Hovnanian F4Q07 (Qtr End 10/31/07) Earnings Call Transcript

Hovnanian Enterprises, Inc. (HOV)

F4Q07 Earnings Call

December 19, 2007 11:00 am ET

Executives

Ara K. Hovnanian – President, Chief Executive Officer

Paul W. Buchanan – Senior Vice President, Corporate Controller

Kevin C. Hake – Senior Vice President, Finance and Treasurer

J. Larry Sorsby – Executive Vice President, Chief Financial Officer

Brad O’Connor – Vice President, Associate Corporate Controller

Jeff O’Keefe – Director of Investor Relations

Analysts

Stephen Kim - Citigroup

Michael Rehaut – JP Morgan Securities Inc.

David Goldberg – UBS

Carl Reichardt – Wachovia Securities

Andrew Brausa - Banc of America Securities

Nishu Sood - Deutsche Bank

Mike Wood - Banc of America Securities

Wayne Cooperman - Cobalt Capital

Susan Berliner - Bear Stearns

Larry Taylor - Credit Suisse

Alex Barron - Agency Trading Group

Jim Wilson - JMP Securities

Chris Melendez - J.P. Morgan

Keith Wiley - Goldman Sachs

Timothy Jones - Wasserman & Associates

Joel Locker - FBN Securities

Presentation

Operator

Good morning and thank you for joining us today for Hovnanian Enterprises’ fiscal 2007 fourth quarter earnings conference call. By now you should have received a copy of the earnings press release. However, if anyone is missing a copy and would like one please contact Donna Roberts at 732-383-2200. We will send you a copy of the release and ensure that you are on the company’s distribution list.

There will be a replay of today’s call. This telephone replay will be available after the completion of the call and run for one week. The replay can be accessed by dialing 888-286-8010, pass code 47517323. Again, the replay number is 888-286-8010, pass code 47517323. An archive of the webcast live will be available for 12 months. This conference is being recorded for rebroadcast and all participants are currently in a listen-only mode.

Management will make some opening remarks about the fourth quarter results and then open up the line for questions. The company will also be webcasting a flat presentation, along with the opening comments for management. The slides are available on the investors’ page of the company website at www.khov.com. Those listeners that would like to follow along should log on to the website at this time.

Before we begin I would like to remind everyone that the cautionary language and forward-looking statements contained in the press release also applies to any comments made during this conference call and the information on the slide presentation.

I would now like to turn the call over to the management, Mr. Ara Hovnanian, President and Chief Executive Officer of Hovnanian Enterprises. Ara, please go ahead.

Ara K. Hovnanian

Good morning and thank you for participating in today’s call to review the results of our fourth quarter and fiscal year ended October ’07. Joining me from the company are Larry Sorsby, Executive Vice President and CFO, Kevin Hake, Senior Vice President and Treasurer, Paul Buchanan, Senior Vice President and Corporate Controller, Brad O’Connor, Vice President and Associate Corporate Controller, and Jeff O’Keefe, Director of Investor Relations.

Overall the housing market remains very challenging, resulting the first fiscal year loss for our company in a very long time. For a full year the company was just below break even before land related and intangible charges, with a pre-tax loss of $21 million equivalent to about 0.04% of revenues. -- 51. We’re working hard on the cost side of the equation to get us on the other side of break even. We’ve had further reductions in construction costs and overheads. In addition, the significant number of our remaining land options have been renegotiated, reducing our land costs and extending terms, which should also help our margins as we build through our own loss and start to deliver more homes on lots with renegotiated prices.

The sizable loss we are reporting for fiscal ’07 was largely related to our charges in the fourth quarter and the full year, so I’d like to begin by discussing those charges. First, charges regarding definite life intangibles. If you turn to slide two, in the fourth quarter we wrote off $78 million of definite life intangibles. These were most of the remaining intangibles associated with the various company acquisitions over the last seven or eight years. In total we impaired or amortized $217 million in definite life intangibles in fiscal ’06 and fiscal ’07.

As you can see on the slide, we ended ’07 with only $4.2 million remaining in definite life intangibles. This means that there’s very little definite life intangible balance left for any further potential impairments. It also means we will no longer have the expenses associated with amortizing these assets, which have been running 30, 40 or even 50 million dollars per year over the last few years. We do have approximately $32 million of good will remaining, however, the majority of that is associated with our 1999 acquisition of Goodman Homes in Dallas, which is remaining solidly profitable throughout the industry’s current cyclical correction.

Next I’ll discuss land option walkaways. We took charges of $105 million related to land option walkaways in the fourth quarter and $126 million for the full fiscal year as shown on slide number three. These charges represent the amount invested in these options, primarily the option deposits. In addition, there were $77 million of impairments that were indirectly associated with the land option walkaways.

Basically, if we walked away from the remaining sections of an ongoing project some of the common infrastructure costs were reallocated to land that we own, which triggered impairments in certain cases. Thus the combination of direct and indirect walk-away costs was over $180 million and, therefore, the largest component of our pre-tax charges for the quarter. These additional walk-away costs recorded in the fourth quarter resulted from our shift to an even greater focus on cash flow versus profits, as well as a continued softening of the market at the end of our fiscal year.

We terminated and walked away from land contracts totaling about 9,000 lots during the quarter and about 18,000 lots for the full year. Our remaining investments in option deposits has dropped dramatically from about $275 million at the end of the third quarter to about $148 million at the end of our fourth quarter.

In our more challenging operations our land option positions have come down even further. In Florida, California, Minnesota and Chicago we only have about 4,200 options remaining out of a total option position company-wide of about 36,000 options. Most of the price or terms or both have been renegotiated on these remaining options so they make economic sense going forward even in this environment. The majority do not have land takedown until after fiscal ’08. In fact, in one of our two remaining parcels under option in California no land takedowns are scheduled to occur until 2010.

The majority of our remaining loss under option are in Texas, North Carolina, Washington, D.C., and the Northeast – about 27,000 total in these areas or 75% of the total of all of our options. In Texas and North Carolina we are generally taking down lots on a rolling option basis from developers and thus we have a very short position in owned lots. Those two markets represent a little less than half of the above total. The markets in Texas and North Carolina have performed relatively well and certainly better than California, Florida and the Midwest. Although conditions are obviously slow, sales and pricing have also held up better in D.C. and the Northeast than in California and Florida.

In some of these markets the resale listings have started to level off. This began to occur in markets like New Jersey, as you can see in slide number four, and in Virginia, as you can see in slide number five. Virginia actually had a lower level of listings in the summer of ’07 than in the summer of ’06. Even the more challenging markets in Florida like Tampa are showing signs of leveling. This gives us some reason for optimism. Obviously, while the trends show some leveling they are still at very high levels. We need to see the existing home inventories come down further for the markets to improve.

Excuse me. Tampa was on slide six.

Our lot position has been reduced dramatically. We reduced our lot position by over 10,000 lots in the fourth quarter from the third quarter. Our remaining 36,000 option lots constitute about a 2.7 year supply at our most recent fiscal year pace. In the most challenging markets, like California and Florida, we are down to very few remaining lots, less than 10% of the total, and many of those, most of those in fact have been renegotiated. Hence, we believe that our risks of further land option walkaways are dramatically less going forward than they have been for the past two years.

Next category of pre-tax charges relates to impairments. As shown on the slide, we incurred impairment charges of $168 million related to land in communities that we own in the fourth quarter and $332 million for the full fiscal year.

As I mentioned earlier, nearly half of our impairments in the fourth quarter were actually the result of land option walkaways causing a re-allocation of common costs into the remaining owned lots. The balance of the impairments are the result of a slower sales pace and/or lower pricing in other communities where we owned lots.

We’ve impaired a total of 98 communities in ’06 and ’07. About half of the remaining active communities – 101 communities in Texas and 52 in North Carolina – are located in states with a high community count and states that remain profitable with far lower risks of impairment. While there’s always some risk of further impairments, our exposure is far less in these markets today.

On our communities in Florida, California, Chicago, and Minnesota, some of our more challenging markets, we’ve already recognized a total of $442 million of impairments in ’06 and ’07, so our exposure continues to reduce in these markets as well.

Let me talk for a moment about pricing. I’ll focus on California because this is one of the markets where we saw some of the biggest price appreciation toward the end of the cycle. Prices of new homes have come down substantially in California, which has lead to the large dollar impairments that we have taken in that state. Turn to slide seven. You see an example of two different communities where our prices have come down over the last 12 months by 28% and 35% respectively. I wish I could say these were the exceptions in California, but they are not. Somehow, this kind of price reduction does not readily show itself in public data, but it is very real. New homes have rolled back to prices of many years ago, before the hyper-heated market.

Taking a step back for a minute and looking at new home prices in general as compared to the price of existing homes, an unusual phenomenon has occurred. Turn to slide eight. We’ve tried to illustrate that historically new homes, represented by the red line, were priced higher than equivalent existing homes, represented by the dashed blue line. However, homebuilders have lowered prices on their new homes much more dramatically than existing home owners have been willing to lower prices on their homes. The public builders in particular have lowered prices dramatically to move inventory. Now things are backwards, with new homes selling at a discount to existing home levels.

We believe that when market analysts speak of the corrections that need to come in home prices what they’re really focused on are the existing home prices and their need to lower their prices similar to what the homebuilders have done with new home prices over the last 18 months. The widely discussed Case-Shiller Index tracks changes in existing home prices and this can often be misleading and confusing. As existing home owners move prices to be competitive with prices of new homes there’s likely to be more sales activity for everyone as potential home buyers must often sell an existing home to buy a new home.

Okay. Enough about macro-economics. Let me get back to our fiscal year. The combination of a slight pre-tax loss before charges with the significant land and intangible charges resulted in a total pre-tax loss for the year of $647 million. We made over $1 billion pre-tax in ’05 and ’06 and, unfortunately, we’re giving back a big chunk of those profits in ’07. That leaves us with the last major area of charges for the quarter and the year, which are related to taxes and FAS-109.

Normally when we record losses we would be recognizing a significant tax benefit. Many of the losses, primarily related to impairments of land, are not eligible for a current tax refund until we actually sell the inventory. But the tax benefit can be carried forward for 20 years. After a recent consultation with our auditors regarding the application of FAS-109 we concluded that we should book a $216 million after-tax non-cash valuation allowance during the fourth quarter. The FAS-109 charge was for GAAP purposes only.

For tax purposes, again, our tax asset may be carried forward for 20 years and we fully expect to utilize those tax law carry-forwards as we generate profits in the future. The net result is that we are recording taxes for the fourth quarter in spite of our losses. The combination of our losses from operations and charges including FAS-109 resulted in an after-tax loss for fiscal ’07 of $638 million. Larry will qualify the issue, will further clarify the issues revolving around FAS-109 in a moment.

After all of our walkaways, impairments, and FAS-109 adjustments we still ended the year with approximately $1.3 billion in shareholders equity or approximately $19 per common share. Our share price is still trading at about 40% of book value, even after all of these charges I’ve just described.

Now I’ll comment on our cash flow and debt reduction. For the fourth quarter of fiscal ’07 we were significantly ahead of our previous cash flow guidance of 175 to 250 million dollars as we generated $376 million of cash flow in the fourth quarter. We used the cash we generated during the fourth quarter to reduce our debt. We retired the remaining $140 million of our 10.5% senior notes and reduced the amount drawn under our $1.5 billion unsecured revolving line of credit by $250 million from about $456 million in the third quarter to about $207 million at the end of the fiscal year.

We anticipate increasing our bank borrowings modestly in the first half of fiscal ’08 with the reductions weighted towards the second half of the year, which follows our typical seasonal pattern. On slide 19 you can see that typical seasonal pattern. You also see the cash flows were better in ’07 than they were in ’06 and we expect them to be better in ’08 than they were in ’07, with more than $100 million of cash flow generated in total in ’08.

Sales. Our net contracts for the fourth quarter were down 10% compared to the prior year, but as we stated in our November announcement , sales for the period were helped by our national sales promotion in September partially offset by significantly slower sales after the promotion. Interestingly, our contract pace in December – normally the slowest month of the year – has been higher than the contract pace in October and November. Obviously a few weeks does not constitute a trend, but we’re encouraged that December sales pace has improved significantly.

Let me give a little more detail on our national sales promotion in September. We reported approximately 2,100 sales. They’re comprised of 1,700 contracts and 400 sales deposits during the sales. On slide 10 you see that through November 25^th we converted 206 of those deposits into contracts and ended up with about 1,920 gross contracts from that sales promotion. Four-hundred-and-eighteen of these contracts have cancelled to date representing a 22% cancellation rate thus far. This compares to our consolidated cancellation rate of 40% during the fourth quarter. Another 451 homes have delivered and that means we still have a little over 1,000 homes to deliver over the next few quarters. All in all we are very happy with the success that we had in this nation-wide sales promotion. We exceeded our internal goals by a wide margin.

Now let me get back to talking about cash flow and debt reduction, which we are accomplishing largely by reducing our inventories. If you turn to slide 11, we ended the year with 36,000 option lots. It’s down about 59% from the peak in April ’06. This reduction has been painful, as demonstrated by our charges, but it is the prudent thing to do. Today we are proceeding more cautiously in converting optioned land to owned land. We are at the point now where each land take must be approved by me personally. While it once was enough for our divisions to move forward with a land take if the initial transaction was approved and it was in our budget, we are now being even more diligent and re-examining all aspects of a land take at corporate before we move forward.

Our owned lot position was just a little over 28,000 lots at the end of October. This was down 21% from a peak a year ago in July of ’06. It’s a little over a 24 month supply at the ’07 pace. We expect our total land position to continue to decline as our pace of lot takedowns under options remains below our pace of deliveries. We will soon be burning through our old land supply and replenishing it with renegotiated land.

If our cash flows are not meeting our targets or if our liquidity becomes more of a concern we could reduce our remain land takedowns even further or eliminate them entirely. At this stage we are primarily taking down lots that will generate a good margin and already have a home contract on them.

Other areas of inventory management. We are also keeping a close eye on dollars that we are spending on land development. During the quarter we mothballed communities where current performance did not justify further investment at this time. We’d prefer to avoid spending money to improve the land today and save the raw land until such time as the markets improve and we can generate higher returns.

We are also closely monitoring the total number of our started unsold homes under more stringent criteria. Our strategy historically has been to build homes after we have a contract and today we are more disciplined than ever in controlling the number of unsold homes that are started. We ended the quarter with 5.5 started unsold homes per community. That’s down from 6.2 homes per community in the third quarter, as you can see on slide 12.

Based on the most recent quarter’s sales pace, we have only a 2.6-month supply of started unsold homes compared to an average of 7.2 months with the industry. We’ve been able to manage this portion of our inventory well and will continue to make strides to reduce our capital that is tied up in these started unsold homes. In absolute terms, the total number of spec homes started has come down from about 2,942 homes at year end ’06 to about 2,390 at this most recent year end.

The market is too challenging right now to make accurate forecasts for fiscal ’08. Fiscal ’08 will clearly be a difficult year, but we’ve already taken significant steps to position ourselves and reduce our overheads to be better prepared for an environment with lower sales and prices.

I’ll now turn it over to Larry Sorsby to discuss our fourth quarter and the full financial year performance in greater detail.

J. Larry Sorsby

Thank you, Ara. Let me start by further explaining one of the more complicated components of our year-end release. On December 7^th Ernst and Young distributed their interpretation of FAS-109 as it applies to homebuilders. After consulting with E&Y and completing our own research on FAS-109, we determined that we were required to take an after-tax non-cash charge during the fourth quarter by reporting a $216 million valuation allowance against our deferred-tax assets. Even though 2007 represented our first loss in many years and we only had a $21 million pre-tax loss prior to land-related charges and all impairments, under FAS-109 we were required to set up valuation allowance for our deferred tax assets.

Due to our October year end, we once again find ourselves being the first builder that has to deal with a new or unusual accounting issue. I can assure you that the other public builders will also soon be dealing with this issue. So let me try to explain and clarify how FAS-109 works. Under FAS-109 homebuilders were advised that they have to determine if they are in a three-year cumulative loss position. Even with the $626 million non-cash pre-tax charges we took during fiscal 2007, we determined that we were not in a three-year accumulative loss position at our October 31^st, 2007, year end. However, this fact did not cause FAS-109 issues to go away. We were then advised that even if we were not in a three-year accumulative loss position at the end of 2007 we then had to project forwards to ascertain whether it was likely we would be in a three-year cumulative loss position at the end of fiscal 2008. That meant that we had to drop off our highly profitable 2005 year and replace it with our 2008 projections. We determined that it was likely that we would be in a three-year accumulative loss position by the end of 2008 and that is why we booked a $216 million non-cash after-tax valuation allowance against our deferred-tax assets.

The non-cash charge was for GAAP purposes only. For tax purposes the tax deductions associated with the company’s deferred-tax assets may be carried forward for 20 years. Although financial accounting requirements limits the company’s ability to consider future profits in determining the need for evaluation allowance, the company is confident that it will generate sufficient profits in the future to openly and fully utilize its deferred tax assets. As we generate future profits the valuation allowance reserve will reverse such that we will not have to pay any federal taxes on our earnings. Once we can determine that we are no longer in a three-year accumulative loss position the entire remaining valuation allowance will be reversed.

We are concerned that not all accounting firms and home building companies will interpret FAS-109 in the same way. Due to the cyclical nature of the home building industry, the fact that most home builders have only experienced one year of losses, and the idea that it is probable that the home building industry will return to profitability during near term years, it is likely that not all accounting firms will interpret FAS-109 in the same manner.

Certain homebuilders, with the concurrence of their outside auditors, will likely not look forward to ascertain if they project that they will be in a three-year accumulative loss position at the end of their 2008 fiscal year. Even if those companies are actually in a three-year accumulative loss position at the end of 2008 year their accounting firms may advise them not to book a tax charge if they believe that that charge will likely be reversed due to profits being generated in the near-term future. Unfortunately, there’s likely to be an inconsistent application of FAS-109 across our industry.

While our valuation allowance charge was non-cash in nature it did affect our balance sheet and our net worth by $216 million. As a result of the FAS-109 charge we needed waivers from our banks with respect to our tangible net worth covenant and our credit facility. We received approval from our lenders for the necessary waiver. Without the $216 million FAS-109 charge we would not have needed a waiver from our banks and we would have been in full compliance with all our bank covenants at October 31^st, 2007.

We have also begun discussions with our bank group regarding an amendment of our current credit facility in anticipation of more challenging ratios in fiscal ’08. The majority of the public home builders have already successfully admitted their credit facilities at least once. Many of them admitted at least two to three times to better operate under the current housing market conditions. This will be our first amendment since the housing downturn began.

We have a strong long-standing relationship with many of the banks in our revolving credits facility. Based on our initial discussions we believe that we will be able to successfully negotiate changes that are needed to the credit agreement to adjust for the change in tax treatment, as well as to provide us with adequate operating room as we manage the remainder of the current housing slow down. We expect to close in late January 2008.

Let me touch on the mortgage markets and our mortgage finance operations since that area continues to get a fair amount of attention. I want to comment briefly on the plan announced by President Bush to clean up the mortgage crisis a couple weeks ago. The steps outlined by the President will certainly help reduce the number of homes which could be exposed to foreclosures. Obviously this is a positive for the market, both structurally and psychologically.

Similarly, with respect to the fed decision to lower the discount rate another 25 basis points, this too will have a slightly positive impact. Again, the impact will be more helpful to home buyers’ psychology.

If you turn to slide 13, our recent data indicates that the average credit quality of our mortgage customers remains higher than national averages. The average FICO score for all of fiscal 2007 was 725; higher than the 715 achieved in fiscal 2006. Of course, some of this improvement in our FICO scores is likely linked to tighter underwriting criteria in the fall off and sub-prime originations this year.

The percentage of buyers using adjustable rate mortgages declined to 7% in the fourth quarter bringing the full year to 14% of our originations compared to 32% for the full fiscal year of ’06. For the fourth quarter of ’07, 93% of our customers utilized a fixed-rate mortgage to purchase their home.

Turning to slide 14. We show a breakout of all of the various loan types originated by our mortgage operations during fiscal ’06 compared to the fourth quarter of fiscal ’07. Keep in mind that we sell all of our loans on a whole-loan basis. We identify a buyer of the loans prior to closing on the loan and would not go to the closing table with a loan that we did not have pre-sold.

Our conventional prime loan business, defined as conventional loans with full documentation of income and assets with either conforming or non-conforming loan limits, has increased from 48.7% during fiscal ’06 to 56.7% in the fourth quarter of fiscal ’07. There has been no issue regarding availability of conforming conventional loans.

FHA and VA loans also increased somewhat to 10.6% during the fourth quarter of ’07 from 7.2% of total originations in fiscal ’06. There has similarly been no issue of availability of FHA and VA loans. As underwriting criteria for sub-prime mortgages has tightened, our level of sub-prime business has continued to contract. The amount of sub-prime mortgages generated by our mortgage company declined from 11.1% during fiscal ’06 to 3.7% of total loan volume during fiscal ’07 and accounted for only 1% of our volume during the fourth quarter of ’07.

Alt-A loans were 22% of our volume in ’06, 27% of our volume in ’07, and 26.1% during the fourth quarter of ’07. It has risen slightly over ’06 because it has filled some of the gap created by the sharp reduction of sub-prime loan availability.

To reiterate what we told you on our last call, the industry is going back to mortgage lending 101 basics: if the borrower can verify their income and assets, are willing to put down a reasonable down payment, and have a track record of paying their bills on time there are loans that are available. The market has just returned to sound mortgage credit underwriting criteria principles.

The percentage of our loans that were conforming loan limits increased during the fourth quarter to 95% from 91% in the third quarter. That means that only 5% of our originations are jumbo loans, which have recently been more challenging in terms of rates and availability.

Our pre-tax earnings from financial services was $28 million in fiscal ’07, down slightly from the prior year primarily based on lower volumes.

Now turning back to the performance of our home building operations in the third quarter. Our contract backlog on October 31^st, ’07, excluding unconsolidated joint ventures was 5,938 homes with a dollar value of about $2 billion. On slide 15 we show the backlog at October 31^st for the prior five years and we provide a breakout of the portion of backlog associated with our Fort Myers-Cape Coral operations. The end of our fourth quarter of fiscal ’07, 1,652 homes amounting to $459 million of backlog or associated with the company’s Fort Myers-Cape Coral operations.

Our operations in this market are very different from most of our company’s divisions and we’ve commented that we view Fort Myers as likely the worst housing market in the country. So we think it is worth providing some additional clarity on the status of this sizable sales backlog and the change you will see in this when we report our first quarter 2008 results.

Most of our home buyers in this market first buy a lot from us and then use construction financing from a third-party lender to build a home. We typically receive between 75% and 90% of the purchase price from our Fort Myers customers via their construction loans. However – given that the market has deteriorated so significantly in Fort Myers, many buyers have chosen not to convert to permanent financing where we would normally receive the balance of our sales price.

Approximately 1,400 of the 1,652 homes in our Fort Myers backlog are expected to deliver during the first quarter of 2008 because construction is now completed and we no longer have any further continuing involvement. Since we will not be receiving the last 10% to 25% of our purchase price from the customers who have not closed on a permanent loan we will report deliveries for these homes at a gross margin close to zero and these closings will cause our first quarter consolidated gross margin to be much lower than otherwise would have occurred.

As of October 31^st, 2007, our remaining investment in land and lots in Fort Myers is only $20 million. So our exposure to this market is rather minimal going forward.

Notwithstanding the effects of Fort Myers, the incentives and price reductions that we’ve instituted across the country have kept our margins below normal levels for the past several quarters. Reflecting the continued weakening of the housing market, our home building gross margin was 10.9% for the fourth quarter of ’07.

Regarding SG&A we have made difficult decisions with respect to our staffing levels. So the number of full time associates is down – excuse me. So far the number of full time associates is down 43% from peak levels in June 2006. Making these decisions is never taken lightly, but it is necessary to take these actions when they’re called for by the difficult operating headwinds that our industry faces today. Our staffing reductions should help our SG&A levels for fiscal 2008.

Our indefinite unconsolidated joint ventures declined to $176 million as of October 31^st, ’07, compared to $213 million at the end of last year. Turning to slide 16, we have continued to maintain modest leverage in our joint ventures and to finance them solely on a non-recourse basis. At year end our debt to cap of all of our joint ventures in the aggregate was 45%.

We report significant details on the balance sheet and profits of our unconsolidated joint ventures in our 10-Q’s and 10-K’s, so look there for more details.

Now I’ll comment further on our cash flow and liquidity. Although we’re working to generate positive cash flow by reducing our inventories, EBIDTA has been declining in line with our profits. For all of 2007 we generated adjusted EBIDTA of $135 million down from adjusted EBIDTA of $753 million last year. Adjusted EBIDTA represents earnings before interest expense, income taxes, depreciation, amortization, and land charges. A reconciliation of our company’s consolidated adjusted EBIDTA to net income can be found as an attachment to our quarterly earnings release.

Due to the slowing velocity of deliveries in each of our open communities our inventory turnover, and thus our interest coverage, declined in fiscal ’07. We’re working to bring our inventory investment into alignment with our lower revenues and profits so that our interest coverage begins to improve and our ratio of debt EBIDTA returns to a healthier level.

Although EBIDTA fell substantially we generated $376 million of cash flow in the fourth quarter and we used the cash we generated to reduce our debt. We generated this cash flow primarily by reducing our inventories. This is also how we will continue to generate cash going forward; by reducing inventories which occurs as we deliver significantly more lots with homes on them for cash than the number of new lots we’re purchasing.

We ended the year with $207 million outstanding on our $1.5 billion unsecured revolving line of credit. Our borrowing based excess improved over $200 million at year end from approximately $132 million at the end of the third quarter. Remember that this is not an absolute limit because the borrowing base would grow if we borrowed more funds and invested dollars in qualified assets. A breakout of the qualified inventory assets in our borrowing base on October 31^st is shown on slide 17.

One last comment before I turn it back to Ara. I want to make it clear that we have a covenant in our public debt indentures that now prevents us from paying dividends on our 140 million non-cumulative perpetual preferred stocks. So we’re not expecting to pay those dividends during fiscal ’08.

Now to Ara for some closing comments.

Ara K. Hovnanian

Thanks, Larry. I’d like to step back for a moment to give a little bit of long-term perspective because it’s easy to get caught up in the throes of this current market downturn, which no doubt feels very negative right now. I’d like to look at the longer-term history of our industry. If you turn to slide 18 it shows you housing starts over the last 30 years in this country. Obviously we’re one of the quintessential cyclical industries. A little like the autos, but we’re not threatened by imports.

There have been a lot of ups and downs in our industry. I’ve put in here in blue the most recent data for ’07. That’s annualized housing starts as of November, which were down to just over 1.1 million starts per year. These numbers just came out yesterday and we’re at a 16-year low. As you can see, ’07 is clearly a very sharp correction, although not unprecedented as you look at past cycles.

If you look at the arrows indicating the downward corrections you’ll see that 1975 and ’81 both had downturns that were also very sharp and quite similar in degree of downturn. I suppose the only good thing I can say about the sharp downturn in the current correction is in at least those two cycles where we saw a sharp downturn it was followed by a very sharp upturn. After under producing longer-term demand for long enough the market does tend to correct sharply. At least, it has in the past.

The last down turn in the late ‘80s and early ‘90s was quite different in nature from this one and one that was much more gradual in reductions year by year, never really having a sharp correction in any one year. The corollary is that we also had a gradual recovery, never having a sharp upturn in any year.

The years shown with a gray over hatch are there just to give you a little more perspective because they show when we had national economic recessions. As you can see, all three of the last three major corrections had an economic recession at the same time. Thus we have currently some unusual times for the housing market. The lack of a recession should create a little easier environment for an eventual recovery than we’ve had in the last corrections.

And by the way, Hovnanian Enterprises has been here for all of these corrections, plus a few more as we’ve steered our way through these prior downturns. My father founded the company back in 1959, so we’re quite familiar with these patterns and what needs to be done during the difficult housing markets. Each housing correction is a little different, but what homebuilders have to do is essentially the same.

An additional point of interest, having steered through a bunch of these, you see the orange bar on the top of the chart? This shows what mortgage rates were like at each of those cycles, all certainly very challenging. Nineteen-eighty-one, though stands out as perhaps the most challenging from the rate perspective and the mortgage perspective.

For those of you that were in the housing market at the time, the 30-year fixed-rate mortgages were over 18%. You can imagine what we had to deal with then: an economic recession and 18% 30-year fixed-rate mortgages. Today we are worried about the marginal credit households qualifying for a home because of the challenges in sub-prime and Alt-A (sic). In 1981 we didn’t even have an option of sub-primes or Alt-As. Everyone had qualification problems because the mortgage rates jumped to over 18% and people were losing their jobs because of a recession. There was a lot of doom and gloom everywhere then as there is in every housing cycle. Inventories were also at high levels then. Amazingly, the markets eventually cleared and in 1983, just a short period after the bottom, the market saw a 70% increase in housing starts.

One last bit of information on this particular chart: the dashed horizontal line shows you average housing starts during these three decades, nearly 1.6 million average annual starts. Unfortunately, the industry has tended to overproduce and under produce that long-term average.

If you go to slide 19 the good news is from the long-term perspective demographics are getting stronger. Almost every demographer and actuarialist is projecting greater household formation and creation over the next two decades than what we’ve experienced recently.

Top row shows the key driver of housing and that’s household growth. The first three columns you see what the history has been over the last three decades. The most recent decade we had about $1.2 million net new households created every single year. The next three columns, or the last three, show projections and included Moody’s projections and the Harvest Joint Centre for Housing projections. That projection, going forward, is about 1.4 million to 1.5 million households being created per year. This translates to greater household demand going forward than we have had recently.

On slide 20 you see new home inventories courtesy of Zelman Associates, hot off the press. While it is clearly at very high levels, it is similar to what the market has experienced in virtually every housing correction. We are not in uncharted waters. We have seen the number of months supply of new homes at or higher than these levels in the past.

We are experienced operators and we’ve been around as a company for almost 50 years. We’ve been through many downturns. We were much smaller then, less diversified, far fewer products and price points, and in far fewer geographies. We’ve successfully managed through these difficult times and we’re taking the steps necessary to ensure that we will be in the best possible position when the inevitable recovery takes place.

With that I conclude my comments for today and will be pleased to open up the floor for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question is from the line of Stephen Kim of Citigroup. Please proceed.

Stephen Kim - Citigroup

Thanks, guys. You covered a lot of ground. It’s hard to know exactly where to begin. Let me start with the commentary regarding your gross margin. I think you had indicated, Larry, that the Fort Myers effect with a couple of quarters worth of zero gross margin, would it be fair for us to assume that the remainder of your business outside of Fort Myers is probably still likely to generate a low double-digit gross margin?

J. Larry Sorsby

Yes. I mean, we didn’t have that many deliveries in the fourth quarter from Fort Myers, so the fourth quarter gross margin of a little over 10% wasn’t really impacted by Fort Myers.

Ara K. Hovnanian

Steve, just to be clear, what Larry was trying to explain is that we expect in our first quarter we’ll be delivering those margins, those homes in Fort Myers and that’s where you’ll see the additional effect for that quarter of those homes.

Stephen Kim - Citigroup

Okay. So yeah, that’s going to be a pretty huge effect if it’s all happening in one quarter. Okay, so that’s important. And I’ll leave the FAS ruling for someone else.

Let me ask you about your joint ventures. You gave some, I think you gave some commentary about the debt that resides at the joint venture. I was curious if you could give us a sense for what your proportion at share, you know, let’s just use a completely draconian assumption instead of assumptions and say that worst case scenario you’ve got to shoulder a bunch of debt related to the joint ventures. Could you quantify for us what you think that might be and walk us through the relevant parts?

Ara K. Hovnanian

I guess I’m a little confused by your question. I mean, the debt is truly non-recourse. They can’t put the debt back to us. We have not taken the same approach some of our peers have with respect to providing maintenance and other types of financial guarantees that would prevent the banks to come back. So I don’t really understand the question.

Stephen Kim - Citigroup

Okay. So you basically say that there are no sort of ways that they can come back to you. Your proportionate share you would say is basically zero in terms of repayment guarantees, contingent payment obligations and all the rest of it. That really doesn’t relate to you in your joint ventures.

Ara K. Hovnanian

Correct. That’s correct. And Steve, just to emphasize, that was specifically our strategy in going with low-leveraged joint ventures. Our target was to be under 50% and, as our chart indicates, we’re at about 45% at the end of the last quarter. That’s why we were able to attain those kind of terms.

Stephen Kim - Citigroup

Perfect. Thanks very much.

Operator

Your next question comes from the line of Carl Reichardt with Wachovia Securities. Please proceed.

Carl Reichardt – Wachovia Securities

Good morning, guys. How are you?

Ara K. Hovnanian

Great.

J. Larry Sorsby

Good morning.

Carl Reichardt – Wachovia Securities

Larry, I hate to ask you to do this. I’m a little confused about the comment that I think, Ara, actually you made earlier about further impairments due to shift to cost from communities that you’re walking away from where you’ve got costs allocated to lots that you aren’t going to build on now. Can you quantify that numerically for us, I guess for the year? And maybe explain it in a way that allows me to get to kind of a number that I should be thinking about as things go forward?

Ara K. Hovnanian

Yeah. Sorry for the confusion. Okay. When you walk away from an option the easy and identifiable costs to write off are the option deposits. And that’s pretty straight forward. What gets more complex is when you have common costs in an ongoing community and you’re keeping some lots but walking away from other lots. Essentially what happens is rather than record some proportionate share of those common costs in the write-off of options, instead you re-allocate those common costs to the land that you still own in the early sections. And then once you have those additional costs you do an impairment calculation and if it impairs, triggers an impairment then you have additional costs that indirectly are related to the decision to walk away. I believe those were $77 million in our recent quarter.

Carl Reichardt – Wachovia Securities

Okay. So it’s an increase in the costs side of the forward projection on the impairment because you have to re-allocate to what you still own.

Ara K. Hovnanian

That’s correct.

Carl Reichardt – Wachovia Securities

Okay. I just want to make sure. The $77 million. Okay. My second and final question is, bigger picture, you mentioned that you were a smaller company in past cycles and fewer markets. As you look at your footprint today and recognizing that some of your lot count has shrunk in some of the markets you’ve entered more recently. Do you anticipate significantly shrinking your geographic footprint or even if you run out of lots in a market like California or elsewhere staying in those markets and continuing to re-invest in there in those places?

Ara K. Hovnanian

Yes. Our current plan is not to shrink our footprint, but shrink the size of the foot that’s in that footprint, if you will. We just plan to pare down our inventories in virtually all of our markets.

Carl Reichardt – Wachovia Securities

Okay.

Ara K. Hovnanian

And use other strategies to mitigate risk that being in some of those markets that takes more dollars to play, like in California. So there’s different strategies that we are contemplating once the market turns to reduce our exposure, Carl.

Carl Reichardt – Wachovia Securities

Okay. I appreciate that, guys. Thanks much.

Operator

Your next question comes from the line of Michael Rehaut with JP Morgan. Please proceed.

Michael Rehaut – JP Morgan Securities Inc.

Hi. Thanks. Good morning, everyone. First question is on cash flow. I was wondering if you could share with us some of the drivers of being able to exceed. In the fourth quarter your, I believe it was, guidance of 175 to 250 and likewise why it seems like your, you know, if this has anything to do with seemingly lowering the goal of ’08 where you had previously said $100 million to $400 million and now you’re just saying over $100 million. If you could give us insight into both, you know, 4Q drivers and how that’s affecting your outlook for ’08. And then I have a second question.

Ara K. Hovnanian

Sure. I’ll try and begin. Some of the drivers, obviously making the tough decisions of walking away from some more land and renegotiating the takedown schedules of some of the ones that we continued with certainly helped us exceed our projections. Being even more strict with land development was certainly one of the factors. And also, as you saw, we made good progress in reducing our specs. That was one of the factors as well that helped increase our cash flow.

J. Larry Sorsby

Going forward into ’08, keep in mind that I believe that we made the $100 million to $400 million project for ’08 at least two or three quarters ago. The market has weakened in the intervening time period. So even though we are taking additional steps that Ara just outlined to control kind of the outflow of cash, deliveries have not been as strong as we would have otherwise expected, margins have been a little bit lower than we would have otherwise expected, and therefore we’re moderating our position. We’re not saying we can’t get to $400 million. We don’t know exactly where we’re going to end up at this point, but we’re more confident saying in excess of $100 million.

Ara K. Hovnanian

Basically the issue, say, is similar to trying to project earnings and revenues. Everyone in our industry has been reluctant to do that. Clearly, and particularly as you get further out, cash flow is very tied to that. So we’re trying to be on the safer side of our guidance.

Michael Rehaut – JP Morgan Securities Inc.

Okay. Thank you. The second question is just related to some of your comments about month-to-month trends. Obviously you’ve had a lot of success getting units in or orders in the door for the Sale of the Century. It seemed like perhaps that could have contributed to kind of an opposite period where in October and November you had an extreme low. Then more recently you noted a pick-up in December. I was wondering if you could give us some perspective in terms of, you know, is this volatility in some ways related to or begun by the Sale of the Century? How would you characterize December relative to October and November and relative to September? How are we to think about what perhaps has spurred some of the December pick-up, perhaps from incentives? If you could just give some background on that.

Ara K. Hovnanian

Well, first, yes, undoubtedly our national sales promotion did have an effect on sales in the subsequent weeks. But thus far what we’re seeing in December is not just relative to that post-sale slow down. What we have been saying for a while is that the psychology is such an important part of what’s going on in the marketplace.

Again, compared to other cycles, interest rates are at record lows. Mortgage rates have actually dropped; 30-year mortgage rates have actually dropped in the last month for a conventional product, which is the majority of our housing product. Prices have been dropping for a while so that housing is definitely much more affordable. And at this stage job growth is continuing. So what we’ve really been battling is just a lot of negative psychology.

Now, I’m not saying that psychology completely changed and homebuyers are doing cartwheels or potential homebuyers are doing cartwheels down the sidewalk, but what did change in December is at least some glimmer of positive news with both our President and the Treasury Secretary announcing some plan for the sub-prime recess, which have really been problematic and of concern for people. Keep in mind, sub-primes I think in the total amount of outstanding mortgages are about 7% of the total mortgages outstanding and, in fact, I think the adjustable sub-primes are an even smaller percentage. But it’s been getting a huge amount of press. So some good news about the recess has definitely helped. And then on top of that, if you remember the feds tried to send earlier a message to the market to not anticipate rates and then at the beginning of December it changes that message and in fact lowered rates.

All of that, you know, while not solving all of the problems, were steps that helped create a little more positive consumer sentiment, a little better confidence, and I believe that is part of what helped improve the sales environment in the most recent weeks.

Michael Rehaut – JP Morgan Securities Inc.

And was that seen across the board nationally or more prevalent in certain regions?

Ara K. Hovnanian

We did not see it related to any one market. It has been pretty uniform in the last three weeks.

Michael Rehaut – JP Morgan Securities Inc.

And degree of magnitude in terms of improvement versus November?

Ara K. Hovnanian

Substantial. It was almost like somebody took the faucets that had been slown to a trickle and opened it to kind of a medium-high kind of level. I mean, December’s a tough market to judge anyway, as you know, because it’s a seasonal slow time of the year. But from being well below our expectations, every week in October, every week in November, we’re now at or above expectations to date in December.

Michael Rehaut – JP Morgan Securities Inc.

Okay. One last question and then I’ll move on. The gross margins, could you just for the fourth quarter, was there any benefit in that from prior impairments in previous quarters?

Ara K. Hovnanian

Sure, we had a little benefit. We’ll have a benefit, a big benefit in ’08, obviously, as well, in every quarter given the large amount of impairments that we have taken in the last two years.

Michael Rehaut – JP Morgan Securities Inc.

Larry, do you have a sense of the dollar impact?

J. Larry Sorsby

I think the team’s looking for it. What was it?

Unidentified Male Speaker

It was $88 million, Mike.

Michael Rehaut – JP Morgan Securities Inc.

Eighty-eight million benefit from, in the gross margin from impairments from prior quarters.

J. Larry Sorsby

Yes.

Michael Rehaut – JP Morgan Securities Inc.

Okay. Thank you.

J. Larry Sorsby

Mike, one point in that. Some of that is in the land sale close of sales as well. It’s not just home building cost of sales.

Michael Rehaut – JP Morgan Securities Inc.

Okay. If it’s possible to get that to me later the breakdown or if you have it now, that’d be great.

Ara K. Hovnanian

We don’t have it now. We’ll try and get back to you.

Michael Rehaut – JP Morgan Securities Inc.

All right. Thank you.

Operator

Your next question comes from the line of David Goldberg with UBS. Please proceed.

David Goldberg – UBS

Thanks. Good morning. Larry, I was wondering if you could give us an idea of how you got to the $216 million for the FAS-109 charge and what gives you the confidence of the deferred-tax assets that are still on the balance sheet are going to be recognized?

J. Larry Sorsby

I want to take the second half of that question and I’m going to let Brad O’Connor answer the first half. The reason that we’re confident that we’ll be able to use them is, you know, we’ve been in business for almost 50 years. We’ve been through these down cycles. We are going to return to profitability just as I believe virtually all of the other home builders will as well. And as we return to profitability we will be able to take a tax benefit every time we earn a dollar.

David Goldberg – UBS

But how does that differ from --

J. Larry Sorsby

We return to a three-year, or when we get out of a three-year accumulative loss we’ll be able to reverse the entire allowance in a single shot. So the only way you wouldn’t be able to realize the benefit is if you never make money again.

David Goldberg – UBS

I guess what I’m trying to understand is the difference between what was taken in the reserve and what’s still on the balance sheet as non-reserved.

Brad O’Connor

Let me try to answer that part of the question. The way we determine how much we needed to reserve is we looked at what deferred-tax assets would actually turn in ’08, which we would be allowed to carry back for two years to 2006 when we had income. So those we know we will use. As well as, we have some amount of deferred-tax liabilities that will turn in the timeframe of the 20-year period we’re talking about which will also be able to be used against the assets. So the amount that’s remaining in the balance sheet is what will turn in ’08 and be used against, be carried back to ‘06s income, as well as the small amount of deferred-tax liabilities that will turn during the time frame of the assets and be used against those assets. So that’s how we are left with what we’re left with on the balance sheet.

David Goldberg – UBS

Perfect. And if I could get a follow up on that, I guess my question would be about the three-year for accumulative loss situation you guys judged you were in. What kind of assumptions are you putting into your models to get to that level? Does it include impairments?

Ara K. Hovnanian

Well, again, to emphasize, we are not in accumulative loss position now. Which was what we initially thought was the key test. We are not in accumulative loss position. The issue is as you look forward, which has been clarified in an interpretation, and you drop the highly profitable fiscal ’05 where we had pre-tax earnings of almost $800 million. When you drop that, if you have ’08, which would be nowhere near that level of profitability, that’s what could drive you into accumulative loss position if you look forward.

J. Larry Sorsby

David, again, I’m going to talk about it from the industry’s perspective rather than Hovnanian specifically. I believe virtually the industry as a whole had a grand slam year in ’05. If you drop that for everybody then you have ’06 which was kind of a so-so year for the industry, ’07 which was a bad year for the industry, and add a projection for ’08, even if you project modest to reasonable profitability virtually the entire industry is going to be in a three-year accumulative loss.

David Goldberg – UBS

I got you. So it’s not an ’07-’08-’09 calculation, it’s an ’06-’07-’08 calculation.

Ara K. Hovnanian

Yes.

J. Larry Sorsby

That’s correct.

David Goldberg – UBS

That’s right. Got it. If I could sneak one more in. Ara, you were talking about the macro-economic conditions and the idea that existing home sales prices need to come down to become more in line where new home sale price declines, new home sale prices are now. Do you think that if we start to see more pressure on existing home sale prices that’s going to cause another round of decline in new home sale prices again even though they’ll remain out of equilibrium?

Ara K. Hovnanian

I don’t think so because traditionally, I mean, look, there’s always pressure in the markets and we’ll see what the future holds, but traditionally new home prices sell at a premium to a comparable existing home. It is a very odd scenario right now where existing home buyers, many of them have just held on to higher prices. That’s why you see this inventory rising in the new homes and yet new homebuilders’ inventories are generally starting to drop. So I think it’s got to get back to the normal balance that’s been in place for decades, which is that a comparable existing house should sell at a discount to a comparable new house.

David Goldberg – UBS

Okay. Thanks.

Operator

Your next question comes from the line of Andrew Brausa with Banc of America Securities. Please proceed.

Andrew Brausa – Banc of America Securities

Hi, guys. I wanted to just address quickly, in your negotiations with your lenders on your amendment to your credit facility, how should we think about the potential for layering, meaning that collateral is something that’s at the table for negotiation in providing your bank lenders or is everything under negotiation and are all options opened? Have you guys thought about that? Can you frame that a little bit for us, being that we are on the public side of things?

Ara K. Hovnanian

Sure. Well, I think at this point, there are many things on the table, including securitization on the revolving credit facility. Really it’s just a matter of what the entire package looks like. Obviously we are not the first to seek amendments. In fact, we are one of the few that hasn’t had to have an amendment yet, so we’re about to go through that process.

But I suspect like everyone, all things are on the table and we have to look at the total package to determine what makes the most sense.

Andrew Brausa - Banc of America Securities

Okay, and I guess the second question I have is with regard to draw on the revolving facility. In the first half of last year, you drew about $400 million in the first two quarters of the fiscal year on the facility and this year, you expect a modest draw up from 207 in the fourth quarter. Is it possible for you to maybe drill down that a little bit and give us kind of a range that modest would quantify?

J. Larry Sorsby

No.

Ara K. Hovnanian

No, it’s -- frankly, we’ve had a lot of moving parts. Right now, it’s a little hard to be really precise so we suspect our increases will be modest relative to what they were.

J. Larry Sorsby

But Andrew, it’s also why we don’t give quarterly cash flow projections. I mean, they go hand in hand, and if you look at the two prior year pattern, which we showed you on the chart, that gives you some indication of the way our sort of normal seasonality.

Two years ago, we were also growing still and growing our inventories in some of those early quarters. We don’t expect to be doing that. We do just expect a normal seasonal pattern so it’s very challenging to project on a month-by-month and quarter-by-quarter basis, which is why we are hesitant to do that.

We think by the end of next year, we’ll have generated positive cash flow and paid down the revolver and debt from where we are today.

Operator

Your next question comes from the line of Nishu Sood with Deutsche Bank. Please proceed.

Nishu Sood - Deutsche Bank

Thanks. The first question I wanted to ask was on your pricing and incentive trends and the effect that it’s having on your gross margins. Now the steep drop in your gross margins in the last quarter would tell me that you were being pretty aggressive in terms of pricing and incentives in late spring and the summer. Now, heading obviously into the deal of the century, Ara, you had said previously that that was more just collecting a lot of promotions that had been out there already.

So my question is I just wanted to get an update on that -- does the deal of the century pricing mean that we should expect further pressure on gross margins in coming quarters? And also, what has happened since the deal of the century?

Ara K. Hovnanian

Well, I think you are cleverly trying to get us to project our gross margins, which we are trying to stay away from.

I’d say gross margins in general clearly were affected by deal of the century, but also to a greater extent have been affected by the market in general.

I don’t see that there’s been a big change in our incentives or pricing in the most recent months.

Nishu Sood - Deutsche Bank

How about this -- what has happened in the communities, let’s say, where the deal of the century was very successful after that sale was over? I mean, did you pull the promotions that were in place or have you kept them in place or have you increased them?

Ara K. Hovnanian

In many instances where sales were very good, we pulled the promotion and went back to either pre promotion pricing or something close to that. And then in other cases where sales did not do well, as well as we had hoped in deal of the century, something very close to the deal of the century might still be in place. So it’s varied dramatically.

Frankly, again this is generally a very difficult time to really gauge what’s going on in the marketplace. As you know, everybody is more focused on the holidays and New Year’s, so we really can’t get a good indication of what’s going on until after Super Bowl.

Nishu Sood - Deutsche Bank

Okay, great. And my second question on your inventories, you did a great job of giving us a lot of details on the amount of lots you will be taking down through options, also on the spec part of the inventory. So the third piece though, I just wanted to get a little bit more detail, the land under development which you described. Obviously you are deferring a lot of the infrastructure and development costs that you’d normally be putting in. And I think the amount from the slide was about $1.6 billion or so of -- I’m sorry, $1.8 billion or so I think of land under development. I just wanted to see if I could get a sense of if I wanted to model what that would be on a finished basis, how much would I add to that? I’m just looking for an order of magnitude. Would I add 25% to that, 50% to that?

Ara K. Hovnanian

It’s just not something -- it’s just not a metric that we track in that way, so I’d love to give you that info because we love lots of data but that’s just not a way that we track it.

Nishu Sood - Deutsche Bank

Okay. Thanks a lot.

Operator

Your next question comes from the line of Dan Oppenheim with Banc of America Securities. Please proceed.

Mike Wood - Banc of America Securities

This is Mike Wood. Can you give us the dollar amount invested in unsold inventory currently, and also how much you think you can work that down next year?

J. Larry Sorsby

We show you the total of sold and unsold loans on that same chart of $1.4 billion.

Ara K. Hovnanian

He’s looking for the unsold.

Dan Oppenheim - Banc of America Securities

Yeah.

Ara K. Hovnanian

Yeah, we don’t break that out. In general, just a number, I’d suspect that unsold will start to trend down a little bit. Keep in mind what we track, and it’s a little different than some builders, we track a home as soon as it’s started, not just finished unsold homes. So frankly, in a lot of the cases, we hope to get a sale before the house is even completed.

In today’s environment, while we’d love to bring unsold homes down to zero, it is prudent to have some unsold homes on hand at each community. We are running about five right now throughout the country.

And the reason for that more than ever in the past is that there are many consumers that don’t want to sign a contract to build a new house until they have sold their existing house. The problem is that once they’ve sold their existing house, they typically have to move in 45 days, 30 or 45 days, and you can’t build a house that rapidly. So it is important to have some level of specs a little higher than we generally have targeted.

Having said that, specs because of accidental specs, if you will, people that canceled in their contracts, did creep a little higher so we still believe we’ve got some opportunity to reduce our general spec level. We just haven’t quantified what that would mean in dollars and cents.

Dan Oppenheim - Banc of America Securities

Okay, and we’ve seen some large land sales from some of the large competitors out there. How are you thinking about the trade-off of potentially selling land to pad cash flow and work down your land inventory versus needing to put out more cash for construction in order to work through land inventory that way?

Ara K. Hovnanian

Well, we’ve done a number of land sales. We certainly followed what’s gone on in the industry and the very interesting transaction with Lennar and Morgan Stanley. We are very familiar with joint ventures, as we have done a few. You know, as I said earlier in regard to the credit facility, the same would be here. We’re looking at all options that make sense for our company going forward. We don’t have any definitive plans but it certainly is one of many intriguing options in the environment today.

Dan Oppenheim - Banc of America Securities

Thanks.

Operator

Your next question comes from the line of Wayne Cooperman with Cobalt Capital. Please proceed.

Wayne Cooperman - Cobalt Capital

You wrote off a lot of stuff this quarter and you still have a $19 book value. I was wondering if you could actually opine what I should take that to mean. I mean, does that imply that you should earn some kind of return on that $19 book value, or you could sell all the rest of your assets and we could get $19? Because your stock’s at $7 and something doesn’t make sense.

J. Larry Sorsby

The stock is too cheap.

Wayne Cooperman - Cobalt Capital

Seriously, though, what does $19 mean to me? I mean, are we going to earn a 15% return on that $19 book value? Are we going to keep selling assets that are now at the same price we’ve written them down to?

Ara K. Hovnanian

Well, as I am sure you are well aware, Wall Street has not been kind to homebuilders. Many are selling below book value and --

Wayne Cooperman - Cobalt Capital

[They believe] in the book value. You guys just wrote off a lot of stuff. The $19 is now your kind of -- what you would think accurate book value, or at least that’s part of the question.

J. Larry Sorsby

What you are really asking us to do is make a projection and as I think we’ve made it pretty clear, we are just not in a position that we are going to make a projection.

Wayne Cooperman - Cobalt Capital

I don’t even want a projection. I just wonder if you could just talk about what you guys see as the -- what’s embedded in that? Do you think you could sell your assets for what you’ve written them down to or do you think they are written to a level where you actually earn a return on them?

Ara K. Hovnanian

If you are planning on a 15% return on $20 of book value, I wouldn’t bank on that at this moment. Fifteen-percent ROE is for normal times. We are not in normal times, so I say if that’s your benchmark, I wouldn’t count on that for the short term.

J. Larry Sorsby

Yeah, when the market recovers, which it ultimately will do, we’ll get back to earning those kinds of returns. But when we are still in a cyclical correction or downturn, it’s difficult to approach a 15% return and that’s about all we can say at this point.

Ara K. Hovnanian

Yeah, I mean obviously when the markets were better, we were earning in excess of 40% returns on our after tax, on our beginning equity. Fifteen-percent we kind of consider a more normalized part of the market. And then when you are in a trough of the market, you’d expect to earn below that for sure.

Wayne Cooperman - Cobalt Capital

The other -- I mean, would you guys expect to sell off more raw land or assets and get close to your book value and pay down debt that way?

Ara K. Hovnanian

No. I think generally speaking, the most logical course right now is to continue building and selling homes. We think that maximizes value and cash flow. As opportunities arise on land sales or potential joint ventures, we are certainly going to explore those as well. The main focus and certainly the main thrust is continuing to build through the housing and we think that maximizes the recoverable dollars that we’ve got invested.

Wayne Cooperman - Cobalt Capital

Okay, thank you.

Operator

Your next question comes from the line of Susan Berliner with Bear Stearns. Please proceed.

Susan Berliner - Bear Stearns

I just wanted to make sure I was clear. The $100 million, does that include any pay down on the bank line for next year?

J. Larry Sorsby

Well, we’re not talking about exactly what we are doing with the $100 million. We are just saying we can expect to generate more than $100 million of cash flow.

Susan Berliner - Bear Stearns

So that does not incorporate any additional pay down on the bank line?

J. Larry Sorsby

We’re not saying we’re going to have excess cash of $100 million after paying down some amount of debt, if that’s what your question is. We’re just saying that we are going to generate in excess of $100 million of cash flow and then we’ll determine how to best use it.

Kevin C. Hake

Maybe you’re confused about what our definition of cash flow is. We were careful about that when we started talking about cash flow and there’s actually a pretty clear description as a footnote at the end of our press release about non-GAAP financial measures, and essentially if you are looking for what that number is, you can get it off of our cash flow statement, which we’ll be filing shortly for the year and for the quarter.

But it is essentially equal to what our cash flow from operating activities plus our cash flow from investing activities, but we have a funny category on there called changes in mortgage notes receivable at our mortgage company, so it excludes that.

So back to your question, it’s prior to any changes in debt. So we are going to generated $100 million or more next year prior to any changes in debt. Maybe that answers it for you.

Susan Berliner - Bear Stearns

That helps. And can you quantify at all, I think last quarter you kind of quantified how much you would spend on land. Can you update us at all on that going forward?

Kevin C. Hake

I don’t think we did give that and it’s just something we don’t generally look at in terms of -- we look at overall changes in projected inventories really more than the sub-components of what the money’s being spent on.

Susan Berliner - Bear Stearns

Kevin, can you describe that at all, what your change in inventory would be going forward? Do you see that accelerating?

Kevin C. Hake

Well, we’re going to generate $100 million of cash flow next year and very little of that potentially from EBITDA, so most of that is going to be from changes in the balance sheet, primarily inventory.

Susan Berliner - Bear Stearns

Okay. Thank you.

Operator

Your next question comes from the line of Larry Taylor. Please proceed.

Larry Taylor - Credit Suisse

Thank you. I wonder if we can sort of follow-up; you had given us an $88 million figure as the contribution from write-downs on land under product you delivered in the fourth quarter. Roughly what percentage of the lots that were delivered in the fourth quarter had write-downs in them?

Ara K. Hovnanian

We don’t track that number.

Larry Taylor - Credit Suisse

I mean as a ballpark, is it half, is it -- I mean, I’m not asking for 10 decimal places but just a rough -- is it 90%, is it --

J. Larry Sorsby

I mean, it’s just not something we track, Larry. We just don’t have it.

Larry Taylor - Credit Suisse

Do you have any sense in terms of subsequent to the write-downs that you’ve taken, what that number might look like going forward?

Ara K. Hovnanian

We’re just not projecting that along with any of our projections, Larry. I don’t think any builder is.

Kevin C. Hake

I think you gave some color on a number of communities written down and those that we haven’t. We just don’t track where our deliveries are coming out of which community, impairments or not impaired.

Larry Taylor - Credit Suisse

Okay. Thank you very much.

Operator

Your next question comes from the line of Alex Barron with Agency Trading Group. Please proceed.

Alex Barron - Agency Trading Group

Thanks. I hope you can hear me. I wanted to ask about the deal of the century. I was under the impression that most of the homes that participated in that program were basically finished specs, so I’m kind of a little surprised why only 450 or so have been delivered so far. Can you comment on that?

Ara K. Hovnanian

Sure. Actually, it was interesting that -- and we had announced this earlier -- that while we thought the big focus would be on spec, that in fact we sold a lot of new orders as well. So in fact I think we announced it was less than 50% of our sales were spec. So many of our homes are currently being built from that for our customers.

J. Larry Sorsby

We announced that publicly, Alex. I’m not sure why you came to the conclusion that most if not all of them were specs.

Alex Barron - Agency Trading Group

Okay. I guess it was just from some company, some community visits I made that that was my understanding, so maybe I got it wrong.

Ara K. Hovnanian

It certainly varied from one community to the other and some communities definitely emphasized specs more. Others targeted specific lots that they thought were more challenging, so the actual selection varied greatly from community to community.

Alex Barron - Agency Trading Group

I wanted to switch topics here a little bit. I understand the FAS-109 and I’m sorry I’m not that familiar with this accounting pronouncement, but to understand the three year cumulative loss position, is this on a pretax basis? Is it also on a last 12 months basis or do you only do it at the end of every fiscal year?

J. Larry Sorsby

It’s a pretax basis and what we did, Alex, again just to clarify, is we looked as of the 36 months ended October 31st ’07, we determined that we were not in a three-year cumulative loss position. In spite of that, what we then did was drop off the 12 months ending October 31st ’05 and replaced that highly profitable year with a reasonable projection of what ’08 would be, which obviously will not look nearly as good as ’05. And when we drop off ’05 and add ’08, it’s likely that we will be in a three-year cumulative loss, in light of the loss we just posted for our ’07 year.

Alex Barron - Agency Trading Group

So basically that’s why in a sense you reversed what you had baked in before and then you took a new charge this quarter?

J. Larry Sorsby

Ara didn’t mention that but it has nothing to do with FAS-109. That’s just in essence what’s kind of occurred.

Alex Barron - Agency Trading Group

Okay. You mentioned that some other builders might not, or some other auditors might not interpret things the same way. Are you referring to that only Ernst & Young has a three-year cumulative loss interpretation or is that standard across the group?

J. Larry Sorsby

I don’t want to speak for what the other auditors may or may not do. We are aware that not all of the firms are interpreting or applying FAS-109 in an identical manner, that Ian Wye has advised us to apply it and that’s about all I’m going to say.

Ara K. Hovnanian

FAS-109 does not go into the level of detail to tell you what three years you are supposed to look at, et cetera. It’s an --

J. Larry Sorsby

-- doesn’t even define three years.

Ara K. Hovnanian

It’s an interpretation, so firms may interpret differently.

Alex Barron - Agency Trading Group

So what I’m saying is, is the three years something they invented or is that something --

J. Larry Sorsby

That’s their interpretation.

Alex Barron - Agency Trading Group

Okay.

Ara K. Hovnanian

And frankly, I think the three years is probably common. The issue is do you only use the current year and two backwards, or do you actually project? And I think that’s where some of the variation may come.

J. Larry Sorsby

And I think it’s also that even if you are determined to be in a three-year cumulative loss, regardless of whether it is historical three years or two years historical and one year prospectively, if a firm or a company believe that they were going to be in a position of being able to recover and generate profits in the near-term years, which is an accounting term, then even then certain firms may not advise clients that they need to take the charge.

Alex Barron - Agency Trading Group

Now, some people have been talking lately about taking tax carry-backs, not carry-forwards, and being able to I guess collect some money from the government. You guys aren’t in a position to do that?

Ara K. Hovnanian

We are. The issue is you can carry back to two years, so that would be ’05 and ’06 for us for this current year, and we are doing that and do get refunds. But the impairments we have, and particularly in some of the cases of the intangibles, they go beyond what you can currently deduct and receive refunds for.

Alex Barron - Agency Trading Group

But since like ’05 is going to be behind us, does that mean -- is it pretty immaterial what you were able to get back or can you quantify that?

J. Larry Sorsby

Well, it was a material amount but we didn’t fully receive -- I mean, if we had done a transaction like Lennar did and sold a bunch of assets at steep discounts right before the end of our fiscal year, we would have gotten a much more material number and a refund than we are going to be receiving now.

There is nothing we can do now to go back and recover a cash refund for the ’05 year because our -- that’s more than two years carry back now because our ’07 year is now ended, so all we can do is focus on the ’06 year and the ’06 year, we will get a refund of virtually 100% of the taxes that we paid in that year.

Alex Barron - Agency Trading Group

Okay. All right. Thanks, guys.

Operator

Your next question comes from the line of Jim Wilson with JMP Securities. Please proceed.

Jim Wilson - JMP Securities

Thanks. Two questions; one, Larry, I was wondering, the inventory item on the balance sheet of land and land options for future development, it actually went up year over year and I was wondering if you could explain a bit of the components, since I assume land options themselves went down, but maybe I’m wrong.

J. Larry Sorsby

Repeat the question again?

Jim Wilson - JMP Securities

Well, on the balance sheet, when you are on your assets and your inventory, obviously your in-process inventory sold on some homes went down but your next item of land and land options held for future development or sale increased year over year and I was wondering sort of what the components were that drove that up, since I assume within it land options themselves in dollars actually declined.

J. Larry Sorsby

One of the primary reasons that went up was because we did have properties that we called mothballed. Those communities went from being under development into being held for future sale.

Jim Wilson - JMP Securities

Is that a pretty material number? Is there any way of describing what is actually -- is some of it just options --

J. Larry Sorsby

-- the number in the conference call, we gave you the numbers on how much is invested in option deposits, which --

Jim Wilson - JMP Securities

Okay. So that and so the difference -- that would be the difference, okay.

J. Larry Sorsby

Well, the difference is not all of it but most of that’s a good --

Jim Wilson - JMP Securities

Okay, well, that will be fine. Okay, that’s fine. And then the other one then, I was just looking through cancellations and looking and noticing the number on the sale of the century, obviously wasn’t too bad, like 20%, 21%, but your total cancellations for the whole quarter were 40, so doing the math right, that would imply an awfully high cancellation rate on the non-sale of the century stuff. Is that about right? And any thoughts or comments on that?

J. Larry Sorsby

I think that’s factually correct and I think one of the reasons that that occurred was that we had people in our backlog that had been previously approved for certain mortgage programs that subsequently became not available and therefore they couldn’t find alternatives they had qualified for and they cancelled, as well as people just getting nervous about what was going on in the housing industry and deciding not to move forward with their transactions.

Jim Wilson - JMP Securities

Okay, any geographic concentration or anything in particular to color that further?

J. Larry Sorsby

Well, I think that’s a fairly generic response that we are hearing pretty much everywhere in the country, other than -- well, even in Texas we had the people using Alt-A and sub-prime, so I think it’s fairly generic.

Jim Wilson - JMP Securities

Okay, makes sense. All right, thanks.

Operator

Your next question comes from the line of Stephen Kim with Citigroup.

Stephen Kim - Citigroup

Thanks. I had a couple of follow-ups. Can you start with the cash flow? I just want to understand the impact of the Fort Myers deliveries on your cash flow. For example, I think you indicated there was like almost $500 million worth of -- yes, can you hear me?

J. Larry Sorsby

Yeah, let me just short-circuit you there; because we’ve already got the cash because these people bought a lot from us and then went and got a third party construction loan and as we built the house, we were advanced monies under their construction draws --

Stephen Kim - Citigroup

Got it. Construction --

J. Larry Sorsby

-- for the most part is going to be cash flow neutral.

Stephen Kim - Citigroup

Got it. Forgot about that. Okay, yeah, because I was really confused other than that. Okay, fine. That helps. And then the second thing relates to the FAS rule. I just want to make sure that I’m clear. I mean obviously from my perspective, it seems a little silly but essentially, the only way -- what this really seems to do is just create a deeper V in your GAAP earnings, whereas it doesn’t really seem to have much impact at all on your cash. It doesn’t impair your ability to use deferred tax assets in terms of reducing your cash tax payments going forward.

What it does though is it sort of warps your reported earnings going forward. Once you become profitable, you are just going to have an all-at-once recovery that is going to boost your book value in much the same way that it just hit your book value, basically.

J. Larry Sorsby

You are exactly 100% accurate.

Stephen Kim - Citigroup

So by extension, if somebody wanted to let’s say evaluate your company, your stock on a price-to-book basis, one would therefore think that they should be taking your stated book value and perhaps assuming an ongoing concern, be adding back this $3 of book value hit, theoretically as well.

J. Larry Sorsby

That would be a logical analysis and conclusion to go through and it also is perhaps highlights why some of the accounting firms don’t necessarily come to exactly the same conclusion because they are fearful that in future periods, if you take the charge now that perhaps future periods will have higher than normal earnings and can be criticized for that.

Stephen Kim - Citigroup

Yeah, no, absolutely. Okay, a couple of just housekeeping items, if I could; there was -- you gave disclosure on the number of owned and option lots. Can you give us a sense for what the JV lots balance stands at the end of the quarter?

J. Larry Sorsby

Someone is looking that up.

Stephen Kim - Citigroup

Okay, and then meanwhile, I had another housekeeping item regarding your -- what is the purchase price of the options that you currently hold? I think it was $3 billion last quarter. I’m just trying to figure out roughly, do you know what it was this quarter?

J. Larry Sorsby

I know we have that in the draft of the K, if anybody has that. We’ll look that up to and if we don’t get it in a couple of seconds, we’ll call you with both those numbers.

Stephen Kim - Citigroup

Okay. That’s fine, and I guess just lastly, just a conceptual question as it relates to modeling; over the last couple of years, your conversion ratios, you know, the number of closings you generated in any quarter relative to your backlog was surprisingly low -- not surprising, but significantly lower and that obviously related to this Fort Myers acquisition you had.

And so therefore, as this fades in the rearview mirror, one should naturally expect that your conversion ratios would be higher, sort of going back to --

J. Larry Sorsby

Higher than they’ve been in the last couple or three quarters, yes.

Stephen Kim - Citigroup

Absolutely, which is -- okay, got it. Perfect. Thank you very much and if I can get that data later.

J. Larry Sorsby

We have one answer for you, Steve.

Kevin C. Hake

The JV lots are about 4,300.

Ara K. Hovnanian

And zero under option in the JVs.

Stephen Kim - Citigroup

Zero under option in the -- okay, right. Got it. Okay. All right.

J. Larry Sorsby

We’ll get back to you with -- hold on. You think you have option dollars here and we can answer that? Is this just JV or is this --

Kevin C. Hake

No, it’s for everything. It’s $2.1 billion.

Stephen Kim - Citigroup

Okay, great. Thank you very much.

Operator

Your next question comes from the line of Chris Melendez with J.P. Morgan. Please proceed.

Chris Melendez - J.P. Morgan

I have two questions; first, can you give me some color on the negotiations with the banks for the amendment -- give me more comfort on why you feel like that you’ll be able to accomplish this in January?

J. Larry Sorsby

Well, let me just -- first off, you all have been very accommodating in your own firm and approved our waiver very timely, so we appreciate that.

Secondly, similar to all of our peers who have gone for at least one amendment, most of them have, and some of them two and three times, we expect to have similar success as we negotiate our amendment going forward. But I’m not going to be able to give you any color on the negotiations beyond that point.

Chris Melendez - J.P. Morgan

Well, not on the negotiations, but is it a smaller syndicate than normal? I think we’ve talked in the past in that you’re very close with three or four banks and the line --

J. Larry Sorsby

No, it’s just -- we are not bifurcating our line at this point or anything like that. It’s the full bank group that we’re dealing with.

Chris Melendez - J.P. Morgan

Okay, so can you give me a number on, you know, in the process --

J. Larry Sorsby

It’s like 26 banks or something like that. It’s all publicly available and it’s not much different than any other big builders.

Chris Melendez - J.P. Morgan

Okay, and then secondly is that with regard to inventory reduction, you guys were talking about a -- in the fourth quarter about a 15% reduction, $597 million sequentially. What should I expect for next year, a sort of similar number?

J. Larry Sorsby

Repeat the question?

Chris Melendez - J.P. Morgan

With regard to your inventory reduction in the fourth quarter, sequentially you produced a 15% reduction, 14.5% reduction of $597 million. Can I expect a similar number to that for 2008?

J. Larry Sorsby

I’m just not going to be making projections for you, so --

Kevin C. Hake

We answered earlier that we are going to generate $100 million of cash flow for the year and we expect most of that likely to come through, or more, and there’s potential upside to that but it is largely going to come through inventory reduction. So that’s the answer for the year.

Chris Melendez - J.P. Morgan

Lastly, with the borrowing base, is that 200 now?

J. Larry Sorsby

That’s what it was as of October 31, 2007, yes, that’s what we --

Chris Melendez - J.P. Morgan

Two-hundred million? Okay. Thanks.

Operator

Your next question comes from the line of Keith Wiley from Goldman Sachs. Please proceed.

Keith Wiley - Goldman Sachs

I’m just wondering if your cash flow projections are incorporating any significant land sales or if you are considering doing any other means to help get the revolver down?

J. Larry Sorsby

We’re just not going to give you the details of our cash flow projections. We are confident that we are going to be able to achieve in excess of $100 million cash flow in the year.

Keith Wiley - Goldman Sachs

Okay, and then one more, if you don’t mind; as far as your write-downs that you’ve taken so far, most economists are expecting an additional price decline in housing as a result of all the foreclosures that are expected to come in 2008. Are you incorporating additional price declines for next year into your write-downs, or if there is additional price declines, should we expect possibly additional write-downs?

Ara K. Hovnanian

Well, as I discussed in my portion, we think there is going to be a lot more pressure on existing homes and foreclosures would be -- competition for existing homes than there is on new home prices. New home prices have already gone through a significant downward adjustment.

Keith Wiley - Goldman Sachs

But you don’t think there will be much more additional downward price adjustment on --

J. Larry Sorsby

We really don’t know. We think that the new home builders are way in front of the existing home sellers and have taken significantly more cuts than existing homes, and when you hear economists quote the Case-Shiller index, that’s only on existing homes and we acknowledge that existing homes haven’t come down much. But I think if you talk to just about any of the public builders, they’ll tell you that they have significantly lowered prices.

Are more price decreases going to be needed in the future? You know, we don’t have a crystal ball that answers that question.

Kevin C. Hake

But Keith, with regard to the second part of your question, it wouldn’t matter what rosy scenario or what negative future view we had. We’ve been very clear how impairments work and how we go through that process and we think we are reasonably conservative in that process but we are using what we believe are today’s conditions and projecting that for a fairly long period going out in the future.

If it’s a very long life community, then we may go some improvement in pace, generally not in pricing, out a couple of years. So the accountants are very much -- work closely with us in terms of being very consistent in the approach we take and wouldn’t really want us to be assuming there is going to be a further decline in pricing and things are going to get worse. Making our impairment number bigger would not be something auditors would necessarily look favorable on, unless that was our standard approach.

So if things deteriorate significantly further, I think we’ve been clear on this comment in prior calls -- yes, if pricing does fall further, that could trigger further impairment.

Keith Wiley - Goldman Sachs

Okay. Thank you.

Operator

Your next question is a follow-up from the line of Michael Rehaut with J.P. Morgan. Please proceed.

Michael Rehaut - J.P. Morgan

Thanks. I know it’s getting a little long here in the tooth with this call but just a couple of quick questions. Can you give an idea of the geographic dispersion of the asset impairment charges?

Ara K. Hovnanian

We’ll see if we happen to have that --

Kevin C. Hake

It will be in the 10-K that’s going to be filed in the next few days. I don’t know if we have it right here.

J. Larry Sorsby

We didn’t give it here but I think we’ve given it in the past through the last quarter and I think you are going to see a similar weighting towards California and the east. It will be in our K.

Michael Rehaut - J.P. Morgan

Okay. Also, there was a question about land sales and cash flow and you declined to give an idea to what that could contribute to ’08 cash flow but in terms of 4Q and perhaps fiscal ’07, can you give us an idea what land sales -- how much land sales contributed to those periods?

J. Larry Sorsby

-- land sales.

Michael Rehaut - J.P. Morgan

Sorry?

Kevin C. Hake

Land sales I think in the fourth quarter were about $42 million. That was the gross --

J. Larry Sorsby

Yeah, that was -- no, no, that’s revenues.

[Multiple Speakers]

Michael Rehaut - J.P. Morgan

Okay. And just lastly, you gave a breakdown of the lots under option and you have about 25,000 that are in Texas, North Carolina, D.C. and the Northeast. Is it safe to say that the remainder is in largely California or Florida --

Ara K. Hovnanian

-- actually then there are about 4,200 in California, Florida, Minnesota, and Chicago. So then the rest are in other smaller markets -- South Carolina, Georgia, Ohio, Phoenix and a few others, little markets.

Michael Rehaut - J.P. Morgan

Thanks very much.

Operator

Your next question comes from the line of Timothy Jones with Wasserman and Associates. Please proceed.

Timothy Jones - Wasserman & Associates

Good afternoon. Just a quick question on this Fort Myers situation, I find it very intriguing. I don’t think in 40 years I’ve seen something like this, but am I to understand that the people bought the lots and paid you for that portion -- you’ve got that from a cash flow basis, and now that for the -- you got 80% of the construction loan, but since they are keeping construction loans and not changing them to conventional loans, you lose the last 20%. Is that correct?

J. Larry Sorsby

You basically have it right. They may have gotten a construction loan that has paid us for the lot rather than the customer actually paying us for the lot but I think the rest of it, you are pretty much on track.

Timothy Jones - Wasserman & Associates

So basically you are not getting that last 20%. Does the customers borrowing go down by that amount too, since he’s not in your profit?

J. Larry Sorsby

I’m sorry, what did you say?

Timothy Jones - Wasserman & Associates

In other words, you were supposed to get $100 but you got $80. The other $20 was your profit. Does the customer basically own instead of $100, does he own $80 to you for the construction loan?

J. Larry Sorsby

Does he owe 80 on the construction loan?

Timothy Jones - Wasserman & Associates

In other words, does he own 80% instead of the 100% because part of that was just what you were going to get as your profit.

Kevin C. Hake

Tim, are you saying owe -- o-w-e -- or are you saying own, o-w-n?

Timothy Jones - Wasserman & Associates

No, what they owed. What they had to owe if you were borrowing $100 but $20 of that was going to you and you are not taking it now, do they actually owe $80 to the construction loan company?

Kevin C. Hake

Yes, they have a construction loan to the bank and your simple analysis, roughly $80 is what they owe the bank.

Timothy Jones - Wasserman & Associates

Okay, lastly, when you said zero gross margins, you were talking just about these 1,400 homes in Fort Myers, hopefully.

Kevin C. Hake

Correct.

Timothy Jones - Wasserman & Associates

Okay. Thank you. Have a nice holiday.

Operator

Your next question comes from the line of Joel Locker with FBN Securities. Please proceed.

Joel Locker - FBN Securities

Just wanted to dig a little more in-depth on the gross margin. I guess the sequential drop last quarter was about 45 basis points and the two quarters before that was about 200 basis points. And this time it was 570. And this is actually with an impairment reversal that would actually add to the gross margin, so I just wanted to see if there was maybe a higher percentage of specs that were actually closed versus the prior quarter or what was behind just the massive fall-off on gross margins?

J. Larry Sorsby

I think it’s an indication of the market conditions out there and in general.

Ara K. Hovnanian

Well, and earlier in the year, we had a lot more sales from backlog that was obtained during better pricing times with higher margins, and as we delivered through the backlog it shifted to more new sales, which clearly have a lower margin.

Joel Locker - FBN Securities

And the people in backlog, just to keep them there, did you have to give them another 5% or 6% from the actual contract price just to make sure they close or -- it’s just --

J. Larry Sorsby

I wouldn’t describe it as an additional 5% or 6%, but were we negotiating with customers from time to time that were in our backlog as they saw us adjust prices for people that haven’t yet bought, the answer is yes. We did make adjustments.

Joel Locker - FBN Securities

Right. It just seems, you know, you had a 230 bp reversal in impairments in the third quarter and this quarter, it looks like maybe 400 or 500, so that would actually add 2% or so to gross margin. So it technically might have dropped somewhere between 700 and 800 basis points sequentially, which just seems like something severe more than just continued deterioration.

J. Larry Sorsby

I think it’s continued deterioration.

Ara K. Hovnanian

Yeah. I think we’ve tried to describe it as best we could.

Joel Locker - FBN Securities

All right. Thanks a lot.

Operator

And there are no other questions at this time. I would like to turn the call back over to Mr. Ara Hovnanian for closing remarks.

Ara K. Hovnanian

Thank you very much. As I started out by saying, these are indeed challenging times but not times that are unfamiliar to our industry or our company. We will navigate through these difficult times as we have many times in our 50-year history and we look forward to more positive news on future conference calls in the future. Thank you very much.

Operator

This concludes our conference for today. Thank you for participating and have a nice day. All parties may now disconnect.

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