MDC Holdings Inc (MDC) 2003 Q4 法說會逐字稿

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

Before introducing Larry Mizel and Gary Reece, it should be noted that certain statements made during this conference call, including those related to M.D.C.s anticipated home closings, home gross margins, backlog value, revenues and profit and responses to questions may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

These statements may 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. These and other 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's Regulation G requires certain information accompany the use of non-GAAP financial measures. Should a non-GAAP financial measure be discussed the information required by Regulation G will be posted on the Investor Relations section of our website, RichmondAmerican.com.

I will now introduce Larry Mizel, Chairman of the Board and Chief Executive Officer of M.D.C. Holdings. Larry?

Good afternoon, everyone. Those of you on the East Coast, you should know Colorado is warm and clear and sunny and we extend a warm invitation to all of you. We'd like to thank you for participating in M.D.C.'s fourth quarter and full year 2003 conference call and Web cast. All of us remember 2003 began with a great deal of uncertainty and turbulence. Not so much for our company or our industry, but more for our nation and the world. Nevertheless, M.D.C. entered the year with confidence that as a company we were well-prepared financially and strategically to weather the storm and to continue to capitalize on a strong homebuilding market.

Today, we can say that while only some of those uncertainties have been resolved, 2003 was another great year to be a public home builder. We and all of the other large public home building companies enjoyed the benefits of record low mortgage interest rates, increased consumer confidence and a constrained supply of new homes in growth markets. This helped all of us to produce record results.

We believe that the solid, financial performance of the public homebuilders over the past decade and particularly throughout the changing times of the last three years, demonstrates that this industry is not the cyclical beast that it was in the '70s and '80s. And with an improving economy likely to produce new job growth in 2004, the future appears brighter, even with the prospects for somewhat higher interest rates. Fundamentals tell the whole story and I take pride in reporting on ours. For M.D.C. 2003 was the strongest and most successful of our 32 years in business, concluding with the most profitable quarter in our history.

This was our sixth consecutive year of record net income and our annual revenues established a new company high for the 10th year in a row. New quarterly highs for home closings and revenues were established in the fourth quarter on our way to a 17% year-over-year increase in the fourth quarter's net income and a 15% in earnings per share. The strong demand for new homes in most of our markets combined with our successful expansion in new and existing markets contributed to a 39% increase in our fourth quarter net home orders. Our highest fourth quarter ever and contrary to some concerns that the housing market is slowing, we extended our strength of record monthly home orders to 22 months with a 40% increase in December.

For the full year in 2003, our earnings per share reached an all-time high of $7 per share fully diluted and we realized new annual highs for home closings, home orders, mortgage originations and homebuilding and financial service profits. Our recent strong home order activity enabled us to end the year with our highest ever year-end backlog of almost 5,600 homes with a sales value of $1.6 billion. Our balance sheet has never been stronger and our performance in 2003 further solidified our financial position. Our year-end stockholders equity exceeded $1 billion for the first time.

Our net debt to capital ratio of .24 is among the lowest of our peers. And we ended the year with $780 million in cash and borrowing capacity with nothing borrowed on our $600 million unsecured line of credit. In the process, we generated a 140-basis points increase in our return on equity with easily exceeding the important 20% mark for the sixth year in a row. As strong as these numbers are, our successes in 2003 cannot be measured by financial results alone.

Here are a few of our 2003 highlights. First, all three major rating agencies issued rating upgrades to M.D.C. in 2003. All at the investment grade level. We are proud to join an elite group of only five homebuilders with investment-grade ratings from all three agencies and we find it ironic that traditionally conservative debt investors have led their equity counterparts in appreciating the secular improvement in the homebuilding industry. We capitalized on this investment-grade status to further strengthen our balance sheet by redeeming our $175 million 8 3/8 senior notes and issuing $350 million of 10-year senior notes with a historically low coupon of 5.5%.

All three legs of our growth strategy were successfully executed in 2003. We continued to expand in most of our existing markets, including significant growth in Salt Lake City, Dallas, Fort Worth, which we entered in 2002. We entered five markets on a Greenfield basis with Houston and San Antonio expected to produce home closings in 2004 and Chicago, western Florida and Philadelphia contributing to our growth in 2005. And in September, we entered our sixth new market of the year with the acquisition of assets of Crawford Homes in Jacksonville, which would produce 400 closings in 2004.

We made further progress towards our primary goal of maximizing shareholder value by increasing our quarterly dividend by 72% in August and repurchasing over 700,000 shares of our common stock in the first quarter at an average cost of less than $37 per share. Finally, in September, we closed our 100,000th home since we began building single-family homes in 1977, which symbolizes our long-standing survival, success in and commitment to this industry. For helping us achieve these exceptional results and accomplishments in 2003, we would like to express our sincere gratitude to our employees, our Board of Directors, our shareowners and all of our other business partners who have supported us throughout the years.

We look forward in 2004 with great enthusiasm. We continue to diversify geographically as our new market operations come on-line and our expansion in existing markets bears fruit. This should position us to capitalize on the apparent, improving economic conditions. Strong demographic trends and competitive advantages available to large, well-capitalized builders. As a result, we believe that we can deliver a 15% increase in home closings and revenues on our way to a seventh straight year of record net income in 2004.

Now my pleasure, I would like to turn the call over to Mr. Gary Reece, our Chief Financial Officer who will describe with more specific financial highlights of our 2003 fourth quarter and full-year performance. Gary?

Thank you, Larry. Before I get into the numbers specifically, I wanted to address one matter of immediate interest to many of you and that is statements that have been made in the press regarding margins. Home gross margins, in 2004 for M.D.C. Holdings. The statement basically was that 2004 margins will be challenged. That statement was taken from a quote from me in our press release that was part of the sentence that continued to discuss those challenges, being the continued ongoing increases in the cost of land and certain building materials, including lumber.

The beginning of that sentence is consistent with our discussions each quarter over the last couple of years. The reason I'm bringing that up now is as you can hear from Larry, we had an extremely strong quarter, highlighted by the highest home gross margins in our history at 25%. That is the context within which these comments were made and the statements regarding challenges in these two areas of land and building materials and other statements that we made, with respect to increased and improved performance of certain markets and certain subdivisions and are entering new markets and the margins there are really consistent with statements that we have made each and every quarter for at least the last two years. My message here as we begin, it's nothing in that respect has changed.

The issuance of this release changes nothing in the marketplace. The fact is the market itself and most of the markets we operate in are very strong. As I mentioned, we're seeing the highest margins in our history, we're seeing price increases in most of our markets, even in the fourth quarter. Incentives are continuing at low levels. You've seen from our orders that Larry stated, came in at the highest level of any fourth quarter, up 39%, headed by a record December, up 40%. So, we've had 22 straight months of record orders. Cancellations are down relative to a year ago. Traffic is up. Basically, the markets look very strong.

So, my message to begin here before we get into the numbers is for those out there looking for a chink in the armor or a hole in the dike, this is not it. This is not what we're reporting on. Fundamentals are very, very strong and that's my beginning comments and I'd like to get into the numbers, which are very strong, as well.

In the fourth quarter of 2003, we produced $67 million in net income. This is 17% higher than earnings of a year ago and our earnings per share of $2.18 is a record for the fourth quarter, as well, up 15%. These earnings were produced by -- or really headed by record homebuilding profits, on revenues in excess of $862 million. In the year, we produced net income of over $212 million, which is 27% above 2002, or $7 a share, which is also up 28%, on revenues of $2.9 billion, which is 26% higher than a year ago. Record homebuilding and mortgage lending profits led their way to those record results.

Going straight to homebuilding, our fourth quarter record profits of $126 million is 25% higher than a year ago. On revenues of $846 million, 13% higher than revenues of a year ago. And profits for the year from the homebuilding segment are close to $395 million, 33% higher on revenues of $2.2 million or $2.851 million.

As we said in the release, record closing levels were one of the primary reasons for these increased earnings and we've included a slide here that shows the 13% increase and the stratification of the orders, I think you will find it interesting when you look at it as to where the orders are. First of all you will see that a real good example of how our diversification has changed. Our largest state is actually Arizona, followed by Nevada. Both of these are up 15% and 37%, respectively. Colorado is actually the third largest state now, with 686 home closings.

We had strong increases in Nevada, Maryland, Virginia, we were down in Southern California and Colorado as we've talked about before because of lower active subdivisions in those markets and in Southern California it's clearly a demand issue where we have sold out of subdivisions earlier and in Colorado, we've reduced the subdivisions there to this point but that's a trend I will talk to you about later that will change in the future. The other interesting thing is the quarter did see 230-plus closings coming from our new markets in Texas, Utah and Florida. So, our 3,374 closings up 13% is a record and 11,211 closings for the year.

You will note that our average selling price as seen here on this slide, we show the trend in average selling price as we've been talking about, has continued to come down as we move into more affordable markets and focus on more affordable product in our existing markets. For both the fourth quarter of this year to the fourth quarter of last year and year-over-year were consistent across-the-board. You can see in this slide and in our press release we've laid out the average selling prices by market. We're sitting right about $250,000 per unit this year and $254,000 for the entire year. We do show that we have five states out of seven producing closings that are actually below the $200,000 level.

Moving on to margins in the next slide, you can see the steady increases in margins and the 25% record level we produced this year, which enabled us to reach in excess of 24% for the entire year. These are the highest margins ever. We had strong margin increases in Southern California, Las Vegas, Maryland and Salt Lake City and we now have, as I mentioned in the release, every division that was operational prior of 2002 reported margins above the 20% level. These higher margins are attributable largely to higher levels of rebates from our suppliers, higher design center margins and significant improvements in margins in Vegas, Southern Cal, Virginia and Maryland.

Our expenses, the slide that's shown here is actually SG&A for the company as a whole. We've seen some increases in our homebuilding SG&A, as well. The selling costs are pretty much in line with the increases in volume. Our G&A expenses at the homebuilding level are up a little bit from a percentage standpoint, a little bit higher than the increase in revenues, primarily due to the additional divisions we've brought on-line that have not yet produced closings. At the corporate level, we've built a number of national departments that will be serving our divisions in the future. We've been moving our corporate offices and we've stepped up, as we talked about before, our investment in technology. So, those types of items contributed to the higher percentages of SG&A relative to revenues.

On the financial services side, while we produced record earnings in excess of $28 million for the year, up 17% versus 2002, our fourth quarter was actually lower at $4.9 million for the fourth quarter compared to $8 million a year ago. There's really several reasons for that, primarily a reduction in gains on sales and mortgage loans and increases in G&A expenses related to the increased volume of loans that we now handle.

Origination fees did reach a record level, but we did experience during this quarter some interesting areas that most of us in this business have experienced and that is the more volatile market caused a change in the amount of gains that could be recognized on the loan but we also saw significant decline in refinancing activity in the marketplace and while we do not do refinancings so didn't affect us directly, this did create a much more competitive environment in the market, which resulted in a more normalized pricing environment for our loans. It also caused, because of the increased competition, we had to broker more loans than we normally do in order to keep some piece of it and we also introduced more arm product.

We now have approximately 20% of our mortgages that we originated this quarter were adjustable mortgages. Now, that is high relative to a year ago, almost twice what it was a year ago, but it is actually 10 points below the national average, which, because of this change in the marketplace has increased to about 30%. So, the capture rate, you will see, is actually pretty close to where it was a year ago in total, but we do have a higher concentration of those originations that were brokered out and those do not result in gains on sales of loans. We do receive a fee but they're not as profitable as the loans that we actually originate.

The slide following the financial services slide does show that financial services profits for the year were up 17% but as a percentage of our business it continues at a fairly consistent level, not a large part of our business, but it has consistently contributed around 7% of our total operating profits.

From a balance sheet standpoint, our balance sheet has never been stronger, as Larry mentioned. Over $1 billion in equity, which is 27% higher than a year ago, which is $34.40 a share. Our debt to cap ratio of .24 is below the .27 of a year ago. And we generated, unlike last year, when we were growing fairly significantly in preparation for growing our earnings this year, we did generate significant cash flow from operations.

We've included a new slide here in our presentation that lays out cash flow and the sources of that cash flow and you will see from this analysis that we actually generated close to $400 million in cash from earnings, from reducing our mortgage loans and issuing new debt to public markets, primarily. We utilized that $400 million, at least $200 million of it, we invested in our company's growth, particularly in work in progress and land. Work in process that's already sold, in fact. So, those are the investments we've made in the future and we also used another $40 million to pay dividends and to buy back shares. That left us with $170 million in cash remaining, which we hope to take advantage of opportunities and this contributed to the $780 million of cash and borrowing capacity we have at the end of the year.

Orders were very strong, as I mentioned earlier. This is the highest fourth quarter we've ever seen. Up 39% and as I said, we've had 22 months in a row of record orders. Our subdivision count is up, but on a same-store basis we were also higher, as this slide shows. 22% higher on a same-store basis.

Our traffic, as I said was up, is up close to 10% and our cancellation rates were down. Our orders for the month, you will see from what's here is strength in Las Vegas, strength in Southern California and Salt Lake City, Northern California you will see these being the markets we've talked about that we've been experiencing particular strength in. Colorado was actually up 11% in the fourth quarter, which is encouraging because our subdivision count was down. So, on a same-store basis, Colorado was actually up 35%.

You will note that Arizona is down, as well as Virginia and Maryland on a same-store basis. Arizona being down primarily because of supply issues are selling out of communities early and not getting the new ones on in time. And Virginia and Maryland is down really because they've had some real challenges with weather and getting the houses built. That market has to be one of the strongest markets in the country for us and we don't want to sell out ahead of our ability to deliver the homes. So, we've essentially slowed things down there.

These strong orders have contributed to record backlog. We're close to 5,600 homes, this is up 39% from where it was a year ago. Sales value of $1.6 billion. The highest fourth quarter backlog we've ever seen. This backlog composition is heavily weighted to high-price markets.

You will note that the average selling price in backlogs is close to $290,000, which is inconsistent with the guidance we've given you on average selling prices being close to where they are today because of the weighting of the backlog to markets like Maryland, Virginia, Southern California, all markets in which the construction period is the longest, generally takes close to 100 days or more to complete these homes and we do have about a third of our entire backlog that's not yet been started and a lot of those are in these high-priced markets. So, that's one of the reasons why that average selling price and backlog is quite a bit higher than our expectations for future quarters of average selling price.

We also have reflected in the next light here, our trend in active subdivisions. We ended the year just short of 200 active subdivisions, right about where we had guided for the last two quarters, which is up 11% from a year ago. We have laid out the divisions which have shown the growth and you will note that with a exception of Virginia and Maryland, all the growth is pretty much in those markets that have the lower average selling prices. Texas, Florida, Salt Lake City. And we've seen some reductions in Colorado and Arizona as I mentioned before, those reasons. We will start to see that trend reverse in Arizona, as well as Colorado in the first quarter of 2004. As we anticipate in 2004 a growth in active subdivisions that approximates our growth in closings for 2004. We're well-positioned for this growth.

You will note in the release, as well, we included a schedule of lots owned and optioned by market. You will see a significant increase in the number of lots controlled and that's primarily in the area of lots under option as we have a little over 16,000 lots owned and just over 12,000 lots under option, which is just over 40%, getting closer to an area that we'd like to operate at 50/50 owned versus options. You will see that most of those increases are in these markets that we are expecting growth. Arizona, Maryland, Florida, Texas, Vegas and Salt Lake City.

I would also mention that we continue, even though the number of lots that we have under option have increased significantly. We still maintained control of these lots with minimal dollars at risk. In fact, for the 12,000 lots, we have less than $25 million in cash and letters of credit at risk. In addition to these 12,000 lots under option, we have an excess of 20,000 lots in the pipeline that we're looking for to fuel our expected growth in years to come.

Speaking of years to come, this has been a great year. We're very proud of it. We're prepared for 2004. We are very well positioned from a backlog standpoint, from an active subdivision standpoint and with these new markets in place to grow our closings by approximately 15% this year.

As I mentioned before, we are expecting our average selling prices to be fairly consistent with where they are today, taking into consideration the new markets that we're entering and the growth, and the focus on lower-priced product in our existing markets. These should enable us to -- we should see our revenues grow, commiserate with the closing levels and we expect to see record earnings in 2004.

That concludes my prepared remarks. I'd like to open the floor to questions at this time.

Thank you. We will now begin the question-and-answer session. If you have a question, you will need to press star 1 on your touch-tone phone. You will hear the acknowledgement you have been placed in queue. If your question has been answered and you wish to be removed from the queue, please press the pound key. Your questions will be queued in the order they are 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 star 1 on your touch-tone phone . Ivy Zelman is on-line with a question. Please go ahead.

Good afternoon, guys, actually Dennis McGill on behalf of Ivy. Gary, I wonder if you could put some of the concerns about margins at ease, just talking about the first quarter, given that you have a pretty good idea of where pricing is and maybe that will help people understand kind of what your outlook is.

Well, Dennis, we have consistently, over the over the years, maintained the same position in terms of guidance. We'd rather not talk specifics about margins. In the near-term or the long-term, except to say that, we've talked about strong pricing power of late and all of the things that are going for us with national purchasing initiatives, an increase in the level of participation in our design centers, as well as higher margins, increased rebates. There's a real focus on the cost side that will start to bear fruit in 2004, but we do know that land costs are increasing.

We do know that the impact of the lumber increases that began in May last year will start to come in in a big way in the first quarter. So, we are going to sell a large number of homes during the first quarter that we will close in the first quarter and that could have a large impact on what the margins are. So, I think that hopefully I've given some comfort just in my comments that there's been no change in the landscape out there.

Would it be fair to say that simply from a comparison standpoint that challenges that you mentioned would be more likely in the back half of the year than the front half of the year?

Those challenges? Not really. Lumber is really going to be in the first half of the year. Land costs have increased significantly over the last year in many of our markets and those will be coming through. The other factors, we did have some strong margins from subdivisions in Southern California, San Diego specifically and L.A. that are very close to closing out in the fourth quarter. And so, challenges has gotten a lot more attention than it probably should. These are just factors and business is still very good and we're going to work through it and we're going to continue to sell homes and close homes in these markets and take advantage of the markets we're in.

That's fair enough. Looking at your expansion in some of the newer markets toward the end of the year, do you feel like you have the capital in place to do most of that expansion after the recent bond deal? Or will more be necessary to finish that up?

For what we have in front of us, Dennis, we're in very good shape. We've got $170 million in the bank to start the year. Our plans are to put that money to use right away and so we are -- but I think with the earnings we plan on generating and the capital we have available to us, there's not a need to go to the capital markets.

Thank you very much, guys.

And David Einhorn on line from Green Lake Capital. Please go ahead.

Hi, good afternoon, guys.

Hi, David.

Quick question, can you comment at all on the multi-year, I know you've talked about 15% top line growth. Would you expect bottom line growth to keep pace with that?

That, David, we've not commented on the bottom line, only because there are factors in between that have a lot of unknowns in them. Margins being the primary one. And our ability to leverage off the administrative infrastructure that we are setting up here, particularly during 2004. We're going to have five new divisions that started with nothing here at the beginning of the year and so we're going to need to put those in place and hopefully when those start to generate, the thing is we will probably be looking at some other markets and other operations by the time 2005 rolls around. It will be putting in place.

But, the margins are going to largely govern where that bottom line goes and our hope is that we could work toward that. In the past we've actually done better at the bottom line but, it's something that there's just a lot of variables for us to consider.

Okay, thanks a lot.

Next we have Steve Kim on line from Smith Barney. Please go ahead.

Hi, it's Jed Barron for Steve Kim. Congratulations on another strong quarter.

Thank you, Jeff.

Gary, to begin with, I appreciate the clarity that you provided on the gross margin outlook, understanding that you don't want to nail down a particular estimate for '04, can you talk to us about perhaps the trajectory that you might expect in margins in '04, and whether that might follow the same path we saw here in '03?

Well, Jed, I hate to repeat myself, but the trajectory that we saw in 2003, we didn't anticipate it this time a year ago, because we didn't build in price increases that we saw that were fairly dramatic in certain markets like Southern California, Virginia, Maryland and Las Vegas. Those are the markets that contributed to these terrific margins in the fourth quarter here, and 2004, what we do see is we have the initiatives that we have in place that we believe will bear increasing fruits throughout the year on the process side but land costs will continue to escalate.

We know that we're coming into some new markets and when you start closing houses in new markets, you're not at optimum margins. As those begin to mature, we will see an improvement in that, whether it's the end of this year or early next year, it's hard to say. So again, I think I'm going to have to look to price increases primarily and our ability to increase prices as to whether the trajectory continues.

Okay. I guess as a follow-up, can you talk to us a little bit more about your opportunities that you've seen recently to raise prices?

Well, our opportunities have been in those markets that I mentioned and we are raising prices in Las Vegas every week and looking at it all the time, even within the week, in some cases, in some of these markets that have really been hot. But the increases have been fairly dramatic and Las Vegas would probably be the one that's seen the highest level and somewhere in the neighborhood of probably 10%, last quarter. And we have probably seen in Southern California and Virginia and Maryland something in the neighborhood of maybe 2% a month.

There have been markets that have not increased. Dallas has not increased. Colorado has seen very little increases, a little bit in Southern Colorado. Salt Lake City has not seen much in the way of pricing increases. But, those are kind of the two ends of the spectrum.

Sure. I guess one other, if I could here... On the SG&A here for '04, I'm understand that you're going to be opening up a number of new subdivisions, could you just talk to us a little bit about what to look for in SG&A in '04?

I think in 2004, we will see an increasing level of G&A. I don't see SG&A, the selling side of it increasing outside of the revenue increase, but I think on the G&A side we will see an accelerating buildup of personnel, in preparation for launching some significant operations in Philadelphia and in Chicago and in Western Florida during the latter half of the year. We will probably see some closings from Houston and San Antonio in 2004, but not really to offset on a relative basis the increase in G&A and Jacksonville should pretty well be acclimated by mid-year.

On the corporate side, I think we will, as we've talked before, we will continue to see n investment by the company in technology, which we will probably exceed what we have spent here in 2003, as well as building up an infrastructure at the corporate level to support the various regions around the country. Now, this year we started a new concept of regions where we have five regions within the company to support the divisions. Those regions, part of their costs have been built into the numbers you see in 2003, but we will see them fully staffed in 2004 in support of our increasing homebuilding operations. And so those are some of the factors that will lead to increases in G&A costs.

Hey, Gary, it's Steve Kim. If I could sneak in here with a question. I know that you have, as do most of the builders, not included in assumption that price increases continue in the guidance that you give and I also know that you have included in your assumptions going forward a number of initiatives, particularly on the G&A side, to build out the infrastructure for your company, you talked about spending on IT and those kinds of things.

My question is this: It's been a while since we've been in an environment where you have not gotten any price increases, net or in fact I've seen prices going down. What do you think, if we actually do see an environment immediately where you're no longer able to raise prices, period, across-the-board, how would that change your strategy in terms of your expenditures, maybe on the SG&A side? Can you talk about what impact you think that will have on your cash flow and how it might impact your decision to do various things with the dividend or share repurchase activity?

Steve, the prices would not stop in a vacuum. I think they might accompany some other things going on in the market. If you're say demand continues at its current pace, that would be hard to imagine, that you'd see the ability to sell 15 houses a month in a subdivision in Las Vegas, if prices were flat.

Right.

So, a lot of things would change. I would say that that would be accompanied by a general decline in absorption rates for subdivision and we would have to re-evaluate. We have very strict criteria for the subdivisions we acquire and that would impact what we would buy. We might, in fact, a result of this, be buying less, our growth might slow down. If our growth slows down, our cash flow would actually increase and we've shown how that works because we have it finely tuned to have a certain level of inventory out there to support a certain level of operations. So, in terms of cash flow, I think we generate a lot of free cash flow in that situation and as far as its impact on our dividend policy, or others, it's hard to say what that would be. We certainly would not be a cash constraint there, but we think that dividends are an important part of the shareowner value plan we have for our shareowners and so we would certainly want to consider a continuation.

How about the impact on G&A, because in your guidance, or in your assumptions, we talked about an environment with no pricing increases. I'm wondering if we're not sort of [Inaudible] on the gross margins side, but still hitting with the SG&A, wouldn't your SG&A, or some of the decisions you would make regarding SG&A be altered somewhat?

Absolutely. Yeah. Again, it would all be tied in and everything is in lock step together. If activity per subdivision declines, we wouldn't be at the support levels that we're planning for. We're planning for certain levels of demand and certain levels of activity. We consider everything we have on the G&A side to be variable.

Right.

And we look at it all the time. So, activity declining, we would create some leverage there. We would adjust with the market.

Great. I think it's important to make sure that the people are aware that you're not assuming price increases on your gross margin numbers but on your SG&A and cash flow, when you talk about cash flow, you are probably assuming an environment that's not much different from today. So, I guess that's all I meant.

You're absolutely right.

Now we have Larry Horan on-line with Parker/Hunter.

Hi, Gary.

Hi, Larry.

Your increase in sales per community is obviously phenomenal and indicative of a very strong demand environment, which you can raise prices. The thing that worries me a little bit in terms of people's focusing on this is that you draw the analogies with retail stores, they can restock their inventories rather easily and rather quickly these days. But you guys run out of inventory in your stores if you sell at this pace, pretty quickly. So, isn't a strong quarter like this more likely to be followed by a maybe a quarter in which sales per community don't rise as fast, simply because you're going to be running out of inventory?

Larry, that's a good observation from someone who understands the way this business works, as you do. We are experiencing the impact of that and we have over the last couple of quarters in Southern California and Phoenix. And we're just getting around to recovering from that, it's a good thing. It's all reflected in our backlog and our ability to close houses, but that is something that we are experiencing in Las Vegas, as well. Las Vegas and Phoenix and Southern California have been markets where the absorptions have been very high and hat's one reason why we increased prices as much as we do is to try to slow that down to the extent we can maximize every dollar we make on every house that we sell.

The review of sales versus pricing increased decisions, obviously you don't do that in the headquarters for all the subdivisions, but is that a regular, weekly, monthly type of process at the subdivision level?

Larry, there are reviews, certainly we have weekly sales meetings, but we don't leave it to the sales meeting to make pricing decisions. We have a strategy going into a weekend in particular, going into a given week, but depending on what we want to generate with incentives or other market efforts, and the people in the field have directives to take certain steps regarding pricing if certain absorptions occur and in some cases, our division managers are involved actively on the weekends, on a daily basis to interact with our sales manager and the sales people to make sure that we make the pricing decisions immediately.

Okay, so you're adapting -- it would be fair to say within a weekly context, if you say 26 subdivision and have eight orders that weekend, you would turn around and probably raise prices on Monday or Tuesday or whatever.

Larry, it's fair to say if we have a 26-unit subdivision and we sold three houses on Saturday, we'd raise them at noon and sell the three in the afternoon at a different price. Okay, great, thanks. That's what I needed to understand. Okay.

And Tim Jones is on-line form Wyeman & Associates, please go ahead.

This release looks like the release you did three years ago. It's almost identical. First of all, I am sorry I missed the first 15 minutes. I'm sure you talked about the margins, but in the land position, I recall, because I've been busting your chops for 12 to 16 months on how your margins keep going up, I remember once I asked you, I think it was a 215-basis point rise in margins -- 100 basis point rise in margins you said something like the differential was that you had land concepts either 100 or 150 points and then pricing is constant. What's the difference. So, obviously your land cost has been going up over the last three years. What percentage of sales let's say over the last three years has land gone from?

I would say that probably when you ask that question a few years ago our land was probably 20%.

Yeah, I thought it was 22%, but 20%, okay.

I think it was about 20%. And it's risen to around 24%.

So, you're already up 4% and it was my impression that maybe your goal, maybe it would get up to 25% or so. I mean isn't most of that land increase already happening over the last three years and I mean do you think it will get up -- just give me a ballpark estimate? Do you think it will get up past say 26%? That's high to the norm of the industry for forms in your price range.

Tim, I wouldn't put it past it even possibly trickling down a little bit.

What do you mean trickling down?

Coming down as a percentage of revenues. It could be lower.

The "Wall Street Journal" doesn't seem to understand that. [ Laughter ]

There are two things. The land, as a percentage of revenues, is really governed largely by the markets that you're in because we may be less than 20% in Colorado and we may be 35 or 40% in California.

And I understand you had that real low price land that you own at one time and it was a very big problem and turned into a blessing. I understand that, too.

Yeah.

That's incredibly important. You actually think that land might decline from 24% of gross.

As a percentage of revenues, it's certainly possible. Because, and that doesn't mean that land costs, the cost of the individual lot in the individual markets aren't going to go up.

I understand. I understand.

But land as a percentage could actually decline as these new markets come online.

That's a very important statement. Now the second one, okay? You're assuming a 15% increase in deliveries. Which would give you roughly 13,000 deliveries. That would be about -- your backlog is 43% of that number as opposed to 36 the other way or taking the reciprocal. If you delivered the same percentage of our backlog over a year ago, you'd be more at the 15,000-plus level. Which is close to 30% instead of 15%. Now, I understand you have limitations on your ability to deliver. Or are you just being conservative? And did you beat your wife last night?

Tim, you know that we are conservative, but in this case I don't know that we can necessarily correlate our year-end backlog to the full year because it depends on how quickly we bring our new asset subdivision online.

You've got an 11% subdivisions already.

Right.

You've got a 43% increase in backlog and 11% more subdivisions if you don't bring anything on.

Well, Tim, we've got that 11% is not 15%.

I understand.

And the increased backlog will help us...

What were you assuming for the increase in subdivisions this year?

We believe by the end of the year we will be up somewhere in the 15% range.

Oh, my God. Okay. You're low balling. And last thing, you said something that confused me, you said in Southern California, Virginia, Maryland you were raising prices 2% a month?

I said that in Las Vegas.

No I thought you said Las Vegas was up 10% for the quarter.

I'm sorry, yes, 2% a month for California.

2% a month is 24% a year.

Yes, sir. But it also depends on timing and where we are --

You're pricing are up 20% and did you mean to say in Las Vegas for the quarter you went up 10%, not for the year.

That's correct.

So, you went up , so, that's on a 40% annualized rate and Southern California is up at a 24% annualized rate. Is that correct?

Well, if you want to annualize it. But if you want the facts, the facts are not that high. Las Vegas is actually a little over 20% for the year.

Okay, but that's tremendous.

Uh-huh.

And how about the other ones?

Southern California is double digits for the year and and several of the other markets, Southern California is probably 10%. Virginia and Maryland are probably in the 10% range for the year.

Okay. Those are great price increases and obviously it is hard to predict them or not, but, anyway, nice talking to you boys.

Thank you, Tim.

Mike [Inaudible] is online now with Citigroup. Please go ahead.

Yes, a couple of questions. I wondered, in 2004, obviously you'll be expanding your community account in the growth markets. Are there any markets you will be cutting it back in?

No, Tim -- I'm sorry, Mike! [ Laughter ] Tim is on my mind! [ Laughter ] We're expecting growth in every market we're in next year, Mike.

Okay. That's my only question, thank you.

Okay.

And now we have Stan Lieber is online from Alpine. Please go ahead.

Hi, gentlemen. Great quarter, obviously, and I think you should be commended for forcefully and clearly stating the case of what's going on operationally. So, thank you. But a couple of quick questions, it's tough to follow on Tim's question [laughter] but I'm curious about your land expenditures, you spent a couple of million dollars two years ago, obviously wrapping up after 9/11 and you spent about $100 million, I'm sorry, in '03, after spending $200 million in '02. What are your goals or budget for this year?

We believe that, we haven't really talked about that specifically but what you're seeing in 2003 is more of a normalized growth pattern for 15% growth, which is kind of what we're focused on to maintain over the next three years. So I would say that what you're seeing in 2003 is a good example of what we would see in '04.

Fair enough. And just a question with regard to materials prices, lumber in particular. Obviously there is a seasonality in prices of lumber. To what degree -- at what point are you buying or to what degree do your costs reflect the current market levels? Do you buy on a quarterly basis? Do you buy on sort of a blended average over time? Do you hedge? Can you give me a little picture on that?

Sure. We do not hedge. We do lock in the prices ahead of time and it varies market to market it may be 60 days. It may be 90 days, it may be 120 days in some cases but we'll lock them in ahead of time. But we've basically buy days in preparation for homes that we're contracted for and so the price increases that we began to see hit the market in May which really ramped up in a big hurry. We were able to, in some cases we were able to avoid a big part of those increases because of the timing of our locking in the prices but for those markets where we're not so fortunate, we've began to see it impact our purchases probably around October. So, the primary impact of those acquisitions of lumber will be coming in in the first and second quarters of 2004 as they hit the bottom line.

Okay. But now correct me if I'm wrong, but certainly it looks like, again, the seasonality, the prices of the season peaked around September/October for most lumber and has come down a little bit. Does that mean that you will then get a little bit of benefit in the second quarter? A little bit lower costs?

It may benefit somewhat in the second quarter and we should see the benefit of those coming down primarily in the third quarter, yes.

Right. That's when you really utilize them the most, too?

Yes.

Okay. Fair enough. Let's see...I guess that is part of it. I guess the only other issue, some of the other comments here have been focusing on the margin issue. Focusing on the various cost structure. No one's really talked much about, I guess the theme of discussion in the sector a couple of quarters ago and that was, of course, internal cost reductions. Construction process cost reductions and so on. How far along are you in those efforts, do you think? And how much more incremental improvements would you anticipate being able to make over the next one or two years or so? Or could you quantify it in some fashion?

It is something that will be -- it's difficult for to us quantify at this time but I can tell you that we have made some significant modifications to the manner in which we manage the purchasing effort. The level of expertise we have managing that effort and we have reached some of the fruits of those efforts in 2004 but we have a plan to attack the cost side even stronger here in 2004 so I would expect -- I may have misstated, we got some of those benefits in late 2003 and we expect to see a larger impact in 2004.

There are some things on the technology side and systems side and process side that also have to be attacked to have the major impact, though, and we do have a team of people who are set up to attack the supply chain, to break it down and to help us create an integrated process. That's where the real impact will be and we will be spending significant dollars on the G&A side in 2004 in developing that system. So, we do not expect to see the benefits of that in 2004. Perhaps in 2005.

Fair enough. Finally, there were some comments earlier, some questions that came from others were basically getting around how you would handle a slowing down if, indeed, something happened as we go into a negative scenario and demand drops off. Now, obviously you pulled in the horns pretty quickly after 9/11, you took a very conservative approach there and then you ramped up very much so in '02. Can you give us a sense of how -- since you've been through this already, whether you can close up shop more quickly than you can ramp it up? And what are the cost differentials in terms of being able to shut down parts of the operations as they be, versus again try trying to ramp up?

The ramp-up takes a while. I will tell you that. I think we can ramp down much faster than we can ramp up. And that's that's a critical part of our strategy is to be able to react quickly. First you have to recognize it, then you have to act. The ramping up, we can see that if market by market it varies. In the Texas market we ramped up in a big hurry. We were operational within 10 months after starting at ground zero and we can probably do the same in Houston, Texas and probably in San Antonio, as well.

In some of these other markets it may take 24 months to accomplish the same type of ramp-up when you start from ground zero. And then Jacksonville is the situation where we bought assets and hired some people and had an operation from day one. I think it's still took us the fourth quarter to really bring them into the fold and teach them the M.D.C. way of doing things and getting their information on our systems and things of that nature.

So, obviously there is cost associated with the ramping up process, then.

Yes, there is.

And then similarly, if you have to go into, again, if we look at the worst case and see business slowing down, how long does it take or how long a period would it require extra expenditures and costs? Could it be done in a quarter or two or...

I would say we would bring it down in a very short period of time. I don't know if it would be a week or two weeks or a month. Once we would -- we haven't had to do this for a while, but I can tell you that we are one of the companies that took immediate action last time we faced this a while back when it was pretty much across the board and in given markets, the key is being decisive and looking at how you're going to approach it, and taking action. And if that's the direction we'd go in the market. We'd start taking actions immediately and it wouldn't take 90 days it wouldn't take six months. It would be immediate.

Great. Fortunately we're facing a different scenario, at least for the visible future. Thanks, gentlemen, great quarter.

Now Jim Wilson is online from JMP Securities. Please go ahead.

Thanks. Good afternoon, guys. Could you get a little look ahead, I guess either Larry or Gary, as to the new markets, maybe over a couple-year timeframe as you grow them, what you think the potential opportunities might be in the new markets, whether it's a couple hundred unit opportunity or significantly larger, depending what the market is.

It does largely depend on what the market is, Jim. Our expectations are higher from markets like Houston and San Antonio. I think we would hope within a couple of years to be at the 500 unit level in Houston and we'd like to be at 1,000 units in Houston within three to five years. San Antonio might be 500 to 600 units in the same timeframe. Whereas in a market like Chicago it may take us three years from the start to get to 200 units, same thing in Philadelphia. And so we would hope that by the end of 2005 we're at the 200 unit level.

Tampa we'd like to be in that timeframe, probably 300 to 400 units. In Philadelphia, 200 to 300 units. So, the Chicago and Philadelphia markets are tougher, more like the Virginia/Maryland markets, where land is difficult to come by, difficult to process, time-consuming but -- but very, very profitable.

Well, the unit itself gives you an awful lot of growth potential over the next couple of years.

Yes.

Forgetting what you made on the existing markets.

Yes, indeed.

All right, very good. Thanks.

Wayne Cooperman is online from Cobalt Capital. Please go ahead.

Hey, guys, how you doing?

Good, how are you?

Good. I know you didn't want to give guidance on margins or earnings, it obviously would be nice if you did. Can you talk about margins, are you seeing margins up or down in any of the existing markets you're in? And, given we have a lot of backlog and a lot of visibility, maybe we could talk about the gross margins in the backlog versus the margins in '03 to get a sense of where they might go.

Well, Wayne, the markets that we're seeing, that is a good thing is that we're relatively consistent, unlike three years ago, where we had a few markets of single digits and a few with 30% and averaged out, at least today we're looking at most of our divisions with fairly high margins above 20%. We've said California is strong. Las Vegas is very strong, Virginia and Maryland.

I know it's maybe hard to forecast your margins because you don't know how many units close into each market and if there are new markets, but if you look at the existing markets, do you think the markets would be up or down in '04 versus '03 or '05?

Wayne, I know you'd like for me to say that, but we really don't want to say if it's going to be up, down or flat. We'd rather discuss some of the factors that --

All right, how about the stuff you've sold in the last few quarters of backlog. Is there any reason to think that the margins in those homes are worse than what you've been closing?

Than the margins? Well, again, Wayne, some of the margins in our backlog are in new subdivisions, new markets.

Right.

Different lot costs. We still have to -- we have 1,800 homes in backlog that haven't even been started yet. That means they've got to visit the design center and there is a lot of unknowns out there, Wayne.

Right. What would a typical margin be in a start-up? Where do they start in a start-up phase?

It varies. It really varies market by market because we require a certain return on assets before we will buy a product an old market or a new market. If you're buying lots in a market that has rolling options, you may be able to achieve the desired returns with an 18% gross margin and still achieve the same return on assets, return on those assets you get from like, 25% margin project.

Is it fair to say you're not closing homes in a 3% market in any of your markets; is that right?

Not by design, I tell you!

I hope not. I don't know in a new market how quick of a ramp you get to be where you want to be?

Yeah, those margins are margins of a distressed project.

Which we don't have any?

If we had any, we had NRVs and we had no NRVs this quarter.

All right, I can only ask the same question so many times! [ Laughter ]

Thomas Marcicone is on the line from Marcicone Capital. Please go ahead.

Hi, Gary, how you doing?

Good, how are you doing?

Good! I want to try to ask a question that doesn't require a difficult answer for you.

I'm ready for that one.

With rates now at 4.03% on the 10-year, where are you seeing most of your activity? Is it coming from people who are moving out of rental units? Or are you seeing job growth in most of the strong markets that you've mentioned? And what do you think the factors are that are driving growth in the markets in which you're participating? I know it differs among markets.

It does, Tom. We're seeing a little bit of both. We're starting to see some job growth. We are pulling some people out of apartments. We are seeing some move-ups in certain of our markets but I think that one of the things that's driving our growth is, one of the main things, is the fact that we are taking market share. We don't necessarily have to have job growth in a market for us to be growing.

So, really that's what's driving the substantial growth we're seeing in Las Vegas and Arizona and Virginia and Maryland and that's the same for all the large public builders. Now, you throw job growth on top of that, which we really haven't had for the last couple of years, on top of a situation where rates are still very low, the economy starts to improve and we're now with larger market share in a position to more than capitalize on that.

All right. Is there a market share position among the top five or 10 home builders that you reach where competitive pricing becomes more of an issue?

I'm not sure I know what you mean, Tom.

Well, let's say unpenetrated markets by the major top 10 home builders. There would be less competition for that intermiddle house to build, where you have the top 10 homebuilders, let's say, there would probably be more competition. So, at what level does market penetration, so, if we're looking at home improvement business where you have Lowe's and Home Depot now representing about 40 to 45% of the market, their ability to penetrate the market further becomes much more difficult because they start competing against one another instead of people who are not financed as well or not financially savvy. So, I imagine that you experienced that over the last several years where you've had let's say easier competitors to deal with than other major home builders. So, at some point in time you do come against major homebuilders when competing for the extra sell. At some level I am sure that you're going to reach that level and you are going to see a more competitive response from other major homebuilders.

I think that at some point it may reach that level. Right now we are competing with every major builder in Phoenix, Arizona, in most in Las Vegas, Nevada. In particular, most of them have come here to Denver. With the exception of Denver right now, which actually we're continuing to raise our market share here in Denver, even though the market has been down, but we have, last year we doubled the size of our operation in Las Vegas, notwithstanding the fact that the large builders had a substantial piece of the market. And Phoenix --

Even in those markets where the major homebuilders are a large factor, you're increasing share in those markets, too?

Absolutely. Phoenix is dominated by the large builders. Maybe a 50% share among the top 10 builders and we continue to grow there. We grew 50% there last year, we're going to grow substantially there again this year. So, it's not really been an impairment to grow.

And in Phoenix, where would you rank now among homebuilders?

I would say we're in the top 5.

Top 5?

Uh-huh.

Okay, thanks very much.

You bet, Tom.

At this time, I show no further questions.

We'd like to thank you again for joining our call today. We look forward to speaking with you again in April following the announcement of our 2004 first quarter results. Have a nice day, everyone. Thank you.

Thank you. That concludes today's conference. Thank you for participating. You may all disconnect.