MDC Holdings Inc (MDC) 2005 Q3 法說會逐字稿

Good morning, ladies and gentlemen and welcome to the MDC Holdings 2005 third-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 call over to Mr. Joe Fretz, who will be reading the statement concerning the forward-looking statements. Mr. Fretz, you may begin, sir.

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

Thank you. Good morning and welcome to MDC's 2005 third-quarter conference call and webcast. We are pleased to announce growth in our operating profits and earnings per share for the 13th consecutive quarter and for the 27th time in the last 28 quarters. Our strong performance in some of the nation's largest and most land constrained markets enabled us to continue to produce exceptional operating margins and returns. These results were achieved despite the previously announced production related challenges we are facing in Arizona and Nevada, two of the fastest-growing markets in the country.

At the same time, we have maintained an investment-grade balance sheet with leverage ratios that are among the lowest in all the public home builders. We have substantially improved our financial flexibility as reflected in nearly a 90% year-over-year increase in our available cash and borrowing capacity to almost $1.1 billion at quarter end. This increase was enhanced by our July 2005 issuance of an additional 250 million of ten-year, unsecured, medium-term notes at a coupon interest rate of only 5 3/8%.

Our conservative operating model governs our day-to-day business decisions as we make and drives the strength of our balance sheet and financial position. In each of our markets we require a strict control of spec inventories and backlog, a highly disciplined underwriting of every land transaction and perhaps most importantly, a focus on limiting our control of entitled lots to a two-year supply in any market or subdivision in which we build.

We have proven our operating model to be extremely successful in the past few years of general market strength. We expect to be equally effective if certain markets become more challenging as some investors believe as it provides us greater flexibility to change product price points, location and capital commitment in response to changes in market conditions. Based on activity in the 2005 third quarter, most of our markets exhibited strength relative to last year as evidenced by increased traffic levels, decreased cancellation rates and higher net orders. Our 21% increase in total home orders allowed us to accumulate a quarter-end backlog of over 9000 homes and a sales value of almost $3.3 billion, up 33%.

On the strength of this record backlog and our anticipated rise in average selling price, we expect to report record 2005 fourth-quarter, full-year end results. Further, given our year-over-year growth in active subdivisions and available lots combined with anticipated contributions to our bottom line from our newer operations in Chicago, Tampa, Philadelphia, Delaware Valley, we believe we are well-positioned to continue to grow and produce new company highs for home closings, revenues and profits for 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 third quarter.

Thank you, Larry. To begin here, we reflected a third-quarter record in operating income of $120.9 million, which is 15% above our earnings of last year on revenues of $1.168 billion, up 14% over last year. This produced an earnings per share of $2.62, which is 11% higher than the $2.36 that we earned a year ago. These earnings per share were aided by a reduction in our effective tax rate from 38.5% last year to 37.4% this year. That reduction added $0.05 per share to our earnings per share this year. That reduction resulted from favorable adjustments to our effective state tax rate as well as the benefits of the Section 199 production activities deduction, which we talked about in the previous quarters. This is a benefit of approximately 70 basis points that will continue for future periods and will be increased under current law in 2007 by an additional 70 basis points.

Our record results this quarter were driven by increased profits from our home building business. We earned $214.6 million from homebuilding, up 11% from last year on home sales revenues of 1.148 billion, up 14%. The primary drivers of these increased results were a 4% increase in home closings, a $28,000 increase in average selling price and a 60 basis point improvement in home gross profits. We saw increases to our operating profits in Arizona, Virginia, Maryland, Utah and Florida primarily.

As we look at the closing levels, we closed 3686 homes during the quarter, up 3.6% from the 3558 we closed last year primarily due to a higher beginning backlog, although our conversion rate was relatively lower than it has been in the past at about 40% primarily due to the fact that we had delayed approximately 250 closings in Arizona and 200 closings in Nevada due to -- in Arizona, due to delays related to certain subcontractors and suppliers and in Nevada, due to delays in receiving power for several subdivisions.

As you can see from this slide, our primary increase occurred in Arizona despite these lost (ph) closings up 11%. We also saw significant increases in Florida and Utah. Lower home closings resulted in California and Nevada due to lower beginning backlogs. But you'll see here shortly that that is a situation that has reversed itself here in the third quarter with strong orders in both those markets.

Our average selling price in the quarter was $311,000, up 10%, excuse me, from $283,000 a year ago. We saw increases really in every market in which we operate with the largest increases coming in the Mid-Atlantic; Virginia and Maryland primarily. We saw increases in Nevada, Texas and Colorado primarily due to mix. Price increases were the primary contributor in Virginia, Maryland and Arizona and really mix and price increases contributed to increases in California, Florida and Utah.

Our gross margins increased in the quarter by 60 basis points to 28.8% and were up 400 basis points from margins in the third quarter of 2003 with the highest margin improvements coming in the Mid-Atlantic region; Maryland and Virginia but strong contributions in terms of increases in Utah, Arizona and Florida, which offset the expected declines from the robust margin levels we experienced a year ago in Las Vegas.

On the SG&A side, we did see our SG&A on the homebuilding side increase to 10.4% as a percentage of revenues from 9.3% last year. We've discussed this previously. This is primarily due to some of the new divisions that we have established, which have yet to reflect revenue growth. We do expect meaningful contributions and some level of leverage on the G&A side as we begin 2006.

On the marketing side on the variable side, our marketing costs were pretty much comparable to where they were a year ago at 5%. We also reflected our corporate G&A on this slide, which as a percentage of revenues, has declined from 2.8% of revenues a year ago to 2.4% this year.

On the financial services side, we also saw improved results recognizing $6.3 million, up 12.4% due to higher levels of origination fees, which were up 24% over last year. Our financial services segment continues to be profitable since it began business in the early '80s and today contributes, as it did a year ago, approximately 3% of the total operating profit of the company.

Some statistics that are meaningful to many in regard to this business, our fixed rate loans as a percentage of our total loans was just short of 60% this quarter with the remaining being variable rate. This is very close to where it was a year ago. So not a meaningful change. And in terms of the 42% roughly in adjustable-rate mortgages, close to 80% of those were interest only, which represents approximately 32% of the total. Of those interest only products, most of them are five years and greater and when you look at all of our adjustable-rate mortgages, approximately 90% of these adjustable-rate mortgages are five years and greater and only approximately 8% are less than three years from a fixed standpoint.

FICO scores continue to be very high on a combined basis, right in the 730 range and that is similar for our I/O loans. They are in a similar range. Loan-to-value is right around 80%. Similar loan-to-values for our interest only products as well. Returns continue to be strong and one of the strengths relative to our peers. As reflected on this slide, our return on average assets increased over last year to 15.4%. When you compare this to our homebuilding peers and an average of 10%, obviously a very strong performance. And our return on equity, which stands just short of 30%, up over last year but also higher than the peer average of 28.1%.

Our balance sheet continues to be one of our strong suits, continue to strengthen here in the third quarter. Our cash stood at $130 million. We had $40 million outstanding on our line of credit. Our equity just short of $1.8 billion, up 40% over last year. Our book value per share has risen 34% to just short of $40 per share. And this number has continued to grow steadily over the years, approximately a 30% compound annual growth rate over the last five years.

As Larry mentioned, our cash and borrowing capacity is up substantially to 1.74 billion and our debt to cap ratio stands today net of cash at 34% at this time which is typically a seasonal peak in that particular level. We have a schedule here that shows the cash flow for the quarter and as reflected in this slide, we generated substantial cash flow from earnings, which was invested in growth through purchases of land. We also reflected significant cash used from financing and cash outflow in investment in our work in process inventories. We had no stock repurchases and we had $22 million in dividends paid during the quarter.

The visibility for the future begins with a view of homeowners and we see from these homeowners another strong quarter for the company, the highest third quarter ever for our company receiving net orders of 3551 homes, up 21% over last year, with traffic up at a comparable level and cancellation rates down approximately 500 basis points from where they were last year.

And also for the first time we have disclosed the value of our orders during the quarter. And when we look at the value of our orders, units being up 21%, average selling price of these orders being up 20%. The overall value of orders is up 45% from where it was a year ago at 1.220 billion compared with 840 million of last year. Average selling price of these orders this quarter was $344,000 compared to 287,000 last year, up primarily due to increases in most of our markets but particularly Arizona, Maryland, Virginia and Florida.

I have had some calls since we put this out and just so everyone understands, there is a simplistic formula you can follow to calculate these numbers with the public information. You will not be able to calculate the average selling price in the third quarter of 2004 primarily because we added to our backlog approximately 540 homes that we had acquired with sales contracts in place from Watson Homes in Jacksonville last September. So that is something that tends to skew that number. But the numbers that we have derived have been pulled directly from our system related to contracts that are in place.

These strong orders led to the highest third-quarter backlog that we have seen at 9078 homes, up 11.2% from last year with a sales value of 3.290 billion, up 33%. We saw significant increases in backlog in Arizona as well as Nevada and then the first meaningful contributions in terms of backlog in Illinois, Utah and Delaware. Virginia was down due to lower levels of orders during the quarter. You will note that the average selling price is up to 362,000 from 303,000 in backlog. This is something that obviously reflects the direction of prices. But as many of you know and as we have discussed, that increase in average price comes through gradually primarily due to the fact that it is significantly influenced by homes with higher prices that take longer to build, primarily in California and Virginia.

From an active subdivision standpoint, we stand at 280 active communities at the end of September, up 18% from where we were last year. The largest increases are listed here in our typical areas that we would expect that we have talked about where we will be growing here in the near future; Nevada, Arizona and California showing the largest increases also with increases in our new markets in Illinois and Delaware Valley. We saw some temporary declines in Florida and Utah primarily due to strong orders in those markets and delays in getting new communities opened. And in Virginia, due to the fact that we did have some significant delays in getting new communities opened there as well. As we mentioned in the press release, we expect our active subdivision count to be somewhere between 15 and 20% higher than it was at December 31, 2004, which stood at 242 active communities.

Our growth has been a little bit slower than we had anticipated earlier in the year primarily due to the strong home sales in Nevada, California and Maryland and as we mentioned, some development delays in getting communities opened in California, Northern California in particular, Florida and Virginia. We do expect to see, in the future, growth in active communities in most of our markets, but in particular in Florida, California, Arizona, the Mid-Atlantic and Utah.

And finally in feeding these active communities, the visibility for growth in the future is reflected in the increase in our lots under control. We have just short of 44,000 lots under control with 51% under option. We control these lots with about $76 million at risk, which is 50 million in cash, 26 in letters of credit, which represents only $3400 per lot at risk. The lot positions in active communities put us in a position to, as Larry mentioned, meet our objective of new highs for revenues and profits in 2006.

That concludes my prepared remarks. I would like to open up the call for questions.

(OPERATOR INSTRUCTIONS). Stephen Kim, Citigroup.

Thanks guys. Congratulations on a good quarter.

Thanks, Steve.

I guess my first question was with respect to your order trends. Can you talk a little bit about some of the variability we see on a regional basis? How much of that you think was due to availability of products? I guess I am looking at the Mid-Atlantic being down a lot, looking at Arizona, things like that. If you could just sort of give some color on the regional situation for orders specifically?

Sure. I think what we are seeing, as I talk to our divisions around the country, what we're seeing in most cases is a more seasonal pattern for orders, particularly in September. September is generally lower than July and August and we saw that pretty much take place across the board. Now there are a couple of things that stand out. Virginia obviously is down. Virginia has had some very strong periods of nonseasonal growth during this time of the year. This has been more of a seasonal pattern for them but their active communities are down as well. So it is a combination of the two that really is driving that relative to last year.

There is a slide that we have included with respect to Arizona that I did not comment in detail on but it is available in the slide projection that shows that Arizona has more active communities than it had last year but yet their orders per community is lower, significantly lower than it was last year but yet is consistent with what we saw in the third quarter of 2003. So last year was actually -- the back half of 2004 was kind of the breakout period for Arizona where it picked up where Vegas and Southern California left off earlier in the year. So that was a difficult comparison there. And so I think that generally, Steve, what we're seeing across the country is a more seasonal trend of orders.

I guess my second question relates to your average price situation. Your average price last year was -- I think at this time -- in your backlog -- about 304,000 and that is pretty much what you did -- it looks like you're on track to do at least that it seems this year. I understand you've obviously had some pricing, which we're not going to assume going forward but given that your backlog is 362 now I would think that you probably won't do an average closing next year substantially below 340. Anything wrong with my thinking there?

Well Steve, I think one of the things that is going to come into play here, we do have some homes in backlog -- some high-priced homes in Southern California that are contributing to this. We will be seeing -- and I think I mentioned in previous discussions the fact that we have opened some new satellite operations. We have a full-fledged office in the Inland Empire now. We have -- our operations in Los Angeles are shifting much more heavily to the Antelope Valley, which is Palmdale Lancaster, which is a more affordable product.

Even our Irvine division, which is one of the higher priced divisions from a selling price standpoint, is going to be focusing on the high desert, which is more affordable as well. And in Northern California, we will be seeing a lot more contribution out of the Central Valley as our Del Valle communities come on. So there are some things that are happening here that are consistent with our objective to move toward a more affordable price point. That, combined with greater contributions from Salt Lake, from Jacksonville, Florida, from Texas, all those efforts have an opportunity to at least stabilize that price point. And by the end of the year could even move them in a slightly downward direction.

When you mean stabilize the price point, which price point are you talking about? The average order price point, the average closing price point or the average backlog price point?

Well they all come back to the same point eventually but you were speaking of closings and I think that in the short run, we do expect the average price to move up because of what is in backlog. You were talking about closing levels next year I believe.

Yes I was talking specifically --

Closing homes at something that would not drop below 340 and we have a lot of homes to sell and homes to close between now and the end of next year and depending on price increases that may occur in all of these markets could mitigate that but our efforts are to achieve a focus on a more affordable price point and to drive that down. So to the extent that we achieve that in these markets, you could see a drop occur in the back half of next year.

Last question and I will let you go. You talked about something that a lot of builders have been addressing recently, which is the ability to have communities open as quickly as you would like as being a bit of a challenge and something that has resulted in maybe some order of impact. I guess my question is, from a strategic standpoint, how do you see that -- theories of delays that you are encountering in a number of markets, how does that affect the way the company chooses to allocate its cash flow as we head forward? Are you likely to, for example, put more things, convert more land that maybe was two years out or one year out, put it in the more immediate hopper just assuming that a greater percentage of them just won't hit or is there some other action that you have taken that suggests it really doesn't affect the way you apply your cash? Can you just give us a sense for what impact you might see in your cash flow as a result of these delays?

First of all, Steve, in terms of the projects that we have tied up, these some 44,000 lots that we control, each one of these lots and each one of the projects that the lots are in are on the fastest track they can be on. We are not holding anything up or holding anything for the future. Everything is proceeding at its fastest pace possible. So we will bring those on as they are ready to come on.

Now in terms of looking at projects for the future, our objective is to minimize the amount of time from the time we close escrow on the project to the time we close on the first house. And that is something that we will be focusing on as we allocate our capital to these markets. We are interested in projects where we can close on the project and close on a home generally within a year and so those that go beyond that will need to be extraordinary performers in order to pass our underwriting criteria.

Margaret Whelan, UBS.

Good morning.

Good morning, Margaret. Congratulations by the way.

Thank you very much. We are excited. Steve asked most of my questions actually but one of the things I was looking at is the fact that your can rate has come down so much and I'm looking at that relative to your pricing. Is it a function of mix that you are selling to a more qualified buyer? Are you seeing that in your FICO score? Have you changed how you're qualifying your buyers or what specifically is driving the decline in the can rate?

I think that -- that is -- I would not say that we have changed the way we're qualifying our buyer, Margaret and the FICO scores have tended to be moving up a little bit from where they were last year. I do not know that that is necessarily a primary driver of this. I think that it is reflective of strength in certain markets. Certainly we are in a stronger position in markets like Las Vegas than we were a year ago and in Arizona. The can rates are generally lower. So I think that as we look across at the cancellation rates in most of these markets most of them are better than they were a year ago. So I think it is just -- the general tone is better.

Do you have markets where your can rate is actually up?

We do. Yes. I mean, the likely suspect is Virginia, which is not very high by the way but with lower gross sales comes a higher can rate.

Are people canceling later in the process? Are they walking away? Do you have a sense if they were flippers or -- because the economy hasn't changed that much. I'm just trying to figure out what --.

I wouldn't say -- it's more a function of lower gross sales than it is higher cans. In fact, the absolute cans haven't changed that much.

I understand. The second question that I had is I just really don't understand why you're allowing your share count to creep up 5% versus last year especially given your model where you auctioned more dirt and given that your cost of equity is going up every day as your stock is going down.

Margaret, can you run that by me one more time?

Your share count is up 5% versus last year. You have lots of cash, which you keep telling us. You buy your dirt using options primarily so you don't need as much cash as some of the others and your cost of equity goes up every day as your share price goes down. So I'm wondering why you would allow the share count to go up. Why aren't you in the market repurchasing shares?

That's a fair question. You know, the share count has moved up because of option exercises primarily and the changes in the share price from last year but primarily the exercise of options. The issuance of new options since last year and --

I do understand that side of it. I was just wondering your logic on not buying in any shares.

That's -- right now, Margaret, we are -- we have bought back shares. We have an active share repurchase program of somewhere around 2.3 million shares that we could repurchase today. It's something that we haven't done for over a year but right now you can see where our capital is flowing into the building the backlog, significant backlog we have and buying land for future growth, which we do weight that -- the anticipated returns from those purchases against the --.

The ROE.

Exactly.

But you haven't thought about maybe committing a percent of the cash to buy back?

It is something that we talk about and Margaret, our Board meets every month. It is something that we actively consider and when the time is right, we will act on the authorization that we have.

Thank you very much. We will see you in November.

Ivy Zelman, Credit Suisse.

Can you hear me?

Yes, sorry. Is this Dennis?

Yes. Sorry.

Hi, Dennis. I didn't hear you the first time.

That's okay. Just a couple of quick ones. I think you had touched on your can rate around the market. Can you talk about your absorption rates in maybe the markets where you're actually seeing an increase in absorption rates?

Over last year, absorption rates are probably -- absorption rates are probably higher in -- I would expect they would be higher in Las Vegas than they were a year ago, although we do have a greater number of active communities there. You know for the most part, the absorption rates are fairly steady.

And what kind of expectations would you be thinking about for '06? On absorption rates, the same thing?

As we look forward, Dennis, we are not going to -- we are not going to be looking for significant changes in absorption rates. We really are focused more on -- when you have extraordinary situations like we had in Las Vegas last year, in Southern California, Arizona, during part of the year as well, you don't expect for those to continue. But honestly what we're hearing from most of our divisions today is a normalized seasonal pattern right now, which is kind of what we look forward to going forward.

I was just looking here, there is one other market that is doing better from an absorption rate standpoint versus last year and that is Salt Lake City. Utah has actually done very well this year. It has picked up the pace, nice price increases. The fact that community count is down in that market is certainly not a function of our commitment to that market. It is a function of the strong sales that we have experienced in that market and again the timing and getting new replacement communities open.

And which markets would you put in somewhat of a weaker absorption rate versus kind of a stable that you talked about in general outside of obviously Phoenix and I would surmise Virginia?

Well, weaker would have to be probably Virginia but it is still seasonal. In talking with our guys, they have had such strong sales in the past, it kind of stands out obviously even on the pace that you can see there. It has really returned to more of a seasonal pattern in that market. I don't know that I would characterize any market as weak from a seasonal standpoint.

When you are thinking about next year from a cost standpoint and looking at the raw materials and where your land is positioned, how much are you expecting costs to be up year-over-year for the full year?

Dennis, boy, that is a loaded question.

You can attack it however you choose.

Well, I think first of all we anticipate that there will be some impact of these hurricanes, some of which has been felt in our backlog, not yet in our -- really in the margins in our closings so far. But we already have seen increases in OSB. Our guys are telling us that we are looking at increases of 33% over what we were seeing before the hurricanes. Steel and copper are up 40% over where they were prior to those activities. We have got rising fuel costs obviously that are going to drive transportation costs higher and we have seen increases in drywall. Carpeting is up significantly. All these amount to -- when you add all these up maybe a couple of thousand dollars a house. And that is just what we have seen so far. So some of these increases we expect will probably stabilize at some point next year but would there also going to be some implications no doubt on the labor side of the equation as the rebuild begins in the South and so that could cause labor costs to move up as well. So it is hard to put a number to it, Dennis, but we do believe that the trend on costs will probably be up.

Can I sneak in a couple more?

How about one more.

Just kind of looking at your originations breakout on the arms and IOs --.

Our origination breakout on the arms?

Just a percentage of arms and also the IOs and I guess any option arms that would be in there as well.

Sure. The arms relative to the total is about 42% of the total. Of those, of that 42%, 77% is IOs, which makes it about 32% of the total.

And are you seeing any increase in the negative amortization product for the option arms?

You know not significantly, no, Dennis.

Do you have what the component is?

I don't have it in front of me. I sure don't.

I can follow up later. Thanks a lot, Gary.

You bet.

Joel Locker, Carlin Financial.

Just was curious about the SG&A. It has kind of gone up the last two quarters and just wondering what the leverage -- you might get some leverage in the fourth quarter with the higher revenues and if you expect it to be up 100 basis points or 60 like the last two quarters.

I think that one of the things that is obviously affecting the SG&A on the homebuilding side are the costs related to these new divisions. Now we mentioned Chicago, Delaware and Tampa where we have really a full staff in place with no revenues to go with it. We have added a new division in Phoenix, a new division in Virginia and a new division in Southern California. And these divisions haven't produced meaningful revenues as yet. So this is a good time -- actually works out as a very good time to establish these new operations when margins are very good. As they start -- and when we look at the revenue side of the equation, we only converted about 40% of our backlog, which is about 5 points below what we have been averaging and that is due to those 450 homes that moved into the fourth quarter. Obviously those revenues would have produced much more leverage than we experienced.

That's what I would assume that SG&A would at least come down a little bit or kind of be flattish or maybe up small in the fourth quarter. I mean is that kind of a right assumption or would you say that they are still going to be higher in the fourth quarter or do you expect a more like flattish year-over-year?

I think we're going to -- the primary leverage that we will see from this will start when we get meaningful contributions from these new divisions next year. But with the rollover of these closings into the fourth quarter, we should see that differential squeeze a bit. I don't think we are going to make it to even but it should be better comparisons than we saw in the third quarter.

So you are thinking like up 20, up 10 or 20 bips (ph) is kind of just an estimate or a fair number year-over-year in the fourth quarter?

I couldn't put a specific number to it. I know that it is something that should move in a positive direction sequentially.

Right. Alright. Thanks a lot.

Drew Sorbin (ph), Litchfield Capital.

First question, regard to your lot count in Texas, this is a fourth quarter where we have seen that decline. I just wonder if that is a market that you're looking to trim down or exit or if there's something else behind that?

No, it is something that we are -- it's a market where we have -- we have not seen as strong of returns in that market as we have in others. We're very selective about the lots that we acquire throughout the company. And it is just a function of returns primarily. And we have seen opportunities to put our capital in some other markets to achieve some better returns here in the short run.

So really just a reallocation of resources then.

Yes.

And then the second question I have is have you seen any meaningful change in the incentives that you're offering to buyers? It doesn't look like it based upon your operating margin but I just wanted to check if there was any markets where you are offering a greater degree of incentives?

Around this time of year you see pickups in incentives anyway. I guess relative to last year, we would have to say that in markets like Phoenix and Virginia, we are probably seeing a little more in the way of incentives than we did last year but the levels are not out of line. They are not -- certainly more in line with what you would expect to see from a seasonal basis. This is kind of the wind down of the selling season as we get ready for January and February when things start to pick up. So this is a time when it makes sense to move spec inventory and to get assets of your balance sheet and so the normal things are happening. There is not really anything that I would characterize as extraordinary from an incentive standpoint in any market.

Alex Baron, JMP Securities.

I wanted to ask you if you could talk about maybe some expectations for margins going into next year. Your orders, especially on the pricing side, have been very strong as you said, 20% or more. And I would imagine even stronger in certain markets like Phoenix. I'm just kind of wondering what your thoughts are on what might happen to the margins next year?

Well Alex, on margin side, as I mentioned, we have had -- in terms of closings, in the margins in our closings thus far, we have had the stars aligning here and really haven't had much of an impact on the hard cost side. In fact, year-over-year, our hard costs are very comparable to where they were a year ago on a net/net basis. We certainly have seen some hard cost increases on the copper, concrete, drywall side but they have been offset by reductions versus last year in lumber and steel. That is what we have experienced through our closings so far.

We do expect costs to rise on a net basis over the next year or so because of some of the things we have talked about before. We are going to be -- we don't know where prices are headed in markets like Phoenix but what we do know is we have this huge backlog of homes that have to get built and it is a struggle out there with a number of our subs. We are competing with every major builder in the country for these subcontractors and soon we may be competing with Louisiana, Mississippi and other states in the South that are affected by these hurricanes. These are things that are coming. We know that. What we don't know is how much pricing power we will have to offset it.

And in terms of your tax rate, I think in previous quarters you have talked about it perhaps starting to go up going into next year. What are your thoughts there?

Our effective tax rate going up?

Right.

No. No, I don't see it going up. It is down to a level that is reflective of an estimate of the benefit of this production activities deduction and current savings on the state income tax side. These are ongoing benefits. So I don't see our effective tax rate moving up. And in fact, as I mentioned, it should move down another 70 basis points in 2007 as a result of the doubling of this Section 199 productions activities deduction under the current law.

Dan Oppenheim, Banc of America Securities.

Wondering if you can comment in terms of what you are doing with your investment in the Virginia area. In the past, you have talked about how you can alter your investment and your product type based on the shorter land supply than some others have. Are you thinking about doing anything there in response to the changing market conditions?

Dan, the change really is more of a recognition of a seasonal position as far as the year is concerned. The underlying characteristics of that market are still very strong, strong job growth, low unemployment. The constraint on supply of land is getting worse, not better. So that market is a market that we are committed to. We'd like to buy more there as opposed to less.

Just one other question, wondering if you can just comment in terms of your spec inventory in different markets where you see that and (indiscernible) market by region by region level if that's possible.

Dan, we really don't comment on specs from a regional standpoint. Our spec inventory levels have -- we continue to maintain tight controls on those. They have moved up a little bit as they typically do this time of year. In the past, we have had markets that had no specs, such as a Phoenix or a Las Vegas during their times of being a very hot market. You couldn't keep houses on the market and those markets have returned to more of a normal situation in which there are spec homes. We still have in the entire company less than a week's supply of finished specs. So it is a very -- at a relatively low level. It is higher than it was a year ago.

Jim Wilson, JMP Securities.

Gary, just two quick questions. How -- if you have any color on traffic patterns regionally where anything has changed much year-over-year just at the community level and then the second thing, if you look out over 12 or 18 months in your planning process, where do you expect to see community counts grow the most?

Sure. Jim, on a traffic pattern standpoint, I think that for the most part we have seen the traffic patterns be fairly consistent with the order levels. I don't see any real outliers there except that perhaps as we see -- as we have seen the pace of orders in Phoenix decline, the traffic levels have actually been very, very strong there. So we're seeing a lot of traffic in that market; it's just the conversion rate is down a bit. So that is the thing that really stands out.

As far as the other markets, they are pretty much following the trend of orders. In terms of where we expect our community count to improve, we're actually, as we look out over the next year, we will probably see a community count increase in virtually every market. But we have seen -- we will not see the kind of increases in Nevada and Arizona that we have seen over the last year but we will see some increases. I think most of the increases that we expect will be coming in Florida, in Virginia, in Maryland and Delaware Valley as we see those markets pickup and we will return some of the -- return back to the levels and exceed them in Salt Lake City as we continue to grow that market. So those are -- that is kind of where we see it.

Craig Kucera, FBR.

I might have missed this but I just wanted to follow up and get a little bit more color on some of the data points from your mortgage origination unit. Did you say your capture rate for the quarter or a ballpark at least?

I actually did not. Our capture rate was right around 73%, which is very comparable to where it was a year ago.

And that includes brokered loans.

Yes it does.

And this might be tough to ask or tough to give an answer to but I know you said your average FICO for the quarter was 730. Do you have any idea of what kind of level was kind of more in the 660 or below range?

What do you mean what kind of level?

I mean as a percentage of your originations?

You know, Craig, I don't have that handy.

Okay, maybe I can follow up a little bit later on that. That's not key right now. I guess one like bigger picture question is that you guys were pretty aggressive the last couple of years in buying land and controlling land. I think from '02 to '03 you grew your portfolio by about 20%, '03 to '04 it was about 50 and now this year, you're up about 10% as far as the lots that you own and control. So clearly a slowdown and I guess I would like to get your thoughts on what is driving that. Is that more volume, expectations about future volume or is it looking at the land environment and seeing prices maybe a little bit more than maybe what you were willing to pay in the last couple of years?

We are very selective in what we will tie up. As you know, Craig, in addition to these 44,000 lots that we control, we do have close to 30,000 lots that we're looking at in the pipeline that we are evaluating in each one of these markets. So we have a constant supply of lots to replace those as we start to close houses on these lots. There is no real directive to reduce it other than the fact that you can't continue to grow at 50%. We put ourselves in a great position earlier in the year and late last year as we saw some opportunities to tie up some lots in various locations. The lots that we tied up in Jacksonville through Watson Homes, the lot that we tied up on Patriot Homes in Delaware Valley, the 1200 lots we tied up in the Central Valley in northern California from Del Valle Homes. These are all opportunities to jump start that supply and also to gear up in some of these new markets.

We have tied up a significant lot supply in Tampa, in Chicago and in Philadelphia and those are all areas that we have added to significantly earlier this year. We are now adding incrementally to that. So it is something that rises and falls but it is -- we would not anticipate that supply to keep at a 2 to 2.5 year supply to be growing at 50%.

But suffice it to say you're not having any difficulty finding land whatsoever. This is just your choice to manage the balance sheet in this fashion?

That's correct. We are not having -- I mean it is always tough but that is the way we like it and that is where we can really leverage our expertise in these markets. But we are seeing a lot of opportunities to buy lots and we're being selective. We are not buying everything that comes on the market in any one of these markets.

Tom Marsico, Marsico Capital.

I had a question for Mr. Mizel. After 9/11, you strategically changed it seems to me the overall visibility of the company in anticipation of some of the events after 9/11. With the changes that we have seen in energy prices and interest rates, how would you change your use of capital? At what levels do rates need to go to or energy prices need to hold back the economy in your opinion and change the affordability index negatively to impact the housing industry?

Well I think that you see through really a silent tax, higher energy costs, both the natural gas and manufacturing in home and gasoline in automobiles and this really is occurring throughout the world and I see that there will be a toning down of actual inflationary expectations. I think what we see now is some higher CPI numbers. But the real core numbers, excluding direct or indirect energy effect, really are pretty reasonable and I would keep our eye on the ball on making sure that the economy remains robust and I would expect that these interest rates, the short-term rates, will be peaking out here over the next two quarters as a possible change in the Federal Reserve direction after they have made sure that there is no inflationary powers in the marketplace.

In the housing market, I believe I see continued affordable interest rates and really a reasonably good housing market, one that has a base demand that we will continue to supply product for and we are operating our company in the same way we always have in an aggressive conservative basis maintaining a high degree of liquidity and staying ready to accelerate where the opportunity allows a shift or a capital away from places of more challenge.

So would you attempt to expand your portfolio in land as we get closer to the end of the rate hikes that you have outlined here that you expect over the next couple of quarters to get more leverage to the housing industry?

Only if the transactions were highly opportunistic. We believe that there has probably been aggressive acquisition of land by others in the industry and, as Gary has said, not only do we have a two-year supply, 42,000 lots, under our control, which is the two-year guideline but we also have in process of review an additional 31,000 lots and as things might slowdown a little bit, the transactions look more attractive and we are able to actually increase our underwriting standards to take advantage of maybe a little dislocation perception in some markets.

Just one last question. Given the accretion of shares of roughly 5% and the movement of your stock, which has been pretty volatile actually along with the industry from April of around $65 to $90 in July and back to 67 or $68 today, how do you view share repurchases as part of your allocation of capital along with dividends?

Over the years, we have tried to always keep our eye on enhancing shareholder value. As you know, the management of the company has over 20% of the company and so we look at increasing dividends, shareholder buybacks as two of the opportunities. But also the prospective opportunistic growth of the company where others have diversions because of other issues in the marketplace, we have always found that when the market gets tougher we even do a little bit better because when it is an easy market everyone can make a lot of money and when it gets tougher it takes a higher skill set. So we have increased our liquidity. We have the ability to increase dividends, the ability to buy back stock and we also have the ability to grow the company where there might be opportunities where others have capital constraints and because of our low debt to cap, we believe we are uniquely positioned for '06 and '07 and '08 and we are looking forward very aggressively to the next two or three years where we believe that we will have as a goal to continue to increase the value of the company for the benefit of all shareholders.

And just one last question, with the changes that we are seeing as far as the accounting for options, are you likely to change your option issuance policy going forward in terms of more longer-term compensation so you don't get the share creep?

We understand the issue and we are evaluating it.

Timothy Jones, Wassermann & Associates.

I'm sorry. I have been pulled off this conference call three times. I hope I'm not being redundant here. When I was listening you were talking about your orders going back to a more seasonal level and that is why the declines in Washington and Arizona versus good results. Is that the same case with Las Vegas being -- was it a year ago when they had the problems out there or was it longer than that? I can't remember now.

Tim, it was this time last year that Las Vegas saw a decline.

So it is just the opposite of the other two?

Yes. The significant decline in Las Vegas -- it started to decline in summer months but it really hit -- probably bottomed out in October of last year and then started to pick up from there.

What percentage of your business is multifamily?

Multifamily being defined as townhomes, we do a few townhomes in Virginia and Maryland and a couple of projects in Florida. But it is a very small percentage of our total business.

About eight units at multifamily, condos (indiscernible).

Zero.

Zero? They were not being affected by the weakness that some people are seeing in the condo market.

No, sir, we are not.

I am sure you are happy about that. Have you changed -- have you put the restrictions in on some of the hot markets like everybody else. I can't remember. You notice that a couple of your competitors, at least one, has eased in Florida. Have you done any changing of the restrictions to try to holdback flippers and investors?

Tim, we haven't eased at all. In fact, we are even more committed to keep investors out of our backlog. As you know and as you pointed out on previous calls, ours is not a -- we don't have a claw back or anything of that nature but the deterrents that are in place and the commitment of our sales force to keep investors to a minimum, we can't eliminate them because we can't always find them. But our objective is generally not to sell to investors.

You do it different than most builders. Can you just explain -- most builders either will say you know you have to give us back the profits or you can't sell or they put up this (indiscernible). How do you stop?

Tim, we have an addendum to our contracts where we require them to represent their position as a buyer, either as a primary residence or as a second home buyer. If they represent that they are an investor, which is also a choice, we generally do not sell to them.

What about if they represent they are a second home buyer and then just go and flip it?

That is something that we have to try to ferret out during the loan process and understanding their personal situation. If they lied to us and we don't figure it out, Tim, there is nothing we can do about it.

But do you stop a lot of them during the loan process or do they just go to an outside lender?

We do stop them.

And what -- I'm sorry -- what percentage of your product do you finance yourself?

We originate approximately 50%.

So that other 50%, they could go to another lender and get by you.

We also process for brokers another 25%.

So 75 effectively. You're monitoring 75%.

Yes.

Sam Kerner, Franklin Resources.

First, impressive quarter to all of you. Good going. On delays, previously I think you had said you had 200 homes in Las Vegas and 250 in Phoenix that would get delayed into the fourth quarter and I'm just curious what the actual amount of delays was relative to your estimated 450?

That was every bit of it, Sam. We are not -- I take that back. We were able to recover a few homes in Las Vegas in one community that we were able to get heated up with power prior to the end of the quarter. But in terms of the issues in Arizona with primarily cabinets, that was the situation that could not be recovered from due to the timing of getting these installed and was not. The power -- we had a lot of houses finished, ready to close on the ground waiting for power and those are in the process of closing as we speak. But it was every bit of the 450.

Interesting. I guess the current status right now -- is there a percentage that you could throw out in terms of what percentage has closed already or are you about to be caught up?

It is a high percentage but to be honest with you when we saw we could not get these houses closed, we focused on the houses we needed to get closed and so they will close throughout this quarter. I will tell you that it is a situation that we continue to work on. Power will always be an issue for us in Las Vegas. It has been for over a year. We have generally been able to work around it but we are exposed in that market more than anyone because of the large number of communities we open and the fact that we have relatively small number of units in each community. So we're opening more communities all the time and we require the attention of the power company more than anyone else. So that is something we will continue to have to battle in the future.

And the situation in Arizona is one that will also continue to be a challenge for us. The cabinet issue is largely under control but there are other components to the home that this volume within that market is going to cause issues that we will have to deal with -- not just us. It is everyone in the marketplace but that is something that we will be working through and also it's not just suppliers on the construction side. But we have experienced delays on the development side. The developers themselves, permitting, all aspects of it are a challenge in a market, which now is the largest market for new homes in the country and the large numbers of builders operating there. But it is part of the business and we will work our way through it.

Are you having any power hookup issues in Florida? Just one of the things I've heard anecdotally is power companies sending employees to help in the Katrina efforts.

Not specifically, that being the issue. Jacksonville, where we are the second largest builder in that market and the number one builder of single-family detached homes, we know -- our guys are telling us we could build a lot more houses there if it weren't for some of the shortages in labor in that market with the large number of public builders who have moved in there over the last three years. The sub base is just not large enough to handle the volume. So power maybe one of the issues but it is not the major issue that we're dealing with there. It's just sheer volume in Jacksonville as well.

Well thank you very much and again great quarter.

Stephen Kim, Smith Barney.

I don't know whether or not you answered this because I actually got bumped off. Last quarter, I believe, you gave guidance with respect to SG&A for the full year 2005. I think you had indicated that you expected full-year SG&A to be below 13% when you combine marketing expense, general admin as well as corporate. Is that still your intent?

Steve, I don't remember that.

I think it was in response to a question that I had asked you about for the year and you said that you expected long-term SG&A with all the components to eventually be in the 10 to 11% range long-term but that you were only willing to commit to being below 13% in '05.

Okay.

I have that in my notes at least.

You get your most amount of leverage in the fourth quarter and you expect that to move us in that direction. I think that for the first nine months, based on what we have seen in the first nine months, that that is something that is not unreasonable.

That's good. And then harping on this average price again, my question, I asked you about '06, which give you little bit of wiggle room with respect to where the price might be because you were talking about how it might drop off in the back half of next year. Can you talk about the fourth quarter, where you sort of feel the pricing might go? I am noticing, put some parameters around it, I noticed that last year -- last year in the fourth quarter you did 305. The backlog at the end of the third quarter, so the backlog price heading into the fourth quarter was 3-0 -- I think it was like 304, although I know that that was a little bit complicated because of Watson. But I think it was 304 and you delivered 305. Here, you have got a 362. I don't think -- I have been looking for anything close to a 362 but I want to get some sense -- can you give us some range of comfort? I would think a 340 type number, which is in line with what you did orders for this quarter. I couldn't imagine that being terribly out of line but again I wanted to see if you could set me straight on that.

Steve, last year was an anomaly. Generally, you will see a discount to the average price in backlog at the beginning of the quarter of somewhere between -- I have got history that is public information but it is anywhere from 5 to 12%. What would tend to push it to the high end of that range is the fact that you have got a lot of houses -- you've got these houses in Arizona that are going to be closing. So it is more heavily weighted. We know those are coming through and the Vegas and Phoenix houses as they come through will tend to have a greater impact on that number and may be driving it toward the higher end of that range.

Other than that, I don't think I could comment anymore other than as we said before, we did expect our average price to be moving up sequentially and to a greater extent in the fourth quarter than in the third I think is what we had said.

Let me understand that a little bit better. You said you expect the sequential increase in the fourth quarter versus 3Q, that percentage increase to be higher than the percentage increase that you saw are from 2Q to 3Q.

That's correct. And again taking into account the fact that when we said that we thought that we would be closing these Phoenix houses in the third quarter.

Okay. I'm going to just work on the assumption that we can probably use a figure that's close to 10% higher or 6%, 7% higher than the third quarter. That would put me -- let me just see -- if we assumed 6% higher -- hold on a second, I'm having some problem here. Sorry for doing this. That puts me at the 330 type range. So I would assume that it's going to be better than 330.

Okay.

Last question I had relates to your EPS guidance and again I don't know if anybody asked this as well but you had, after you reported your orders last time, you had indicated that you felt that you would do better than the current consensus in 3Q I think you said. Or at least that you would do better than the 1044, which is the street consensus but that you might do less than the 265 and the bottom line is that it seems to me that your commentary now is indicating that you're going to do o better than 372 for the fourth quarter.

Obviously the street consensus is 392 and it is -- I think the market is reacting here in part to the fact that your implied guidance here seems to be that you're sending a signal to the street that you're not terribly comfortable with where the street has taken the fourth quarter. Can you give us an indication of is that the message you're trying to send because clearly here you had an opportunity to take a second crack at adjusting the guidance a little bit and everyone is trying to read the tea leaves and all you did was basically reiterate what you said before, which seems to suggest -- you were saying something along the lines of no, we actually meant something more like 372. Can you help us out here because I think that would help to solve some confusion?

We don't want anybody to be confused, Steve. But I am confused by your question.

Oh, okay.

Here is the thing, Steve. We are not sending any subliminal --.

Easy for you to say.

We are not sending any messages. What we are doing is reiterating what we said. We said we would beat 1044. You all did your estimates based upon that. We didn't say by how much. We are not saying that we -- we didn't say we are not going to beat what's out there. We said we will beat 1044. Your number beats 1044. So there is no hidden message there. We just wanted to maintain a consistent message from what we had communicated a month ago.

I think that's important to state because a lot of other companies that give a lot more guidance and give guidance much more often in the past have maybe spoiled people but you guys really didn't mean anything by what you said today other than what you had said last time last month.

Honest, Steve, we didn't mean anything by it.

I believe you. Thanks a lot.

There are no further questions at this time.

We would like to thank you again for joining our call today. We look forward to having the opportunity to speak with you again in January following the announcement of our 2005 fourth-quarter and full-year results. Have a great day.

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