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Ryland Group Inc. (NYSE:RYL)

Q4 2007 Earnings Call

January 24, 2008 12:00 pm ET

Executives

Drew Mackintosh - VP of IR

Chad Dreier - Chairman, President, and CEO

Gordon Milne - EVP and CFO

Dave Fristoe - SVP and Controller

Analysts

Michael Rehaut - J.P. Morgan

David Goldberg - UBS

Daniel Oppenheim - Banc of America Securities

Carl Reichardt - Wachovia Securities

Nishu Sood - Deutsche Bank

Robert Jordan - Morgan Stanley

James Mccanless - Ftn Midwest Securities Corp.

Ivy Zelman - Zelman & Associates

Steve Surrell - Conning Asset Management

Scott Cavanaugh - Merrill Lynch

Alex Barron - Agency Trading Group

Joel Locker - FBN Securities

Operator

Good day, everyone, and welcome to the Ryland Group fourth quarter 2007 earnings release conference call. Today's conference is being recorded.

At this time for opening remarks and introductions, I would like to turn the conference over to Mr. Drew Mackintosh, Director of Investor Relations.

Please go ahead, sir.

Drew Mackintosh - VP of IR

Good morning, and welcome to Ryland's fourth quarter 2007 earnings conference call. Today's call is being transmitted live over the Internet and can be accessed through Ryland's Investor Relations section of the web site at Ryland.com.

In a moment, I will be turning over the conference call to Chad Dreier, Ryland's Chairman, President and Chief Executive Officer. Also joining us today are Gordon Milne, Ryland's Executive Vice President and Chief Financial Officer, and Dave Fristoe, Ryland's Senior Vice President and Controller.

Before we begin, please be aware that certain statements in this conference call are forward-looking statements based on assumptions and uncertainties that include the completion and profitability of sales, changes in economic conditions and interest rates, consumer confidence, and general economic business and competitive factors. These factors and others may cause actual results to differ from the statements made in this call.

With that out of the way, I'll now turn the call over to Chad Dreier.

Chad Dreier - Chairman, President, and CEO

Thanks, Drew.

Hello, and thank you for joining us today for a recap of the Ryland Group's fourth quarter and full year 2007 results.

As I'm sure you saw in the earlier release, earnings for the quarter came in a loss of $4.80 per share, which brought our full year results to a loss of $7.92 a share.

Profitability was once again impacted by the need to take charges related to noncash impairments and option abandonments. In addition to $198 million in inventory valuation adjustments and $45 million in option deposit and feasibility cost write-offs, we also took a $75 million charge to reflect the creation of a deferred tax reserve allowance. Excluding these charges, earnings per share would have been $0.54 for the quarter and $2.58 for the full year.

2007 turned out to be one of the toughest years for homebuilding in recent memory. Buyer confidence eroded, the mortgage market tightened up, and the levels of new and existing homes for sale rose to high levels.

These issues will likely continue to negatively impact our business as we begin the new year, however I am encouraged with how Ryland is positioned to face the challenges ahead. I will elaborate on this in a moment, but first let me go over some of the details from the quarter.

In the Homebuilding segment, fourth quarter revenues came in at $854 million, a 37% decline from the fourth quarter of 2006. This decrease was due to a 30% drop in closing and a 10% reduction average closing price.

Gross profit margins were negative 15.3%. Excluding the inventory valuation adjustments and write-offs, gross margins would have been 13.9%.

We were able to lower SG&A by $20 million and corporate expenses by $5 million compared to the fourth quarter of last year.

As a percent of housing revenue, SG&A came in at 10.2% in the fourth quarter.

We generated 1,596 new sales in the quarter, 7% less than the same period last year.

Sales were essentially flat in the Southeast region, down 4% in the West, and down 10% and 12% in the North and Texas regions, respectively.

Cancellations continue to be a serious headwind for the industry and for Ryland. The cancellation rate for the period was 46% as a percent of gross sales. It is obviously tough to gain any sort of momentum when buyers fall out of backlog at such high levels.

Despite the high cancellation rate, our sales force did an excellent job of clearing out our unsold inventory. Our spec count at the end of the year, December 31, stood at 823 homes, a decrease of 53% from December 31, 2006.

For the full year, we closed 10,319 units and sold 8,982 net new homes. Our backlog of sold homes at the end of the year came in at 2,869 units.

We had a number of divisions that generated profits in 2007, even after the effects of inventory write-downs. The top five were: Orlando, Baltimore, Charlotte, Charleston and Indianapolis. These five divisions also fared the best in terms of return on investment as well.

I want to thank all of our employees for their hard work in what proved to be a very difficult year.

Our Financial Services segment, which provides mortgage, title, escrow and insurance services, contributed $16 million in pre-tax earnings in the fourth quarter. For the full year, they generated $41 million for the company.

The mortgage options currently available for buyers are pretty straightforward. You need to qualify for a prime loan or you need to be eligible for a government-insured loan. In the fourth quarter, 72% of the loans we originated were prime loans and 28% were government-issued.

The good news for qualified buyers is that rates continue to trend down as the yield on the benchmark 10-year Treasury remains well below 4%.

The average FICO score for our buyers was 711, and our capture rate came in at 79%.

As most of you already know, Bank of America announced that they will acquire Countrywide Financial later this year. Countrywide has been a great strategic partner for us, acting as the primary buyer of our mortgages for many years now. We've always found their systems and mortgage platform to be the best in class, and based on initial conversations we've had since the announced acquisition, we believe it will be business as usual as far as our relationship with them is concerned. The combination of Bank of America's considerable capital and Countrywide's technology and expertise will hopefully be a stabilizing force in the mortgage industry.

Turning to the balance sheet, we were able to end the year in great financial shape. In the fourth quarter, we generated $312 million in operating cash flow which allowed us to pay off the remaining balance outstanding on our bank line, retire another $25 million of senior notes due this year, and increase our cash balance to $244 million.

Our net debt-to-capital stood at 35% at the end of the period.

Interest incurred and capitalized interest included in cost of sales both came to roughly $14 million in the quarter.

Our lot count was down 34% at the end of 2007 compared to the end of 2006. We ended the year with 39,900 lots under control, with a breakdown of 26,647 owned and 13,253 optioned. Based on last year's closings, this translates into a little less than a four-year land supply.

Further deterioration in several markets compelled us to take the additional $198 million in inventory valuation adjustments in the quarter. The biggest impairment charges were taken in Las Vegas, followed by Washington, D.C., Tampa, Chicago, and Jacksonville, Florida.

We also dramatically reduced our option land position, walking away from $45 million in option deposits. We now have $75 million left in option deposits on the books, and $24 million in specific performance commitments.

The majority of the forfeitures - walkaways - occurred in Washington, D.C., Chicago, Atlanta and Northern California. These charges were painful but necessary steps to bring the value of the land on our books in line with the market and lower our optioned lot count to a more appropriate level.

In conclusion, 2007 was one of the toughest years I have ever experienced in my 30 years of homebuilding. While there are still a number of headwinds facing the industry, I believe Ryland is in a position to weather this storm and ultimately capitalize on the opportunities that will arise when the market does turn.

We enter 2008 as a pretty lean company. Our spec count is at its lowest level in over eight years. Our headcount of 2,026 employees is down 37% from the peak and is on par with staffing levels from the late 90s.

We had no debt outstanding on our credit facility as of December 31 or today. After we pay off the remaining $50 million in senior notes coming due this year, our next long maturity occurs in 2012.

The fact that we generated $312 million in operating cash flow in the fourth quarter should alleviate some of the concerns about our ability to generate cash flow. Our limited capital requirements in terms of land development and purchases leads us to believe that the cash generation will continue in 2008.

Finally, the one silver lining in regards to the billions of dollars the public builders have taken in inventory valuation adjustments over the last 18 months is that our average lot cost is now significantly lower than what it used to be, particularly in the toughest markets. Hopefully we have reached a land valuation basis in those markets at which we can sell affordable homes profitably. We will know more about the health of each market in the spring.

That concludes my prepared remarks, and now we would be happy to take your questions. Thank you.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) And our first question today comes from Michael Rehaut with J.P. Morgan.

Chad Dreier - Chairman, President, and CEO

Hey, how are you? Hello?

Operator

One moment please.

Chad Dreier - Chairman, President, and CEO

Okay.

Michael Rehaut - J.P. Morgan

Hello?

Chad Dreier - Chairman, President, and CEO

Yeah, hello.

Michael Rehaut - J.P. Morgan

Yeah. Can you hear me now?

Chad Dreier - Chairman, President, and CEO

We can.

Michael Rehaut - J.P. Morgan

Great. I had this problem on the Lennar call also. I don't know what's - my phones are just -

Chad Dreier - Chairman, President, and CEO

You need to switch to Verizon.

Michael Rehaut - J.P. Morgan

There you go. First question just relates, Chad, to you mentioned some of the markets, you know, that had still turned profitable for you.

I was wondering, with these impairment charges, how much further - I mean, what needs to happen in a California or in Vegas, for example - you know, some of the real tough markets? Do these impairments get you back to a normal level of profitability, or are you still dependent on further let's say SG&A cuts or a pickup of volume?

Chad Dreier - Chairman, President, and CEO

You know, that's a good question, and if I had the perfect answer, I'd give it to you.

But I think basically in California and Vegas - that's the two you mentioned - I think you're still going to continue to see big incentives to move the houses, even if we're at a market value. I think the buyers just - it s a buyers' market still, and I think we're going to need to significant incentives to move the properties, at least in California.

In Las Vegas, we're a little closer to the market and, you know, I feel a little better about the general, I guess, marketplace in Vegas. And the prices have gone down significantly. I think you could challenge in California whether affordability is good enough yet.

So that's probably not a very clear answer.

Michael Rehaut - J.P. Morgan

No, but I appreciate the color.

Second question, just if you could give us a sense for how orders trended throughout the quarter, and if possible, maybe an early read on January?

Chad Dreier - Chairman, President, and CEO

Well, I wouldn't comment on January. You know, it's just too early and it's a long year. So on the fourth quarter, do you have any - I don't know that I would say there was any significant trend up or down from October to November to December, so nothing that would stick out that would lead you to conclude one thing or another.

Michael Rehaut - J.P. Morgan

Okay. And one last question if I could. If you have it on you, the benefit in gross margins from prior impairments?

Chad Dreier - Chairman, President, and CEO

Yeah, we do have that.

Gordon Milne - EVP and CFO

For the quarter -

Chad Dreier - Chairman, President, and CEO

Yeah.

Michael Rehaut - J.P. Morgan

Yes.

Chad Dreier - Chairman, President, and CEO

Here, hold on. I got it. We had $28 million in impairment reversals, which benefited margins by 330 basis points. Is that what you're looking for?

Michael Rehaut - J.P. Morgan

That's it.

Chad Dreier - Chairman, President, and CEO

Okay, thanks.

Michael Rehaut - J.P. Morgan

Thank you, Chad.

Chad Dreier - Chairman, President, and CEO

Okay.

Operator

And next we'll go to David Goldberg with UBS.

David Goldberg - UBS

Thanks. Good afternoon.

Chad Dreier - Chairman, President, and CEO

Dave, how are you?

David Goldberg - UBS

Morning, you guys.

I was wondering if you could talk a little bit about the valuation allowance that you took? It doesn't seem to me that you'd be in a cumulative loss position, so what drove the need to take the valuation allowance and maybe some mechanics behind how you determined it?

Chad Dreier - Chairman, President, and CEO

I don't understand the question.

Gordon Milne - EVP and CFO

Well, I'm going to stay a little general because we're not giving out guidance for 2008, but the following factors are relevant in determining the reserve required: the impairment levels versus income over the last few years, future income, timing of impaired asset turns, and reliance on income after 2009.

Just to help you, the allowance included $22 million of state taxes for which carrybacks were not allowed. And for federal taxes, to the extent that deferred assets turned in the near term, no allowance was required.

David Goldberg - UBS

Okay, thanks.

And Chad, if I could get a follow up here, I guess I'm wondering if you'd give me an idea of where people are cancelling in terms of how far along in terms of construction? Is that changing at all? Does it tend to be later in construction now or earlier in construction?

Chad Dreier - Chairman, President, and CEO

I would say it's all over the board. I mean, you know, there's people that cancel because they can't get a loan. There's people that cancel halfway into construction. There's people that cancel, you know, on the day they're supposed to close. So it is still all over the board.

And, you know, we're actually working harder on dealing with buyers who have houses to sell, which is obviously a challenge, in that we're trying earlier in the game - you know, Mr. and Mrs. Goldberg buy a house, and they have a house to sell - we're actually trying to work out a deal to get a third party involved to see the value of their house so that it will sell in time for us to close.

So I still think that's a problem, but I think it's all over the board. You know, I mean, every day you hear another horror story if you're a buyer, so that's a challenge, and I think it continues to be a challenge.

We're hopeful with interest rates staying lower and maybe life gets better. But it's a tough area for everybody.

David Goldberg - UBS

Great. Thanks.

Operator

And our next question comes from Dan Oppenheim with Banc of America.

Daniel Oppenheim - Banc of America Securities

Thanks. I was wondering if you'd comment on what you're doing in terms - to your pricing side, to the orders can. And I think a little better than what we and some others were expecting. How you're looking at that; if you would say there was much of a change for you or if you think it's just more effective sales strategy there?

Chad Dreier - Chairman, President, and CEO

Well, I mean, I think it's fair that our incentives were higher. And, you know, we moved out a lot of specs in the fourth quarter, so that probably helped a little bit.

I don't think we've significantly changed our pricing strategy. I mean, you and I've known each other for a long time and I think most of the analysts and the people on the call know we're not particularly rushing to get volume. So, I mean, we'd like more volume, but we're not going to give it away.

So I don't think other than being more aggressive to move the specs out we did much significant.

Daniel Oppenheim - Banc of America Securities

Okay. Thanks very much.

Chad Dreier - Chairman, President, and CEO

Okay.

Operator

And next we'll go to Carl Reichardt with Wachovia.

Carl Reichardt - Wachovia Securities

Good morning, Chad. How are you?

Chad Dreier - Chairman, President, and CEO

Hey, pretty good. How about you?

Carl Reichardt - Wachovia Securities

Good. So you guys are looking now at I think you said 26,000 lots you own, so a couple plus years of land you own.

Chad Dreier - Chairman, President, and CEO

Yeah.

Carl Reichardt - Wachovia Securities

Your cash position's fine, and you don't have any billets due, so the cash you generate in 2008 I assume is coming from continually reduced [inaudible] position. So it that going to take place as a function of you exiting some markets where you have a peripheral presence or sort of shrinking the overall number of communities that you have or an increase in the homes you deliver in all of your markets? How do you sort of think about LA?

And then, last question, what are you going to do, then, with that cash? Just let it sit, or where does it go?

Chad Dreier - Chairman, President, and CEO

Okay. The first part of the question, I mean, I think it's a little bit of both.

I mean, we're not - you know, there's a couple markets, I think we've talked about them before, that we're just not going to put any more money into. And I hate to call any market peripheral because if you live there, it's your home.

But, you know - and then second, my guess is we're still not going to make very many land purchases this year.

And third, on that side of it is, you know, most of the lots we've got now are pretty much developed as opposed to, you know, when we - a year ago today we had to put a lot of money to develop lots in the first half, nine months of the year.

So if you buy into all that and we generate more cash in 2008, the second half of the question's what do we do with it?

First of all, I think there's nothing wrong with having a lot of cash today. And I think the first six months are still an uncertain market in general, and I'd like to get us through the first six months of the year and generate as much cash as we can, and then I think we'd sit down in the late summer and, from a finance point of view, take a look at what to do with the cash.

I mean, if the market doesn't turn more positive, my guess is you'd look at stock buybacks. If it did, you'd probably start replacing some land.

But I actually really don't think the company would be in much of a position to really give you a better answer than that until like July or August or something like that.

Carl Reichardt - Wachovia Securities

Terrific.

Chad Dreier - Chairman, President, and CEO

It's a really good question, and we talk about it all the time.

Carl Reichardt - Wachovia Securities

Good deal. Thanks so much, Chad.

Chad Dreier - Chairman, President, and CEO

Okay.

Operator

And next we'll go to Nishu Sood with Deutsche Bank.

Nishu Sood - Deutsche Bank

Thanks. Chad, I actually wanted to follow up on the land question.

Chad Dreier - Chairman, President, and CEO

Yeah.

Nishu Sood - Deutsche Bank

You've given us a great number to work with. Last quarter, I think you'd said, you know, your lots were probably 87, I think, was the number.

Chad Dreier - Chairman, President, and CEO

Yeah.

Nishu Sood - Deutsche Bank

Percent of fully developed.

Chad Dreier - Chairman, President, and CEO

Yeah.

Nishu Sood - Deutsche Bank

And you obviously walked away from a lot of options, so order of magnitude, can you kind of help us understand the decrease in your land spend, both on development and taking down lots from last year to this year?

Chad Dreier - Chairman, President, and CEO

Yeah. I'm going to have Dave Fristoe respond to that.

Dave Fristoe - SVP and Controller

Well, to answer what I saw as two questions, the lot owns, you know, it's similar the amount we've spent. The lots we control but not own, the spend is probably more like 60% now.

And your last question, we spent about $300 million last year, and next year we'd probably spend about the same.

Chad Dreier - Chairman, President, and CEO

Yeah, I would think for 2008 compared to 2007, on how much we would spend on land, it would be essentially pretty close to the same.

Nishu Sood - Deutsche Bank

Okay. And I guess I'm a little bit confused there.

If your lots are close to fully developed, that proportion would come down a lot. So is that being offset by a greater number of lot takedown?

Chad Dreier - Chairman, President, and CEO

Well, you know, boy, that gets hard to answer without going into all the detail.

So I'll tell you what. I'll ask Dave to give you a call or Drew a call later, and you guys can go into more detail on that unless you have a -

Nishu Sood - Deutsche Bank

Great. Thanks a lot.

Chad Dreier - Chairman, President, and CEO

Okay.

Operator

And next we'll hear from Robert Jordan with Morgan Stanley.

Robert Jordan - Morgan Stanley

Hi. Good morning or good afternoon.

Chad Dreier - Chairman, President, and CEO

Yeah. How are you?

Robert Jordan - Morgan Stanley

I'm well, thanks.

I just want to ask briefly about the Financial Services side.

Chad Dreier - Chairman, President, and CEO

Yeah.

Robert Jordan - Morgan Stanley

I notice that the net gains on mortgage sales were pretty linear with the decline in closings, which made sense.

I notice that title, escrow, and insurance was actually about the same as a year ago, and wanted to know if you could explain why that's strong and if that should remain at that level, which would be great.

And also just, with the cost structure I noticed that G&A expenses are about in line with fourth quarter of last year. Is that basically the - close to the minimum expense to run the business?

Chad Dreier - Chairman, President, and CEO

The way I'd answer the first question is we had a one-time sale of some of our insurance renewed business. It was about $4 million.

And on G&A, it's actually down, while we did have some higher indemnification expense which more than offset.

Robert Jordan - Morgan Stanley

Okay. And second question, have you noticed any trends or anything in warranty expenses? Are they still -

Chad Dreier - Chairman, President, and CEO

Actually, that is a good question. Actually, everybody's had a good question. I didn't want to imply they weren't.

But actually, the warranty actually has not changed much. [Inaudible] had a discussion with the Audit Committee the other day, and this sounds arrogant from my point of view, but I think we build a pretty good house and try to take care of the buyers early on, so we have not seen significant changes up or down in warranty. But that's obviously something we track, and in this kind of environment, you know, home buyers are a little tougher, so we feel pretty good about that area.

But thanks for the question.

Robert Jordan - Morgan Stanley

Okay. And final question, I understand not giving - in answering the question about the deferred taxes and stuff you said obviously not giving '08 guidance. Can you share a set of national sort of operational assumptions in terms of units year-over-year that obviously can change depending on the market but that you're planning your business around?

Chad Dreier - Chairman, President, and CEO

You know, I mean obviously we know you're going to ask that. It's just too early and the market's still so uncertain, you know, it's sort of like saying who's going to win the Republican - who knows? I mean, you know?

So I mean I just think we need to get through the first six months of the year, and we'll see what happens.

Robert Jordan - Morgan Stanley

Okay. Well, best of luck. Thank you.

Chad Dreier - Chairman, President, and CEO

Okay.

Operator

And next we'll go to James Mccanless with Ftn Midwest.

James Mccanless - Ftn Midwest Securities Corp.

Hey, good morning. Two questions for you.

Chad Dreier - Chairman, President, and CEO

Yeah.

James Mccanless - Ftn Midwest Securities Corp.

Since you've already given indication on lot cost, that your lot costs are a lot lower now than they used to be, how's the rest of your inputs looking - lumber, building materials, labor - how are those trending, and what do you see those doing in 2008.

Chad Dreier - Chairman, President, and CEO

Well, you know, that's a good question.

I mean, we've had a pretty hard - you know, Larry Nicholson took over as COO in August, and he's done really a great job on dealing with the subs. And I forget what number we're using, but our costs per house are down significantly.

I think that would be hard to match in 2008. I still think, you know, that the subs need to work with us, but, you know, there's only so far you can go on that side of the business.

James Mccanless - Ftn Midwest Securities Corp.

Sure. And then my follow-up question, with the pick up that we've seen in mortgage application, purchase activity, refinance activity, et cetera.

Chad Dreier - Chairman, President, and CEO

Yeah.

James Mccanless - Ftn Midwest Securities Corp.

Has it given Ryland's sales associates a little bit more leverage in their individual communities to keep people from hopping from community to community, et cetera?

Chad Dreier - Chairman, President, and CEO

Yeah. You know, that's a really good question.

I was driving to work today listening to, I don't know, Bloomberg or something. And the guy - you know, I have no idea who it was - but was talking about the 30year or the fixed mortgage rates about 5.5% and he was talking about, you know, the purchase applications and resale applications are up. And people are refinancing now, and a lot of people who were in trouble in the last three years are able to get out now at 5.5% - refinance at 5.5%.

I mean, I think that's all positive. I think it's actually too early to answer the question you just asked. I still think buyers are not that loyal to their transaction yet.

But I think - and once again, I always hate to get political on these calls - but, I mean, you know, if this tax stimulus goes through, and I know Congress is talking about raising loan limits and all that. I mean, I think each one of those things is a little better for us, and that's why I keep saying hey, I think in the next three or four months we'll see better.

Sooner or later - and, you know, it's still like who knows - but, I mean, there will be a bottom. I mean, I think it's too hard to call a bottom yet, but it's, you know, the builders are writing off a lot more money. Sooner or later prices are going to be down low enough and interest rates will give buyers a chance to buy a house, and they'll feel better about it. And when that happens, you'll start to see more sales.

So I think all of those are positive factors, just like if you go back a year ago, most of the factors were negative or negative inclined and we ended up in this mess we're in now. Sooner or later, we'll get out of it. We are a cyclical business, so we'll see what happens.

James Mccanless - Ftn Midwest Securities Corp.

Sure. And one follow up, if I could.

If you take that forward and you say, in previous downturns, we were able to increase our pricing leverage at X point, is there - could you put some kind of fine point on that? I mean, I know you can't call the bottom, like you said, but is there typically a trend that, you know, once the downturn starts, we know within X number of months historically we've been able to regain our pricing leverage?

Chad Dreier - Chairman, President, and CEO

Well, you know, that is a really good question.

I've always sort of thought these downturn - and I'm not an historian and I'm not an economic guy - you know, I mean, it'll last 24 to 36 months. So part of the problem is when do you call the peak, you know, which I sort of always thought it was November of '05 in hindsight. You know, I'm pretty good on hindsight.

So, I mean, I think you could say we're two years into that - different markets, obviously, at different points in time - and that's why I keep thinking as we get into 2008, you know, we'll start to get out of that.

I mean, obviously we don't even think about pricing power now because we've just got to get back to our normal - we've got to get to a stage where we're not giving away as many discounts and there's less supply and our colleague brother builders aren't building a lot of houses, you know, as a group.

And sooner or later, you know, the media will start telling everybody, hey, now's the time to buy, and you'll start to see more traffic and, you know - but that's not something that happens overnight.

But I would like to think by the end of 2008 we'll be a little more in equilibrium, and that 2009 would give us some of that ability you talked about.

James Mccanless - Ftn Midwest Securities Corp.

Okay, great. Thank you.

Chad Dreier - Chairman, President, and CEO

Okay.

Operator

And next we'll go to Ivy Zelman with Zelman & Associates.

Ivy Zelman - Zelman & Associates

Good morning, everybody. Thanks for taking the call, Chad.

Chad Dreier - Chairman, President, and CEO

No problem.

Ivy Zelman - Zelman & Associates

I don't know, maybe I'm trying to be optimistic, but I've been hearing signs from some builders that they actually are seeing a little life out there, signs of traffic increasing, some anecdotes that suggest that, you know, maybe absorptions might be picking up. No price stability necessarily, but is there any markets that that, in your opinion, might be true? Is there a price that, you know, finally the consumer's coming out and saying it's a pretty good deal?

Chad Dreier - Chairman, President, and CEO

Yeah. Well, I'm kind of like you. I hate to be too optimistic, especially on my call.

Ivy Zelman - Zelman & Associates

Right.

Chad Dreier - Chairman, President, and CEO

But we are seeing traffic picking up, and I would say across the country. So I think it's too early to be optimistic, but we feel a little better, and we're going to advertise and hope to get some of those traffic converted.

And once again, I think lower interest rates is going to help.

Ivy Zelman - Zelman & Associates

You know, one of the things, Chad, some of the builders are saying, you know, obviously putting their foot on the brake and not going forward because of the inability to get the absorptions, and there's some good assets that they're better off waiting and hoping for an improvement down the road.

When you think about the foreclosures - and I don't know, I apologize if someone already talked about this - you know, obviously there's a big burden in many of the former hotbed markets where homes that are either in foreclosure or will be foreclosed are fairly new and could be competitive to what, in fact, you guys are trying to absorb or move through your pipeline.

Are you in a position where your markets, you're really not worried about competing with those foreclosures, or maybe you've already moved through the markets where foreclosures are most prevalent?

How are you positioned with that as a risk?

Chad Dreier - Chairman, President, and CEO

Well, Ivy, that's a good point.

You know, generally, I believe - and this is just Chad Dreier, you know, this is just one like those TV guys, this is not Ryland, this is me - I actually think most new homebuyers don't go out and look at a foreclosed house and then go to a new model home.

I mean, you know, most foreclosed houses by definition, the owner hasn't paid the payment for six months; he hasn't done any maintenance. It's sort of lost the new home smell; all those kind of things.

You have to have a lot of tenacity to buy a foreclosed home and go in and repair it.

So by and large, they're not comparable, you know, Mr. and Mrs. Zelman don't go to a new home and then go look at a foreclose.

Ivy Zelman - Zelman & Associates

Right.

Chad Dreier - Chairman, President, and CEO

Having said that, I mean, I think it would be naïve to think that - there's been a lot of foreclosures in a lot of new home markets, although I still think most of the foreclosures are in resales or used homes or whatever the right buzz word is.

So I don't think it's a direct problem, but hey, it certainly lends to that there's more inventory out there and so that's part of the supply-demand equation, and so that's a problem.

Ivy Zelman - Zelman & Associates

Right. Well I appreciate it.

Chad Dreier - Chairman, President, and CEO

But it's like everything else - some markets are better than others.

Ivy Zelman - Zelman & Associates

Right. Thanks, Chad.

Chad Dreier - Chairman, President, and CEO

Okay.

Operator

And next we'll go to Steve Surrell with Conning Asset Management.

Steve Surrell - Conning Asset Management

Yes. Your orders in the quarter on a units basis were only down 7%, which is a noticeable improvement from the past few quarters.

Chad Dreier - Chairman, President, and CEO

Yeah.

Steve Surrell - Conning Asset Management

Do you attribute that to anything? I mean, I know the comps were still tough year-over-year, but is that a glimmer of hope?

Chad Dreier - Chairman, President, and CEO

Hey, well listen, I like being down 7% better than 20% or 30%, so that's a glimmer of hope.

I mean, the fourth quarter, I think, is always hard for any homebuilder, the fourth calendar quarter, you know? I mean it's just, who's buying a house in December, you know what I mean?

So I really don't put a whole lot of that into - it's not that great of a deal.

I mean, I think if you go back in hindsight, in September of '06, you know, that was our peak of spec homes and we put some of the brakes on. And so, I mean, it was an easier comp from 2006.

Hey, you know, I'm optimistic pretty soon the comps will get better, so - but I wouldn't read that much into the 7% number.

Steve Surrell - Conning Asset Management

Okay, and one other question. Given where your cash balances were at the end of the year and lower orders on the books, do you think as you go to the seasonal capital build in the spring and summer you'll need to tap your bank lines or can you do it all from your cash balances?

Gordon Milne - EVP and CFO

Yeah, it's going to be close. We think [inaudible] forecast would have us maybe not needing to draw on our bank line.

Steve Surrell - Conning Asset Management

Okay. Thank you.

Chad Dreier - Chairman, President, and CEO

Okay.

Operator

And next we'll go to Scott Cavanaugh with Merrill Lynch.

Scott Cavanaugh - Merrill Lynch

Good afternoon, guys.

Chad Dreier - Chairman, President, and CEO

How are you?

Scott Cavanaugh - Merrill Lynch

Good. Good. Two housekeeping questions for you.

Looking at your net worth covenant, what's your cushion today, and are you in the midst of talking to lenders?

Chad Dreier - Chairman, President, and CEO

Yeah, we still - I mean, we ended the year [inside] all our covenants, you know, approximately $100 million of room under a net worth covenant. I think the banks have been willing to talk to people adding back the tax impairment or tax provision, so we'd definitely go back to our banks and ask to get that added back again.

So we think we're in good shape on our bank line.

Chad Dreier - Chairman, President, and CEO

Okay, and second, right now you have investment-grade ratings at S&P. Should you guys get downgraded, I know you have a borrowing base calculation coming into effect. What's your headroom under that borrowing base calculation under your credit facility?

Chad Dreier - Chairman, President, and CEO

Again, that's something - we're talking to the bank because, if we go for a change, we'll get that, to request an adjustment on that, too.

So we've definitely got room. Since we're not borrowing any money, obviously it's not an issue right now for the next six months.

And we'll let you know. We're going to look for an amendment to adjust that calculation, too.

But we're - if we went to our borrowing base, we've definitely got room under our facility to borrow [on].

Scott Cavanaugh - Merrill Lynch

Okay, thank you very much.

Chad Dreier - Chairman, President, and CEO

Okay, thanks.

Operator

Our next question comes from Alex Barron with Agency Trading Group.

Alex Barron - Agency Trading Group

Hey, good morning, guys.

Chad Dreier - Chairman, President, and CEO

Hi.

Alex Barron - Agency Trading Group

I wanted to ask you about on impairments, I don't know if you mentioned how many communities were impaired this quarter, and I guess how many unique communities were impaired since the beginning of the downturn?

Chad Dreier - Chairman, President, and CEO

About 39 for the quarter and unique, I'd say slightly over 100.

Alex Barron - Agency Trading Group

Okay. And how many were impairments this quarter?

Chad Dreier - Chairman, President, and CEO

Oh, this quarter?

Alex Barron - Agency Trading Group

Yeah.

Chad Dreier - Chairman, President, and CEO

One or two.

Alex Barron - Agency Trading Group

Okay. My second question has to do with this FAS 109 charge. I'm trying to understand how does it work? It looks like you guys only impaired about 40% or so of your Q3 deferred tax asset. KBH and Hovnanian, they impaired more.

And that's part of it, and the other question is: Going forward, if you don't make money going forward, are you not allowed to keep building up the deferred tax asset, or is that just something you evaluate at the end of every fiscal year? How does that work.

Chad Dreier - Chairman, President, and CEO

Well, with regards to the first question, I think it has to do with our impairment levels versus income over the last few years.

On your second question, you know, it just really depends. You're right. I mean, we look at it at the end of every period, evaluate it, see where we are. Don't really want to say much more than that.

Alex Barron - Agency Trading Group

Okay, got it. I'll get back in the queue. Thanks.

Chad Dreier - Chairman, President, and CEO

Okay, thanks.

Operator

And our next question comes from Joel Locker with FBN Securities.

Joel Locker - FBN Securities

Hi, guys. I don't know if you guys mentioned it, but just wanted to get a figure on prior impairments that were actually reversed on the income statement in the fourth quarter?

Chad Dreier - Chairman, President, and CEO

Yeah, I think we did mention it. I think it was $28 million.

Joel Locker - FBN Securities

$28 million? And that was all through home sales, none through land sales, or there was only $5 million or so?

Chad Dreier - Chairman, President, and CEO

Small amounts in land sales.

Joel Locker - FBN Securities

Small amount in land sales? All right. Thanks a lot.

Chad Dreier - Chairman, President, and CEO

Okay.

Operator

And next we'll return to Michael Rehaut with J.P. Morgan.

Michael Rehaut - J.P. Morgan

Hi, thanks. Just a separate question, kind of take on Carl's geographic positioning.

You know, you're building up a cash position. I believe you mentioned on the last call that you had very, very low exposure to like a Fort Myers, I think it was. And I was wondering if a) you could just kind of review your exposures to some of the more difficult markets of, you know, California, Florida in terms of your inventory position.

Chad Dreier - Chairman, President, and CEO

Yeah.

Michael Rehaut - J.P. Morgan

You know, certainly - I don't want to ask you in terms of a timing question, but, you know, all else equal, which of those troubled markets would you look to start getting back into over the next year or two, you know, more aggressively than others?

Chad Dreier - Chairman, President, and CEO

Okay. Let me - you know, the last part of that - you know, first of all, Fort Myers was one of the, in my opinion, one of the most difficult markets in the country. Eight trillion condos and every builder in the world went there.

It will be hard for Larry Nicholson to convince me to buy anything else in Fort Myers right now.

But having said that, I still think Tampa and Orlando and Jacksonville and Florida in general is a great place to live and a great place to be a homebuilder. I think the prices got a little ahead of themselves. You know, Orlando and Tampa'd been low, low, low home prices for a lot of year, and then it just ramped up so fast. And so I would feel pretty good about Florida in general.

You know, the Carolinas never had a big run, so they haven't had much challenge.

Baltimore, for us, has been a good market, strong market. You know, we've been there 40 years. We think we know what we're doing. We feel really good about that.

Virginia - Northern Virginia has, you know, has been a lot of overbuilding and skyrocketing prices. I think that's going to take another year or so to get back into equilibrium, but it's a great place to live. You know, forgetting whether you're a Republican or Democrat or Independent or Ron Paul or whatever, government's going to be big, so Northern Virginia will be a good market, and we'll get back there under the right terms and conditions.

Texas, you know, Texas - I don't even know if we've had any impairments, maybe one or two. You know, it's not a high priced market. I would say sort of business as usual there.

Chicago, really like that market. It's the capital of the center of the country, and we do really well there and we like that.

Minneapolis is a tougher market, and I would be hesitant to jump back in there with great vigour.

Indianapolis, we do very well. We like that market. Great team there.

Cincinnati I think we've talked about before; we're kind of winding down there.

Phoenix is one of those markets; it's a very difficult market. It was - one of the reasons it did so well is it had really affordable housing for a long time, and then skyrocketed, you know, California, then Vegas, then Phoenix. It's got to get back into equilibrium, and I don't see that yet. But I think it's a good market that's here to stay.

I already talked about Vegas a little bit. You know, I like Las Vegas as a market. It got way out of whack on housing prices, and then when the price got so high, lots of builders did screwball product, including ourselves, and so we've got to get back to more normal product at a normal price. But that'll be an okay market.

California, you know, that's a tough market, both northern and southern. I mean, obviously, if you live here, the prices are outrageous. Even after they've come down, I don't know, you give me the number - 20%. They're still very high, and it would take a pretty strong deal at a great price and good terms to convince me to jump back into that market.

So that's off the top of my head, and I hope it's responsive to your question.

Joel Locker - FBN Securities

Yeah, that's great.

I think just the back half of that question about, you know, you largely wound down your exposure in Fort Myers. From an asset allocation standpoint, I was wondering if you could give us a feel for your exposure to, you know, some of the more challenged markets now?

Chad Dreier - Chairman, President, and CEO

Well, after $500 million of impairments, we've got a lot less than we had a year ago. So I would feel that we don't have any market now that is, you know, at risk more than any other market. I mean, I think we're at market.

Now, you know, who knows what's going to happen next year, but we feel pretty good about that. We wouldn't be that long on land anywhere.

Joel Locker - FBN Securities

Right. I mean, maybe just another way of getting at and then I'll get off, just, you know, obviously you've always been very geographically diversified. Maybe you could kind of give us a feel for your top five markets in terms of percent exposure?

Chad Dreier - Chairman, President, and CEO

Well, I guess exposure - you would imply that that's just amount of inventory?

Joel Locker - FBN Securities

Yes.

Chad Dreier - Chairman, President, and CEO

Well, I think we have the most land in Chicago, I think. You know, if you go by years' supply of lots, Chicago, Tampa and Orlando, and, interestingly enough, Houston, which I think's a pretty good market. You know, if you like oil, you like Houston.

So those would be our four biggest exposures, I would say - Chicago, Orlando, Tampa, Houston.

Joel Locker - FBN Securities

And Chicago, then, would it be 15% of your total lots?

Chad Dreier - Chairman, President, and CEO

No, it would be lower than that.

Joel Locker - FBN Securities

Okay. Thank you.

Chad Dreier - Chairman, President, and CEO

Okay.

Operator

And next we'll return to Alex Barron with Agency Trading Group.

Alex Barron - Agency Trading Group

Yeah, thanks. I was wondering if you had a breakdown of the impairments by region, like dollar-wise?

Chad Dreier - Chairman, President, and CEO

Well, I'm sure we do. Do you have that [inaudible]?

Dave Fristoe - SVP and Controller

Well, let's see. By division, we can add it up for you real quick. Let's see, about $60 million - well, here, I'll just give it to you by major demographic areas.

Chicago, about $20 million, Washington, $40, Tampa, $42, Las Vegas, $44, Jacksonville, $20, Northern Cal about $10 and Southern Cal, $15.

Chad Dreier - Chairman, President, and CEO

That's as good as we can do for you.

Alex Barron - Agency Trading Group

That's pretty good.

Chad Dreier - Chairman, President, and CEO

Okay.

Alex Barron - Agency Trading Group

And is that for both - is that just for the communities, or is that the options and the communities combined?

Chad Dreier - Chairman, President, and CEO

No, that's - well, that's the valuation reserves.

Alex Barron - Agency Trading Group

Oh, okay. How about -

Dave Fristoe - SVP and Controller

The walkaways would be an additional 11 in Chicago, same in Washington, and Atlanta about 13 and Northern Cal 5.

Alex Barron - Agency Trading Group

Okay. All right. Thanks a lot.

Chad Dreier - Chairman, President, and CEO

Okay.

Operator

And, Mr. Mackintosh, we have no further questions at this time.

Drew Mackintosh - VP of IR

Great. Well, thanks for joining us today, and we'll speak to you again soon.

Operator

That does conclude today's conference call. Thank you.

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Source: Ryland Group Inc. Q4 2007 Earnings Call Transcript
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