MDC Holdings Inc (MDC) 2007 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. And welcome to M.D.C. Holdings 2007 second quarter earnings call. At this time, all participants are in a listen-only mode and later we'll conduct a question-and-answer session with instructions being given at that time. (OPERATOR INSTRUCTIONS)

As a reminder, today's conference is being recorded. I would now like to turn the conference over to your host, Mr. Joseph Fretz, Secretary and Corporate Counsel. Please go ahead, sir.

Before introducing Larry Mizel and Gary Reece, it should be noted that certain statements made during the 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 2006 Form 10-K. It should also be noted that SEC Regulation G requires that certain information accompany the use of non-GAAP financial measures. Any information required by Regulation G will be posted on our website, MDCholdings.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 2007 second quarter conference call and webcast. As many of you know, our friends at Ryland will be discussing their latest earnings in about an hour. To allow you to participate, we'll end our call today no later than 1:00 P.M. Eastern Daylight time. As you've heard from a number of our peers and various media sources, homebuilding market continues to show little or no improvement in the 2007 second quarter. In an effort to preserve our backlog and generate new homeowners at a pace consistent with current market conditions, we increased incentives and lowered prices at many of our projects across the country. While our efforts did achieve some success, they also resulted in a substantial additional impairments to our inventories. These impairments comprised the bulk of our operating losses for our 2007 second quarter and for the first six months. While we're aware of the difficult conditions faced by our industry today, we realize that we cannot single-handedly change the market, nor can we accurately predict when the eventual recovery will occur. But we can continue to prepare our company to take advantage of the opportunities that we believe will be present as markets begin to stabilize. Strengthening our investment great balance sheet remains our primary focus, which is evident in our results.

During the second quarter, we reduced our lot supply by 15%, allowing us to generate $50 million in operating cash flow. We did this during a period which typically requires the use of substantial cash to prepare for higher deliveries later in the year. This quarterly amount increased our total operating cash flow over the last 12 months to $675 million. We ended the quarter with almost $1.9 billion in cash and available borrowing capacity including $668 million in cash on hand, greatly enhancing our capacity to react to changing markets. Our ability to capitalize on an industry turnaround will depend not only on our financial strength but also on our success in streamlining our operations and transforming our company into a more efficient customer-oriented business.

In the second quarter, our G&A expenses declined by more than $35 million from the same period in 2006 as we resized our operating and administrative infrastructure. Even as we reduced our overhead, we continued to invest in key initiatives designed to enhance future profitability for our company. These initiatives included unbundling our construction cost to identify opportunities for savings, as well as examining our construction process to streamline the material supply chain, reduce cycle times and improve inventory terms. We focused on enhancing our systems, processes and procedures and have provided valuable training for our employees. We furthered our efforts to create an extraordinary experience for homebuyers through the wide selection of product offerings at our home galleries across the country and through the roll-out of our customer experience initiative nationwide. As our industry continues to work through this cycle, we'll continue to exercise discipline in running our business every day. Our ongoing efforts to adjust our overhead land supply to current market conditions, develop more efficient customer focused operations in each of our markets and preserve our capital for future growth should further our goal in maximizing long-term shareowner value. I would like to now turn this call over to Gary Reece, our Chief Financial Officer, who will describe more specific financial highlights of our 2007 second quarter.

Thank you, Larry. During the second quarter, we recognized a net loss of $106.1 million, or $2.32 a share on $716.7 million of revenues. This compares to net income of the second quarter of 2006 of $76.5 million or $1.66 a share on $1.232 billion of revenues. Our pretax operating loss here in the second quarter of $171 million was essentially comprised of the asset impairment charges and project abandonment costs we recognized during the period, totaling $167.5 million. For the six month period, our pretax loss of $314.7 million, primarily comprised of impairment charges and abandonment costs totaling $312.9 million for the six-month period. The decline in earnings from the second quarter of last year to the current period is essentially due to these impairments as well as lower home closings, lower average selling prices, lower home gross margins as well as lower profits from our financial services segment. These are partially offset by lower SG&A costs. I would like to talk briefly about each one of these. Impairments I'll hold until later.

In terms of closings, we closed 2,031 homes in the current quarter, 40% below where we were last year. Primarily, the decline resulted from a lower beginning backlog which was down 41% from the backlog beginning in second quarter of last year. Our conversion rate of that backlog in the current quarter was actually up slightly at 48% of our beginning backlog. We were down in closings in all of our markets, with the largest declines coming in our western segments comprised of Nevada, Arizona and California, where we were also down in excess of 50% closings in Colorado. In terms of average selling prices, we saw a decline for the first time in a number of quarters by $13,400 per home to $338,700 -- down from $352,000 in the second quarter of last year. We saw significantly lower average selling prices again in our western markets -- California, Nevada and Arizona -- but also saw very large declines in Virginia and Maryland. While these were offset somewhat by prices peaking in the Utah market, up $78,000 per unit, we were also up slightly in Colorado.

In terms of our gross profit margins, we saw margins of 14.1% compared to 23.3% for the second quarter last year. Margins were actually down in all markets except for our Delaware Valley market, which is starting to percolate a bit there and starting to gain some footage in that market. The decline year-over-year is really due to the higher incentives that are required to be offered in this competitive environment as well as higher land costs relative to land sales -- home sales revenue. These increases in costs were partially offset by the fact that we did see an $18.8 million reversal of some of our impairments that we've taken year-to-date, which represent about 270 basis points relative to our margins.

Also contributing to the decline in profits this quarter are the lower financial services and other profits, which were down some 60% from where they were last year -- really attributed to lower mortgage lending profits which resulted from lower gains on sales and mortgage loans. These lower gains were a result of the lower level of closings, as well as a slightly lower capture rate from the year-ago. We had a capture rate of 72% this year versus 75% a year ago. Another contributing factor to the lower gains though is a change in our execution strategy in terms of how we sell our loans. We're selling them faster in order to mitigate some of the risk of holding these loans longer. And the gain is a little bit smaller, but also the risk is lower as well. And we did start to see a fairly significant shift in risk with regard to this business during this quarter, and particularly from last year. We saw our fixed rate loan originations increase to 83% of the total. This is up from 48% in the second quarter last year and up from 68% in just the first quarter of this year. Our prime loans as a percentage of the loans we originated jumped from 58% in the second quarter to 86% of the total, while our Alt-A product dropped from 35% in the first quarter to only 5% of our total originations during this period of time, and we originated no subprime loans during this period of time -- which, in the past, has been fairly small in any case. Our loans with second mortgages also dropped from 52% in the first quarter down to 30% and as a result, our loan to values have been coming down. They were approaching 90% earlier this year and are now down back into the mid 80s. And FICO scores continue to remain in the 720 to 730 range.

As I mentioned earlier, the largest contributor to our declining profits is impairments. During this period here in the second quarter, we recognized impairments of $161.1 million. We also had some project abandonment costs that we recognized for $6.4 million. The impairments were really the result of higher incentives, lowering of selling prices in view of price movements by our competition, and also to sell homes at a market pace in each one of our markets. And this contributed to a total for the year in impairments of $314.7 million. 82% of our impairments this quarter came in our western segment, which is California, Arizona and Nevada -- with California alone being 48% of the total. These impairments in California occurred primarily in outlying areas like the Antelope Valley, the High Desert, Riverside County, and San Diego -- up north in the Central Valley, Fairfield and Brentwood. We also saw 23% of our impairments in Arizona, being the second largest impairment location in the outlying locations like Maricopa and Casa Grande. The impairment impacted some 4,400 lots and 83 subdivision. 22 of these 83 subdivisions had been impaired previously. The assets that were impaired, preimpairment were in excess of $600 million and after impairment, they represent a total of $448 million of assets on our balance sheet currently. So, our impairment actually resulted in a reduction of impaired inventories of approximately 26%. So, this impairment this quarter brings our total to date to $414 million, combined with $35 million in write-offs with the turnaround that we've seen so far -- we've turned approximately $28 million of the impairments. And of the total impairments, we have impaired approximately 40% of the 20,600 lots we currently own.

I would like to, as we talk about this, I want to make it very clear that we do evaluate all of our lots, each and every quarter. And our evaluations for impairment of the 20,600 lots and homes under construction we own to June 30th were based upon absorption paces, prices and incentives that reflect our perception of current market conditions. As a result, for purposes of this impairment, none of our lots or subdivisions have been deemed to be held for development or construction in some future period when theoretically, market conditions might be improved.

Offsetting these declines in profits, as we mentioned earlier, is a reduction in our SG&A. Our SG&A declined some 22% here in the quarter, which represents $48.1 million. The bulk of this decline is actually in the G&A category as Larry mentioned. Our total G&A in the company declined to $80 million which is down 31%, primarily due to reduced salaries and bonuses as well as benefits from our rightsizing efforts as we lowered our head count from some 3,900 employees to June 30th last year to 2,700 June 30th of this year. We've also combined a number of divisions and regions during this period to streamline our operations. We've gone from some 26 operating divisions in the homebuilding side to 19 operating divisions as of June 30th.

Turning to other activities during the quarter -- orders. We received orders for 1,970 homes, which is down 28%. The estimated sales value of those orders was $653 million, which is also down some 28% from last year, giving us an average price which runs in the low $330,000 range, which is approximately the same as where we were a year ago. Our orders were down on a net basis in all of our markets except for Illinois. We saw the largest decline coming in our Utah market, as conditions in that market have started to come off all-time highs from a year ago. Arizona was -- had a relatively strong quarter, being down only 10%, Maryland being down only 6%. Our estimated cancellation rate during the quarter was just under 44%, which is very similar to what it was a year ago. As a percentage of beginning backlog, the estimated cancellation rate was 36.6%, which is down sequentially from the first quarter -- which I might add is the first sequential drop, albeit only 0.5 point, but still the first time this has dropped since the middle of 2005. These lower orders contributed to a backlog of 4,134 homes, which is 36% below backlog of a year ago with every market again being down in terms of backlog. The estimated price for that backlog also dropped 39% to $1.480 billion.

Our lot supply continues to stand among the industry's lowest. We ended the quarter with 21,000 lots controlled, which is down 15% from the end of the first quarter alone. It is down over 40% from June 30th of 2006. We owned 15,259 lots at the end of the quarter, which is down 32%. We controlled 5,747 lots under option, which is down 70% from where we were last year. And with the control of those lots, we only have about $23 million of deposits at risk and only another $4 million or so in other costs that have been capitalized with respect to lots that we're looking at. So, we're in a great position to react to opportunities on the lot acquisition side as they are presented in the future.

The next slide shows a makeup of our cash flow over the quarter. Larry mentioned the fact that we had produced again positive cash flow from operating activities in the quarter, this time reaching $50 million. We saw really the major contributor being changes in our inventories and while we did increase our work in process inventory by $140 million, we did lower our land inventories irrespective of the impairments by approximately $160 million. Those were -- that was a large contributor to this positive cash flow. Year-to-date, we've generated just short of $200 million of positive operating cash flow, and over the last 12 months, we have accumulated $675 million in positive operating cash flow. And as Larry mentioned, our balance sheet and financial position continue to be a primary focus for us, and the results speak for themselves. We ended the quarter with cash and available borrowing capacity of a $1.889 billion, which is up 44% from the same time a year ago. Our debt to cap ratio, including all debt and capital, increased slightly from a year ago to 0.36 from 0.35, but when you -- and we've done a reconciliation in the press release to show how this is calculated. The way some of you look at it and excluding cash and mortgage lending debt from that calculation, that number has dropped to 0.14 in terms of this net debt to cap ratio compared to 0.30 at this time in 2006. That concludes our prepared remarks. We would like to open the floor for questions.

Thank you. (OPERATOR INSTRUCTIONS) Our first question will come from the line of Michael Rehaut of JPMorgan. Please go ahead.

Hi, thanks, good morning, everyone.

Good morning, Mike.

Or good afternoon here. Good morning for you. First question is on the impairments and then I have a follow-up. Just got off another builder's call where in making the assumptions for how much to impair land, the builder actually made assumptions that home prices would continue to decline and that the pricing over the next couple of quarters would actually be worse than current. I think you said that in your analysis in terms of how much to impair, you were looking at prices more at current levels. Any reason not to get even a little bit more conservative given where we are with inventory levels still remaining at excessive points?

Mike, I think that we have carved out our position from Day One that we will base this analysis on what we know. We don't -- what we don't know is how far they may decline if they decline further and to what extent we'll have to raise incentives. There are limited circumstances where we have -- in certain subdivisions where we've had difficulty finding the market and have had difficult selling houses. And in those circumstances, we will have to -- we will take a conservative view on where we think prices or incentives will have to go in order to sell houses at a market rate. But we believe that this analysis is to be done based upon known pricing and incentives. That's what we have based it on from Day One.

Thank you. Our next question will come from the line of Stephen Kim of Citigroup.

Hi. This is [Johanna Ross] for Steven Kim. Was wondering if you could comment on the trends you saw for the quarter in terms of sales base or cancellation rates.

We have not really gotten into those trends. I mean it would be hard to say what happens in one month is definitive on what's going to happen for the rest of the year or the cycle. This is a -- despite what's happening with the cycle itself, this is a slower period of time in general. And from a seasonal standpoint, things tend to get slower as they go through the summertime. So, I think that to -- from our standpoint to comment on it could be really misleading.

Thank you. Our next question will come from the line of Alex Barron from Agency Trading Group.

Hi, Gary. Hi, Larry.

Hi, how are you?

Good.

Where are you?

Where am I?

I'm kidding.

No, first of all, I wanted to say I think you guys did a very good job with your disclosure and the press release was very helpful. I wanted to ask you though how many -- do you have a breakdown of the communities by region, how many you impaired this quarter?

We do. We have not disclosed that information by market. I think it would flow pretty significantly along the lines of where the impairments occurred, with the bulk of the communities that were impaired occurring or located in the west. California being the most and then followed by Arizona and Nevada.

Thank you. Our next question will come from the line of Joel Locker of FBN Securities.

Hi, guys. Just -- you're one of the only builders looking for land. I just noticed your land under development went down about $280 million sequentially. It doesn't look like you're finding much that pencils in at current home prices. Is that fair to assume?

Joel, that is fair. At least $120 million or so of that decline was a result of the impairment. $157 million is a result of decline in the land balances. We did buy some land in markets like Utah and Colorado and it's spread throughout the country but it is very limited. In terms of what we're buying and we're -- we are on the active hunt for land, but you can see the net results of our efforts.

Thank you. Next we'll go to the line of Dan Oppenheim of Banc of America Securities.

A question that's actually related to that. Wondering if you would look at land and your need for it over the next couple of years -- when you've been looking at the deals that are out there at this point, what's the difference in terms of what you would be willing to pay versus what you think sellers are looking for at this point?

Well, Dan, it varies by market. There's clearly a disconnect between what we would need to see to make a purchase versus what the sellers are willing to sell the land for. I think that there's still, in a number of markets, there is a sentiment among the land sellers that this cycle may be short-lived. And in markets such as Las Vegas, which are severely land constrained, they know it is land constrained and they have staying power to wait it out. So they're not really willing to come down to levels but it could be -- it could vary anywhere from, depending on the market, anywhere from 10% to 30% in terms of the gap between what they're willing to sell for and what we would buy it for.

Thank you. Next we'll go to the line of David Einhorn of Greenlight Capital.

Actually, those were my questions. Thanks so much.

Next we'll go to the line of Jim Nelson of JMP.

Or Jim Wilson. Good morning, guys. Gary, thanks. I know you gave the gross margin you had seen ex the impairments in the quarter. Can you give any thought or color to the orders you've taken recently, particularly the quarter -- how much if different the gross margins by looking those orders that you've taken recently?

Jim, it is very difficult to use that as a basis to predict. You know, we're finding that cancellations are still very high and we found that a very high percentage of our sales -- homes that close and homes that sell during the period are actually on a spec basis and we -- you would anticipate that the impairments, with everything else held equal that sales of lots, sales of homes on projects that have been impaired, you would expect to see all else held equal for those margins to be higher. It varies very significantly project by project and market by market. So, we would not be able to lay out anything definitively at this time.

Thank you. Next we'll go to the line of Carl Reichardt of Wachovia Securities.

Morning, guys. How are you?

Hi, Carl.

Gary, I was curious about the Colorado-related impairments. Seems like it is a market that's been weak for a substantial period of time. Can you give us more color on that? Was there a change in more of your absorption estimations or your selling price estimations that drove that?

Carl, they kind of go hand in hand. Most of these impairments are in the northern part of the -- of our market. In areas that have -- are extremely competitive. Areas where we have seen other competition dropping prices or raising incentives and our absorption pace has not been acceptable. So, it is kind of a combination of -- really the absorption pace does not in and of itself create the impairment that impacts the discounted cash flow analysis so it impacts the degree of the impairment. So, it is really the fact that we've had to lower prices or raise incentives in order to achieve a level of absorption that we've deemed to be acceptable in that market.

Thank you. Next we'll go to the line of Tom Marsico of Marsico Capital. Please go ahead.

Thank you. Larry, I was wondering if you could take a look at this cycle in comparison to the energy crisis that was experienced in the -- through the energy build in the '80s, in the RTC period. And at what point do you think the liquidity in the market is causing problems? And if the FHA's ability to refinance subprime mortgages might help out the situation, there is an HR bill 1852 going through the House right now that would seem to get at this issue of the ability to refinance subprime mortgages.

In looking at the last cycle, you might say it is broadly defined of the '80s tailing off in the early '90s. During that period of time, we had a collapse in real estate market in general throughout the country -- not just housing but whether it was office or retail or warehouses. It didn't matter. There was an implosion of real estate in general. We also had the '86 tax bill. We had [FIREA] in '89. You had the S&Ls going broke. You had a real implosion in housing -- and housing just happened to be one of the assets. I think this cycle we find that at this point, the effect is in basically residential for sale and that it is not nearly as difficult as the '80s when it was a broad-base implosion of real estate values. And so I see the difference that it's painful now and it will continue that way until we eat through the standing inventory --whether it's new or resales. And the financing assistance that may be given through refi-ing some of these subprime and what not I think is a factor. But I think most important factor of the cycle deals with job creation, employment, a basically decent economy in our country. And even though it may have some liquidity effect now because subprime rolled into maybe the -- some of the securitization of other debt instruments, I believe it is something that we will work through. And, as usual, in all of these real estate cycles, those companies that are the strongest will have the greatest opportunity as the market corrects itself.

Thank you. Next we'll go to the line of Susan Berliner of Bear Stearns. Please go ahead.

I was curious about what had you talked about on the mortgage business about selling loans faster. I was wondering if you could walk through what the timeframe was before and what you're doing now as well as any potential for any loans to come back to M.D.C.

Susan, what we were doing previously is, in order to maximize profitability on the gain on the sale is we would generally accumulate these loans, and sell them in bulk. These packages could be $50 million, $100 million or more. Obviously to achieve those levels, we would have to hold the loans for a longer period of time. Which created -- it did a number of things. You would have a greater -- you would have some risk during the time you're holding the loans and then it would extend if you had an EPD, early payment default, period, following the sale, it would extend that some period of time as well. So, what we have -- what we're doing now is selling it more on a flow basis, selling it earlier in the process and that gets it off our books faster. And we're also, in many cases, able to sell it this way without early payment default exposure and so, just overall, it is a lower risk proposition.

Thank you. We'll go back to the line of Michael Rehaut of JPMorgan.

Thanks, actually all of my questions have been answered.

Thank you. And we'll go back to the line of Stephen Kim from Citigroup.

Thanks. Basically, I wanted to follow up on the response that you gave to Johanna which was basically saying you didn't want to comment too much on trends from one month's data. I guess the nature of the question was that we just got off a call where one of your major competitors was saying that they had taken -- obviously a big one -- they had indicated they had made significant adjustments on pricing. And I guess really what we're asking is whether or not you have seen some of the competitive pressures in a meaningful way, intensify due to pricing, whether you've actually heard any sort of feedback from your local operators along that front.

Steve, hi, it is Gary. I'll respond to that. In terms of talking specifically about orders, that's what I didn't really want to get into. I will say that we have -- that we did see approaching the end of the quarter, a -- kind of as we did approaching the end of the first quarter that competitive pressures did increase. We saw the need to move pricing and incentives as we -- our process of evaluating levels of impairments is one in which -- which we go through this very rigorous process in which we talk about every single subdivision with every division president around the country and talk about what their experience has been and what strategy they may have to deploy in order to pick up the pace if necessary. And we did see, in June, could have been seasonal, it could have been whatever, we did see the need to respond to some movement by some of our competition. We did see a number of subdivisions where we were not selling product, our traffic was low. We needed to do some things to generate traffic and so we were going to have to make some changes in pricing, lowering prices, increasing incentives -- and that those efforts are very much part of what generated the levels of impairments that we saw here in the second quarter. So, we did see competitive pressures increase and we responded accordingly and the result was higher level of impairments than perhaps what we would have seen had we done the analysis at the end of May.

Thank you. We'll go back to the line of Alex Barron of Agency Training Group. Please go ahead. Mr. Barron, your line is open.

Can you hear me?

Yes, we can.

Hi, Alex.

Okay, great. Thanks. I think the operator cut me off last time. Anyway, I wanted to ask you how many of the percentage of your communities in these key states -- California, Arizona, Nevada and Florida -- what percentage of your communities have been impaired?

Well, Alex, it has been -- I will tell you that in our -- it varies market by market and I really can't get into specifics. What I can tell you is something you might anticipate, a very high percentage of our subdivisions and communities in California have been impaired as well as in Florida, and to a lesser degree in the other markets.

Thank you. Next we'll go to the line of Joel Locker of FBN Securities.

Just a follow-up question on Utah. Just saw that orders fell 57%. That was kind of the one remaining strong markets, a couple quarters ago. Just wanted to see if you could give us some color on that.

Joel, Utah has started to soften a bit this year. And it is reflected in orders. It is reflected in all of the things we see in other markets. Little bit higher cancellation rate, the slowdown in the ability to raise prices, higher incentives. But Utah is -- it is still a decent market and it did not experience the high level of price appreciation that most of the other markets did.

Did you?

I'm sorry? Go ahead, Joel. Or did you get cut off?

Mr. Locker's line is open.

Joel?

Mr. Locker, your line is open.

Okay. Anyway, Utah is -- its rate of growth is slowing. It is showing signs of -- showing signs of hitting the top there but remember that these comparisons are compared to the highest levels of orders that we've seen in that market. So, we're comparing to all-time records.

All right. Thanks a lot.

(OPERATOR INSTRUCTIONS) And gentlemen, I show no further questions at this time. I'll turn it back to you.

We would like to thank you again for joining our call today. We look forward to having the opportunity to speak with you in October following the announcement of our 2007 third quarter results.

Thank you. Ladies and gentlemen, this conference will be available after 5 P.M. Mountain Daylight Time today until August 23rd at midnight. You may access the AT&T Executive Playback service at any time by dialing 1-800-475-6701 and entering the access code of 878471. That number again is 1-800-475-6701 and the access code of 878471. That does conclude your conference for today. Thank you for your participation and for using the AT&T Executive Teleconference Service. You may now disconnect.