Lennar Corp (LEN) 2007 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Lennar Corporation third quarter conference call.

At this time, all lines are in a listen-only mode.

Later there will be a question and answer session, and instructions will be given at that time.

(OPERATOR INSTRUCTIONS) As a reminder, today's call is being recorded.

Now before we get started, I would like to read a forward-looking statement disclaimer from the Company.

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

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

Forward-looking statements represent only Lennar's estimates on the date of this conference call and are not intended to do give any assurance as to the 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 Lennar's actual activities to result 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 contained in Lennar's annual report on form 10-K for its most recently completed fiscal year which is on file with the SEC.

Please note that Lennar assumes no obligation to update any forward-looking statements.

With that said, I would like to turn the conference over to Mr.

Stuart Miller.

Please go ahead, sir.

Thank you, Ken, and good morning, everyone.

Thank you for joining us for our third 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 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 again by Diane Bessette, our Vice President and Controller who will participate as she has in the past with an update on our asset review and impairments.

I know there are a lot of questions this morning, so accordingly, I would like to request 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 join or rejoin the queue if you have additional questions and we'll attempt to answer as many as possible in the hour, more or less, that we've allotted for the call.

Now, as noted in our press release that we issued this morning, these continue to be very difficult times for the home-building industry.

In fact, there are times when the market speaks loudly and clearly and gives an indication that it is time to pull back, to retrench and to wait for another day.

These are those times.

Our third quarter results reflect a very strong and definitive movement by our Company in sync with current market conditions.

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

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

It was clear from these meetings that current market conditions are primarily defined by the overhang of inventory in their market, which is comprised of completed homes on the ground, spec homes that are back on the market, and owned homes that are up for sale.

The overriding sentiment in our reviews was that the market has continued to become more and more competitive as inventories are managed and there continues to be a great deal of downward pricing pressure through the use of incentives, price reductions, and incentivized brokerage fees.

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

All of these have very quick closings available.

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

In addition to the standing inventories of new homes, it is apparent there is a growing backlog of existing homes, both from speculators and owner/occupied, that are not selling at yesterday's prices, and they are now repriced in order to sell.

Overall, the supply of homes to sell continues to climb in many of our markets and we're not yet able to get a good reading on how quickly this inventory will be absorbed or whether it will continue to increase as foreclosures increase and add to inventory.

While potential foreclosures might be limited by governmental pressure on lenders or through proposed legislation, it is currently not clear what their impact is going to be.

On the demand side, there are customers out there, but they're simply not motivated.

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

While the recent cut in interest rates by the Fed might begin a process of rebuilding confidence, it will most certainly not be a panacea for conditions as they exist.

Although traffic has been increased by the use of incentives and mortgage buydown programs, many of the deals that are struck have been prone to cancelation at the first sign of a better deal.

Adding to the sluggishness on the demand side is the continued deterioration of the mortgage 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 needing foreclosing cannot qualify.

While we are hopeful that the GSEs, Fannie Mae and Freddie Mac, and the FHA will fill the void left by the mortgage market at large, we have not yet seen stability in the mortgage market either.

What is clear is that supply and demand have continued to shift more rapidly than expected.

In our last conference call I noted that three things will have to happen before we see a stabilization and recovery in the market.

They were -- 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; and, number three, consumer confidence is going to have to be restored so that purchasers once again believe in the ultimate value of their home.

In fact, we have not only not seen evidence of any of these items resolving, but instead we have seen further deterioration throughout our third quarter.

Lennar's strategy has been certain and consistent as we've seen these market conditions unfold and remain unresolved.

Our overriding strategy first and foremost is and has been to remain focused on our balance sheet.

This means both generating cash wherever possible and also properly stating every asset on our books so it can contribute to profitability in the future.

Our Company has intensified the focus on generating cash and keeping inventories low.

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

While we continue to believe that the best way to generate cash flow is to deliver our inventories, that is completed homes, homes under construction, and developed land, by reducing prices to market pricing and converting inventory to cash, we have stopped short of fire-selling our homes while others are clearing inventory.

Accordingly, our sales pace has dropped considerably, and we've dramatically pulled back production to properly size our divisions to the reduced demand levels in the market.

Our starts year-over-year are now down over 62%.

Additionally, we have curtailed all land purchases where possible and have walked from option deals on land contracts.

Concurrently, we have impaired land positions on our books to reflect a continuing decline in the market.

The evaluation process has been difficult, as with each additional move downward in the market a reexamination of our impairment charges reveals the need for further charges still.

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

We have even mothballed some valuable land assets where residual value analysis in today's market results in an absurdly low land valuation.

While our results for the third quarter are disappointing, they are reflective of our strategy for dealing with these market conditions and preparing for the future.

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 first quarter -- for the third quarter were down 44% to $2.3 billion, our balance sheet continues to remain strong with our debt to total capital standing at 33.5%.

While we have recorded a loss of approximately $514 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.

Our management team has 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've mapped out a strategy to regain margin when the market stabilizes.

We've reviewed our business plan within each division, considering sales, starts, closings, inventory, and asset base and we've adjusted production levels so that they are tailored to each division's unique position.

Within each Lennar division there is a daily morning meeting where sales starts, closing inventory and asset base are carefully reviewed.

This review dovetails with a daily executive management meeting where the same elements are reviewed on a Companywide basis.

Our strategy overall has been recalibrated daily to match the ongoing pullback in the overall market.

From our quarterly operations reviews to our daily plant meetings in each division to our daily corporate call, we are currently focusing on the fact that two factors will define our ability to be profitable in the future.

First, our land position, rewritten to current market values, will contribute to profitability when the market stabilizes, and second, our overhead is being resized to materially reduce production levels.

As noted in our press release, to date we have reduced our headcount by 35% and we expect to continue reductions until we are sized properly for current production.

While we are focused on reducing the size of our operating machine, we continue to enhance our division management teams so they are properly equipped to move forward as the market stabilizes.

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

Additionally, we have and continue to rebid our construction costs, and we have made material gains in this regard.

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

In conclusion, let me say that in current market conditions it sometimes feels like the market will never recover.

It will and we are working towards that better day.

Our third quarter results on their face are disappointing.

Nevertheless, they're part of a program to reflect the harsh realities of a very difficult market condition and to reposition our Company to emerge from these times scaled down and prepared to reclaim profitability another day.

We have a seasoned management team and a group of associates at Lennar that have worked through difficult market conditions before.

Both I and they know that times like these require 24/7 attention and focus, and we are most certainly on that program.

In that regard, I would like to thank the many associates who have weathered the sometimes thankless undertaking required in difficult market conditions.

Unfortunately, in the short-term hard work only seems to result in another step backwards.

What isn't so clear is that in the long-term the investment we are making today will remake Lennar as a stronger and better Company for the future.

To that end, I and our associates are focused on maintaining the strength of our balance sheet as a foundation for defining both stability in a difficult market and also future opportunity and growth as the market returns.

We are focused on reducing the size of our Company, while improving our operations, and we are focused on returning to profitability.

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

With that, let me turn over to Bruce.

Thank you, Stuart, and good morning.

I am going to discuss our balance sheet and our third quarter results.

We have remained very consistent with our balance sheet first strategy.

Inclusive of impairments, our debt to total capital finished at 33.5% or 32.4% on a net debt to total capital basis.

Our debt levels have been reduced by over $200 million since the prior year's third quarter and we continue to be positioned with ample liquidity.

We ended the quarter with $300 million of borrowings on our $3.1 billion revolving credit facility and reported $128 million of cash on the balance sheet.

We have continued to carefully manage our inventory levels as they have decreased from $8.7 billion in the prior year's third quarter to $6.7 billion during the current quarter.

Of this reduction, $600 million was not related to impairments.

We have continued to manage starts, as Stuart mentioned, every day in our daily plant meetings to determine the right activity level given each market's local conditions and as a result of the market deterioration, an increased supply in the market, we've reduced starts 62% in the third quarter and that's inclusive of unconsolidated joint ventures as compared to the prior year.

Although the mortgage market was extremely volatile during the quarter, we were still able to reduce our completed unsold homes by approximately 200 homes since the second quarter of this year and they remain between one and two homes completed on average per community.

As a result of our aggressive focus on asset management, we have reduced home sites owned and controlled by 138,000 home sites from the peak in the first quarter of 2006 from 345,000 home sites owned and controlled to 207,000, a 40% decline.

Included in the 207,000 home sites are 86,000 home sites owned, 43,000 controlled by option with third party land sellers, and 78,000 optioned from joint ventures.

The remaining 43,000 home sites controlled by option with third parties declined almost 70% from the peak in 2006.

This quarter's option deposit walk away expense was approximately $243 million, representing 15,000 home sites that we walked away from.

In order to preserve the ample liquidity we have, we requested an amendment from our lenders to eliminate the interest coverage ratio covenant and instead convert its calculation to define the maximum leverage ratio.

We received 93% bank approval for our revolving credit facility amendment.

And our EBITDA to interest incurred coverage ratio this quarter on a covenant basis, and this is on a trailing four-quarter calculation, finished over two times coverage, and our home-building debt to EBIT leverage, also on a four-quarter average, was 4.5 times.

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

We have continued to increase the transparency regarding our joint venture debt obligations.

Our 10-Q will provide a detailed breakdown of the categories of our joint venture debt.

Lennar net recourse exposure on joint venture debt was reduced from $947 million in the second quarter to $872 million in the current quarter.

With respect to joint venture indebtedness, we contributed $24 million in the third quarter related to remargining of recourse debt, the majority of this was the result of impairments that have been taken at the JV entity level.

We have contributed $84 million on a year-to-date basis.

Despite continued volatility in the secondary loan market, and tightening investor and financing guidelines, Lennar's mortgage banking subsidiaries continued to have sufficient warehouse financing for the mortgages we originate through two existing facilities with a total of nine banks that aggregate to $1.1 billion.

At August 31st, total borrowings were $528 million and the two facilities expire in April and June 2008 respectively.

There were no stock repurchases during the quarter.

And in conclusion with our balance sheet, our balance sheet first strategy has been working as intended.

We've been reducing inventory while renegotiating pricing on remaining controlled home sites or walking away, and we have been focused on generating strong cash flow, reducing debt, while maintaining ample liquidity.

Turning to the operating results for the quarter.

As part of the division operating reviews, there were additional impairments, which Diane Bessette will go through in a few minutes, as a result of the $857 million pretax charge related to the valuation adjustments, write-offs of option deposits and pre-acquisition costs, goodwill and notes receivable.

Excluding these adjustments, we had an $0.08 profit for the quarter.

Our 44% decrease in revenue from home sales is due to a 41% decrease in wholly-owned deliveries and a 6% decrease in average sales price on wholly-owned deliveries from $316,000 to $296,000 year-over-year.

This decrease was a result of increased sales incentives from $36,000 to $46,000 per home year-over-year.

The average sales price by region is detailed as follows -- the east region was down 17% from $340,000 to $282,000; our Central region was flat at $205,000; and our Western region was down 2% from $451,000 to $440,000.

Our gross margin on home sales percentage before impairments decreased from 19.5% in the prior year to 14% in the current period.

The gross margin percentage decreased in all of our operating regions with the rest at -- I am sorry, with the east at 14.2%, the Central at 14.4%, and the West at 13.5%.

This decline in margin was driven by the increase in sales incentives from 10% in the prior year to 13.4% in the current quarter.

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

Diane will comment on the land in joint ventures as she talks about the impairments.

And turning to SG&A, we have consolidated home-building operations in many markets and have reduced our total home-building division count by approximately 30%.

Our associate headcount has been reduced by 35% from the peak in 2006 through to date.

This focus on right-sizing SG&A along with reduced variable compensation expense are the primary drivers leading to a reduction in our SG&A expenses year-over-year for the quarter of $122 million or 29%.

Additionally, we have incurred some unusual and nonrecurring charges this quarter, primarily impacting SG&A as follows -- severance and lease cost of approximately $7 million; costs relating to our research and development facility, which we have established at the former El Toro military base, to produce more efficient and appealing homes, was $4 million during the quarter; and conversion costs to our national Lennar branding campaign was $4.5 million during the quarter.

As a percentage of revenue, SG&A increased to 14% during the quarter, primarily as a result of the 44% decline in revenue during the quarter.

New orders were down 48% during the quarter compared to the prior year.

New orders weakened as the quarter progressed, with August being the weakest month, and this was a broad-based decline experienced in all of our operating regions.

The number of homes in backlog declined 60% year-over-year, with each region experiencing greater than a 50% decline in homes in backlog year-over-year.

The cancelation rate for the quarter was 32%.

Our financial services profits decreased from $61.7 million in the prior year's quarter to a loss of $5.2 million.

In the prior year's quarter we had a gain of over $18 million from the sale of our personal lines insurance business that is not recurring.

Mortgage decreased from $34.5 million to a loss of $2.3 million.

The decline in profitability was due to a 34% reduction in mortgage originations and the $9.3 million of partial write-offs of land seller notes receivable.

These notes are a result of land sales made by the home builder with a portion of the sales price taken in the form of a note.

This quarter our mortgage capture rate increased from 67% to 72%, and this quarter, as you know, the mortgage market experienced tremendous volatility, and the following are mortgage statistics for the loans that we originated and funded during the quarter.

The average FICO score remains in the low 700s.

Our fixed rate loan percentage increased to 88% from 63% in the prior year.

Jumbo loans were approximately 16% of the total loans.

And the percentage of FHA or VA loans increased to 25% in the current quarter from 12% in the third quarter of last year.

Subprime loans are about 1% of total loan volume and these are agency-eligible product in that 1%.

Alt-A product has been reduced considerably from 41% in the prior year to 25% of the originations in the current quarter.

And the Alt-A product has changed significantly.

The days of no verification, no down payment, and low credit scores are past.

Alt-A product in today's market requires credit scores over 680 along with a higher down payment and partial or full verification of income.

Our title profits decreased based on fewer transactions from $11.3 million in the prior year's quarter to a loss of $1.3 million, and as a result of our operating loss, we recorded a tax benefit for the quarter and we have adjusted the tax benefit to the projected rate of 38% for 2007.

In conclusion, as we indicated, we are not providing a future earnings goal at this time due to uncertain market conditions.

However, our management team remains focused on generating strong cash flow, carefully managing our inventory, right-sizing our overhead and positioning for profitability when the market stabilizes again.

Now Diane is going to provide us with an update on our impairment process.

Thank you, Bruce, and good morning.

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

Throughout our third quarter the housing market continued to deteriorate.

Therefore, it was important once again to maintain our comprehensive and rigorous process of division by division asset reviews to ensure that our assets are properly stated.

So as we looked at land under option, we continued to evaluate, re-evaluate and renegotiate deposits on land under option as markets continued to decline.

For those option contracts where we were not able to adjust or readjust the terms to a level that would lead to an acceptable return based on current market conditions, we made the decision to walk away from the contract as we have done in past quarters.

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

On an asset by asset basis we applied the standards of FAS 144 to ensure that the carrying value of the asset did not exceed its fair value in the unpredictable market conditions that exist today.

We continue to evaluate and re-evaluate our investments in joint ventures.

We focused on the recoverability of our investment relative to the market conditions that exist today.

We applied the standards of FAS 144 to the assets in our joint ventures, including the evaluation of discounted future cash flows, which should produce profitable returns in the future.

Additionally, we applied the standards of APB 18 to our investment balance related to those ventures.

In this morning's release we outlined our third quarter valuation adjustments by segment.

However, let me quickly review the information once again.

Starting with option deposits and pre-acquisition costs.

We wrote off approximately $243 million of option deposits and pre-acquisition costs, which represented approximately 15,000 home sites.

The segment detail is as follows -- in the East segment $45 million; Central segment $38 million; West segment $140 million; and Other $20 million.

Additionally, we recorded approximately $418 million of valuation adjustment on wholly-owned land split between homebuildings, $303 million, and land, $115 million.

The segment detail for the impact on homebuilding is as follows -- East segment $93 million; Central segment $36 million; West segment $150 million; and Other $25 million.

The segment detail for the impact on land is as follows -- East segment $32 million; Central segment $16 million; West segment $41 million; and Other $25 million.

Finally, we recorded approximately $171 million in total of valuation adjustments related to our investment in joint ventures.

The segment detail is as follows: East $23 million; Central $15 million; West $129 million; and Other $4 million.

So as we look ahead, what do we see with respect to future valuation issues?

That is a difficult question to answer because future market conditions 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.

Now we would like to open it up for questions.

Great.

Thank you very much.

(OPERATOR INSTRUCTIONS) Our first question then today comes from the line of Ivy Zelman with Zelman & Associates.

Please go ahead.

Good morning, guys.

Good morning.

I am a little confused.

If we talk about your strategy, Stuart, you've always said that when you purchase land you might as well have thought about it as if the homeowner was buying it at the time because you were going to move it through the production line in your manufacturing machine until it got sold and you generated cash, and that's how you've been operating all along.

You've been operating moving through the inventory as many mothballed and decided to wait for a sunnier day.

And yet right now you're changing that strategy but at the same time you have higher impairments than anyone in your peer group and you have worse orders than anyone in the peer group and others are doing these sale bonanzas and wondering why you're changing strategy?

From what I understood all along you preferred with carry costs and everything associated with holding land was not what you guys were strategically going to do in a down turn.

I don't think the strategy has really changed much, Ivy.

We continue to price the market conditions.

But as we went through the third quarter, we saw just so many competing programs to dramatically reduce inventories that you kind of got to a point where pricing was just unrealistic and maybe even ridiculous.

I think that -- I think you have to be sensible as you work through market conditions like that.

Remember, we've been through these conditions before.

We were anticipatory in their approach to the way that the market would reveal itself.

We worked through a number of communities and a lot of inventory.

We've kept our inventory low throughout.

But what we don't want to do is jump into the middle of the toughest of competitive environments and sell things at below a reasonable price point.

I think that if you look backwards, it seemed like we were discounting ahead of the market or we were probably moving quicker to sell some of our inventory and to work through it.

That, in fact, was the case.

But as the market has just deteriorated more and more, we don't want to go below a certain floor, and that is the floor of reasonableness.

Aren't you worried, Stuart, that maybe that price that (inaudible) and Standard Pacific went to, for example, might be the real price and therefore you might even have to go below where they were and you're missing out on what could be sales today for you that can move through inventory and generate cash?

First of all, highlighting any particular participants, it really is the market overall, and I think that the programs that various participants have in place are good and responsible programs.

Are we missing potential sales?

I think in advance of where we are today and being responsive to market conditions, we pulled back on production kind of anticipating that as we came to year-end in particular and as a number of factors would kind of indicate that inventories would want to be burned through, we pulled back production dramatically and positioned ourselves to be able to pull back sales and not work as aggressively through a sales program.

Do I think that this is problematic?

No.

This is why we have focused so heavily on building a strong balance sheet.

It is for times like these, where you have to be able to navigate very strange waters and have the ability to pull back and sit idly while the market moves through.

Again, I just want to emphasize that both I and our management team have seen these things before.

We have been through these situations.

There are times where we want to be participatory in the market pricing that exists.

There are times where we want to be sidelined and we're pleased that our balance sheet gives us the latitude to be able to navigate.

Great.

Thanks a lot, guys.

Thank you.

Thanks.

And our next question comes from the line of Carl Reichardt with Wachovia.

Please go ahead.

Morning, guys, how are you?

Good morning.

Sort of had a question about your current market spread.

Are you now or are you anticipating, looking at your current geographic positioning, altering that in a significant way?

By that I mean getting out of some markets where you have a relatively thin presence, holding onto that capital thinking about re-concentrating it later?

Or do you expect to keep your current geographic diversification as set?

Our current thinking, Carl, is to maintain our geographic footprint as it is.

It is an unusual time where almost every market across the country is similarly impaired.

Now there are some that are a little bit less than others, but all of the markets are down.

Fundamentally, each and every one of the markets that we're in are good and strong markets.

I think that our primary focus is to scale back and scale back across the board.

We still believe that diversification geographically is a good program and we're not inclined to pull out of any markets right now.

Since that echos what most every other builder has told me as well, despite hearing of some who have either surreptitiously or perhaps otherwise publicly exited some markets, I am trying to figure out how the hyper-competitive conditions in the market place ease if everyone is staying where they are and they are not reducing their geographic footprint, so that when things recover the focus on acquiring land bids up land prices quickly on the recovery?

I don't see how, without reduction in the markets in which you participate, you're able to continue to see that, expect that kind of recovery in the marketplace if you do.

Can you comment at all on this?

I am still confused as to why builders aren't pulling back more aggressively.

I think that builders are pulling back aggressively, perhaps not in geographic footprint.

I hear your question and I think that if you really think historically, most of the strategic markets in the country have been defined by smaller builders growing up and maybe ultimately becoming a part of larger builders.

That trend, if there is a void in these markets as they start to recover, there will be a new group of smaller builders that emerge and fill that void.

I don't think it really is going to matter whether it is the larger builders or the smaller builders that are competitive within each market.

I think that what is going to resolve the market conditions is the fact that, number one, people are going to recognize that the markets are more impaired than they think.

There will be a pullback in volume across the board in each market, and the rebuilding process, rather than being a knee jerk response to an exuberant market condition, will be a slow and methodical rebuilding process that will not lend itself to people just jumping back in and gobbling up land that is available.

If you think back through prior cycles, the rebuilding process has not, or the move upward in the market has not revealed itself overnight and lent itself to people jumping back in.

Fair enough.

Thanks.

I will get back in.

Okay.

Thank you.

Our next question comes from the line of David Goldberg with UBS.

Please go ahead.

Thanks.

Stuart, I wonder if you could comment on how comfortable you are with your JV partners.

If you're concerned about distress among any of your JV partners and can you give me some examples, some hypotheticals on how the JVs would play out in case the JV partner felt some distress or capital constraints?

That's a good question, David.

Good morning.

I think that you can't lump all of the JV partners together in one basket.

There is some that are weaker than others.

Many of our JV partners are very strong.

They will each play out differently.

What I will say generically across the board is that our JVs have worked well to date and I say somewhat unfortunately, just as we have shared on the upside the opportunity to profit within our JVs, the JV structures have in fact proven to be a mitigating factor in terms of absorbing some of the downside impact, And realistically, we and our partners have shared some of the deterioration in market conditions.

Where we have weaker JV partners, we will have to work with them in a more adversarial relationship.

I will say that those are few and far between.

In most instances in our joint ventures we have partners that stand toe to toe with us and stand tall relative to the obligations of the venture.

Thanks.

My second question was and I -- please forgive me if I missed the number, but if you guys had -- let us know how many unsold units you had under construction or completed and how that's going in terms of even flow process and how you're adjusting your starts base given that you're seen deterioration through the month?

The number, David, as far as unsold completed inventory was over 1,200 homes, which is down a couple hundred homes from the last quarter, from the second quarter.

And the number of homes that were unsold that were under construction was about 5,100.

As addressed in your question, with respect to even flow, our focus on trying to meet the market conditions as the market moves and after determining the right level of demand, we're continuing to try to spread out the activity on as close to an even-flow basis as possible, but that's after we're insuring that we're matching the demand in the marketplace.

And as that demand might change in our daily plant meetings, we're adjusting accordingly.

And you don't think that given the deterioration that's necessarily creating more inventory that's out there?

Because it takes a certain amount of time to lag on the start space?

Well, we've reduced the inventory -- your question about inventory under construction, if you looked at the unsold inventory at this time last year, it was about 10,700 that were unsold under construction, and we only had closer to 700 that were completed unsold.

So the inventory has been reduced significantly.

Okay.

Thanks.

Thank you.

Thank you.

Our next question comes from the line of Michael Rehaut with JPMorgan.

Please go ahead.

Hi, guys, this is actually [Ray Quan] on for Mike.

Wondering if you could comment on some of the trends throughout the quarter, dis-complete can rates, orders, pricing incentives, through August and then whatever you can give us on September?

We generally don't comment on trends into the next quarter, Ray.

I will say that relative to the third quarter we saw a downward trend through the quarter.

August was clearly a worse month than the prior two, the prior two months.

Relative to mortgage cancellations, there is no question that there was a spike upward in cancellations in the month of August.

August really seemed to be a melting pot of all things negative, and that defined the end of the quarter as we went into the fourth.

Okay.

And a follow-up.

Given the pretty large write-down this quarter, how much breathing room do you guys have left on the minimum tangible net worth covenant?

I think it was about a billion last quarter, maybe if you could update on what the amount is for this third quarter?

Sure.

Ray, we expect to have in excess of $900 million cushion in terms of tangible net worth covenant, so we still have ample room with respect to that covenant.

Okay.

You guys only went back to the banks on the interest coverage ratio, is that correct?

That's correct.

We went back and within that amendment we eliminated the interest coverage covenant and as defining leverage where we do have below a 2 to 1 interest coverage there is a ratcheting down over time of maximum leverage.

And in that calculation we do include our portion of joint venture recourse debt and essentially eliminated most of the nonrecourse debt.

That calculation today our leverage on a covenant basis is somewhere in the mid-40% range.

Great.

Thanks, guys.

Thank you.

Our next question then comes from the line of Jim Wilson with JNP Securities.

Please go ahead.

Thanks.

Good morning, guys.

Was wondering, Stuart or Bruce, if you could maybe color -- obviously everything is pretty negative in price pressure out there, but could you give a little color on where and what markets and what instances you're still seeing reasonable margins in any parts of the country where that's still the case?

I know they're, I am sure, still disappointing but where you might be seeing reasonable levels of profitability still?

Jim, it is really community by community.

This has been a broad-based declined.

As you looked at our gross margins excluding impairments, they were close to 14% across the board.

There is really -- in the past we've always highlighted a few markets that were better or worse, and it is really hard to depict any particular area and try to lead to a conclusion.

It has really been a broad-based decline and the 14% gross margin before impairments was fairly consistent through the regions.

Okay.

And then second question.

Just with all the broad-based or advertised sales and the price cuts that have been associated with many builders, do you feel like you have generally -- you're generally matched in most markets to where you see other builders have gone in pricing or have you held out longer or in turn have you been any more aggressive?

Well, at certain points, Jim, we've been ahead of the curve and probably led in some of the prices in number of instances, more recently we've tried to pull back short of extremely aggressive pricing.

There aren't easy answers to this, to what we've done or what we should be doing.

It is really touch and feel and it is relative to each division individually and each community individually where we've had to kind of measure our response to the discounting efforts of others, and make sure that we don't kind of spiral that pricing downward to very, very, very low levels.

And in connection with that, Jim, we've really managed our inventory through the process.

So with respect to pricing decisions that we're making, everything we've done has been in the context of continuing to make sure that inventory is moving downward and we're very focused on the balance sheet.

Okay.

Great.

Thanks.

Thank you.

We're going to a question now from the line of Kenneth Zener from Merrill Lynch.

Please go ahead.

Good morning.

Interested in the joint ventures.

If I look at your joint ventures' impairment as a percent of their assets, it seems like it is a few hundred, basically 200 to 400 basis points lower than what you guys were seeing at a corporate basis.

I am just trying to understand why the joint ventures would have less impairment.

And see if that is because a joint venture run impairments test based upon the contracts that they have with people to take down developed lots, like you or other builders.

So I am seeing if you can kind of explain why that might be happening, if they don't need to take impairments because they know builders are taking down lots, which the builders themselves might walk away from and what that means about future funding?

I don't think we've really looked at it or sliced it that way to make that comparison, so I don't think we're going to have a good answer for that.

But we've -- I can tell you as a matter of process that what we've done is looked at our joint ventures just as we look at every other asset within the Company.

So we haven't made any distinction or differentiation between the evaluation process that we have in the joint venture versus others.

But it seems like the joint venture actually has a contract with builders, it could have been from the principle, such as yourself or another builder, which justifies them not writing off land.

So would they just not be writing it off because they have a contract saying builder is actually going to buy the land and it doesn't get impaired until that point?

No.

In your question -- embedded in your question there are two kind of roads you can go down.

Number one, maybe there is a contract with us.

I can tell you that in our joint ventures where there is a contract with Lennar to sell developed home sites, Lennar has aggressively gone back, renegotiated those deals to market conditions or walked away even from joint venture deals.

As it relates to third party builders, we have not stuck our head in the sand and failed to recognize that any contract that might be in place might not be a contract that's performed on, so our evaluation process has been very focused on real market conditions.

Okay.

Then I guess with the 14% gross margin ex charges, given that housing conditions deteriorate so much, it was surprised to see a 40 bip sequential increase.

Could you explain how that could be happening amid a deteriorating housing market and isolate the contribution from, let's say, your sticks and bricks reduction, and quantify the amount of previous impairments that are flowing through?

As far as the gross margin percentage, your comment in terms of the improvement, we're at 14% and you're referring to which period?

This period -- you had 14% this quarter.

Last quarter I think it was pre-adjust to 13.6%.

You're going back to the second quarter?

Sequential, correct, I am sorry.

Correct.

So it just seems like things got worse and you're doing better even though your impairment is clearly a document, a deterioration in either absorptions or price, a combination of both, so just trying to understand how much impairment benefit is flowing through or if you're just so successful renegotiating the sticks and bricks side?

There are different components that go into the program and there has been a focus and there has been success on cost reduction.

We have been over the last number of quarters impairing assets that needed to be impaired, and there is some contribution from that category as well.

Is that quantified?

No.

We haven't quantified that, so we would expect, and earlier in this year we did expect that as the year progressed, the second half of this year, we would see improvement in gross margin unless the markets were to go downward, and therefore we didn't get as much improvement in margin as we would have hoped for.

So that was actually what we were thinking earlier in the year, that the margins would improve, but the define in the markets have minimized that improvement.

Right.

But you're not willing to quantify?

It seems it's a pretty -- it seems strange that it would be in a worsening housing market up sequentially?

Yes.

No --

I do think people are more concerned about the real returns on your capital than the impaired benefits.

So I think that's really what I am trying to drive at is what the real returns on your business are ex these impairment benefits and charges, since that's how you're presenting it.

That's all.

We haven't quantified that.

Keep in mind that as we're trying to make sure that our land basis is appropriate for today's market conditions, it comes from different buckets.

You have some impairments.

You have renegotiation of home sites that we've optioned with third parties or joint ventures.

So you have to keep in mind all those different buckets that factor in to try to appropriately state land to where today's market conditions are.

Thank you.

You're welcome.

Thanks.

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

Please go ahead.

Sure, good morning.

I just want to kind of touch on free cash flow.

It seemed to me that last year this quarter, and clearly in the fourth quarter, you generated a lot of cash and it seemed like this quarter you used cash.

So was wondering if you could quantify it.

And also, since the rating agencies are so focused on free cash flow, if you can give us any sort of guidance for 4Q.

Hi, Susan.

We remain very focused on generating strong cash flow and we continue to state that we'll be cash flow positive for the year.

We have not given out a number for this quarter yet because in the computations, we'll have that for our 10-Q, there is a number of different items that we have to include there relative to different categories that aren't complete yet.

But our focus on balance sheet and generating free cash flow remains very aggressive and, again, we believe we'll be in that positive cash flow position again with a strong balance sheet as we see the end of the fiscal year.

Bruce, can I just follow up with it seemed like you used cash this quarter and then last year you generated a lot, so I guess what was the rationale there?

What am I -- what should I take away from that?

There is nothing to take away from that.

I think from our perspective we've reduced inventory aggressively again.

We're focused with the reduction of starts.

If you look at a 62% reduction in starts and, as Stuart mentioned, we've significantly reduced land acquisitions as we go forward.

We're positioned to have an improving balance sheet as we continue through the year focused on cash flow generation, and I think you will see that as we get to the end of the fiscal year in November.

Great.

Thank you.

You're welcome.

Thanks.

Our next question then comes from the line of Dan Oppenheim with Banc of America Securities.

Please go ahead.

Thanks very much.

Was wondering if you can just talk about the process, what you are assessing whether to mothball land or whether to build it out.

If you'd said earlier that you are looking at if it is below reasonable levels, you're mothballing now.

Just thinking about it, if some of the weakness in the industry now is self inflicted by builders who have just continue to build too much, is this strategy of mothballing now dependent on others pulling back as well?

No.

I think that we've gotten to a point in some markets, Dan, where when you look at the cost to develop a parcel of land and to actually develop home sites and you include that and the cost of building the home and you get to a point where the residual value of the land, the land itself, in well-located areas is maybe close to 0, you just know that you're in a market where it just doesn't make any sense to put the next dollars into the piece of ground, and you know that the land has to to be worth more than 0.

It is not -- it is not really by way of inventory management, land inventory management, that we're making the choice in some instances to mothball the land.

It is just by way of recognizing that valuation is just a SKU right now, we're living in a no-bid market relative to land sales, and there will be a brighter day in terms of valuing the real estate assets.

Understood.

I guess what I am wondering is that if we are to think about that and just think about home prices continuing to fall based on the excess supply that is out there and working through it, doesn't that mean to justify land being worth more than 0, you would either have to -- either home price have to increase there, which (inaudible) markets right now, or you have to see a great reduction in the construction costs.

Are you assuming we're going to get that much more of a decline in that area coming soon?

No, I don't think that there is going to be a great reduction in construction costs.

I think that there will be some things that will be reworked in the industry.

But I think that there will be another day where prices move in a positive direction.

And I think that there will be a day where, once again, homes sell for something greater than their replacement costs.

Thanks very much.

Thanks.

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

Please go ahead.

Thanks.

I had a question on the impairments.

Are you becoming, in general I suppose, in assessing these impairments more aggressively negative in your assumptions, because I was also following up on what Ken was talking about earlier.

A little bit surprised to see impairments at the level that they were in a quarter when gross margins were actually up sequentially?

This is Bruce.

What we're looking at is the reality of the market conditions.

And the market certainly took a step backwards as we went through the quarter, and we're not betting on things turning around tomorrow.

We're looking at the market for what it is and we're taking our best guess of what the cash flows for a particular communities through their build-out will look like.

With respect to the negative, the negative came from the market as opposed to a change in the way that we're looking at impairments.

Our analysis of impairments remains consistent and we're looking at the market for what it is.

What were the biggest deltas in terms of your assumptions?

Was it on the volume side?

Are you assuming pricing is going to continue to decline at a substantial pace?

I think that a big part of it is seeing an absorption and pricing is pricing, and maybe it is moving down a little bit more and there is a little bit more negativity injected in the pricing, but the absorptions are really pulled out.

Okay.

Just a question, Stuart, on in your commentary you mentioned that a more recent phenomenon, apart from the builders continuing to take prices down, is prices coming down in the resale market.

I was just wondering if maybe you could fill us in on -- in your discussions, let's say, with your local managers, how do your local managers respond to changes in the existing market, let's say, as compared to competing with a builder down the road?

I don't think that there is a specific response that they can or do give to adjustments in the existing home market.

They just -- they're working with a sense of pricing within their overall market and in particular in the low Cal surrounding each community that they're in.

The pressure in pricing might come from the existing home market or from the new home market, but what we've heard from our divisions, many of our divisions more recently, is that while the existing home market had been on the sidelines in terms of adjusting pricing, the existing home market is moving much more rapidly to adjust down downward.

Thanks.

Thank you.

Our next question comes from the line of Stephen East with Pali Capital.

Please go ahead.

Good morning.

Good morning.

Talk a little bit on the JVs, on the impairments, what were the -- a few main ones on the impairment charges?

You're talking about the specific joint ventures?

Right.

Okay.

We haven't really itemized those out because we've never listed out the joint ventures and certainly there is a number of them.

The $170 million of impairment with the joint ventures, there were a few joint ventures that if you totaled them up it made up more than 50% of the impairment.

So it was a little bit more concentrated in a few joint ventures.

But we -- it wouldn't mean anything to the group if we named joint ventures because it has never been publicly laid out joint venture by joint venture.

Okay.

Just a couple of your big JVs in California.

The LandSource, I know you all have decided to not take down lots and I understand that has some consequences with potentially triggering reappraisals and you all had a meeting with the bankers, et cetera.

If you could talk about that along with your decisions to slow down the El Toro, sort of maybe compare/contrast what's going on between the two?

Those are good examples.

Both of those ventures are both moving forward pretty much as underwritten and I know that sounds strange given what you've said relative to the walking away.

In the underwriting of both of those ventures, because they are long-term land positions in very strategic markets, both of them were underwritten and stressed relative to a substantial downturn during their lifespan.

And the timing of that downturn wasn't expected at the time, but the downturn forecast was very much used in the modeling of the expected profitability of those ventures.

So they're both in strong positions right now, and I think there is a lot of confidence in the future of both of them.

Does the land source situation, does that I guess change -- I guess I am wondering the relationship, someone asked earlier, the relationships, how they perform and that type of thing, has this changed or has the strategy changed on it moving forward?

That's a fair question.

I think that these are two examples where we're dealing with partners that are very sophisticated and comparable financial footing to our Company.

And in the context of these ventures all parties understand the market conditions that exist and we're working cooperatively to work through these times and work with our assets.

I guess some of your question is has it stressed the partnership that we've acted in compliance with our rights and position within the partnership, and I would have to say I don't think so.

We have a very healthy relationship with all of our partners.

They understand that this market has adjusted and this is not a walk-away that is caviler nor unjustified, so I think its incumbent on and welcomed by the partners that we recognize the realities of the market and move forward constructively.

And I think we have a good healthy working relationship with both sets of partners.

Okay.

Just one other quick question for Bruce and Diane.

When you all talk about on write-offs or when you -- I think you talked about artificially the land is temporarily sort of valued at 0 type thing, which of course we all know it has economic value long-term, but are you required to write those down accordingly or are there different assumptions that come into play there?

What we do, Stephen, on each of the deals is we run the cash flow through the life of the community.

And that's what we do is we look at the cash flow and if it doesn't generate positive cash flow through the life of the community, then of course we're required to write down the asset currently.

But in the cases where we might have mothballed a community and put it off because there is too much supply in the marketplace or some other reason, we're still looking at a cash flow that over the life of that asset will be positive and if it required an asset write-down, we would have taken it, and if it didn't, then we would not.

Okay.

But it doesn't automatically trigger then if you wind up mothballing?

No, it does not.

Okay, thanks.

You're welcome.

Thank you.

Our next question comes from the line of Alex Barron with [Agency Training Group].

Please go ahead.

Hi, guys.

Hoping you can talk a little bit about your thinking or the math behind the options that you still haven't walked away from, how you're thinking about those.

And also you've talked about some land positions that you're mothballing, what the math is on those.

And my last question is whether you've contributed any additional equity capital to some of your JVs.

Thanks.

Let me comment on the options and any contribution to the joint ventures.

As we indicated from the peak, Alex, we had 132,000 home sites that were auctioned from third party land sellers and that's been reduced by approximately 70%.

So there remains about 44,000 home sites give or take option and with each of those our program is we're looking at current market conditions and if those options are reflective of current market conditions and our inventory position still requires us to necessitate lands in that marketplace, then there is a likelihood that we might go forward.

If it doesn't, we'll try to renegotiate or we potentially might walk away from some or all of the reminder of those 44,000.

We're looking at it deal by deal.

With respect to any contributions that we were required to make this quarter to any of our joint ventures, we've contributed approximately $100 million to joint ventures this quarter.

And your last question, which was with respect to the math behind the mothballing of any of the land, as we stated just a little while ago, we're looking at each asset and each asset has its strategy when we meet with each division and review every asset.

And for various reasons there might be too much inventory in a market for the moment, we might decide that some land should be mothballed for a later date and it is land that we would like to possibly develop in the future.

We run the cash flow on that particular community and if that community needs to be impaired, then we would impair it.

If not, we're just putting it aside and waiting for the right opportunity to move forward.

But we're very focused on balance sheet and cash flow going out the door and we're not looking to develop any communities and put dollars into the ground if we don't believe we're likely to take down those home sites or build on those home sites in the short-term.

It is a very focused balance sheet strategy with respect to any land that is being mothball today.

And just real quick, as it pertains to the communities you impaired this quarter, how many were there and how many were re-impaired, please?

There were over 200 active communities in total that were impaired and two-thirds of those approximately were new communities that were not previously impaired.

Thank you, Bruce.

You're welcome.

I think we'll take one last question.

All right, thanks.

That last question comes from the line of Rob Stevenson with Morgan Stanley.

Please go ahead.

Good afternoon, now, guys.

In terms of deposits, there has been some anecdotal stories of builders reducing the deposit requirements in order to get orders in the door.

Have you guys seen any of that and are you guys actively doing that in any markets?

There is no question that deposits have been reduced materially as some of the incentivized programs out there have come to market.

It is one of the reasons that we avoided some selling [indices], the current market conditions.

We live in a competitive environment and we have to kind of take the market as it comes, but the market today is clearly challenging one in terms of getting a sizable deposit on the sale of homes.

Okay.

And then in terms of the can rate, when you look at that today, what's the can rate differential between when you're selling dirt or something that is under construction that's at the beginning of the cycle where it is going to take four, six, eight months to develop versus stuff that's closing relatively quickly within the next 60, 90 days?

The can rates on the homes that are preconstruction sales tend to be higher.

People who are purchasing homes that are for pretty approximate closings, say within a month or two, are generally not walking away from the purchase.

If your overall can rate is 32%, does that mean that any can -- that the can rate on dirt is probably closer to 60% and the can rate on spec is -- completed spec is closer to 5% or 10%?

We haven't done the math.

I can only give you a sense and I don't know what those numbers would be and I don't want to guess.

Okay.

Thanks, guys.

All right.

Well, thank you all for joining us for our update.

We look forward to better times ahead and we'll talk again at the end of our fourth quarter.

Thank you.

Thank you.

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