With a rock-solid balance sheet, conservative land strategy, and a legacy of strong field operations, Wall Street analysts expected The Ryland Group's 2Q2009 performance to be in line with, if not ahead of, that of peers.

KB Home, Lennar Corp., Standard Pacific, and most recently M/I Homes, which reported Thursday morning, came out of the second quarter with some strong improvements in performance. Even Meritage Homes, which posted a sizeable $73.7 million loss, mainly due to a huge write-off related to a 1,200-lot option contract, had made rather big strides toward improved profitability.

So, when Ryland posted a $73.7 million, or $1.70 per share, loss for the quarter, analysts were not only surprised--Wall Street consensus was a loss of $1.04 per share--but disappointed. As one housing analyst commented offline, "I'd say compared to the others, Ryland laid an egg." (For more detail on the company's 2Q2009 performance, including information on the retirement of $70.6 million of its senior notes and termination of its $200 million revolver, click here.)

The "elephant in the room," as Joshua Pollard, an analyst at Goldman Sachs, put it during the company's earnings call on Thursday, was margins. Ryland executives had been promising margin improvement for a number of quarters. And there was some--gross margins excluding charges moved from 6.0% last quarter to 7.8% during the second quarter--but analysts were hardly impressed with the improvement, especially compared to the 12.5% gross margins the company had a year ago.

In a research note, Raymond James analyst Buck Horne wrote:

"Unfortunately, we still remain very troubled by Ryland's unusually low 7.9% gross margin (before impairments), even though it does represent a slight sequential improvement. Despite having made significant adjustments to its overhead structure, we still believe these core margins imply more inventory impairments are on the horizon. Our current estimates include another $50 million of charges in 2H:09."

Pre-tax charges for inventory and other valuation adjustments and option write-offs for the quarter also came in greater than most analysts expected at $47.3 million, reducing earnings per share by $0.32.

Company CEO Larry Nicholson responded to the concern over the company's margins by reminding analysts that the company is still operating in challenged markets. He cited Charlotte, N.C.; Chicago; and the company's three Florida markets--Jacksonville, Orlando, and Tampa--as the "most difficult" markets and pointed out that there's still a lot of discounting in Western markets. Moreover, appraisals, particularly in markets besieged by foreclosures, were also causing a wrinkle, as the company sometimes had to capitulate on price to get a home to close, he said. Add to those two market conditions the fact that the company had 34 out of 218 actively selling communities in close out, and it makes for tighter margins, he said.

However, on go-forward basis, Nicholson reiterated that the company would improve margins, although he declined to give any guidance. "A lot of communities with lower margins are going away," he said.

Like many peers, the Ryland management team has been aggressively looking for land to refill its pipeline at a lower cost basis, which will ultimately improve profitability. However, unlike some of its peers, the deals it's been chasing haven't been in the distress market.

The company inked three option deals during the quarter--one in Indianapolis and two in Texas. When asked if the transaction price was at a discount to development costs, Nicholson responded, "They were more than development costs but not much." CFO Gordon Milne added that significant discounting wasn't to be expected given that the markets in which the deals were made were far from being labeled in distress.

The announcement provoked a number of questions from analysts about who the land sellers were and what financial assumptions the company was making. Milne said the deals were not done with banks or developers and the company was seeing 18% to 20% gross margins on deals and rates of returns well over 30%.

Although closings were off 40.3% year over year, dragging home building revenues down 43.6% from the same period a year ago, the company's new orders performance was better than expected. The company's unit orders declined 16% year over year to 1,716 units, against tougher comps. The other bright spot was the company's backlog increased 33.7% sequentially to 2,482 units, although it was still down 33.0% from 2Q2008, providing some future operating cash flow assurances.

Management appeared fairly comfortable with its sales performance, telling analysts that it had no intention of ramping up spec production in an effort to sell and close more homes before the expiration of the $8,000 federal first time home buyer tax credit on Dec. 1. "We are going to maintain our spec discipline of roughly two per community. We don't expect to move away from what we've historically done," said Nicholson.

But Nicholson hardly down played the boost the tax credit has given the company, saying "it's been a help." However, when asked if he thought the tax credit had pulled demand forward, suggesting the selling environment could become tougher after the tax credit expires, he said, ""By the time we get to November, we'll have few more months of price stability and hopefully consumer confidence will improve, so I'm hoping there's not a lot of fall off."