in our daily plan meetings, as Stuart mentioned, to determine the right activity level, and as a result of the increased supply in the marketplace and market deterioration, we have reduced starts 57% year-over-year.

This includes unconsolidated joint ventures.

The number of homes under construction has also decreased significantly year-over-year, from 23,588 under construction to 11,237 homes under construction, a 52% decline.

Our completed unsold homes remain in the comfort level of 1 to 2 on average per community.

Home sites owned and controlled declined 102,000 home sites from the peak in the first quarter of 2006 from 345,000 to 243,000 in the current quarter, a 30% decline.

Included here are also long-term strategic home sites, such as home sites at the New Hall location, an El Toro Marine Base that we have controlled for the future.

We have been saying for some time by controlling home sites via option with third parties, we have mitigated a significant portion of our land risk.

We have successfully reduced home sites controlled by option with third party land sellers from 132,000 in the prior year's quarter, to 66,000 which is a 50% decline.

This is a result of either renegotiating these home sites in order to reset land prices to reflect current market conditions or walking away from option deposits.

The current quarter option deposit walk away expense was $49 million, representing 5400 home sites.

Our balance sheet first strategy has been working as intended.

We have been reducing inventory while renegotiating pricing on remaining controlled home sites.

We've been reducing debt, and improving our leverage while improving liquidity.

Turning to the operating results for the quarter, as part of our division operating reviews, we reviewed each division's assets in detail to determine if there are additional impairments to to be raised.

As a result of this review, we recorded a $329 million pretax charge, which Diane will walk through in a couple of minutes.

Excluding the impairments and deposit walk aways, we had a $0.22 loss for the quarter.

Our 33% decrease in revenue from home sales is due to a 29% decrease in wholly-owned deliveries, and a 7% decrease in average sales price on wholly-owned homes from $322,000 per home to $298,000 per home year-over-year.

This decrease was a result of increased sales incentives, from $25,000 per home last year in the second quarter to $44,000 in the current quarter.

The average sales price per region is detailed as follows: the east region was down 13% from $330,000 to $287,000.

Our central region was flat at $208,000, and our western region was down 8% to $434,000 from $471,000.

Our gross margin on home sales percentage before impairments decreased from 23.7% in the prior year's quarter to 13.6%.

The gross margin decreased -- the percentage decreased in all of our operating regions with the East at 10.3%, the Central at 16.8%, and the West at 13%.

This decline in margin was driven by the increase in sales incentives from 7.1% in the prior year to 12.7% in the current quarter.

The sales incentives were again broad based in this quarter, and generally the markets that experienced the highest gross margins in the last few years also have experienced the largest sales incentives.

The results in land and joint ventures are primarily related to impairments which Diane will cover, so I won't get into any detail there.

But I would like to talk about SG&A, and we've been very focused on right-sizing our SG&A.

We have consolidated home-building operations in many markets, and therefore we have reduced our total home-building division count by 25%.

Our associate head count, excluding financial services, has been reduced by 2,500 associates or 25%.

As a result of these measures, we incurred nonrecurring consolidation expenses during the quarter of approximately $10 million.

Including these nonrecurring charges, we were successful in reducing our SG&A by $79 million or 17%.

As a percentage of revenue, SG&A increased to 14.7% during the quarter, but that's primarily due to a 33% decline in revenue as well as the nonrecurring charges I mentioned.

We have also continued to focus on corporate G&A, as these expenses were reduced by $10.7 million or 19% in the second quarter compared to the same period last year.

New orders were down 31% during the quarter compared to the prior year.

Although this is a broad based decline, the central and west regions experienced the largest year-over-year new order declines.

The number of homes in backlog declined 54% year-over-year, and each region experienced greater than a 50% decline in the homes and backlog year-over-year.

The cancellation rate remained at the high-end of our typical range of 20 to 30%, as it was 29% for the quarter.

Our financial services profits decreased from $34.6 million to $14.2 million.

Mortgage decreased from $23.4 million to $19.9 million, and that's before the $14.4 million of partial write offs of land seller note receivables.

These notes are a result of land sales made by our home-building operations with a portion of the sales price consideration taken in the form of a note.

These notes are managed by the mortgage company due to their expertise in managing notes, and we have a total of $133 million of land seller notes in the mortgage company, and after a careful review of each note, we determined that $14 million of writedowns were appropriate.

This quarter, our mortgage capture rate increased from 64% in the prior year to 72% in the current year.

Our average FICO scores for the loans that we originated for our homebuilding operations remain in the low 700s for our mortgage company.

Fixed rate loans increased and are now over 80% of the total loans originated, and the percentage of FHA/VA loans increased from 12% in the second quarter of last year to 19% in the current quarter.

Our title profits decreased from $11 million in the prior year to $8.1 million in the current year.

As a result of our operating loss, we recorded a tax benefit for the quarter.

There are certain impairment and tax items and minimum state taxes which adjusted our tax benefit rate to 36%.

As we indicated, we're not providing a goal for 2007 earnings at this time due to uncertain market conditions.

However, we remain focused on generating strong cash flow as we continue to focus on our balance sheet first strategy.

Now I would like to turn it over to Diane to update us on our asset reviews.

Thank you, Bruce, and good morning, everyone.

In conjunction with our balance sheet focus, we continue to realistically evaluate and re-evaluate our assets each quarter.

As Stuart mentioned, very few of our markets have stabilized.

In fact, many markets have continued to show signs of ongoing deterioration.

Therefore, it is extremely important to maintain our comprehensive and rigorous process of division by division, asset by asset reviews to ensure our assets are properly stated.

Last quarter, we performed the same asset reviews which established accepted revenues and net margins for each asset.

During the second quarter, as we again performed our asset reviews, it was clear that the market deteriorated as we just mentioned.

This deterioration necessitated a re-evaluation of expected revenues and net margins.

Obviously for many assets this re-evaluation yielded lower expected revenues and lower expected net margins, and therefore additional impairments were required to be recorded this quarter.

Let me give you some color in that category.

As we look at land under options, we continue to evaluate, re-evaluate and renegotiate deposits land under option as markets continue to change.

For those option contracts where we are not able to adjust or readjust to the terms to a level that will lead to an acceptable return.

Based on current market conditions, we continue to make the decision to walk away from the contract as we have done in past quarters.

We continue to evaluate and re-evaluate the fair value of land that we own.

On an asset by asset basis, we apply the standards of FAS 144 to ensure the carrying value of an asset does not exceed its fair value in the deteriorating market conditions that exist today.

As we continue to evaluate and re-evaluate our investments and joint ventures, we're also focused on the recoverability of our investment relative to the market conditions that exist today.

With that said, let me summarize the asset valuation amounts that were recorded in the second quarter.

We wrote off approximately $49 million of option deposits and preacquisition costs, which represented a walk away from about 5400 home sites.

The segment detail is as follows: in the East segment, $16 million; Central segment, $10 million; West segment, $22 million; and Other, $1 million.

Additionally, we recorded approximately $241 million of valuation adjustments on wholly-owned land; split between home-building, which was $172 million and land, which was 69 million.

The segment detail for the impact on home-building is as follows: East segment, $101 million; Central segment, $16 million; West segment, $49 million; and Other, $6 million.

The segment details for the impact on land is as follows: East segment, $30 million; Central segment, $3 million; West segment, $19 million, and other, $17 million.

Finally, we recorded approximately $39 million of valuation adjustments related to our investment in joint ventures.

The segment detail is as follows: East segment, $4 million; Central segment, $1 million; West segment, $34 million.

There were no valuation adjustments recorded in our Other segment.

As we look ahead, of course the question on everyone's mind is what do we see with respect to future valuation issues.

That answer is embedded in market conditions that are still uncertain, but our direction is very clear.

We will continue to focus on our balance sheet through our comprehensive and rigorous quarterly asset reviews that focus on a realistic evaluation of our assets in current market conditions.

Through these reviews, we will continue to ensure that our balance sheet is accurately stated as market conditions continue to evolve.

With that, we would like to open up for questions.

(OPERATOR INSTRUCTIONS).

Please limit yourself to one question and one follow up.

First to the line of Carl Reichardt with Wachovia Securities.

Please go ahead.

Good morning, guys.

How are you?

Good morning, Carl.

Stuart, could you provide a little more specificity on the SKU reduction you're undertaking broadly, and actually just we'll start with that and then I will ask another.

Well, Carl, in slow times like these, these are times to pull back and think about some of the processes in place.

We started a process that was really two-pronged, and that was to really reduce the number of floor plans that we offer within our Everything's Included program which is now across the board, and within our floor plans, we have focused a lot of attention on reducing the SKUs that we offer, and really, we started it with the kitchen faucet, and we reduced our kitchen faucet offering to I think four now across the Company, and that could be a slightly wrong number, but the general philosophy is that we're not going to get pricing power unless we're buying mass quantities of specific SKUs, and so we've gone pretty much item by item within our home offering and really tried to refine the SKU offering and unify it as pretty much a corporate matter, and it is all about reducing construction costs and getting affordability back into the cost structure of the homes.

Okay.

And then second question, it is a little broader, Stuart.

You talk about the three things you think need to happen for business to change.

Two of them conflicted.

One is inventories stabilized, in other words we find a market price where we can deplete inventories, and the other is consumer confidence gets restored in the home pricing mechanism itself, in other words, consumers no longer feel like they have values fall underneath them.

Trying to figure out how, you had mentioned a couple of quarters ago you thought you had maybe gotten slightly more aggressive on pricing than maybe you wanted.

I think that was Q4.

Where do you think your pricing structure sits now?

You say you're at market but the turnover rate is not especially strong.

I know you had a tough comp.

In your past experience, I guess, where do we sit?

How far do you think things need to go, and when will we find them?

I don't mean to be so unspecific, but it's a prisoner's dilemma to a degree.

It is a really tough question, and as we did our asset -- as we did our operating reviews at the end of the quarter, we found that in many of our markets, we're not at the low end of the market at this point.

We're finding that the adjustment is happening across many of these markets, and the competition is really heated up, and what I said is, first we're going to have to stabilize the inventory that's out there, and what I mean by that is it is not just new homes that are coming on the market.

It is the cancellations, it is the homes that were sold in prior years that are coming back on the market, either through investors or speculators or people moving out, but it is also the new home inventory with the adjustments that we've seen in the marketplace -- I am sorry, the existing home market.

The existing home market has been a little bit stickier in terms of adjusting its pricing, and the inventory build-up in existing home markets which I am not so sure is reflected in some of the national data that I see.

In certain specific markets, you're seeing the existing homes inventory build up to fairly high levels.

First, that inventory is going to have to stabilize, and then it is going to have to be absorbed, and there will be those price fluctuations that will take time, and they will be somewhat erratic because it is not just builders, it is speculators and investors, and it is existing homeowner that is are kind of struggling to find out where or figure out where that right pricing is that will define when pricing stabilizes, and it is only then that I think consumer confidence can start to rebuild itself.

Okay.

Thanks a lot, guys.

You bet.

Our next question is from the line of Stephen Kim with Citigroup.

Please go ahead.

Thanks, guys.

First question relates to your cancelation rate as a percentage of your backlog.

You talked about the fact your percentage of gross orders but pretty stable at 29%, but the can rate as a percentage of backlog jumped a lot, looks like it went to about 36% which is materially higher than it has ever been as far as I can tell.

I guess my question was, I know there was some odds in this quarter with respect to the backlog, but wanted to see what your sense was for sort of why that happened, what the ongoing nature of a can rate like that as a percentage of backlog is in your eyes.

That's my first question.

Well, Steve, the can rate overall has been pretty consistent, close to 30% over the last year, and it certainly is reflective of the deteriorating market conditions that we've seen throughout the quarter, and as conditions have gotten tougher, the can rate as a percentage of backlog has gone up.

As prices have come down, that percentage has gone up a little bit as well.

I think that's what I would attribute it to.

I guess the thrust of my question was just that looking at it as a percentage much gross orders may not be as meaningful as looking at is it as a percentage of your backlog, and a 36% increase would suggest that things are demonstrably worse than we were in the third quarter of last year, and the backlog can rates as far as I can tell hit 28% in the back half of last year, when basically everything was falling apart in the industry and then i went down to 26 in the first quarter for you, and then it went up to 36 in the most recent quarter.

It would imply that a significant number of your people and your backlog are canceling on you.

I guess I just -- it doesn't sound to me like from what your tone is that this is something that you perceive as an untenable situation, but a 36% backlog can rate seems like it might be, and so I guess I am trying to test you a little bit on do you not look at it on a percentage of backlog?

Is there something unusual in this quarter you think may not lead to an ongoing can rate, percent of backlog in that range or what?

Steve, I have to say that I don't think that we have studied the relationship of cancellations to backlog, so I am sitting as you're speaking and trying to think about how that relationship works, and some cancellations come towards the back end of production, some towards the front end, and I would have to give some thought as to what the import of that relationship would be, and we just don't really look at it that way.

If what you're asking is is it indicative of the fact that the market is probably hit a new low point, I think the answer would be yes, and I think that's what we've tried to come out and say.

Sure.

Okay.

The last question I had relates to your inventory, or let's say your cash, specifically.

You did talk about the strength of your balance sheet year-over-year.

I know there was also a seasonal pattern to your balance sheet.

I would generally suspect in the 3Q and 4Q your balance sheet would strengthen just naturally as you go through the year.

Can you give us a sense for what might be realistic in terms of a targeted range of cash flow generation over the next couple of quarters, by year end, you know, how much cash you think you might be able to generate?

Well, what I can say, Steve, is that we're very focused on continuing our strategy of converting inventory to cash.

We believe the strategy is continuing to work, will continue to work.

We don't have a projection per se of what the cash balance will be.

I think you can read into the fact that we have the comfort of paying down some debt we paid down last week that we feel comfortable with that strategy, but we don't have an actual target that we would lay out there for you because it is still volatile times.

But it does strengthen by the end of the year?

We believe that our balance sheet will continue to strengthen as we get to the end of the year.

Great.

Thanks very much, guys.

You're welcome.

Our next question is from Michael Rehaut with JPMorgan.

Please go ahead.

Good morning.

Good morning.

First question is on the margins.

You spoke last quarter, particularly on the gross margins, of trying to rebuild that, and obviously you continue to have a tough time in it, and it is going against you the other way.

What have you done over the past quarter, I guess, and you outlined some steps in terms of what you need to do going forward, but I guess I am just looking for some incremental examples of perhaps where those efforts have gone, have been lacking or there's more to do, and also how much of this is just a result of the continued aggressive workdown of the homes under construction and spec homes?

Mike, if it came across that way, it shouldn't have come across that we were beginning programs of revamping some of these areas.

We've been working hard in the areas for quite some time.

As it relates to overhead, we have had material reductions in workforce as we've right-sized our operations in the field, and in corporate, to the size of the business that seems to be upon us now.

I can't tell you the exact number that we've had in reduction, but it is probably been north of 20% of our workforce, so --

Wouldn't that hit SG&A more, Stuart or does that also hit on the gross margin side?

It would hit SG&A.

Okay.

Now, I am sorry, you were going to say?

No, I am focused more on the gross margins for the moment.

Okay.

I am sorry.

On the gross margin side, our focus on construction costs has been heightened for well over a year.

I think that we've made meaningful progress, but I think that the force of price increases or decreases is stronger than the force of costs increases or decreases, and while we have brought down costs materially, and we monitor that in each division, and by product line on a quarterly basis, and in many instances as part of our daily discussions, the cost reductions have not been able to keep up of course with the price reductions in the marketplace.

We've had meaningful advances in bringing down construction costs.

On that, the SG&A, even excluding the $10 million of charges, was up about 4% sequentially, which is right in line with closings up -- units up 4% sequentially.

Why haven't we seen more progress of your head count reductions up until this point?

I would say embedded in some of these numbers you have things like severance costs and other extraordinary -- not extraordinary, but other pieces of the puzzle that are moving around, and I think that we would expect to see -- we would expect to see those, let's call them advantages or the better numbers flow through over the next quarters.

Okay.

Thank you.

You're welcome.

Our next question is from the line of Kenneth Zener with Merrill Lynch.

Please go ahead.

This is Phil Jungwirth on for Ken.

Orders in the East were basically flat compared to a 46% decline in the West, and I am wondering if there is a difference in terms of strategy between these regions in terms of balancing margins with sales volumes because you have also taken over half of the roughly $500 million in inventory impairments to date from the East, so I am just trying to figure out if we should expect further impairments in the west if you have to start reducing prices to increase their volume?

Did you miss the first part of that question?

We missed the first part of your question.

Sure.

Basically the question is that the orders in the West were down significantly more than the East, so I am just wondering if there is a difference in terms of your strategy between balancing margins with sales volume?

And then what would that imply if you need to reduce sales prices to pick up volumes in the west for future impairments in that region?

I think the bottom line answer is that, no, there is not a difference in strategy between the markets.

As I said, each market has defined its own unique strategy for dealing with its particular market conditions, so we don't anticipate that we're going to see a material shift either in impairments or in sales performance.

Okay.

And then what were the whole communities that were impaired during the quarter, and generally how much of these communities were under development versus raw land because some builders have indicated that they don't have enough visibility into future market condition to say really go through the impairment process, input the variables into the impairment models even though the market value of the raw land could be less than actually what it is on the books for?

We had to just answer your simple question, we impaired probably call it 15% or so of our communities in the second quarter, and as I think about that, I will say that the majority of that are communities that are in some stage of development versus communities that are raw land.

We don't have a lot of raw land on our balance sheet.

Many of our longer, more strategic pieces are at the joint venture level.

On the wholly-owned side I would say that it's definitely weighted more towards the land under development.

I would say overall relative to our assessment we are looking at all assets on our books, and we're applying the same metrics and assumptions to all of the assets, whether they be raw land or whether they are assets that are fully developed or under development, so we're not making a distinction as to the visibility relative to raw land, and that's been consistent for the past quarters.

The management fees and other income you have a net expense of about $13 million during the quarter.

I was wondering what drove that?

I would think that would be a little bit more stable of the line item of the management fees?

In the other category there is some interest expense relating to some settlement of '02, '03, '04 IRS audits included in Other in this quarter which amounted to about $15 million.

Okay.

Great.

Thanks, guys.

Thank you.

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

Please go ahead.

Thanks very much.

Was wondering, Stuart, earlier on you talked about the three things we need to see the market rebound, and one was inventory stabilizing.

It would seem that to get inventories to stabilize really need to see a significant decline in construction activity which we have seen overall, and I think earlier you sort of in the past couple of quarters, you have been one of the more aggressive ones in terms of continuing to go move volume.

Can you talk about how you're viewing that now and how you evaluate starts in the different markets in terms of determining what level of starts to have at a point in time?

Yes.

Good morning, Dan.

If you go back and think through what we said in earlier times, the past quarters, what we've said and what we did is, we delivered our conveyer belt of homes under construction.

What we included in that were home sites that were fully developed, and we viewed that as part of the overall conveyer belt.

We just chose not to shut down construction or production and chose to continue to deliver.

Sorry, hello?

Yes, thanks.

Just had a little blackout in the office.

I wanted to make sure you guys were still there.

In any case, we continue to deliver that conveyor belt of homes that were under construction.

We said from the beginning that we would taper back as the conveyer belt was delivered, and we would match production and starts to our sales pace.

We have remained very sensitive to the sales pace and done exactly that, matched our starts to that by reviewing our sales and starts on a daily basis really at each division, and with corporate oversight.

As we look ahead, when you ask the question what is the right number or the right production level, I think that's a division by division, every day kind of evaluation, and what we are doing is making sure that our construction pace is very much aligned with our sales pace so that we're not getting out ahead and building ahead of where demand actually is.

Okay.

Thanks.

If you could talk about during the quarter potentially into June what you saw in terms of the monthly trends?

We know the quarter was down 31% in orders, but how did that work over the course of the quarter?

Over the course of the quarter -- one second.

It was fairly stable through the three months of the quarter, Dan, in terms of new orders.

It didn't really vary that much, but again you have to highlight that from a standpoint of sales incentives, it did deteriorate throughout the quarter from a sales incentive standpoint, although orders were more consistent, sales incentives did increase throughout the quarter.

Thanks very much.

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

Please go ahead.

The first question, Stuart, I wanted to ask is on the impact of the pricing environment, on your fundamentals.

On a normal environment, price declines on current orders, we wouldn't expect to see the impact of that in your income statement for a couple of quarters until that was delivered.

There were a couple things that might be bringing that forward?

Obviously you're turning your backlog a lot more than you were a few years ago, and probably to some extent some discounting to keep people from canceling out of backlog.

I was just wondering if you can help us understand in terms of the impact of your pricing on your fundamentals, how much of that is being brought forward and how much should we expect to see down the line?

I just don't think that we have a good percentage or -- I don't think we can give a good number on it, but I think we can say that you clearly seeing the impact of the deteriorating market conditions being moved moved forward, unlike when market conditions are getting better, you can't bring that to your current production level or your current production, but customers through cancellations and renegotiations at the table are clearly pushing pricing lower in the current quarter, and, again, do you have a quantification of that, Bruce?

No.

There is really not a quantification of that, NISHU.

The incentives that came down through the quarter, it wasn't that significant of a change from the first quarter where I think it would be that significant as you're looking forward, so I don't have a quantification, though, to answer your question.

How about another take on it?

Would your proactive approach to pricing and converting the balance sheet to cash bring it forward more, let's say, than another builder that might be deferring things a little bit more?

Well, there is no question that as you mentioned, our backlog conversion ratio is right around 100%, so we're selling and delivering and aggressively making sure that our inventory is being delivered to our customers, so there is no question that we're certainly handling it and as quick as possible, and I think with respect to other competitors, you'd have to talk to them specifically, but there is no question we're seeing the current activity in the quarter also being delivered on a realtime basis.

Second question I just wanted to ask about, Stuart, your comments in your opening remarks about the level of standing inventories rising.

The census figures, obviously everyone is well aware of the shortcomings in the census figures, but they continue to show that inventories have been stable, if declining.

How do you make sense of the discrepancy between what you're seeing out there in the reported figures?

Is it merely a matter of cancellations, even though those have come down a lot in the past couple of quarters, or what else do you look to to make sense of the discrepancy?

Well, I often wonder as I look at some of the national numbers how they jive with some of the interactions that I have with some of our divisions, and there are a number of caveats to keep in mind.

One of them is that national numbers include a whole bench of markets that we're just not in.

The feedback that I am giving is really relative to a subset of markets, and there might be some markets out there that are stronger or more stable, less volatile, that we just don't happen to be in that are kind of averaging down the overall, but when we sit with our division people and we go through market conditions, we talk probably the most in looking at each individual market as what they view as the inventory situation that they're trying to sell into and how they're arriving at their pricing.

As we go through that, we do an assessment of the home builder inventories that are out there and we try to understand which of our competitors are the biggest and most aggressive inventory position.

We talk about some of the newer communities where there are resales coming on at a greater pace, and we have talked more agitatedly recently about the existing home market and how the existing home market has been building up in inventory.

This is the subset of markets we're looking at, and that's all I can really report on.

Okay.

If I can sneak one last quick one in there, can you give us your specs as a percentage of your under construction as you have the past few quarters?

Our specs, sure.

As I mentioned earlier, our inventory under construction is down considerably, and that number that I gave which was 11,237, about 5,000 some-odd homes were sold and about 6,000 unsold.

Thanks.

You're welcome.

Next question is from Chris Hussey with Goldman Sachs.

Please go ahead.

Thanks, gentlemen.

I apologize, I'm on my cell phone.

I wanted to ask two questions.

One on the cost structure, try to get my hands around the -- are you making money today, because you said a couple of things.

You said that your write offs -- your incentives are accelerating as the quarter went on, and you didn't make a lot of money, but there was a $50 million IRS charge and there was a $10 million restructuring charge.

I am just trying to get a sense as you guys are working today, do you have an operating margin excluding those special charges?

Do we have an operating margin excluding the special charges?

Yes.

Okay.

We ended up with a negative margin as you indicated, and basically if you pull out at least the charges you mentioned, we're probably pretty close to break even.

It would be a market by market evaluation, but we're close to break even and maybe even losing a little bit right now.

Okay.

And just kind of get a sense of how you guys think about that, as you go forward, given that you spent a lot of time developing some of the this land overall, what's your feeling feeling about pushing through development on these sites where you're going at a loss at this point?

Do you do it a little less aggressively because you are losing money or do you do it more aggressively because on a cash flow basis you make lots of money?

How do you guys think about that?

No, no.

We're clearly slowing the development effort.

Remember, our program really was to deliver the conveyer belt of homes and home sites that were under production, but as far as new development is concerned, I still think that overall, across the country, in most of the major markets, there is ultimately an imbalance to the negative side on the land that's going to be available, and that's just a matter of the approval processes and a growing population.

We certainly aren't pushing through development on new land parcels to try to sell into these deteriorated and temporarily deteriorated market conditions.

Okay.

Thanks.

Last question on land prices.

I know we spoke only recently, but are you seeing any capitulation from the land holders in terms of land pricing?

Are you seeing land prices decline yet or are they still holding up relative to home prices?

I still think you're not seeing capitulation.

I think you're seeing a little bit of softening, and I think there is a recognition that is sinking in that this market is weaker and is likely to remain weak for a longer period of time than people anticipated, and I think that it is starting to trickle down to the land holders as well.

I appreciate it.

Sure.

Next we'll go to Timothy Jones with Wasserman & Associates.

Please go ahead.

Good morning, everybody.

Good morning, Tim.

The first question, you've implied, about three years ago when you had assimilated U.S.

Homes, you were about 50/50 with Design Centers and Everything Included.

Sounds like you got dramatically towards Everything Included.

Can you give me the percentage now that it is Everything Included and why either Everything Included is better or Design Centers are worse?

Well, let's start with the last question first and say that there is room in the world for a lot of different philosophies, and/or programs, and I think both marketing programs work.

I think we're better suited to focus on one program as our predominant program, and I would say that in terms of the percentage of communities that are Everything's Included versus Design Studio, I would say that we're about 95% Everything's Included.

There are a few communities where we have a Design Studio component maybe because it is required by the neighborhood or there is a unique set of circumstances, but we are really a unified program across the country focused on fewer floor plans, fewer SKUs, and a cost structure that is built for affordability and value.

To stay on that question obviously you went from 50/50 to 95/5, you found something dramatically better.

I say remember you saying, hey, we can give the different cuts what they want and each side and you know the song and dance.

Obviously you saw something dramatically more attractive with Everything Included as opposed to Design Centers.

Can you nail something concrete for me on that question?

Well, listen, philosophically, Tim, first of all, let me say this.

I think we're better as a company if we're doing one thing well rather than trying to be all things to all people, so being both Everything's Included and Design Studio at the same time I think has its flaws.

With that said, let me say this.

Most of the homes that are being sold today are inventory homes.

As such, they really are Everything's Included homes.

Whether they're Design Studio companies or Everything's Included companies, they're really all what you see is what you get homes.

In Everything's Included, what we try to do is say, okay, we're going to try to do that thinking process of figuring out what people need and want ahead of time so that we can make our production process simple and bring our costs down using simplicity and consistency in the production process to get there.

Now, Everything's Included was born in times that were more like these.

We have found historically that a production program that brings value to the market works very well, but I don't want to disparage the other side.

I think the other side would argue that the flexibility in design studios works well for them.

It is just for us that we believe that the ability to focus on one program across the board using national approach to SKUs for strategic materials will bring better value to the ultimate purchase price for the home and that's going to work well in the declining market, and we know it will work well in the good market as well.

The second question is this.

You said that you're head count went down about 25%, and if you do the math, it implies,k this is in the construction area, you went down 2500 people.

That implies that you basically went from 10,000 construction-related workers to 7,500.

Given the fact your starts and your backlogs are down 50% and if my 7,500 number is correct, you're still about 1,500 above several of your equal-sized competitors.

Can you address if there is going to to be more cuts on the personnel or some folks to get that more in line?

Tim, let me just say that we're happy with the reductions that have been made, and we've certainly consolidated a lot of the home-building divisions in different markets that have led to the majority of that 25% reduction, and the 50%-plus reduction in starts this quarter is not indicative that every quarter is going to have a 50% reduction in starts, and for now we think that we've taken the appropriate steps to significantly reduce over head levels, and we'll see where we go from here based on what the buying will be in the future.

At this point we feel very comfortable we've taken prudent steps and we feel that we've right-sized SG&A significantly to reflect the decline in the market to date and we'll see what starts and volume are going to be as we go forward.

Thank you, Bruce and Stuart.

You're welcome.

Next we'll go to Joel Locker with SPF Securities.

Please go ahead.

Hi, guys.

Wanted to see if you can break out Florida from the East region?

In terms of orders?

The East was pretty strong, only being down about 4% and just wondering to see what the Florida group was.

Sure.

In terms of orders for the East region, Florida for this quarter year-over-year was only down about 3%.

The whole region was down 4%.

Florida was pretty consistent with that, and again this is compared to the second quarter of last year, and Florida was about 2,000 of the new orders in that region for the quarter.

2,000.

Just to follow up on that, just with the recent upticks mortgage rates went up about 30 or 40 basis points since the end of the quarter.

Was wondering if that was just giving your buyers affordability problems on top of all the subprime issues you already witnessed?

Doesn't help, and every little element especially in times like these is a contributing factor.

How we would actually isolate the impact of 30 or 40 basis points in mortgage rate and its impact is hard to say, but it its impact is more than just affordability though generally 30 or 40 basis points isn't going to change the picture for most of the buyers.

It does have an impact on psychology, so we'll just have to wait and see how it turns out.

If I can get one last one in, just impairment reversals in the second quarter, did you witness any of this from previous quarters?

There was something but we don't report on what the reversals are because it comes through in so many different communities but we have certainly started to see the beginning of some of those reversals.

Thanks a lot.

You're welcome.

Our next question is from the line of Susan Berliner with Bear Stearns.

Please go ahead.

Good morning.

Just a question.

I guess on the increase in your bank line with nothing outstanding, cash on hand, I guess why would you increase your bank line right now?

Well, we increased -- there were some banks that had some interest in coming into the facility at the end of the quarter, and we did bring in new banks as part of that, and at the same time, our bank facility is lower cost than some of the floating rate notes we paid down recently, so we're also bringing down our costs to the extent that we were going to be using the facility to borrow.

It increases our liquidity at a time where we think it is a good thing to have ample liquidity and those were the reasons we went that direction.

If I can ask about any other markets, any specific commentary about Southern California or Phoenix or Las Vegas?

About additional deterioration?

Well, those markets have weakened.

The areas that started to soften the most were some of the areas that would be further out in the Inland Empire, for example, further away from the job base, where there is also more supply as well as Palm Springs, which tends to be a secondary market, less of a job base out there.

Those markets in particular were notable in terms of further deterioration, but in general all the markets, it's been broad based have been weakening a bit.

Great.

Thank you.

Next we'll go to Alex Barron with Agency Trading Group.

Please go ahead.

Thanks, guys.

I wanted to focus a little bit on the impairments.

I guess you said you impaired 15% of your communities this quarter.

I was hoping you could help me understand how many you've impaired over the last twelve months, and I think you said some of them were kind of, you have already impaired before and I guess you added on more.

Can you help me understand how much was new versus incremental this quarter?

Yeah.

We had, I would say at least two-thirds of the communities that were impaired this quarter were new communities, and about a third were communities that were previously impaired.

And the total communities to date?

To date and the prior year we had about 10 to 15%, so if about a third of them were previously impaired, you're looking at somewhere in the mid-20% range.

And my second question is I guess you just had an option of you just mentioned the Southern California market is weakened, and I think you had an auction in the Palm Desert.

Can you talk about your experience there and whether those were some of the projects you wrote down this quarter and whether you would do that again?

That was a situation where we had a build-up of inventory and we were actually closing our home-building division in that market and consolidated it into one of our other divisions in Southern California, so it was a creative marketing strategy.

It was a one-off creative marketing strategy.

It worked fine for what our goal was which was to reduce inventory in that location, and we'll have to evaluate it market by market if there is another situation that would be similar where we would like to try that again.

Got it.

Thanks.

Lastly, do you have a breakdown of your inventories by work in progress versus land?

We're going to have an exact breakdown for the 10-Q, but as we look at it today, we're looking at the categories for the 10-Q where you had finished homes and construction in progress, that came down somewhere in the $3.6 million, $3.7 million range.

Land under development is roughly in that $3.5 million, $3.6 million range, and consolidated inventory not owned is between $400 million and $500 million.

Thanks, Bruce.

You're welcome.

Next we'll go to [Sayas Habid with DA Capital].

Please go ahead.

Hi, guys.

What was your EBITDA number as for your bank agreement this quarter?

EBITDA per our bank agreement for the quarter was approximately just for the current quarter and as you know, we had a rolling four quarter number that we used, but for the current quarter it was about 56 million.

Okay.

And my second question is in terms of your own land as well as the optioned land, could you give us a sense of what the vintage is, how much of it is pre'04 and how far is post as a percentage of total?

No.

We don't actually age each of the pieces in the inventory, and something to keep in mind is as Stuart mentioned earlier, the controlled home sites that we still have controlled, a very large portion of those have been renegotiated as well, so as you look at the bucket of owned land, we move through that bucket faster.

The control zone sites we've been renegotiating or walk away, and the joint venture piece tends to be the longer strategic programs like New Hall and El Toro in that category but we don't actually age the home sites in our owned and controlled home site count.

Thank you.

I think that this will be the last question.

And that will be from Mark Reider with Partner RE Asset Management.

Please go ahead.

So when you increased the revolver size from 2.7 to 3.1, did you change any covenants, and then do you have any concerns about meeting the interest coverage covenants?

I know if you said the current quarter was $56 million and your interest is about the same, that sounds like one times coverage.

Curious going forward do you think that might be a problem?

Well, look, we'll have to see what the future holds, but we did not change any of the covenants at this point and just exercised our accordion that existed from the revolver put in place last June, and as far as coverage goes as we look at trailing four quarters, we have over $1 billion of EBITDA, and we've been paying down debt.

We had two floating rate note series that we have paid down since the fourth quarter of last year, so it is something that will continue to monitor as we go forward.

You're not concerned about some of those better quarters start to roll off?

Well, look, we know it is a volatile environment, and certainly there is no projections we've given going forward, and we get concerned about everything of course, so we'll have to continue to manage this as we go forward.

Yes.

Let me just say that we stayed very close to our banking relations, and in fact this evening we're having our annual bankers meeting to begin.

I think that there are all kinds of things that can be accomplished with the banks, but until we think that there is a situation that's ripened, we just don't see the value in making changes or asking for changes, waivers or other things, but that's why we have remained so focused on our balance sheet and why we are so focused on staying very close with our bank, particularly at difficult times, giving them as much information and realtime sense of the management here, as markets deteriorate.

Thanks.

Okay.

Well, I think that will be it for today.

We appreciate everyone's attention, and being with us for what is somewhat discouraging information about the market, but nonetheless a lot of focus and energy from the management team here.

Again, thank you for joining us.

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