After the stock market's close tomorrow, The Ryland Group will release its 3Q2008 earnings. With impairments and write-offs expected to have tapered off from last quarter's $180.4 million, stakeholders' focus will be on whether or not the company has improved its profitability despite a declining sales environment.
With sales and revenues likely to continue their slide, the spotlight will be on margins. Fewer impairments and other charge-offs should improve gross profit margins from last quarter. Valuation adjustments and write-offs, along with increased sales incentives, were a huge drag on gross margins in 2Q2008; the company's gross margins averaged -18.2% for the quarter. Without the inventory charges, gross margins would have topped 12.5%.
Buyer incentives also have been contributing to a swelling of Ryland's SG&A in recent quarters. After hitting 16% of revenues in 1Q2006, management has been working on several cost-cutting initiatives aimed at bringing SG&A back in line at 11% by 4Q2008. Last quarter, SG&A came in at 11.5% of home building revenues, as the company cut corporate expenses significantly from $19 million to $7.1 million. The drop by and large was due to lower incentive compensation resulting from declines in earnings and stock price.
However, shaving off additional basis points from SG&A will become increasingly difficult. Cost of sales likely will not shrink substantially through the end of the year following the ban on seller-funded down payment assistance (DPA) that took effect on Oct. 1. The ban directly affects builders' abilities to net new orders; JPMorgan housing analyst Michael Rehaut estimated that public builders rely on these programs for as much as 17% of their loan originations. Consequently, builders such as Ryland may be forced to up incentive packages to offset the loss of DPA programs.
Despite an anticipated slowdown in balance-sheet charges, Ryland is not expected to come out of the quarter write-down free. In early July, management made a third amendment to its senior credit facility. The changes made were related to tangible net worth and leverage ratio covenants, a move that FTN Midwest Securities Corp. analyst Jay McCanless said pointed to future charges in 2008. In a research note from July 7, McCanless estimated that Ryland would incur roughly $207 million more in land impairments, as well as a $151.2 million deferred tax asset charge, by the close of fiscal 2008.
The company finished out 2Q2008 with $199.4 million in cash on the balance sheet, after paying $50 million toward notes due May 2012. The company could have seen improvement in its cash position during 3Q2008, as nearly 48% of its inventory is classified as work in progress, suggesting that, unlike raw land, it could quickly be converted to cash if necessary. However, the company's solid debt position--it has $250 million due in 2012--indicates that its current cash position likely is sufficient for the moment.