普爾特房屋 (PHM) 2006 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the fourth quarter and full-year 2006 Pulte Homes Incorporated earnings conference call.

My name is Tawanda and I will be your coordinator for today.

At this time, all participants are in a listen-only mode.

We will facilitate a question-and-answer session towards the end of this conference. [OPERATOR INSTRUCTIONS] As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the call over to Mr. Calvin Boyd, Vice President Investor and Corporate Communications.

Please proceed, sir.

Thank you, Tawanda, and good morning to everyone.

Thank you for joining us today to discuss Pulte Homes financial results for the three months and year ended December 31, 2006.

Again, I'm Calvin Boyd, Vice President of Investor and Corporate Communications.

You have all had a chance to review the press release we issued last night detailing Pulte's fourth quarter and full-year operating and financial performance.

On the call to discuss these results are Richard Dugas, President and Chief Executive Officer, Steve Petruska, Executive Vice President and Chief Operating Officer, Roger Cregg, Executive Vice President and CFO, and Vinny Frees, Vice President and Controller.

For those of you who have access to the Internet, a slide presentation available at www.pulte.com will accompany this discussion.

The presentation will be archived on the site for the next 30 days for those who want to review it at a later time.

As with prior conference calls, I want to alert everyone listening on the call and via the Internet that certain statements and comments made during the course of this call must be considered forward-looking statements as defined by the Securities Litigation Reform Act of 1995.

Pulte Homes believes such statements are based on reasonable assumptions, but there are no assurances that actual outcomes will not be materially different from those discussed today.

All forward-looking statements are based on information available to the Company on the date of this call and the Company does not undertake any obligation to publicly update or revise any forward-looking statements as a result of new information in the future.

Participants in today's call should refer to Pulte's annual and quarterly reports provided on Forms 10-K, 10-KA, 10-Q, and 10-QA for a detailed list of the risk and uncertainties associated with the business.

As always, at the end of our prepared comments, we will have time for Q&A.

We will wait until then before opening the queue for potential questioners.

Let me now turn over the call to Richard Dugas for a few opening comments.

Richard?

Thank you, Calvin.

Before I get started, let me introduce Calvin to those of you who haven't met him yet.

Calvin has more than 18 years of experience with Pulte Homes, most recently as our Assistant Treasurer, where he was responsible for overseeing the Company's centralized treasury operations.

For those of you who got to know Jim Zeumer over the years, Jim recently took a position with Allied Waste Company in Arizona.

We wish Jim well and are certainly pleased to have Calvin heading our Investor and Corporate Communications efforts.

Let me begin by saying that it's no secret that 2006 proved to be the most challenging operating environment for homebuilding in many, many years.

Lower demand for new homes, increased cancellation rates, and materially higher impairments and land-related charges put a significant damper on this year's results.

In the face of this difficult period, Pulte Homes adjusted its tactics because it was the right thing to do, and we made progress, big progress.

We improved our balance sheet, reduced land and house inventory, and worked to right size our SG&A levels.

Pulte knows how to execute and the results have been significant.

We ended the year with a $0.5 billion in cash, a net debt to cap ratio in the low 30s, meaningful reductions in our house and land inventory, as well as a significant decline in spec units under production.

All of this leaves our balance sheet in great shape.

In addition, we did a very nice job managing our SG&A expenses.

We thank the men and women who manage our operations and whose unwavering efforts in the face of dramatic changes led to these solid results.

Both Roger and Steve will give more detailed information on these metrics in a moment.

Pulte Homes had a small loss from continuing operations for the fourth quarter of 2006 while absorbing significant impairments and land-related charges.

Roger will have more detail on our land charges in just a moment, but I wanted to mention that we are encouraged by the early signs we're seeing in January and are hopeful that the majority of these charges are behind us.

I mentioned earlier that we have adjusted our operating tactics in the face of this housing correction and are proud of the results the shift has yielded.

Looking toward the longer term, however, we remain committed to our strategy, which as many of you know has four major tenets.

First, segmenting our business and investing where demand exceeds supply.

Second, being operationally excellent.

Third, focusing on people, our most important asset.

And fourth, financial discipline.

Each of these elements of our strategy continues to strengthen our company and our position within the industry.

Our segmentation focus is well known and it continues to pay dividends, especially as we continue to open active adult communities under our Del Webb brand.

Steve will highlight some of the success we continue to have with Del Webb in a moment.

Operational excellence means many things, including delivering the industry's best quality and service to our home buyers, running our operations in an efficient manner, and focusing on our simplification strategy to add dollars to the bottom line through sustainable cost reductions and incremental revenue.

Anybody can lower house costs in a down environment by asking for reductions from contractors, but in addition to that, Pulte is focused on driving sustainable change by driving process efficiency like Toyota does.

Again, Steve will have more to say about our efforts there in a minute.

I'll just say that our disciplined focus as I travel around the country is encouraging.

Let me add this about financial discipline, it works.

Our entire organization understands our need to stay flexible and we're proud of the progress we've made to improve our financial position.

As an example, our total lots under control now stands at 231,000, down 38% from our peak in September of 2005.

Finally, allow me to say this about our people, they are the best.

It has been extremely painful this past year to reduce our workforce dramatically as the business has slowed and we have taken great pains to ensure that every single laid off employee was treated the right way as they left.

We are using this slowdown as an opportunity to further strengthen our focus on people development so that we can continue to enjoy a culture that is second to none in this industry.

As I look toward 2007, our goals include maximizing profitability, not driving for high unit volume or building homes for practice.

We believe a balanced approach is best, where each community works to improve returns by finding the optimum blend of price and pace and selling from a position of strength without excessive spec inventory.

This approach will help our company and the industry, we believe, recover sooner by not adding excessive speculative inventory in the market.

Looking ahead, we are seeing some early encouraging signs of a more stable operating environment.

First, our cancellation rates showed modest improvement during the fourth quarter of 2006 and continued to trend downward in January of 2007.

This improving cancellation trend is a result of a combination of lower backlog levels plus improving gross sign-ups.

In other words, it's not just the lower backlog that's helping this metric.

In addition, many markets have experienced a meaningful improvement in traffic and additional new orders thus far in January, ahead of what we expected coming into the year.

Please keep in mind that it's still early and that we're not yet ready to say the worst is behind us, although we are encouraged.

Our focus entering 2007 is to continue selling spec inventory, open some great new stores in key locations and overall to build backlog.

Steve will have a little more color in a minute, but as I mentioned, the early signs are encouraging.

One last note before I turn the call over to Roger.

We normally host an annual investor conference in February each year to discuss our earnings estimates.

Since this current environment makes it difficult to achieve any realistic visibility from our perspective, we are postponing that conference.

Once we have more information at hand, we'll get back to you about the possibility of rescheduling the event later this year or resuming in February of 2008.

Thank you and now let me turn the call over Roger Gregg.

Roger?

Thank you, Richard, and good morning, everyone.

Fourth quarter homebuilding net new unit order rate decreased approximately 34% from the fourth quarter last year.

And in dollars, decreased 38% to approximately $2.1 billion on an increase in community count of approximately 4% versus the same quarter last year.

Revenues from home settlements for Pulte homebuilding operations decreased approximately 15% from the prior year quarter to approximately $4.3 billion.

Lower revenues for the period were driven primarily by lower unit closings that were below prior year by approximately 20%.

The average sales price increased approximately 6% versus the prior year quarter to an average of $341,000.

The increase in the average selling price versus the prior year is primarily the result of an overall volume-driven mix in product and also geographical market mix.

In the fourth quarter land sales generated approximately $46 million in total revenue, which is a decrease compared with the previous year's quarter of approximately $5 million.

Homebuilding gross profits from home settlements, including homebuilding interest expense for the quarter, decreased approximately 58% to $472 million, or a decrease of approximately $651 million from the prior quarter.

Fourth quarter homebuilding gross margins from home settlements as a percentage of revenues were 11% compared to 22.3% in the fourth quarter of 2005.

The decreased margin conversion of approximately 1130 basis points versus the prior year quarter is attributed to produce and geographical mix, increased selling incentives, higher material and labor costs, and land and community valuation adjustments.

Additionally, homebuilding interest expense increased during the quarter to approximately $93 million versus approximately $59 million in the prior year and contributed approximately 80 basis points in a decline in margin versus the previous year quarter.

Included in this interest expense of $93 million for the quarter is an additional $16 million of expense related to land and community valuation adjustments.

Also included in the gross margin for the quarter was a charge related to land and community valuation adjustments in the amount of approximately $130 million, which contributed approximately 300 basis points in the decline in margin versus the prior year quarter.

The total gross loss from land sales posted for the quarter was approximately $21 million.

The gross profit contribution from specific land sales transactions were approximately $5 million for the current quarter versus approximately $9 million in the prior year fourth quarter.

Land sale transactions during the fourth quarter included single-family custom lot sales, residential parcels, and several commercial land parcels.

In addition, we recognized the fair market value adjustment for land being held for disposition in the current quarter in the amount of approximately $26 million, which is included in the land cost of sales.

SG&A costs as a percentage of home sales for the quarter was approximately 7.2%, an increase of approximately 100 basis points over the prior year quarter.

The decreased conversion versus the prior year quarter was the result of lower revenues offset by our internal initiatives focused on controlling costs in the current business environment as the actual expense decreased by approximately $7 million on a 15% reduction in revenues.

In the other income and expense category for the quarter, the expense of approximately $179 million is primarily the result of the write-off of land deposits and pre-acquisition costs of approximately $83 million associated with land option contracts that we determined not to exercise, the valuation adjustment of approximately $96 million related to certain investments in unconsolidated joint ventures.

In addition, we have internally announced the closing of our Pulte Homes Science manufacturing facility in Manassas, Virginia, and took a charge related the shutdown expenses in the quarter of approximately $19 million, which included lease termination costs, the write-down of assets, and other miscellaneous shutdown expenses.

The closing of this facility does not change our strategy related to vertical integration.

We continue to look upon these types of innovations to improve the quality of our homes and drive value to the bottom line for our shareholders.

In the case of Manassas, we were able to achieve superior structural quality in the components manufactured, but were unable to provide a viable solution to overcome the cost disadvantage in the marketplace.

To recap the components of the $369 million of charges included in the fourth quarter, home cost of sales included approximately $146 million, resulting from valuation adjustments to land inventory.

Land cost of sales included approximately $26 million and net in the other income and expense category includes the write-off of land deposits and pre-acquisition costs, investments in unconsolidated joint ventures and the Pulte Homes Sciences manufacturing facility totaling approximately $198 million.

With this focus on our balance sheet and land positioning, we have over the last several quarters dropped land deals of approximately 95,000 lots representing a value of approximately $3.8 billion.

The homebuilding pretax loss for the fourth quarter of approximately $34 million resulted in a pretax margin of approximately a negative 0.8 of 1% on total homebuilding revenues.

Excluding the charges related to the valuation adjustments in land, inventory and investments, land held for sale, the write-off of land deposits and pre-acquisition costs, and the shutdown costs of the manufacturing facility during the fourth quarter, homebuilding pretax margins converted at approximately 7.7% for the current quarter.

At the end of the fourth quarter our homebuilding operations had a backlog of 10,255 homes valued at approximately $3.6 billion compared 17,817 homes valued at $6.3 billion as of the prior year quarter.

The fourth quarter pretax income for Pulte's financial services operations was approximately $30 million, or an increase compared with the prior year quarter of approximately $4 million.

Lower revenues from decreased volumes were offset by a favorable product mix shift to higher profit loans and an increase in the capture rate.

The level of adjustable rate mortgage products originated during the fourth quarter of 2006 decreased from approximately 42% of origination dollars funded from our warehouse line in the fourth quarter of last year to approximately 23% this quarter.

Pulte Mortgage's capture rate for the current quarter was approximately 93%.

Mortgage origination dollars decreased in the quarter approximately $285 million, or 9% when compared to the same period last year.

The decrease is related to the overall slowdown in the homebuilding closing activity for the quarter.

The other non-operating category, pretax loss for the fourth quarter of approximately $14 million, includes corporate expenses of approximately $12 million and corporate net interest expense of approximately $2 million.

Loss from continuing operations for the fourth quarter are approximately $8 million, or loss of $0.03 per diluted share as compared to approximately $532 million, or $2.03 per diluted share for the same period last year.

Fully diluted shares were approximately 257.6 million shares for the quarter.

Now to the balance sheet for the fourth quarter, we ended with a cash balance of approximately $551 million.

House and land inventory ended the quarter at approximately $9.4 billion, or an increase from year-end 2005 of approximately $620 million.

House and land related to house inventory decreased from the prior year quarter by approximately $530 million, or 17%.

And the balance of the increase, or approximately $1.2 billion, is related to land acquired, under development and held for future development.

For the fourth quarter the Company's debt to total capitalization ratio was approximately 35%, and on a net basis was 31.2%.

During the fourth quarter we generated approximately $1.2 billion in cash flow from the homebuilding operations resulting in a cash position of $551 million and having no debt outstanding on a revolving credit facility.

Interest incurred amounted to $71 million in the fourth quarter compared to $61 million for the same period last year.

Pulte Homes shareholder equity for the quarter was approximately $6.6 billion with a return on average shareholders equity for the latest 12 months of approximately 11%, a decrease of approximately 1800 basis points versus the same period last year.

Pulte Homes return on invested capital for the latest 12 months was approximately 8%, a decline of approximately 1100 basis points from the same period last year.

During the fourth quarter we had no shares repurchased.

On a year-to-date basis, we repurchased approximately 3,568,000 shares for approximately $117 million at an average price of $32.84 per share.

The Company has approximately $102 million remaining on its current authorization.

Now looking ahead under the SEC regulation FD guidelines, we provide the following guidance our current expectation for the first quarter of 2007.

First quarter earnings per share from continuing operations are estimated to be in the range of approximately a breakeven to a loss of $0.10 per diluted share.

This range does not include the potential for additional land valuation adjustments and option deposit and land pre-acquisition cost charges.

Although we may incur additional write-offs, it is uncertain at this time to estimate the amount.

This earnings per share number is calculated based on approximately 258 million fully diluted shares.

Unit settlements in the first quarter of 2007 are projected to be approximately 34 to 40% below the same period last year, driven primarily by the lower order rates experienced in the third and fourth quarters resulting in lower backlog for deliveries.

Average selling prices for closings in the first quarter are estimated to be approximately 3 to 4% below the fourth quarter of 2006.

The projected decrease in the average selling price is primarily being driven by product and geographical mix as well as additional incentives for homes projected to be delivered during the first quarter.

Gross margin performance from home settlements as a percent of sales for the first quarter are anticipated to be approximately 1,000 basis points below the first quarter of 2006.

The projected lower gross margins for the quarter primarily reflect pricing strategies in generating sales momentum and pricing incentives experienced over the period in response to market conditions.

We are currently projecting no [land] sale gains for the first quarter.

As a percentage of sales, SG&A is expected to be in the range of approximately 13 to 15% for the quarter.

The higher percentage is reflective of lower revenues offset by internal initiatives to reduce spending.

In the homebuilding other income and expense category for the quarter, we are projecting an expense of approximately 3 to $4 million.

Given no material change from the current and short-term projected interest rate environment, or a significant shift in consumer and mortgage product preference, pretax income in our financial services operations is expected to be approximately 10 to $11 million for the first quarter of 2007.

Total other non-operating expenses are projected to be 11 to $12 million for the first quarter.

We're projecting the effective income tax rate to be approximately 36.6% for the quarter.

Normally we give our outlook for the year, but given the continued uncertain market environment and the lack of visibility to look beyond the quarter, we will assess conditions through the first quarter and provide an update on our first quarter conference call.

I will now turn the call over to Steve Petruska for more [inaudible] on the comments on operations.

Steve?

Thanks, Roger, and good morning, everyone.

As Richard discussed earlier, the challenging conditions of this industry continued throughout the fourth quarter of 2006.

Our operating tactics continue to center around right sizing our land pipeline, reducing starts to match current sales and planned closing volumes, and staying extremely focused on reducing costs in our business at both the SG&A and cost of sales line.

Our efforts have produced some positive outcomes that I will briefly highlight.

Slowing the pace of land purchases, shrinking our lot supply and renegotiating terms and conditions on ongoing land purchases are our primary focus.

At the end of Q4 2006 Pulte controlled approximately 231,000 lots.

That's a 21% decline from our third quarter of 2006 and down 36% from the same period last year.

Even as we continue to right size our land pipeline, we will selectively invest in new land positions that make strategic and economic sense.

We will continue to invest development dollars into our owned projects, as well.

Our Del Webb communities, which are typically larger in scale, will require further investment as they open throughout 2007.

We have also reduced the number of speculative homes we've put into production during the quarter.

Overall, we reduced our spec count by 35% during the fourth quarter to approximately 5,000 homes.

That follows a 14% reduction we realized in the third quarter.

Altogether our current spec counts stands 44% below our second quarter peak -- second quarter 2006 peak.

Our field operators' diligence on this front will most likely to continue to drive improvements in our speculative homes under construction throughout the first quarter of 2007.

Keep in mind that the spec count represents homes in all stages of production.

Over the next couple of quarters, we will stick with our goal of starting significantly fewer specs.

As Richard mentioned, we will not push volume through at the expense of margin.

We will aggressively market the spec homes that we have previously been started, but we will only start new spec homes on a very limited basis where our operators can demonstrate that the home can be sold to a qualified buyer prior to the completion date.

We also continue to see significant improvement around all aspects of cost management within our business. 2006 was a tough year in that we reduced our workforce by nearly 20%.

As difficult a task as that was, our field operators did an outstanding job of treating these departing employees fairly.

Our ongoing human resource planning process ensures that we've retained our best employees and I'm confident that we're building a much more efficient field team that will continue to drive SG&A leverage in future quarters.

As you are probably aware, most builders are lowering house costs and land development costs simply by going back to their trade base and requesting better pricing.

Given the operating environment everyone is experiencing, this is to be expected, and I can assure you we are engaged in that process, as well.

However, combine that with our continued focus on simplifying our processes and our ongoing supply chain initiatives, and we have the beginnings of some sustainable cost improvements that will benefit us as we put new sold homes into production throughout the year.

With that said, let me give you a few details on the quarter.

Our fourth quarter saw settlement revenues decline nearly 15% as a 20% decrease in home closings was offset by a 6% increase in the average sales price.

The price increase was driven more by mix than true price increases taken in the field.

Sign-ups for the fourth quarter totaled approximately $2.1 billion as our average sales price declined approximately 5% from the same period a year ago and unit volumes decreased approximately 34% year-over-year.

As I mentioned earlier, our operators have priced aggressively to move existing inventory.

We have to be competitive in the markets that we operate, but building inventory for practice just creates more price strain.

Continuing the trend we have experienced over the past few quarters, gross sign-ups for the fourth quarter were down approximately 22% compared to the fourth quarter of 2005.

Our previously reported cancellation rate of approximately 35% in the quarter --was 35% in the quarter.

But as Richard noted, we did see an improvement in the cancellation rate each month during the fourth quarter of 2006 and that trend has continued into January.

Beyond the aggregate numbers, here's a little commentary on what our regions have experienced.

Fourth quarter sign-ups in the Northeast were down approximately 11%, significantly better than the third quarter.

Community count was essentially unchanged.

As we have said numerous times on previous calls, this part of the country is extremely limited in new home lot supply.

High resale inventories continue to be the biggest constraint to new home sales in the Northeast.

For the most part, we have seen a leveling of the resale inventories and we view that as a very positive sign for this region.

The Southeast, which includes the Carolinas, Georgia, and Tennessee held up fairly well.

Year-over-year unit sign-ups were down approximately 27%, but margins have remained relatively stable in this part of the country.

Operationally our continued emphasis on the active adult buyer in the Southeast is paying off nicely.

We are seeing some increase in average sales prices as our mix changes and additionally our sales paces are very consistent.

In Florida the news was pretty much the same as last quarter.

The high cancellation rate of approximately 40% drove an overall decrease in sign-ups of approximately 51%.

Resale inventories have yet to subside in Florida and there's also a lot of builder inventory in the markets like Fort Myers-Naples, Orlando, Tampa and Jacksonville.

Better traffic in January and continued strong macro economics are helping, but we don't expect to see things change dramatically in Florida over the next couple of quarters.

Sign-ups in the Midwest were 40% lower for the quarter.

The Midwest has been one of the most challenged regions in the country, as Cleveland and Michigan continue to struggle with difficult economic situations.

Our focus in this region continues to be moving capital to the better markets of Chicago, Indianapolis, and the twin cities.

In our Central region, which includes Colorado, Kansas City, and Texas, sign-ups for the quarter declined 50% year-over-year compared with 43% in the third quarter of 2006.

Our cancellation rate in the region increased slightly from the third quarter to 38% in the fourth quarter of 2006.

In the Southwest we experienced a 28% decline in sign-ups during the quarter compared with the prior year's quarter.

The decrease primarily came from Las Vegas, down 41% from 2005, as our large Del Webb Sun City community there winds down to its final 500 lots and our overall community count is decreased by approximately 17% from a year earlier.

Arizona, buoyed by the strength in the Del Webb brands, showed only a slight 11% decline in year-over-year sales.

I have been very pleased with the continued sales strength we are seeing in Arizona.

Our California operations experienced the most significant improvement with sign-ups only down 13% compared with the prior year's quarter as compared with a 46% decline during the third quarter.

Our operators did an excellent job of moving inventory in the quarter.

In northern California we continue to see market weakness in Sacramento, but our bay area and central valley operations are actually doing quite well.

The story is the same in southern California.

We saw some improvements in our north inland empire in north L.A.

County business, but continue to see oversupply and affordability issues hampering our San Diego and Orange County businesses.

To conclude, we are happy to have 2006 in our rear view mirror.

That said, it's still way too early to predict what kind of housing environment we will experience in 2007.

As Richard and Roger have already brought to light, we are just as ready as anyone else to see 2007 become a year of change for the better.

The early signs of improvements mentioned by Richard, although encouraging, would have to be experienced for the next several months to signal an overall better housing environment.

Regardless of the environment we see in 2007, I believe we are much better prepared as an operating team to take what the market gives us and produce a winning outcome for our shareholders, stakeholders, and employees.

With that, let me turn the call back to Calvin.

Thank you, Steve.

I want to thank everyone for your time and attention on the call this morning.

We are now prepared to answer your question.

So that everyone gets a chance, participants will be limited to one question and a follow-up, after which they will have to get back in the queue.

At this time we'll open the call to questions.

Tawanda?

Thank you. [OPERATOR INSTRUCTIONS] Your first question comes from Michael Rehaut with JPMorgan.

Please proceed.

Hi.

Good morning.

Morning, Mike.

First question on the gross margin expectations for the first quarter.

You had mentioned in the remarks that you really had some good success working down the spec count, and I wanted to know with that in mind, if that was part of the further deterioration in gross margins?

And what's the differential, the margin differential you may be seeing between the canceled homes that you're reselling, which is I guess part of the spec decline, versus the new orders that you're writing today, that are, you don't have a spec in production associated with that?

Yes, Mike, this is Roger.

Certainly the pressure in the first quarter is definitely from the spec sales that we've seen in the third and fourth quarter.

It's hard to say exactly what that differential is from writing, you know, pretty much a dirt sale because a lot of them have been more spec-driven than anything else.

But I would tell you that tending to look at dirt versus spec, there is an improvement in the dirt sales versus the spec.

But I think maybe over the next two quarters we're going to see more influence in pressure on margin because of the specs that we're trying to move through.

Okay.

Great.

And then just second question.

You mentioned that traffic and can rates improved in January and while it's only January, obviously, and we still have the bulk of the spring selling season to kick in, I was wondering if you could give us any quantification of what you mean when you say improvement in traffic in terms of year-over-year growth?

And also where you ended the quarter in can rates.

You said that it improved throughout the quarter and where did it get to in January?

Mike, this is Steve Petruska.

I'll take the traffic part of that.

Our final reports will actually come in today so I don't have any specific numbers for you, but what I'll tell you on a year-over-year basis through the first four weeks of our reporting, we've seen traffic actually flat to last year, which if you remember, last year for us the first two months of the first quarter were pretty flat to 2005.

So if you look at the traffic compared to what we saw predominantly in the second half of last year, it's very, very encouraging.

And Mike, this is Richard.

In terms of the specific numbers on sign-ups or cans, we don't have that information for you.

We are encouraged because it was ahead of our expectations coming into the year, but we're not going to give out any specific numbers.

But when you consider the fact that typically your selling season doesn't kick in dramatically until after the Super Bowl typically, we're encouraged by what we've seen in January.

And Mike, on the cancellations.

This is Roger.

If you look from where we were in third quarter at about 35.8%, we wound up in the fourth quarter at about 34.7%.

So we picked up about 1.1 percentage points between there.

Certainly looking at it, there's always influences, but we looked at the reduction in sign-ups, which typically happen in the fourth quarter relative to the cancellations and the cancellation rates actually helped improve the overall drop in the cancellation rates itself.

So we saw lower cancellations even though we saw lower sign-ups so it wasn't the sign-ups actually driving the rate down.

In addition to that, some of the biggest impacts really, when you start taking a look at it is, really, the adjustment between price expectation of the seller and the buyer, as we look at the marketplaces.

And we saw pretty much improvements very broad based across all of our markets.

There were a few that were still challenged and they were in the Midwest or in the Rocky Mountain area and Texas area, but for the most part, we're very pleased with just what we saw across just about all of our markets overall.

And again, historically, if we looked at it, typically we saw increasing cancellation rate in the fourth quarter, which was really more volume-driven than anything else, but we saw just the opposite this time around.

So the number in itself we don't think is significant.

So we're not putting a lot of weight in it other than it's different from the trend that we've seen over the last number of quarters in 2006, and again, it's just a trend, minor, but nonetheless a positive trend.

Your next question comes from Stephen Kim with Citigroup.

Please proceed.

Thanks very much.

Exciting times.

I wanted to ask you a question.

Let me follow-up on the cancellation rate and gross order trend if I could.

First, the gross order trend, I think you did about 23%, you know, you were down 23% or so on gross orders year-on-year in the fourth quarter, and you'd made some commentary about how I guess gross orders, the trend was starting to improve.

I was wondering if you could be a little more granular on that and give us a sense for how the comparisons sort of were lining up there on the gross orders.

Basically I'm trying to figure out on the gross order number in the first and second quarters whether we should be anticipating that maybe you approach breakeven based pretty much simply on the easing of the comps in the gross orders.

Steve, this is Richard.

We're not prepared to give specific numbers.

What I was trying to indicate on the comments was that a lot has been written that can rates are going to improve just based on a lower backlog and while that's true because of the way the number's calculated, what we're seeing thus far in January is not just because of a lower backlog.

Our gross orders have begun to come in a little better than we expected.

So it's a combination of the two and obviously with the two metrics working in your favor, it helps.

So we don't have any specifics, we're not giving guidance on the number of sign-ups for the quarter or comps versus last year.

But it's not just as a result of a lower backlog coming in.

Okay.

Let me turn my attention to the margins.

Really, I wanted to ask you a question about your gross margin and your SG&A and particularly the trajectory because you were very specific about what you expect in the first quarter.

Other builders have, some other builders have indicated that they felt as a result of both some of both some of the write-offs they've taken, you know, thus far, as well as better negotiated terms with their subcontractors and suppliers that they actually see an upward trajectory throughout '07, sequentially, you know, quarter-on-quarter, and also some of the builders have indicated that because of their very aggressive actions on headcount that they would be seeing an SG&A rate that doesn't seem to be, you know, anticipated to be rising as much as yours in the first quarter.

So my question is, on the homebuilding operating margin, of which there are two components, can you walk us through sort of what you're doing or not what you're doing but rather what you see trajectory wise up or down relative to what you're anticipating in the first quarter?

Steven, again, the perspective that I gave you, first on SG&A.

If you look at SG&A levels from last year's actual relative to the guidance, you will notice that the actual SG&A is coming down in dollars so, you know, it's a fun with numbers type thing on a percentage basis.

As the volume is significantly below in the first quarter of '07 relative to the first quarter of '06, you're going to wind up with a different percentage.

So I think if you truly look at the dollars and the guidance that I gave, you'll see the actual dollars are a pretty significant savings so I would agree with the comment that you made about other builders seeing that same trajectory.

But for second, third, and fourth quarter I'm not giving guidance on that at this point, but I would say that the trend is going to be relative to the trend that we see in the business overall and we're prepared to make those changes one way or the other given what trends we actually experience going forward.

As far as the margins are concerned, again, I think the first quarter margin, if you look at a normalized fourth quarter for adjusting for the impairments, you know, basically is 150 basis points relatively speaking between the guidance in the first quarter relative to the fourth quarter.

And as I had mentioned, a lot of that is being driven by the spec sales as we move some of those out.

Now to your comment as far as looking at overall cost changes and that type of thing, I think we'll see some of those maybe on the back end of 2007, but certainly not on the front end of 2007 as we continue to price our product to move.

So we do see material costs abating, we do see some of the labor changing, as well as Steve had mentioned in negotiating with suppliers, so a lot of that we think will come through.

But sitting here today, not knowing what market prices are going to do, we're not going to commit that you're going to see a margin expansion.

But again, looking at the costs themselves, we do see some abatement in those and expect those going forward, as well.

Your next question comes from Margaret Whelan with UBS.

Please proceed.

Hey, guys.

Good morning, Margaret.

I'm on my cell phone, can you hear me okay?

It's a little light, but we can hear you.

I wanted to ask two questions.

The first one is in terms of the land charges that you've taken, recognizing that you think the fourth quarter would peak, when would we start to see a normalized margin?

Is that an '08 or an ['09] event?

Normalized margin, I'm not sure what normalized margins are after we just came through this period.

Certainly, taking a look at pricing and the cost structure for what we've adjusted, it's going to be a while before we start to build those back up, certainly.

As we look at our returns on our projects, we're, you know, we've certainly seen the returns end up going down because of the pricing environment.

So I would say 2008 would be something that, again, what you're trying to get at a normalized margin, again, I'm not sure, you know, it's going to take a while to get back to what we saw in '05 for sure and --

But that was a peak not a normal, like if you look at your average, [inaudible] maybe 10 or 11%?

When would you get there?

Yes, again, we're looking to hopefully be in, certainly, that range and above in 2007.

So again, there's going to be continued focus on the cost side of it as we've talked about it and even our simplification strategy.

But even on the pricing side, we're going to have to see how that shakes out in 2007.

But I would say 2007 is going to kind of be the transition year where we just come through in 2006 on the downside the ability to push on the upside through and into 2008.

Okay.

And then the second question is and, you know, recognizing that it's hard to pinpoint when the margins are really going to improve sustainably, at what point would you start shrinking your balance sheet significantly reducing your debt?

I know you have very little bank debt or short-term debt right now, but do you have any plans to shrink the balance sheet in terms of the equity or the debt at this point?

I would tell you right now sitting here today, there's no plan to shrink the balance sheet.

Certainly, I think in 2007 our expectation is our investment level will come down again given market conditions, we're not expecting market conditions to improve significantly.

So again, we're going to be sitting here kind of on the fence watching where the movement goes in the business and responding to that accordingly.

But we don't see big changes on the upside in 2007.

Expect it, actually, to be shrinking a bit.

And from a cash perspective, our view would be, would be holder of cash for a short period of time until, again, we could see what the overall market conditions are doing going forward.

Your next question comes from Ivy Zelman with Credit Suisse.

Please proceed.

Good morning, guys.

This is actually Dennis in for Ivy.

Hi, Dennis.

My first question just has to do with a comment you made back when we were meeting at your offices, I think it was late November where you had expected pricing to be aggressive across the industry in 2007, and just wanted to see what your stance was there on pricing and the outlook and what you're seeing as far as incentives whether you're having to offer more or are able to pull any back?

And that's my first question.

Dennis, this is Steve.

I would tell you that we're still competing with a lot of resale inventories out there as well as new home inventories.

And although we're seeing higher traffic numbers, which would typically indicate to some firming in pricing, it's firming at a much more aggressive level than what it was a year ago.

So I would expect that our focus is going to continue to be judicious with our pricing.

We've got to be competitive in the market.

And as we get the opportunity to raise price, we certainly do that, but that's going to be driven more by what we're seeing at the sales offices when the traffic shows up.

And first quarter is clearly kind of the continued process with out with the old.

We want to be able to get to some of these new houses that we can put into production with lower house cost to drive some margin opportunity there.

But, you know, we don't expect it to be a euphoric selling environment by any means in 2007.

Dennis, this is Richard.

If I could just add one thing there.

The real key here is going to be what happens on pre-sold margins versus spec margins.

And when you look at, as Roger commented, the first quarter being impacted heavily by specs, I mean that's virtually all we were selling at the end of last year because we had a lot of spec.

And so we'll have to wait and see how the season unfolds.

I think we indicated earlier, typically pre-sale margins are better than spec margins and while we're hopeful of that to Steve's point, it's still a tough environment for a while.

So I think we'll have a lot more color probably toward the next conference call after we've seen the next three months unfold.

Can you elaborate where in maybe your major markets where you're seeing that improved traffic so far in January?

You know, pretty much it's across the board.

It's just been a phenomena that started really the first, second week of January and has been pretty consistent across the board in just about every market we operate in.

Your next question comes from Kenneth Zener with Merrill Lynch.

Please proceed.

Good morning.

Good morning, Ken.

Good morning, Ken.

Just so, Rich, [do] you expect there to be more margin pressure over the next, not only first quarter, but kind of the second and into the third just based upon the specs that you're selling currently, right?

Well, I mean if you look at the backlog coming in, obviously, we had a lower backlog number than we've had in the past and a heck a lot of that was spec sales and it wasn't a lot of pre-sold built up over the third and fourth quarter that would be flowing through.

So a lot of the margin pressure is due to the fact that inventories were in excess and we're moving that inventory.

Right.

And if I understand your question is kind of when does that abate?

No, I just wanted to confirm that.

And then I was interested in the profit concentration that it kind of implies about the Company because in the third quarter, I don't know if you could actually give an update on the profit by segment because in the third quarter the Southwest contributed around 50%.

Is it really the degradation of that market and Florida that are driving it predominantly?

That's the question.

I'll give you a piece and Steve can comment a little more specifically.

As Steve indicated, we've been pleased with the activity we've seen in the Southwest.

I would tell you in the fourth quarter and kind of expectations going forward is that Florida is not recovering as quickly.

So I don't know that it's as much the Southwest as you might be implying.

Steve?

Yes, Ken, and to Richard's point, we came in with some very, very significant backlogs in Florida and in our Southwest markets in 2006.

And I think our operators did an excellent job of holding on to that backlog, which was at significantly higher margins.

So that as we closed those homes throughout 2006 and through the third quarter reporting period, that's where the profits were showing up.

So certainly, we're going to see some degradation of that profit line just because the margins are smaller in those markets.

But holistically as we look going forward, I think the Southwest for us we're seeing better retention of margin in the Southwest versus Florida.

Florida is, you know, had a much more difficult time with oversupply.

Thank you.

I guess my second question is what is the dollar value of the options that you have left and how many of the option charges that you had taken in the fourth quarter could have been a reserve where you actually still hold the option, you haven't canceled it.

Thank you.

Yes, this is Roger.

Typically when we write off the option, we're not holding the option any longer so it's a walk away, we don't reserve for it.

We actually write it off.

It's a write off of the deposit and the pre-acquisition costs that go with that.

And so there is no reserve, so to speak, set up for that.

Your next question comes from Carl Reichardt with Wachovia Securities.

Please proceed.

Good morning, guys.

How are you?

Hi, Carl.

Good morning.

Can you talk a little bit about your community mix for 2007?

I'm particularly interested in if there's going to be a significant change in either price point, this is excluding Webb now, and/or geographic mix as you look at what you're going to add in '07 versus what you expect to work through?

Carl, on an overall basis, we're kind of projecting community count, first of all, to be flat.

I know that wasn't your question.

As it pertains to mix sans Del Webb, pretty much the same businesses that we've been in.

Maybe a slight geographical shift in overall unit volume as a percentage of our total to the Southwest where our average prices are a little bit higher and a little bit less in Florida where pricing's still relatively affordable.

So I would tell you, you know, I think Roger --- we were seeing like maybe 4 or 5% in the first quarter, but that was all pretty much just based on mix and we're not giving too much guidance as we go out further on that.

Okay.

I understand.

And then just on the update on January when we talked about flat traffic and I assume that's total folks as opposed to folks per store but I don't know that.

In '05/'06 have conversion rates changed appreciably in January relative to what they were last year and in '05, gross conversion rate now?

Gross conversion rates to gross traffic are still slightly down from last year, what we were seeing in the first and I would imagine we're going to see a big shift in March because that was our first slow month in 2006 where it was noticeable for us.

But gross conversion rates are slightly down, but the traffic is pretty much on par to what it was in January of '06.

And that's in total traffic, Carl.

I think you'd asked traffic per store and so it's in total traffic.

Store count's up, Carl, as we reported only about 4% year-over-year at the end of the fourth quarter, not much has changed in the first four weeks of January.

Your next question comes from Alex Barron with JMP Securities.

Please proceed.

Thanks.

Can you talk about the number of communities that you guys impaired this quarter and year-to-date, please as well as their pre-impairment value?

Yes, this is Roger, Alex.

Not going to get into the pre-impairment value, but that's indicative of the write-off from the amount, but we can't sit here and go through each one of these.

We actually impaired roughly about 51 communities or projects for the quarter.

And year-to-date?

Year-to-date --

It's about 60.

About 60 in total.

Okay.

And my second question is can you talk about, I guess what regions and also what was your work in progress?

I think I missed that.

What regions for?

I guess how your different impairments, you know, where you took kind of allocated by region?

Alex, this is Vinny Frees.

I can probably help you out with that.

When you look at all of the different impairments that we recorded, and I do believe you're asking for just impairments not the total of all of the land-related charges.

So addressing your question of just impairments, primarily there were three regions that aggregated greater than 70% of our total impairment and [are of] those three segments would have been California, Midwest, and Florida.

Your next question comes from Jim Wilson with JMP Securities.

Please proceed.

Mr. Wilson, your line is open.

Hello, can you hear me?

Yes, we can hear you.

Sorry.

Just a question on pricing.

So where, and particularly California and Arizona where your order rates, while down, are doing pretty well.

Can you discuss a little bit what it's taken in price reductions or incentives, kind of the total reduction to kind of keep that volume at reasonably stable levels?

Yes, this is Roger, Jim.

Basically when we look at those areas, we've dropped prices in those areas, but they're still better than most of the other areas in the country as we've looked at the pricing conditions itself.

Our price discounting has gone basically from last quarter from roughly 4 to 6% on average, this quarter about 8%.

And in those areas, again, we've been able to do a little bit less than that from the overall average in the country.

What about incentives?

I guess I was trying to get sort of total return to you? 10%, 15%?

In overall incentive levels?

Yes, on top of the prices.

That's all inclusive basically when we look at the pieces from the selling price.

It's hard to get into the cost side as we look at what options may be given at that point that may wind up in costs.

So measuring really at the level of the pricing side, you know looking at what we've done in the past.

This quarter in the fourth quarter has run anywhere between roughly 8 to 10% on average for the Company in total.

Okay.

All right.

Thanks.

Your next question comes from Steve Fockens with Lehman Brothers.

Please proceed.

Hi.

Good morning, guys.

Hi.

First question on, and Roger I think you said this earlier, but in terms of your priorities for cash that you, I guess intend to generate in the coming year, it sounds like your first priority maybe is to actually sit on that.

I wanted to clarify that.

Is that correct, to sort of maintain your flexibility from where you may want to put that?

Yes, Steve, as you well know, typically in this business as you saw in our fourth quarter, a lot of the cash flow inflow is back end loaded in the fourth quarter.

So to be doing anything significant between the first and the third quarter of 2007 given the environment wouldn't be advisable given where we had just come through in 2006.

So, again, as we look out, my guess is through the fourth quarter, we'll be someone to sit on that cash at that point unless we see a definitive move in the market one way or the other that would make us rush off and pay down debt or go the other way to buy back stock or to invest overall.

So all those things, again, we're kind of on the fence at this point but for us we'll probably sit on the cash through the balance of the year until we see a definitive movement in the market.

Fair enough.

And then at some point in the future, obviously you will be reinvesting in land again.

Have you given any thoughts to any changes you might make in either your hurdle rates or your due diligent process or anything else in the whole land buying process?

Anything different versus the way you've done it in the past or do you think you'll probably go back with what you've done in the past?

Steve, this is Richard.

I think from a hurdle rate standpoint, we'll keep it where it is.

And frankly, our asset management process overall we feel is very robust.

I guess the comment to make here is obviously we're going to assume current pace and price assumptions like we always would in the market going forward and those are obviously significantly down from where they had been in prior years so we'll keep that current philosophy in place.

But overall our hurdle rates and our philosophy on underwriting deals will, I believe, stay very consistent.

Your next question comes from Dan Oppenheim with Banc of America Securities.

Please proceed.

Thanks very much.

Was wondering if you can comment a little bit more on your statements that you don't want to just try to push volume?

As you look at backlog in a market like, or region like Phoenix, or sorry, not Phoenix, Florida.

How is it you think about how low you'd want to see your backlog before you'd want to sort of build some specs as to support your SG&A and keep a presence in the market?

Dan, it's Steve.

You know, bottom line is that our Florida operations, just like the rest of the operations around the country, won't put a spec into production as a start unless they have reasonable assurance and that reasonable assurance comes from kind of a rolling three-month, four month sales pace, net sales pace, that by the time the home's completed that they'll have a qualified buyer that will close on it.

We probably told you a couple of quarters ago that historically we might have 35% of our starts be spec starts.

And I would tell you that right now that's probably down to 5% or less.

And as we see market conditions improve, i.e., that rolling net sign-up pace that's going to be indicative of what we think volumes can sustain, then I'm sure our operators will see an opportunity to put a few more homes into production.

Our cycle times, especially in a place like Florida, remain pretty good, which still gives us, you know, the better part of 11 months to assess what market conditions we're going to be experiencing out there.

But I would tell you that they're going to be cautious rather than aggressive.

And just to add a little bit to that, Dan.

As Steve indicated as business improves, we'll be more willing to start spec but if business declines from here, don't look for us to start spec to support SG&A levels, we'll probably adjust SG&A levels if we need to.

Okay.

Thanks very much.

Your next question comes from Greg Gieber with A.G. Edwards.

Please proceed.

Good morning, gentlemen.

I want to get back to Ken's question on options.

Could you tell us the dollar value of options you still have on your books and what percentage of those would require further capitalized expenses or actual takedowns during the current fiscal year?

Yes, Greg, we don't have in front of us what every one of those projects is going to takedown this year and, again, we're not giving guidance for the balance of the year so I wouldn't get into that.

And we're looking for that.

And first of all, we're not anticipating, if I knew today which ones we were going to actually charge off, I'd be able to give guidance for that.

So there was no guidance given for that because I don't have an expectation sitting here today to write-off any of those options.

Now what's in front of us is certainly the ability to have to negotiate, some of them are under negotiation as we pushed out some of our takedown periods and we won't know that until we actually get there, for instance.

If I have one on the 20th of March, I won't know whether that needs to be adjusted or not until I actually get to that point where it triggers whether we walk from it or continue with that particular option overall.

Okay.

I was just trying to get an idea of what the ceiling would be there.

If I could turn to the land impairment charge, it's $146 million that you took in the fourth quarter.

Could you tell me the number of lots involved and when you expect the benefits of that to roll through your P&L?

Are these projects currently under construction?

Yes, the majority of them were under construction.

For roughly about, I think it was roughly about 37,000 lots that the option, or the impairments were for the quarter.

The value of those 37,500 lots was approximately $1.2 billion.

And Greg, you were also asking for the value of the options that we currently have.

The value of the options that we currently have were about -- our 75,000 lots is approximately $4.2 billion.

And all those lots are not planned to be taken down in 2007.

Those go out for years in front of us.

You know, as a lot of those may be under development today in different phases and that type of thing.

As far as the impact for the write-offs and what the impact of the margins could be next year, we don't see it as significant.

I would tell you maybe 20 to 30 basis points if you looked at the ones we've charged off in 2006 and the ones we expect potential volume coming from in 2007.

And again, I'll tell you we did not impair our best projects.

So I know a lot of comments out there that I've seen about big margins coming in 2007 because of the write-offs.

A lot of the projects that were adjusted were the underperforming projects, not overachieving projects.

Your next question is a follow-up from Ivy Zelman with Credit Suisse.

Please proceed.

Hey, guys.

Just a quick one.

Talking about the split between to be built homes and spec.

If you look in the fourth quarter what percentage of your orders were on spec homes and what percent were on to be built homes?

We don't have that information, Dennis, broken out like that.

Dennis, it's -- it was a high percentage of spec.

I can tell you that.

We didn't have a lot of pre-sales, but we don't have that number.

Do you have a general sense of the variance and incentives between the two?

On a general sense basis, I would probably guess, since we were discontinuing about, as Roger indicated, in the 8 to 10% range on the specs it was probably 4 to 6%, which is more in line with historical.

You were discounting less on specs that to be built homes?

No, our specs were 8 to 10 and our out front sales were probably in the 4 to 6% range.

Okay.

Got you.

Okay.

Thank you, guys.

Your next question is a follow-up from Michael Rehaut with JPMorgan.

Please proceed.

Hi, thanks.

On the cost initiatives, and I'm sorry if you didn't -- if I missed this from before, you know, that you're focusing on particularly with the SG&A, other builders have ventured to try and give some type of dollar cost saving goals that they are hoping to achieve in '07.

I was wondering given the headcount reduction and other initiatives that you're doing if you were to give us an idea what that might generate in terms of cost savings in '07?

Yes, Mike, this is Roger.

And no, we're not in a position to lay that out at this point.

Again, I would tell you that relative to what the market conditions are, I think indicative of looking at what you see in the first quarter of the guidance we've given, potentially you may see that trend out but, again, the volume's going to dictate whether it moves up or down based on what we see in the current market.

So at this point, I'm not laying out a full-year, no expectation that I've got significant movements in that other than the first quarter guidance that you can see against the first quarter last year.

We're prepared to certainly structure our SG&A in the organizations accordingly based on the business condition we're in.

So that's all really I can give you for now.

If you look back at the SG&A, it has been a real positive story for you guys and working it.

It's been under 10% for quite some time and you actually got down to below 8% in '05.

On a normalized basis, you know, what are you shooting for?

Yes, Mike, I'll tell you as I look at it, certainly we benefited from being able to leverage with our strategy of segmentation in the markets.

I think I will tell you we continue to look for that.

We've not changed our strategy from that standpoint.

So I would tell you that you're going to continue to see us put a lot of emphasis on that.

That's one of our hallmarks and our focus in each one of these markets is to leverage that.

So coming through this period right now where we've had a significant decline if you look at the volume, is giving us less ability to leverage that, but we're working to get that back.

So at this point I'm just not prepared to be able to extrapolate that out into the full 2007 at this point because I need to understand where that volume goes to actually be able to measure what that might be.

Mike, we're confident that the end of the year you'll look back and say we did a good job with the SG&A.

But to Roger's point, you know, with the current conditions we can't give you more detail.

Your next question is a follow-up from Greg Gieber with A.G. Edwards.

Please proceed.

Yes, I wonder if you looked at, well, looking forward, when you bring new product to market, are you bringing a different type of product than you have in the past?

Is it priced differently?

Can you just compare what your new product this year, this spring will look like compared with last two springs?

Greg, overall, our product per se isn't drastically different.

The cost structure around that product is different.

We've been working diligently through this downturn on a lot of our simplification efforts to value engineer the homes.

You start to couple that with the supply chain savings that we're seeing as well as what we've just simply been getting back from our contractors.

And the cost structure, like I said, looks pretty different, but the product itself, not entirely different, no.

I'm just trying to get to, you know, affordability seems to be one of the major issues out there and restricting demand.

I was just trying to see what you were doing to address that affordability question.

I can help with that.

This is Richard.

One of the things we're doing is on a go forward investment level trying to ensure that our investment strategy is in those areas that are not as affordably challenged.

As an example in Southern California continuing to emphasize our strength in the desert, north and inland empire areas, north L.A.

Ventura County areas, and not so much on the coast where you've got affordability issues.

And to Steve's point, overall our product per se we continue to work on value engineering, et cetera, to help from a cost perspective, but the best thing we can do there, Greg, is make sure on a go forward investment level that we're putting less eggs in the basket of those areas that are the most challenged on affordability.

Ladies and gentlemen, this concludes the question-and-answer session.

I would like to turn the call over to Mr. Calvin Boyd for closing remarks.

Thank you, everyone, for your participation on the call today.

If you have any questions or follow-ups, please give me a call later today.

Thank you very much for your time.

Have a great day.

Thank you for your participation in today's conference.

You may now disconnect.

Have a great day.