MDC Holdings Inc (MDC) 2006 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the M.D.C. Holdings 2006 second quarter conference call. [OPERATOR INSTRUCTIONS] I would now like to turn the call over to Mr. Joe [Fretz] to read 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 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, 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 2005 Form 10-K and 2006 first quarter Form 10-Q.

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 and welcome to M.D.C.'s 2006 second quarter conference call and Webcast. The first six months of 2006 have provided significant challenges for the home building industry. The generally robust demand characteristic of the last several years have given way to an increasingly competitive environment in many of the country's key markets. Net orders for subdivision in these markets have declined as cancellation rates have increased sharply.

Builder concessions and incentives have risen to stimulate demand and preserve backlog in the face of expanding unsold new homes and resale inventory levels. Speculative demand in many markets generally has subsided. Faced with an uncertain outlook for home prices, many prospective buyers have displayed a lack of urgency, preferring to postpone purchasing a new home until the market stabilizes. We have responded to these challenges on a variety of fronts. With a primary objective of strengthening our investment grade balance sheet and financial position.

To that end, we did not repurchase any of our common stock so far this year, which has enabled us to preserve capital for future uses. Also, we have raised the underwriting standards we apply when evaluating proposed lot acquisition opportunities. Evaluating our already conservative requirements to an even higher level. This has facilitated the adjustment of our supply of owned and controlled lots to conform more closely with our two year lot supply objective, as home order absorption rates declined to their current levels.

In the process, we have pursued the modification of pricing in terms of proposed and existing land acquisition contracts. Choosing to terminate several existing contracts with terms that did not meet our standards. As a results of these efforts, we achieved a 13% year to date reduction in the number of lots we own and control, which contributed to a reduction of our investment in land in the 2006 second quarter. And we determined through our quarterly evaluation process that no accounting impairment of this investment was required.

In addition to our focus on the balance sheet, we stepped up our efforts to control our operating costs by negotiating price reductions with our subcontractors and vendors. We also increased our focus on operating efficiencies to reduce our construction cycle times. Finally, we have taken steps to consolidate our organizational structure and reduced our overhead as appropriate on a market by market basis in response to changes in demand and the competitive dynamics of each market.

We will continue to respond to changes and market conditions without compromising our commitment to the quality of our product and the integrity of our financial position. The success of our response to date is reflected in our leverage ratios at the end of 2006 second quarter, which are comparable to last year's strong levels and ranked among the best in our industry. In addition, our cash and available borrowing capacity at quarter end exceeded $1.3 billion for the first time.

Furthermore, our continued profitability during the 2006 second quarter contributed to a 32% year-over-year increase in our stockholders' equity to more than $2.1 billion or $47.28 per share at quarter end. We are proud of these achievements. While the length and severity of the current market adjustment is uncertain, we are hopeful that the fundamental drivers that still present in most of our markets will in due course return the home building industry to a more healthy level of demand.

Regardless of the timing of any industry turnaround, we remain committed to our conservative operating model and financial and operating disciplines. Our financial strength, combined with our continuing efforts to reduce cost and expenses and improve our operating efficiencies; give us flexibility to take advantage of opportunities that may be presented in this challenging environment. 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 2006 second quarter.

Thank you, Larry. I'll start with -- and you can follow the slides here. I'll start with the income side. We recognized net income in this order of $76.5 million or $1.66 per share on $1.233 billion in revenues, compared with $102.6 million or $2.25 a share on $1.046 million in revenues in the second quarter of last year. For the six months, we saw our earnings rise to $171.9 million or $3.74 on $2.375 billion in revenues, compared to $187.3 million or $4.10 a share on just short of $2 billion in revenues. Our decline in earnings here in the second quarter of '06 is attributal really to the fact that despite the fact that we saw very high levels of financial services earnings, these were offset by lower home building profits and lower corporate -- excuse me, we had a positive impact of lower corporate G&A but the lower home building properties actually more than offset that.

On the home building side, our profitability reached $133.3 million on $1.195 billion in revenues, compared to $187.6 million on $1.029 billion in revenues. For the six months ended, we achieved $307 million, compared to $350 million last year on $2.3 billion on revenues this year versus $1.9 billion last year. The decline for both the three and six month period is really due to lower levels of home building gross margins, an increase in our SG&A and reduced home closings, which offset the impact of higher average selling prices.

Before I get into each was of these categories, I would mention that as Larry said in his comments, we did not recognize in this quarter any impairment on our land of balances, as we do complete each quarter an analysis. And that analysis, based on current market conditions, indicated no impairment was required as of this date. Looking at closing levels. We closed 3,376 homes, compared with 3,512 last year. And for the six months, 6,574, down slightly from the 6,670. In this quarter, we actually closed -- we started the quarter with a backlog that was down 10%. We converted 47% of it, which was up from 44% last year. So, the lower beginning backlog really drove this.

Most of our operations were down in terms of closings with the exception of Nevada and Maryland, which were both up slightly. On the average selling price, which was up year-over-year by over $60,000, we saw our price rise to $354,000 in the quarter, compared to 293 last year. And for the six month period 352 versus 292. In this quarter, similar to the first quarter, all of our operations were up in terms of average selling prices with the exception of Illinois. With our largest increases coming in Maryland, Arizona and Florida. And we also saw a significant increase in Utah on a relative basis.

The -- one of the major focuses here in the quarter is the home gross margins, which were down 540 basis points from the second quarter of last year and 400 basis points sequentially from the first quarter. We saw margins reach 23.2% from 28.6% last year. And the largest single impact can really be attributed to the -- as we have said over the last year, our margins in Las Vegas have been declining from extraordinary levels.

And as we said in the press release, our levels are approaching more the levels that are average for our Company. And that being a high volume state, that has a very large impact on our overall margins. As do the margins in California, which have also declined due to inventory and competition pressures in that market. The other significant impact, as we pointed out in the quotes in the press release, is the impact of an accounting adjustment, which caused us to eliminate approximately, just short of $20 million in profits.

I'd like to say a little bit about that because I've gotten a lot of calls on that today. That impact on our margins was 120 basis points by itself, in terms of dropping margins this quarter versus last year. And relative to the first quarter, in fact. This accounting provision is related to the recognition of profits on the sale of homes where a home builder provides financing. This is not a new provision, it affects all home builders, not just M.D.C.

And it applies when we sell a home to a home buyer and provide them financing, excluding government financing. And you have to look at, from the buyers' perspective, how much they invest. They have to have a minimum amount down regardless of where the funds come from. And when that minimum is not met, the accounting rules require that you cannot recognize gain on the sale of that home. Even though title is transferred, we've received their money, the home's closed, the revenues and profits are in the kitty, you cannot recognize the gain until the loan that you originated has been sold.

And so the way the accounting works is the amount of profit related to those homes, for which you have to defer profit, lowers the amount of revenues. Costs stay in there, the assets are removed from the balance sheet, and the only impact is really to the revenues and to the profits, obviously. And then the revenues and profits are recognized at the time the loan is actually sold, which in our case is generally within the next 30 to 45 days.

So, it's purely a timing issue and it's something that impacted this quarter. It is a provision that is applicable and has come about in more prominence of late with us and a number of the other builders by virtue of buyer demands for higher loan-to-value loans, the greater use of interest-only loans, and second mortgages. Interest onlies require greater committment by the buyer from a down payment standpoint. And it's also impacted by the strategy that our mortgage Company uses to sell its loans.

We obviously want to maximize profit. And our mortgage Company is determined that a lot of these loans we can profit the most over the long haul by packaging them in bulk and selling them at a later date. So, it's all impacted by timing of the sale of the home, timing of the sale of the mortgage. And it's something that had a material impact, this particular quarter. And it could potentially, under similar circumstances, impact future periods, as well.

In addition to this impact, we also saw, obviously, the impact of higher incentives in most of our markets. As well as land as a percentage of the selling price also increased several hundred basis points. And a smaller impact but still a very real impact; is the fact that our hard costs have been increasing in every category, except for lumber, basically of late. And that by itself had a 30 to 40 basis point impact on margins, as well.

Turning to SG&A. Our SG&A costs were also up in home building segment. We saw our SG&A up to 12.5% of revenues from 10.8% last year. This increase is really due to higher levels of commissions on sale of our homes, greater levels of advertising due to the more competitive environment. Deferred marketing is up as it relates to model homes. And we do have more model homes in operation today than we did a year ago, so those costs are up.

But the larger increases are related to higher home building related salaries and our abandonment of certain project costs, option deposits and acquisition costs that we incurred, which were up approximately $8 million from this time last year. The other impact is also an increase in the corporate charges to our home building segment, which is offset by an increase in receipts from our home building segment within the corporate area.

I would say that if you look at our -- on the G&A side, our G&A level is actually very comparable to where it was in the first quarter. The only difference really being the higher level of project cost write-offs during the second quarter. On the corporate G&A side, as I mentioned earlier, our corporate G&A is actually lower than it was a year ago. And lower in fact than it was in the first quarter.

We saw our corporate G&A drop to 21.3 million from 27.9 million, also down for the year as a whole. And this is due in large part to lower levels of compensation related costs at the corporate level that are tied, in large part, to the performance of the Company. As I mentioned, the higher charges to the divisions and other miscellaneous costs that are down, which by the way also offset the impact of the stock-based compensation costs of expensing our stock options that were approximately $3 million in the quarter. So even with that negative impact, we're able to reduce our corporate overhead.

Turning to financial services, which had a very strong quarter. We saw our financial services segment earn $10.2 million, compared to $4.1 million last year. And for the six months ended, we've earned over $18 million, compared to only $7 million in the first six months of last year. This is largely attributal to higher gains on sales of mortgage loans. It resulted from our increased originations, which came from higher sales volume and an increase in our capture rate.

Our capture rate ,actually, while it in the quarter grew to about 75% from 73% last year; the big reason for the impact on our profitability on mortgage loan gains is that we actually originated close to 60% of the loans needed by our buyers compared to less than 48% last year. So that piece, obviously, would contribute to a greater level of loans originated in higher profitability. Just some side information that we generally talk about in terms of fixed rate versus ARM's this period, very similar to the first quarter.

51% of the loans that we originated during the period were adjustables and 49% fixed, compared to a year ago, which was 48% adjustables and 52% fixed. Of the adjustable mortgages we originated, 85% of them were interest only, which makes 43% of the total loans originated as interest-only product, compared to only 36% in the second quarter last year. And 96% of all of the loans that we originated are fixed for at least five years. Our FICO scores continued in a positive direction in the -- between 727, 730 on average. And that's fairly consistent with where we were last year. And the loan-to-value has increased as we've originated more seconds, we're up a couple of points from where we were last year, around 87% this year versus 85% last year.

Turning to the balance sheet. Larry mentioned a couple of key points. Our balance sheet continues to be our primary focus and a very bright spot for our Company as we prepare for the future. Our equity grew to 2.126 billion, up 32% from where it was last year, which gives us a book value up $10.40 to $47.28 per share. Our cash and available borrowing capacity was $1.3 billion, compared to just over $1 billion last year.

And our debt to cap ratio, which is -- the way we calculate it is to include in our debt our home building and corporate debt and include that with our equity in the denominator. We were right at 30%, which puts us comparable to the 30% last year and down, which is unusual on a seasonal basis to be down from where we were at the end of the first quarter. This is also very much below where our peers are, which average about 43%. The next slide you see is a very brief summary of our cash flow for the quarter, which is very positive. Showing our cash from operations being virtually flat, as our income that we generated we used to basically increase work-in-process inventories and to pay taxes in April and to pay down debt and pay down dividends.

Otherwise, the direction of this is reflective of some of the steps we've taken to reduce our land inventories, which is partially offset by an increase in work-in-process inventories this time as we build through our backlog. On the order front, orders for the quarter were 2,738 units, compared to 4,832 a year ago. Every market during this period, except for Utah, was actually lower. And this can be attributed primarily to the significantly higher cancellations that we've experienced during the period, as well as some degree of lower gross orders, as well.

For the -- in terms of the value of these orders, while the number of orders was down 43%, the value of these orders was $914 million, compared to $1.7 billion last year, down 46%. The average selling price of our orders this quarter actually dropped to $333,000m compared to 352 in the second quarter of last year. Primarily due to the fact that our orders are coming from lower priced markets. And in particular, Utah saw a very large increase on a relative basis and we seen a smaller relative number of orders from our higher priced markets in Virginia and California. Our cancellation rate, as we mentioned in the release, is 43%, that's up significantly from 19%. By the way, our cancellation rate, as we define it, is the absolute number of cancellations for a period divided by the gross orders that we received during the period. So, that's how that is calculated.

In terms of absolute cancellations, every market, except Texas and Colorado, was up over where it was last year. And our can rates are up over 1,000 basis points in every market except Texas and Utah. Primarily, due to the high supply of new homes in the competitive environment in all of these markets. This lower level of orders led to a backlog that is at 6,496 units valued at $2.440 billion. That's compared with 9,213 units or $3.140 million a year ago.

Our average selling price of our units in backlog is fairly consistent with where it was last year, as well and down slightly from where it was in the first quarter. Our active subdivisions dropped primarily due to, due to the closeout of subdivisions and the sale of subdivisions in Texas. But we did see a drop in Nevada and Colorado. We saw some increases over last year in Arizona and California, which were also up from where we were in the first quarter.

And then we saw declines in Nevada, Colorado and Texas. And as we continue to -- our efforts to right size our business and we are being very careful in the evaluation in potential acquisitions and that's led us to a reduction in our lot supply. We ended the second quarter with 36,676 lots under control. Of which 39% of them are under option or just over 14,000 lots. We control those with %55 million, roughly, in cash and letters of credit, which is just under $4,000 per lot. So these again, a nominal value and a true option available to us as we look at these and evaluate these going forward.

This is down from not only last year, which -- where we had over 43,000 lots under control but at year end we had 42,000 and at the end of the first quarter, 41. So, this has come down fairly rapidly here as a reflection of our efforts to bring our lot supply more in line with our two year supply objective. That concludes my prepared remarks. I'd like to open the floor for questions.

[OPERATOR INSTRUCTIONS] The first question is from Michael Rehaut from J.P. Morgan, please go ahead.

I was wondering if you could review the process in terms of determining land write-downs and the criteria and what type of evaluation or is it an MPV, or if you could just kind of update us on how that works?

Well, basically we -- the process that we go through is we evaluate at least on a quarterly basis, every asset that we have. And we focus primarily on those that have a little less -- lower performance than others. And then you have to do an evaluation of whether or not the -- based on future projected revenues from that project, that you can actually realize the value that you have in that asset.

And it's kind of a two-step test. You go through the process on an undiscounted basis, excluding interest and if you pass that test, there's no impairment. If you fail that test, if in fact, your future revenues do not exceed your current and future costs excluding interest, you basically have to go through another calculation, which is more of a valuation based on a discounted -- some type of discount rate. So, there is a -- it is a rather complex calculation. And it's based upon a variety of assumptions surrounding a particular project.

So, the write-down would generally then occur if you were to project that you'd lose money on a gross margin or an operating margin basis? To put it more simply.

That would be taking into account direct costs related to that particular project and excluding interest.

So, it's closer to a gross margin basis?

It's pretty close to a gross margin, less commissions, depending on whether you include commissions in gross margins.

Okay. Thank you. On the deferred profit issue, could you give us an idea what type of amount, $20 million, certainly stood out this quarter. But what that amount is typically per quarter? And for these types of loans also, is it that you guys put up 100% of the loan or were there no amount that the buyer put up? Was it a 100% LTV type of a loan? Or what was the average LTV?

First of all, Mike, we in terms of what it typically is, it's typically -- it's not typically anything. I don't mean it's not typically 0, it's not typical. It's based upon facts and circumstances within a given period. And until this period, it's not been material, the impact. And it may or may not be material in the future depending on what the circumstances are. So there's no way to really predict it, unfortunately.

In the case of the loans that this relates to, it could be -- generally the buyer has to come with a minimum of 5% down. And by the way, there are loans that we originate with less than 5% where the loans are sold and the profits are recognized. But it's what you have to scope in and evaluate and it's what's outstanding at the end of the period.

And so, in the case of noninterest only, nongovernment loans it's generally about 5%. There are a whole host of other facts and circumstances that can impact the amount and it's higher than that if it's an interest-only product. And depending on the life, the fixed period of the interest-only product, there's a lot of variables that goes into it but generally an interest-only product, an interest-only ARM requires more than 5% down.

Well, what I'm getting at is -- perhaps, to ask it another way. If you're saying that in the past this hasn't been material, which then I would assume that maybe on average it's $2 million, what was different this quarter? And was there a particular region or a particular community where there was this higher LTV type of loan that was being underwritten by your Company? And again, if you could just give a little more detail on what was the higher LTV relative to your corporate average.

This was first of all, as to prior periods, the materiality amount is dependent on the level of your results in any given period. But the -- what happened this period is simply an evolution of the development of a product that has grown in use, that being the interest-only product. Our desire to originate that product, whereas we may have previously brokered it in prior periods to some degree.

But it's an evolution of the demand by the buyer of a certain type of product. Our efforts to originate more of that product because it is more profitable for our Company. And the timing for selling those loans, which maybe -- we would -- we might sell it -- we have the ability to sell it the same day it's originated, if it makes economic sense to do so. Or to sell it within a few days. But generally it's within 45 days of the time we originated.

But that decision is really more based upon a business decision and a strategy rather than trying to time out recognition of dollars, if you know what I mean.

Okay, just a couple more questions so I fully understand this and then I'll get back in the queue. One is, as an IO product, were these types of loans, did they have higher or lower FICO scores than your corporate average? And the second question is, since you're already three weeks out of the quarter, 20 days or so, which is -- you're talking about 30 to 45 days that typically these loans can get sold; can you give us an idea if and how many of those loans have been sold? And of this $20 million, what at this point perhaps have you already booked into the fourth quarter?

Anyway, we are -- Mike, we're going to need to limit the questions so we can get some other callers but just very quickly. These -- there's no typical -- there's nothing atypical about the FICO scores of these buyers, it has nothing to do with them. It's simply the timing really as much as anything. And a lot of these have been sold, a lot will be sold in the next week or two. Most of these loans will be sold by the middle of next month. And so, it's not a situation where we have changed our approach of holding loans. It's just simply the fact that we had a large magnitude of these types of high loan-to-values at a point in time that had not been sold.

The next question is from Stephen Kim from Citigroup. Please go ahead.

Thanks, guys. I'm actually not that interested in the deferral. But I'm actually interested in your gross margins and your SG&A. Let's talk about that a little bit. First of all, with respect to the gross margins, could you give us a sense for, when you look at your backlog, what you think the embedded gross margin that you see in there might be?

Well, we really -- we don't talk about that, Steve. And first of all, let me say that we don't know what the future holds. Whatever's there is subject to change because of the high level of cancellations we've seen. And those cancellations generally lead to different margins than are there. So it's not something that -- it's something that's consistent with our -- the fact that we don't talk about the future.

Okay. Got it. I get the sense that there were a couple of looks shot across the room there. But that's fine. I'll just leave that one alone, I don't want to bang my head against the wall on that one.

SG&A, it looked to me like the SG&A in this quarter rose a little bit more than that I might have thought, even given the fact that you had the deferral and whatnot that moves some revenues out of the quarter. We do a calculation that basically assumes a certain amount of fixed SG&A and all the rest of it and sort of triangulate in on sort of what you should do. And you guys had a much higher level than we would have thought. Can you maybe give us a sense for some of the actions that you may be taking as you go forward here?

Maybe give us some sense, either qualitative or quantitative of what you think you can do to bring your SG&A rate down if revenues do not improve, which I don't imagine you're anticipating they are near term?

Sure. Steve, we are actively pursuing all avenues. And part of it deals with kind of changing or holding the direction that we had started well over a year ago. Where we had talked several quarters ago about the fact that we have expanded within our home building operations into a number of different divisions in order to enable us to grow faster. And given the fact that we are not growing at the moment, we have to reevaluate those. We did split out Virginia into three separate divisions, we've already moved one of those back. And so we're down to two divisions. We had three divisions here in Denver where we brought that down to two. And we've done similar things in other markets. Those are just some examples. That obviously eliminates the need for layers of overhead. The impact of that has yet really to be realized. These are things that have been done recently.

Okay.

So, what you're seeing in this quarter is probably more of a transition period where the revenues are there faster than the impact of some of the changes that we've made.

Good.

And so that's something that we will be working toward going forward. At the same time, we are in a very competitive environment and some of the things we're doing impact mar margin, some of them impact SG&A. We have stepped up our advertising program and we have been incurring more dollars there on a relative basis for advertising and promotions in response to this competitive environment. And in addition to that, we still have -- we have some new model homes at some higher levels, those costs will be written off over time. And that's something that has added to these costs.

The other thing that's happening is that the commission rates, even though our co-op rates, which are typically run about 60%, something just short of 60, the percentages that are being paid to some of these outside brokers is actually higher in certain, more competitive markets in order to compete with the other builders in that marketplace. So, the average dollar per commission paid out has actually increased, as well.

Got it. No I appreciate that. Since I didn't get an answer to my first question, can I sneak in another one?

I'll give you one, Steve.

One more? Good. Basically, I wanted to ask you about your cancellations. The reasons behind the cancellations, one of the things that we've been curious about, is maybe some intramural competition, if you will, between builders. And in the past, I imagine you were seeing cancellations driven by speculative buyers and whatnot that -- flippers, that really decided they really didn't need to follow through on the transaction. But more recently, we've begun to wonder if you've maybe been losing some sales to other builders, maybe public ones who -- and you've not been willing to match the offers that you've been getting -- that they've been getting. Can you comment on maybe what roughly what percentage you think of the cancellations that you've seen -- maybe of the increase you've seen has come from that area and maybe what the trends kind of look like there? Have you seen any moderation in that whatsoever?

Steve, where we've seen -- we have seen some of that. Where it's been most dramatic has been in our Arizona subdivisions. Particularly, those where we have -- where we opened for sales before the end of this last year and made sales prior to the end of the year, that's where we're seeing the greatest impact of that.

Now, where we've been able to actually come out with a new product at the right pricing, at current market pricing and without the need for the same level of incentives; we've been able to compete very effectively there. We're working through, and particularly in the Arizona subdivisions, the ones that pre-date 2006, keeping those buyers in the fold because they are seeing that that was basically before a lot of the incentives were offered and after a lot of the sales price increases were put into effect. And while we try to work these buyers very hard, they're also out there looking at the competition. And we've had a lot of buyers who have been canceling late in the process.

That's one of the trends that's been most alarming for the Company is that it used to be that we'd see half of our cans come in before we even started the house. That's where we were at the second quarter of last year. This year in the second quarter, only a 25% of our cans occurred before we started the house. And that's primarily driven by what's going on in Arizona because we are seeing them -- and in some cases waiting right til the closing date to actually cancel because they've got another opportunity our here and there's really no motivation for them to -- If they're going to give up their deposit anyway, which they will forfeit their deposit, under those circumstance, that there's no motivation for them to can.

The impetus is on us to work those very hard and we are. And we're working through those that level of inventory. And it's getting close to being gone. So that, I would -- that aspect of the cancellations should be pretty well worked through here in the third quarter. But we are seeing out of all of our cans, last year, you might put it into the buyers remorse category. We had roughly 12% to 13% of our buyers were that canned were walking away because they changed their minds and this year it's closer to 20%.

[OPERATOR INSTRUCTIONS] The next question is from Ivy Zelman from Credit Suisse. Please go ahead.

Good afternoon, guys. I am trying to figure out whether or not -- what your strategy is relative to some of your competitors. You've talked about in the last downturn that you certainly saw a different environment. And you jokingly called yourselves cowboys, that you were out there buying land and weren't underwriting. And disciplines are much better today and public builders are much more rational. It seems as if though where the markets are probably the most consolidated out in Denver and in Phoenix and in places in California and Vegas, that it seems to be there's more irrational behavior going on.

So I'm just curious Larry and Gary, your experience, how would you kind of rank this downturn? Has it been really kind of surprising and the magnitude of it? I remember, Gary, you said to me, "well, Denver was wrecked" so to speak, "post-2005 tech wreck." And you saw absorptions down 50% and margins got clobbered. But you said, "thank God we don't -- we have a lot more diversity than just Denver." Here we have almost every market in the country looks a lot like Denver did post-2000. So, I want to understand how you guys are thinking about this. We hear some publics say, "we're just seeing normal, things are normal, everything's fine." And I want to hear it from you, what you think.

Well, I think the best way to answer it Ivy is to look at the last decade and look at what we've done as a policy. At one time we were criticized by only having a two-year supply of land because we were missing all of the opportunities. And it looks as though having a two year supply of land into declining markets was a pretty good approach. Not having any joint ventures, not having any goodwill, not having any off balance sheet financing, having a very, very conservative spec policy; these are the things that we've done for the last decade.

We adjusted for the change of market conditions starting in probably May or June of last year. And we've continued to adjust as the markets adjusted. So, as you look at our balance and the strength of it and the direction of it and the available liquidity, I don't think anybody is stronger than a market. But within the market, I believe that our Company is most uniquely positioned to be able to change with changing times, as we've demonstrated it now. As we have changed with the times and as the market works through this slowdown that has taken place.

And as long as the basic economy of this country remains strong, and it seems to be remaining strong, we will as an industry work through the supply of both resale and new homes. And we believe that we will distinguish ourselves because of the conservative nature of how we run our Company.

Now, Larry, realizing I wanted to nail down your thoughts. You kind of agree that as long as the economy's good this is just a supply-side issue. And one of the things that you have to ask, is realizing you're doing, as Gary said, it's more competitive out there. You have to do more 100% LTV's to get loans done. Realizing that rates have gone up a lot. I think -- understanding, do you think there's not a demand problem here? You think it's just supply? Or do you think demand is also being impacted? And this is like a downturn we've seen in the past or is it as severe? How is the Company thinking about the next 12 to 24 months? Is this sort of a correction that's going to be short-lived? Do you think it's a real downturn? And are you worried about demand or are you more worried about supply?

Well, I think that one thing about housing, it's a self-correcting issue. If you have a job creations and if you look at the markets that we're in. Our principal markets are the mid-Atlantic. The Washington market has I think 65,000 job creations. Las Vegas has job creations. Phoenix has job creations. California has job creations. Even Colorado's beginning to look pretty good. What you have is a timing adjustment that several things came together at one time. To us you could see it, if you read the tea leaves, that it was sequentially slowing down as your conversion ratios decreased.

I believe that -- we listened to the Fed Chairman speak yesterday, I think he's very positive. He's going to try to avoid stagflation, which some of us who remember, maybe even the early 70's where you had inflation and deflation at the same time. It seems as though in our country, the only apparent weakness in the real estate market happens to be in a residential housing. And that of course, ties also into land for mostly homes. And that seems to be the weakest part of the economy. And I'm not dealing with auto sales, I'm dealing with housing and real estate broadly defined.

So, this isn't like some of the other cyclical turns when you saw everything out of control. So, I'm comfortable that the Chairman of the Fed will act responsibly, whether they raise the rates another 0.25 of a point or 0.5. His background, and as you study his educational philosophy, I believe that this country will act responsively. And we will be looking at better times sooner versus later. I had previously made a comment that in 2008 we would look back and be very proud of what we achieved in 2007 that we had started working on in 2006.

And we're doing exactly what we said we were going to do. We've run the Company exactly the way we've advocated it. And the very, very conservative nature that we have operated under for over the last decade that you have watched and sometimes agreed and most of the time didn't agree. We're trying to do the right job in adjusting for the right size for the market.

[OPERATOR INSTRUCTIONS] The next question is from Dan Oppenheim from Bank of America Securities. Please go ahead.

Hi, this is Mike [Goode]. Just looking for some additional information on the write-offs of the option deposits. Were they in a certain area or can you also tell us when the land was purchased? Or when that was put under control?

It's not any one area. In fact, I think every market had a write-off of some kind. I'd say the largest piece of it was in the mid-Atlantic region.

Okay.

And the timings variable, as well.

And just, I believe that I read in the press release that you had looked to manage your incentives to adjust to the weaker pace of sales that you've experienced this quarter. I was wondering if that's a change in the philosophy where you're going to look to be more or less aggressive than peers on a relative basis, or is this just in reaction to the overall market?

We're not looking to be more or less aggressive. We are doing what we believe is appropriate to respond to changing market conditions and to maintain a reasonable pace of operations within each one of our markets.

Okay, thanks.

The next question is from Joel Locker from FTN. Please go ahead.

Hi Gary. I just wanted to talk to you about community growth going forward. Seems like it's leveled off here from the first quarter. And what you were expecting or projecting for the third and fourth quarters on a community basis?

Well, Joel, we had anticipated the impact in Texas, obviously as we work through those subdivisions.

Right.

And the other subdivisions have really -- the growth has slowed because of what we've experienced in these markets. We have picked it up in Utah and we've picked it up. And we've seen a pretty large decline in Las Vegas here recently but that's -- we'll probably replenish that because that market is still doing fairly. The down absorptions are down little bit but there's a lot going on there. And so, we'll be bringing that back up to speed. But we're not -- we can't predict really, at this point, where the subdivision count will be. But we are -- you can see that the lot supply is dropping and that's directly tied to --.

Right. Would you take it -- you'd stick around 300 or is that kind of a rough assumption? I'm not going to pin you down or anything like that.

Is that your final question?

Just the other one is just, have you made any adjustment in prices and backlog just on downward? You came in with 7,100 homes you closed 3,300, so you had 3,800 left. Of those 3,800 left, have you and if so what percentage of those have you dropped the prices to keep your buyer in backlog?

Joel, it's really a subdivision by subdivision decision based upon when that subdivision came on board. I would have to say that there had been some adjustments. It hasn't been widespread because it's really based on -- we have a short supply of land in each subdivision, so we're not dealing with something where we have a long tail on it. But it's been limited in certain markets. It would be hard to put a percentage on it but it is a -- we are -- that's one of the things that we're doing in reacting to our competition. We would rather make that adjustment than lose the buyer to another competitor.

The next question is from Alex Barron from JMP Securities. Please go ahead.

Yes, hi guys, thanks. Wanted to ask you regarding spec building, just in general, if you could tell us how many homes you guys are currently building on spec and what percentage generally they represent of your starts?

Okay. Well, first of all, we don't generally disclose the absolute number. But I will tell you that in terms of the -- our spec level has increased but primarily due to the cancellations that we've been experiencing. We start very few spec homes. In terms of the starts, we still have a large number of homes that have been sold and not started.

And we're not -- that's not part of our strategy really to start a lot of spec houses. We have today about a six week supply of spec homes in total in the entire Company. And of that amount, maybe we have a little over a week's supply of finish specs. We also have in that group, about 1.5 week supply of just foundations. So, we haven't put much in terms of an investment in that particular lot. And so we have roughly 3.5 weeks supply of specs in some form of -- some phase of construction at this point in time.

Okay. So I'm guessing you're not facing the same pressure to sell specs as other builders. My second question has to do with land. It sounds like you guys are trying to stick to some sort of two year supply of lots. I'm assuming that that's owned? And my question is, if your sales are down say 1/3 or your total deliveries are expected to be at, let's say down a 1/3 or whatever the number happens to be next year from last year; should we expect your land position to be down roughly the same? Or how should we think about that?

Alex, we are trying to right size this. We have -- if in fact orders are down, our lot supply will be down. But you should not assume by the way, our objective is not two years of owned lots, it's two years of owned and auctioned lots.

[OPERATOR INSTRUCTIONS] The next question is from Ben Atkinson from Gagnon Securities. Please go ahead.

Yes, thank you. My first question is on your lots. You mentioned that they're down 13% year-over-year. Your inventory is up year to date -- I'm sorry the lots are down 13% year to date. So, we should imply that that your average cost per lot going forward will be higher or is there something else going on there?

The average cost per lot is higher and fairly consistent with the price of the homes that we're selling today are higher. But part of the inventory levels being up -- if you're looking at and I won't charge you a question for this but is this -- you're looking year-over-year in land only or inventories in total?

Versus year end in looking at land.

Okay. Yes. The average cost per lot is relative to where it was.

And second, if you're using financing incentives, for example, a lower than market interest rate; is that an incentive that would be charged to the home building unit or to the mortgage Company?

It is charged to the home builder.

Okay. Very good. Thank you very much.

The next question is from Carl Reichardt from Wachovia Securities. Please go ahead.

Good morning guys, how are you? I have a question --.

That's not a question, by the way.

What a kind man. Let me ask it this way then. Can you describe for me, either Larry or Gary, what specific set of conditions from either debt level, lot supply, cash generation, you would have to have in order, or stock price, in order for share repurchase to become a more important focus for the Company?

The short answer to that is no. There isn't a straight answer for that. There are a lot of factors that come into play in considering that. It is a strategy. But it -- there's a lot of things in terms of where the direction of the market and opportunities on the horizon and things of that nature.

What's the single most important factor preventing you from buying shares back now? Is it just the desire to maintain a current debt to cap?

They're all important. And I'm not trying to be cute, Carl. I can't pinpoint one. We are where we are and there's a -- we do have an authorization out there. And what will motivate us to act on that is not -- really can't be predicted. But when we do decide to buy, or when we buy, we will let -- the market will know. And that's really all that we can say about it.

The next question is from Sam [Kerner] from Franklin Resources. Please go ahead.

One thing, just a statement and then a brief question. But you really are looking pretty smart here on an obviously, in an awful environment. And I don't think you're getting any real credit for it relative to some of the other builders. But I just wanted to mention that. But my one question here is whether you'd consider selling? Or if -- under what types of scenarios you might consider an LBO or anything along these lines? If you could just address those issues.

Sam, that's a highly speculative topic. And it's not something that we can really comment on. I don't think we have an answer for you. You can have another question, though.

I'm all out of ammo.

The next question is from Lauren [Horen] private investor. Please go ahead.

Yes, this should be a simple one. Basically, you said that your write-offs or project costs increased by 7.9 million, what's the absolute number? What was the total write-off in the quarter?

Right at 10 million.

Okay. So, they've been relatively diminimus until this quarter and that's why you're calling them out?

That's correct. We did call out 3 million last quarter, as well.

I'm showing at this time that we have no further questions.

I'd like to thank all of you for joining for our call today. We look forward to having you to speak with us again in October following the announcement of our 2006 third quarter results.

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