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Lennar Corp. (NYSE:LEN)

F1Q08 Earnings Call

March 27, 2008 11:00 am ET

Executives

Stuart Miller – President and Chief Executive Officer

Scott Shipley – Director of Investor Relations

Bruce Gross – Vice President and Chief Financial Officer

Diane Bessette – Vice President and Treasurer

David Collins - Controller

Analysts

David Goldberg - UBS

Carl Reichardt – Wachovia Securities

Dennis McGill – Zellman & Associates

Tom [Martego] – [Martego Capital]

Stephen East – Pali Research

Ken Zener – Merrill Lynch

Michael Rehaut – JP Morgan

Jim Wilson – JMP Securities

Nishu Sood – Deutsche Bank North America

Operator

Welcome to Lennar Corp.’s first quarter earnings conference call. At this time all participants are in a listen-only mode. After the presentation we will conduct a question-and-answer session. Today’s conference is being recorded. If you have any objections you may disconnect at this time.

I will now turn the call over to Mr. Scott Shipley, Director of Investor Relations, for the reading of the forward looking statement.

Scott Shipley

Thank you and good morning.

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

These forward-looking statements may include statements regarding Lennar’s business, financial condition, results of operations, cash flows, strategies and prospects. These forward-looking statements represent only Lennar’s estimate on the date of this conference call and are not intended to give any assurance as to actual future results. Because forward-looking statements relate to matters that have not yet occurred, these statements are inherently subject to risks and uncertainties. Many factors could cause Lennar’s actual activities or results to differ materially from the activities and results anticipated in forward-looking statements. These factors include those described under the caption “Risk Factors” contained in Lennar’s annual report on form 10K for the most recently completed fiscal year which is on file with the SEC. Please note that Lennar assumes no obligation to update any forward-looking statements except as required by Federal Securities Law.

Operator

I would like to now turn the call over to your conference host, Mr. Stuart Miller, President and CEO. Sir, you may begin.

Stuart Miller

Good morning and thank you for joining us for our first quarter 2008 update. In the context of market conditions they continue to be difficult and frankly continue to deteriorate. We would like to update you both on the status of the home building industry market conditions and on the strategy and progress of Lennar in particular.

I’m joined this morning by Bruce Gross, our Chief Financial Officer, and Diane Bessette, our Vice President and now our newly appointed treasurer – Congratulations Diane, and David Collins who is now our Controller – Congratulations David. David has been a member of the Lennar accounting team for 10 years as our Director of Financial Reporting and has taken on the role of Controller as Diane has moved into our Treasurer position.

Bruce Gross will provide additional detail on our numbers after my opening remarks and David will participate with an update on our asset review and impairment, a report we have given now for the past two years, and Diane will be available to participate in our question-and-answer.

This is a housekeeping item before I begin…I would like to request that in our question-and-answer period that will follow my opening remarks, or our opening remarks, that you please limit to just one question and one follow-up so that we can be as fair as possible to all participants. We welcome you to join or rejoin the queue if you have additional questions and will accept or attempt to answer as many questions as possible in the hour, more or less, that we have allotted to the call.

As noted in our press release that we issued this morning, the housing market has remained challenged in the first quarter of 2008. What is also beginning to become clear is that the rest of the economy has now followed suit and I believe has now slipped into recession. The deterioration that took place so quickly in the housing market last year now seems to be happening at the same rapid pace in the overall economy.

Data points these days are all over the place and are prone to misinterpretation and second guessing with each new report. The only thing that seems clear is that regardless of what is reported in the news or by the economists, in the market, the grocery store, at the pumps and in the working world it just doesn’t feel good.

The only real bright spot today is that when the news is particularly dire and is confirmed in some way, the government and other market forces have acted quickly and decisively. While we might argue or suggest that actions are late, they do nonetheless suggest that there is a floor out there where enough negative news confirmed will result in enough action to bring on sustainable stabilization.

It seems that we are now nearing that point of confirmation. Today’s data, the GDP has slipped to 0.6% growth rate, is the beginning of confirmation. A weakening labor market and growing jobless claims is confirmation. Illiquidity in our financial market is confirmation. Higher food and energy prices are confirmation. The lowest consumer confidence numbers in five years is confirmation. Reduced orders for durable goods is confirmation.

The indicators keep coming and while there is discussion and disagreement back and forth on what they mean and how to fix things, it seems that we are quickly approaching the time where decision makers will reconcile to the reality that positive, constructive steps need to be taken to properly support weakened markets and enable them to recover.

We believe that an integral part of the answer that will emerge is that the fixing of the component of the economy that has led us into this economic contraction, i.e. home building or housing, will be that first and most important step and fix in leading us out.

This fix, it seems, is the bright light that I see at the end of home building’s dark tunnel. As I noted in our press release, the home market is faced with an increased supply and a suppressed demand. Home inventories, particularly existing homes, are expanding and will have to be absorbed before pressure is relieved on sales volume and price. If we are going to get home ownership back on its feet we are going to need to facilitate the absorption of inventory by encouraging buyers to start purchasing again and we are going to have to facilitate a mortgage market to be able to lend at multiple price points to those purchasers.

Whether over the next six months or after the election, these steps will be taken out of necessity to facilitate housing’s leadership out of the economic doldrum. This is simply my view of today’s landscape.

But what do we at Lennar do in the interim? Well this is exactly what we have prepared for and exactly why we have taken the steps we have taken. We have done the things over the past 24 months that have situated Lennar for success going forward. As you can begin to see in our first quarter results, we have made quite a lot of progress in having our company prepared.

First and foremost our balance sheet has been fortified with a substantial cash position of over $1 billion, nothing borrowed on our revolver and a responsible debt-to-total capital position at 38% to 38.2% and net debt-to-total capital of 24.5%.

In the wake of the meaningful restatements of assets that we have undergone and the repositioning of many of our joint venture properties this is meaningful progress. While we continue to lose money in our first quarter with loss of $0.56 per share and home building operating loss of just under $110 million, aggregate levels of impairment and losses are clearly now dissipating.

We have done the heavy lifting on impairment and are now situated with stated assets that can and will produce improving markets when the rate of decline in market pricing subsides. We believe that even with continued degradation of market conditions our stated asset base will not suffer nearly the level of impairment that we have seen to date.

Next, our home building margin is beginning to improve. With a 50 basis point improvement this quarter to 14.3% or 17.1% before valuation adjustments up 150 basis points. While the margins are still weak we expect to see in the coming quarters a stabilization and hopefully improvement in margins that begin to market trend.

Each of our divisions is focused on responsible margins on each and every home started as we now have land marked down to where margins can be achieved. Construction costs have been negotiated and are being renegotiated again. With the realities of the market now known to everyone current market pricing is being remarked lower on everything except commodities.

Because our standing inventory levels are extremely low and current, new construction costs are defining the cost structure of most of our deliveries, particularly as we get into the third quarter.

Overhead levels are low. Markets have been consolidated and systems have been paired back to match our current volume levels. All forms of reporting at local and corporate levels have been reconsidered in light of redefining ourselves as a leaner and more efficient company.

We have reworked or are close to reworking our non-performing joint ventures. While we have not and cannot comment on specific ventures, we have held true to our conviction that we do not support the debt of non-recourse obligation and we are not excusing partners from sharing partnership losses. While the renegotiation process can be difficult and time consuming, many of our partnerships have presented us with an opportunity to actually enhance our investment position.

To conclude, I would like to talk about our sale at year-end 2007 to the Morgan Stanley fund. This program continues as one of our points of progress as we have reflected on the sale through the first quarter of 2008. When we concluded this transaction the market gasped and asked why. Today, in retrospect, we are decidedly pleased that the reasons that we concluded the deal at year end are born out today.

First we raised capital by selling assets. The land assets are situated in a vehicle that is designed to own land while cash in the current market as it has continued to evolve is a distinct advantage to Lennar’s balance sheet.

Second, we concluded this sale at a time when financing was still available. While the debt for the transaction is well situated for success as part of the fund, that facility could not be duplicated today because of debt market dislocation. For this reason alone, our deal could not be duplicated at the same levels using 100% equity.

Third, we priced this sale properly so that the sale of home sites in the future to third party home builders or at our discretion to Lennar will enable the purchaser to build homes that yield appropriate home building margins.

Fourth, we remained in the deal as a minority investor and as an investor we have made an excellent purchase that will provide profitability for the future.

Fifth, we cemented an excellent relationship with our partners at Morgan Stanley with whom we have worked for the past 15 years.

Perhaps more importantly, through the experience of concluding this sale we have grown a potential framework for working jointly on similar assets across the country and have together learned that the barriers to entry into this business are higher than many expect.

Sixth, we have used this transaction to streamline our organization and to supplement overhead coverage with fee income associated with managing the assets in the fund.

Finally, we have re-injected Jeff [Karznov] into our business as an architect of business in the future and as the eyes and ears to be very close to the deals that exist in the market place at large.

In the current market environment we feel we are being exposed to all deals that are in the market whether they be asset deals or debt deals. In as much as Jeff and I and Lennar’s management team have done this before and because there is equity capital looking for ways to invest we believe that we will find opportunity once again.

Many in the market have questioned this transaction both in its completion and its post-closing execution. No doubt this is a one of a kind deal and it leaves us with one of a kind positioning for the future. Rumors in the market seek to cast a cloud on its viability and its current standing. With market conditions as they are, we recognize that there are some things that are just out of our control and we’re simply not going to be able to alter those elements. But the items that are within our sphere of influence, we are all over them. The Morgan Stanley fund, like the many other elements of our company, are within our sphere of influence and we are all over them. These are the things that define our positioning in this very difficult market and mark the future for Lennar.

With that let me turn it over to Bruce.

Bruce Gross

Thank you Stuart. Good morning every body. Over the past several quarters we have mapped out a strategy relative to our balance sheet and our joint ventures and I’d like to give you an update on the progress that we’ve made towards that strategy. Additionally, I will provide some more color on our first quarter results.

Starting with the results on our balance sheet strategy, we have continued to remain focused on strong cash generation through aggressive asset management and maintaining ample liquidity. We have continued to carefully manage our inventory levels as they have decreased from $8.3 billion in the prior year’s first quarter to $4.6 billion during the current quarter. The finish tones and construction in progress inventory was reduced 46% from $4.2 billion to $2.3 billion year-over-year. Land under development was also reduced 57% from $3.6 billion to $1.5 billion in the current quarter.

We have continued to manage starts to today’s realistic volume levels and as a result we have reduced starts 49% in the first quarter compared to the prior year’s first quarter and that is without unconsolidated joint ventures. Homes under construction declined 61% from 13,900 in the first quarter of last year to 5,400 in the first quarter of 2008. Unsold inventory under construction was reduced by approximately 58% year-over-year and we were also able to reduce our completed unsold homes count to 814 at the end of the first quarter of this year, which is a reduction from 1,659 in the first quarter of last year.

Our home sites owned and controlled also reduced significantly and there is a decline of approximately 200,000 home sites from the peak in the first quarter of 2006 from 346,000 to now 145,000. Included in that count are 72,000 home sites owned, 21,000 home sites controlled by option with third party sellers and 52,000 optioned from joint ventures.

Our continued strategy of converting inventory to cash further strengthened our balance sheet during the quarter as we generated positive operating cash flow and we ended up with a $1.1 billion cash number on the balance sheet at the end of the first quarter.

Additionally, as Stuart mentioned, we ended the quarter with no outstanding borrowings on our $1.5 billion revolving credit facility which we had amended in January and was already discussed in detail on the last conference call in January.

Inclusive of impairments, our net debt to total capital improved to 24.5% at the end of the first quarter from 28.6% at the end of the first quarter last year. Our debt levels have decreased by over $300 million since the prior year’s first quarter.

There has been significant progress made in both the reduction of joint venture recourse obligations as well as the reduction in the number of joint ventures. The company has been very focused on reducing its recourse JV indebtedness which was cut in half from approximately $1.8 billion at the end of 2006 to $917 million at the end of the first quarter. Sequentially we also noted improvement from November 2007 when the balance was $1.33 billion.

Lennar’s net recourse JV exposure improved from $795 million at the end of 2007 to $668 million at the end of the first quarter. The joint ventures with JV recourse guarantees, just to highlight again, are supported by hard assets and in excess of $1 billion of partners equity which reflect the valuation adjustments that have been taken each quarter as part of our detail asset-by-asset review process, which David is going to talk about in a second.

The absolute number of joint ventures have also been reduced from the peak of close to 270 joint ventures in 2006 to 210 joint ventures at the end of 2007 and now down to 180 joint ventures at the end of the quarter. We continue to focus on considerable further reduction in this number as we go through the year.

There was also significant progress in the reduction of financial letters of credit during the quarter. Fees have also been cut significantly from a peak of $728 million at the end of 2006. We are now down to $355 million at the end of the first quarter and sequentially from year-end there was also reduction. That count was $424 million at the end of 2007.

Turning to operating results for the quarter, we had a $0.18 loss excluding $107 million of pre-tax valuation adjustments which David is going to walk us through. Our revenues from home sales decreased 64% to $953 million. This was driven by a 60% decrease in home deliveries and an 8% decrease in average sales price to $278,000.

The average sales price declined regionally as follows:

The east was down 14% to $271,000. Central was down 1% to $206,000. West was down 6% to $389,000 and the other region was down 13% to $289,000.

In the first quarter of 2008 we achieved the highest pre-impairment gross margin going back to the third quarter of 2006 and that number was 17.1% percent during the quarter, up 150 basis points over the prior year first quarter.

As you will note, the results tie into our strategy of pricing the market to move inventory as our sales incentives were $48,000 per home versus $45,500 in the prior year. The improvement in gross margin is primarily due to a lower land basis which reflects the exhaustive asset reviews we have had each quarter, impairing assets to be reflective of today’s market conditions as well as renegotiating land contract and options and new land purchases to achieve a land basis reflective of today’s market conditions.

Additionally, we have continued to focus on reducing construction costs which also helped in the gross margin improvement. Gross margin percentage improved in all regions except the central region where the gross margin didn’t decline as much during the down turn.

David will talk about the land joint venture and management fee numbers which are most importantly impacted by valuation adjustments during the quarter.

Turning to SG&A, we have been very focused on right sizing our overhead levels. We have continued to consolidate home building operations and reduced our associated headcount. That is now down from a peak of 14,100 to approximately 6,200 associates through today. This focus alone with reduced variable selling expenses drove a significant reduction in absolute dollar number of SG&A expenses which are down $194 million or 53% compared to the same period last year.

As a percentage of revenue SG&A did increase to 18.4% during the quarter and that was primarily a result of a 64% decline in revenue. We do expect that this percentage will continue to decline throughout the year as our divisions are on track to significantly reduce SG&A as a percentage of revenue throughout 2008.

New orders were down 57% during the quarter compared to prior year. As you saw in the press release they did weaken in all regions. We did note that the cancellation rate declined to 26% during the quarter from 29% in the prior year’s quarter.

Financial services profit decreased from $15.9 million to a loss of $9.7 million in the quarter. The loss for the quarter included about $2 million in severance and lease termination costs. Mortgage decreased from a profit of $13.5 million in last year’s first quarter to $1.1 million of profit. The decline in profitability was primarily due to a reduction in mortgage originations. This quarter our mortgage capture rate increased from 70% in the prior year’s first quarter to 80% in the first quarter. Fixed rate loans are about 98% of the originations versus 72% in the prior year. Jumbo loans are only about 3% of the total loans versus 17% in the prior year.

The percent of FHA loans increased to 44% in the current quarter from 9% in the first quarter of last year. The higher loan limits with FHA went into effect after the end of our first quarter and the new FHA [selling] loan limit for 2008, which does vary by market, has increased from a max of $363,000 to approximately $730,000.

Our title losses increased from about break even last year to approximately $12 million in the current year and that is the result of fewer transactions and what is typically a slower first quarter we have been aggressively reviewing the title operations branch by branch and closing a number of branches.

Our tax benefit during the quarter was at a calculated rate of 42.8%,which will fluctuate throughout the year based on our results and as we indicated in the first quarter conference call we did receive $852 million of cash relating to the carry back of NOL’s to 2005 and 2006.

As a result of accounting pronouncements effective during the quarter primarily related to FIN 48, we took a charge to retained earnings of approximately $30 million and as we have indicated in the last number of quarters we are not providing a current earnings goal due to the current uncertain market conditions, however we remain focused on our strategy of generating strong cash flow, carefully managing our inventory, right sizing overhead and positioning for profitability when the market returns.

Let me turn it over to David now who is going to go over the valuation adjustments.

David Collins

Thank you Bruce and good morning everyone. In conjunction with our balance sheet focus we continue to evaluate and re-evaluate our assets each quarter. Although we believe that most of the significant impairments are behind us, we continue to remain actively engaged in our comprehensive and rigorous process of division by division asset reviews to ensure that our assets are properly stated. In this morning’s release we outlined our first quarter valuation adjustments by segment. However, let me quickly review the categories once again.

The first category we have the home building side of our business. We apply the standards of FAS 144 to land that we intend to build homes on and recorded a valuation adjustment of $26 million. The segment detail is as follows: East segment $8 million, central segment $2 million, west region $10 million and our “other” section $6 million.

The second category is land that we sold or intend to sell to third parties. Consistent with our strategy of converting inventory into cash, we identified land that we sold during the first quarter or intend to sell subsequent to the first quarter. We applied the standards of FAS 144 to that land and recorded a valuation adjustment of $15 million. The segment detail is as follows: East $1 million, central $9 million, west $4 million and “other” $1 million.

The next category related to land is option deposits and pre-acquisition costs. We continue to evaluate, re-evaluate and renegotiate deposits on land under option as markets remain challenged. For those option contracts where we were not able to adjust or readjust the terms to a level that would lead to an acceptable return based on current market conditions we made the decision to walk away from the contract as we have done in past quarters. As a result, we wrote off $17 million of option deposit and pre-acquisition costs which represented approximately 2,600 home sites. The segment detail is as follows: The east segment $7 million, central $4 million, west $4 million and “other” $2 million.

The last category is joint ventures. We continue to evaluate and re-evaluate our investments in joint ventures. We focused on the recoverability of our investment relative to the market conditions that exist today. We applied the standards of 144 to the assets in our joint ventures including the evaluation of discounted future cash flows. Additionally, we applied the standards of APB 18 to our investment balance related to those ventures. As a result we recorded a valuation adjustment of $49 million. The segment detail is as follows: East segment $5 million, west segment $43 million and “other” $1 million.

So after that overview we would like to open it up to questions.

Question-And-Answer Session

Operator

We will now begin the formal question-and-answer session. If you would like to ask your question please press *1 on your touchtone phone. You will be announced prior to asking your question. If you would like to withdraw your question at any time please press *2. Once again, to ask your question please press *1 on your touchtone phone.

It looks like our first question is coming from David Goldberg of UBS.

David Goldberg - UBS

Thanks. Good morning. Stuart I was hoping we could revisit something you mentioned in your opening comments about the JV renegotiations and re-approaching JV partners. Can you give us some kind of estimate, maybe a ballpark, what percent of the 180 JV’s do you have left as you have re-approached partners, started the renegotiation process and how are you finding I guess both the lenders and your partners are willing to renegotiate at this point?

Stuart Miller

Interesting question, David. You know our joint ventures are certainly the topic of a lot of discussion and speculation. There is some myths that simply have to be dispelled. First of all, many of our joint ventures are really in very good standing. Some of the assets, or many of the assets in a number of our ventures are really very well positioned and we really don’t have an issue with our partners or with our lender. In many of our ventures we have adequate collateral to support the venture for now and for the future. It is important to understand that there is a base number of ventures that are just in good standing. So the question really is of the ventures how many or what percent of them where there is some kind of dysfunction have we approached that we tackled and have we undertaken? I can’t quantify that specifically but I can say it is the vast majority. There is a subset of trouble ventures where we had partners that didn’t step up, that didn’t support, that became difficult or what not and we have resolved most of those ventures. There are a few of them that are lingering.

There are other ventures where we might have come to a debt maturity or to a moment in time where action needs to be taken where there is a funding requirement or something where there is just a negotiation. In all of those ventures we have worked with our partners. Where we have had difficult partners we have taken the tough position that our equity holders would expect us to be taking. Sometimes that has meant we had to walk at the edge of the line of default or more difficult positions. But in all instances we have negotiated and positioned ourselves to be able to manage the venture and end up with a good execution.

So I’d have to say as kind of an answer to your question for the subset of ventures that are showing signs of trouble the vast majority of them have been reworked and there is a small subset that are still being reworked.

David Goldberg - UBS

Thank you for the color on that. I guess the other question I would have would be it seems like your own land position went up sequentially by about 10,000 if I have the numbers right. I’m just wondering what margins you have on the land that you’re taking down now? If they are similar to what we are seeing come through the income statement now and how those pro forma when you take a look at them?

Stuart Miller

I can’t think of an exception to this and I’m always reluctant to say in all cases, but certainly in the vast majority of cases our margins are recalibrated to what I would call a responsible margin. Is that 17%? 20%? 22%? It is in that kind of a range on land that we’re taking down. We’ve either impaired the land or we have renegotiated the deal on land that we are taking down. Virtually anything that we are taking down is recalibrated to an acceptable margin for the future. Part of the problem with answering the question is in a market where you are continuing to see decline and decline of pricing it is hard to really represent a margin.

David Goldberg - UBS

I guess that’s why I asked because it seemed like in your opening statements you were talking about possibly being able to build on the margin from where it is today and based upon the pace of sales and the deterioration of the market it would seem like that would be tough on new land as it flows through.

Stuart Miller

You know in most instances we are taking down land as needed. To the extent that we are doing that we are basically putting homes in construction where the margin is being carefully crafted and capped at the time that we are taking down the land. There is no question that you will have some pull outs and cancellations and some situations where a home doesn’t get sold or started immediately and the market will continue to deteriorate. I noticed today listening to you on CNBC your forecast is that home prices will continue to go down. In that scenario some of the margins will not be as high as projected but we continue to renegotiate land take down and renegotiate any of the land contracts that we have under contract to match up with a margin potential given market conditions as they exist at this time.

David Goldberg - UBS

Thanks.

Operator

Our next question is coming from Carl Reichardt of Wachovia.

Carl Reichardt – Wachovia Securities

Good morning guys. How are you? Bruce can you talk a little bit about your store count relative to last year roughly and what your sense is for what it might be in 2008 as you look out here?

Bruce Gross

In terms of store count that you are referring to communities. We haven’t really given any community data. But to answer your question overall I’d say that it is down approximately maybe a couple hundred communities compared to the same time last year.

Stuart Miller

We’ve always felt that store count data is more confusing than it actually adds value and I know that you would say that we should leave that to you guys to decide. But we’ve always been reluctant to talk much about store count but there is no question that the number of communities we have under development is declining and we would expect that as we look ahead it will continue to decline.

Carl Reichardt – Wachovia Securities

Following up on David’s question, Stuart, as far as the gross margins…as we look at the 150 basis points in gross margin improvement year-over-year, how would you divide that out as far as a reduction in the [durax] versus building on land that you had previously impaired and you’ve lowered the basis on?

Stuart Miller

Good question. It’s really a hard question to disentangle. We have really tried to put pencil to paper on some of that. I would have to say that our construction costs probably year-over-year have come down somewhere north of 10%. The question of impairment and how they are flowing through our actual numbers these days…the answer under the best of circumstances is convoluted. In all instances we are working off of impaired land. What I mean by that is we have either impaired it on our books or we have renegotiated the land contract or we are buying new land at today’s market value or we are renegotiating an options price. So when you get down to it, Carl, the price of land is now recalibrated across the board. You could almost argue that all of our margin comes from the recapturing of pricing of land across the board.

Carl Reichardt – Wachovia Securities

Okay. I’ll get back in the queue. Thanks.

Operator

Our next question is coming from Mr. Dennis McGill with Zellman and Associates.

Dennis McGill – Zellman & Associates

Good morning guys. How are you? First question just has to do with and I want to talk about absolute communities. I assume you do look at absorptions. Thinking about where those are today I would imagine they must be well south of where you want them to be, maybe even below 0.5 a community per week. When you think about where they are and you look out over the next year, how are you guys approaching the pricing decision? What are you assumptions when you think about buying land today at market price about where home prices go for the industry over the next year or two years?

Stuart Miller

Well, first of all yes absorptions are down but I think that one of the things that is becoming better known and better documented is that there is a clearing site in the market. It just happens to be particularly low. In all instances where we’re buying new property we are recognizing that we are going to have to find our absorption levels that are acceptable at that clearly site, which is a low clearing site. Therefore, we have adjusted our view of the market so that we are expecting absorption to be modest. We are taking down home sites only as we need them where it is possible. We’re pricing to market, recognizing that this is not a market where pricing can be pushed. So that’s kind of the thinking that is injected in all the negotiations surrounding any new land acquisitions or renegotiated option positions.

Dennis McGill – Zellman & Associates

Sorry to cut you off, but just to kind of push you on that. Are you assuming that absorption can maintain their pace where they are at and you are comfortable at running well below one per community per week and pricing you think can stay where it is and it is just a function of time and confidence, like you talked about, in the community which will allow you to get absorptions back where they are? Or are prices going to clear lower to generate absorptions that are going to generate returns for you?

Stuart Miller

We are assuming that pricing is a moving target and one that we can’t peg down. Pricing is going to be the determinant of absorption. So in instances wherever we can where we’re not dealing with a fast contract wherever we can we are injecting flexibility to task our take downs, our absorptions, our pricing to whatever the market brings to us. It is one of the toughest adjustments that is happening or is going to happen in the land market right now. That is land holders are going to have to be flexible if they are going to move their properties because this market is not going to be pushed. It is a market where we’re going to have to take the pricing that is available, both land seller and home builder.

Dennis McGill – Zellman & Associates

Okay. I guess that’s where I am trying to understand the divergences because it seems like it would be hard to price that land today and a lot of your comments you made on the larger Morgan Stanley deal are coming to fruition with some of the bigger deals you are seeing out there being priced below. So it just seems like a dichotomy for land prices to continue to be under pressure but home prices not to be.

Stuart Miller

Oh, no I think home prices to be under pressure and I think I said that in my opening remarks as well, but I think that land prices are under greater pressure. I think that home prices especially in the new home world have recalibrated themselves more dramatically than land prices have. Land prices still have a ways to go.

Dennis McGill – Zellman & Associates

Okay, I think that’s fair. Just on that note and then I’ll jump off, in a lot of your markets where are you guys seeing into the price relative to the existing home sales?

Stuart Miller

I think the anomaly that we see in the market place generally, not just for us but for the new home market, is that new home prices are generally below existing home prices. The existing home market has not corrected as much as the new home market. That is a relative position that is going to right itself over time as the existing home market continues to adapt to market reality.

Dennis McGill – Zellman & Associates

Thanks as always guys.

Operator

Our next question is coming from Tom [Martego with Martego Capital.]

Tom [Martego] – [Martego Capital]

Hi. I was just wondering if you can comment on the recent actions within FHA and also Fanny Mae and Freddie Mac expanding the borrowing limits as to the impact that you have seen it have on activity and traffic. I know these have been recent changes so any color you can give on that would be interesting.

Stuart Miller

Unfortunately, look these are very, very important changes and I wish there was more color to give. These are recent changes and the filtering through to the field; we really don’t have data points yet to be able to give information. But I would just highlight, Tom, that as we go forward the starting points that we have relative to FHA and GSE’s is an important starting point. I think there is more work to be done and these will be important parts of what helps us get out of the supply/demand imbalance.

Tom [Martego] – [Martego Capital]

Stuart have you put together marketing plans associated around the various prices that you can now charge in those markets to be within these GSE and FHA plans so you might build a smaller house to fit under the cap whereas before that might not have been something that you anticipated?

Stuart Miller

No I think in every one of our communities today we are acutely aware of what those caps are and we have recalibrated our product to fit within the limit that either exists today or where those limits are going. And realistically the deals that are getting done today are conforming type products. There is not a lot of jumbo business out there. There is certainly not an AltA kind of product or market out there or anything sub-prime. So you’ve got to be conforming and product across the country really has to be very aligned with where FHA and the GSE’s are positioned.

Bruce Gross

Our average sales price today, Tom, we’re positioned very well within the new limits and although it is early FHA limits just went into place, the lower down payment of 3% is certainly something that we are hopeful will help sales in our market place.

Tom [Martego] – [Martego Capital]

In a reasonable time frame to see if they are being helpful, is it a month and a half, two months? Have you reached out to your marketing associates to make certain they understand what the plans are? Here in Denver just canvassing a few of the guys that I’ve talked to there is still some uncertainty as to what qualifies and what doesn’t.

Stuart Miller

Knowing your…going to have to go out and do some homework I am reluctant to make a bold statement, so I am going to say that I would be hopeful that throughout the field our people are very much aware of the programs as they are coming down. Given your question we are going to re-intensify our making sure that our division people are really on top of that. It has been a very big focus at the corporate level going down to the field that the programs that are available, which I think are the lifeblood of our business right now, are known down to every person in the field and I would hope that is the case throughout our company.

Tom [Martego] – [Martego Capital]

I wasn’t insinuating or anything. I was just interested in as far as what you are doing. Thank you very much.

Operator

Our next question is coming from Mr. Stephen East with Pali Research.

Stephen East – Pali Research

Good morning. If I could ask you just first on land spend. Ignoring JV’s, I know it is going to be down in 2008, what do you think between acquisition and development you will spend this year?

Bruce Gross

We haven’t given an actual number out, Stephen, but we do expect it will be significantly less and as Stuart mentioned it will be matching what we’re seeing in the market and taking down home sites as needed for our business. So it is somewhat dependent on market conditions but it will be significantly below where we were last year.

Stephen East – Pali Research

Okay. I understand. If you just look at JV spend and the quarter, when you wrap up all the different things, you reduced the number of JV’s some I assume you consolidated and some you walked away, etc. If you look at everything involved, consolidation, infusion of cash, land buy and development, etc. what do you think you roughly spent on JV’s for the quarter from a cash perspective?

Bruce Gross

A couple of components on that, Stephen. We did have re-margining payments of approximately $24 million during the quarter and we had land purchases from JV’s that were somewhere over $100 million and a few joint venture consolidations which wasn’t actually a spend, it would just show up on the books. So somewhere between $100 and $200 million relating to land purchases, re-margining payments would be the number. When we put out our cash flow statement we’ll see final numbers relative to joint venture contributions as well.

Stephen East – Pali Research

Okay. Just one last question. I appreciate that most of your JV’s are in good shape. Two of your larger ones you all have been going through the process. Are those renegotiation processes, etc. done or are they ongoing? Just sort of the status of those without getting into the nitty gritty detail that you all don’t want to talk about.

Stuart Miller

It’s not that we don’t want to talk. It’s that we really can’t. Those have their own public debt and statements that we’re just restricted on. The negotiations on those are ongoing but they fit the mold of exactly the discussion I laid out in my opening remarks relative to JV’s.

Stephen East – Pali Research

Okay. Thanks.

Operator

Our next question is coming from Ken Zener with Merrill Lynch.

Ken Zener – Merrill Lynch

Hello. I appreciate you addressing some of the cash contributions of the JV. If I add $850 million to where you were in the fourth quarter it looks like your cash went down a little over $400 million. Where else did the cash go? It looks like your units under construction was basically the same as well as your described inventory balance.

Bruce Gross

Yeah, our cash…what you’re doing Ken is you’re taking the $600 million of cash we had at year end and add in the $850 and we ended up at about $1.1 billion. Our land purchases during the quarter, which includes what we purchased from the joint ventures was approximately $350 million during the quarter. That would be the lion’s share. That is down considerably from the first quarter of last year and that is where the bulk of that would be and it was a little more heavily loaded in the first quarter as we have seen in past years putting in place the home sites that we are looking at for where we need them for the current year.

Ken Zener – Merrill Lynch

Okay. And I guess related to your land spending, your units under construction sequentially they went down but your completed unsold looks like it went up modestly. Can you talk about the desire to put new vertical? I believe several months ago Stuart you were talking about your lack of desire to put up vertical because it just wasn’t profitable. Has that basically changed because of your land position and you think your competitors aren’t putting as much pricing pressure given the absence of their year end?

Stuart Miller

No, our appetite for putting inventory in the ground is still very, very low. I think that we have in all instances adjusted our starts very carefully in each market to our sales pace. We don’t want to kid ourselves and say each home that we put under construction gets sold in advance because we recognize the cancellation rate can easily frustrate what one thinks in the sold homes under construction and make it an unsold home. But I think that our desire to build inventory or to start new homes is very carefully matched to what we think the market demand is at the current moment.

Ken Zener – Merrill Lynch

Okay thank you. If you could just make one comment about the FHA, which to me I understand it provides a lot of liquidity for the industry in general but it doesn’t seem to address kind of the structural issue or the problem that we are in now. Meaning, giving people liquidity, i.e. 3% down, but in the deflationary environment which I think we are in and it sounds like you would agree with that they are going to be under water very soon. Isn’t that the issue that we face? They can get a house but then they can be unmotivated to keep the house given their slow down payment? So I think it helps liquidity, but I’m not sure it is going to help the structural element. Can you address that conflict? Thank you.

Stuart Miller

I think that in today’s current market the lion’s share of the downward pressure, especially for new homes, is behind us. The U.S. housing market has always been dependent on a sizeable part of our market looking for the lion’s share of its purchase price coming from the debt market. We’ve had a housing market that has supported itself very well through the years by being a fairly highly levered market with fairly high loan to value ratios. I think that the sub-prime market was a market that got away from us. Underwriting did not start with underwriting the ability of the customer to repay. I think in a market today where adequate underwriting controls are in place to make sure that we are financing homes to people who can afford to actually repay the mortgage and who are invested in the home – even though the investment might be relatively small, I think ensures you have a market that starts to stabilize and in a stabilized market I think you end up with homes or loans that do get repaid and a housing market that is in good condition.

Ken Zener – Merrill Lynch

Thank you.

Operator

Our next question is coming from Michael Rehaut of JP Morgan.

Michael Rehaut – JP Morgan

Thanks. Good morning. My first question I think just goes back to the impairment charges and working off…certainly I understand that you do an exhaustive review each quarter but you also mentioned that you primarily in terms of the land that you own you primarily do it on the homes that you intend to build on. You also mentioned that certainly you are starting to moth ball and put some land aside. I was wondering if you could give an idea of how much of that land you are sort of deferring in terms of putting it aside for maybe construction in 2009 or 2010. Has that portion increased?

Stuart Miller

Michael I’m not sure. You might have a mix up with one of the other conference calls. We’ve been pretty clear as we have gone through our quarterly reviews to say we have reviewed every asset in our backlogs. It is not just the home sites that we are preparing to build on; it is each and every asset that is in the portfolio.

Michael Rehaut – JP Morgan

Okay. Because I thought Stuart that I heard that before when you had the more detailed break down the first category was reviewing land that you intend to build homes on is how it was described. I was just wondering in terms of the other assets if those are just being put aside for a later date or not?

Stuart Miller

Diane has given a report each quarter on our impairment process. If you could speak to that Diane?

Diane Barrette

You know what I’m thinking. Maybe there is just some confusion in how we categorize it. As we described, the reviews that we have gone through certainly we start with the assets that we are going to build homes on, then we go to the assets that we are looking to sell in the short term, but then we also mentioned that we look at the assets that currently there is no plan to sell. I think Stuart’s point is right that it really is each and every asset and maybe there’s just some confusion in the way we broke that discussion up. There is no limitation as to what we look at. We have not spent a lot of time deciding which assets were more full; in fact I think it is probably the opposite direction in that we have been very aggressive of looking at everything. Even the assets that perhaps do go out into the future a little bit more than some of the current assets we are expelling. We have really been very clear that we look at every single asset regardless of whether it is a current asset or longer term asset, including all the assets that exist in our joint ventures, which is where the bulk of the longer term assets would be.

Michael Rehaut – JP Morgan

Okay. I appreciate that. Second question I guess along these lines. I’m just trying to ascertain the relationship to order price versus paces and impairments. If you look at the prior quarter, the fourth quarter, you took specifically on the land charges obviously a much, much larger number. A lot of that had to do with the Morgan Stanley sale, but still you had $225 million in the gross margins, another $230 in the land sales. Your order ASP fell about $22 in Q4 from Q3. This quarter the pricing was more flat and I think at the same time you mentioned things have continued to be pretty tough and there has been some further price deflation in the market. So my question really gets to the extent there is further negative home price deflation over the next quarter, do you still expect that to have an impact or a result in your impairment analysis?

Stuart Miller

As we sought to go through impairments and come to the end of 2007 as you described, I think that it was our decided strategy to try to get ahead of the situation instead of lagging behind it. I think that even with order trends looking like pricing could continue downward, as I said in the opening remarks, I think we are going to see a materially lesser impact because of the heavy lifting that we have already undertaken. I think that as we have looked at assets, as we have gone through our impairment review through time and redacted those numbers that frankly I’m not sure I want to look back on so much, we did that with an eye towards understanding that the market would likely continue to deteriorate and if the market does continue to deteriorate there might be some additional impairment it will be not near the magnitude that we have seen in the past.

Bruce Gross

Keep in mind, Mike that our land under development dollars now the first quarter are down to $1.5 billion. There has been a significant decline of what is remaining on the balance sheet on the inventory category.

Michael Rehaut – JP Morgan

Last question. I appreciate the response so far. It is very helpful. Just on the JV’s. I think last quarter the JV’s themselves has a set to cap at about 65% and just wanted to get a sense for whether that was sustainable or I know you have done some re-margin payments but they have been relatively small up to this point, if that is something that as you have mentioned in a number of JV’s there are ongoing discussions. How are we to think about that going forward? Is that an acceptable debt to capital level? Give us some sense of how that might play out.

Stuart Miller

I think that is going to continue to be a moving target and hard to kind of peg. Debt to capital in JV’s you know you kind of have to question at this point is it debt to capital? Debt to value? What the right kind of question is that has to be pointed out. Every joint venture in reality stands on its own. Very much an important question within each joint venture whether it is a recourse, non-recourse, debt facility and what the responsible parties has their respective obligations. So it is kind of a generically pegged what a right debt to capital percentage is for joint ventures as a group. I think it is something that we are probably not going to be able to peg for you. As I noted in our last quarter conference call, all of our joint ventures were conservatively capitalized at the outset. The market movement downward has rocked that capitalization into the negative in pretty much all instances. But the reason they were capitalized conservatively in the beginning was to be able to withstand negative impact and that is what most of them are doing and those that are not they are being renegotiated into that position. Bruce?

Bruce Gross

One thing to add, Mike, as you look at the overall joint venture debt to total capital, if you strip out land source because we didn’t step up the basis last year when we admitted a new partner in the first quarter of last year, land source has close to 100% debt to total capital as a result of not stepping up the asset, which is included in your numbers. In the current quarter, the debt to total capital excluding land source is about 57%.

Michael Rehaut – JP Morgan

That’s helpful. Sorry, let me just sneak in one more. Kyle Canyon has been out there that it lists interest payments. Can you give us an idea if possible of the total debt that is out there from the JV’s that you are involved with? Maybe what percent is in that category?

Stuart Miller

Unfortunately, Mike, I am going to have to reprimand both you and Bruce. I said we wouldn’t talk about specific joint ventures. Bruce started it out by talking about land source and you’re following it up with Kyle.

Michael Rehaut – JP Morgan

Bruce, I’ll take the blame on that.

Stuart Miller

We’re going to have to go to the next one.

Operator

Our next question is coming from Mr. Jim Wilson with JMP Securities.

Jim Wilson – JMP Securities

Thanks. Good morning guys. I won’t ask about JV’s then. I wanted to talk about; I guess two questions would be on cost. The first one, as you reduced headcount dramatically and I was just wondering if you have thoughts or anything you can say on any further it might go. On the one hand you reduced it a lot, but obviously your SG&A ratio is still 18% of revenue, obviously on depressed revenue. But if you have any further thoughts on where that might go? The second one is how much benefit if there is a way to quantify that or coloring that, the lower construction costs in general have helped margins or even could help margins in the future? What have you seen and what might you see further?

Stuart Miller

Jim, it’s going to be all of these pieces happening together and in tandem. Our SG&A will go down as we go through the year. Each of our divisions has a plan that for the year their SG&A in relation to revenues should be close to 10%. That is a far cry from where are today at 18% but a large part of that is that revenues in this first quarter are clearly slow. We are continuing to move SG&A down.

The re-negotiation of construction costs continues to be a positive factor that will improve margins. It might be in smaller percentage amounts as we go forward, but we are continuing to hammer at construction costs and inject reality into the market place in general. So it really is all components, the land component as well. Everything chipping away at driving higher margins.

Jim Wilson – JMP Securities

Okay. Great. Thanks that’s all I have.

Stuart Miller

We’ll take one last question.

Operator

Our last question is coming from Nishu Sood with Deutsche Bank North America.

Nishu Sood – Deutsche Bank North America

Thanks. I also wanted to ask about the gross margins. Now I know you have said you don’t track this in the past but you did mention in your commentary about how the gross margin benefited from the prior impairments marking the land assets down to kind of a current value. I was just wondering, given the magnitude of the jump if you could just help us to frame some kind of quantification of how much gross margins benefited from the amount that they were marked down to current values?

Stuart Miller

You know, Nishu, Bruce and I spend a lot of time anticipating your question today and in trying to come up with something that made sense to us given the magnitude of the impairment we have taken over the past couple of years you could almost argue that all of it has come from adjustment in pricing and land. The bottom line is within this industry the reality is you just don’t make margins on land prices that are wrong or that are too high. That is kind of an axiom of the industry. So in this market where we’ve seen such degradation in pricing over the last couple of years anything that had been negotiated or bought, put on the books in 2005 or 2006 was land that was going to be producing a negative margin in 2007 and 2008. So the only way that new homes would be built would be on re-priced land. Now that is in combination re-priced either through impairments that have been taken or by renegotiation of contracts that were in the pipeline or purchase of new land at new prices or renegotiation of options pricing. But it is really all the same. That is it is the re-pricing of land assets to a level where a home could be built on a positive margin.

Nishu Sood – Deutsche Bank North America

Got it. Now that is helpful. The second question I had was on the financial services. Obviously the profitability has diminished a lot. You mentioned market conditions out there just lower originations of loans. We have also noticed in some of your communities you have been offering below market rate financing. I was just wondering if in the past few quarters you have stepped up the use of the below market pricing or anything to your financial subsidiary as a means of driving sales?

Bruce Gross

We have, Nishu. We have offered some programs that we have seen some success with and there has been a bit of a step up in offering lower rates to help with the affordability of attracting buyers into our communities.

Stuart Miller

I think financing for the time being is going to be at the heart of where sales are made. We are going to continue to see that be part of the pricing mechanism and the attraction mechanism for home buyers coming into the market. I think if you look historically over past cycles coming out of a downward trend has always been defined by a combination of purchase pricing and financing packages.

Nishu Sood – Deutsche Bank North America

I see. So you have been shifting away from simple price cuts, or lets say option price reductions more towards the financing side of things?

Stuart Miller

I would say that is the case. We have less of an options program across the board anyway so we don’t really use that tool to attract buyers. But we definitely think it is the financing side of the program that is going to draw buyers back to the market.

Nishu Sood – Deutsche Bank North America

Got it. Thank you very much.

Stuart Miller

Okay. Thank you every body for joining us. We look forward to reconvening at the end of our second quarter.

Operator

This will conclude today’s conference. Thank you for participating. All parties may disconnect at this time.

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