MDC Holdings Inc (MDC) 2005 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the M.D.C. Holdings 2005 second-quarter earnings conference call. At this time all participants are in a listen-only mode. Later we will conduct a question and answer session. Please note that this conference is being recorded. I would now like to turn the conference to Mr. Joe Fretz who will read the statements concerning the forward-looking statements. Mr. Fretz, you may begin, sir.

Before I introduce you to 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 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. These and other factors that could impact the Company's actual performance are set forth in the Company's 2004 Form 10-K.

It should also be noted that SEC Regulation G requires that 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.

Good morning, everyone. Welcome to M.D.C.'s 2005 second-quarter conference call and webcast. We are pleased to announce record quarterly operating profits for the 12th consecutive quarter and for the 23rd time in the last six years. Improving job growth, declining unemployment, rising consumer confidence, low interest rates and a generally improving economy are providing M.D.C. and other well-capitalized public builders with a strong platform for producing outstanding results. However, our industry's superior performance over the past decade demonstrates an ability to prosper in a wide range of economic circumstances. This has resulted in no small part from forces driving the consolidation of the U.S. home building industry in favor of M.D.C. and its public peers.

M.D.C. has emerged as one of the strongest performers in this dynamic sector, as well as any other sector in corporate America. Our recent recognition as one of the top six companies named to the prestigious Barron’s 500 attests to this fact. Aided by our conservative operating model, geographic diversification and strong financial position, we have produced record earnings, revenues, operating margins and returns, including our 28.6 home gross margin in the 2005 second-quarter and a 31.2% after-tax return on average equity over the last 12 months.

As we produce these record results, we remain focused on enhancing shareholder value while strengthening our financial position. Total stockholders equity now exceeds 1.6 billion, and our quarter-end ratio of net debt to capital of 0.30 is one of the lowest in the industry. We increased our June 30th cash and available borrowing capacity by nearly 60% from this time last year, and our financial flexibility improved even more last week when we closed on the issuance of an additional 250 million in medium-term notes at a coupon rate of only 5.38% to achieve our desired balance in the allocation of capital between growing our operations and sharing our success with our shareholders. We increased our quarterly dividend by 56% over last year, effectively tripling the dividends we paid 24 months ago.

In our most recent quarter we received more orders for homes than in any previous quarter, and our quarter-end backlog, valued at just over $3 billion, was at an all-time high, evidencing that the overall demand for new homes has been strong. With 30% increase in our lot supply and active subdivisions and our highest ever quarter-end backlog, we are positioned to generate new company highs for revenues and earnings in 2005. And we look forward to a continued solid growth in 2006. I would now like to turn this call over to Gary Reece, our Chief Financial Officer who will describe more specific financial highlights of our 2005 second quarter.

Thank you, Larry. To begin with, and those of you following the slide you can see from this slide that we produced a record second-quarter operating income level of $102.6 million, up 24% from this time last year on record revenues of $1,046,000,000 which is up 20%. This produces earnings per share of $2.25, which is 20% above the $1.87 we earned a year ago. One of the things that we benefited from in this quarter I wanted to point out, you will note that our tax rate declined from even sequentially from the first quarter from 37.7% to 37.4% and is down 110 basis points from this time last year, primarily related to the new Section 199 production activities deduction that we discussed last quarter and the benefits of reduced effective state tax rate. This helped our earnings per share this quarter by about $0.04 per share relative to last year, and this is an effective tax rate that should continue for the balance of this year. And as many of you noticed, production activities deduction is not just a 2005 phenomenon. It does continue and at an increased rate for the balance of this decade.

The record results we produced were driven by record profits from our home building segment, primarily improved results in our growth markets in Arizona, Nevada and Virginia and our new markets in Utah and Florida. We produced a record level of $187.6 million, up 23% from last year on home sales revenues of $1,030,000,000, up 20% from last year. The primary drivers of this growth are a 14% increase in home closings, an increase in average selling prices of close to $14,000 per unit and 100 basis point improvement in home gross margins.

From a closing level standpoint you can see from this slide a stratification of our closing levels in this quarter. You will see that the largest increases actually occurred in the state of Florida, followed by Arizona and Utah. We closed 3,512 homes, up 14% from last year, largely attributable to the fact that we began the quarter with a record backlog, which was up 11% over last year. And we did convert about 44% of that backlog, which is fairly consistent with where we were in 2004.

From the standpoint of average selling prices these prices were a bit higher than the guidance we discussed in our last conference call and higher than we had anticipated, primarily due to the closing of a greater number than expected homes in the higher-priced California markets and fewer homes as of the end of the quarter in the lower-priced markets in Arizona. We did complete the quarter with an average price of $293,200, which is up close to $14,000 from last year. Every market in the Company was up with the exception of Texas. And as this graph shows where those increases occurred, Virginia showing the largest increase, followed by California. And then we saw some closings in Chicago at a fairly high level followed by Maryland, Nevada and Colorado.

Gross profit margins reached an all-time high this quarter, as Larry mentioned 28.6%, up 100 basis points from last year. We saw fairly significant improvements in margins in Virginia with also some nice improvements in Maryland and Arizona, which were offset by a decline in margins in Nevada, which we had discussed before and have expected relative to the extraordinary levels we experienced a year ago.

As we also mentioned in our conference call we benefited this quarter from some non-recurring items related to insurance recoveries and other cash recoveries related to warranty and land development costs that had been expended in expense through cost of sales in previous periods.

One thing that is not on the slides here but I wanted to touch on because it's something that came up during our discussions about last quarter, you will note that marketing costs and G&A costs are up this quarter fairly significantly. Marketing costs, on the one hand, are up commensurate with the increase in revenues. They are consistent at 5.2% of revenues, consistent with last year and consistent with the first quarter. G&A, on the other hand, is up relatively higher than it was a year ago at 5.6% of revenues compared to 4.9% last year. It is down from the first quarter, which was at 5.8%. But the thing driving this high G&A primarily is the fact that we do have some new divisions that are gearing up, have been relatively fully staffed with not much in the way of revenues at this point in time, Chicago, Delaware and Tampa. We also have new divisions in our existing operations in Phoenix, Virginia and Southern California, which are also incurring costs without revenues to go with it at this time. We would hope to see some additional leverage from the additional revenues from these divisions next year.

Along those same lines on the corporate side we also saw our corporate expenses increase relative to last year on an absolute basis and on a percentage basis but down on a percentage basis from the first quarter. Similar situation here as in the first quarter where we have increased compensation costs related to our growth and profitability, our increased focus on technology and training and our expanded national programs for purchasing, marketing and advertising. So as a whole, as a company we saw our SG&A as a percentage of revenues at 13.5%, which is up 90 basis points from a year ago but down 90 basis points from the percentage of revenues we saw in the first quarter this year.

On the financial services side we saw improved results for the first time in several quarters, very positive. Earnings of $4.1 million up 30% over last year. This is primarily attributable to an increase in loan origination fees related to the record level of mortgage loans originated in this quarter, partially offset by lower gains on sales of loans due to the more competitive mortgage pricing environment that we operate in. A couple of statistics I know many of you are interested in related to this business that I would like to inform you of. Number one, our fixed to variable ratio this quarter, 52% of the loans originated by our mortgage company this quarter were fixed-rate; 48% were variable. Of that 48%, 75%, which is 36% of the total, were interest-only loans. What is interesting is the vast majority of those loans had a fixed component of five years or more. In fact, 63% of the 75 was five years or more. And as we look at our total portfolio that we originated this quarter, 90% of the loans, including fixed and variable, had a fixed component of five plus years. And only 2% of our total portfolio had less than a three-year fixed component.

FICO scores were up from last year, and another interesting note the interest-only loans have gotten a lot of publicity. The fact is that the FICO scores on our interest-only loans are up 6 to 7 points higher than the Company average. Our loan to value is actually up a couple of points, near 80% from where it was last year. And our interest-only loan to values are approximately the same as they are for the rest of the Company. Moving on to returns, our returns continue to rank among the highest in the industry. Our return on revenues here in the second quarter was an all-time second-quarter high at 9.8%, up 40 basis points. Our operating margins for the home building business with our margins and our SG&A percentages taken into account are 18.2%, up 50 basis points from this time last year.

The average return on assets continues to rank among the leaders in our industry. We had a 16.2% -- actually 16.3% return on average assets over the last 12 months. That is 230 basis points over where we were last year. That's compared to a peer average, an average of all of our peers in the industry of just short of 10%. And our return on equity, as Larry mentioned, was 31.2%, almost 400 basis points over where we were last year and compared to a peer average of 27%.

Our financial position continues to remain strong as it has consistently for a number of years. We saw our cash and borrowing capacity, actually Larry mentioned that number, well over $1 billion. Our cash position we have over 70 million in cash. And we only had $30 million outstanding on our line of credit at the end of the quarter. Our equity continues to grow significantly. Our book value per share now is just short of $37 a share, up 35% over where it was last year. Our debt to cap ration net of cash is down to 30%, and a lot of that is attributable -- that is attributable to the way we manage our business and the way we manage our assets. And I know spec inventory is a focus. It continues to be a focus for us. And as a we look at our supply of finished specs, it continues at a very low level, less than a three-day supply of spec homes that are finished in the entire Company.

We do have a new slide in this package that shows you our cash flow, focuses on the cash flow components for the first half of this year relative to last year. I think as you have the chance to study this you will note a couple of key elements. Number one, there is very little increased investment in unsold homes. That is consistent with our policy, consistent with prior periods. You'll note that the earnings that we have received during the first half of the year primarily has been invested in growth in the Company through an increase in our land position as we prepare for growth in the future. While the cash outflow that you see, which exceeds last year, in fact is almost twice what it was last year, is almost entirely attributable to work in process, which is building our backlog of homes that will close here over the near future and will be monetized.

Also reflected on this schedule is the fact that we have had no stock repurchases during this first six-month period, and we paid close to $15 million in dividends for the period. As we look to the future, demand has been strong as reflected in demand for new homes in most of our markets, is reflected in our record home orders for the quarter. This is the highest quarter in homeowners in our history. It is the best year-over-year comparison since the second quarter of last year, and it's unusually high in that it is one of the few times you will see the second quarter actually exceed the first quarter from a seasonal standpoint in terms of orders. We received 40,832 orders in the quarter, which is up 14% compared to last year. Sales are up in our existing markets in Nevada, California and Maryland, which is a nice return to positive form in all three of those markets. Also up in our new markets in Florida and Utah and our first significant orders in Delaware Valley and Chicago.

We're down in Arizona from the exceptional levels of a year ago as first of all we have some tough comparisons because it was a very strong year ago, but we also intentionally slowed sales in that market in certain subdivisions in order to allow construction activities to catch up with our backlog of homes sold and not yet started.

We have some additional slide here to give you some feel for trends in orders per community this year versus last year. As I mentioned, last year was an extraordinary year in Arizona where we were receiving 11 orders per community. This quarter it was 8.3, which is very similar to and in fact exceeds where we were in more normalized years in 2002 and 2003. The same type of situation in California, although by the second quarter last year California was returning to a more normal level, and the level of orders per community in California this quarter were very consistent with prior quarters. Similar situation in Nevada. We were still relatively high a year ago at over close to 14 orders per community. We're down to 10.4 in this quarter, and that is fairly consistent with where we were prior to 2004.

These record orders led to the highest level of quarter-end backlog that we have ever seen. We ended the quarter with 9,213 homes in backlog, which is up 12% from last year. Our sales value was just over $3.1 billion, which is up 26%. The story of this analysis is the significant increase in average selling price in our backlog, which reached $340,000 per unit, up from $307,000 at the end of the first quarter. This is due primarily to a change -- I mean, it's due to a couple of things. First, there have been price increases, obviously, that have helped in many of our markets. But it also can be attributed to a change in mix between markets. Largely a greater percentage of our backlog now is in the higher-priced California markets. And while the Arizona backlog actually increased, it became a smaller piece of the pie because of the large increase in our backlog, and therefore it brought the average -- that decline actually brought the average up. So anyway, very positive backlog trends at this point.

Also, as a forward indicator is the movement in our active community count. We spent a lot of time on that this year, and we are pretty much on track with what we have said before. We are up about 30% over where we were this time last year. We ended the quarter with 282 active communities compared to 217 last year. We had said previously that we would approach 300 active communities by September and should be close to or exceed by the end of the year. And, as I said, we are on track for that to reach those goals.

The increases thus far have come, as we've also mentioned, in Nevada. We mentioned a couple of quarters ago that by the end of the second quarter we will have doubled our position in Nevada in terms of active communities. And we are there as of June 30th. We are up significantly in Florida as we have opened some new communities in Tampa and we expand our position in Jacksonville.

Also up in California, which is a reversal of the trend in recent quarters, and Arizona has started to pick up the pace, as well. We are down in Virginia, primarily due to be time required to bring these new communities online as compared to a very strong sales base we have experienced in existing markets. So that is a market that we expect to see some community count growth in over the next couple of quarters and into next year, in addition to continued growth in Arizona, Nevada, California and Florida and our new markets in Delaware Valley and Illinois.

A further indicator of our preparation for future growth is the number of lots that we have under control, and you can see from this slide that we have almost 43,000 lots under control, which is up 30% over where we were last year. Of this amount over 20,000 are under option, which is 47% of the total. These are true options. We have no specific performance. We have no off-balance sheet financing, no joint ventures. These are the lots that we have under option, and they are true options where we have only $3200 per lot at risk. So we are in great shape from a lot standpoint, and we are well-positioned to meet the growth plans that we have for the balance of this year and next year. That concludes my prepared remarks. We would like to open it for questions.

(OPERATOR INSTRUCTIONS) Michael Rehaut, J.P. Morgan.

Just a couple of questions. First, a point of clarification. You mentioned the FICO scores ant the LTV. I was wondering if you could just give those numbers -- you mentioned the corporate -- you referred to the corporate average. If you could just give those numbers, what they were this quarter on average versus a year ago and also the LTV. And then I have a second question.

The loan to value is running around 80% on a combined basis compared to 78% last year. FICO scores on average are running in the high 720s, like 727, 728. That is up about almost 10 points over where we were last year.

Great. And you referred to also the community count, and you gave some good regional color. Are we still to expect, as a result of this and particularly in California, some acceleration in order growth over the next couple of quarters?

I think we are still -- that would be the, as we grow our community count we would hope that that would in fact be the result.

Okay. Final question here. You mentioned in the press release fewer than expected homes closed in Arizona due to weather and subcontractor-related delays. I was wondering if you could comment on that a little bit more with a little more description in terms of what the labor situation is in Arizona and also if you are seeing any delays in Nevada and where you see that going over the next quarter or two.

With the high-volume, Michael, we are seeing some strains on the labor side of things almost across the board, really significant strain as it relates to the land development side. And we are working our way through it. It is just something that is a characteristic of a very hot market. The same type of situation in Las Vegas, very strong growth there, and so we are -- being one of the larger builders in both of those markets is an advantage for us relative to the smaller guys. So we are in a better position to react to it than most, but we are feeling some pinches at the end, and it is causing some delays and has caused construction times to extend a few days as a result of that.

Okay. But over the next couple of quarters you don't see that necessarily improving? Would you see it worsening? Would that cause, perhaps, this continuation of the mix shift toward some of the higher-priced regions?

Whether it causes a mix shift to higher-priced, I think as it relates to Vegas and Phoenix with the volume of homes that they are doing, I can see -- I don't see over the balance of this year much of an improving situation. I think that volumes generally pick up later in the year, which could provide some additional strain on the system. We are making preparations ahead of time to deal with that, adding additional subcontractor options and trying to reduce construction times in other areas as much as we can. But it is something that probably will not ease through the balance of this year. We may see some easing seasonally at the beginning of next year. Whether that means we bring in more -- these are two of our, have been two of our lower-priced markets. Vegas actually has come up very close to the Company average, but any time the Arizona deliveries drop, it could have a tendency to move the price point mix up a little bit.

Okay, great. Thanks, Gary.

Stephen Kim, Smith Barney.

First off, congratulations. Great quarter, guys. I wanted to delve into this average price if I could a little bit. We do an analysis, and I know it's not 100% perfect, but we do an analysis where we try to impute what your actual new order average price is every quarter. And if you run that analysis, it's pretty striking what you would see for your company in the second quarter. While your average backlog probably has jumped 341, it looks like your new order price jumped more to like 360. I know that there are issues there with mix shift and all that and stuff, but it would seem to me that a reasonable expectation for where we could see your average price, let's say two quarters from now in sort of a steady-state environment could easily be 340, 350. Is there any reason why we couldn't see that kind of an average price from you guys?

Steve, first of all I think we have to consider the fact that our average orders per community in Arizona were down because we intentionally slowed it down, so we could see a pick up there when things start to open up again, which would tend to work against that. That is something that led to the numbers that you are alluding to. But the backlog, I think, is the best indicator of where prices could be headed here in the near-term.

Right, because you've got the influx of higher price points in Philadelphia and Illinois and Virginia remain strong. So it sounds to be average prices. Certainly we're not talking about a story sort of staying in the high 2s. It looks like we're definitely headed towards the mid-3s.

It is headed in that direction, but I would also point out something that we mentioned, and I am sure you picked up on it, Steve, is that we do see that phenomenon begin to take shape more in the fourth quarter and early next year than in the third quarter.

Right. No, I got that. Great. Okay, and then the second question I had relates to your gross margin. You talked about how there were some onetime boosts to your margin this quarter and so forth, backing out some things I guess you expensed previously. That was about 50 basis points. Is that what you indicated in your release?

That is correct.

Was there anything about your gross margin this quarter which was negatively impacted by some items that you, let's say, you didn't mention in your release? Or are you saying that sort of an ongoing run rate for gross margins might be sort of the 28.1%?

I didn't say that that would be the run rate. I did say that was the net - net effect in this quarter.

I was trying to trap you there into giving guidance.

I know that. I am listening. I had my Wheaties this morning.

Okay.

There is nothing really negatively on a non-recurring basis that I can think of other than we did mention that the Vegas margins, which kind of jumped in the second quarter last year relative to the first quarter last year, which was still pretty strong and then stayed pretty strong through the balance of last year and into the first quarter have started to come down as we kind of expected because the pricing power has diminished in that market for the last six-to-nine months.

Right, but meanwhile you have obviously seen some surges in pricing in other areas like Florida and so forth, correct?

We have seen increases. (multiple speakers) -- surges might not be the right word, but we have seen some increases.

Good. And obviously that should offset that issue. Last question I had -- actually I had a quick one on SG&A. What is your long-term run rate or what do you think this business should run on a combined SG&A basis sort of on a normalized basis going forward, not necessarily this year or next year, per say, but just where do you sort of see this kind of business running on an SG&A rate?

You know, Steve, I would say that we believe we should be somewhere between 10 and 11% overall.

And you're running at like 13 now, right?

Well, we should be lower than that by the time the smoke clears. It is always higher in the first two quarters, and then it generally comes down as volume picks up and as we start to see some leverage. We have some goals to get to lower levels and where we are, but right now we are more concerned about making sure that our workforce is trained and that we get systems in place that will enable us to grow to the levels that we would like to see in future years. So we would tend to see it a little higher here, not only this year, but next year as this implementation process of a new system will take us a couple of years to get in place.

Okay. That is very encouraging. And last question I had for you relates to your land profits. I'm talking about your tax rate here. Obviously it's going down, but in part and parcel of doing that, of course, is that you have to estimate what percent of your land profits or what percent of your overall profits are coming from what the Treasury Department would consider to be passively holding land. Have you -- do you have a number that you've used in making that estimate?

Steve, we have, I think if you use a -- it can be extrapolated from what we have put out here. 70 basis points is the effect overall, and so I mean that translates into about 25% related to land. However, we don't have any guidance from the IRS on how to compute this as yet. As you know, and pointed out in your piece, we probably had the lowest level of land related profit of anyone in the industry, save one other company. And so very likely this is a conservative estimate.

Yes, you would probably make any adjustments that the IRS finalizes that probably in the fourth-quarter, right? So we could see potentially maybe an unusually, you know, a lower tax rate in the fourth quarter when this gets resolved, right?

If it goes that direction we would adjust it as part of our rate at that time. Right now we are all believe that we are appropriately conservative in our estimate based on a methodology that we have adopted at this point and agreed to with our auditors.

Got it. Okay, well thanks very much. Great quarter.

Thank you.

Craig Kucera, FBR.

Good morning. I had a couple questions. Just kind of wanted to follow-up a little bit on some of the loan stats for the quarters. What was your capture rate first quarter?

Capture rate overall, including our brokered loans, was right at 73%. And without the brokered loans it was around 48%.

Okay, and I guess kind of along that I was interested in hearing if you guys are now tracking the level of option ARMs in your portfolio that you’re either brokering or originating.

We are not, I mean we are as a company. I don't have that information. I know it is a relatively new product. Interest only is relatively new for us. We have only been doing it about a year. It is something that we will definitely keep an eye on, and if the investment community is interested in it.

Okay. Well, we can certainly follow-up on that as time goes. Also, I was going to ask you obviously -- and Steve hit on this -- you had a great increase in your price quarter-over-quarter from first to second quarter on new sales, and I know you probably can't give me a hard number, but kind of ball park how much do think of that was mix versus just raw price appreciation?

Are you talking about comparisons year-over-year?

I guess just looking at it more on a sequential basis. I mean, if you were selling homes of an average price of about 314 in first quarter and you popped up to 360 in the second quarter, how much of that was -- a big part of that, I'm sure, is mix and the fact that you are selling more homes in California -- but some of it, just looking at it mix versus raw price, what do you think your raw price was in the second quarter versus first quarter?

I think the biggest part of it is probably mix. I would expect overall maybe 20% of it was price increases.

Okay, ballpark, so 20/80. And I guess finally, it looks to me like based on your sales per community levels in Las Vegas particularly, which has been such a big part of your story last year and continues to be a great part of your story this year, it looks to me like your numbers are about back to where they were in '03. Is that maybe -- a little bit lighter -- but do you see that environment pretty much normalizing now?

We do. The market is still very, very strong there. It looks to be for the foreseeable future with all the activity going on in that market and the continued diversification of the economic base there. So we see that as a strong market for a number of years to come.

Okay. Thanks a lot.

Andrew Sorbin (ph), Litchfield Capital (ph).

Good morning. Out of the 200 home closings that were delayed from the first quarter were any of those closed this quarter, or are those still looking to be third and fourth quarter?

It is really not a one for one. You had some delays from the first into the second. You had some delays from the second in to the third. I would say that we didn't make any net gains this quarter, and the fact is that with the labor issues in many of these markets that we are relying heavily on for deliveries -- we have alluded to it in Arizona -- will make up some but maybe not all of it even in the third quarter. It just means it ripples through the whole process, and it is not just delays in building the houses, but developing the lots and in some cases doing work that we have no direct control over. All of this has an impact on closing levels, has an impact on community openings and in some cases our ability to even acquire and purchase the lots.

Okay, so do you expect to be back on track, so to speak, by the fourth quarter, or do think that will even push a little bit into '06?

I think by the end of the year we should be on track.

Okay, great. Second question is how have upgrades as a percentage of the home price, how have those been trending this quarter as compared to this quarter last year?

Our design center is showing an improvement, and part of this is mix related because we are seeing higher closings from some lower-priced markets. But net net we are up about $1000 per unit, and profitability is up a little bit, as well.

How much is that figure per unit?

That is not something we disclose.

Okay. Thank you.

Ivy Zelman, Credit Suisse.

Good morning, Gary. Actually Dennis McGill in for Ivy. Just a couple of follow-ups on some things you mentioned earlier. On the loan side I think you said the LTV was 80%, and you said on a combined basis. Were you referring to in aggregate, or you are saying that includes simultaneous second?

Actually by combined I meant conventionals and governments. It is much higher on a government basis, but most of our loans are conventional. So our seconds add maybe another couple points to that.

Okay, so if one of your buyers does want to take out a simultaneous second, you will do that, or do you outsource it to another originator?

We do do that on a limited basis.

But it sounds like it is less than 5% is what it would --?

2%

2, okay. And do you track how many of your loans would be low doc (ph) or no doc (ph)?

I am sure that we do. I don't have that information, Dennis.

Maybe I can follow-up after the call. And then just getting back to the Phoenix market, you guys, I believe based on numbers we see, are the third biggest builder there. I'm just trying to wonder how far do you have to separate yourself from the pack before the volume benefits and the leverage and the size, economies of scale allow you to not have to deal with these delays or labor constraints in a market. And shouldn't you, as the third biggest builder there, be benefiting from that and not running into the same problems that everyone else is?

I believe we are benefiting because I believe those who are outside the top five are suffering to a much greater degree than we are. We are, relatively speaking, much better off because we are a top five builder. There are a number of trades where there are suppliers who only cater to the top five builders. And even though we are having problems, the smaller guys are having much greater problems, we believe.

Okay, so it wouldn't be a surprise to see this same type of topic come forth with a lot of the smaller builders in that market coming forward?

I would expect it.

All right. Thanks a lot, Gary.

You bet.

Jim Wilson, JMP Securities.

Thanks. Gary, you have done a great job and answered most of my questions. I was just looking through all the community count changes by state and was wondering if you could color a little bit -- I know, obviously even just looking at your map how much the California mix has moved inland. Could you comment a little bit on that mix as far as Nevada, whether those price points, but in effect you're moving concentrically further out, the same thing Arizona and just sort of the directional mix of some of the major markets as far as what part of the market you are now serving? And as we look further forward in these communities, then, you know, whether these are really a full-year basis kind of working into the lower-priced parts of the market, even though obviously the current order rate based on state mix shows that your average price is higher?

That is a very good question, Jim. Very good. You'd make a great straight man. The growth that we are seeing in communities and the growth that we are planning in the future in Southern California, for example, is going to be more toward the Inland Empire. We are right now experiencing some pretty mature sales pace, sales rates coming out of some very high-end communities in Irvine, the Irvine Ranch, which is helping to move that price point up considerably when you're looking at homes that average over $2 million per home. It doesn't take too many of those to move the price point up. I'd note in California we have had a number of projects in the Bay Area that have influenced the pricing we are seeing today. We are going to be moving into some newer communities in the Central Valley that we acquired through Del Valle Homes. Those are really not even online yet, and so as we gear up in the Central Valley that would tend to, which will be communities that aren't even shown as active right now. This is where these communities will be added here over the next few quarters. That would tend to have the impact of moving the price point down over the longer haul.

Okay. So it sounds like even though I am sure the general trend certainly would be up, given the fact that you're growing simply as anything you're growing in Nevada and California in total, that the jump to 360 seems like it is more likely to moderate, although certainly a lot higher than your recent closing prices.

That is a fair statement, yes.

That is, I think, all I had. Obviously, a great quarter.

Joel Locker (ph) from Carlin Financial.

Great quarter. I just wanted to say that first.

Thank you.

I was just wanting to talk about the backlog conversion rate. I see it picked up a little bit, and you guys are one of the only ones in the sector actually doing that. What you expected for the third and fourth quarter on a backlog conversion rate, I guess you have comparisons of 43 and 53% third and fourth quarter?

That is a good question, Joel. It's something that -- you can see that we are tracking pretty close to where we were last year. We are at backlog levels today and levels of backlog not yet started that we have never seen before. So when you go back more than a couple of years, you get into areas that are not quite as relevant as they are in the last year or two. We are in a position where we have a very high beginning backlog and a lot of homes that have been sold not yet started, and we have got these development delays. So I can't tell you specifically where we are going to come out, other than that our 2004 conversion rates are probably closer than years prior to that.

Right, because I guess in 2003, it was actually 49 and 54 in the third and fourth quarter. So they slowed down a bit in '04, so I was just wondering if they had kind of maybe picked back up to somewhere in between those two years, or do you still think it is going to be comparable to 2004?

It is hard to say, Joel. I mean we would have to see -- with all the things that we have talked about with the difficulties and delays in labor and the weather issues earlier in the year just seem to work against that move in the near future.

Right, so it's just somewhere pretty much similar to where they were last year then?

Again, I can't say specifically, but that is your best indicator right now, I think.

I understand. Did you guys purchase any shares back in the second quarter?

No, sir, we did not.

None at all. All right, thanks a lot.

You bet.

Bruce Sutkin (ph) from Greenlight Capital.

Hi, actually it's David. A couple questions. Can you talk about how the cancellation rate changed in the second quarter, and particularly was there an unusual change in that in June?

Well, first of all, Dave, I would say that our can rate was probably a little lower this year than last year. I am not sure why -- I don't know that I could say anything specific about June.

I'm just wondering if because there was the big increase in net orders in that month. I'm wondering if part of that is attributable to lower cancellation rates as opposed to higher gross orders.

I don't think so, Dave. We had a pretty strong quarter throughout. It has been easier comparisons, obviously, as the year goes on would have created a little different situation in June than in earlier months because things started to slow down kind of mid-May last year.

All right, super. Thanks so much.

You bet.

Alex Baron (ph) from JMP Securities.

Just a quick question on your community count. I think you guys had talked about hitting 300 by the end of the year, and it seems you're on pace to do that. Just kind of wanted to know incrementally which markets would have the most change from where you are today?

We are really looking at continued growth in Arizona, Nevada, California and Florida. And we should be adding a few in Virginia, as well.

Okay. So you would expect the Virginia count to come back from this little dip it had here?

You and I talked about that last night. It has been coming down over a long period of time, and it will not happen over night, but we expect to see some positive movement in that over the balance of the year.

Okay. How about Nevada and in particular, do you have any more specific idea of where you think that might end at the end of the year?

I think with -- you know, we have got about 18 units to go to get to 300, and we have a lot of divisions. It is going to be pretty well spread. I don't see anything dramatic in any of the markets.

Okay. Great. That is all I had. Thanks.

Margaret Whelan, UBS.

Good morning, guys.

Good morning, Margaret. I'm used to you being number one.

I know. I must have gotten up late. I didn't have my Wheaties. I guess since we haven't picked up coverage, you're bouncing me. Is that it?

Well, I'm glad you brought it up.

I had just a couple of wrap-up questions, actually. First of all, in terms of your costs of goods sold, is that anything breaking now? We know timber and wallboard prices are coming down. You actually feeling that as you are doing the deliveries?

We are, yes. But we are also seeing just about everything else increase. Steel is down a little bit, but you know cement is up. Copper is up. There is -- actually what is interesting when you look at it all, and we get a fairly detailed analysis from our purchasing group on what has happened and what is flowing through the P&L, net net it is about flat for the quarter with the ups and downs.

Okay. Can you give us a sense for which parts are moving the most? Or I can follow up with you if it is easier.

Hold on one second. Lumber and steel have been moving down the most, have the largest positive impact in terms of foundation, steel and on the lumber side, the sheathing. But concrete, wallboard are the two biggest negatives.

Okay. So net net it is a wash?

Yes.

Got it. And the second question I have for you is bigger picture. You have been pretty conservative over time in securing your land. You have a shorter holding period than most of the others, and you're not involved in any of the JVs. But it does look like some of your peers are getting more sophisticated with the JVs, the off balance sheet, for example the Transeastern deal, the Town & Country deal. Do you, are you looking at what is going on? Are you thinking of reconsidering, or are you going to just stick with your strategy?

Margaret, we know and are looking at these deals and trying to understand them. And I think we are going to stick with our strategy. I think that we are not adverse to being sophisticated about the way we approached it and are looking at other possible sources for capital, but our big focus is we are going to remain visible so that everything is very obvious to the investing public on what we are doing. And if we do tie up some lots with people through options they will be true options. The different way things are being done on the option side you have a lot of different players in that arena. But the types of transactions where it is smoke and mirrors, and it is balance sheet engineering where the builders retain the risks, those are things we are not interested in doing.

Margaret Whelan - UBS - Analyst

But do you think your actual years of land under control is going to increase from here?

I think that we are comfortable with the 2.5 year supply. That type of flexibility is what we believe will put us in an advantageous position if anyone of these markets starts to move in the wrong direction. So that flexibility is something we will not give up through expanding our lot supply.

Okay. Well done. Thank you very much.

Thanks, Margaret.

Timothy Jones (ph), Wasserman & Associates (ph).

You did not do -- I missed the first five minutes because I had to reboot my computer -- but you did not change anything on your estimates, did you, for the year?

No, we didn't.

The reason I'm asking this is what is happening with most builders, they are not basically changing their original deliveries much, but most of them have been surprised, and I am sure you have, too, by the continued strength in pricing in the first half and what is in their backlog and usually have been moving up. And that reason -- is the margin expectations. Do you have any comment on that, why you haven't done it?

Tim, first of all we don't provide guidance of any kind specifically as it relates to earnings for future quarters or for the year. So there is really nothing for us to change. I think that we have tried to provide color and information as best we can from a qualitative standpoint. And what we are seeing and where the margins are improving, and as you know as well as anyone, the mix has as much to do with margin levels, absolute levels, as anything. You can have margins moving up in every market, and the mix changes and overall they could go down. There is a lot of factors that come into play there, and we have tried to give enough qualitative data so that people can understand where the growth is coming and where we have been down. And they can move the numbers around accordingly.

Is your lawyer still holding the gun to your head?

He's standing right here.

Tell him to listen to the 14 other homebuilders and find out the guidance they give. From me, okay. Okay. You talked -- there have been certain markets that have slowed down in pricing. You may have gone over this. The major one is Southern California, dropping from around a 10% level to about the 2 to 3, fell off, but still quite a bit less. Are you seeing that in California? And you may have gone through the markets, if you could do it again, if you have seen a slowdown in pricing.

The price increases year-over-year are down pretty significantly in Southern California and Vegas. They are still positive.

(indiscernible) you mean the rate, like I'm saying?

That's correct. Yes, the rate of increase.

Is that 10, 2 to 3 about right for Southern California?

That's not unreasonable.

And what was the other one you said is down the same way?

Las Vegas.

Really, because your average price, that's all makes it tough there, then.

I think part of it is mix, yes.

Now, remember, Gary, a year ago or when Pulte had the problems we talked about homes selling over $300,000, and you had very few, which saved your pink little body. And I notice that your backlog in Vegas is approaching that $300,000 danger level and the 400,000 suicidal level. Could you comment on that?

Yes, I would. And thanks. I have a Tim Jones schedule in my file here that I need to put my hands on. I tell you what. Let me see if I can find that and tell you exactly what we have. Okay, I will tell you exactly what we have, Tim. In the second quarter in terms of actual closing price, two-thirds of our homes closed were below 300,000.

So then you were two-thirds or below. So you are obviously, then, building some of the 400,000 plus.

We have a couple of communities that are selected with that concern in mind. We're not going to go overboard on that, but in a couple of submarkets there, there are some areas that we are willing to open communities at that level. And we have done very well in them. But it is very limited.

Be careful, Grasshopper.

Yes, sir.

Okay, and lastly, you have by far, I think, the highest rise in average communities. Is this basically the last three or four quarters we have talked about? You say you have had delays, delays, delays. Did they all come into fruition finally, you know, in bringing them on?

Tim, I think that is a factor, but another factor is that we were low last year because of the very strong sales, and so we sold out of a lot of communities that put us a little bit behind the 8 ball last year during part of a year. The slower sales pace has normalized things, and our communities are coming online. Plus we have six markets to feed, six new mouths to feed that we've opened up in the last couple of years that are starting to hit their strides. So all of that plays a part.

The slowdown in pricing in Nevada, is that similar to the California slowdown, still off but 10% to 2%, something like that?

It is off probably, I would say the rate of price increase in Vegas was higher, and so it has dropped more in terms of rate of increase because it is comparable now to Southern Cal.

But 2 to 3 and maybe it was closer to 15 before?

It was --.

Okay, nice. Okay. Those are the only two markets that you're seeing this? You're not seeing it in Florida? I hear something about the Northeast slowing, but that is more closer to the New York area.

We are not seeing any of that in the mid-Atlantic markets that we are operating in.

Thank you, Gary.

You bet, Tim. Any other questions?

Sir, at this time I am showing we have no further questions.

We'd like to thank you again for joining our call today. We look forward to having the opportunity to speak with you in October, following the announcement of our 2005 third-quarter results. Everybody have a great day. Thanks from Gary and I.

Ladies and gentlemen, this concludes today's teleconference. Thank you for participating. You may now disconnect.