MDC Holdings Inc (MDC) 2012 Q2 法說會逐字稿

Good afternoon. We are ready to begin the MDC Holdings Inc Q2 2012 earnings call. I'll now turn it over to Bob Martin, Vice President of Finance and Business Development. Sir, you may begin your call.

Thank you. Good morning, ladies and gentlemen. Welcome to MDC Holdings 2012 second 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 this conference is being recorded and will be available for replay. For information on how to access the replay, please visit our website at www.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 2012 second quarter Form 10-Q, which was filed with the SEC today. 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 is posted on our website with our Webcast slides. And now I'll turn the call over to Mr. Larry Mizel for his opening remarks.

I am pleased to announce that the second quarter income of $0.22 per share, making our second consecutive profitable quarter. We believe that our favorable results were largely attributed to our implementation of several key strategic initiatives, which we announced over the past few quarters combined with improvements in homebuilding and overall market conditions. In the second quarter, not only did the pace of our homebuilding orders continue to improve, but we also saw continued success in raising prices in many subdivisions across our markets. These favorable factors provided excellent back drop for improvement in our operating results during the remainder of 2012.

Our net profit for the 2012 second quarter of $10.6 million was an improvement of nearly $40 million year-over-year, resulting largely from our initiatives to reduce overhead and capital cost. Even as we grew our homebuilding revenues by nearly 25% year-over-year, we decreased our homebuilding SG&A expense by $10 million, in part reflecting the impact of a 30% decrease in our general and administrative headcount.

In addition, our interest expense decreased by $7.3 million for the second quarter due to the $500 million debt reduction we completed during the last half of 2011, and our impairment charges fell $8.6 million. Our second quarter profit benefited from a 200 basis point year-over-year increase in our adjusted gross margin based on our efforts to improve our product offering and sales processes over the past few quarters. We are focused on achieving sequential margin gains in the coming quarters. We believe, however, that even if margins do not improve meaningfully in the near term, our improved operating leverage created by a combination of increased new home deliveries, and a reduced expense structure can drive sustained profitability over our Company.

During the second quarter, our net new orders increased 32% year-over-year to a five year second quarter high, driven by 24% improvement in our absorption pace per community and the 900 basis point reduction in our cancellation rate. With our ending backlog for the second quarter at a five year high, up 42% over the prior year, we are well positioned to achieve the level of new home deliveries needed to achieve continued profitability in the third and fourth quarters of 2012. Given the continued improvement we have seen in both market conditions and our own operating metrics, we are focused on opportunities to invest in new homebuilding projects that will drive future growth for our Company.

We have started accelerating our acquisition pace. During the second quarter, we approved the acquisition of approximately 750 lots in various markets followed by the approval of nearly 600 additional lots in July alone. These lots include some that we will develop on our own and others that are [finished]. While finding land at a reasonable price and terms is always a risk for our business, we still believe in operating with a land-like business model, given our success in doing so. Furthermore, we believe this model is prudent considering that economic conditions remain fragile for our industry despite the recent improvements we have seen.

Thank you for your interest. I will now turn the call over to John Stephens for more specific financial highlights of our 2012 second quarter. John?

Thank you, Larry. We move on to Slide 4. Our closings were up 21% to 861 new homes, lead primarily by increased deliveries from our west markets, specifically our Nevada, California and Arizona operations. The increase in deliveries was driven largely by a high number of homes in our beginning backlog as compared to the prior year, which was partially offset by a lower backlog conversion rate of 58% for the 2012 second quarter versus 71% in the prior year period. This shift in backlog conversion rate is representative of our emphasis on pre-sold dirt sales versus speculative home sales and the impact of acquired backlog for our Washington operation in the prior year second quarter.

Also consistent with our pre-sold dirt sales strategy and consistent with our 2012 first quarter, 58% of our 2012 second quarter deliveries were from dirt sales versus 21% for the 2011 second quarter. Our average selling price for the 2012 second quarter was up in nearly all of our markets due to a mix shift to better located communities as well as lower incentives. However, on a consolidated basis, our average home price is only up 2% year-over-year to $298,000 due to a number of geographic mix shift factors including a 94% increase in deliveries from our Nevada operations and a 30% increase in our Arizona deliveries, markets with our lowest average sales prices within the Company, which was partially offset by significant increase in closing from our California operations, which had an average selling price above our company wide average at $325,000.

Our gross margin from home sales was up 530 basis points over the prior year second quarter to 14.2%. We did not record any inventory impairments or warranty adjustments during the quarter, whereas we recorded $8.6 million in inventory impairments and $1.8 million in warranty benefit in the 2011 second quarter. Excluding inventory impairments, warranty adjustments and interest and cost of sales, our gross margin from home sales was up 200 basis points year-over-year to 16.9% versus 14.9% in the 2011 second quarter and was up 20 basis points sequentially from the 2012 first quarter. The year-over-year improvement in our adjusted gross margin was driven primarily by delivering more pre-sold dirt homes, which generally generate higher margin than speculative homes, coupled with reduced incentives in many of our subdivisions.

With respect to our homes in our backlog, we have seen a slight upward bias in our gross margins resulting from improved demand, price increases in certain communities and markets, and increased operating leverage. However, our expectation as it relates to margins and backlog is somewhat tempered as a result of potential cost increases for labor and materials and higher land costs due to increased housing activity. Our homebuilding SG&A expenses, which includes our corporate segment, were down 20% or $9.9 million from the year ago second quarter, and our SG&A as a percentage of home sale revenues was down 850 basis points to 15.3% versus 23.8% for the 2011 second quarter. The lower SG&A rate was driven by greater operating leverage due to a 24% increase in revenues coupled with cost reduction efforts that were instituted over the past several quarters.

The year-over-year decrease in our G&A expense to $21.1 million was driven largely by a $3.9 million net reduction in our overall compensation expense due to reduced headcount and a $3.8 million in legal recoveries received during the quarter. The net reduction in our total compensation related expenses was after the impact of increasing our performance based cash bonus accrual and stock option expense due to improved operating performance. In particular, we recorded $2.5 million of performance based stock option expense or one third of the total option grant value during the 2012 second quarter versus none in the 2012 first quarter or the year ago period. For the balance of 2012, we expect our homebuilding G&A expense run rate to be fairly consistent with what we incurred in the 2012 second quarter, exclusive of the $3.8 million of legal recoveries recorded in the 2012 second quarter and absent any other unusual items.

Our commissions expense, which is a variable cost and was 3.5% of home sale revenues for the current quarter, increased 19% as compared to the 2011 second quarter, which was in line with increase in our home sale revenues.

Our net new orders for the quarter were up 32% both on a year-over-year basis and on a sequential basis. The increase in orders reflected the overall improvement in most of our markets, better execution and changes in our sales process and strategy, and to a lesser degree, an increase in our average community count. On a per community basis, our sales rates were up 24% year-over-year to 2.6 sales per community per month compared to 2.1 per community in the 2011 second quarter, with particular strength experienced in Arizona, Nevada, and, of late, in California. The improved absorption rates were encouraging due to the fact that the 2011 second quarter was the strongest quarter for the Company in the prior year due to two large sales promotions conducted during that period, which is followed by a period of high cancellations in the back half of 2011. Our cancellation rate as a percentage of gross orders for the 2012 second quarter improved to 20% versus 29% last year, and it was stable versus 21% in the first quarter of this year., Lastly, with respect to our sales strategy, we continue to focus on maintaining the appropriate level of balance between sales pace and increasing prices where possible.

As you can see from this slide, our land acquisition activity has accelerated modestly in the second quarter and is higher than each of the previous three quarters. With respect to our lot supply, we currently own and control over 10,000 lots including lots under construction, which represented a 3.4 year supply based on our last 12 month delivery pace and a 2.9 year supply based on our last 12 month order pace. Our primary focus continues to be on finished lots and quality locations; however, we do have experience to acquire and execute on development deals that are in well located parts of the market. We believe we are well positioned to take advantage of land opportunities with our strong balance sheet that included over $800 million of cash and marketable securities at the end of the 2012 second quarter and equity balance of over $870 million before realizing any portion of our $273 million or $5.71 per share net deferred tax asset, which has a full valuation allowance against it. And on that note, the Company has generated three consecutive quarters of positive pre-tax income before debt extinguishment charges, which is a positive factor when we evaluate the valuation allowance against our deferred tax asset. We will continue to analyze the deferred tax asset, and when the appropriate time to unwind a portion or all of its valuation will be.

At this time, we would like to open up the presentation for questions.

(Operator Instructions)

Michael Rehaut, JP Morgan.

Thanks, good morning, everyone. First question I had was on gross margins. I believe you cited they were up a little bit in backlog, but at the same time, you're expecting some cost increases, and certainly -- I'll save that for the second question, but can you give us a sense with those competing statements -- and even earlier in the call you said you're focused on achieving sequential gains -- how we should think about the back half? You're in kind of this low 14% range on a reported basis, how should we think about the back half? I mean when you talk about sequential improvement, should we think modest or something else?

Yes, I mean Mike we are seeing some upward pressure in our margins, which is a good thing. We've seen price increases and probably about half of our communities during the quarter company wide, and those price increases range, they varied by market, but kind of in the 3% to 4% on average range for those communities. And we're starting to see that more in the second quarter and off the first quarter into the second quarter, so we hope to see the benefit of those margins come through in Q3 and Q4, but we are also seeing some of the trades in certain markets are under pressure with increased demand in housing, and so we have seen a little bit of an offset from a cost increase standpoint. And then also I think appraisals in certain markets where prices have moved up pretty quickly, we want to just be cautious with respect to that too and the impact on margins.

Okay. Secondly, about your land acquisition and lot supply. You've started to increase the acquisition of lots but on a net basis, your total lots controlled continued to decline. So as you get more aggressive, are you able to get the lots at the same gross margins that you've been acquiring in the last one to two years, and how do you think about your ability to acquire land at attractive pricing given that I think relative to some other builders, your supply has decreased and that might make you more, on the margin, a little more aggressive than some other builders out there.

Well, I think with respect to our lot supply, Mike, it has decreased, but remember the Company did add a lot of communities in the first part of last year, so there was a big build up in community count, and we've seen that community count level off. So obviously we've increased pace and burned through some of these lots, but as far as -- we're in the land market on a weekly and daily basis in each of our divisions. In terms of what are the costs we're paying for land, it's competitive just like all of the other builders who are buying lots, so that's kind of what I would add to that point.

Alan Ratner, Zelman & Associates.

Hi guys, thanks for taking my question. John, on slide 6, I was hoping to dig in a little bit deeper on the G&A. I think if we back out the litigation recovery this quarter, it looks like you're running around $20 million, $25 million or so on a run rate basis, and that's up about $6 million plus from what is your near term trough back in Q4, and I think you highlighted about $2.5 million of comp accruals. But I was just curious what makes up the difference there, and I know you mentioned that it's going to be running at about this $25 million pace going forward, so curious if that's a result of added headcount or other factors there.

You know, Alan, just looking at the bar chart here, I think in Q4 there was some other adjustments kind of positive and negative going through that Q4 line item, or that period I should say. I think Q1 is probably a better proxy on a comparison basis because last quarter, we also have a $3.8 million legal pick up, so that would put our Q1 number of '12 at like $24 million, and so the increase I think from Q1 to Q2 is -- a lot of it's related to the stock based comp expense, which we didn't have any in Q1 as well as some other items too, but really not looking to increase our headcount per se. It's really just some of those comp related ads, and I think the Q4 number again had a lot of -- oh, it has Financial Services in there too.

It's split out just a little bit differently, Alan, so in Q4 we are presenting all G&A including Financial Services together, and if you look at that number in total, that was what we presented as kind of a run rate because there are things in the Financial Services that were offsetting the other costs in the home builder, so it's a little bit but just a different presentation at this point.

Okay, so those numbers aren't necessarily perfectly apples-to-apples, but [25%] is a good number going forward. Second question, just kind of looking at some of the disclosures in your Q, it looks like while FHA/VA loans is still a big chunk of your business at around 64% of closings in the quarter, it's down from about 73% a year ago, so I was hoping that you could maybe talk a little bit about the trends you're seeing and the different price points and whether we can kind of ascertain from that, that maybe the move up is accelerating or taking some share from entry level in terms of what you're seeing.

Yes, we are seeing some of our move up products in certain markets. We have seen a little bit more increases there, which I think has resulted in the conversion from an FHA kind of buyer or borrower to more conventional, like in Colorado, we've got a couple projects here that we're kind of up in the higher kind of price points, and so we're probably out of the FHA limits with respect to some of those communities. And I think the move up market is improving in terms of what we're seeing and our -- historically, I think we've been about 40/60, 40% first time buyers, 60% move up, I think in the last few years its probably been more like 50/50, but we are looking at more move up opportunities as those present themselves.

Joshua Pollard, Goldman Sachs.

Hi, thanks for taking my question. I first wanted to ask on your cancellation rate now down to 20% last year was at 29%. As you look out into the back half of the year, you guys were in the mid 40%s. Can you talk about what your experience is so far through July both on overall net orders and what you guys expect for cancellation rates, should they be back down in those mid to low 20% levels, or should we be expecting a pick up?

Well, I think with respect to our can rates, higher order activity in the first part of the year, so our can rates are generally lower. I think last year in the third quarter, we had a pretty high can rate because we had a couple large sales promotions during the second quarter, and in fact, we had a large sales promotion in June of '11 that there's a lot of I'd say cancellations in the third quarter which impacted our third quarter numbers and our July numbers. And don't really have a prediction as to where the balance of the can rates will come out the rest of the year, but normal seasonality does tell you that order trends do slow down later in the year. But because we have -- the month has not yet closed for us, I know today is July 31, but we report on a weekly basis and we're not going to be able to give July sales numbers in year-over-year percentage changes that we just don't have all that information yet. However, thus far we are encouraged with the overall activity we have seen in July.

Okay, the other question I had was around your margins. I'm trying to understand the question about the margin and backlog. I'm trying to see, are you guys attempting to be conservative with 3% or 4% price increases across half your markets by saying you expect inflation so you guys just aren't quite sure what your inflation marks are going to be? Or maybe if you could give us a better sense of at what point you guys get more clarity about the cost increases in your business, my assumption is that what's in backlog you sort of have a good sense of what the labor and material costs were going to be.

Yes, I think there is some cautiousness there. We've had a couple good quarters in a row in terms of order activity and of late price increases, but it does put demand on the system, and the trades are under a lot more pressure than they were a year ago, and with prices moving up and appraisals in certain markets, we just want to be cautious and let's just wait and see how it kind of all pulls through. So that's kind of what I would guide you with, with respect to our margins, Josh.

Adam Rudiger, Wells Fargo Securities.

Thank you. Larry, you mentioned in the beginning you were accelerating your approval process, and you mentioned you were buying some lots or approving some lots that needed to be developed. I was wondering how the mix of the lots you're looking at now or proving now in terms of developed versus undeveloped relate to what you've been buying over the last few years.

I would say that I expect to be looking at doing more development in the next couple years than we have in the last few years. The last few years there was a substantial amount of finished lots available in quality locations, and we're going to continue to focus on quality locations, and as the competition, which by the way I consider to be wonderful, I'm glad to see everybody selling homes, it creates good momentum in the market. I do expect that we will be more active in the development world. Over the past 30-40 years, we've done just about everything. And what we are focused on is staying in high quality locations, and we always go in bite size pieces. We don't take on major communities, so our comfort zone and our transition to more development activity is normal, and I consider it healthy, and we will evolve into it same way we do everything in a conservative basis.

Okay, thank you, and my second question was what were the closings from I think what you previously said is newly acquired subdivisions, what were the closings this quarter as a percentage?

(Inaudible)

Excuse me?

Adam, in terms of percentage?

Yes, in the past like, I think you've said in the past in the fourth quarter of last year, you said 77% of closings came from communities open since 2009, so I was just looking for the comparable figure.

It's probably more than 80%, Adam.

Okay, thank you.

Will Randall, Citi.

Congratulations on a profitable quarter. So Larry, on your last call, you made an interesting comment. You said its only been 120 days of [reality], and I'd love to get your perspective today, how has it changed?

Well, a few more days have passed, and if I don't have to look at the rest of the world and I get to look at beautiful skies in Colorado and most of the Markets we're in, I would say I feel good for the single family detached owner/occupied housing market in the United States. Our caution is that the United States doesn't stand alone even though we stand strong, and I'm thrilled that the housing market is picking up momentum. I'm pleased that there's some pricing power and as I commented earlier, I find it very comforting that virtually most of the public builders are really doing well in sales and momentum and pricing. It's been a long time since there's been one or two or three percentage point price increases and a reduction of incentives, so as we see continued reduction of incentives, a tiny bit of pricing increase, the lowest interest rates for someone to get a mortgage I guess in a current recorded history of whatever that term line means, it's a good time to buy a home and I'm glad to be a home builder. And it was a long seven years and I'm looking forward to seven good years starting January 1, so we're into it now six months and I'm very optimistic.

I'm glad to hear that. Can you guys discuss if your underwriting margin target has changed with recent lot acquisitions, if you're assuming home price increases in your recent land acquisitions, and have you been able to keep your land game as strong as it once was considering the reduction in overhead?

Well, I would say that we take the market as what it is, not what we hope it's going to be, which makes us on the conservative end of determining values, and the land team, we continue to make it stronger, is it as strong as it was in 2005? No, but in 2005, the industry was 80% larger, so I believe that not only ourselves, but others will be ramping up a little bit. The nice thing that we do not have, which is legacy assets, so I don't have old land that needs to be recycled, and I'd say virtually everything we owned in the way of active lots has developed or being developed, so we're very pleased with where we are in the process and in the cycle.

Stephen East, ISI Group.

Thank you. John, you talked some about the land and acquisition. Could you give us a little more clarity on what parts of the country are you primarily focused on buying and getting additional communities, and what are you seeing on land costs on a year-over-year basis as you go through the major markets for you all?

I would say that I believe you can see in the Q and in the Press Release additional information on individual land where we are and what we're doing. We are looking to acquire land in all of our markets, and the velocity is predicated on the opportunity, and I think that we try to make it more transparent than most others as to where we are in each market, and we will continue to expand as all the markets at this point are healthy. Healthier than they were.

Okay, and when you look at your -- at what land is looking like today, I guess I asked this in some of the other builders last week. It said that they were seeing extremely strong acceleration in the west markets but not as much in the east markets. I was just wondering if that had sort of caused you all to change your thought process about where you would go for land, that type of thing.

No, I think you go for the land where the business is, and if we go back a period of years, everyone talked about the West and how fabulous it was, and then we go back two or three years and we talk about how horrible those same markets were and they were never going to recover in Phoenix and Vegas and Colorado, or just like the worst in the world. Now, a couple years later, they're some of the hottest growth markets in the country. The other parts of the country have gotten their legs underneath them, and they're moving forward as the tone in the market throughout the country has improved. I expect lot values to go up in the A locations and they go up because you now have a little bit of pricing power and the consumer is back in a nominal basis from looking at new home sales, nominal basis still isn't a very high absolute number, but it's a heck of a lot higher than its been for the last year or so. So it's all a matter of balance, and good demand is where the sales are happening, and there is still a shortage in the Mid Atlantic for quality finished lots, and that creates its own opportunities because the opportunities come with reasonable pricing for the product.

Okay, and then just one last thing, you focused a lot more on pre-sold versus spec, but when you, the table that you have in your Press Release, your specs have actually gone up a fair amount. What's the strategy there and what's driving the increase in the specs?

I guess the reality is that we're now giving smaller concessions for the specs than what we previously were. If you go back quite a few years, you could sell a spec for the same or more than a dirt start. A person wanted to buy it, they wanted to buy it now, and then we went through this very difficult period over the prior few years where specs were bad, the buyers were bidding on them, the realtors were not being helpful, sales organization was not being helpful, and as the market has turned, we have turned with the market because we find that we're getting better pricing for our specs, people are willing and are interested in getting delivery sooner versus waiting, so we're taking advantage of the change of the market, and I expect that change to continue for a period of time.

Dan Oppenheim, Credit Suisse.

Thanks very much. Was wondering as you talked in the release about putting more in the options into the base price of the homes, we are seeing other competitors taking a bit more out so sort of just thinking about what are the customers willing to pay for and the environment where consumer is gaining a bit more confident now. How are you thinking about that from the options perspective, what's driving that decision in terms of just putting more in that way and how do you see that going over the next couple quarters?

Well, I think that we went through a period of time where the options we were getting paid full price for them, and then we went through a period of time in prior years where the options, the consumer was looking for that to kind of be tossed in the upgrades, and then we went through a period of time where the appraisers didn't give you full value for the options, then you went through a period of time where you included the options in the base price, so you could have better comparables against from one builder to the next. Now you're probably entering just round one of a long fight that people are beginning to want and willing to pay for some options over the base, and so I'm sure like this industry normally does, it's starting another cycle, and in that cycle, you will continue to change as the consumer changes on what they're willing to pay for. I expect the appraisal issue to pretty well sort itself out over the next year or so where the appraisers are having trouble keeping up with the market improving. They had such tremendous pressure on them for when the market imploded and they didn't move quick enough. Now that the market's improving, they're moving slow, but that's just part of homebuilding. You continue to adjust as the market adjusts, and so I expect that our upgrades and design center work in the future will improve. Meanwhile, we're focused on the base case, which is giving the consumer the absolute best value for the money, and that's where we're going at this time.

Okay, thanks, I guess one other question just in terms of land. You talked about the benefit of not having the legacy assets but certainly a shortage of the finished lots in a lot of markets which are putting upward pressure on the lot prices and how you could do a little bit more in terms of development but would be conservative with it. How are you balancing that? When should we expect to see more activity on the land particularly if you do the development work it's going to take a bit more time than if you're buying finished lots given this is upward movement in the order activity, how are you thinking about that in terms of getting more of that under contract here?

Well as we previously disclosed a few minutes ago, we have improved the tempo of what we're dealing with, and we will continue to adjust, keeping in mind that the recovery is six months old. We've run a lion like model for decades, and we don't speculate in land and consequently, our metrics are different than most others, except for one other builder.

Nishu Sood, Deutsche Bank.

Thanks. Wanted to return to the topic of gross margins. Specifically your commentary that you're focused on improving your margins going forward. That's a pretty big shift from your statements in prior quarters where you didn't want to address the issue. So what I wanted to focus in on was what exactly does that statement mean? Does it mean there will be new explicit strategic actions taken to improve margins perhaps on pricing, the pricing versus absorption mix, or does that mean alternately that you're just sitting and looking at your backlog, looking at pricing trends and demand trends and if you project those forward, then gross margins have to rise?

Well, I think that we are still working on our expense side. We are working on our product side. We're working on our procedure vis-a-vis especially controlling pricing pressure on the construction side. We are working on the sales side, better sales execution, and all the elements that entail in this business as we stated last year that we were focusing on those elements to make us profitable and we are focusing on those elements to make us more profitable, and the gross profit margin increase that you have seen over the last 18 months, we believe that we can and will continue to improve on a sequential basis, maybe a little slower than one would expect, but in a very controlled plan of where we are and where we're going and that's something we've always been very transparent about.

Okay, great, thanks.

Nishu, just to add to that point too, to your point on strategy, we are looking at what are our sales rate in the various communities, so when we see an uptick in activity in a sales community, we are making sure that we're looking at our pricing and do we need to raise prices if we're seeing increased demand, so it's very community by community specific, and we're paying like Larry said very close attention to that here.

One community at a time. Each one is different and each issue is different in each of the markets, and I think that the execution, I'm very proud of our people for what they've achieved.

Buck Horne, Raymond James & Associates.

Thanks, guys. I was wondering if you could just elaborate a little bit on the Financial Services gains in the quarter. You got the $4 million of benefit. Is that just a timing of when you originated the loans and when you were able to sell off the paper?

Let me kind of address that question. I figured it would be one of the questions out there. Our pre-tax margin or income at the mortgage company was up 4.4 million during the quarter, and really there's a couple things driving that increased profitability. One is in the prior year, we gave away more incentives and more seller lender paid fees that were given out last year to our buyers, they are about a third of what they were a year ago, so that represented about $1.2 million of the increased profitability. We've also were growing our mortgage pipeline on a year-over-year basis. We have more orders this year than we do last year albeit at a lower capture rate, but we still enjoyed a little bit more income there, and the other couple things is really the balances. The gain on sale of mortgages, it's better execution of that mortgage company and also just improved mortgage market conditions. So kind of those factors all kind of lead to the increase in our profitability there.

Okay, and do you have any expectation or guidance on what we can think about for with the active community count is going to look like over the back half of the year?

Well, you know, we did see our community count drop a little bit from Q1 to Q2 and depending on the sales pace, it might come down a few more between Q2 and Q3, at the time the sales rate we're selling the communities out of relative to when we bring new communities on, but it will be relatively flat, maybe down a smidge.

Alex Barron, Housing Research Center.

Yes, thanks guys. I guess you've sort of addressed this to some degree, you bought the potential cost increases coming down the line, but I guess I'm just wondering to what extent do you think the prices that you're getting are just to cover those costs or how much, if you raise the price $1000, how much of that is really just going to cover costs versus what you think will drop to the bottom line?

I think there will be a little improvement to the bottom line. We are optimistic that we're ahead of the cost curve.

Okay, and on the -- as far as your land strategy, are you guys, to put it simply, are you guys focused more on chasing sort of demand in the A locations, or are you kind of thinking of moving out further out to find lot opportunities that maybe haven't gone up in price as much?

We're going to stay in the best locations in each of the markets.

Mike Widner, Stifel Nicolaus.

Good afternoon guys. So most of the questions have been asked, but first just wanted to follow-up, maybe if you guys could elaborate a little more on how you're thinking about the DTA. We've seen a couple companies bring it back on already, but I think it's probably a this year event, seeing things continue to go the way they're going or is it a 2013 thing, or some have talked about needing a three year rolling look back on profitability so that would be the most conservative approach, so curious where your heads are currently at.

We put together three consecutive quarters of pre-tax-- positive pre-tax income including debt extinguishment we had in the fourth quarter last year. The overall housing market continues to improve and our core operating margins and backlog are up meaningfully year-over-year. So all these constitute positive evidence that need to be considered when we're reviewing our deferred tax asset and whether the valuation allowance would be removed or lowered, so we're currently analyzing that now. I can't really give you a time frame of when we will benefit it, but it's something that's clearly we're very focused on and paying very close attention to.

Great and so then just another one I wanted to follow-up again on kind of the gross margin question, and let me see if I can get your reaction to a broader way to look at it. You indicated I believe about 80% of your sales or closings are coming from communities open since 2009, if I heard you correctly there. As we look around and think about land prices today versus where they were in 2009, pretty much what we hear across-the-board is that -- I don't want to say it's hard to get numbers to foot, but certainly it's harder than it was in 2009. So if we look at it as a lot of your purchases or recent purchases are already flowing through, that's getting you to kind of low 14%s gross margin, land is not getting any cheaper. To see material improvement there, doesn't that sort of imply we need to see continued recovery in home prices. And if so, you need to see something that's home prices improving faster than the cost of the trades, the cost of the materials is improving as well. So forget about the second half of this year and what's currently in backlog, but as you guys think about being a land light builder in a market where land prices are heading up, everybody is participating presumably at some point the privates start getting access to capital again. Are you optimistic we get back to a high teens in the next couple years, low 20%s, are we kind of stuck closer to sort of where we're at now? How do you think about that?

I think I look back in history and when the market was very robust, we were able to make as a builder an excellent gross profit in a good return on our equity without speculating in land, and I think we're in a transition period here where you've got old stuff, kind of old stuff, new stuff and pricing changing that this transition period, it too will pass. And I'm very confident that our performance will demonstrate that a light land model is a lower risk approach than one that has more land assets. As you can look at our balance sheet, you can see that we have a little bit different approach and you can look at our liquidity, and it all balances in a risk adjusted return, and I think that's a better way to look at it and I do expect things to continue to improve and as they have been sequentially for the last six months.

Ken Zener, KeyBanc.

Good afternoon. I wonder, there's two things if I compare your comments to some of the broader, other comments of builders is you seem to focus on the appraisals more. I don't know if that's perhaps an area given your retrenched market given where you're seeing better dynamics A, and then B, while it might be conservative outlook you're taking, it seems as though you're focusing on a more moderate kind of gross margin given where you are. Do you think that could possibly be related to the fact that given your conservatism, you did pull back on the volume so you aren't getting as better price or as better look at some of the trade? Certainly it's the case that some of the other builders bring up, so do you think it's valid?

I would say that anyone that's competed against us would say we're moderately aggressive on both sales and purchasing, and my comments are construed dealing with balance sheet conservatism in the building business. We compete for land with everyone. We sell against everyone, and I think we have continued for many years to demonstrate an ability to excel, and we will continue -- you shouldn't take an interpretation of the comments on the appraisal. I'm not sure that maybe everyone pays the attention we do when an appraisal doesn't clear because of whatever the reason is since we do 98% of our business of our mortgage company is for the builder, we're very sensitive and conservative on how the mortgage process goes. You can also see for the footnotes and our financials, we don't have a mortgage company that's hanging out there with at least known or identified issues that all of us have read about and seen, so maybe it's the fact that we look from the top to the bottom that makes us comment on something that someone else might not comment on, but the facts are the same, everyone has exactly the same issues.

Paul [Pribilski], ISI Group.

Yes, I was wondering as you migrated to including more in the base of the home, what percent of your deliveries, that accounted for this quarter versus the first quarter?

Paul, we don't have that number readily available. Sorry about that.

That's okay, and then in the mountain region I guess orders were a little bit lighter than what I would have expected. I was wondering if you had any color there, if you were more focused on price or what not.

Well, we continue to be very focused on price. The absorption pace in the mountain -- really in Colorado actually was pretty good. It was a little bit slower in Utah, probably the market where we've had a little bit not as good of results in the mountain region, but Colorado again we have a lot of communities there as you know. We are the largest builder in Colorado and so -- but our absorption pace was up year-over-year in Colorado and we're pleased with what's going on in the state here.

Okay, thank you.

Michael Rehaut, JP Morgan.

Thanks. Appreciate it. First question, on the just going back to the Financial Services profit line there for a moment. You did $4.1 million on the gain on sale of mortgage loans and that compares to $1.2 million of a gain in the first quarter, and really hadn't broken it out in prior quarters, so how should we think about that going forward because it appears that if we just look at the quarters comparatively, that was the big driver of improved profitability sequentially, all else equal.

I mean, Mike, that is the big component of our revenues for that division or that operation. Again, in terms of predicting where the gain on sale of mortgages will be in the future, don't want to give that prediction at this point in time, but we are again getting better execution, and the market has been better for us, so -- but again, that is the primary component of our revenues of the Financial Services.

Okay, so nothing in terms of maybe that $4 million versus the $1 million part of that maybe just being some stars aligning this quarter? I mean certainly, maybe you expect some type of contribution going forward, but that type of big jump, you're saying -- I would assume you're saying that we shouldn't expect that every quarter.

No, I wouldn't expect it every quarter.

Okay. The second question on the pre sale as a percent of delivery, that 58%, how should we think about that going forward? I think that had been a driver of gross margin improvement relative to 2011. At the same time, you're now starting to dip more back into spec as spec inventory is up sequentially, and Larry, you're talking about spec pricing being a little bit better. So the pre sale as a percent of deliveries, where should that go into the back half, should we continue to see further improvement, and would there be -- it doesn't seem like it's a big impact one way or another in terms of margins just given that you think that it will, margins will be more driven by pricing partially offset by cost.

Yes, I think the 58% pre-sold homes or deliveries, we've been there for a couple quarters now. I'd say we hang in that range, in terms of our backlog might just give you a sense, almost 70% -- or excuse me -- almost 85% of our backlog is a dirt sale versus 15% that were specs at the end of Q2, and that compares to the prior year of under 70% of our backlog was pre sold. But I think probably this mix is probably will hover for a while, but we will put specs out there in communities where we think there's more demand, and like Larry alluded to where there's opportunities to get some more deliveries. But we've also seen our margins tighten between our specs and our pre-sold homes as the markets continue to improve.

Joel Locker, FBN Securities.

Hi guys. Just on the community count, how many did you open and close during the second quarter, and how many are you planning to open in the third and fourth quarters?

We opened 19 and we closed out 32 for Q2. Haven't given kind of the estimate for Q3. We're not giving that projection, Joe.

You're not. Okay, and then the other thing on the average price increase on orders, you mentioned 3% to 4% in half your communities, was that sequential, year-over-year and was that on all your homes -- in essence, is the math on every order, on all orders across-the-board you increased 1.5% to 2%.

The increase was sequential. What was the second part of your question?

Second part is that across-the-board like was that on every single home in that community you increased it 3% or 4% or was that only on certain plans or certain premium lots or what not?

I think it's new releases or new homes, homes that are currently available for sale or new releases.

So would you say--

And certain plans that are in higher demand would naturally get higher increase in price as would lot conditions. You have a better lot or a premium lot relative to your standard lot.

But the average increase would be 1.5% to 2% on all 1400 orders combined?

Joel, I think it's simply a matter of at the start of the quarter we were at one price and at the end of the quarter we were up 4% on those 50% of the communities. So we haven't given out exactly how that applies to the orders precisely, but that at least gives you a sense for where we're at now versus three months ago.

And we have no further questions at this time. I'll turn the call back over to our presenters for any closing remarks.

Thank you for being on the call today. We look forward to having you again for our third quarter results.

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