MDC Holdings Inc (MDC) 2003 Q2 法說會逐字稿

Good morning, ladies and gentlemen and welcome to the M.D.C. Holdings, 2003 second quarter earnings conference call. At this time all participants are in a listen-only mode. Later we will conduct the question and answer session. I would now like to turn the call over to Mr. Joseph Fretz, who will read the statements concerning the forward-looking statements. Mr. Fretz, you may begin.

Before introducing Larry Mizel and Garry Reece, it should be noted that certain statements made during this conference call, including those related to MDC's anticipated home closings, home gross margins, backlog value, revenues and profits and responses to questions may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements involve known and unknown risks, uncertainties and other factors that may cause the company's actual results, performance or achievements to be materially different from the results, performance or achievements expressed or implied by the forward-looking statements.

The company's actual results, performance and achievements may be impacted by various factors. Including, among others, changes in general economic conditions, changes in interest rates or labor and material costs, the availability and cost of insurance, weather, government regulations, consumer confidence, actual or threatened terrorist acts and other acts of war and the results thereof, and competitions. Additional factors that could impact the company's actual performance are set forth in the company's 2002 Form 10-K. It should also be noted that SEC Regulation G requires that certain information accompany the use of non-gap financial measures. Should a non-gap financial measure be discussed, the information required by Regulation G will be posted on the investor relations section of our Web site richmondamerican.com. I will now introduce Larry Mizel, Chairman of the Board and Chief Executive Officer of MDC Holdings. Larry.

Thank you. Good morning to everyone. We would like to welcome each of you and thank you for participating in MDC's second quarter 2003 conference call and Web cast. The first six months of 2003 have been very exciting and productive for the home building industry, including MDC. Despite continuing economic challenges and concerns surrounding the ongoing global war on terrorism, public home builders have continued to have achieve new records in virtually all measures of operating performance. Historic low interest rates and new home inventories, improving consumer confidence and continued strong demand for new homes in growth markets have all supported these outstanding results. We are proud to report that MDC has capitalized on these factors to produce operating results in the 2003 second quarter that rank among the strongest for any quarter in our more than 31 years in business.

We further strengthened our balance sheet in May, capitalizing on our status as one of only five investment grade home builders. We followed the redemption of our eight and three/eight senior notes with the issuance of a $150 million new 10-year senior notes with a five and a half percent coupon. The lowest interest rate for a 10-year note ever issued in the public markets by a home builder. Our strategy of controlling a two to three year supply of lots, limiting development risk, and thinking as close as a just in time delivery as possible has enabled us to develop a relatively liquid balance sheet.

At the same time, we have continued to maintain a substantial amount of dry powder, ending the quarter with $430 million in cash and available borrowing capacity under our lines of credit. Almost 40 percent above the levels of a year-ago. These key elements of our capital structure should provide additional protection in the event of a market downturn and give us flexibility to pursue opportunities in both an improving and a declining market. Building an affordable product with real value in growth markets has been the focus of our organic growth strategy. This strategy has enabled us to expand our presence in most of our existing markets and has begun to bear fruit in our new markets in Salt Lake City, Dallas/Fort Worth. As announced earlier this year, we have launched new operations in the Houston and Philadelphia Delaware valley markets and we are considering entries in Chicago and several markets in Florida. These are important steps to facilitate our continued growth over the next several years. We look forward to the remainder of this year with a great deal of optimism. In view of our performance through the first six months, and the strength of our backlog, we are positioned to close more than 10,800 homes on our way to establishing new company highs for revenues and profits. I will now turn the call over to Garry Reece, our Chief Financial Officer, who will describe more specific financial highlights of our 2003 second quarter.

Thank you Larry. As Larry mentioned, this was a tremendous second quarter for MDC. We set new records for the second quarter in home closings, revenues and net income, and supported by record performances by both our home building and financial services businesses.

During the second quarter, our operating income reached $42.7 million, which is 24 percent higher than the $34.3 million we earned in a year-ago period. Adding to a six-month total of 79.7 million, approximately 20 percent above last year. These earnings were made on record revenues, $689 million, which are 35 percent above revenues of a year ago and our total for the six-month period is $1,259 million, 30 percent above a year-ago amount. From an earnings per share standpoint, we earned $1.43 a share, which is almost 29 percent higher than the $1.11 that we earned in the second quarter of last year, contributing to a total of $2.66 cents a share earned year-to-date which is 23 percent above last year. As we said in the press release, one of the items that we did recognize, which is a little bit different from prior years, we recognized a loss on the redemption of $175 million of our senior notes that were due in 2008. This loss, which under prior accounting rules would have been treated as an extraordinary loss, under the current rules it is required to be treated as ordinary. And it was $9.3 million pretax, 5.7 million after tax, or approximately 19 cents a share. Had we excluded that, our earnings per share and earnings without these amounts would have, had we excluded those, this would have been the second best quarter in our history. Beaten out only by the fourth quarter of last year, which was a record high for all quarters in our history.

As I mentioned, the home building segment produced record operating profits here in the second quarter, earning over $85 million, which is just about 40 percent higher than earnings of a year ago on revenues of $672.4 million, which is 35 percent higher than the year-ago amounts. Contributing to these record results, primarily were record levels of closings. This was the second highest level of closings we've ever seen in a quarter, 2,624 homes, 34 percent above the 1,956 homes we closed in the second quarter of last year, giving us a total for the year of 4,724 homes closed, 30 percent above last year. The divisions that contributed these record closings were the divisions that we've talked about in prior quarters, as being our focus for growth. Las Vegas closings in the second quarter were up over 100 percent. Virginia up over 60 percent. Our Southern California market was up over 50, along with Arizona. And we also realized closings from our Salt Lake City and Texas markets.

From an average selling price standpoint, average selling prices were relatively consistent with where they were last year, up slightly just above $256,000. As we mentioned in the press release, we do expect these average selling prices to decline by as much as five percent in the third quarter, as we had previously disclosed at the end of the first quarter, as we continue to focus on a more affordable product in most of our markets. So we continue to see a greater percentage of our closings coming from the lower price markets that have prices below $200,000, in Las Vegas, Phoenix, and then the contributions from Dallas/Fort Worth and Salt Lake City. And we're also focusing on a more affordable product in the Southern California and in Northern California in Sacramento and Southern California, in the Inland Empire.

The other contributing factor to these strong results here in the second quarter were improved home gross margins. Our margins reached 23.3 percent compared to 22.5 percent a year ago, and without interest, were the highest we've seen in the company at 24.3 percent, a 100 basis points above the margins of last year. This resulted really from an improvement in most of our divisions in terms of home gross margins, but in particular in Las Vegas, Southern and Northern California, Maryland and Salt Lake City. This year we saw seven of our ten major markets contribute home gross margins over 20 percent. This time last year, less than half of our markets were at those levels. From a SG&A standpoint, we saw the levels increase, but they are comparable in terms of percentage of revenues to SG&A of a year ago levels. And we also saw a record performance from our financial services segment. Where we earned $8.6 million in profits. This is 66 percent above levels of a year ago. The mortgage lending business, contributed most of those profits.

We saw increased gains on sales and mortgage loans, which were up. just about 105 percent, contributing gains of $8.7 million, origination fees were up over 30 percent. So volume levels contributed about half of the increase in profitability, with the balance of it coming from the very favorable interest rate environment we have enjoyed during this period. We did see our, the level of our originations and brokered loans reach record levels at $456 million, which is up 35 percent from a year ago period. From the standpoint of stratification here, we saw our fixed rate product increase very close to 90 percent compared to 80 percent of a year ago and our average loan amount increased to $213,000 from $208,000 a year ago. Our balance sheet continues to be a major strength for our company, as we said in the press release. We saw our equity increase 19 percent from this point last year, up to just short of $870 million. We did not repurchase any shares this quarter. We did pay a 10 percent stock dividend in May. And to further enhance share owner value, we also increased our quarterly stock dividend from eight cents a share to nine cents a share or a 13 percent increase. Our equity did increase to just over $30 a share taking the stock dividend into account, which is up 22 percent from this point last year.

We continue to pay close attention to our debt levels and our debt to cap ratio, which was 0.36 at the end of the 2003 second quarter continues to be one of the lowest in the industry and well below our peer average, which is just below 50 percent. In terms of cash and borrowing capacity, if you look at, we not only have a lot of availability, but we have a relatively liquid balance sheet. We've included a slide here that many of you we meet on the road have seen, but we wanted to display this in the release based on second quarter numbers. You'll see here that this slide presents the liquidity that we have in our balance sheet. If we look at our long-term asset or what's viewed as a long-term asset, which is our land, which stood at $725 million at the end of the second quarter. And by the way, our land is relatively short in duration. We take very little development risk. It's about a two-year supply of lots. So it's going to be converted into cash relatively quickly anyway. But if you take that asset and compare it to our long-term capital, it's only 83 percent of our total share owners equity.

If you look at our true more liquid assets, those that will be convert to cash within the next six months, that being our working process, our backlog in process, our model homes and a few specs that we have, as well as our mortgage loans, which were sold generally within 30 days of origination, that's just short of $870 million. If you compare that to our total debt burden, including our mortgage lending debt, of 502 million, these liquid assets exceed our total debt burden by over 50 percent. So this is representative of just how liquid our balance sheet is, which provides us additional protection as Larry had said in the event of a downturn, but a lot of flexibility on the upside. In terms of cash and borrowing capacity, at the end of the quarter we have had just short of $430 million, which is almost 40 percent above where we were at this point last year. As I talk about the balance sheet, we're getting a lot of questions about FIN 46. So I just wanted to make a brief statement about that.

We have adopted FIN 46 for consolidation of variable interest entities or what's called VIE's. Although we believe that the interpretation has had unintended consequences for our industry, we'll appropriately consider all option arrangements we have with entities that may need to be consolidated under these rules. We believe that many of the entities that we're analyzing may not fall under the provisions of FIN 46 and will not be consolidated. Based on our analysis, any resulting consolidation will have no effect on our net income in the current or future periods that may impact the balance sheet. We can't make a definitive conclusion as to the magnitude of this impact until our valuation is complete. But we do not expect it to be material. Any assets, liabilities or minority interest that result shall be fully identified on the face of the balance sheet so that they can be properly identified and considered by the users of our financial statements. In any case, we don't believe that any consolidation of VIE's pursuant to these rules changes the effectiveness of our option arrangements with these entities from the standpoint of minimizing land risk and maximizing our flexibility to react to changing market conditions.

The fact remains that of June 30th, this is similar to where we've been in prior quarters. We controlled over 6,600 lots under options and had less than $20 million of capital at risk. In terms of managing our inventory levels, just to say a brief word about our specs, we continue to maintain tight controls on our spec inventory. We ended the quarter with about a week and a half supply of spec inventory and if you take out the foundations it's less than a week's supply. And we had less than 100 spec homes that were finished in the entire company.

As we look forward to the indicators of the strength of the business that will materialize in closings for the future, and taking a look at our sales activity, as we previously reported, we recognize the highest quarterly sales ever in this period. It's unusual. It's the first time it has ever happened in our company where the second quarter actually exceeded the first. Generally the first quarter is the highest level of orders on a seasonal basis, but we actually exceeded the first quarter levels here this year. We received orders for 3,665 homes which is over 33 percent above the 2,753 homes we received orders for in the second quarter last year. The strength came from these growth markets we've discussed previously.

Las Vegas was up almost 90 percent in the quarter. Virginia was up 73 percent. Maryland 55. Phoenix 51. And we're pleased to see Colorado up for the first time in three-quarters, we had seen a positive trend begin to develop in Colorado being up seven percent for the quarter. We also received over 160 orders from our new markets in Salt Lake City and Dallas/Fort Worth. We did see lower orders in the Southern California markets, which happens to be probably one of our strongest markets. Although we saw a temporary decline in active subdivisions in that market during this period due to a strong sales that we experienced late last year in the first quarter of this year.

So it's really more of a supply issue than a demand issue in that market. Traffic was also up for the quarter, up 12 percent. And it was up in every market except California. We removed California from the mix. All the other markets were actually up approximately equal to what the sales were up, at 33 percent. Can rate continues to be at very low levels. Below 20 percent range, fairly consistent with last year. The strong orders contributed to the highest level of backlog we've ever seen from both a unit and a dollar value standpoint. We had over 6,300 homes in backlog, up 29 percent from the 4,935 homes last year. And the future sales value is $1.6 billion, which is 25 percent above where we were a year ago.

Active subdivisions were also up year-over-year, up 15 percent. We did expect going into the quarter that the level of active subdivisions would be a little bit higher, but the strong orders that we experienced in virtually all of our markets caused us to sell out of active subdivisions in many of our markets earlier than anticipated. We still continue to be well above where we were a year ago and well above where we were at this point last year. We do lay out for you here on this slide, if you're watching the Web cast, where our active subdivisions are and where the large increases are. And they're the areas where you're seeing the strong orders. Virginia is actually up 14 active subdivisions from where it was a year ago, and that's kind of what we had anticipated as they plan to double in size this year compared to last year. The other increase is coming in Arizona, which was eight subdivisions higher. Las Vegas was up seven and Texas now has six active subdivisions.

The lower subdivision count coming in Colorado and the California markets. As we did say in the press release, we do expect that because of these strong orders, we will sell out of subdivisions faster than expected in future quarters and we've got a few delays in bringing on some new subdivisions so we expect the subdivision count to be relatively flat over the next couple of quarters, but to see growth begin again in the first quarter of next year, as we prepare to meet our growth objectives for the next several years. That concludes my prepared remarks. I'd now like to open it up for questions.

Thank you. We will now begin the question and answer session. If you have a question, you will need to press the one on your touch-tone phone. You will hear an acknowledgment, you have been placed in queue. If your question has been answered and you wish to be removed from queue, please press the pound sign. Your questions will be queued in the order that they're received. If you're using a speaker phone, please pick up the handset before pressing the numbers. Once again, if there are any questions, please press the one on your touch-tone phone. Our first question comes from Joseph Sroka from Merrill Lynch, please go ahead.

Good morning, everyone.

Good morning Joe.

Garry, I think, previously you had talked about in the last call that you thought SG&A may be higher because you were opening more subdivisions. I think relative to your revenue line it was kind. Did you take some proactive steps to bring your SG&A down or was that just because the revenue line was strong and the second half of that question would be, if you're going to push out some subdivision openings for the first quarter of '04 do we see a tick back up in SG&A then?

Joe, I think that it really relates as much as anything to the high level of volume and increased revenues here during the quarter. We are going to see as we build for our new operations in the Philadelphia/Delaware Valley market and in Houston, we'll see some increases there. But we are starting to see some leverage develop as we see the growth from the new divisions we established in Virginia and Phoenix, begin to bear fruit in the way of home closings. You know, I don't know that we'll necessarily lose leverage as we move forward. We kind of developed an infrastructure that's capable of building at these higher levels. And they are working today in processing these new subdivisions to come on line.

OK. Then on the mortgage side, as you attempt or move more down market, trying to sell more affordable product, do you anticipate that your loan to value ratios would climb and then the piece of that is, what was the loan to value ratio in the quarter? If I take that 213 over the 256, it looks like it's about 83 percent?

That's very good. That's pretty close. You know, it is up a little bit from where it was in the second quarter. So we are seeing a little bit higher percentage of governments where the loan to value ratio was higher. So it's a couple of ticks above. I wouldn't expect it to increase materially from there.

OK. Fair enough. I'll pass it to the next person.

Our next question comes from Bob Martin from MDC Holdings. Please go ahead. Bob Martin, your line is open for the question. Please go ahead.

We'll pass to the next one.

We will continue to the next question. We have Larry Horan from Parker/Hunter. Please go ahead.

You have had a very strong margins here in the first half and quite a good sequential improvement in gross margins in the second quarter. Is there any reason to believe that gross margins in the second half wouldn't be in the range that they've been in the first half?

Larry, I think that some things that we have to consider is that we are going to see a greater percentage of closings coming out as our operations increase, coming out of Texas and coming out of Salt Lake. Those margins have improved over the last year, but they are lower than our company average. So that's one consideration.

Would they fall into the category of being in the three markets that had below 20 percent gross margins that you mentioned?

Yes, they will.

OK.

And lot of it is going to depend on just how strong our pricing power continues. We do have some amount of these closings in our backlog here. We do have some sales that have to occur, in order to meet our closing levels for the balance of this year. So closing of spec homes was out of our backlog which is very strong. We still do have close to a third, actually a little over a third of that inventory has yet to be started. So a lot of it will not be able to be delivered this year so we'll be dependent on selling some specs. So there's still some things that have to happen in order to determine exactly what those margins would be.

OK. Thank you very much.

Our next question comes from John Lynch from Lynch Research(ph). Please go ahead.

Thanks. Hi Larry. Hi Garry.

Hi John.

One question that I'm unsure about, thinking back over many years, I'm not sure the past gives me a good answer. The level of business obviously has been driven by mortgage rates down around the five percent level. Now, rates have moved up, the 10-year notes moved up 60 basis points. And the question is have you, it's only the last two weeks we've seen this. Has there been any change that you've sensed or expect to see in, A, either a number of people who can qualify changing or, B, the product that they elect to buy being somewhat lower in price than they would have bought two to three weeks ago?

John, it's a little bit early to tell.

Right.

But what happens in a lot of cases when you see rates move a little bit is you see a lot of the fence sitters jump off and actually see a spurt in demand. And we're still in the midst of this so we don't know whether or not that will materialize or not. But that's been our prior experience and still rates are very, very low. So at this point, we're not in a position where we think there will be a material difference that our consumers will be making major changes in their choices here based on what has happened over the last two weeks.

OK, and the other question, similar one, is Colorado. It has been pretty awful. What's happened to make it better?

I think there's some things that are showing signs of improvement in this market. For one thing, we have been -- because it is our home market, we know it better than anybody else. We get to see a lot of the best land deals. We have a strong basis in our property and great relationships with land sellers, and we've been able to leverage that to increase our market share and really take it to the rest of the competitors here in this market. In Denver in particular, we've seen over the last couple of months, our market share has increased over 20 percent. And so it's still not the healthiest of our markets, but a number of industries here have started to see some improvement. Hopefully tourism is kicking up, because the drought is easing. And there's just some signs of life. A lot of economists have come out here in recent weeks and said they're starting to see signs that things may have bottomed and are starting to move up and are expecting to see some growth here over the balance of the year. We are expecting in 2003 to see some positive job growth in the last half of the year after seeing some fairly significant declines last year.

Thanks.

Our next question comes from Ivy L. Zelman from Credit Suisse First Boston. Please go ahead.

This isn't Ivy L. Zelman. It's Carlos for Ivy here.

How are you doing?

John actually just asked my question regarding Denver, but I am wondering can you comment regarding your margins in Denver? I mean, has your market share increase come at the expense of your margins in that market?

Well there has been, it's not at the expense. We haven't necessarily targeted to lose margin to gain market share, but incentives were higher in this market than they are in other markets. They have been for some time. Margins as a result have declined in this market. And because they are, Colorado is still a large part of our business, those declines have impacted and have tended to offset some of the increases we've seen in other markets, because they did, a couple years ago they were the highest margins in the company. But we haven't really done much recently to increase them dramatically. But margins are -- excuse me, incentives are higher and margins are a bit lower than they were a year ago.

Incentives just in the general market, you say there are still 10 to 15 percent of the average price or have they come off that?

It really varies. I don't know if that sounds very high, for the market in general. It really varies depending on the subdivision.

OK.

And you might see it and also whether you have some specs that you want to move on particular houses, but in general that sounds like a high number.

With respect to, you mentioned community count and how we may see a big jump in community count in the first quarter of '04, can you comment in terms of what your projections are for community count growth by the end of year '04?

I Could not comment on that at this time, Carlos. We know that a couple things are going to happen. Number one, the growth that we're seeing is coming, even though our subdivision can't may be staying relatively flat, we're seeing maybe a moving around of these subdivisions from some of the higher priced markets to lower priced markets. Vegas has picked up dramatically. Picking up in Texas and in Salt Lake. And these are areas where we are more likely to see a greater absorption throughout the subdivision than we do in some of the other markets, in Colorado or in some of the California markets. So we would hope that because of this we'd be able to get a greater level of absorption out of the same number of active subdivisions. At the same time, we have stated that we have an objective to grow assuming the market is there, at a rate that will approximate 10 to 15 percent per year in order to double in size from 2001 to 2006. And we know that that will require a level of increase in active subdivisions. So barring some type of acquisition, at this point in time I couldn't tell you that we would expect it to be much higher or lower than that.

OK. Fair enough. And just one last question. When do you expect to start selling out to communities in Philadelphia and Houston?

In Houston we would hope, we would be in a position by the end of this year. Certainly by the first quarter of next year.

OK.

In Philadelphia, it will probably be a year later. It just takes you know, you can buy finished lots in Houston, and we already have a number of opportunities that we're considering which may enable us to get sticks in the air before the end of the year. The Philadelphia market is, we have to buy it earlier in the process and it will take a little while. Although we do have some opportunities there as well and we expect to be on track to begin sales in the latter half of '04.

Great, guys. Congratulations on a great quarter again.

Thanks, Carlos.

Our next question comes from Jim Wilson from JMP Securities. Please go ahead.

Thanks. Most of my questions have been answered. But I guess Garry, if you look at your community count, as you go into next year, where would you say you might actually be a little lower than you are this year? Obviously as you're trying to get to 10 to 15 percent total in Houston will help and Salt Lake will help on the upside. But, in places like California, possibly Colorado you might shrink a little?

The Colorado, I think we'll probably see it, as you saw, the subdivision counts down a little bit in Colorado. Five to seven subdivisions here. We could see that start to build back up by the end of the year. Jim, I guess, what we're looking at is we are blessed with the opportunity to grow in virtually every market we're in. So our expectation is that we will see some level of movement up in every market that we're in. I don't see us as declining in any of the markets.

OK. And I guess, as you sort of think you have a lot of (inaudible) parts, all of the mix issues, any thoughts on where average sales prices might trend to next year? I know there's a lot of parts there to put together, but sort of give a mix down a little bit or somewhat flat?

You know, we're going to start to see -- we're really seeing a transition occur this year that will probably a little bit more distinct because of the tremendous jump we saw in Las Vegas and Arizona and Texas and Salt Lake this year. It's not likely to occur that dramatically next year. And we are going to see a growth out of Virginia and growth out of -- and some contributions coming from some of these other markets with a higher price. You know, I don't see anything that will tend to make it s quite as dramatic as it has been this year going on next year.

OK. Very good. Great quarter.

Thank you.

Our next question comes from Pat Boyce from Cliffwood Partners. Please go ahead.

Good morning. I was just wondering and I'm looking at your marketing costs. It rose at a 43 percent pace for this quarter and a 37 percent pace for this year-to-date period. While your overall revenues are not growing at that same pace. So I'm wondering why are your marketing fees outpacing revenue growth because you're having margin expansion of the gross margin level, but marketing is obviously reducing that. Are there incentives going through there or is that buildup of new communities that you get to open or why is that growing so much faster?

Actually, the primary driver of that is the higher -- it's related to a higher level of model home openings. We added a number of new communities over the last year. And a lot of new model complexes and so we have seen a disproportionate increase in the level of costs associated with model homes. It's probably driven it up, the three or four points higher than the revenue increase.

Well, that's good. It's good that you got expense (inaudible) don't capitalize it.

Well, actually, what happens is we do capitalize it initially and it's amortized over the life of the project, in terms of at least the first 100 units. So it's amortized on a per unit basis, but we've had the benefit in prior years of actually selling out of some older subdivisions that had models available. And we've added so many new models in new markets that we've had to build all new model complexes. So the expenses have been higher this year on a per unit basis.

OK. Now, if you, the incentives that you do give, how do you account for that? Do you account for that as an expense or do you account for it as a net against revenue?

Actually, it flow through margins as a cost to sale, generally.

OK. So it's supposed to be gross margins? There's nothing in marketing that would be incentive?

No.

OK. Great. Thank you.

Sure.

Our next question comes from Gregory A. Nejmeh for Deutsche Bank. Please go ahead.

Good morning Garry. Good morning Larry. Terrific job as usual. A couple of questions. One you've entered several new markets recently and I think Larry mentioned in his remarks the possibility of Chicago and select Florida markets. To what degree do you consider in evaluating new markets the degree to which they're fragmented and the degree to which your financial wherewithal would permit you to gain share in a more rapid rate? Is that a key criteria in your decision?

It is a key element. We believe that, first of all, we have a lot of confidence in our ability to deliver a product that the market will appreciate. And we also think it's important to find a leader in those divisions who can grow a business and one thing that's important to note, we consider all the openings that we have made, both in Houston and in the Philadelphia/Delaware valley and as we approach some of these other markets, we're hiring managers who are experienced in running large divisions. These are not just land people who are finding land. They are operators who know how to run large divisions. Our objective is to, first and foremost, to find the proper real estate and they do know the land sellers and they know where the right places to build are. They know how to develop an appropriate product and they can leverage our knowledge and merchandising capability from a construction standpoint as well to build the right kind of product for that market. And then we expect them to grow that business. And they are operators who are capable of building a staff and running a much larger operation.

I guess the second question, Gary, relates to FIN 46. Really it appears as though FIN 46 is intended to protect investors, but perhaps one of the unintended byproducts at least with respect to home builders is that it could invite greater confusion at the least with regard to your risk profiles. Have you had conversations with the agencies with respect to how they view FIN 46 and whether or not they'll treat any debts required to be consolidated under FIN 46 as they do mortgage company debt in fact treating get this non-recourse to the parent?

In our discussions what the rating agencies, Greg, they are well aware of some of the unintended consequences in this industry. The fact is that all of these ratings agencies have full knowledge of our option agreements, what they mean, what they represent, what we have at risk. And it's not my impression that just this statement is going to change that. They are already considering whether or not, because of the nature of the agreements themselves, they constitute some type of contingent obligation. They understand the level of risk inherent in each one. And I believe in our case they fully understand that these are true options with very limited capital at risk. So we are going to maximize the potential for their understanding of the impact of this provision on us by fully segregating what anything that might come out of this analysis, so that it can be dealt with appropriately. But I don't believe that what you see on the balance sheet is going to be the full extent of what they consider in their analysis.

On a related topic, is that dis-aggregation something that you could share, will be able to share on an ongoing basis with the investment community in your supplemental data?

Dis-aggregation in what respect?

Well, of some of the unintended consequences of perhaps having to consolidate certain debts and JV's under FIN 46. Would you be on a going forward basis to distinguish those items that had to be consolidated as an outgrowth of FIN 46, so that we could distinguish your balance sheet under traditional measures from those balance sheet measures that are a byproduct of FIN 46.

Absolutely, Greg. We will do that for the investment community. And in our case, more better. Full disclosure and full understanding of what's going on. So we will make the disclosures necessary for people to understand that impact.

And that will be in your supplemental data?

It will to a certain extent, or it be segregated on the face of the balance sheet.

OK. All right. Great. Thanks.

You bet.

Our next question comes from Chris Hines (ph) from Perennial Partners (ph).

Good morning gentlemen. Congratulations on a good quarter.

Hi there.

How are you doing?

Good.

I was hoping if you could comment a little bit on some of the recent insider stock sales, what motivated those and what you anticipate going forward?

OK. I'd be happy to the extent I'm aware of it and the only thing I'm specifically aware of is my own situation. But there have been some sales recently. The level of the transactions is relatively minor compared with the very strong insider ownership in this company. In fact, the level of ownership has not changed dramatically for a number of years. The activity that occurred over the last couple of months, particularly as it relates to the officers, is more tied into the fact that there are some options that were granted by the company a number of years ago that are expiring here in the next couple of months, or the next few months. And in my particular case, I had two sets of options that were expiring. One set of ISO's I exercised and held the shares and the other I exercised and sold only to the extent necessary to generate cash to exercise the option and held the balance. So I know there were some other officers that were in the same situation I was in. So in terms of going forward, I would not want to comment on people's motivations in that regard. But I appreciate you asking the question. It is something I hear a lot about and I think people should focus on the fact that this activity is relatively minor to the ownership interest of the insiders.

Which is currently at what, approximately?

It's approximately at 30 percent of the outstanding shares.

OK. Thanks. Congratulations again.

Thank you, Chris.

Bye-bye.

Our next question comes from Alex Barrons from Franklin Templeton. Please go ahead.

Thank you. Good morning. Great job once again. I have a question. Can you tell us, you said you expected to sell out sooner than expected out of some communities in some areas. What markets are these in?

It's really happening in virtually every market. Particularly the ones that are selling the fastest. And we've already seen the impact of that in Southern California. I think the one that is probably going to be most impacted going forward is Phoenix. Phoenix has had tremendous order growth over the last several months. And so they are most likely to see the highest level of early sell outs over the next few months.

Do you think it will be to the level where the year-over-year numbers would be quite negative or not (inaudible).

It's hard to say and it will also depends on how strong our sales are over the next few months. One thing that we can -- in this type of a market it's more difficult to accelerate openings than it is to watch the acceleration of closings, because sales have been so strong and it continues to be difficult to get land through the process. So that is, I guess, more difficult to see the additions coming on than those going off. So if strong sales continue, they might very well outpace the ones coming on. This quarter, in particular, we usually see somewhere in the neighborhood of 25 to 35 new active communities come on during a given quarter, and somewhere in that neighborhood of communities going off. We saw closest to 45 active communities sell out during this last quarter. And that's about as high as we've ever seen it.

OK. Can you comment on how you expect the FIN 46 to affect your desire to option land versus own and developed?

It will not affect it in any way, shape or form. This is purely a reporting statement. We really structured the arrangements we entered into based upon the true financial and operational consequences. We do not enter into option contracts or have not to this point unless they represent a true shifting of risk. And that's a priority for our company to option as much as we can. But only in circumstances where there's a true risk shifting involved. We believe that's the right way to do business and this interpretation will not impact that.

OK. And in fact to ask one more, what sort of initiatives, I guess, are you going to be begin focusing on in terms of supply chain and so on?

We have a very strong initiative going on right now. In fact, we have taken this to a new level for our company, or at least put ourselves into a position to take it to a new level, by bringing on a new corporate executive. You may have seen the announcement we made in the last 30 days, a gentleman by the name of Louis Solis (ph) who has significant experience in this area. He's enabled us to drive a corporate initiative which includes a focus on the purchasing side throughout all of our divisions, whereas the purchasing effort was very decentralized with a corporate purchasing executive who kind of provided ideas to the division. And that enabled us to achieve some savings on national contracts. We also have now changed the approach, the purchasing effort is now more regionalized and reports directly to Louis. And so he is controlling the, has control over the national purchasing effort going all the way down to the division level. And we think this will help drive this supply chain initiative. We also are making significant investments in the IT arena to support this effort as well. And that's a large part of why I think we talked about this on previous calls, but that's one of the major reasons why our corporate G&A is a bit higher than it's been in the past and continues to be, as we are making substantial investments in our systems and processes and procedures to achieve substantial improvements on the supply chain side of our business.

OK. Great. Thank you.

Our next question comes from Barbara Allen from the Texas Blie Schroeder (ph). Please go ahead.

I want to make sure that I understand a line on your balance sheet data, the supplemental data. You have homes under construction of just over 5,000. Yet your backlog is over 63 hundred. I actually would have expected homes under construction to be somewhat above the contracted backlog.

Well, we have over 2,100 homes in our backlogs that have not yet been started.

OK. And why is that?

Just as we have, Barbara, it has a lot to do with our focus on dirt starts, as opposed to building spec homes. We won't start a home until we get a contract. And even further than that, there are certain steps that we require from a standpoint of obtaining loan approval before we'll start the house. Combine that with the fact that it is taking longer to get a building permit than it has in the past in most of these markets and there's where you see the high level. However, I will say that as a percentage of our backlog, it's really no higher than it was a year ago. It's just that overall our backlog level is higher.

Yeah. Well it's a very conservative position relative to some of the other builders I've seen. And also on your land and lots controlled, by my calculations you've got just over two years based on your estimated deliveries for this year, which puts you at about half the exposure of the next lowest big builder, which (inaudible) over about four years. What are the advantages or disadvantages of electing a shorter land exposure or shorter duration, I guess?

The advantages really are, since it's a primary focus of our operating strategy, we're pretty much right where we want to be. It gives us a -- we believe it minimizes the risk of being caught by a downturn in the market, it gives us more flexibility to shift our focus in terms of price points and product. One thing that shouldn't be forgotten is that we are in a constant state of replacing and replenishing this supply. We have close to 17,000 lots that are in various stages of evaluation to come right in and replace some of these. We are throughout all of our markets. So we have soft dollars up and these are not committed from our standpoint, but we have identified them. We have letters of intent that are non-binding, but nevertheless they're identified and are in various processes of review, and so those are -- it's not that we're stuck with just these lots, we have a large amount of lots coming right in behind these.

And lastly, are there any markets in the country that you are at the moment avoiding purchases because prices are too high?

The markets that we're in?

Yes, or are you avoiding going into any particular new market because land costs are too high?

You know, there's a lot, I don't know that I could identify the latter. In terms of the former, first of all, we are selecting markets that we believe we can find lots and we can build an affordable product and gain market share and develop a strong market position. We won't go into a market unless we think we can achieve our goal of being a top five builder in that market. So we are specially selecting those markets that we believe we can achieve that. In terms of the markets we're in, there's no market that we're intentionally not buying lots in because of they're over inflated prices. We may not be buying as many, for example, in the coastal southern California versus the Inland Empire just because we're seeing greater opportunities and more affordable opportunities in that particular market. So we're making choices as to where within given markets we might put more capital. But there's really nowhere where we're currently building that we're saying we want to trim back or stay out of that.

OK. Thank you very much.

Our next question comes from June Han (ph) from Banc One Capital Markets.

This is June Han from Banc One. I just wanted to question had a question regarding your strategy in Colorado. It seems like you were saying earlier that you wanted to grow your market share there and currently it's about 32 percent of your total sales. Do you see that growing or shrinking or stabilizing as you're growing your market to 2006?

We see the opportunity to continue to grow here as we expand our product offerings in various areas within the state that we can offer product. It is our home market, and we've done very well here and continue to do well here. But we do see that percentage shrinking. In fact, it already has shrunk fairly dramatically, especially from where it was a couple years ago. We're seeing a change, a transformation of this company from what has been perceived as a primarily a Colorado home builder to a much more diversified major regional home builder and we'll probably see that position -- we've already seen, if you look at the total number of active subdivisions, if you look at the level of backlog, the you look at the level of orders and closings, we actually see the Colorado percentage move down into the mid 20s.

OK.

And so well we're not intentionally reducing Colorado, we're expanding in these other markets, which is reducing the relative size of Colorado.

So Colorado essentially is going to be flat whereas everything else will be growing?

No, I wouldn't say that. We think that we're bottoming out in Colorado in terms of the economy. And I think that there are positive signs that the market could be changing and moving in a positive direction. Believe me, when the market starts to pick up, we will be the one to take maximum advantage of that. So as we see the market improve, we believe we can continue to grow in the Colorado markets.

: Then I had one other question regarding your higher priced product versus your lower end priced products. You were saying earlier that you were seeing growth in the homes that were under 200,000.

Yes.

Are you seeing the products that are in the higher end flattening out or declining in comparison?

I guess, I don't know that I would necessarily say that. It's just a question of what our focus is. We are seeing, even in Colorado, the percentage of our homes close to the lower price points increase. And in Southern California our average selling price is declining. It's not that the upper price points are flattening out, it's just that, for example, in last year and even in the first quarter of this year, we had one project in New Port Coast in Southern California that had selling prices over $2.5 million. We're pretty much close out of that. When you take that project out of the mix, the average selling price for the division as a whole drops $50,000. So it's more a question of mix and change of focus.

So it's more by design?

Yes, absolutely.

OK. And then my last question is regarding FIN 46. You were saying that the valuation is not complete currently when do you expect that evaluation to be completed?

It will be included in our second quarter form 10-Q as it relates to options entered into after January 31st and then for all options outstanding will be reflected in our third quarter 10-Q.

OK. Great. That's all my questions. Thank you.

Our last question comes from Alex Barrons from Franklin Templeton. Please go ahead.

Just one last question. Can you tell us where you've seen the greatest pricing power and approximately how much year-over-year?

Our greatest pricing power from a percentage standpoint has probably been seen in Las Vegas. And that's been running probably on average somewhere in the neighborhood of a percent a month. In the last quarter, we also saw some strong pricing power in Northern California. So we have seen that market start to, not start, but it continues to recover. Those are the two strongest markets here in the last quarter.

OK. Thank you.

Once again, if there are any questions or comments, please press the one on your touch-tone phone. At this time, we have no further questions or comments.

We'd like to thank you again for joining our call today. We look forward to speaking with you again in October following the announcement of our third quarter 2003 results. We wish all of you a great day. Thank you.

Thank you, ladies and gentlemen, this does conclude today's teleconference. Thank you for participating. You may now disconnect.