MDC Holdings Inc (MDC) 2012 Q1 法說會逐字稿

Good afternoon. We are ready to begin the MDC Holdings Inc. first quarter 2012 earnings call. I will now turn it over to Bob Martin, Vice President of Finance and Business Development.

Good morning, ladies and gentlemen, and welcome to MDC Holdings 2012 first quarter earnings conference call. On the call with me today I have Larry Mizel, Chairman and Chief Executive Officer; and John Stephens, Chief Financial Officer. At this time, all participants are in a listen only mode. After finishing our prepared remarks, we will conduct a question and answer session, at which time we request that participants limit themselves to one question and one follow-up question. Please note that this conference is being recorded and will be available for replay. For information on how to access the replay, please visit our website MDCHoldings.com.

Before turning the call over to Larry, it should be noted that certain statements made during this conference call, including those related to MDC's business, financial condition, results of operation, cash flows, strategies, and prospects, 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 2011 Form 10-K. It should also be noted the SEC regulation G requires that certain information accompany the use of non-GAAP financial measures. Any information required by regulation G is posted on our website with our webcast slides. And now, I will turn the call over to Mr. Mizel, for his opening remarks.

Good morning. For the first quarter of 2012, we achieved our first pretax profit since the third quarter of 2006. This accomplishment demonstrates the progress we have made in implementing the key company initiatives we announced in prior quarters. It also marks a significant milestone for our Company, as we work towards our goal of achieving profitability for 2012 full-year. Our pretax profit for the first quarter was a $26 million year over year improvement, resulting largely from our initiative to reduce our overhead costs. Even as we grew our home building revenues by nearly 15%, year over year, we decreased our home building SG&A and expenses by $14 million, largely reflecting the impact of a 32% decrease in our general and administrative headcount.

We also reduced our marketing costs by eliminating programs that prove to be ineffective in generating sales leads for our Company. Although overall market conditions for the home building industry have started to improve, we have remained focused on decreasing our expenses with the goal of driving significantly better operating leverage going forward. Additionally, after completing our previously announced plan to reduce our debt by $500 million during the last half of 2011, our 2012 first quarter benefited from an $8 million year over year decline in interest expense.

We're pleased to announce a 51% increase in our net home orders for the quarter, which is the biggest first-quarter sales increase we have seen in almost 20 years. We believe this increase is partially explained by a 21% increase in our average active community count, as well as the impact of recently implemented changes to our sales process. These changes included a modification of our base level product offering and an adjustment to our promotional and marketing strategies. Both of these changes are designed to reduce our incentives by better communicating the value of the homes we offer to our customers. We have also implemented a more conservative standard which must be met before we officially recognize a contract as a home order. This change helped to drive our cancellation rate down significantly to 21% for the 2012 first quarter, which is the lowest level for a first quarter since 2005.

During the 2012 first quarter, our net home orders also benefited from an overall improvement in the housing market conditions. It is becoming increasingly evident that our industry has reached a bottom and is now starting to recover. Not only has the pace of our home orders improved, but we are also having limited success in raising prices in some subdivisions across our markets. We believe that a historical low level of new home inventory, combined with an improving employment picture, and rising consumer confidence provides an excellent back drop for improvement in our industry during the remainder of 2012.

Given the continued improvement we have seen in both market conditions and our own operating metrics, we are closely evaluating opportunities to invest in new home building projects that will drive future growth for our Company. With unrestricted cash and investments of over $800 million, exceeding our senior note balance by more than $70 million, at the end of the first quarter, we believe that we are well-positioned to take advantage of a recovery for the housing sector.

Before we move on with the call, I would like to take a moment to remember our former Board member, Gil Goldstein, who passed away last month. Gil served on our Board for more than 30 years and was an invaluable resource to our Company. He will be greatly missed. Thank you for your interest and attention. I will now turn the call over to John Stephens for more specific financial highlights of our 2012 first quarter. This is John's first earnings call as the CFO of our Company, and we are excited to have him on board as the leader of our financial organization.

Thank you, Larry. Moving to Slide 4, our closings were up 12% to 619 new homes, led primarily by increased deliveries from our Nevada division, and our newly acquired Washington operation. The overall increase in deliveries was driven largely by a higher number of homes in are beginning backlog, as compared to the prior-year period. But, was partially offset by a decrease in the percentage of homes under construction in our beginning backlog. The drop in the percentage of homes under construction in our beginning backlog is consistent with our strategy to shift more of our orders and deliveries to pre-sold dirt sales versus speculative home sales.

On that note, 58% of our first-quarter deliveries were from pre-sold dirt sales versus 23% in the 2011 first quarter. As a result of having a lower percentage of homes under construction to start the quarter compared to the prior year, our backlog conversion rate declined to 59% for the 2012 first quarter, versus 66% in the prior-year period. Also, it should be noted that the 2011 second-quarter conversion rate was higher than normal due to the acquisition of homes and backlog related to the Seattle acquisition that was completed in April 2011. Our average selling price was up in nearly all of our markets due to a mixed shift to better located communities. However, on a consolidated basis, our average home price was only up 1% year over year, due to a number of mix shift factors, including a 61% increase in Nevada deliveries, which had the lowest average sales price within our company, and 44 deliveries from our recently acquired Seattle operation, which had an average sales price below our company wide average.

This next slide illustrates our gross margins from home sales, with and without adjustments. It should be noted that the as reported gross margins on the left-hand side of the chart now includes inventory impairments while in previous quarters it did not. On a year over year basis, our gross margins from home sales were up 60 basis points to 14.1%. We did not record any inventory impairments or warranty adjustments during the 2012 first quarter. Whereas, we recorded a $400,000 warranty benefit and a $279,000 inventory impairment in the 2011 first quarter.

The slight decline in our 2012 first quarter as reported gross margin as compared to the 2011 fourth quarter, primarily resulted from a $2.3 million favorable warranty adjustment recorded during the 2011 fourth quarter. Excluding inventory impairments, warranty adjustments and interest and costs of sales, our gross margin was up 70 basis points year over year, to 16.7%, versus 16% in the 2011 first quarter, and was essentially flat with the 2011 fourth quarter. The year over year improvement in adjusted gross margin was driven primarily by delivering more pre-sold dirt homes, versus speculative homes. Additionally, our gross margin in backlog remains stable, and have the potential to improve during the balance of the year based on increased operating leverage and our ability to raise prices in certain select subdivisions.

This next slide details our home building a corporate SG&A expenses. We have segregated our homebuilding and financial services activities to provide more clarity with respect to our financial results by segment, and more consistency with how our peers present their results. As you can see from the slide, our homebuilding and corporate SG&A expenses were down 28%, or $13.5 million, from the year ago first quarter and our SG&A rate, as a percentage of our homes on revenues, was down 1,070 basis points to 18.5%, versus 29.2% in the 2011 first quarter. The decrease in our SG&A expenses was primarily the result of a $7 million reduction in compensation related costs, due to a 32% year over year reduction in headcount, a $3.8 million non-recurring benefit from various legal recoveries and settlements, and a $2.3 million decrease in marketing expenses due to decreased signage and Internet advertising.

Our 2012 first quarter G&A also included $900,000 in severance related costs due to further reductions we have made to our staffing levels, which were down 4% from December. Our commissions expense, which is a variable cost that moves with our home sell revenues, increased 10% as compared to the 2011 first quarter, which was in line with the increase in our home sell revenues. Going forward, we expect our homebuilding G&A run rate to be fairly consistent with what we incurred in the 2012 first quarter, exclusive of the $3.8 million of legal recoveries recorded. Incentive compensation expense may vary with our profitability and any other unusual items.

Our net orders were up 51% year over year to 1,063 homes and were up 103% on a sequential basis from the 2011 fourth quarter, versus our historical seasonal pick up from the fourth quarter which generally runs in the range of the high 60% range. On a per community basis, our sales rates were up 27% year over year to 1.9 sales per community per month, compared to 1.5 per community in for 2011 first quarter. We believe the increase in orders reflected the overall improvement in housing market conditions, an increase in our active community count and changes made to our sales process and sales leadership. Company wide, our traffic for the quarter was actually down 14% year over year, however, our conversion rates nearly doubled, which speaks to the improvement in the quality of traffic and the effectiveness of our more targeted marketing programs as opposed to large national promotions that we conducted last year. While we are cautiously optimistic about the momentum experienced with our first-quarter orders, our second-quarter comparisons will be more challenging, as we had two large sales promotions in the 2011 second quarter, which was followed by significant cancellation fall out in the 2011 third quarter.

Our cancellation rate as a percentage of gross orders for the 2012 first quarter proved to 21%, versus 32% last year, and 43% in the 2011 fourth quarter. This was our lowest first quarter cancellation rate since 2005, and cancellations as a percentage of beginning backlog improved to 27%, versus 40% in the year ago period. We believe that among other things, our new sales process contributed to a lower cancellation rate as we are conducting more front end diligence before we contract as a sale. Additionally, another factor that helped our cancellation rate was that we started the quarter with a lower percentage of contingent buyers in our backlog, then we had in our beginning backlog a year ago.

This next slide gives an overview of some of the major components of our balance sheet. We continue to have ample liquidity and a low debt to cap ratio with our cash and investments exceeding our total homebuilding debt by $72 million, even after the repayment of $500 million of debt during the latter half of 2011. As a result of this large pay down, our debt is better aligned with our current inventory levels, and we have significantly reduced our total interest costs. With our strong balance sheet and liquidity, we believe we are in excellent position to take advantage of land opportunities as they arise.

This last slide gives you an overview of our land and development spend, as well as our overall lot supply. Our total land spend for the 2012 first quarter was $54 million, down from the prior-year first quarter, but up sequentially over the last two quarters. With respect to our lot supply, we currently own and control over 10,000 lots, including the lots in WIP, which represented a 3.7 year supply based on our last 12 month delivery pace. We believe this level of supply is adequate based on the current housing demand levels. Having said that, we are focused on prudently growing our land positions as the housing market improves, and we are currently evaluating more than 6,500 lots in our pipeline to facilitate future growth. At this point, I would like to open up the presentation for questions.

(Operator Instructions). Michael Rehaut, JPMorgan.

First question I had was on the cancellation rate, which obviously you guys did a great job there in getting it back to closer to where it's been historically or even maybe below where it has been historically. I was wondering if you could comment on your expectations for that number going forward if you think you can -- if it is kept in the low 20s going into April, and I noticed that in the second quarter, you had a slightly higher can rate a year ago, if there is some seasonality there, if you do expect it to maybe even stay in the low 20s, but just pick up a little bit in line with what might be lower normal.

Michael, I expect it to stay in the low 20s and I think last year, we've changed our sales and our underwriting process before we deem a sale bookable. We are taking it very conservative with the mortgage market underwriting seeming to evolve on an ongoing basis, we are paying close attention to the underwriting standards and I feel very confident that low 20s will be something we'll see going forward.

Also, I was hoping you could also talk about pricing. I believe you said that you've had some success, I think you used the word limited success in raising prices. I was trying to get a sense of both on a nominal basis what might be the average company wide type of change in price and if you are also moving the needle on the incentive front?

I'd say that we're working continuously on reducing the incentives and predicated on subdivision by subdivision, we are seeing some ability for pricing power of 1% or 2%, on maybe plus or minus 30% of the subdivisions. It's subdivision specific, it's not general, it doesn't go across a specific market. It's really highly individualized and we're focused, both on the reduction of incentives and the improvement of pricing on an active hands on basis.

Adam Rudiger, Wells Fargo Securities.

Last quarter the orders were a bit weaker than peers and you attributed some of that to your switch away from spec building. I wanted to ask you about spec this quarter because obviously the orders were much improved. Curious what your impact -- how you realized the strong orders this quarter without the spec, how you think that impacted it? Also on the orders, with your new conservative approach, does that imply on an apples-to-apples basis your orders would've been up even more if you had last years standards?

I think on the specs versus the dirt sales, Adam, we continue to push that forward and our -- the dirt sales we have in our backlog is in this two thirds range versus the specs we have in our backlog. I think it's the improved sales orders, we're improved. Market conditions, as well as a lot of the initiatives we have out there in terms of our sales folks, our sales leadership and how we are going about selling our homes and our product. I think, including more items or features in our homes and adjusting the base pricing, I think we've eliminated some confusion we had in the past. And I think everybody is very focused on sales on a continuous basis rather than these large national promotion. That's what I would add to that.

Focusing on margins, obviously you made some great progress on the SG&A and interest expense are coming down too. One piece of the puzzle that is still, I think, you'd want to focus on would be gross margin and still not clear to me exactly what's transpired over the last couple of years because in 2009, 2010 they were in the 18% to 19% range. Could you possibly walk us through on a multi-year period what the trends have been, the drivers have been and how you see that whole gross margin picture evolving through the last few years?

I think the last few years have been affected by the purchase of land in line with the market versus utilization of land that had been highly impaired by previous times. When you have land that was purchased early, call it early at the end of the cycle or early at the beginning of a new cycle, you have a higher cost in that land versus land that you have held previously that had been impaired substantially. What we have, we believe is somewhat unique in the sense that the current land that we are buying is priced in line with today's market and, we believe that our gross profit margins are reasonable in light of today's land cost with a very nominal amount of previously impaired land coming through in our gross profit margins.

With being in that position, we believe that what you're really seeing is the true homebuilding valuations as we see it today. Taking a conservative view, as John previously commented, we have a reasonable supply of land of about 3.7 years predicated on last years running rate, and we are actively looking in all markets, but we are looking on a very conservative basis because previously, we would like to run on a 2 year land supply, not a 3 or 3.5. We are moving forward and then improving market, but we are not taking our eye off the fact that we have a conservative approach and we don't speculate with land, that's not our business, land speculating. We are a homebuilder and we build and sell homes and make a reasonable profit and a good return for our shareholders on a risk-adjusted basis.

Nishu Sood, Deutsche Bank.

I wanted to ask in terms of your new sales processes and pulling back on incentives. I wanted to understand how much of that might have run through the financial services line? I imagine that some of the promotions before the current sales regime were running through the financing part of the business so, and the financial services delivered a pretty strong number. Is that the correct way to look at it? Is that to where a lot of the promotions were cut back?

I think we have seen a cut back in -- I think last year we had some special financing programs going on that did drag down the earnings a little bit in the financial services sector. This year were not having to give as much away there. I think we have seen an improvement there. In terms of quantifying that, probably don't have that exact number available for you.

Second question I wanted to ask, obviously, a very, very strong order number in the first quarter, a real contrast obviously with the order pace in the second half of last year. Your gross margin obviously hasn't moved up that much. One interpretation is that since you are building more dirt sales that you're gross margin has lagged, it is reflecting obviously the more difficult selling environment you experienced in the second half of last year. Gross margins may improve here further. The alternative interpretation is that you are willing to accept the current gross margin and ramp up volumes at the current gross margin so, which is the correct interpretation?

I think it's probably a little of each. We're focused on growing our business on a balance basis, and that is something that I think is important as we've repositioned our sales organization in a manner that we believe is consistent with market conditions. Over the last period of years we've worked on several different initiatives trying to break open the market on a positive basis before the market was ready to move. We adjusted as you recall, I commented last year, I said listen -- our goal is to do whatever we've got to do to be profitable at today's market levels and not expecting any improvements in the market. I think the improvement in the market have been okay, not spectacular but I think we've done really well by an improvement of sales process and procedure. We're very fortunate that we have a highly energized sales organization that's delivering what I believe not only is in line with the market, but I think it will continue to improve even just a little bit better than the market.

Joshua Pollard, Goldman Sachs.

If you could be very clear about what has changed in your sales process. My clients ask me a lot of questions about what really is different? There is a number of things that we can all point to, but can you talk about by impact? What have been the biggest changes in your sales process? If you could ultimately quantify how those benefited you this quarter, that would be extremely helpful.

I think, the most important change is we have a change in sales leadership. As we all know, it's a people, process and procedures and we're in prior years, we approached it by having major sales programs and then after those sales initiatives were over, then we found that we had a higher fall out then really the industry average so, or net sales probably didn't improve at all with the substantially higher costs to create the sales. We are focused on an energized sales organization that we are spending a lot of time and effort on continuous training and it's different, because it's able to deliver on a current basis and more, I would say, more consistent than what we had before on how to price it.

I think you give it a couple quarters and it will become self-evident that through our merchandising, marketing and sales cost, we have gone down substantially because of the changes. As you would explain it to a client, I think the best way to explain it is the Company is adjusted its sales message and techniques in light of market conditions as they exist and May of 2012 versus an attempt to push the needle, as they say, a wet noodle, you can't push a wet noodle no matter how much you try and what we are doing is working on the old economic theory of demand pull and we think it's working well.

My second question is a two-parter. Number one, what was your order growth in April? You guys noted the sales promotion last year, make your comps a little tougher. I want to try and get a sense of how much. My second question is, how do you get this business from a gross margin standpoint back to 20%? It seems like land developers are beginning to raise their prices, inch them up a little bit, we are obviously seeing some inflation on all things building material related. I am wondering, what needs to happen for you guys to get back to 20% margins from here?

Our goal on getting back to 20% I think it will be all up to the market and I feel confident that going forward there is fewer builders in the industry across all markets and that should allow our gross profit margins over the ensuing years to improve as the market allows it. We had good sales in April and I think it was up approximately 30% and we fill really good about that.

Dennis McGill, Zelman and Associates.

Larry, I think if you go back before the restructuring, if you want to call it that, one of your hesitancy's was cutting costs, which you didn't want to be behind the eight ball when the market turned, but then you came to the strategy of being profitable at any sort of volumes here today. We do you think you have sacrificed in those cost cuts in the short-term?

Absolutely nothing.

Why would they have been in earlier, if there is no offsetting costs?

You try different strategies at different times and I don't believe in being a victim and just because the market was the worst it's been in 40 years or 60 years or 100 years, doesn't mean you don't try to do something different to achieve profitability. We accepted the fact that the market was the market and we adjusted, as I previously made the comment on the second-quarter call, I said we are going to be profitable even if the market doesn't get any better. We have done just what we said we are going to do.

Dan Oppenheim, Credit Suisse.

Hi. This is actually Will on for Dan. In terms of your community count, can you give some color on where you think you might end the year? Also, in terms of your markets, which markets do you see the greatest community count growth and which markets do you think you might slow growth?

Our community count is up 15%, year-over-year, and I think it is going to depend a lot, Will, on how the rest of the year shapes up. Obviously we are looking at a lot of land opportunities on a continual basis. It's possible it ticks down a little bit, but at this point it really depends on how many opportunities meet our underwriting thresholds in the various markets where we might need to resupply on some lots there.

In terms of geographic expansion for community count?

I don't think we have given expansion by actual geographic states at this point,

Not perspectively. I think we are certainly out there looking for subdivisions in each of our markets, we are committed to those markets long-term. As John indicated, it is really dependent upon looking at these deals, subdivision by subdivision and seeing what pencils.

Stephen Kim, Barclays.

Congratulations on a much, much better quarter. My first question relates to the issue of land spend. Basically, this quarter it looks like you spent at a level, if you include land development, slightly above the amount of land investment you probably burned off through your revenues in closings, but given your balance sheet, obviously one would think that you could spend considerably more or at a much higher rate than you did this quarter. I was curious if you could give us an idea of where you feel you might wind up for the year or at least a level that you're unlikely to exceed this year? And, a minimum level that you might spend this year?

Stephen, we take every day as it comes. As you know, we have a land group in every market. We have the ability to take advantage of any unique opportunities and we have the discipline of not transacting just for the sake of doing business. We have an adequate supply of land and lots and we are going to take every day as it comes knowing that we have the maximum flexibility in order to take advantage of market conditions as it might occur.

Unwilling to give a particular number, or a range of numbers. If you could talk about where you think the long-term level of leverage that would be appropriate as a market normalizes, that you feel your company could run at. That might be another way of coming at the same question. Because I know I will probably get cut off of I leave it there, the second question that I had relates to your sales. As you were referring to earlier, there was a promotion in the year ago period. There is a tendency for people to fixate, as you know, on short-term moves and order trends. I was curious, you mentioned April was up probably 30%, but had we, at that point, or have we at this point anniversaries those promotions in particular you were referring to or, are those promotions primarily going to have a negative year-over-year effect in, let's say, May and June?

Stephen, we did have a couple promotions last year in the second quarter. And actually, one was in April, one was in June. That order comp is based on having the benefit of promotion last year.

Also, your question on leverage, I think a person runs the company the way market conditions permit and we're pleased that we are still investment grade. I think that's an important item to distinguish oneself as we enter into the new cycle. The biblical seven good years and seven bad years, I am pleased to say the seven bad years are behind the industry and we're now starting at least seven good years and we will see how it all plays out.

Alex Barron, Housing Research Center.

Good job, guys on the efforts you've done in the last couple of quarters (Inaudible). Larry, I was looking at your land positions, and it looked like you are at the lowest option level I've seen I think in the last 10 years. I am trying to figure out when the markets bottomed in 2009 you started ramping up the land position quickly, at least the options and so far you haven't done that. I'm trying to figure out if you are not -- what you are looking for. Also, I think in the last couple of years you took advantage of distressed lots, I am hardly understanding there's not so much of those opportunities now. Are you going to be developing them? What is your strategy going forward?

I think our strategy in the land going forward is to take the opportunities as they might come. As you know, we prefer finished lots and we believe that we have the opportunity to leverage our liquidity and be more opportunistic and to tie up lots on options. Sometimes there is a good time to do it, sometimes it's better to use your capital, but what we've tried to do is -- it's interesting, the world has only turned rosy for 120 days. There is no reason for everyone to think that everything is going to be perfect going forward. With a 3.5 or 3.7 year supply of land, let's say that decreases because our sales might increase as they look like they are, we have plenty of opportunity to balance the book on what our needs are and what our opportunities are.

My other question has to do a bit with your sales strategy. I was in Denver recently, and you guys had rolling something called the (Inaudible) collection which has higher square footage and lower prices. Is the thought process there to basically offer the consumer something that is more affordable than what the rest of the people have and gain market share that way?

I think it would be better to say not more affordable, but a better value for the consumer. What we have done is developed one of several new products that we will use in the different markets in the country, as we are able to adopt it, which is probably consistent with what other builders are doing. Trying to build a greater value for the consumer, the consumer has the highest affordability factor they have had in many years where they can buy a home and afford it with today's interest rates being as low as they are, in line with a reasonable price. What we've done is develop a product that has slightly, of course we are biased, we think it has superior value for the consumer. Predicated on the initial response from the consumer, which is still early, that it's been extremely well received and I hope you considered buying one when you were here in Denver.

Steve East, ISI Group.

First of all, given your order growth this quarter, I was wondering what your strategy is for price pace moving forward? With a 1.7 absorption, what level do you want to go to before you focus more on increasing price?

I would say we focus on increasing prices daily. 1.7 is great compared to where we were, but historically, we've been substantially higher and the market, as you look across all the builders, it's improving across the whole industry. I think all of us are working on being more efficient and we certainly are and that absorption is always a conversation between do you want more sales or more gross profit or less incentives, et cetera. We work on balancing it daily by subdivision. I'd say it's probably the most active conversation that takes place here in our organization of anything. You are right on track as far as the thought process. It is give-and-take and it can go in both directions.

On your orders this quarter, did you even notice any useful change in the gross margin with the sales of homes with higher specifications versus your old model of low base price and options and heavily discounting the base of the options?

I don't think we are in a position to comment on it.

A lot of the sales haven't come through yet as deliveries. We're still working through the process. In fact, some of them are still going through our options and things like that. I think it's probably a little early on that right now.

Joel Locker, FBN Securities.

Curious on that 186 communities you have, how many of those communities have you either raised prices or lowered incentives or both?

I think we've commented that approximately 30% of the subdivisions have had between 1% and 2% increase on prices on certain homes within the subdivisions. I would say that's the best color we can get you at this time. They may be more next quarter, but for this quarter it is early.

That leads to a follow-up question, having the market be so different than it was four months ago, obviously higher prices, more demand but also, material cost pressure and some of the land pressure. Are you still seeing, in the land market, in the last say two weeks or a month, actual pro forma gross margins of 17% or has it moved up a little bit? Has that changed all versus four months ago?

I can't comment on what we see on gross profit margins on a prospective basis. I can say the big difference between now and four months ago in general is consumer confidence. Consumer confidence, at least through the end of last week, was pretty good. We believe we see probably shortages in some markets of brand-new homes that the builders are producing. The markets find their own level with the resale market picking up and the multiple bidders on the foreclosure market and the standing inventory on brand-new finished homes, I think that all bodes well and it's coming together more transparently now.

At the end of last year there was no transparency on anything good and clearing the market, the market has a way of clearing itself. Sometimes, even quicker than even people assume. In listening to some conversation with regulators and/or the administration, I think the best advice we've been able to get them is how about leaving everything alone for a while and let the market clear itself. The change from last year to this year is the housing market, I think is distinguishing itself in the new home sales as something that is receiving positive attention versus continuous negative attention that it received for about four years straight.

Mike Widner, Stifel Nicolaus.

I wanted to follow-up a little bit on some of the financial services revenue. In particular, if you could talk a little bit about the margins there. I know this is a new break out for how you guys report it, and there seems to be some one timers in there. The margins on that business, at least for the quarter, are substantially above where we see most of the peers. Wonder if you could talk a little bit about what you expect the profitability of that segment to look like going forward and talk about some of the one timers. You mentioned a decrease in the level of special financing programs, you mentioned you had $600,000 decrease in loan loss reserve, which I presume is a one-timer. You talk about a $600,000 reduction in overhead, I assume that's ongoing but in general, any color you could provide there, particularly about the margin expectations going forward would be good?

Yes, I think this quarter, without getting too granular, obviously the gains on sale of mortgages. I think the markets were favorable in our favor there and we are the benefactor of that, this quarter as well as not having large increases in our loan loss reserves, cutting our overhead as you alluded to. I think those are the primary factors and not having as many of those special financing programs that we did a year ago to get the sales traction that we were looking to achieve. I think it's a combination of all those things that created this large uptick in our margins there. Will we be able to continue that going forward? That remains to be seen.

Margins that we see more relative to the revenue profit as a percent of revenue tend to be more in the 15 up to 30 and you guys were obviously more than double that in terms of a margin number this quarter. Should we be looking at more -- industry norms, say 0.5 that or lower?

The other thing, Michael, I'm not sure if you looked at it in our press release, but we did actually break out the revenues, the components of revenues in the financial services. You can see there were some other items in there like insurance revenues and title, which isn't really large. I don't really want to predict what we are going to do going forward in the financial services. I think we feel pretty good about the gentleman who runs that group and he is very on top of things and we think we have one of the best in the mortgage group running that.

Jay McCanless, Guggenheim.

Wanted to ask first on spec count. It looks like your average specs have come down to about 2.8 from 4.2 last year. With the new strategy, do you have a targeted level specs per community?

I think we don't want that spec number to run up to high. It's probably a couple per community, some are started and some are finished. You want to have some availability in delivering some quick move-in homes, but we probably don't want to go over three on average. Some divisions we might go a little higher or if there is subdivisions where we are seeing more demand, we might put a few more starts in the ground.

Wanted to ask also in terms of -- are there any cities where you are seeing a bigger use of -- or people are buying more built homes, standing homes versus being more favorable towards buying a dirt home?

I think, Bob mentioned, our Seattle market tends to be more of a spec market. I think also in California we might have more specs from time to time. I think also where markets where we're generally doing better, we are seeing more demand. We're willing to soak up those spec units because, quite frankly, at times we put a premium on those. It's a market where there is a lot more demand. That's probably a little color on that.

[Matthew Lens], Point.

I had a question about the biblical timeframe we are working in now. At the start of the seven happy, fat years, as you guys have mentioned, things seem to have turned for the best a few months ago and we are still in the early innings of what I think we all hope is a turn. How much longer would you like to see things perform well before you get the confidence level to meaningfully push the button on the new start side? I'm asking this in a very general way, just to get your sense of how you think this will play out in terms of, if one was to be thinking with the stars in their eyes about 1 million housing starts in the US in a few years. How do you think this plays out?

I think it plays out slowly and cautiously. Getting back to 1 million from 300,000 is a huge jump. I don't think it's going to be quick at all. The circumstances, even with the demand, will make it a little slower. However, I think it will be more profitable for those that are in the business, that have the ability to grow in a capital constrained industry, the wide availability of capital for the private builders is very, very limited at this time. There is no indication that the banks are going to jump back into the market in a meaningful way. They may get back in a careful, conservative, thoughtful way, but certainly not in an aggressive way.

This is about my fourth cycle, I think, and each time it's different and each time when you are living through it, you can't believe it is happening. We've seen the United States in '08 and '09 have some pretty rough times in the capital markets. They have self corrected through a lot of pain and a lot of costs, and you see that going on in other parts of the world today. The housing market in the United States, for new homes that are primary residence, I think are going to be favored. I think the tax law is going to change and the deductibility for housing, other than really what the public builders are doing, I think it's going to be substantially limited and the programs, whichever ones will be viable for providing mortgages, are going to be limited also. This is a unique period that has, I think, very clear transparency that things are starting to get better and there is a lot to look forward to and it will carry itself probably even longer than that seven good years. I won't predict anymore than the biblical period.

I think that sounds like a sensible restraint on one's forecasting.

Michael Rehaut, JPMorgan.

I was hoping you could give us a sense of where your gross margins are in backlog relative to the gross margins that you demonstrated in this past quarter?

Yes, as I commented earlier, Michael, they were pretty stable. Not really a lot to add other than pretty consistent.

Secondly, if you could give us a little bit more clarity, the gain on sale of the mortgages in the financial services line? How much did that contribute and is that something that is a lumpy number or is that -- I know that perhaps sometimes you get that on an ongoing basis, but what was that number? And, maybe what is in the last few quarters?

Yes, I do have it in terms of what it was the last few quarters and I think a lot of it does depend on the interest-rate environment, Michael, and how the market moves. It's tough to predict. It was a very strong quarter from a margin standpoint, a gain on sale.

What was that number?

I think it was about 325 basis points, plus or minus in that range. $1.2 million.

Was the total gain on sales, $1.2 million.

Dennis McGill, Zelman and Associates.

Wanted to follow-up on my initial question so, if the market grows 20% or 25% over the next few years, let's use that as a rough bogey, your sense is even after the cuts you made, you can pace with that at least?

I am not sure when you say pace with that, what exactly are you asking?

Can you grow with the market, at least over that time period based on the cost structure and the land structure you have today?

Absolutely.

On pricing, I don't know if you touched on this, but which areas or markets are you seeing the strongest pricing power today?

I think it's subdivision specific. It's across the markets, but it's by subdivision. It's not easy to have it jump out on you. We all look at those that were the worst, were like Nevada and Phoenix. These are the ones that have turned around, that are becoming the best. Everyone got excited. Michael, it's a flip. That which was bad is getting good and that which is good is getting better.

(Operator Instructions). Alex Barron, Housing Research.

I wanted to ask about the design center. I think that is something that you guys were probably emphasizing in previous years, but it seems to me your strategy has now changed to including more upgraded features with the homes. I am wondering how that is working out for you guys? And, if the margins are roughly similar or better under this new strategy?

I think it's working out really well and we've simplified the process substantially. We've down sized the size of the design centers and we've included in the base spec of the homes, pretty much everything in a highly competitive basis and we look forward to the gross profit margin centered in the house versus looking at the design center. What we do provide, which is very unusual, is we still allow you to personalize your home. You are able to individually select those items that are unique as far as colors and finishes. We believe that it will, not only as a reduction of G&A, but it is a reduction of incentives, and it has been very well received as a sales process, making it much easier and efficient to execute what we are doing.

My second follow-up is regarding -- I've been to several markets in the last few weeks and I've noticed in some communities, not necessarily yours, but comments from salespeople that there is investors buying, like in Phoenix. I didn't see that in Vegas or in Denver. I am curious, what your thoughts are on the investors and selling to investors? Is that something that you guys are seeing a lot of demand from investors?

I think we've read about it in the Journal. We've heard about it, but we've seen very little of it.

With no further questions in queue, I turn the call back over to the presenters for any closing remarks.

Thanks for being on the call today, and we look forward to speaking with you again following our second-quarter results.

This concludes today's conference call. You may now disconnect.