KB Home (KBH) 2006 Q2 法說會逐字稿

Good day, everyone and welcome to KB Homes' second quarter earnings conference call. As a reminder today's call is being recorded and webcast on KB Homes' website at www.KBHome.com. KB Homes' discussion today may include certain projections and forward-looking statements regarding KB Homes' business, future actions, and expected results. These are based on management's assessments of the Company's current business and assumptions about future operating conditions, but should not be considered guarantees of future performance. Please be aware that KB Homes actual results may differ from those that are expressed or implied by the projections and forward-looking statements that the may be made today due to risks, assumptions, uncertainties, and other risks and events outside the Company's control and that -- the differences may be material. Many of these Risk Factors are identified in the Company 's Annual Reports on Form 10-K, quarterly reports on Form 10-Q, and current reports on Form 8-K filed with the SEC and the Company urges you to read them. For opening remarks and introductions I would now like to turn the call over to KB Homes' Chairman and Chief Executive Officer, Mr. Bruce Karatz. Please go ahead sir.

Good morning, everyone. Thank you for joining us today to discuss the financial results for our second quarter of '06. With me this morning are Jeff Mezger, our Executive Vice President and Chief Operating Officer; Dom Cecere, SVP and Chief Financial Officer; Bill Hollinger, our SVP and Controller; and Kelly Masuda, our SVP of Investor Relations and our Treasurer. We are pleased to report strong profitability in the second quarter. Our financial performance this quarter reflects our continued focus on superior customer service and refinement of our disciplined KBnxt operating model to improve all aspects of our business. Let me briefly share some of the second quarter financial highlights with you.

We posted solid top line revenue growth in the quarter with Company-wide unit deliveries, up 6% on a year-over-year basis, and revenues up 22% to 2.6 billion. Total company pre-tax for the quarter was 320 million up 16% from 275 million in the second quarter of last year. Pre-tax income as a percentage of revenue was 12.4% this quarter compared to 12.2% in the first quarter of '06 and 12.9% in the second quarter last year. Diluted earnings per share for the quarter was $2.46 up 19% from $2.06 a year ago with 84 million diluted shares outstanding compared to 88 million in the year earlier quarter. We repurchased another 2 million shares of our stock, common stock this quarter, following the 2 million shares repurchased in the first quarter of '06 and the 2 million shares repurchased in the fourth quarter of last year.

We concluded the first half with a solid order backlog of 27,412 sold homes with a revenue value of approximately 7.7 billion. Our backlog value of sold homes entering the second half is up $865 million or 13% compared to a year ago. Gross unit orders for new homes in the quarter were down 5% this quarter and net unit orders were down 19% from a year ago. Remember that in 2005 and 2004, second quarter net unit orders for new homes were up 15% and 28% respectively. The average U.S. sales price of homes and backlog entering the second half of the year was 295,000, an increase of 13% from 261,000 at this time last year. It was a solid first half with 4.8 billion in revenues, up 27%, $4.48 in diluted earnings per share up 29%, and a backlog of sold homes entering the second half valued at 7.7 billion , up 13% with the average sales price in backlog also up 13%. Now I'll ask Dom to take you through some more financial highlights for the quarter.

Thank you, Bruce. The average U.S. sales price of homes delivered in the second quarter of 2006 increased 16% to 295,300 from 254,500 in the second quarter of 2005. The average sales price of our homes benefits from both price improvements and the continued diversification of our product and geographic mix. Positively impacting pricing was demand for designed studio options. Where our studio options as a percent of base price increased to 11.9% in the current quarter from 11.1% in all of 2005.

Our cancelation rate which was the primary driver of the overall decline in net orders for new homes increased to 37% this quarter compared to 32% in the first quarter of 2006 and 25% in the second quarter of 2005. While it is still difficult to predict, we believe that cancelation rates should begin to improve and have a less of a negative impact on orders in future quarters. The net increase in cancelation was 1,600 units which by the way was only 6% of of the 27,000 units in quarter end backlog. The average price of new home orders for the total company in the second quarter was up approximately 13% year-over-year reflecting our continued focus on maintaining pricing and resisting price concessions to drive sales. The higher average sales price for new orders in the quarter partially offset the decline in unit orders and contributed favorably to the value of our quarter end backlog which reached 7.7 billion up 13% from the previous year.

U.S. community accounts were essentially flat this quarter with 419 active selling communities compared to 415 in the second quarter of 2005. We are curtailing community account growth in sub markets where there's an excess supply of finished lots and returns on invested capital are below our cost of capital. Housing gross margin was 25.8% this quarter down 20 basis points from the 26% housing gross margin in the first quarter of 2006 and down 100 basis points from the second quarter of 2005. SG&A as a percent of housing revenues improved by 30 basis points including the expensing of stock options. Excluding these costs, SG&A at a comparable basis improved by 40 basis points over the second quarter of 2005. Construction, pre-tax income for the quarter of 314 million improved by 14% over the 275 million in the second quarter of 2005 which was up 83% over the second quarter of 2004. Our debt to total capital at quarter end was 54.5% which was higher than expected as higher cancelation rates impacted deliveries. We expect to see our debt to total capital ratio improve by year-end with free cash flow from operations being used to reduce debt while interest coverage and debt to EBITDA ratios remain at solid investment grade levels.

Company-wide we had approximately 184,000 lots owned and controlled at May 31, 2006, compared to approximately 180,000 lots at this time last year. Our land positions have become more geographically diverse as we have expanded our business, approximately 50% of these lots are under option contract. With our continued focus on a risk adverse, build to order home builder we had only 600 completed unsold homes of inventory at quarter end which approximated less than 4% of the over 18,000 KB Homes currently under construction in the U.S. Our investment in inventory continues to be guided by our detailed analysis of each sub market where we sell homes and our overall focus on after-tax returns on investor capital which for the last 12 months was over 19% and our return on equity for the last 12 months over 34%.

Our build to order KBnxt operating model provides KBH with one of the largest and most diverse backlogs of sold homes in the industry. We have a very geographically balanced business today with 4,256 homes sold and in backlog in our West Coast region, 4,794 in the southwest, 5,945 in the central region, 5,929 in the southeast, and 6,488 in France. You can also see the revenue contribution going forward from our southeast region which at quarter end had 1.5 billion of sold homes in backlog compared to 2.2 billion in the West Coast region and 1.5 billion in the southwest region.

In summary revenues for the first half were up 27%. Pre-tax profits of 589 million were up 28%. Pre-tax income is a percent of total revenue improved from the first quarter. Our SG&A ratio continues to improve, and we reduced the average numbers of diluted shares outstanding. This contributed to an EPS of $4.48 up 29% over a very strong 2005 first half of $3.47 which was up 67% over the prior period. Now I will turn it back to Bruce for the wrap up of our second quarter conference call.

Thanks, Dom. With the decline in new home demand and the increase in new and existing home supply, home sales in our communities remained sluggish with higher cancelation rates impacting unit order growth for the first half of this year. While it is difficult to predict, we do believe that the cancelation rates will begin to subside as the backlog of new buyers replaced those who placed orders when the housing market was more robust. In the meantime, our focus is to profitably grow our business while delivering sustainable long term value for our shareholders. This focus translates into several operating strategies that we reviewed with investors in May at our Investor Day conference.

One, we continue to repurchase shares of our common stock which we see as a high return, low risk use of available funds. We repurchased 4 million shares of our stock in the first half of this year and anticipate repurchasing additional shares in the second half of this year. Two, we are being much more selective and more demanding on terms for land purchases focusing on "A" locations and land constrained markets and contracting land holdings in emerging markets and in markets where there is an excess supply of existing inventory. We currently have a 4 to 5 year supply of lot lots owned and controlled providing an ample supply of lots to support our operating plan for '07 and '08.

Third, we are focused on reducing the cycle time from the sale of our homes to close. This includes improving even flow production and turning our inventory faster. We have targeted a reduction in cycle time of 20 days to improve pre-tax profit and increase inventory turns. Fourth, we have targeted programs in place to drive improvements in the direct cost of construction of a home and are continuing our efforts to lower SG&A which improved by 60 basis points last year and by another 40 basis points in the first half of this year, excluding the expensing of stock options. Fifth, while we continue to price homes to remain competitive in each of our sub markets, we are resisting the use of short-term sales incentives to drive orders, instead we're maintaining our focus on selling the value of our brand, our sense of community, our customer service, our quality product and the full array of design options that make buying a KB home a value buy, not a purchase based on sales incentives, and we believe that these operating strategies will provide $1 billion in free cash flow from operations over the next 18 months for continued share repurchases and a strengthening, strong balance sheet.

With our first half EPS up 29%, our $7.7 billion backlog of sold homes at quarter end up 13%, our continued share repurchase program, and our focus on cost reduction and productivity improvement, we are entering the second half prepared to perform in what is continuing to be a more challenging housing market. Higher cancelation rates have impacted deliveries, and until we see clear evidence of this moderating, we are lowering our unit delivery outlook for the year by 5% from 42,000 to 40,000 units. We are lowering our revenue projection for the year by 5% or $600 million to reflect the reduction in unit deliveries. The total revenue forecast for the year is now 11.4 billion versus the 12 billion first forecasted in September of '05 at our Investor Day presentation last year. The 11.4 billion in forecasted revenues for this year would still be an increase of 21% over the 9.4 billion of total revenue last year. And, we are lowering EPS from the 11.25 previously given to $10 for this year to reflect lower forecasted revenues and the negative impact on pricing power from an oversupply of housing inventory. At $10, EPS in '06 will be up 5% over the $9.53 achieved last year which in turn was up 67% from the $5.70 EPS achieved in 2004. We will now open up the lines to your questions.

[OPERATOR INSTRUCTIONS] We will now go to Margaret Whelan with UBS.

Good morning, guys.

Hi, Margaret.

Nice quarter. And I'm trying to get a sense for the trend in the quarter into June. I was surprised that your growth orders were just down a couple of percents on a flat community count. Seems like you must have had high quality traffic. Can you just give us a sense of whether or not that's true and how it worked out through the quarter and into June, please?

Margaret, it's too early in June really to make any comments because we've only had two weeks of sales.

Yes.

But through the quarter, the second quarter our traffic was down on a Company basis roughly the same as our net sales, it was down about 20% in the U.S, So we're seeing less traffic. I think that's reflective of the investors haven't left the market.

But it seems like the traffic relative to the fact that your community count was flat was pretty good.

Yes, traffic is still favorable. I mean it's down from what it was, but last year at this time it was at much higher than historical levels per community but traffic is still solid to run the business.

The one piece of color I would give you from my perspective is that you focus on, for us, a very important fact which is the gross sales, and because I'm one gray hair or no hair guy around here, I do remember past downturns and this is definitely different from recessionary periods.

Yes.

We're not struggling to get sales. We want more sales. We obviously do not like negative comps, but we are still looking at very strong backlogs, and feel comfortable running our business essentially the same way today as we did when it was more robust, and those were not the conditions. If you look back to the most serious, most recent serious downturn which was the early '90s, very, very different from those days.

And what's your best guess for '07 based on what you're seeing right now?

Best guess as to what?

For '07?

For '07? Well, we're not going to jump out today on '07. Well, '07 is going to be determined a lot on what happens over the next six months, and as we indicated, I don't think it's reasonable to assume market conditions to significantly change at least over the next six months. So my view is that from KB's standpoint, we need to get all of our new communities open as soon as possible because we think we've got some very compelling product and locations that will sell well, so we've got to get those open and we've got to continue pushing with all of the same disciplines that we talk about but we've got to do it better with working with brokers, taking every broker sale we can, and making sure that every customer who comes through has the right follow-up. We use registration cards during good times, sales people think registration cards are kind of a nuisance. Today, we would kind of like them to follow-up with those reg cards and make sure we're selling everyone who wants to buy a home. So I think today just generally without giving you any quantifiable numbers, I think '07 is going to be a fine year, but it may not be -- it's not likely to be a record year.

Okay.

I would say, Margaret, for the group, I mean, we've taken the actions now to set ourselves up to be in position to weather whatever '07 brings. That's why we've been buying back shares, that's why we've been holding prices, that's why we operate we're one of the largest backlogs in the industry, that's why we're focusing on reducing SG&A, that's why we're talking about generating free cash flow. So I think we're positioning ourselves for whatever '07 brings.

What was your share count at the end of the quarter, not the weighted average, but at the end?

About 83.5 million.

And then the lot count was 184 which was lower than I expected relative to your delivery, so have you walked away from lots or sold lots?

Yes, we have. We have walked away from some options. If you look at our option lots quarter to quarter, I think they are down 10, 12, 15,000 units so we have been walking away from lot positions where we don't think it makes sense to put cash in the build homes when your stock is trading close to book you're better off buying back shares with the money.

I didn't see that in your P&L though. Was there a charge?

We have abandonments, it's part of our business, in the normal course of business and we've had them every quarter but they're not a meaningful cost compared to overall cost of construction. I would take options and abandonments versus purchasing land outright as a risk adverse way to run a business that provides returns on invested capital in this industry three times higher than the S&P 500 so it's a good thing not a bad thing.

But you're running them through the P&L, it's not one time?

No, we run them through the P&L, we run them through the P&L every quarter.

Okay, thank you, guys.

Our next question comes from Stephen Kim with Smith Barney Citigroup.

Thanks, thanks, guys. I guess I had a few questions if I could, a couple of sort of housekeeping items I guess. Can you talk about the inventory figure as we go forward? How much inventory build should we be expecting as we head into the third quarter? I guess the way I would think about it would be that you're probably going to have a greater build in inventory in the third quarter on the one hand because you might have, you're going to have a higher cancelation rate and all that, on the other hand with reduced sales your overall inventory may be lower. Can you give us a handle on what you think is the best way to forecast inventory over the next two quarters given a certain assumption of orders?

Well, Steve, we're assuming that just -- well, just to give you a feel, generate about $450 million of cash flow from net income and that inventory will be down somewhere between 200 and 300 million by year-end.

Okay.

Now you're already building inventory for your big fourth quarter delivery so you may not see that in the third quarter but you'll see it by the end of the year.

And that's from where we are today or where we began the year?

From where we are at the end of the second quarter?

Okay, good. Great. And can you give us the break down on inventory construction in progress versus land to land development?

Bill's looking.

Okay. While he's looking, if I could have a little conversation with you on the SG&A? Obviously SG&A is going to move depending on some assumption for fixed overhead. What do you think is a good approximation for fixed overhead? I kind of generally use around 30 to 50% depending on the builder, but what would you say fixed versus variable is in the very short-term, I'm talking like two quarters?

We're not going to get into fixed variable costs again are we, Steve?

Not too much. I'm just assuming 30. Can you just tell me if that's a number that you think is way off?

Yes, we think it's way off. We've always said our fixed is more closer to 10.

Yes, okay. And on the short-term basis, short is like two quarters you think?

Yes.

Okay. And then lastly, if you could talk a little bit about the conversion rate. My sense is that with slowing sales and you've talked about reducing your cycle times that you're going to see a pretty significant increase in conversion rates, backlog conversion rates, that is. Would it be entirely unreasonable to assume that if the order -- if your backlog continues, I don't know how to say it, but I guess if your order rate continues to be sort of at the same rate that it was in this quarter down 20%, if it continues like that for another quarter or so, is it unreasonable to assume though that your conversion rate would move back up aggressively to maybe even as high as it was three years ago like in 2003 where it hit 54% in the fourth quarter?

I don't know if 54 is the right number but our conversion rates are going to start to improve quarter to quarter. I don't think I'm going to see a big spike in a quarter but we should start to see improvement.

You feel comfortable quantifying that in anyway, because this quarter was actually as you know probably down year-over-year, I mean should we expect a full handle here in the third and fourth quarters? Well, the third quarter I guess? Fourth quarter should obviously have a full handle?

No, the third quarter won't have a full handle, because the third quarter is going to be in the 30s and the fourth quarter if I knew what my backlog was into the third quarter I could probably tell you but it probably is a full handle, yes.

Yes, okay so it sounds like you're not looking for a big increase in conversion rates. Are you expecting a greater increase -- a big increase in '07 perhaps?

We should start to see a steady improvement through this year and into '07.

But it will be more steady?

Because we're also controlling inventory but it's declined over several years so we should start to see improvement because a year ago our backlog had stretched out to 7 or 8 months and now it's going to probably come back closer to 5.5, 6 months and with that you'll see a higher conversion of backlog.

Steve this is Jeff. My analogy would be this is turning a very large boat out in the ocean.

Okay.

There's a lot of little things that we do to compress our cycle time and you've covered us a long time. You can go back to '01 or '02 when our contract to close was under six months.

Right.

As a lot of the markets overheated and the cities were slower on permits and subs were a little tighter, our build times extended and our process times extended, we're hopeful that we can get back to the '01, '02 levels, it's a question of how long it takes because there's all these little moving parts that we're tweaking and pushing in order to get there but we do expect as our -- some of these markets have softened a bit, the cities we're seeing a lot of evidence already on permit times coming back down, we're seeing a lot more sub availability so our build times are already starting to come down and all of these things, each of these little components over time should get us back to the '01, '02 levels. It's a question of how long.

Steve when I look at the unit deliveries, in third quarter, fourth quarter, they are going to be up around 6% in both quarters year-over-year and if you had set that your conversion ratio in the third quarter would be in the high 30s but not quite 40%.

Got it. Okay appreciate it and do you have those numbers on inventory yet?

Yes, Steve of our $7.6 billion inventory, $4.9 billion is homes in production and the remainder of 2.7 would be land under development.

Can you go a couple more digits for me?

Okay. Well, I rounded so it's 4.873 for--.

Yes.

And then you could just subtract the difference.

Got it. Okay, thank you.

Our next question comes from Carl Reichardt with Wachovia Securities.

Good morning, guys how are you?

Hi, Carl.

I think Steve got to this but the cycle time reduction that you're targeting the 20 days is contract to close, Jeff, not start to finish?

That's correct.

I can go back and get that. Okay. Can you guys talk a little bit about the Nehemiah programs and the gifted downs from charities and what the IRS ruling from last month is going to have impact-wise on you if any?

Carl, it's really a very small component of our business, so we're not really concerned about it. There's so many other products out there. It's an FHA-type loan. Most of our markets we don't even build in FHA price ranges right now, but we don't see a material effect on our business.

Okay, fine so it's just an FHA issue then?

Yes.

And then two other real quick things. Do you have French community count handy there?

You know, I mean it's a difficult number to actually calculate, but I do have it if you want it.

Yes.

At the end of the third quarter France was 133 communities.

133. Okay.

I'm sorry, second quarter was 131.

I'm sorry, 131?

Yes.

And then Bruce, just lastly, can you talk a little bit about Martha Stewart, how it's performed over the last quarter or so and then expectations for expansion of different areas?

Yes. We believe if we had 40 or 50 Martha Stewart communities open right now, our net sales would have been considerably better. The Raleigh market has responded extremely well and it is driving sales and traffic throughout the whole market for us and I believe Jeff, correct me, I believe we've become the largest builder in Raleigh?

In the second quarter.

In the second quarter of this year which part of it is due to our Martha Stewart KB branding. We are opening towards the end of July a large community in south Atlanta, Fulton County, with Martha again. We are very excited and we also are beginning to build models in Houston. We are trying to get every single KB division throughout the country to get a Martha community going. We think it is a wonderful branding strategy particularly in a market like we have it. Unfortunately, we don't have enough communities going that it's going to have a material impact on our numbers at -- yet.

Terrific. Great. Thanks a lot, guys, appreciate it.

Our next question comes from Greg Gieber with A.G. Edwards.

Good morning, guys.

H, Greg.

A couple of first -- a number of questions. A couple of months ago when you gave your guidance you shared with us your expectations on share count. Could you give us what your revised numbers are?

On share count for the rest of the year?

Yes. Third and fourth quarter.

We are just still showing 84 million, same as we had second quarter so I probably have a little cushion on share count through the year.

So you're holding share count steady in your guidance but saying it's in actuality it's going to decline?

We said we'll be doing some share repurchase in the second half so that's probably right.

Okay. On the SG&A, How much of the reduction are in the percentage came from reduced accrual, bonus accruals or reversals of previously taken bonus accruals?

It didn't have a big adjustment in the quarter to bonus accruals. Our bonuses are performance based so for our performance and most of that is tied to pre-tax profit, so if pre-tax profits are down then our bonuses will be down.

So it's been taken; okay. And from all of the local newspapers I get information from you're doing a lot of headcount cuts out in the field. Could you just tell us what might be your projected end of the year headcount versus what it was at the end of last year?

No.

Okay.

I don't think it's a good thing to talk about headcount and reductions. It always comes off negative. We are taking actions to streamline the business to set ourselves up for a terrific 2007 and the way you do that is you try to run lean and mean through these type of environments.

Now, question for Bruce. You've been through a good number of housing downturns which can be sharp and nasty as we all know. But most of them occurred during a recession and there's obviously yet no indication of a domestic recession. The last time we had, in fact probably the only time we had a sharp downturn in housing without a recession was back in the '94, '95 period and I just wonder, Bruce, if you could do compare and contrast? I mean what you -- we know this is different but how is it different? And how do you attack it differently?

Well, as I mentioned a few minutes ago, Greg, the most serious one was the early '90s and really it hit California the toughest and it affected land values, house values, and the difference was we lost 500,000 jobs, high paying engineering jobs in Southern California, and that had a consequential effect on real estate of all types including residential. In our major markets today, we are seeing positive employment, positive economic growth, and continuing population growth primarily driven through immigration, and so the conditions are still very favorable for housing. What we have to get through in order to see continued comp growth is for enough people to feel secure that pricing isn't going to deteriorate. That has -- hangs in the air like a cloud as to whether it's a smart thing to buy a home today and that's what we fight, but this is not recessionary times and it is, from our standpoint while it's obviously easier to run the business when everything is going up at 15% a year in value, we do think it's a nice breather for us to get our disciplines honed again to get all of our teams working on making their businesses operate better and by any relative measure, our businesses in very good shape and will continue in good shape. I am aware that investors want to see growth and we do too and -- but it still is operating in a very healthy manner, and believe me, being able to sell homes every day without having to give them away as the auto industry does is to me a very healthy thing.

But don't we still -- we have an inventory overhang right now of vacant homes, both new and existing homes. Doesn't the price have to crack at some point to work that off in a reasonable period of time or are we stuck with prices just kind of holding and takes a long time to work off that overhang?

I think you have to go market by market. I would not, -- because first of all, the overhangs while greater than they were in many of the so-called good markets they aren't serious on a serious level, and you can make a lot of mistaken conclusions by seeing what somebody will do to sell three or four homes in a community and assume that you will then transpose that over an entire market. Pricing -- now there's some markets that are -- that there's more of an overhang than others. Phoenix is a market where there's more overhang and there's going to be some pricing adjustments and it will rattle through the whole market but it's still -- it is still, in spite of all of that, one of take your right hand, it's one of the best housing markets that exists and will continue to exist in the United States. So it's a little bit of a shake out, but it's still very solid demand.

Okay, thank you. I'll let somebody else drill you now.

All right

Our next question comes from Stephen East with Susquehanna.

Good morning, guys.

Hi Stephen.

Just three quick questions. If you look at your -- the canceled homes that are coming back into the fold to sell again, just generally speaking, what would be the gross margin on those versus say your corporate gross margin?

I don't think we've ever looked at it Steve, but I think one thing to think about when you look at the cancelation rates, if you look at the units that have canceled, increase quarter-over-quarter from last year, we had really in units only 1,600 more cancellations this quarter versus a year ago and if you compare that 1,600 to our unit backlog of 27,000, it's only 6% of our backlog. So even if there's somewhat of a price adjustment it's only on 6% of our backlog not on 40% of our backlog. That's because we operate with one of the largest backlogs in the industry, so for us it may have a margin compression but it's not a small portion of the backlog.

Okay, you actually answered the direction I was going. I'm trying to figure out how big of an impact looking forward the canceled homes would have on your gross margin overall.

I think it's less for us than many just because of our backlog versus our unit deliveries for a year.

Okay, all right. And then if you looked at your land costs over the next couple of years, the impact on your income statement on a basis point-type setting, what would you expect all else being equal that it would hit your income statement in '07 and '08-type of impacts?

This year was probably the largest year for land going up, and that really was, we had differences of our biggest impact because our overall lot cost you have to realize it's because it's also different product and geographic mix, our finished lot cost up about 20% this year so you needed 7% price to cover your land cost that's coming down significantly next year.

Okay, it is. All right. And then the last question, California I guess from an order perspective was a lot better than I thought. Florida was a lot worse. Could you all just sort of talk about what you're seeing in those two markets and maybe why California was improved substantially quarter-over-quarter?

Stephen this is Jeff. In California, as Bruce mentioned before in his comments to Greg, you can't even look at the state because the state is so broad based and varied, so it's -- while one sub market may be tough 90 miles away you can have communities selling very well. I think our overall sales in California held up better because of the price points that we operate at. In every market, there's a price point where sales slow and typically, our average price is below those price points so our sales have held up pretty well in most of California.

In Florida, again, it's like Arizona or Nevada. There's parts of Florida where the investor activity became very frothy last fall. The Treasure Coast, East Coast of Florida comes to mind while other parts of Florida have held up very well for us so within the State of Florida, our sales have been impacted due to the softness in the markets where inventory grew as the investor activity went away such as a Treasure Coast. So we think you'll see Florida come back in the balance here quicker than some of our other markets.

Okay, all right. And Jeff, I guess this is my last question. Directed at you when you were talking about the backlog conversion rate improving, how do you specifically -- if you could just sort of give us a few examples again of how you improve that and ramp that up, ignoring just your backlog shrinking obviously?

Sure, as we shared in New York in May, there's really three different buckets as we call it in the cycle time. One is the time from contract to start, second is start to completion, and third is from completion to the actual closing. I've already mentioned on this call that our subcontractor base is not as stretched as they were a year ago so we're seeing some improvement in the build times but not as significant yet. On the permit side the -- we've already seen a lot of evidence around the country of the cities being able to push permits through at a quicker pace. Las Vegas, for instance, I know has already cut about 10 days off of that cycle. And lastly one of the things, Stephen, that we're pushing across our company, we're big believers in the wall panel approach to framing where you can reduce your framing time by a week to 10 days. A year ago approximately 50% of our homes were built with wall panels, today we're closer to 85 and our goal is to get to 100. So as we roll that out, that will shape the build times just through that process let alone what we can get from the contractors.

Okay, thanks a lot.

Our next question comes from Ivy Zelman with Credit Suisse.

Good morning, guys.

Hi, Ivy.

I have three questions. My first is with respect to your gross orders down 5, how many units did you go back to the backlog and let's assume like someone walks in the door and says I'm going to cancel because Lenar is offering a better deal up the street that you actually kept in backlog by giving them a -- renegotiating their contract?

I don't think we would track it, Ivy. I mean it's an interesting question and I don't know if you know, Jeff, but I certainly don't know.

We couldn't give you a unit count, for rewrites, Ivy. I think in some of our markets where our competitors have adjusted an incentive package that's 50 or 70,000, if our buyer comes in and says hey, I'm going to cancel, we will do something to keep the buyer in the transaction but we're not going to go to those kind of numbers.

I mean I think the overall evidence, Ivy, is just look at our price was up 16% this quarter and it's up 13% in backlog so we're having a meet market, it's obvious that we're trying to hold prices.

And when you say that you guys are not going to incentivize does that mean that you're doing alternative things? I know that you tend to come into a market with new communities priced lower than the market. I've read in local papers that you are cutting prices so where you may not be incentivizing are you cutting price?

Jeff would say it's a house by house transaction, and you try to meet market but you continue to try to sell based on value.

The other thing is if you look at the vast majority of our advertising marketing expense, it's being spent on driving brand, choice, and value, and actually I don't believe, I hope we're not generally opening up at prices below market because if we did, then our margins should be dramatically below market margins which they aren't. So we do believe in value and the other thing is where there were cancellations and we're late in the process and you had to resell homes, you can do things with incentives to move three or four houses which is different from setting a marketing strategy for a whole community.

Okay. Next question, and hopefully two quick ones. Just the first one, you said that you had made abandonments walking away from deposits, can you tell us what that was for this quarter compared to let's say a year ago?

It's not a big number, Ivy and it's up but so is our revenue up, but as I said you can see it in our margins. Since our margins held quite well year-over-year I think compared to what other builders have been projecting for, we saw in the first quarter with margins only down 100 basis points and land cost up 20% abandonments, it's 1/10, 2/10 of a percent is all it ever is.

And then lastly, Dom, on land spend in '06 your estimate versus what it was in '05?

Oh, on the purchase of lots not just development?

Correct.

What did you say, Jeff, down 3, 4, 500 million?

Yes.

In the U.S.

But it's still incrementally, you're still buying land? You aren't stopping buying land out there?

No. Because 3 billion of land flows through the P&L so you have to replenish so we're still buying lots of land but nowhere near the levels we were a year ago.

But the quantification of that was how much? I'm sorry, I don't know the numbers from what you're saying they were down from?

I believe last year was around 2 billion. Land purchase if you remember you have a like amount almost in land development.

It could be more than 500.

It could be more than 500 Jeff says.

Okay, thanks, guys.

Our next question comes from Dan Oppenheim with Banc of America.

Thanks very much. Was wondering, you had talked about having 18,000 homes under construction right you now and just think it was 4% of those being completed, spec homes. If you were to look at what's happened with the cancellations and see what's under construction, but also the completed homes what percentage would that be?

Do you have the inventory report, Kelly? I don't think it's -- well, I don't have the number in front of me, Dan.

Is he asking what's the total?

The total inventory on the construction, but I don't know if I have it year-over-year, but industry under construction that's unsold, excluding the 600 we talked about is another about 6,000 homes.

Okay.

Go look at the number that are permitted.

Oh, I'm sorry, wrong number.

Pull that out. Typically, Dan, we track about 10% unsold under construction as high as 12 or 13, as low as 7 or 8.

Okay. I imagine just probably the higher side of that right now with cancellations?

Yes.

Got it and then just--.

It's just less than 10%.

Bruce, wondering just about your commentary earlier that essentially running the business the same way as when conditions were more robust. What would you need to see to change the approach of the strategy, given this employment trend can often be lagging indicators? What are you looking at in terms of the strategy that you're taking with the business right now?

Well, to say we're running it exactly the same would be to minimize all of the strategies that we laid out for you in New York a month ago; okay? So I don't think that would be a fair characterization of what I've said. What I did say that we're still selling value. We're selling brand. We believe product is still important and choice, so to that extent, we are still running the business the same as opposed to the car industry which is having difficulty figuring out what they have to do to get people to come into show rooms to buy cars. Conditions that would have to change to cause us to reflect on whether what I just laid out briefly here and in greater detail in New York, a month ago, would be a dramatic fall off in gross sales.

How about if all of a sudden we started seeing gross sales drop off dramatically? Then I think you got to take another look at decisions we've made. I mean we've tightened SG&A and you don't do that when times are robust. We have cut back on land acquisition. You don't do that when times are robust. You don't go back and renegotiate contracts with subs to reduce construction costs when times are robust. You don't lengthen option contracts with land sellers and restructure those deals when times are robust. So it's not times as they were, but they still are -- a lot of what I just said are frankly home building 101. It's not -- that's what we do.

Thanks very much.

Okay.

Let me just throw in some housekeeping items that I wanted to get across. One is that when you look at the $10 in earnings per share for the year, the third quarter will be around $2.30 and the fourth quarter around $3.20, so just to give you some guidance on the quarter outlook and that's with unit deliveries up 6% in the third quarter and 6% in the fourth year-over-year.

Our next question comes from Alex Barron with JMP Securities.

Yes, thanks, guys. Wanted to focus a little bit on your capital allocation for the last six months. Obviously you've bought back a ton of stock at much higher prices and your land investments are up 140% year-over-year, so I'm just kind of wondering why you guys think you should keep pursuing share buyback going forward?

Well, if you look over a long period of time, we repurchased 49 million shares of our stock on an average price of around I think $23, so it's proven to be a very good investment and now that we're trading what could be close to the stock today is getting closer to the book value of the Company by the end of the year. It's just prudent sense to be able to use some of your free cash flow when the market has flowed like it has for share repurchase. But remember, the Company has been able to do share repurchases, pay a dividend, and grow the business for the last 15 years and do all three very effectively. It's just that in certain markets you weigh it more towards share repurchase and when the market is robust you weigh it more towards land purchase and growth. That's what we're doing.

But I mean wouldn't you guys be expecting land prices to come down quite a bit in the current softening market and if you raise cash at this point you could buy land cheaper over the next 6 or 12 months?

It doesn't always work like that, Alex, and land is not a auction market and while you'd have to go sub market by sub market and while that is true that generally speaking, there are fewer buyers and more sellers and conditions are more favorable if you're a buyer today, the fact is is that generally speaking, there has not been a significant crack in land values and which is not to say that it couldn't happen and you pick a market and we could have a debate about it but it hasn't happened and in the land constrained submarkets, it still remains attractive and believe me, we're not backing away from land acquisitions that we believe are in land constrained markets and are attractive.

Okay. Wanted to focus also on the southwest region, your orders down quite a bit, they're 50%. Which of the 2 markets, Phoenix or Vegas is really getting hammered and why do you think if it's Vegas, I thought that market had already crashed a couple years ago and was kind of doing okay.

Alex, our southwest region also includes Tucson and New Mexico, not just Phoenix and Vegas.

Okay.

But when you say Vegas crashed a few years ago, it was about a 90 day speed bump if you will in the fall of '04 that came back very strong in early '05. I wanted to correct that for you because if you look at Vegas, there's still positive job growth. The economy and the demographics still support a strong housing situation. There has been an inventory spike and inventory is now out of balance relative to demand compared to what it was a year ago and as the inventory settles back out, you'll see sales come right back. So we're both Phoenix and Vegas, we've been dealing with two markets that had the inventory spike. Each of them will balance out on their own. Vegas continues to be a market that's very land constrained, very difficult to enter and our expectation is that that market will come into balance faster than Phoenix.

And what are you guys seeing in Phoenix at this point?

Phoenix inventory spiked higher than Vegas. Sales softened a little more than Vegas in the general market so we think it will take a little longer for Phoenix to get back into balance, but underneath it still in Phoenix, there's job growth occurring and the economy is still very strong. It's how long does it take for the inventory to balance out.

Okay how about in Florida. Are you guys seeing the same kind of weakness that you're seeing in Phoenix and Vegas? Is it worse or not as much?

There's pockets but the overall state is performing better than in Vegas and Phoenix, the market.

Okay, great. Thanks.

And that's all the time we have for questions. I'd now like to turn the conference back over to our presenters for any additional or closing remarks.

Well, thank you all for joining us today for our second quarter conference call. And look forward to speaking with you three months from now. If not before. Thank you. Have a great weekend.

This concludes today's presentation. Thank you for your participation and have a wonderful day.