MDC Holdings Inc (MDC) 2006 Q3 法說會逐字稿

Good morning ladies and gentlemen, and welcome to the M.D.C. Holdings 2006 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. Joseph Fritz with [inaudible] and forward-looking statements. Mr. Fritz, 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 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 2005 Form 10-K and 2006 first and second quarter Form 10-Qs.

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 Web site, richmondamerican.com.

I will 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 third quarter conference call and webcast.

The last three months have been extremely challenging for industry and our company. The competitive factors prevalent throughout the first half of 2006 continued to persist during the third quarter.

In each of our markets we experience reduced orders for new homes largely attributed to significantly higher cancellation rights and lower homebuyer demand. Both of these were driven in large part by increased inventories of new and existing homes.

Builder concessions and incentives continue to rise. Confronted with expanding inventories and increased uncertainty, many buyers displayed a wait and see approach to purchasing a new home.

In face of these challenges, our priority has been and continues to be, to reinforce our investment grade financial position. Almost 18 months ago we tightened our underwriting standards and began renegotiating our land purchase contracts. These actions have enabled us to keep our land supply at a level more consistent with our two-year supply objective.

We reduced the number of lots we own and control by more than 25% since the beginning of the year. Our investment in land decreased by almost $100 million in the third quarter alone, and less than 3% of our shareholders' equity is at risk in connection with our 11,000 lot of options.

Our reduced expenditures of land allowed us to generate $71 million in operating cash flow in the third quarter. Our debt to equity ratio declined year-over-year by 1400 basis points and our cash and available borrowing capacity increased by 25% over the prior year. Finally, our stockholders' equity and book value per share grew by more than 20% over the last 12 months.

Our operating philosophy has often been criticized over the past few years as being too conservative, lacking large supplies of lots, joint ventures, off balance sheet financing and specific performance contracts and speculating in land. We did not do any of these. However, even though we were perceived as being boring in some eyes, our strategy has been developed with more than a century of home building experience shared by our three senior managers.

Through multiple real estate cycles we have learned that the way to be successful in these difficult times is to focus our strengthening the balance sheet, generating cash flow, and preserving capital for future opportunities. While we are proud of our progress in each of these areas, we also recognize the need to prepare our company for future successes.

To that end, we are continually reviewing each component of our operations to identify and improve inefficiencies. In doing so, we are directing our efforts toward reducing cycle times, controlling our construction costs, streamlining procedures and training our people to achieve their full potential.

Also, we are using this market transition to focus on creating greater value for our homebuyers, including the design of new products and launching of a new customer experience initiative aimed at improving the home buying process. As the market continues to evolve, we remain confident that our strong financial position, combined with the improvements we are making to our business, will help us better serve our homebuyers and prepare us for opportunities to grow when our markets begin to return to a more normal condition.

I would now like to turn this call over to Gary Reece, our Chief Financial Officer, who will describe more specific financial highlights of 2006 third quarter.

Thank you, Larry.

The third quarter 2006 characteristically was similar to the second quarter in that we saw our home building profits lower partially offset by higher financial services and other profits and lower corporate G&A.

Our net income in the quarter was $48.7 million compared with $120.1 million in the third quarter of '05, $1.06 a share versus $2.62 a share. Our revenues here in the third quarter of '06 were $1.83 billion compared with $1.168 billion.

We did have some unusual items in the quarter that we will talk about as we go through the various segments. Starting with home building, our pretax net income for the home building segments combined were $82.3 million compared with 211.3 a year ago.

We saw our revenues, home sales revenues, this quarter of $1.58 billion compared with a $1.147 billion. The lower profits this quarter were really attributable to higher impairments and project write-off costs, a decrease in home gross profit margins, lower closings, higher SG&A, all of which were offset by the impact of higher average selling prices.

As to the asset impairment charges, we took impairments of just short of $20 million here in the quarter. These are primarily related to five projects in California that saw slower sales pace and higher incentives.

In addition, we recognized just short of $10 million in project write-off costs that were spread pretty much across most of our markets. These costs were included in SG&A.

These are compared to costs of $2.5 million a year ago. Year-to-date that brings our project write-off cost to right around $23 million compared with $5.2 million of a year ago.

We've had this morning some inquiries as to what these project write-off costs were in prior periods. They have not been disclosed in most cases separately because they are not material in and of themselves, but for those who are interested in getting that information for their models, you'll give Bob Martin a call or an e-mail, we will have a schedule sent to you on that.

Looking at our closing levels, our closings were down as well, 731 units to 2,955 homes. This is really attributable to a lower backlog coming into the period. Our backlog was down 30% compared to a year ago to start the quarter, however, our conversion rates were up, we actually converted 45% of our beginning backlog which is up from 40% a year ago.

As I said before, our average selling prices were up, which created a significant offset to some of the other negatives. We actually saw our average selling prices increase to just over $358,000 in this quarter compared to $311,000 a year ago, up $47,000. All of our markets were up except Virginia and Illinois with the largest increases coming in Utah, Arizona, Maryland, and Florida.

Looking at gross profit margins now, margins were just short of what they were in the second quarter at 22.7%. This compares to our all-time high quarterly margins of 28.8% a year ago so we're down 610 basis points, and as I said, 50 basis points from the second quarter.

We saw, really, gross profit margin declines in every market except Utah and Delaware Valley. Nevada and California, as has been the case over the last year, they continue to decline from their all-time highs that they reached a little over a year ago. Virginia has also showed some signs of decline as well, although it's still among some of the highest margins in the Company.

The FAS 66 implications, which we discussed in the last call, we had discussed an impact of $20 million in the previous quarter. In this quarter, we actually saw an impact of $12 million.

That is a net effect of $30 million of deferral from the previous quarter coming into this period and $18 million of additional deferral with respect to homes that were closed in the current periods. So the net effect was a $12 million increase which had a favorable impact on out home gross margins here in the quarter.

As we look at our expenses, and we have some slides here that show the trends in our marketing, commission and general administrative expenses for the home building segments, we saw our ratio to revenues increase to 12.9% from 10.4% a year ago. This is attributable to several factors.

Our marketing costs are up due to higher competition, higher co-op rates, and a higher level of advertising costs because of the greater level of competition. Our G&A costs are also up in excess of $7 million because of the higher project write-offs.

On the corporate side, our percentage of revenues is down from 2.4% a year ago to 1.8%. Actually down in absolute dollars almost $9 million. This is primarily due to reduced compensation costs related to our efforts to reduce costs in view of declining market conditions.

The next slide actually shows, which I thought you would find interesting, what our G&A has been doing for corporate and home building on a sequential basis since the third quarter of last year. You will see that on the corporate side, our G&A is actually well below where it was a year ago since we talked, and we've seen sequential declines throughout this year notwithstanding the fact that we're overcoming approximately $3 million per quarter in additional costs we did not have last year with respect to expensing stock options under Section 123R, excuse me, FAS 123R.

On the home building side, while we're up year-over-year, primarily due to the higher levels of project write-offs, we started to see sequential declines here in the last couple of quarters, so here again, our efforts to reduce costs are starting to pay off.

On the financial services side, we continue to see our financial services in other segment continue to strengthen. We realized profits this quarter of $13 million compared to $9.6 million a year ago, that's up 35% primarily related to higher gains on sales of mortgage loans which are up 21%.

These higher gains resulted due to the higher level, actually record levels of mortgage loans originated in the quarter. We originated $541 million in mortgages, which is up 15% from last year which is due to the fact that our capture rate is up significantly because we're offering more products to our homebuyers as well as we're seeing higher loan balances attributable to the higher average selling prices on the home building side.

On the balance sheet as Larry said, it continues to be a priority for us. Our equity is up to $2,167,000,000 up 23%, we've made no stock repurchases during this quarter. Our book value per share is just over $48 a share, up 22% as well.

Our cash and borrowing capacity continues to grow. We're at $1,356,000,000 here at September 30th, which is 25% higher than it was at this time last year.

And our debt to cap ratio continues to decline as we preserve our capital for future opportunities. We're sitting now at a home building and corporate debt to capital of 28% here in the quarter compared to 34% at this time last year and a peer average of 44%.

We do have here within the slides a reconciliation of our home building and corporate debt to total debt and capital. We have a slide here as well that we've added on cash flow which I think is a very positive picture for us and for you to see.

On the operating cash side we generated $71 million in operating cash flow this quarter compared to $229 million used in the third quarter last year. Year-to-date we have used $516 million less than we did year-to-date last year.

Here in the third quarter, we have, we've shown a reconciliation to free cash flow, we actually generated $57 million in free cash flow this quarter versus $243 million negative free cash flow a year ago, and we are as of September 30th, free cash flow positive over the last 12 months.

Our orders for the quarter, 2,120 orders received in the quarter compared to 3,551 a year ago. The average sales value of our orders received this quarter were $678 million compared to $1.223 billion a year ago.

We saw really every market in terms of orders down, due primarily to reduced homeowners in each market and a significantly higher level of cancellations. Our can rate in the quarter was just short of 49% compared to 25% last year.

Cans were up in every market, except for Nevada, Colorado, and Texas, and they're up over 1,000 basis points in every market but Utah. The highest cancellations here in the markets you might expect where we've seen significant competition that being Arizona, Virginia, Florida, California and Colorado.

The average selling price of our orders this quarter was $320 million roughly, compared to $345 million, excuse me, $320,000 per home compared to $345,000 per home at this time last year due to a smaller share of orders in California and Virginia, and we've also seen the impact of some of the higher priced homes cancelling. This $320,000 per home is a net number, and we're seeing cancellations of higher priced homes.

Our backlog is also at a lower level than it was a year ago at 5,661 homes with an estimated sales value of $2.1 billion. This is compared to 9,078 homes a year ago with an estimated sales value of $3.3 billion.

Our average price in backlog is $371,000 per home, up from 362 a year ago, but we have seen sequential declines here over the last few quarters. So first quarter was 378, second quarter 375, and now we're seeing $371,000 here in this quarter.

We have also included the slide in this package to give you some idea of the different trends in pricing here. Kind of the leading indicators being the order pricing which has taken a dip here in the quarter, primarily because of the net effect and the effect that the higher priced cancellations are having, but the lower prices of our orders are causing our backlog pricing to decline while our closing pricing has continued to increase through this quarter but I think most of you have seen the correlations between the pricing and our backlog and the pricing and our closings on a lag basis, so that's something that should provide you visibility for the future.

In terms of active subdivisions we have 295 active communities at the end of this quarter compared to 280 a year ago, you can see where the increases have come. We've seen significant increases year-over-year in Arizona, California and Florida. These are offset by declines in Nevada and Colorado.

In terms of lot supply, we ended the quarter with 31,000 lots. That's down 28% from where we were last year and down 25% from where we are at the end of the year. Of the 31,000 lots we control, which by the way, this decline is by design to bring our lot supply more closely in line with our objective to keep a two-year supply under control at any one point in time.

Of the 31,000 lots, 11,000 lots are under option. We had those under control with $50 million in cash and letters of credit at risk and less than $10 million of other costs at risk in the association with those.

On terms of deposits, we have around $4500 per lot risk, and as we said before and as Larry said in his comments, this represents less 3% of our equity at risk for these lots under option.

That completes my prepared remarks. We'd like to open it up for questions.

Thank you. We will begin the question-and-answer session. We ask that everyone limit themselves to one question and one follow-up question to allow others the opportunity to speak. [OPERATOR INSTRUCTIONS] You first question is from Michael Rehaut from JPMorgan. Please go ahead.

Hi. Good afternoon. Just, I guess, two questions here.

The first, I was wondering if you could discuss the trends as they progressed throughout the quarter, if they got worse or if they were the same. And you know, if you could also kind of relate that to if any regions in particular stand out or if there have been any areas that you might have seen, you know, progressively get worse or that were relatively stable. And then I have a follow-up.

Mike, it's obviously the trend in this particular quarter would be positive from a seasonal standpoint. It usually is. I mean September is usually better than July, and I can't say that that's, that has not been the case.

We did run a couple of very successful campaigns, sales campaigns in September that helped our results in September, so whether that's the campaigns or the markets, it's hard to say, but certainly, we saw the markets respond very favorably to these campaigns. As far as whether any markets stick out, I can't say that there's anything that we can point to.

Okay.

And in terms of these sales campaigns, was this more on the incentive side or more just on the overall advertising and marketing, and as a result of these campaigns, do you expect your average order price to continue to decline?

This was a limited campaign, Mike. It was ten days campaign which we extended through the end of the month for a few extra days, so it was really, it was a marketing campaign that also had some incentives tied to it. So this was a limited offer, and of course, there will be others, but --

Okay.

And then I guess the second question regarding the impairments, you know, to the extent that you can talk about, you know, going forward if you think that this is sort of a level this roughly $30 million, if that's something that you might see continue, would you expect to see that continue for a quarter or two?

And if you could go into a little more detail into exactly, you know, what is the difference, I guess, between the impairments and the project write-off costs.

Mike, is this your follow-up?

That's it for me after this.

Mike, we do these impairments on a quarterly basis based on facts and circumstances that exist at that time. We cannot predict what may happen in the future because they would only occur if circumstances changed. And so we can't predict whether there will be a continuation of these.

These evaluations occur on a project-by-project basis in submarket- by-submarket within individual markets, and each one has its own separate demand characteristics. So this is a very extensive analysis that we do based on current facts and circumstances, so I could not predict what the results might be in the future.

As to the difference between the project write-offs and impairments, the project write-offs relate to projects which we have not acquired. They could be option deposit costs, feasibility costs, other due diligence costs that we have incurred and capitalized in anticipation of acquiring these assets and then we've subsequently determined that more likely than not we will not acquire these assets or in fact, the time has passed for acting on it.

So as for the impairments, they relate to lots that we actually own and are calculated pursuant to the accounting provisions based on our ability to recover, our expected ability to recover our investment in those assets.

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

Thanks. I basically had two questions, which is, I guess, good.

One was related to cancellation rate trend. Mike sort of touched on, I guess, some general trends, I wanted to focus specifically if you could on the cancellation rate either for the Company as a whole or for some of the key markets. Could you give us a sense for whether there was an upward trajectory in the cancellation rates or they we're fairly stable throughout the quarter, or just how it moved?

The, actually, Steve, they were fairly stable throughout the quarter.

And is that a figure that you're giving us, on what basis is that figure you're giving us? Is that as a percentage of orders, is that gross orders, is that a percentage, you know, is that your statement about cans in the regions or is that sort of a company-wide can rate or what is that number?

It's company-wide. Again, there weren't any significant changes that we could point to as being material differences between markets. As you can see, the markets I outlined in terms of the ones that were highest were a lot of our larger markets, and they're all experiencing a high cancellation rate and our cancellation rate, we calculate by reference to gross orders.

My second question relates to the issue of land margin. It seems to me that you're a bit of intriguing example in the group because we know, obviously, that things have been weak in the housing market for almost a year, and given your short land position, would I be wrong in guessing that if you made essentially all your money from the passive investment in land, and basically no money actually building the houses, that if the environment in the home building didn't improve over the next 12 months that by that time your margin essentially would be close to zero. Your operating margin for the Company, your home building operating margin would essentially be close to zero.

Are you assuming because --

I'm not saying that, I'm asking basically would that be an appropriate way of looking at your company in the event that you actually don't make any money from actually building houses?

I'm not sure where, you know, Steve, what you're saying in the beginning is somewhat odd in that we don't attribute much of our profits to the land because we buy the land very near, just in time and our land portfolio is fairly new and so very little of the land, of the profits that we make are related to the land. The profits are primarily related to--

Passive holding of land.

No, no but to building the house.

Oh, I see. Okay. I thought you meant very little of your profit is from the passive holding of land.

That's right. Yes. Because we don't hold it.

That's basically what I was getting at. I mean it just seems that there's, I think, a great deal of confusion as to what home builders should be worth, and there's a perception, I think, that builder are going to be reporting very scant to barely visible profits at all over the next year, you know, from some people's opinion, because they basically don't believe builders really make significant money from building the houses and your company seems to be a good example that sort of forces the hand of investors who would like to look at builders that way because you really don't have very much land profit, and particularly in another six to nine months, whatever you report would seem to be a pretty clean home building merchant builder-type margin and I was just sort of setting you guys up as an example as a company that whatever you report, I think about six to nine months is going to be a pretty clean home building type number, and land would be just gravy on top of that. That's really what I was getting at.

Okay. Well, I've got you Steve. I agree with everything you said.

Okay. Great. Sorry about the convoluted question. Talk to you later.

The next question is from Dan Oppenheim from Banc of America Securities. Please go ahead.

Thanks very much.

Wondering if you can talk about the incentives as a percentage of the average selling price of homes and how those trended throughout the quarter?

The incentives continue to trend up, and our base incentive has generally been around 3%. That's pretty much where we were a year ago, and I think we said in the last conference call that we were pretty much double that last quarter. And this quarter is probably a couple hundred basis points higher than that.

Okay. Thanks.

And then you had much higher community growth in Arizona relative to the Company as a whole. Given the challenges in that market, how do you look at your community counts going forward? Would you think about slowing that down and not adding supply to that market, or are you looking to more just work through the land that you have there?

Dan, we are, we have not bought much land in any market recently. That is a market that we feel like we are in pretty good shape in, and we have, we started this expansion before the change in the market occurred, and we have, we do have some projects that we will probably slow down on.

I mean we have the ability to conserve capital in multiple ways, either buying land or inputting dollars into development and where we have projects that may compete with another project we have that's moving at a slower pace we will slow down the development process of that land. So I can see this community count probably and we're not looking to continue to grow there to add supply to that market in view of what's happening in that particular market.

Having said that, there are still pockets within the Phoenix market that are doing quite well. The right place, the right price point, the right product are still selling very well in that market.

Okay. Thanks very much.

The next question is from Timothy Jones from Wasserman & Associates. Please go ahead.

Hi, Gary. Hi, Larry. A couple of questions, I only got two.

One probably you'll like the question is, can you give me the number of homes you have under construction and what amount of those are spec homes and how you classify a spec? That's my first question.

Okay.

And give it to me from last year, too, please.

Okay. Tim, we have 6600 homes under construction today.

Okay.

Last year we had 92 homes under construction.

Wait a minute. What?

9200 homes under construction.

I thought you said 92 homes.

No, 9200.

How much of those are specs on each year?

That's a number that we haven't disclosed.

I think you should because some of the guys are as high as 50% and I bet my bottom dollar you're way below that.

We are way below that, Tim. In fact, we're --

[Inaudible] percentage, what at 25%, 30? 25 I'd guess.

No. Tim, we have disclosed it, but we, it is something that we try to keep very, to a very low level.

And most of this is backlog and we still have part of our backlog that's not yet started, but anyway, it's a, the majority of these homes are backlog homes. What's also included in this is model homes are also included in this number.

Yes, you should probably pull them out. Okay.

The other number is, can you explain the deferred profits? I don't think I've come across this before, the $18.5 million, the $30 million you took from last quarter. I don't understand what you're doing there to tell you the truth.

Okay.

Tim, we had, there's an accounting provision called FAS 66 that requires you to, it creates a timing difference in recognition of profits on the sale of certain homes where our mortgage company originates a high loan to value loan. And that means somewhere between 85 and 95% loan to value, or 85 to 100, depending on what it is.

And the rules require that if you haven't sold that loan by the end of the quarter then the profit related to that house must be deferred until the loan is sold. So it's purely, since we sell most of our loans within 30 days it's really a pure timing difference.

We had deferred at the end of last quarter $30 million related to homes that closed in the second quarter. That immediately was recognized primarily in July and so the $30 million turned around in the third quarter, but then we ended up deferring $18 million approximately of profits related to homes closed the third quarter. So net effect is a positive of $12 million.

I understand the FAS 66. What I don't understand is why am I not hearing other builders talk about this?

Is your number a lot larger compared to your total company, or why are you bringing it up? I don't see other builders mentioning it.

You're right. It is typically, it's not a material number to most. It was material to us in the second quarter. It affected us in prior quarters, but it was not material so we didn't talk about it either.

Why did it become material?

Purely timing. And I mean we had a lot of loans at the end of the second quarter that we hadn't sold. We don't gear our business around this recognition issue, Tim, because this is pure timing.

We time ourselves and mortgages according to the highest profits we can receive from that sale, and if it occurs before or after the end of the quarter it doesn't matter to us from a business standpoint, the accounting will take care of itself.

Can a bear say, and I'm not a bear, obviously, but could a say that you're actually taking more risky loans by giving these high, these low down payment loans?

No. No. We're not doing something that other builders are not doing, and the FICO scores that we continue to see from our borrowers are still as high and, in fact, slightly higher than they were a year ago.

What are they?

They're in the 730 range.

Very good. Thank you.

You bet.

As a reminder, we ask that everybody limit themselves to one question and one follow-up question to allow others an opportunity to speak. The next question is from Ivy Zelman from Credit Suisse. Please go ahead.

Wow. I thought you guys were trying to keep me off or something. I had too much coffee so I'll try to go slow.

With respect to my first question, I hope it's an easy one. What are your gross margins in backlog, roughly?

Ivy, that's an easy question for me because I know it but I can't tell you. I mean it's not something that we talk about.

Directly, should I assume based on the order pricing being down that it will be down in a several hundred basis points?

I don't know, I think directly, you're seeing the margins move down. How much is really a question mark.

You know we had, you heard some of the markets that I talked about that are moving down. Virginia has just started to move down, and Arizona, which has, you know, we know what's going on, we all know what's going on in Arizona. That has not really filtered through the income statement as yet and so that's yet to come.

Okay. I won't push you further on that.

If we can look at your land that you've written off and the abandonments, can you tell us the timing of when those underwritings were approximately priced?

Sure. They were for the most part '04, '05 acquisitions.

'04, '05. Was it split evenly or more skewed to the '05?

It's pretty even.

Okay. I guess I'm asking a lot, but we're doing it quickly so I view that the same. If you look at your cans what percent of them were at closing?

You know what, it is, there were a lot of them that were very late in the process. In fact, we're seeing about, this quarter, about 60% of our cans were very close to the end, certainly, after 90 days, so we're seeing a major shift to later cancellations.

Okay. And then one more quick one.

In terms of your quarterly profit breakdown that you've now filed with the SEC, you indicated you were breakeven in the southeast region. I believe it was the southeast region, one of your markets, regions you were breakeven.

If we're understanding what's going on in those markets, can you elaborate a little bit to give us a better sense that you are still making money on building houses?

We actually don't have a southeast region, Ivy, we're showing--

Whichever region you called it, but you broke even in.

Okay. In the other home building?

Yes.

[Inaudible] our Mountain and our East and Other includes mostly our startup markets, it includes Texas, it includes Florida, includes Delaware Valley, and includes Chicago. So those are markets that are still kind of getting rolling.

So you're breaking even in those now and as the markets, all within that category, is there some that are profitable significantly more than others are in the red?

Actually this quarter, Ivy, we're showing $4.7 million loss in other home building. Obviously, Jacksonville, where we are the largest, or one of the top two largest single-family builders in that market is the most profitable of that group.

I'm trying to understand, though, if you have all these markets in other, how many of them are profitable than Jacksonville?

Jacksonville is really, the other markets are still finding their way. We're not real established in the others, we're still kind of in startup mode so Jacksonville is the profitable market.

You're also seeing the impact of Texas in there and we are working our way through Texas. We sold some assets there over the year and so that, too, has had some negative implications on that particular segment.

Great. Well I took up more than my share. Thanks.

The next question is from John Emerich from Iron Works Capital. Please go ahead.

Thanks. First question, it's just kind of rephrasing I think what other folks have kind of circled around.

If you look back at the last six years, all of which, I think, have been pretty good for home building, you had a three year period, let's say, where the gross margins were in the mid to high teens or something like that, or mid teens, and then they doubled in '03, '04 and '05. You have a short real estate book so while it was beneficial it wasn't nearly as impactful, probably, as other companies, but home prices in general kept rising.

I guess my question is, is there, longer term, I'm not talking about next quarter, longer term, is there any reason that gross margins won't kind of revert back to the average over the last ten years?

That's a, it's hard to answer that question because I mean so much has changed over the last ten years for us in improving processes, focusing on, our leverage is so much lower than it was ten years ago and I think part of what you're seeing with us is not just a, just the effect of improving markets, but improvements to our business that have given us the ability, I believe, to achieve higher margins on average than we were back in some ten years ago.

We did not have design centers ten years ago and now we've evolved to a design center on steroids with our home gallery where we're contributing somewhere around 3.5% to our margins that we didn't have ten years ago. So that combined with our national purchasing efforts, and our improvements on processes, and our rebate programs and things of that nature should give us some positive implications relative to [inaudible].

Ten years ago you're right, wasn't fair. I mean if I just talked about, you know, four or five years ago, '01, '02.

And not just you, I'm just thinking about you and the environment, the home building industry in general go back just to '01 and '02, where I think margins were, you know, I don't know, a few hundred basis points lower than they are even at this current run rate. I'm just wondering why that isn't where we kind of settled if you will?

Is there any logic, is there anything fundamentally, you know, from a, you know, make it up, [inaudible] prospective a positioning that home builder have today that is so different from three, four years ago that margins won't go all the way back to where they were in '01 and '02?

Again, I think it's very hard to generalize, and we all have different strategies. You know ours gives us the ability to move in and out of markets that are doing better or worse and that ability to be nimble gives us an advantage to take advantage of markets that grow quickly, like a Phoenix or like a Vegas or like a Salt Lake City, and then all of the fundamental changes to the way we run our business, whether it settles there or not, I think our hope would be to do better.

A lot of it has to do with where you're operating at what time and what volumes. So many factors.

I appreciate the color.

My last question will just be, you mentioned your quote unquote newer markets that are breakeven on average and you threw out Texas, Chicago and Delaware. Are Chicago and Delaware markets that you consider to be, have better prospects for improvement from this level than the more, the markets that have kind of dominated your geography in the last couple of years?

You look at those as being superior opportunities less downside, more upside in the next couple of years?

First of all, just to clarify, in terms of breakeven, you're talking about the 9-month period ended September 30th where these markets that are in the other home building segment are showing a breakeven. And yes, I mean it is primarily made up of newer markets.

We do believe Chicago and Delaware showed demand characteristics that give us, you know, we are hopeful that these will be markets for the future when the market in general begins to turn. Now these are markets that we hope to grow in and will be part of our expanding footprint when the market conditions return to more closer to normal.

Thank you very much for your time.

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

Hi, Gary. Thanks.

I was hoping you could discuss the five communities in California in more detail, like where they are, price point, as well as kind of walk us through the math of what prompted you to take a write-down on those?

These, Alex, I guess, I really can't get into specific details. They we located, some in the north some in the south. They were in a variety of price points as well and the write-downs were really related to specific actions taken by our management to move product in those particular markets.

What put them kind of over the line for purposes of the impairment were steps taken to increase absorptions primarily where we added some incentives and we did this to generate higher interest and those efforts we hope will be successful, but those are reflective of where we think the market is now in those particular subdivisions in those markets.

Could you be a bit more specific as far as, for example, Southern California, and does that imply, does your answer imply that you're basically breaking even or losing a little bit of money after the incentives?

After the incentives on those particular projects, we were losing money. And so we actually, I mean the first test is kind of a gross margin analysis and if you're losing a dollar, then you have to create, calculate an impairment based on some discount rate depending on the risk and the project. And so for those particular projects, we were losing money after the incentive.

Okay. Got it.

And I guess my second question is, I guess of your markets can you kind of help us understand which maybe top two or three you're seeing your biggest price declines in orders or biggest incentives that you're having to offer?

Percentagewise, it's probably Arizona and Colorado are our two highest from a percentage standpoint. You know, and that's market-wide. The, Colorado has been relatively high relative to the rest of the Company for most of the last five years and that has continued.

Our Arizona markets have typically required higher levels of incentives even in a good market because that's what the market requires, but today, those incentives are probably at the high end of what we're offering. Dollarwise it's probably more in California just because we're dealing with higher average selling prices.

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

Just wanted to talk to you about the average deposit per percentage of the purchase price and if that's any different than last year.

Joel, the average deposit is, by homebuyer, is between 7500 and $8000, and it really hasn't changed.

So it's still running right around 2.5% or 3% or so?

Yes.

And then just if you could talk a little further on the Colorado market. I mean even with the community countdown on absorption rates for down about 48% year-over-year, and it just seemed like a year ago it was pretty week. And just was wondering why there's just so little demand in Colorado?

The, as to why, it's a bit of a mystery. I mean we have job growth in a positive way here for the last couple of years, and it's a vibrant community, you would expect there to be more on the home building side, on the new home side, but we have seen MLS listings rise, foreclosures on a per capita basis are the highest in the country, and there's still some uneasiness about, I think we still have a lot of buyers sitting on the sidelines.

We've got close to full occupancy on apartments, and so there's a lot of renters who, or a lot of people who are renting and kind of waiting it out. You've got interest rates that are moderating and there's no real sense of urgency right now.

Thanks a lot.

The next question is from Randy [Raisman] from Durham Asset Management. Please go ahead.

Hi.

As I kind of stepped back for a minute and listen to everything you guys have been saying so cancellation rates were up pretty, you know, significantly, ASPs are coming down, and you're kind of saying no markets are really sticking out at all. I mean is that basically lead, I mean that kind of that leads me to conclude that it doesn't seem like anything's really stabilizing at this point and I just wanted to kind of get your guys' perspective on that.

Stabilizing is, I guess there's a difference between stabilizing and continuing to decline. There are I can't say that we have, are necessarily seeing declines at a faster pace.

I think some of the competitive factors we're seeing in terms of the listing of resales started to moderate in some of these markets. We're hopeful that translates into a greater level of demand for the new homes as our buyers are better able to sell their own homes right now.

But at this point, it's going to be a difficult time period to measure any change because we're headed into a seasonal down cycle right now and it will continue to cycle down through December. So the best indications for us as to where the market is, will come as we start our selling season campaigns in late January and February.

And then are there any indicators that you would advise people to look to to kind of, you know, a couple key indicators that you think would signal sort of where things are heading or when things are going to turn? Where would we see that?

I think that, of course, we see information every day and every week. We see traffic reports and we see sales reports and cancellations are reported on a regular basis. You all do not see that, but you see it on kind of a lag basis.

I think that the thing that a lot of people are focused on is what's happening in the resell market. That comes out every month.

You could drive by the parking lots of some of our subdivisions on the weekends and if they're full, it's changing, but there's just a lot of factors out there and so many of them come in so late that it's hard to see, but there are some reports in markets like Vegas and Phoenix that report every week, sales activity, and we certainly look at that and that reports by subdivision, by home builder within those markets what's going on and those are great indicators of what's happening in those markets. It's not available in every market, but those two markets in particular.

That information is very helpful. Thanks.

The next question is from Scott O'Shea from Deutsche Bank. Please go ahead.

Yes. Thank you.

Should we expect to see another buildup in cash towards the end of the fourth quarter?

Well, the fourth quarter is usually a period where we close a lot of houses. We're not starting a lot of homes because we, typically sales are slower, so it's usually a pretty good period for cash increases if you look at our history.

Okay.

The cancellation rate, is there anything in the mix of cancellations that would suggest that it's peaking? You mentioned that 60% is coming later in the process. Do you think that signals maybe that we're getting into the peak here in the third and fourth quarters or is it just still too turbulent to really call?

I would not want to call it based on what we're seeing. You saw the can rate deteriorate somewhat from where it was in the second quarter, and so while it's not, it's not changing as dramatically as it has in the past, it still hasn't really stopped, stabilized.

That's helpful. Thank you.

Next question is from Dan Oppenheim from Banc of America Securities. Please go ahead.

Thanks. Just a quick follow-up.

Was wondering about the other 3,000 owned lots you have in California. Assuming that some of those are near the communities where you took write-downs this quarter, how are you looking at those? What levels of incentives and pricing are you assuming when not writing those communities down?

Well, Dan, there's 3,000 different answers to that question, because we have to look at it community by community and sometimes lot by lot. We're obviously watching it very closely, but to this point, we're either selling in those communities or we're about to open and test the market with it. When we do these evaluations, we base it on what we're doing today and where management thinks the market is based on our experience in those communities so it really is, there can be no general answer to that.

There are pockets in all of these markets where we're selling houses where it's the right price point and the right product and the right location, and we feel like we have a lot of that because we do focus on A, locations first when we make acquisitions. But we will continue to watch it and if the markets, submarkets and conditions change, we will take appropriate action in the future.

Thank you.

Next question is from Wayne Cooperman from Cobalt Capital. Please go ahead.

Probably a little repetitive, but I was off for a few minutes.

Your balance sheet's in great shape. I mean, are you guys waiting for some bells to ring? Is there a market that you're looking to add land to or at what point do you just start buying back stock because you're close to book value and that's the best return of cash?

Wayne, we are continuing to carry out the strategy that we've talked to you about in the past. We are, you know, maybe we are waiting on some bells to ring only very softly, so we're the only ones to hear them and we're watching every indicator in the markets to see where the opportunities will pop up.

We know they'll be there, we just don't know when or where, but we're open to just about everything, and on the stock side, it's, we're in the same position we were. We need to preserve our options in all respects at this point in time until the market becomes more visible to us.

But I guess the question is, if you're buying back your stock close to your book value and that end up being such a good return that you're willing to do that and step up?

Well, you know, it's not to say that we wouldn't. We do have an authorization out there but as to when or at what time we do that and at what level, it's, I think we're still sitting and watching what's happening out there.

All right. Thanks.

The next question is from Margaret Whelan from UBS, Please go ahead.

Hi, guys.

Hi there.

Just trying to get a sense for potential future inventory coming into the system. It seems that based on some of our channel checks that there are private builders were struggling today that probably won't make it through the spring of '07 and subsequently might be discounting more inventory. Can you give us a sense for that in your markets and at what point, as Wayne said, you would step up and buy some of them out?

Well, Margaret, can you rephrase that?

Are you having a hard time hearing me or understanding?

Yes, I am. I expected you to be the first one on the call, you always are.

I know. I missed my Wheaties this morning.

So the question is that, we've intuned to a lot of private builders over the last couple of weeks and they're really struggling to get through '06 and I don't think that some of them are going to make it through '07, especially through the spring selling season because there's so much inventory in the system and I'm wondering if you would agree with that and which markets the situation may be the most chronic in and as opportunities arise, to Wayne's question earlier, would you think about leveraging the opportunity and buying some of those distressed assets?

Margaret, I guess that I think that it is going, it is getting increasingly more difficult for the smaller guys. There's no question about that. We know what we're going through and we have pretty much all the capital that we need to operate in this environment.

They have to be coming under pressure, and I don't know if I can pinpoint a single market where it would be worse. I think Florida for sure and probably Phoenix, Vegas, California, north and south, probably maybe to a certain degree in Virginia, but there aren't quite as many smaller guys up there as there are in the other markets, but we, those are the kinds of things that we listen for and are looking for.

I can't say whether we would act or not. It would have to be the right opportunity but we see lots of things coming across our desk and at some point, those are the kinds of opportunities structured properly to fit into our box we would considerate at some point.

Would it make sense to buy some of those assets instead of putting new supply into the system with new communities?

That certainly would make, that could make some sense in some markets. It doesn't necessarily make sense to go in and compete with more subdivisions in each case because of the over supply in most of the markets. That could make some sense as well.

Okay. Assuming you can structure it properly.

Exactly. We're not going to, as we pursue these opportunities, we're going to need to maintain our disciplines, and so we believe we'll have some leverage to fit it in our box at the appropriate time.

Okay. Thanks.

The second question I have is just relative to your finance business and the potential for early payment defaults and not going to [inaudible] might create an inventory later? Are you seeing any signs of stress yet?

Not really, not really at this point, our default rates are still extremely low, and so perhaps as we've increased the level of second mortgages that we've originated, there's a greater potential there but still it's a relatively minor number.

Okay. Thank you.

Yes.

Next question, Ivy Zelman from Credit Suisse is on line with a follow-up question. Please go ahead.

Hi, guys. I'm Edie now.

Larry, you talked about the, I guess, lack of investment or declining investment in land. A lot of us are trying to understand where land is going, and I hear there's a no-bid land market out there, especially in places in Florida, in California, Nevada and in Arizona. Have you seen any pick up in interest in land at discounted prices, call it significant enough, at fire sale prices enough that you would be willing to step up?

We also hear that some builders are renegotiating option contracts sometimes twice and even three times because of values continue to decline or absorptions are continuing to slow. Just your big picture view of what's happening on the land front, please.

Is that to me, Ivy?

I guess so, or Gary can take it. Whoever wants to.

I know Gary wants to take it so I don't want to step in.

This is an unique opportunity for us to have the liquidity and be focused on how we run our business, and I'm sure over the next period of time there'll be opportunities for us to make attractive purchases of assets and I don't know when that will happen but we're open for business.

Okay. I don't know that you answered my question. You skirted it well, I give you credit for that. Maybe, Gary, you want to take a shot at it? You get a "D" on that, Larry.

Actually, I gave myself an "A".

Depends on who's grading it, I guess.

Ivy, we have heard of some renegotiations, I think all of us are participating in some of that in our markets, now, whether we, there may be some opportunities for us to pick up some of the pieces along the way, but right now, we have been, we're conserving our capital and we're picking our spots very carefully.

Is there a price, take a market like Jacksonville where you're dominant and, obviously, the market's held up maybe in that area better than other parts of Florida. Are you today willing to commit capital in Jacksonville on new land deals, not on things that you had optioned that you now have to decide whether or not you want to exercise it or not, are you willing to put new capital or sign new option contracts in Jacksonville?

That's a little bit more pointed. It might help you.

What we, it will have to be the right deal, and it will have to be priced at a point that gives us enough cushion for further decline in the market. We're looking at deals all the time in all of these markets, we haven't taken positive action on some of them, we have on others, we have tied some things up, but they're deals that set a different set of underwriting criteria, much tighter, much closer to the finish line in terms of the lots being finished, smaller take-downs, lower prices, and greater protection for us in the event that the market continues to decline, that being smaller deposits, and things of that nature.

So we're very, very selective but under the right circumstances with the right structure, we would commit capital on a limited basis.

Are there any markets, thank you, that's a good answer. Are there any markets, you get an "A" or maybe a "B".

Are there any markets that you would not even consider committing capital today because the market is, has got too little visibility or zero visibility? Anywhere, for example, southwest Florida, south Florida, places in California, where you would say I don't want to go there yet?

I'd say the only place we're not willing to commit capital today is Texas.

Anywhere else you're willing to buy right now at today's market prices?

We're willing to commit capital at a level at all markets at all times.

No, I know, but that's not my question, Larry. I'm saying are there prices right now in the market, land prices being prices offered to you on deals in other parts of the country where they're not cheap enough that you are not today willing to underwrite land because there's a considerable risk in your opinion? Are there markets that fit that bill?

I would say, Ivy, we continue to evaluate everything on a continuous basis and it's just like the stock market. It changes all day, every day with new information and we're increasing our liquidity, and I expect that we will be rewarded for the fact that we will have a high liquidity to take advantage of something of some scale at some time in the future, and that's what we'll do when it's right.

Got it. Okay. Thanks.

Did I answer you question?

Not really but I'll take it. It's okay.

Okay. Thanks.

The next follow-up question is from Michael Rehaut from JP Morgan. Please go ahead.

Great. Couple of quick things here.

Gary, you had mentioned, I believe, if I heard right that some of the resale listings in some markets have moderated and that you were hopeful that over time that might translate into a little bit of improvement in demand, I guess, from where we are today. II was wondering if you could highlight which markets you were referring to?

Well, for one, things seem to be, at least not growing as quite a fast pace in the mid Atlantic region. In fact, I think some of their statistics show it's down slightly in recent months, last couple of months.

The rate of increase has diminished in some of the other markets including, I think, Phoenix. Phoenix grew so quickly over a 12-month period and it's started at least to not grow at quite the same pace, same thing in Las Vegas.

Great.

And in terms of getting back to the impairments in California, can you give us an idea by what percent you wrote down the assets in those markets? Or overall what that $20 million of write-off represented as a percent of the original cost basis? Or the investment on the balance sheet?

Mike, it's varied so significantly project-by-project, that depending on we had a couple of small projects that had primarily lots that were being built on, we had other projects that were in the process of being developed and each one is, you know, you've house investment in some and lot investments only in others and partially developed and fully developed, there just really isn't a metric that makes a whole lot of sense that we could generalize on.

Even in terms of broad ranges? Would it, some communities be maybe 10%, 20% others be 30, 40% or more. I mean were there some that it was you're writing it down by half or?

I don't think I could, Mike.

All right. Well, I gave it a shot. Thanks.

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

Thanks.

I was hoping you can discuss how you guys are handling builders that are just pushing volume? I mean how are you, what's your strategy there?

We attempted to say something, but I won't say it.

We have a different strategy and we believe each company has to follow what they think they need to do and since we haven't speculated in land and we're not long in land, we believe that one of the things that we want to do coming out of this adjustment is we want to maintain the integrity and the value of a Richmond home and have it perceived by the consumer as what it is, which is a quality home that distinguishes itself.

And one could create a view that you could impair your perception of value of your product if you merchandised it or marketed it, I would say, in a way that looks more akin to the car business versus a home that's the most important asset that someone has, and I think people would like to protect both the real and the perceived value of their home and not look at it just as a commodity and I think that one of our commitments to ourselves and to our consumers is to do the best we can to maintain the integrity of our product.

Okay. I guess. Okay.

My second question is you mentioned that you guys ran some sort of campaign the last month or two that you found pretty successful. I was hoping you can go into more detail, you know, what that involved and how, what were the results of your success?

It was a pretty, it was a very high level, high quality campaign, both in print, media, on the Internet, and we called it 10 Days 10 Ways, and what we really did was talk about options and upgrades that you can add to your home and it was very well received in a very high level manner, and it dealt with different upgrades and enhancements of the home itself.

Okay.

You could probably go on our Web site and find some of it if you'd like to learn about it. Is it gone now? If you have an interest, we'd be glad to send you an ad or some of the marketing material.

Yes, I'd like to see it. I thought you guys had been trying to get some incremental buyers through lowering the deposits or something like that.

No.

Okay. Thanks.

There are no further questions at this time.

We'd like to thank you again for joining our call. We look forward to having the opportunity to speak with you again in January following the announcement of our 2006 full-year results. Everybody have a great day.

Thank you.

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