Lennar Corporation
Q3 2007 Earnings Call Transcript

Published: 27 Sep 2007

[Operator:]

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 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 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.

[Stuart A. Miller:]

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 impairment. 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 will attempt to answer as many as possible in the hour more or less that we have 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 were times when the market speaks loudly and clearly and gives an indication that it's time to pull back, to retrench and to wait for another day, and 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 condition, we reviewed their performance for the quarter and we reviewed their strategy for each asset they own in their respective market. It was clear from these meetings that current market conditions are primarily defined by the overhang of inventories in their markets 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 reduction and incentivized brokerage fees. Many of the competitive sales are standing inventory homes, which resulted either from cancellation 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's apparent there's 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 are 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 to proposed legislation. It's currently not clear what their impact is going to be. On the demand side, there are customers out there but they are 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. And although traffic has been increased by the use of incentives and mortgage buy-down programs, many of the deals that are struck have been prone to cancellation 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 needed for closing cannot qualify. While we are hopeful that the GSEs, Fannie May and Fannie 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

[Bruce E. Gross:]

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 mange 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, everyday 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 and increased supply in the market, we have 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 homesites homes owned and controlled by 138,000 homesites from the peak in the first quarter of 2006 from 345,000 homesites owned and controlled to 207,000, a 40% decline. Included in the 207,000 homesites are 86,000 homesites owned, 43,000 controlled by option with third party land sellers and 78,000 optioned from joint ventures. The remaining 43,000 homesites 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 homesites 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 on a trailing fourth quarter calculation, finished over 2 times coverage and our homebuilding debt to EBIT leverage also on a four quarter average was 4.5 times. These calculations exclude the impact of impairments as they are non-cash items. We've continued to increase the transparency regarding our joint venture debt obligations. Our 10-Q will provide a detailed break down 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 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 9 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 have been reducing inventory while renegotiating pricing on remaining controlled homesites 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 though 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

[Diane J. Bessette:]

Thank you, Bruce, and good morning. In conjunction with our balance sheet focus, we continue to realistically evaluate and reevaluate 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 continue to evaluate, reevaluate and renegotiate deposits on land under option as markets continue 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 continue to evaluate and reevaluate 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. And we continue to evaluate and reevaluate our investments in joint ventures. We focused on the recoverability of our investment relative to the market conditions that exists 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-acquisitions costs, we wrote off approximately $243 million of option deposits and pre-acquisitions costs, which represented approximately 15,000 homesites. The segment detail is as follows

[Operator:]

Great, thank you very much. And again, ladies and gentlemen, if you do, could you please limit yourself to one question and one follow up during the Q&A session today. [Operator Instructions]. And our first question then today comes from the line of Ivy Zelman with Zelman & Associates. Please go ahead.

[Ivy Zelman:]

Hey, good morning guys.

[Stuart A. Miller:]

Good morning.

[Ivy Zelman:]

I am a little confused. If we talk about your strategy, Stuart, you have 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 we are going to move it through the production line and 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 are changing that strategy, but at the same time you have higher impairments than any one in your peer group and you have worse orders than any one in the peer group. And others are doing these sale bonanzas and wondering why you are 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 downturn.

[Stuart A. Miller:]

Yes, I don't think the strategy has really changed much Ivy. We continue to price market conditions, but as we went through the third quarter, we saw just so many competing programs to dramatically reduce inventory that it kind of got to a point where pricing was just unrealistic and maybe even ridiculous. I think you have to be sensible as you work through market conditions like this. Remember, we have 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 have 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. And I think that if you look backward, 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 reasonable amount [ph].

[Ivy Zelman:]

Aren't you worried, Stuart, that maybe that price that Hovnanian 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 are missing out on what could be sales today for you that can move through inventory and generate cash?

[Stuart A. Miller:]

First of all, highlighting any particular participant, it really is the market overall. And so I think that the programs that various participants have in place are good and responsible programs. Are we [ph] missing potential sales I think in advance of where we are today and being responsive to market conditions. We have 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 burnt through. We have 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's for times like these where you have to able to navigate very strange waters and have the ability to pull back and sit idly while the market moves through. And 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 exist, there are times where we want to be sidelined, and we are pleased that our balance sheet gives us the latitude to be able to navigate.

[Ivy Zelman:]

Great. Thanks a lot guys.

[Stuart A. Miller:]

Thank you.

[Operator:]

Thanks. And our next question comes from the line of Carl Reichardt with Wachovia. Please go ahead.

[Carl E. Reichardt:]

Good morning guys. How are you?

[Stuart A. Miller:]

Good morning.

[Carl E. Reichardt:]

Stuart, I have 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 on to that capital thinking about reconcentrating it later or do you expect that you keep your current geographic diversification as set?

[Stuart A. Miller:]

Our current thinking, Carl, is to maintain our geographic footprint as it is. It's an unusual time where almost every market across the country is similarly impaired. 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 are in are good and strong markets. And 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 are not inclined to pull out of any markets right now.

[Carl E. Reichardt:]

And since that echoes 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 hypercompetitive conditions in the marketplace ease if every one is staying where they are and they are not reducing their geographic footprint so that when things recovers, the focus on acquiring land bids [ph] up land prices quickly on the recovery. I don't see how, without reduction in the markets in which you participate, you are able to continue to see that... expect that kind of recovery in the marketplace that you do. Can you comment at all on this? I am still confused as to why builders aren't pulling back more aggressively.

[Stuart A. Miller:]

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's 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 pull back in volume across the board in each market. And the real... 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's 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.

[Carl E. Reichardt:]

Fair enough. Thanks. I will get back in.

[Stuart A. Miller:]

Okay.

[Operator:]

Great, thank you. And our next question then comes from the line of David Goldberg with UBS. Please go ahead.

[David Goldberg:]

All right, thanks. Stuart, I wonder if you could comment on how comfortable you are with your JV partners. If you are concerned about distrust among any of your JV partners and what would... can you give me some examples, hypothetical, on and how the JVs would play out in case a JV partner felt some distress or capital constraints?

[Stuart A. Miller:]

It's a good question David. Good morning. I think that you can't lump all of the JV partners together in one basket. There are 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 that 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.

[David Goldberg:]

Okay, thanks. And 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 the even flow process and how you are adjusting your start base given that you are seeing deterioration to the month?

[Bruce E. Gross:]

The number David as far as unsold completed inventory was over 1200 homes, which is down a couple of hundred homes from the last quarter, from the second quarter and the number of homes that were unsold that were under construction was about 5100. And as addressing 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 are continuing to try to spread out the activity on as close to an even flow basis as possible, but that's after we are ensuring that we are matching the demand in the marketplace. And as that demand might change in our daily plant meetings, we are adjusting accordingly.

[David Goldberg:]

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 base?

[Bruce E. Gross:]

Well, we have reduced the inventory... your question about inventory.

[David Goldberg:]

Yes.

[Bruce E. Gross:]

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.

[David Goldberg:]

Okay. Thanks.

[Stuart A. Miller:]

Thank you.

[Operator:]

Great and thank you and our next question then comes from the line of Michael Rehaut with JP Morgan. Please go ahead.

[Unidentified Analyst:]

Hey guys, this is actually Ray Kwon [ph] on for Mike. I was wondering if you could comment on some of the turns throughout the quarter can rates, orders, pricing incentives through August and then whatever you can give us on September?

[Stuart A. Miller:]

Yes, we generally don't comment on trends into the next quarter Ray. But 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. And 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 fourth.

[Unidentified Analyst:]

Okay. Then 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 covenants? I think it was about 500... or about 1 billion last quarter, maybe you can update on what the amount is for this third quarter.

[Bruce E. Gross:]

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

[Unidentified Analyst:]

Okay. And you guys only went back to the bank on the interest coverage ratio, is that correct?

[Bruce E. Gross:]

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 non-recourse debt. And that calculation today, our leverage on a covenant basis, is somewhere in the mid 40% range.

[Unidentified Analyst:]

Okay, good. Thanks guys.

[Operator:]

Great, thank you, and our next question then comes from the line of Jim Wilson with JMP Securities. Please go ahead.

[James Wilson:]

Thanks. Good morning guys. I was wondering, Stuart, or Bruce, if you could may be color... I mean 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 are still seeing reasonable margins in any parts of the country where that's still the case? I know they are, I am sure, still disappointing, but where you might be seeing reasonable levels of profitability still.

[Stuart A. Miller:]

Jim, it's 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. So there is really... in the past, we have always highlighted a few markets that were better or worse, and it's really hard to depict any particular area and try to lead to a conclusion. It's really been a broad-based decline and the 14% gross margin before impairments was fairly consistent through the regions.

[James Wilson:]

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 or generally matched in most markets to where you see other builders have gone in pricing or have you held that longer or in turn have you been any more aggressive?

[Stuart A. Miller:]

Well at certain points, Jim, we have been ahead of the curve and probably led in some of the prices and in a number of instances, more recently, we have tried to pull back short of extremely aggressive pricing. And there aren't easy answers to this to what we have done or what we should be doing. It's really touch and feel, and it's relative to each division individually and each community individually where we have 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 downwards to very, very, very low levels.

[Bruce E. Gross:]

And in connection with that Jim, we have really managed our inventory through the process. So with respect to pricing decisions that we are making, everything we have done has been in the context of continuing to make sure that inventory is moving downward and we are very focused on the balance sheet.

[James Wilson:]

Okay, great. Thanks.

[Operator:]

Thank you. And we are going to a question of the line of Kenneth Zener with Merrill Lynch. Please go ahead.

[Kenneth R. Zener:]

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's a few hundred, basically 200 to 400 basis points lower than what you guys were seeing at a corporate basis. So I am just trying to understand why the joint ventures would have less impairment and seeing if that's because a joint venture run impairment tests 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 imperilments because they know builders are taking down lots which the builders themselves might walk away from and what that means about future funding.

[Stuart A. Miller:]

I don't think we have really looked at it or sliced it that way to make that comparison. So I don't think we are going to have a good answer for that. But we have... I can tell you as a matter of process that what we have done is looked at our joint ventures just as we look at every other asset within the company. And so we haven't made any distinction or differentiation between the evaluation process that we have in the joint venture versus others.

[Kenneth R. Zener:]

But it seems like the joint venture actually has a contract with builders. It could have been from the principals such as yourself or another builder which justifies them not writing off land. I mean, so, would they just not be writing it off because they have a contract saying builder X is going to buy the land --

[Stuart A. Miller:]

No.

[Kenneth R. Zener:]

If it doesn't get impaired until that point?

[Stuart A. Miller:]

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 homesites, 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 valuation process has been very focused on real market conditions.

[Kenneth R. Zener:]

Okay. And then I guess with the 14% gross margin ex charges, given that housing conditions deteriorate so much, it was a surprise to see a 40 BP 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?

[Bruce E. Gross:]

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

[Kenneth R. Zener:]

Well, this... I mean you had 14%.

[Bruce E. Gross:]

Right.

[Kenneth R. Zener:]

This quarter. Last quarter, I think it was a pre-adjusted 13.6%.

[Bruce E. Gross:]

Okay, so you're going back to the second --

[Kenneth R. Zener:]

Sequential, correct, I'm sorry.

[Bruce E. Gross:]

Okay.

[Kenneth R. Zener:]

Correct. So it just seems like things got worse and you are doing better. Even though your impairment is clearly a document deterioration in either absorptions or price, a combination of both. Just trying to understand I mean how much impairment benefits flowing through or if you are just so successful renegotiating the sticks and bricks side.

[Bruce E. Gross:]

Well, 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.

[Kenneth R. Zener:]

Is that quantified?

[Bruce E. Gross:]

No, we haven't quantified that. So we would expect in 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 decline in the markets have minimized that improvement.

[Kenneth R. Zener:]

Right. But you are not willing to quantify. I mean it seems it's a pretty... it seems strange that it would be, in a worsening housing market, up sequentially.

[Bruce E. Gross:]

Yes. No --

[Kenneth R. Zener:]

I just 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 are presenting it.

[Bruce E. Gross:]

Yes, we haven't quantified that, and keep in mind that as we are trying to make sure that our land base is appropriate for today's market conditions, it comes from different buckets. You have some impairments, you have renegotiation of homesites 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 lands at where today's market conditions are.

[Kenneth R. Zener:]

Thank you.

[Bruce E. Gross:]

You are welcome.

[Operator:]

Thanks. And our next question comes from the line of Susan Berliner with Bear Stearns. Please go ahead.

[Susan Berliner:]

Sure. Good morning. I just wanted 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 I 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?

[Stuart A. Miller:]

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.

[Susan Berliner:]

Bruce, can I just follow up, but 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?

[Bruce E. Gross:]

There is nothing to take away from that. I think from our perspective, we have reduced inventory aggressively again. We are focused with the reduction of starts if you look at a 62% reduction in starts. And as Stuart mentioned, we have significantly reduced planned acquisitions. As we go forward, we are 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.

[Susan Berliner:]

Great. Thank you.

[Bruce E. Gross:]

You're welcome.

[Operator:]

Thanks. And our next question then comes from the line of Dan Oppenheim with Banc of America Securities. Please go ahead.

[Daniel Oppenheim:]

Thanks very much. I was wondering if you can just talk about the process which you are assessing whether to mothball land or whether [ph] to build it out. And if you'd said earlier that you are looking at... in other words, it's below reasonable levels you are mothballing now. Just I mean thinking about it, if some of the weakness in the industry now is self inflected by builders who are just continuing to build too much, is this strategy of mothballing now dependent on others pulling back as well?

[Stuart A. Miller:]

No, I think we've gotten to a point in some markets and we are... where when you look at the cost to develop a parcel of land and to actually develop homesites and you include that and the cost of building a 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 zero. You just know that you are 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 be worth more than zero. So it's not really by way of inventory management, land inventory management that we are making a choice in some instances to mothball the land. It's just by way of recognizing that valuation is just a SKU right now. We are living in a no-bid market relative to land sales and there will be a brighter day in terms of valuing your real estate assets.

[Daniel Oppenheim:]

Understood. I guess what I am wondering is that if we were to think about that and just think about home prices continuing to the fall based on the excess supply that's out there and working through it, doesn't that mean to justify land being worth more than zero you either have to... either the home price have to increase there, which someone unlikely made in markets [ph] right now, we have to see a greater reduction in the construction costs? Are you assuming that we are going to get that much more of a decline in that area coming soon?

[Stuart A. Miller:]

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 another day where prices move in a positive direction and I think that there will be day where once again homes sell for something greater than their replacement cost.

[Daniel Oppenheim:]

Thanks very much.

[Operator:]

Thanks. And our next question comes from the line of Nishu Sood with Deutsche Bank. Please go ahead.

[Nishu Sood:]

Thanks. I had a question on the impairment. 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.

[Bruce E. Gross:]

Ken, this is Bruce. What we are 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 are not betting on things turning around tomorrow. We are looking at the market for what it is and we are taking our best guess of what the cash flows for particular communities though their built out will look like. So with respect to the negatives, the negatives came from the market as opposed to a change in the way that we are looking at impairments. Our analysis of impairments remains consistent and we are looking at the market for what it is.

[Nishu Sood:]

And 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?

[Stuart A. Miller:]

Yes, it's... I think that a big part of it is seen in absorption. Pricing is pricing and maybe it's 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.

[Nishu Sood:]

Okay. And just a question, Stuart, 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 discussion, 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 the builder down the road?

[Stuart A. Miller:]

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 are working with a sense of pricing within their overall market and in particular in the locale surrounding each community that they are in. The pressure in pricing might come from the existing home market or from the new home market, but what we have 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 downwards.

[Nishu Sood:]

Okay. Thanks.

[Operator:]

Thank you. And our next question comes from the line of Stephen East with Pali Capital. Please go ahead.

[Stephen East:]

Good morning.

[Stuart A. Miller:]

Good morning.

[Stephen East:]

You talked a little bit on the JVs, on the impairments. What were the few main ones on the impairment charges?

[Bruce E. Gross:]

You are talking about the specific joint ventures?

[Stephen East:]

Right.

[Bruce E. Gross:]

Okay. We haven't really itemized those out because we have never listed out the joint ventures, and certainly there is a number of them. And the $170 million of impairment with the joint ventures, there were a few joint ventures that if you totaled them up that made up more than 50% of impairment. So it was a little bit more concentrated in a few joint ventures. But it wouldn't mean anything for the group if we named joint ventures because it's never been publicly laid out joint venture by joint venture.

[Stephen East:]

Okay. And just a couple of your big JVs in California, the land source, 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 etcetera. 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?

[Stuart A. Miller:]

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. But 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 are both in strong positions right now and I think there is a lot of confidence in the future of both of them.

[Stephen East:]

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 is the strategy changed on it moving forward?

[Stuart A. Miller:]

Yes, that's a fair question. I think that these are two examples where we are 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 are 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 have 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 cavalier nor unjustified. And so I think it's incumbent on and welcome 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.

[Stephen East:]

Okay. And just one another quick question for Bruce and Diane. When you all talk about on write-offs, or when I think you talked about artificially the land is temporarily sort of valued at zero type thing, which of course we all know it has economic value long term that are you required to write those down accordingly or are there different assumptions that come into play there?

[Bruce E. Gross:]

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 are required to write down the asset currently. But in cases where we might have mothballed the community and put it off because there is too much supply in the marketplace or some other reason, we are 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 didn't, then we would not.

[Stephen East:]

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

[Bruce E. Gross:]

No, it dose not.

[Stephen East:]

Okay. Thanks.

[Bruce E. Gross:]

You are welcome.

[Operator:]

Thank you. And our next question comes from the line of Alex Barron with Agency Trading Group. Please go ahead.

[Alex Barron:]

Hey 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 are thinking about those. And also you have talked about some land positions that you are 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.

[Bruce E. Gross:]

Let me comment on the options and any contributions, the joint ventures. As we indicated from the peak, Alex, we had 132,000 homesites that were optioned from third party land sellers, and that's been reduced by approximately 70%. So there remains about 44,000 homesites give or take options. And with each of those, our program is we are looking at current market conditions, and if those options are reflective of current market condition and our inventory position still requires us to necessitate land 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 remainder of those 44,000. We are 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 have contributed approximately about $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 are 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'd like to possibly develop in the future. We run the cash flow on that particular community and if that community needs to be in impaired, then we would be impair it. If not, we are just putting it aside and waiting for the right opportunity to moving forward. But we are very focused on balance sheet and cash flow going out the door and we are not looking to develop any communities and put dollars into the ground if we don't believe we are likely to take down those homesites or build on those homesites in the short term. So it's a very focused balance sheet strategy with respect to any land that is being mothballed today.

[Alex Barron:]

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

[Bruce E. Gross:]

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

[Alex Barron:]

Thank you, Bruce.

[Bruce E. Gross:]

You're welcome.

[Stuart A. Miller:]

I think we'll take one last question.

[Operator:]

All right, thanks. And that last question comes from the line of Rob Stevenson with Morgan Stanley. Please go ahead.

[Robert Stevenson:]

Good afternoon now guys. In terms of deposits, there 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?

[Stuart A. Miller:]

There's no question that deposits have been reduced materially as some of the incentivized programs out there have come to market. It's one of the reasons that we have avoided some of the selling into the current market condition. We live in a competitive environment and we have to kind of take the market as it comes. But the market today is clearly a challenging one in terms of getting a sizeable deposit on the sale of home.

[Robert Stevenson:]

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

[Stuart A. Miller:]

Yes, 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 genuinely not walking away from their purchase.

[Robert Stevenson:]

But 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%?

[Stuart A. Miller:]

We haven't done the math. I can only give you a sense. I don't what those numbers would be and I don't want to guess.

[Robert Stevenson:]

Okay. Thanks guys.

[Stuart A. Miller:]

All right. Well, thank you all for joining us for our update. We look forward to better times ahead and will talk again at the end of our fourth quarter. Thank you.

[Operator:]

Thank you. And ladies and gentleman, this conference will be available for reply starting today, Tuesday, September 25th at 2.30 PM Eastern Time and it will be available through Tuesday, October 9th at midnight Eastern Time. And you may access the AT&T Execute Playback Service by dialing 320-365-3844 and then enter the access code of 887014. That number once again is 320-365-3844 and again enter the access code of 887014. And that does conclude our conference for today. Thanks for your participation and for using AT&T's Executive TeleConference. You may now disconnect.