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Standard Pacific Corp. (NYSE:SPF)

Q3 2009 Earnings Call

October 30, 2009 1:00 pm ET

Executives

Lloyd McKibbin - Senior Vice President and Treasurer

Kenneth Lind Campbell - President, Chief Executive Officer, Director

John M. Stephens - Chief Financial Officer, Senior Vice President

Scott D. Stowell - Chief Operating Officer

Analysts

Alan Ratner - Zelman & Associates

David Goldberg - UBS

Michael Rehaut – JP Morgan

Susan Berliner – JP Morgan

Jim Wilson - JMP Securities

Alex Barron – Agency Trading Group

John Reardon - Craw Whedon

Operator

Good day, everyone and welcome to the Standard Pacific Homes third quarter conference call. Today’s conference is being recorded. At this time for opening remarks and introductions, I would like to turn the conference over to Mr. Lloyd McKibbin, Treasurer. Please go ahead, sir.

Lloyd McKibbin

Thank you and good morning. Our formal presentation will be followed by a question-and-answer period. I will now read a notice regarding forward-looking statements.

This conference call and the accompanied slide presentation contain forward-looking statements. Such forward-looking statements may include but are not limited to statements about our outlook, markets, new home orders, absorption rates, pricing, deliveries, backlog, number of spec homes, impairments, liquidity, cash flows, cost reduction, including through operational restructuring, inventory reduction, supply chain improvement, value engineering and the implementation of best practices, profitability, the potential benefit we may realize from our deferred tax asset, our ability to extend project-specific financing, acquisition opportunities, and the condition of the housing market. In general, any statements contained in these materials that are not statements of historical fact should be considered forward-looking statements. We assume no obligation to update these or any other forward-looking statements.

We caution you that forward-looking statements involve risks and uncertainties and there are a number of factors that could cause our actual results to differ materially from those that are contained in or implied by these statements. These factors include but are not limited to local and general economic and market conditions, including consumer confidence, employment rates, interest rates, the availability of mortgage financing, and the supply of homes for sale in the market.

These and other risks are discussed in our press release of October 29, 2009. We refer you to this press release and our most recent quarterly report on form 10-Q and our annual report on form 10-K.

The recorded presentation will be available for replay today two to three hours after this call ends and will continue to be available until November 30th. The audio portion may also be replayed by dialing 888-203-1112 and entering pass code number 5369884.

Sitting in the call this morning are Ken Campbell, our CEO; Scott Stowell, our COO; John Stephens, our CFO. Also joining us is John Babel, our General Counsel.

I will now turn the call over to Ken.

Kenneth Lind Campbell

Good morning or good afternoon, everybody. I like to start every one of these calls with an update on the weather here in Irvine, since generally that’s always going to be good news, and so it’s in the 70s here in Irvine. It happens to also be in the 70s in every market that we are building homes today, except one. So we are reviewing whether or not to keep that community open at the time. I guess it’s also pretty nice in New York, so maybe we don’t really get bragging rights here.

I was going to go through a list of my personal pet peeves on the call because I think that would be a little more interesting than listening to a CEO talk about a homebuilder but I have been told by our General Counsel that that’s probably inappropriate and I’ve been told by others that they don’t really give a hoot about my personal pet peeves.

So we will try to go through the pitch, the description of our results as quickly as we can, which is not easy since I like to talk a lot. But hopefully we will get your questions a little quicker than usual, since they are always more interesting than what I have to say.

The one little thing I like to mention though, I am very thankful that neither of the L.A. teams made it into the World Series because the office is already a little challenging on some days but if L.A. was playing New York, I was going to get bombarded with like who are you rooting for, and I’m rooting for the Yankees, so that would have been bad. Now I don’t have to tell you who I was going to root for.

Okay, so -- highlights here going into it are all pretty straightforward. A lot of this was in the press release but we did manage to make a lot of progress on the debt restructuring. We reduced it by $80 million or so by exchanging some debt for equity, mostly, and then we also managed to move some debt out from 2013 to 2016. What that managed to do for us was to sort of remove what I would call any sort of tension or pressure over the next few years. You know, we are down to having $300 million or something of total debt due before 2013 and given the amount of cash that we are generating at this point from current operations, we don’t really see that as an issue anymore. And we’ve also got the JV recourse debt down to $45 million and not to mention the fact that we have $80 million of equity in those joint ventures, so a lot of progress on dealing with debt and any concerns we might have about our ability to deal with that.

The gross margins sort of hung in there, is what I would say. You know, relatively strong, maybe some emphasis on the word relatively. Obviously we need that number to go up to get back to where we want to be but it’s not going down. It’s inching up a little bit or handing in there. And this is on basically flat sales prices. It turned out this time that ASP was actually flat I think from the prior quarter, like $302,000, something like that. It also on a same-store basis, it’s slightly up but I mean slightly. So it might be up 1% or something, so basically the ASP is a pretty good indication this time of what our average sales price actually is. That is not usually the case.

Anyway, our SG&A, although it went up a bit as a percentage, you know we kept -- the spending was pretty flat. Our deliveries went down a little bit so we ended up with a slightly higher percentage. I think that that will actually head in the other direction a little bit in the fourth quarter due to sort of deliveries in about the same level and maybe a slight up-tick in some margins and a slight down-tick in actual SG&A spending.

So on the margin, slightly positive. So at the end of the day if you exclude all the noise, land sales, impairments, restructuring, we lost a little bit of money instead of making a little bit of money. That’s not a good trend and we need to turn that around and as I -- we’ll talk about it more later, I am sure. I think that there may be some improvement on the horizon but not a lot. I think the highlight probably should have started with the cash flow generation -- not so much from the land sales, although the $55 million or so that we generated on the two sales -- three, actually maybe, but mostly two from my perspective, although we took a $7 million or $8 million hit, I think they were good transactions. They were -- it was a podium product that we couldn’t -- hadn’t figured out exactly what to do with and land that we were never planning on building in, so I actually viewed the impairments as a pretty small number relative to the cash it generated in the short-run, which we can spend on going out and buying land. And then our current cash position sitting with $530 million plus or minus after all the debt stuff cleared the air, you know, I think it puts us in a pretty good position.

So we generated about $75 million of cash before you put in the land, buying, and selling, maybe $20 million of that was from inventory reduction, so we are generating something in the $50 million or $60 million range at this sort current price levels and volumes. You add that into a cash balance north of 500, so we think we are in pretty good shape in terms of our cash position and ability to acquire land, if and when it comes available at returns that meet our thresholds.

So next slide, I’ll just hit a couple of the big points -- I think the deliveries out of backlog in the quarter were more what I would call normal. Second quarter was hit by a pretty big spike in sales and we had a lot of specs lying around. I think that actually at this point, we don’t have enough specs lying around and that probably hurt our deliveries a little bit in sales but we ended the quarter with about the same amount of backlog as we did at the end of last quarter, around 1,000 houses and with a similar kind of timeframe for pull-through that sort of leads you to a conclusion that maybe the outlook anyway is for a similar quarter, fourth quarter as it was in the third.

The average sales price we comment on -- flat, same-store is up slightly. The backlog is -- you know, you see more of the same, so we may shift our mix a little bit more towards California in the fourth quarter, or at least that is what the backlog would tell you, and that has the effect of making it look like our prices are going up when they are not, so I think that the prospect for the ASP to go up is pretty -- well, they are probably going to go up but the question you have to make sure I answer after the next call is was it mix or same-store, but the mix is definitely going to put upward pressure on ASP, which is good because that actually turns into cash. That’s a real number.

Gross margin, hanging in there, kind of like ASP. There’s a very small upward bias to the number in the backlog but it’s fragile and as we bring back mothballed communities, you know, they are not always at the same margin so the benefits we are getting out of value engineering and rebidding and things like that, there’s some downward pull, depending on what prices do as we bring communities back on. So small upward bias but very fragile and hard to rely on.

The SG&A, as I said it went up but it was flat spending with less deliveries. There are going to be some small declines in SG&A I think in the fourth quarter and you know, you tell me what deliveries are going to be and then I will tell you what the percentage is going to be. But if the deliveries are flat, we should see a small amount of improvement in that going forward.

Fourth quarter sales -- you know, the fourth quarter is never a great quarter for us if you look back in history. The quarter has started weak, maybe even a little weaker than historical trends would lead you to believe. It’s still early days and we have the same problem I think now as we had in the beginning of the year where it’s unclear what the government is going to do so it kind of puts a freeze on people a little bit. They don’t want to buy a house and miss the window where they could have gotten a credit, that kind of thing. I am fairly optimistic about the credit getting extended but its politics and I’m not a politician so I don’t really know how that plays out. I guess we’ll have to wait and see and I am sure somebody will ask me about it but I am no more qualified than anybody on the phone, I don’t think, to answer.

So I am going to turn it over to John now. He is going to run through some of the usual slides and then I’ll come back and then we will see if anybody has got interesting questions.

John M. Stephens

Okay, great. Move to slide 5 -- the year-over-year decrease in the company’s third quarter net loss from $370 million to $23.8 million was driven primarily by a $361 million decrease in impairment charges from $368 million to $7.8 million; a $125 million decrease in deferred tax asset charges; and a $33 million reduction in our SG&A expenses from $77 million to $44 million, a 43% decline. These decreases were partially offset by a $9.3 million reduction in gross margin exclusive of impairments due to a reduction in revenues, an $8.7 million increase in non-capitalized interest expense to $12.6 million, as a result of total debt exceeding total qualified assets, including the effect of placing projects on hold and a $7 million increase in debt restructuring charges to an $8.8 million non-cash loss related to the early extinguishment of debt.

Excluding the asset impairment, debt, and other restructuring charges, the company generated a net loss of approximately $3.6 million, or $0.01 per diluted share for the 2009 third quarter. Please refer to the exhibit at the end of the presentation for a reconciliation between net income loss before and after impairment, debt, and other restructuring charges.

Turning to slide 6, our total homebuilding revenues including land sales for the 2009 third quarter were $327 million, down 18% from the prior year period, primarily due to a 25% decrease in new home deliveries to 893 homes and a 9% decline in our average home price to $302,000. These decreases were partially offset by a $52 million increase in land sale revenues from $5 million in the prior year to $57 million, driven by the bulk sale of a Southern California podium building and a sale of unimproved land in Florida.

Our average home price for the 2009 third quarter was flat compared to the 2009 second quarter, and was up slightly on a same plan basis based on net new orders.

Our 2009 third quarter backlog conversion rate was 91% versus 78% for the same period last year, and 137% for the 2009 second quarter. The higher conversion rate experienced during the 2009 third quarter as compared to last year reflects homebuyer preference for a shorter escrow and an increase in the number of spec homes delivered during the current quarter as compared to last year. Conversely, the decline in our backlog conversion rate from the 2009 second quarter reflected a decrease in the number of spec homes delivered during the 2009 third quarter, which totaled 294 homes, or 33% of our deliveries, versus 466 homes, or 49% of our 2009 second quarter deliveries.

Our backlog conversion rate over the last six years has generally averaged in the 60% to 65% range and can vary significantly based on spec inventory levels and other factors.

Moving to slide 7, our gross margin from home sales excluding impairments for the 2009 third quarter was 18.6% versus 14.1% in the prior year period and 18.5% for the 2009 second quarter. The higher year-over-year gross margin reflected higher margin in California and lower direct construction costs as a result of sub-contractor rebidding and value engineering.

Including impairments and land sell revenues, the company’s home-building gross margin was 13% and reflected the impact of $7.7 million of inventory impairment charges, all of which related to the sale of a podium building and land in Florida. The company did not incur any impairments during the 2009 third quarter related to ongoing or inactive homebuilding projects.

Please see the exhibit at the end of the presentation which reconciles the homebuilding gross margin percentage to that excluding land sales and impairment charges.

Moving to slide 8, our SG&A expenses for the 2009 third quarter were down $33 million or 43% from last year. The 2009 and 2008 third quarters included $1.5 million and $3 million respectively of restructuring charges related to severance and facilities related costs. Excluding these restructuring charges and land sell revenues, our 2009 third quarter SG&A rate was 15.6% versus 18.7% last year, despite a 32% drop in revenues from home sales.

The year-over-year reductions in our SG&A expenses and SG&A rate largely reflected a reduction in personnel costs, stock-based compensation and advertising and other marketing expenses. Our 2009 third quarter SG&A expenses were down slightly compared to the 2009 second quarter from $46 million to $44 million, but our SG&A rate excluding land sales and restructuring charges increased 100 basis points from 14.6% in the 2009 second quarter to 15.6% in the 2009 third quarter, primarily due to a decline in revenues.

We remain focused on our overhead structure and we will adjust these costs as needed based on changes in demand in our sales volume. Please refer to the exhibit at the end of the presentation which reconciles total SG&A and SG&A percent excluding restructuring charges and land sale revenues.

Turning to slide 9, our consolidated net new orders for the quarter were down 3% from last year; however, on a same-store basis, orders were up 35% as our average community count dropped from 186 active communities to 134. Our monthly sales absorption rate for the 2009 third quarter was 2.2 sales per community compared to 1.7 sales per community in the 2008 third quarter, and 2.7 per community for the 2009 second quarter. The year over year increase in monthly sales absorption rates was due primarily to the relative improvement experienced in California, Arizona, and Florida. The 19% decline in our per community sales absorption rate from the 2009 second quarter was slightly higher than the seasonal decline, which on average has historically been in the 15% range.

Our consolidated cancellation rate for the 2009 third quarter remained low at 15%, down from 16% for the 2009 second quarter and 26% for the 2008 third quarter. The dollar value in number of homes in our backlog for the 2009 third quarter was down from the prior year levels; however, the dollar value of our backlog was up 7% from $309 million in the 2009 second quarter to $330 million as of September 2009, primarily due to a mix shift to more California homes and includes the impact of consolidating two joint ventures during the quarter. Order trends, as Ken mentioned thus far in October have slowed from the levels generated during the 2009 third quarter, and our cancellation rates have remained stable.

Turning to slide 10, over the last year, we have reduced total completed and under construction spec inventory units by 45%. During the quarter, we reduced our completed spec homes excluding podium product by 37% from 258 homes or 1.9 completed specs per community at the end of the 2009 second quarter, to 163 homes, or 1.3 completed specs per community at the end of the 2009 third quarter.

We believe that having some level of spec homes is beneficial in an environment where many buyers prefer a shorter escrow and our target is to maintain around two completed spec homes per community. Due to the low level of completed specs currently on hand, we expect to increase the number of specs available per community to get more in line with our target levels moving forward.

Our completed spec inventory for our podium projects, which are typically four storey condominiums with 50 dwelling units per acre, remained flat with the 2009 second quarter at 193 units and related to three podium projects in Southern China, including 17 units from a joint venture that was consolidated during the quarter. As discussed in previous quarters, the completion of these podium buildings occur at one time versus traditional single family product that can be started and finished in smaller phases.

Moving to slide 11, during the quarter we generated $113 million of cash flows from operations compared to $32 million in the prior year period. The 2009 third quarter cash flows included $78 million generated from homebuilding activities before the purchase of $22 million of land, and $56 million related to the sale of a podium building in Southern California and a land sale in Florida. The 2008 third quarter operating cash flows included $9 million of land purchases.

Our adjusted EBITDA for our 2009 third quarter was $32 million compared to $13 million for the 2008 third quarter and our adjusted EBITDA for the last 12 months ended September 30, 2009 was $105 million versus $81 million for the prior year period. Please refer to the exhibit at the end of the presentation for a definition of adjusted homebuilding EBITDA, a reconciliation of adjusted homebuilding EBITDA to GAAP operating cash flows.

Slide number 12 provides an overview of the significant progress we have made in transforming all of our overall debt structure and liquidity over the last 15 months. Since just prior to receiving the [Mallon Patterson] equity infusion in June of 2008, and after given the effect of the refinance and tender offer that we recently completed on October 9th, we have reduced our total debt including joint venture recourse debt by over $725 million from nearly $2 billion to $1.27 billion. During that same period, we reduced the amount of total debt that was scheduled to mature before 2013 from $1.33 billion to $322 million through a combination of debt repayments, debt for equity exchanges, and the recent issuance of $280 million of 10.75% senior unsecured notes due 2016. At the same time, our cash balance increased from $204 million to $533 million.

Additionally, as a result of reducing our debt balances since June of 2008, we reduced our annual interest cost by approximately $25 million per year. During the quarter, we paid off the balance of our revolver and term loan A bank credit facilities and amended the remaining covenants under the revolver and the term loan B, which resulted in the relaxing of various financial and other covenants. The revolver commitment was reduced from $361 million to $50 million, as we did not foresee using the revolver for cash advances before its may 2011 maturity date. Going forward, the revolver will be used solely for the issuance of cash secured letters of credit.

As a result of reducing the revolver commitment and paying off the balance of the revolver and term loan A facilities, we will save over $6 million in fees and interest costs. In addition, subsequent to the 2009 third quarter, the company procured an additional $40 million of cash secured letter of credit facilities with two lenders, which have a lower fee structure than a revolver.

The company also exchanged $33 million of its senior subordinated note due 2012 during the quarter, for approximately 7.6 million shares of common stock at an effective price, share price of $4.30.

In connection with paying off and reducing the commitments under the bank [inaudible] facilities and completing the debt-for-equity exchange, the company incurred an $8.8 million non-cash charge related to the early extinguishment of debt. This charge consisted of the write-off of deferred debt costs, the unwinding of the team loan A interest rate swap, and the de-recognition of a portion of the convertible debt discount that was previously included in stockholders equity.

We believe that the combination of our current cash position, our debt maturity profile, and our letter of credit facilities provide the company with the necessary liquidity and runway to fund our business in preparation of the housing market recovery.

Slide 13 gives an overview of the significant progress the company has made with reducing its joint venture debt exposure. As you can see from the slide, we have reduced total unconsolidated joint venture debt, including non-recourse debt, from nearly $1.3 billion in December of 2006 to approximately $270 million as of the end of the 2009 third quarter. More importantly during that same period, the company’s joint venture recourse debt was reduced from over $650 million to $45 million as of September 2009.

The remaining $45 million of recourse debt related to three joint ventures, all of which have been recently reappraised and have current debt maturities ranging from June 2010 to January 2011, and have an aggregate book value in excess of $80 million.

During the 2009 third quarter, the company unwound two Southern California joint ventures with $80 million in real estate inventories by assuming $52 million of secured project debt, of which $23 million was repaid at a discount during the quarter. The blended projected gross margins on the remaining lots in these two projects improved from approximately 9% to 22% as a result of our partners forfeiting their share of joint venture equity.

The remaining non-recourse joint venture debt relates to the north Las Vegas joint venture. The joint venture’s reorganization plan was recently confirmed and the venture is expected to emerge from bankruptcy in November 2009, which should result in a $48 million reduction in the joint venture’s total debt balance and will reduce the company’s remaining land takedown and other funding obligations from approximately $21 million to $11 million.

Slide 14 is an overview of our lot position by state and by category, including lots owned, option and joint ventures. We currently control about 20,000 lots, of which about 15,000 are owned. Of the 15,000 plus lots that are owned, approximately 7,100 or 46% are finished lots, and 2,500 are under development or partially improved. We are actively seeking land opportunities in order to enhance our growth prospects when the market recovers.

I will now turn the presentation back over to Ken.

Kenneth Lind Campbell

Okay, thanks, John. As you can see, I’ve made very little progress with John becoming a little more fluid but I can vouch for his reading skills. They are excellent. I don’t think we missed more than six or eight words in there. Anyway, okay, so -- where are we? Unlike talking about the weather every time we start, I am going to talk about what we did versus what we said we were going to do this time, so don’t get used to this because I am only going to do this when we do what we said we were going to do. But in this particular case, I look back at the slides from last time because I had to do ones for this time and I noticed that we said we were going to do three things in the third quarter -- we were going to do some debt tuning, we were going to make sure we didn’t slip back on operating performance, and we were going to step up efforts on land acquisition, and we managed to do all three. So we paid down $144 million of debt and we pushed out $255 million from pre-2013 to 2016, so that qualifies as debt tuning, no slipping. We held the G&A flat, maybe it up-ticked a tiny bit in percentage but the dollars were flat and gross margin was flat to slightly up and as I said before, the -- if there is a bias in the backlog it’s for those things to improve slightly in the quarter coming up and stepping up efforts on land acquisition -- that really kicked into gear actually more than I even thought, although the acquisitions haven’t been very big yet. We spent $22 million -- we spent a little bit more in October -- there is a lot of stuff in the pipeline. As you can see, we have $300 million plus of letters of interest in the pipeline, so lots of activity, a lot of my time now being spent on trying to see if we can find some stuff to buy with the returns that meet our threshold.

Looking forward, this time for this quarter what are we going to focus on -- we need to get a business plan in place for next year, as I mentioned earlier. I think it’s going to be another tough year, so we are going to make sure we are prepared for it. If it turns out to be better than we thought, then I think that we won't suffer by preparing for a tough year. I think it just helps us benefit more on the upside. We are going to push forward on all these LOIs and some other deals that are out there on the land acquisition side. There’s lots of activity out there. It’s not clear how it is all going to play out yet but I expect that to continue and we are going to make sure that we continue to execute in the fourth quarter on our operating performance, although it’s maybe fairly good compared to some, it’s not good enough and for sure we have to make sure it doesn’t deteriorate, so we don’t want to take our eye off the ball.

Last couple of comments -- you know, there are several things that I don’t worry too much about anymore, although some of you on the phone may wish that I did, but one of the things I don’t worry about anymore is sort of a massive operational restructuring like we did in the first quarter. I don’t spend much time if any thinking about what more debt restructuring we have to do and the joint venture exposure, we don’t even have meetings anymore on talking about it. So those are three things that I don’t worry about anymore, which is quite a change from when I came here in January. If you asked me when I got here in January, what are the three things that I am focused on, those would have been the three things. So just like Forest Gump, three less things to worry about.

What do I worry about? I’m actually not too worried about the fourth quarter. I am a little worried about the first quarter of next year. I guess that’s a good sign that the things I am worried about, the farther away they get, the better off we are. You know, like a year-and-a-half ago we were worried about the month or something, so that’s maybe a good sign. Although I think that the government may help. It’s an unpredictable animal to me. I don’t spend any time at all in Washington so I’m not sure that would help me predict the outcome any better but I think that they may sort of give us some credit. The credits that they are talking about today, not only are they talking about extending them but the modifications that they are talking about all sort of work in Standard Pacific's favor a little bit. They are extending it to beyond the first-time homebuyer. We have more non-first-time homebuyers. They are increasing the income limits -- anyway, they are doing a few things that would help us on margin. Mostly it would help if they just kept doing it. It would provide some underpinning to the market, so we may get some help and I think in the second half of next year, I am less concerned than in the first half because I actually think the economy will be driving at that point the way that the free market people would hope, you know, and employment prospects at the second half of 2010 are better and when employment prospects brighten and we are in the third quarter of the recovery, people’s attitudes improve and they start buying houses. And I still think it is a great time to buy a house, if you have a job and can afford it.

I also think that the second half, as we get through the recession that the public builders are going to get this big kick, this benefit from the fact that there is less competition out there so when the up-tick does happen, I think that we may be a little surprised or the up-tick at least in the performance of the whole homebuilding sector, I think the prospects are pretty good.

The elephant in the room is foreclosures. I think the issue with foreclosures is not are there lots of them teed up or things like that. We all know how many there are in the pipeline and how many people are more than 60 days overdue and all this other stuff -- I think the big issue is not so much how big is the pipeline -- it’s whether it’s going to come out of the hose as a drip or a slight pour or a fire hose. And I think that that is what will determine sort of the impact on prices in general, you know, as we’ve been experiencing this year. Our prices have been flat to slightly up since the first quarter and we’ve had pretty many foreclosures.

So I think it’s probably prevented us from raising prices but I’m not sure if it continues at this rate and then the economy starts to improve and banks do more modifications of loans and you know, maybe it won't be a fire hose. If it is a fire hose, then life could get really unpleasant. Somewhere in between is probably manageable.

So anyway, that’s it for talking. I probably talked just as long as I did last time, even though I said I would try not to. I also said I wasn’t very good at not talking, so I hedged. Anyway, so now I guess I am going to turn it over to questions, right? That’s -- yes, no more slide. Okay, so questions. Does anybody have one?

Question-and-Answer Session

Operator

(Operator Instructions) We will go first to Alan Ratner with Zelman & Associates.

Alan Ratner - Zelman & Associates

Ken, a quick question on the land spend and what some of your comments about that -- I was a little bit surprised to see the letter of intent number so large there, $300 million. And I know in the past you’ve kind of indicated that you thought the real land opportunities was more of a 2010 event, coming from the distressed side and just looking at that number, it seems like maybe that might have come a little bit earlier than you were originally expecting, so I was wondering, was there anything that changed in the quarter, either from the bank’s willingness to bring attractive lots to the market, or are these primarily lots sitting on the developers books? Any color that you can give surrounding what is the composition of those lots, who owns them, what pricing looks like, would be very helpful.

Kenneth Lind Campbell

I wouldn’t get too scared of the number because what you need to get -- what’s the ratio of letter of intent to sales is pretty small. The -- so I mean, it’s an indication that there’s lots of stuff to look at but it’s not a very good indication about -- of how much do you think we are actually going to spend. So the first part of it, I used to say I thought 2010 was when the opportunity is. I still think it’s 2010. So I don’t really think we are -- we will buy much in the next couple of months. I think we will buy some but maybe a little more than we did in the quarter that just finished, or maybe not. So I still think it’s 2010. I think this is just a precursor.

In terms of who is selling, a lot of our purchases have been from banks, so banks are the new land bankers. I think maybe -- no, there’s been a couple from developers or whatever but almost -- a lot of it is from banks. I think that the banks are definitely starting to at least stick their toe in the water with the let’s see if we can sell this sucker. I think that part of what is happening is the initial sales of some of the banks turned out not to be disasters for the banks, that the prices that were bid and the number of bidders and things like that were reasonable and so that is bringing a little more out of the woodwork. You know, the banks had the ability to hold the assets for some period of time, and they didn’t want to do the fire sale thing that they did the last time because they saw a lot of people making money off of them by flipping properties in short periods of time, so I think that that’s encouraged some of the owners of these assets that well, maybe it’s a reasonable time to sell after all.

So I think the market actually is kind of working, and I think that the prices that people are bidding are for the most part reasonable. You know, people that have SG&A rates as high as we do as a public home builder space can't afford to bid too low because we lose money. Some people are being more aggressive than others in order to sort of get their SG&A rate down so they can get their volume up but in general, I don’t think anybody is being particularly reckless.

So I think the prices are kind of reasonable. So mostly banks, a little bit really non-debt stressed developers, and lots of stuff in the pipeline and we’ll see but I still think it’s 2010 before we see the big opportunities.

Alan Ratner - Zelman & Associates

That’s really helpful, and if I could sneak in one second on a -- a little bit unrelated here, just thinking about the gross margin. I know you said that there is still some upward momentum looking in the backlog but clearly you guys have done a great job of marking down your assets to a point where your gross margins are top of the pack and looking forward in terms of the new land that is going to be coming through the pipeline either from mothballed assets or new purchases, how confident are you that the current levels of margins are sustainable? Or are you actually going to see a negative mix shift from some of these distressed land purchases because your margins today are just so strong?

Kenneth Lind Campbell

We are not going to see a negative pull on new stuff because if we can't do gross margin north of 20 with IRRs north of 25, we’re just not going to buy it, and we don’t need to buy it, as some of you might point out. We’ve got plenty of land to sell for a while, so we are only going to buy it if it produces those kinds of returns. And it’s got to produce those kinds of returns with our current view of price appreciation in the market and in the next couple of years, we don’t think there is much price appreciation in the market. And in some markets, we actually think prices may go down a little bit.

So we just won't buy it, and we don’t need to buy it. So I don’t think there is any downward -- anything we buy new will have -- will pull our margins north and north of 20. It’s just a question of how far north of 20.

There was another part of that -- oh, the mothballed stuff, it kind of depends on when we pull it out and have prices recovered or not. In other words, we could play the game of wait three years and bring it out then, because then prices will be higher and since they are mothballed, they don’t acquire any capitalized interest expense, so if you wait long enough, you can make whatever gross margin you want on mothballed properties -- just wait for inflation. It just increases the gross margin.

That’s not what we are doing but in communities or parts of the country or whatever where people are buying houses, we are going to start bringing them back on when we can sort of make a reasonable amount of money and our SG&A is whatever it is, 14.5. It’s going to go down a little but not a lot, so we are -- you know, holding cost is not too high but when we start to bringing them on, they might be in the couple percent below where we are currently selling, so they are at 16.5 or something. If we wait another year or so, then they would be 18.5, we wait two years, they are at 20.

So we are not trying to, as you’ve seen or as we have demonstrated, we are not a place that is trying to generate volume to cover our overhead. If we don’t have the volume, we’ll reduce our overhead. So I think while there might be a little bit of a negative pull from mothballed, it won't be big because we will just get smaller, if that is what we have to do, and we’ll wait.

Alan Ratner - Zelman & Associates

Great. Thanks a lot and nice quarter.

Operator

We’ll go next to David Goldberg with UBS.

David Goldberg - UBS

First question, Ken, as you look forward to 2010 and you still think there is some of those opportunities, I am trying to get an idea of how you think the current liquidity position supports the growth, what kind of rate of increase in terms of run-rate for deliveries that you think you guys could do, given the liquidity position that you are in now and given the changes you have made to the cap structure?

Kenneth Lind Campbell

Well, I mean, you have seen how much cash we have generated from operations at current prices and volumes, right? So what have we generated -- if we sort of stay at the current rate, we are going to generate before any land spending, $400 million, something in that neighborhood, if we continue at the current rate? So $100 million of that is going to go to interest, right? So that means we’ve got $300 million. If sales are flat and prices are flat and our overhead is flat, we are going to generate $300 million of cash, something I that neighborhood. I’m assuming you can do your own math.

I don’t see that -- any reason why that would change materially one way or the other, so you know, I don’t know how much land we will buy next year but -- because it’s all a function of if it makes money and increases the value of the business by generating higher returns on our cost of capital, then we will do it. But if we go out and spend $300 million on land next year, for instance, we are going to generate $300 million of cash, so that would make us neutral.

Will we go buy more than $300 million of land? Well, only if we can get the returns. So we don’t -- I mean, we have sort of target market shares in various markets or whatever but we are not there, you know? Some companies buying 450,000 new homes a year or something, eventually they are going to go back to 900,000 or something like that. And -- but I don’t think they are going to start doing that for a couple of years.

We have plenty of cash and we have $530 million in the bank and we have a few hundred million of debt due over the next few years, so I’m not -- we have plenty of money to buy $300 million, $400 million of land before I worry about it, and we are not there yet. So I think later on it might get more interesting but as long as we are buying land based on a threshold, you know, a rate of return with modest assumptions about price appreciation and volumes -- if we find lots of opportunities to generate 25% returns with modest price appreciation assumptions, then you know, we spend a lot of money, we will go get some more capital but right now, we don’t need to think about that yet, I don’t think.

David Goldberg - UBS

Got it. Second question -- a little more theoretical -- when you were talking about maybe some improvement in the second half of 2010, in terms of the operating environment, just trying to get an idea of how you think about mortgage rates in that environment, especially if the fed stops buying MBS in March like they are planning to do.

Kenneth Lind Campbell

Yeah, you know -- right. Mortgage rates ought to creep up. If we start getting inflation though, then it’s sort of -- that’s kind of a wild card that -- I mean, I don’t know how you guys factor that into your analysis but if you are a company with lots of assets and fixed price debt, even though higher inflation would lead to slightly higher mortgage rates, I’m not sure that is bad news for a homebuilder. In fact, I think if you do the math, it’s good news for a homebuilder even if it is slightly depressing in terms of the recovery. I mean, obviously higher prices, you know, affect sales but do mortgage rates have to stay below 5% for people to buy homes? I don’t think so. I mean, as people -- so the question is how much does the fact that unemployment rate is going down and the economy is growing and incomes are rising -- does that offset the higher cost of buying the house? I mean, the cost of buying a house right now is awfully low compared to what it has been over the last 15 years as a percentage of the people’s income. So there is room for prices to go up without it being like oh my god we’re into a new thing.

So I think the problem is you’ve got to weigh the one against the other but I think if you get sort of general -- if you end up with higher price appreciation or inflation, whatever you want to call it, which also feeds into mortgage rates and obviously the government stopping to buy depends on if anybody else steps in to buy mortgage backed securities, but think that you are right -- interest rates will creep up, that will have a negative effect but if prices also creep up, that has an overwhelmingly positive effect, so I think the net would be better. But it’s a reasonable point.

I’m not planning on massive growth in 2010, I’ll tell you that.

David Goldberg - UBS

Got it. Thank you very much.

Operator

We’ll go next to Michael Rehaut with JP Morgan.

Michael Rehaut – JP Morgan

First question, just if you could give us a sense with at least the -- let’s say keeping at the current rate of land purchases that you did in 3Q, when you would expect the community count to stabilize and possibly begin to increase?

Kenneth Lind Campbell

If I had to guess, I think it is sort of -- I think somebody asked on one of the other calls or whatever, where it is going to be at the end of next year. If I had to guess, I’d say our community count is going to be the same at the end of next year as it is now. In other words, I think that the year will be one of where we basically replace the communities that we finish and some of that will be mothballed stuff and some of that will be with new stuff.

Now, I’m also assuming the world is going to be flat next year because I missed that class about the round thing, so in a world where it is flat, I think we’ll end up the year plus or minus with the same number of communities as we did before. If the world starts to get a curve to it and it goes up, hopefully it’s that kind of a curve, then we will open more communities and lord knows we’ve got communities. You know, we got 50 of them or something -- is that right, Scott?

Scott D. Stowell

Yes.

Kenneth Lind Campbell

Mothballed and we are buying communities. So it will go up if sales volumes go up but right now I think it’s already stabilized.

Michael Rehaut – JP Morgan

And that kind of hits on the next question where you said next year will be a tough year but you are still out there with letters of intent and some land purchases, so I would assume that while tough, when you are baking in assumptions for current land purchases, you are looking at sales pace and pricing similar to what -- similar to today’s environment. Is that fair?

Kenneth Lind Campbell

You know, when we look at stuff -- I mean, we look at a couple of different -- sort of there’s this traditional thing the homebuilders do where you look at it with no price appreciation, see where that gets you. And then you put in a little bit of price appreciation, see where that gets you and that kind of gets your over or under or whatever. Or sometimes the asset turnover is really fast and then you can sort of deal with slightly less returns.

But most of our stuff, it’s sort of -- if there was a rule of thumb, it’s got to start with a two in terms of a gross margin with little or no price appreciation and needs to get sort of towards 25 if you get any price appreciation and IRRs are obviously higher. And as a number of deals are coming through these days, I think there is increased sort of attention being paid the rate at which you buy things at when you buy them, so it looks more like option purchases, although maybe they are installment sales and not options that people are buying things more in pieces which improves the asset turnover which helps juice the returns, the IRRs. Doesn’t juice the margins, the gross margins, but the ratio of IRR to gross margin sort of creeps up but wow, is it early days to start trying to do projections on. You know, what did we buy, $22 million worth of stuff? We go through $300 worth of inventory every year at current sales paces, so I think it’s really dangerous to draw too many conclusions from the first $50 million or whatever we have spent on land.

Michael Rehaut – JP Morgan

Fair enough -- one more question, if I could -- competition for lots, I know you mentioned over the next couple of years that with so many less private builders in the mix that that should be something of an advantage for the few remaining publics. At the same time, we’ve heard that in certain markets, competition has increased. I guess among the survivors, either public builders or some private equity backed ventures, so I was wondering if you could just comment on that in terms of what you are seeing in the marketplace and obviously you are able to get a small amount of deals done but is that -- let’s say preventing you from doing more deals or is it primarily all go back to the banks and their willingness to participate --

Kenneth Lind Campbell

I think there’s two things. One is it’s absolutely happening. A lot of -- I mean, the buyers right now are largely public builders, big public builders and there’s lots of competition, particularly on lots when it’s going to public auction and blah, blah, blah. And we’ve bid on some of those, and won some of those. One that was -- somebody was alluding to on our last call, which is in the Inland Empire where we spent in the neighborhood of $100,000 a lot on some property there but since then, lots around the corner have gone for 130 a lot. So even though there were 28 bidders on ours, we had a lot of experience working in that environment and we understood the issues with community development funds and things like that that maybe not everybody knew, but we definitely underwrote it to the high standards that we are talking about.

I think that the governor on the behavior is the high overhead rates of public builders and even though a lot of people are underwriting them with anticipation of declines as volumes go up, they can't get wildly aggressive. So while there are lots of bidders, they are all bidding about the same price.

And then there is the flip side, which is you know, how do you get deals -- I mean, everybody is trying to figure out how do you get deals without the bidding. And a recent example of something we did is we didn’t wait for the trustee to go to the bid. There was a not involved and we went and bought the note at a discount, which gave us a bidding advantage, a large bidding advantage over anybody else if they showed up, so nobody showed up.

And we are talking to other sort of bankrupt entities and things like that about doing weird things that are non-conventional but they haven’t sort of gotten over the edge yet. We are spending a lot of time and effort working on some of these deals and some of them are significant in size but none of them have happened yet, so there still is sort of a bid asks spread although it’s not that simple anymore. It’s not they are willing to sell for X and you are willing to buy for Y, it’s they want the money this way and you are willing to do it over this period of time with this kind of sharing and you know -- you take this risk, we take that risk, so we will see if they come out the other end. We are definitely working on them but it’s not clear it’s going to get that we have bridged a gap between the bid and the ask. It’s just there’s a lot more activity.

Michael Rehaut – JP Morgan

Would that type of altered structures involve going back into different types of JV arrangements?

Kenneth Lind Campbell

Yes. I mean, we’ll call them something else because JVs have a bad rap -- you know, and the problem with joint ventures wasn’t that they were joint ventures. I mean, by itself, I don’t think. I mean, there were lots of issues with the joint ventures and the way they were structured and the kind of obligations people took on and this, that, and the other thing. You know, the presumption that by putting it off balance sheet, somehow that was helpful or whatever. But I think there will be deals where the seller stays involved one way or another over an extended period of time, whether you call it a joint venture or an installment sale or a preferred equity or whatever, I think that there will be some weird structures and joint venture might be as good a description as any, except we are not allowed to use that word in the homebuilding business.

Michael Rehaut – JP Morgan

Thank you.

Operator

We’ll go next to Susan Berliner with JP Morgan.

Susan Berliner – JP Morgan

Just a few questions -- one was a little housekeeping; what’s the outstanding on the converts right now?

John M. Stephens

The face amount is like $45 million and on our balance sheet net of the discount we have to record, it’s like $33 million, so $45 million of obligation remaining.

Susan Berliner – JP Morgan

Okay, great. And then I know you were talking about the breakdown between your owned lots and 7100 lots were finished, 2500 you said were partially and I am assuming the other is raw, is that right?

John M. Stephens

Correct, yes.

Susan Berliner – JP Morgan

And would you guys contemplate doing something like you did this past quarter? I mean, is there stuff that you have on the market that we could potentially look for for sales going forward?

Kenneth Lind Campbell

I wouldn’t, if I were you. I didn’t expect either of those two things to happen -- they’ve been on the gonna happen list since before [Mallon Patterson] invested in the company. So I mean, there are -- and you know, when we say lots held for sale, whether it’s us or any other builder, it’s like well, it’s held for sale unless we -- the prices go up and we can build on it ourselves and stuff that isn’t in lots held for sale is for sale and if somebody comes along and offers you a lot of money. So it’s not like we behave a lot differently or put it into a different legal entity or whatever -- there’s no sort of magic to it.

It’s possible that things get sold but it’s not like we have a whole active effort trying to unload stuff because even if the stuff that is held for sale in all our little analysis that we do for each one of the communities, we are not trying to generate cash out of that activity at this point. We will sell stuff if we think we can put the money to better use, so if we think that there is land buying opportunities with 25% returns out there and we can sell something at a price where we can generate more profit by buying something new, then that is what we will do. But we don’t have a lot of activity out there trying to sell stuff because even if we are going to sell it, I’m thinking it’s probably a couple of years before we ought to sell it and the cost of maintaining the stuff is pretty small.

Susan Berliner – JP Morgan

Great, and then just two other questions -- Ken, you had kind of talked about October coming in a little bit weaker than you anticipated. What do you think that is due to?

Kenneth Lind Campbell

You know, I stayed at a Holiday Inn Express this morning so I am feeling really smart about things. I think there is a little bit -- I got to believe that the end of the tax credit, you know, obviously nobody is thinking about that at this point when they are buying -- or if they are, they are guessing because you can't buy and deliver a home fast enough anymore, even if you are one of the faster builders, let’s say. I don’t want to give any free advertising but -- so I think maybe people are a little bit waiting to see what happens but I also think that whether you call it a W or whatever you want to call it, I think people got a little excited. They thought the world had turned around and everything was getting good a month or so ago, whether it was the stock market or whatever else, and I think that there is still a lot of big challenges out there in the economy and in the homebuilding world in particular -- homebuilding world is being dominated mainly by foreclosure effect but it’s just not going to be that easy and so people are pulling back a little.

I think the government effect might be big enough to sort of describe the more than seasonal decline but keep in mind this is four weeks or whatever and didn’t include an end of the month week and so I think a little bit, people ought to be a little careful of trying to do these projections based on little bits of data. I know you guys have to do that, it’s your business but I think it’s a bit dangerous at this point. But traffic has drifted down, but a little bit, not a lot.

Susan Berliner – JP Morgan

Okay, great and my last question, I apologize, I know you guys were talking about the north Las Vegas joint venture coming out of bankruptcy and I was just wondering if you can kind of go over the numbers again, the lot take-down, is it $11 million?

John M. Stephens

Yeah, we’ve got -- the obligation before the bankruptcy was $21 million and the remaining funding obligation is about $11 million, which includes some other items in addition to just buying the land. So we did reduce our obligation by $10 million.

Susan Berliner – JP Morgan

And then the joint venture debt, that 270 number will decrease by another -- did you say $46 million?

John M. Stephens

I said 48.

Susan Berliner – JP Morgan

Forty-eight, okay, perfect. Thanks so much.

Operator

We’ll go next to Jim Wilson with JMP Securities.

Jim Wilson - JMP Securities

Most of my questions have been answered but on your -- Ken, on your land acquisitions of $22 million, could you give a little more color? Did you pay cash or were you able to option lots? Are these entry-level oriented lots for communities or move-up?

Kenneth Lind Campbell

Well, in the $23 million or whatever, one of them -- a big chunk of it was the inland empire thing, which I guess you would call that a move up. Is that what you would call it, Scott? Why don’t you answer that question?

Scott D. Stowell

There was roughly $20 million that was all cash transactions in California and then about $10 million in option deals in our existing -- in our remaining divisions across the country.

Kenneth Lind Campbell

So there is more of a bias towards option/installment sale stuff outside of California is still more cash, although we are doing a deal right now where it’s cash but it is sort of gradual take down at rates that are below what we actually think we are going to sell, so it looks -- it will behave on the balance sheet like option unless the world collapses again, whatever. But -- so that’s kind of the mix so far.

Scott D. Stowell

And the California purchases were busted projects coming out of bankruptcy, bank sales -- they were cash deals. There still may be some option or installment sale deals in California, certainly is a preferred structured and we are trying to do that anywhere we can.

Jim Wilson - JMP Securities

Okay, that’s great. That answers my other question, who was selling -- the banks and distressed developers, obviously.

Kenneth Lind Campbell

Yes, more banks than -- but a little of each. I mean, a little of developers. There’s still some out there.

Scott D. Stowell

Some of our take down deals were just -- you know, we’ve got existing programs, we renegotiated with the land developer a structure that we like in terms of the number of lots we are taking down, or in some cases we’ve renegotiated price still. So they are not distressed land developers. They are just continuing to try to work through their projects.

Jim Wilson - JMP Securities

Okay, very good. Thanks.

Operator

We’ll go next to Alex Barron with Agency Trading Group.

Alex Barron – Agency Trading Group

I wanted to see -- I’m assuming you guys have thought a lot about this five-year NOL proposal and I was just trying to figure out what you think it means for you if it gets passed in terms of immediate cash that you can get out of it?

Kenneth Lind Campbell

I don’t spend too much time on this particular topic but -- this is sort of like reading tea leaves or trying to predict politics is harder than trying to predict stock prices for me, so I can't -- I’m not going to do either one. But I can tell you that the taxes that we paid that are available are $160 million of taxes in 2004, so depending on how it all plays out, that is what is up for grabs but I don’t -- I have zero knowledge beyond what is in newspapers speculating about what they are actually going to pass. But if you want to sort of do your own analysis, we got $160 million of taxes we paid in 2004, which under some of these circumstances might become available.

Alex Barron – Agency Trading Group

Okay, and let’s assume that it does become available -- would you guys be predisposed to sell some land at a low price just to try to get this cash in your hands?

Kenneth Lind Campbell

No, we don’t need to.

Alex Barron – Agency Trading Group

Okay. My other question was do you guys know how -- let’s assume you become profitable in the next year or two. How would the current deferred tax asset that has been the valuation allowance, how does that come back on the books? Is it --

Kenneth Lind Campbell

It won't come back -- it won't come back for years. The way it has to work is first you have to generate profits, then they have to like decide that you have been generating them long enough and the prospect of continuing profits -- I mean --

John M. Stephens

So really what will happen is as we start generating income, that deferred tax asset will unwind. And then as more years have passed, then they will make a determination as to whether more of the deferred tax asset can be unwound but again, like Ken said, we’re not really anticipating much of that coming back right away. When we start turning a profit, we will unwind that portion of it.

Alex Barron – Agency Trading Group

Okay, and my other question, in terms of gross margins this quarter, did you guys give the benefit from previous impairments?

John M. Stephens

No, we didn’t give that.

Kenneth Lind Campbell

We don’t -- I don’t even know what it is. I don’t calculate it.

Alex Barron – Agency Trading Group

Do you have it available?

Kenneth Lind Campbell

I don’t look at it, calculate it, ask for it -- none of the above.

Alex Barron – Agency Trading Group

Okay. I thought you guys gave it last quarter.

John M. Stephens

We may have, yes.

Kenneth Lind Campbell

So John has it?

John M. Stephens

It’s $75 million for home sales.

Alex Barron – Agency Trading Group

Okay, excellent. Thank you.

Operator

We’ll go next to John Reardon with [Craw Whedon]

John Reardon - Craw Whedon

I actually only have one question -- could you briefly go over your operating areas and just -- you know, is Florida still a black hole, is California your best market? Could you talk about your various markets that you are operating in?

Kenneth Lind Campbell

I can. I mean, at any given point in time, one of these markets does better than the other, as you’ve observed -- I mean, I don’t know if you observed but if you look at past recoveries or declines in the home building market, different markets go down before other ones and different markets recover before other ones. We take a long-term view of the markets that we are in. We don’t sort of rethink whether we should say in Florida because one year is bad or visa versa. So Florida is still pretty weak in terms of the job -- and most of it is driven by job prospects and you know, volume of available inventory. So Florida is pretty weak right now. Charlotte is not doing great because the bank is having some difficulties and California is doing quite well, despite the fact that we got 11.5% unemployment and the most screwed up tax situation on the planet.

I mean right now, California is doing better than everywhere else and Florida is doing worse. I think the prospects for Florida are they have to challenge the continuing challenge going forward but part of this is because compared to California, we took bigger write-offs in California earlier. And in some of these places like Texas and Carolinas, we never took as big write-offs as we did in California.

So I don’t know -- so I guess California is doing pretty good right now and Florida/Charlotte is not doing so good, and Phoenix and Texas are kind of in the middle.

John Reardon - Craw Whedon

Okay. Thank you.

Operator

We will take our last question from Scott Kincaid with [inaudible].

Scott Kincaid - Analyst

My question was already answered. Thank you.

Operator

At this time, I would like to turn the call over to Mr. Ken Campbell for closing remarks.

Kenneth Lind Campbell

Okay, well I don’t have a lot of closing remarks. Go buy a home and we’ll talk to you next quarter. Bye.

Operator

This concludes today’s conference. Thank you for your participation.

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Source: Standard Pacific Q3 2009 Earnings Call Transcript
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