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M.D.C. Holdings, Inc. (NYSE:MDC)

Q4 2008 Earnings Call

February 10, 2009 10:00 am ET

Executives

Robert N. Martin – Director of Corporate Finance & Investor Relations

Larry A. Mizel – Chairman & Chief Executive Officer

Christopher M. Anderson – Senior Vice President & Chief Financial Officer

Analysts

Michael Rehaut

Dan Oppenheim

[Nashaf Font]

Alex Barron

[Joshua Pollard]

[Unidentified Analyst]

Josh Levin

James McCanless

[Adam Reder]

[Steven Kim]

Jim Wilson

[Joe Walker]

[Alex Barrons]

Operator

Good morning. We are ready to begin the M.D.C. Holdings, Incorporated fourth quarter earnings call. I will now turn it over to Robert Martin, Director of Corporate Finance and Investor Relations. Sir you may begin.

Robert N. Martin

Thank you. Good morning ladies and gentlemen and welcome to M.D.C. Holdings 2008 fourth quarter earnings conference call. On the call with me today I have Larry Mizel, Chairman and Chief Executive Officer; and Chris Anderson, Senior Vice President and Chief Financial Officer.

At this time all participants are in a listen only mode. After finishing our prepared remarks, we will conduct a Question-and-Answer session at which time we request that participants limit themselves to one question and one follow-up question. Please note that this conference is being recorded and will be available for replay. For information on how to access that replay please visit our website at 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 M.D.C.’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 2008 Form 10-K.

I should also note that Regulation G requires that certain information accompany the use of non-GAAP financial measures. Any information required by Regulation G will be posted on our website. And now I will turn the call over to Mr. Mizel for opening remarks.

Larry A. Mizel

Good morning and welcome. Since our last earnings call in late October the recession has tightened its grip on our economy, with job losses reaching into the millions and consumer confidence plummeting to new lows. During 2008 these general economic issues coupled with problems unique to the homebuilding industry prevented us from returning to growth and profitability. With a new administration in Washington, there has been much discussion about what can be done to shorten the down part of this cycle.

However, we are not relying on short term solutions as we prepare our business for the future. Even though the downturn in housing negatively impacted our operating results for 2008, we have strengthened our balance sheet during the year thereby bolstering our position as one of the strongest companies in our industry.

Through our efforts to reduce our inventory balances and adjust our organizational structure, we generated $480 million in operating cash flow during the year, including more than $50 million in the fourth quarter. On the strength of that strong operating cash flow, our cash and investment balance rose by more than 40% to $1.4 billion at year-end and now exceeds our total debt balance by nearly $400 million. In addition, we have no debt due until 2012 and no outstanding borrowings on our building line of credit. This gives us flexibility in how we deploy our capital over the next few years.

We are enthusiastic about what can be accomplished in 2009 not because we think that a turnaround in housing is imminent but because we have already made and believe we can continue to make significant progress in our company wide initiatives to streamline our processes, systems and improve the home buying experience for our customers. We have the resources and the expertise to reinvent how we operate as a company and we intend to take full advantage of that opportunity.

In addition, we will continue to explore opportunities to redeploy our capital with an open mind and different ways in which we might take advantage of current market conditions. Given the fundamental changes that have taken place in our industry during this downturn it is not reasonable to assume that we will conduct business the same way as we have historically.

Now I would like to turn this call over to Chris Anderson for more specific financial highlights.

Christopher M. Anderson

Thanks Larry and good morning everyone. The first thing I’d mention is that we did file our 10-K this morning so there’s plenty of detail out there for your view. We do have a few slides that we’ll share with you to give you the highlights.

The first slide that you see here has been a staple of our earnings calls. For the tenth consecutive quarter we have generated positive operating cash flow, more than $1.5 billion in total including the $51 million we generated this quarter. For the year we generated $480 million in operating cash flow and we’ve already filed our tax return for 2008 which should allow us to collect a $165 million refund in the first quarter of 2009 to keep this trend going.

This next slide shows the trend over the past year for both our land and with lots with sequential declines every quarter for each category. Our methodical reduction lot count has been the most significant factor in our ability to generate operating cash flow throughout the downturn. Overall including lots both with and without construction currently in progress we’re down 39% for the year and 80% for the fourth quarter alone.

Looking at the land side of things we decreased our lot count by 34% 2008. However, for the fourth quarter the decrease is only about 2% compared with reductions exceeding 10% for each of the first three quarters of 2008. There are a couple of factors in play here. First we slowed down our land sales in the fourth quarter. We only sold 133 lots as compared with 1,638 over the first nine months of the year. Because we have an ample supply of cash, a relatively low supply of land and we were able to maximize our tax refund early in the quarter, our motivation to sell land decreased to some degree.

Secondly, though we generally eliminated our new land acquisitions, we acted on a few limited opportunities to buy lots in various markets during the quarter. The 133 lots we sold during the quarter generated approximately $3.4 million in proceeds. Most of these lots were in our Arizona and Utah markets. While we recognized the loss of less than $1 million on these sales for book purposes, the tax loss associated with these sales was over $8 million since these lots had been significantly impaired. So these sales helped us reach our maximum available tax refund for 2008.

Of the 7,600 lots we have remaining, about 950 of those are classified as held for sale, meaning that we have determined the best use for them is to sell them to an outside party. At the end of the year these lots had a book value of about $12 million. About 700 of these lots are in California and Arizona, with the balance split between Virginia, Illinois and Florida. As we’ve indicated on our previous calls, the vast majority of the lots that we own are finished so there’s not a lot of development money to be spent on these assets.

And we’ve continued to focus on keeping our exposure on the surety side down. At the end of the fourth quarter we had only $172 million of bonds outstanding, which is down 8% since the end of the third quarter and we estimate that we have less than $25 million of development work that is required to fulfill our obligations under those bonds.

For work in progress, our lots are down 1,600 at the end of the quarter. That’s a decrease of 29% during the quarter and 54% for 2008. Of these about 450 are completed homes that have not yet been sold as of the end of the quarter. Never completed unsold homes is down only about 12% for the year, but that’s a little misleading. We’ve closed a good number of models in the interest of saving on our selling costs so they’ve moved into a speculatory classification as we work to sell them. About 30% of those 450 completed unsold homes fit into this bucket of models that we are now selling.

We’ve also decreased the lots that we have under option by about 15% during the quarter, but year-over-year they are down 35% to 2,358 at year-end and for these lots we only have $11 million at risk, $10 million being deposits and $1 million in due diligence costs. In the fourth quarter our active subdivisions fell from 211 to 191. The largest declines occurred in Arizona, Florida and Virginia. We had 278 active subdivisions to start the year so for 2008 we decreased our store count by about 30% with the majority of that decrease 60 out of 87 coming from our west segment markets.

This next slide really captures the strength of our financial position. While we’ve always maintained a fairly conservative financial profile, we took it to a new level this year. Starting in the first quarter our cash and investment balance exceeded our total debt and now the spread between the two is almost $400 million. And on top of that after making a few adjustments to our line of credit agreement in the fourth quarter, we have $539 million of available borrowing capacity. With the expected payment of our tax refund in the first quarter we have the potential to continue to increase our cash balance as we look for opportunistic investments.

Turning to some of our key operating metrics, you can see that demand is still limited when you look at the significant decline in our orders. In the fourth quarter we received 350 net home orders, down 53% versus the same period last year. Only Virginia and Maryland had a year-over-year increase in sales.

Our 30% decline in our average active subdivision count contributed significantly to the drop in new orders. But we’re down on a same store basis as well with net orders per average active subdivision dipping below a half per month in the fourth quarter. The average price of the net home orders increased 13% year-over-year to roughly $283,000, mostly due to a high mix of homes in our higher priced Virginia and Maryland markets, which saw a year-over-year up tick in homeowners as I mentioned previously.

Our cancellation rate of 52% was down from 65% in the fourth quarter of 2007 but it’s still relatively high in the industry and by our own historical standards. As has been the case for most of the year, the most common reason for a cancellation during the quarter was financing issues. These lower net orders in Q4 have contributed to the significant decline in our backlog, which is now down to 533 homes. Our average price in the backlog is also down from $334,000 at the end of 2007 to $325,000 at the end of 2008.

This next slide takes a look at our bottom line. The story is much the same as last quarter. Both our home closings and average selling price declined year-over-year for the fourth quarter. But we were able to narrow our losses on a pretax basis and an after tax basis due to a significant decline in impairments and SG&A. So the revenue for the fourth quarter fell 62% to $296 million. Average price was down 8% to about $300,000 in the fourth quarter. That’s off $25,000 from where it was last year.

All of our markets posted a decline except for Colorado, with the biggest drops coming in Arizona and Nevada. In Colorado, the slight increase was a function of the mix of product we sold not price appreciation. In addition, our closings were down 57% with large declines in every market.

Looking at gross margin overall for the company we were at 12.9% for the fourth quarter which was down 120 basis points from last year and down 240 basis points for the third quarter. We’ll give a little bit more detail on that on the next slide.

We decreased our SG&A expense year-over-year by about $45 million, a 39% drop. Even more significant was the decrease in impairments which declined by $116 million to only $60 million in the fourth quarter. Financial services profits were down 43% for the quarter primarily due to an overall volume decrease. The mortgage company experienced lower gains on sales of mortgage loans due to volume, but this was partially offset by a decline in G&A.

On the corporate side we shifted from a small loss to a $22 million loss in the fourth quarter. A few things really drove this decline. First we recognized $7 million in interest expense at the corporate level this quarter outside of what runs through our cost of sales because we could no longer capitalize the full amount of interest incurred related to our senior notes. No interest was expensed in the corporate segment last year.

Second, in the fourth quarter of 2007 we recognized the benefit of $3.5 million due to the adjustment of bonus accruals whereas this year we recognized the $1.3 million expense in the quarter for this category. And third, we earned less interest income during the quarter as higher cash balances did not offset much lower rates returned on our investments.

And finally, consistent with last quarter the supervisory fee that we charge to our other segments was lower in the fourth quarter versus the same period last year. Overall, our pretax loss for the third quarter was up $86 million, down from $190 million last year. Our net loss for the quarter was $89 million as compared with $281 million in 2007 fourth quarter.

As you might have noticed we actually booked a small provision for income taxes during the quarter despite our significant pretax loss. The reason is we recognized an $18 million valuation allowance against our deferred tax assets, which basically eliminated the benefit from income taxes that you might have expected to see. The valuation allowance we booked in the fourth quarter of 2007 was much more significant at $160 million.

Focusing for a moment on our gross margins, this slide shows our trends since the fourth quarter of 2007 on both our free and after interest basis. The amount of interest that we now attach to each dollar of inventory is much higher now than in past years because our inventory balances declined so sharply over the past couple of years. So it’s coming through as interest to cost of sales at a much higher rate, even after we expensed some of the interest incurred in the past two quarters.

In the fourth quarter of 2008 the interest in cost of sales reduced home gross margin by about 400 basis points as compared with only a 200 basis point impact a year ago. Even looking at things before the interest impact shown as the green bar on the slides, our gross margins are up by about 320 basis points from the same quarter last year. This trend is a bit deceptive. The improvement in margins is really a function of the significant amount of impairments we’ve taken in the past. Had we not taken any impairments in past periods our gross margin would have been negative in the fourth quarter.

So the year-over-year improvement isn’t indicative of an improvement in market conditions. It’s a function of the land basis decline due to mounting impairment charges.

Compared with the third quarter our pre-interest home gross margin decreased by about 100 basis points. Much of the decrease can be attributed to additional incentives offered at the end of the year designed to reduce our exposure to speculative inventory in certain markets. The impact of spec sales continues to weigh on our margins.

As was the case in the third quarter about 65% of our closings in this quarter were from specs which typically generate a lower margin than dirt sales. Our management team is focused on putting procedures in place to reduce the number of closings from spec inventories so we hope to see that materialize in our 2009 results.

Moving on to selling expenses, we’ve really done a fantastic job of reducing our selling expenses as evidenced by the nearly 60% year-over-year decline that you see here. The decrease in commissions is really just a function of the decrease we’ve seen in home sales revenue. But the reduction in marketing expense is a result of the conscious effort to curb our spending in this market in a couple of ways.

First, we’ve adjusted our approach to product advertising and substantially reduced our dependence on print media and save on Internet advertising. This is not just a lower cost alternative. We believe it’s really more in tune with the way our average buyer shops for a home. Second, we’ve actively worked to significantly reduce the expense we incur related to model homes. Over the past year the 47% decline in our model home count has outpaced the 30% decline in active subdivisions as we’ve reevaluated the number of models we need in each community or moved to sell homes in multiple communities using a single set of models.

And we’ve taken a close look at the merchandise spend that we put into each of our homes. We think that there’s more we can do here so we’ll continue to take a look at this area throughout 2009.

Looking at our G&A expenses we’re down 20% for the fourth quarter as compared with last year. We’ve done this primarily through significant adjustments to our employee headcount which is down around 40% for the year. We’ve also consolidated or eliminated a couple of operating divisions during the year to better align our structure with the market. In addition, our G&A line benefited from a significant reduction in the write-off of option deposits and capitalized costs related to land deals that we decided not to pursue given current market conditions.

On this final slide here we have an update on impairments for you. This shows the history of our impairments since the beginning starting in the third quarter of 2006. Looking at our most recent quarter we’re down significantly from both the third quarter of 2008 and the fourth quarter of 2007. Also of note, in each of the previous nine quarters the west segment has led all others in the dollar amount of impairments booked. In the fourth quarter, the mountain segment has booked the most impairments, in part because it now holds nearly half the company’s land held for development or sale.

Overall, we impaired a little over 2,100 lots in 132 subdivisions. This includes 369 lots in six subdivisions that are held for future sale. Breaking down the incurrent charge, $40 million of that was related to our land account; $15 million was related to our work in process; and $3 million was related to our held for sale assets.

While we can’t speculate on when the housing market will rebound, we do believe that the efforts that we’ve put forth in 2008 will provide a more efficient operational platform in the years ahead. We believe that our investment grade financial position, the expertise of our management team and the initiatives that we have in place to improve our business provide us with the unique position to seize upon opportunities yet to come.

Before we turn the time over to questions, I do want to take a minute and thank our M.D.C. team across the country for their work in the face of a difficult market. They’ve done a fantastic job even when we’ve had to make some difficult choices in reducing our staffing levels. We are confident that together we can continue to do great work and approach for profitability in our operations. And finally I’d like to thank everyone on the call for their continued support and interest.

Now at this time we’ll open the line for any questions that you have.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Michael Rehaut.

Michael Rehaut

First question and I have one follow-up, but my first question Larry you know at the end of your prepared remarks you said it’s not reasonable to assume you’ll conduct business the way you have historically. And I know that in the last few quarters you’ve talked about perhaps trying to branch out and do some more innovative things like provide advice and services for banks that are looking to monetize assets. And I wanted to know if you could just expand on that last statement.

And are you thinking about things outside of the traditional merchant home building model that M.D.C. has been on for the last ten years? Or is it just more that you’re looking opportunistically in terms of how you buy land and sell homes?

Larry A. Mizel

I think our key focus is on our skill sets and we have the advantage of on a domestic basis to deal with some of the largest financial institutions largely defined who have assets that are substantially impaired that at some point we believe will have value. But it takes skill set. There’s a multitude of aggregators of capital that are either have started or are starting entities to acquire whether it’s distressed assets, assets finished and unfinished lots, loans, securities that will be restructured, all of them to create ultimate liquidity will need someone with the skill sets that we have and the ability to develop residential assets.

And this is how ultimately they’ll be cash created liquidity event for those that are acquiring these type assets. We have been in previous years pretty close-minded on exactly what we want to do and how we want to do it. The opportunities for the skills that we have and the capital that we have are very broad, very deep and we will explore each of these in a very serious way and look forward to completing transactions that will be of substance at some point in the future.

Michael Rehaut

I guess my follow-up is really given the significant fall off in backlog, is it safe – and given your comments in answer to my first question, is it safe to say though that at the end of the day volume might pair up with different capital partners or land owners or asset owners, you would still be sticking to broadly defined that merchant homebuilding model? I mean as it stands now, obviously you’ve always kept a very low land supply. The backlog shows that to the extreme today.

While you might be pairing up and looking more creatively in terms of how you get the input, the land and the assets, can we still kind of think of you guys over the next two, three, four years as ultimately still a merchant homebuilder?

Larry A. Mizel

I don’t know what a merchant homebuilder’s going to look like in two or three years. I don’t think we’re going to go in the auto industry. We haven’t seen that as being attractive but the entire spectrum of real estate that has been impaired isn’t in most areas rapidly deteriorating. We look forward to working with whatever the tax credit will be on housing. We look forward to possibly lost carry backs accelerating. But there will be a need for capital in the real estate markets. And we of course know housing the best. And that’s our focal point.

However conversations with whether it’s other people in our industry or institutions that are related to it, I think we have to keep an open mind. We have nothing that is imminent but we have healthy dialogs in a broad spectrum that I think will be viewed as being very opportunistic at some point.

Operator

Your next question comes from Dan Oppenheim.

Dan Oppenheim

I was wondering if you could talk about the land opportunity that you saw during the quarter and what you’re going to do in 2009 in terms of managing spending on any land relative but also looking at cash flow where the backlog is now.

Larry A. Mizel

Well Dan we continue to reduce our inventory of land as you can see from the balance sheet. We still have an ample supply of land. And we’re doing our business smarter and better. We are working, we are spending money on improving our information process and procedure technology. We are revamping and remodeling our IT system. Those things to make a better as we call it home buyer experience we’re working on. We are revamping new products for most of our markets that we will be utilizing those new products during ’09 in the back part of the year.

We are continuing to adjust G&A. As you know there’s a wide factor of business incurred and G&A opportunities to be taken. We are very active in improving and enhancing the efficiency of our enterprise. I believe that on a prospective basis those people that are in the housing industry will be required to create value for the consumer where they have a product that they wish to acquire that has both perceived and real value. The execution of financing for the consumer and the efficiency thereof will be important.

The opportunities that we have with a material reduction of competition certainly amongst the private builders and some of the public builders have other areas that they need to work on as to the financial viability where we are really, really focused on the future of becoming a more efficient builder with a better product, better controls, improved systems. And we are quite excited with what we’re doing that is not necessarily through the P&L at this short time interval. But on a perspective basis we’ll have a much better company.

I look forward to the recovery of our industry. And during the recovery phase and the acceleration of growth I believe we will have an opportunity to be a more dominant player than we have been in the past.

Dan Oppenheim

If we can talk about the order strategy where you talked about where the orders for a community were this past quarter. What is your goal as you go through 2009? That’s difficult in terms of I mean that hasn’t been great but we’re certainly seeing other builders working to compete against foreclosures. Certainly there are some buyers out there that are looking at foreclosures. What would your goal be in terms of what you’d like to get orders for community to get in ’09?

Larry A. Mizel

I can’t give you a specific order count but everyone is aware that there are foreclosures. We are also aware that the reduced availability of brand new finished homes never been occupied is substantially being reduced on a monthly basis. And one can look at re-sales, one can look at foreclosures or however one might describe distress sales that are in fact sales taking out of a demand factor for housing.

But ultimately the lines will cross where the demand for a brand new home, never occupied, that will be customized. Not as a custom home but the ability for the consumer to come into our design center and select the finishes and the colors that they want I believe will be very compelling. The crossing of those lines we don’t know when that will happen but from the public information available the availability of brand new homes continues to diminish as starts are being reduced.

And at the time that that demand picks up we expect to have a unique opportunity that the consumer can come in and personalize their home with us. Because our basic strategy will be develop our unsold inventory that will be started to what will be called dry wall hold, where then the purchaser will be able to come in and have something unique and of value. And we are positioning ourselves in those markets that we have a reasonable position to be able to execute that plan.

Operator

Your next question comes from [Nashaf Font].

Nashaf Font

I wanted to follow up on Mike’s question earlier about the potential changes in the way you might conduct business, specifically the implications for your disclosures because currently you have among a nice quality, most comprehensive disclosures among the builders. And that’s obviously a function of your choice of what you disclose as well as the clarity and simplicity of your business relative to some of the other builders and their land transactions.

So what can we expect as you consider these new potential ventures or business opportunities? And how much of a factor will disclosure play in what you decide and how you decide to structure things going forward?

Larry A. Mizel

We expect to be able to receive the same nice compliments you just made on a continuous basis.

Nashaf Font

I mean especially if you consider the involvement of third parties, if you’re involved with financial institutions or other builders and there are other parties involved in deciding what you’re going to disclose and how you’re going to disclose it, so in that case are you saying that disclosure would be an issue? You might avoid certain types of transactions or structures?

Larry A. Mizel

I said that we would continue the high standards that we currently maintain. But I guess that’s my best comment is you should assume that we will continue to do what we’ve always done.

Operator

Your next question comes from Alex Barron.

Alex Barron

Interested in your thoughts on the five year NOL both on a short term and a long term perspective and obviously what you think it means to you and what you think it means to the rest of the industry.

Larry A. Mizel

I guess I’ll be pleased to see what bill finally comes out of conference, so I – you know as they say it’s always the devil in the details. And next conference call we’ll be able to give you clarity on what it means. And today it would be premature to size it or evaluate it.

Alex Barron

My other question had to do with some of your land purchases. I was noticing in the Vegas market looks like you guys acquired a few lots. Can you talk about I guess what you find attractive about these lots and what kind of state they’re in and just roughly what kind of I guess valuation to maybe their original costs you guys are picking these things up at?

Larry A. Mizel

The only thing that we have commented on is we have made a few nominal purchases. And nominal is nominal. And one should assume that they were compelling as to valuations. And that’s all I can comment at this time.

Christopher M. Anderson

Just one general comment though on that from a direction standpoint, I mean we’re focused on finished lots. We’re not focused on buying a lot of undeveloped raw land. So our focus for those and anything going forward really is on completed lots.

Operator

Your next question comes from [Joshua Pollard].

Joshua Pollard

First question is on your land spend. You spent about $5 million last quarter. How much did you spend this quarter and what’s your plan for 2009 on the land acquisition side?

Christopher M. Anderson

It’ll be about $10 million this past quarter and going forward, Josh, I think Larry’s statements are probably the best that we’ll evaluate opportunities and we have probably one of the lowest land positions in the industry. So we’ll look for opportunities as they present themselves in 2009.

Joshua Pollard

And then on the development side do you have those numbers as well? And in 2009 are you guys looking to close out the $25 million needed to secure your bonds?

Christopher M. Anderson

Yes. I mean that’s going to happen as those subdivisions get worked through so I’m not sure if we’re going to complete all of that work because it’s just based on the pace of those sales in those subdivisions. So some of those will be complete. I’m sure we’ll exit the year with some of those still outstanding.

Operator

Your next question comes from [Unidentified Analyst]

Unidentified Analyst

First question was on the corporate G&A line. I know Larry highlighted how you guys are currently attacking that line but $21 million it was up a bit sequentially and it continues to trend up, so I’m just wondering when we should start to see some type of improvement there. And kind of what you think a normal run rate should be once you get to your targeted range?

Christopher M. Anderson

Well, we’re pretty intensely focused on our corporate G&A. You know as we said in the commentary some of the increases that you see from a year-over-year, Q4 to Q4 are not necessarily spending increases. Some of those are allocations. Some of those are interest and the way that interest is allocated between cost of sales and G&A. But we’re heavily focused on that.

As we look at 2009 we’ve taken a lot of actions in headcount reductions. Some of those headcount reductions don’t show up in the results for Q4 because of when some of those actions were taken. And so those will benefit us going forward.

Unidentified Analyst

So would you say that should be on an absolute dollar basis down in ’09 year-over-year?

Christopher M. Anderson

Our expectation is that we’ll manage that number tighter from ’08 to ’09. Yes.

Operator

Your next question comes from Josh Levin.

Josh Levin

I wanted to ask you about first Slide 12 where you show the inventory impairments over time. And it kind of looks like a bell curve, the peaks in ’08 and ’07 and trends down. Then you couple that with the fact that you’re saying most of your impairments are now in the mountain division which was a less [frosty] market during the bubble markets. Can we sort of conclude that you’re getting towards the end of the impairment cycle?

Christopher M. Anderson

Well, Josh, I think when you look at our inventory balance with land being $220 million we can’t in some cases you could go negative but it would be unlikely that you’d get it much lower than that. And most of the impairments generally get split, probably 70-30 to land. Like I said at the end we can’t call the downturn or the recovery in the housing market. And the majority of impairments were driven by in the market in pricing.

Josh Levin

This is in regard to – I know you don’t typically talk about the current quarter but I think a lot of your competitors have been doing it just talking at least to the quality of comments on what’s going on in January. Can you give us some color about how January looks compared to the end of ’08?

Larry A. Mizel

No. What I would say is Q4 was a very, very tough quarter. When you look at the order pace of 350 and it was pretty unusual to see that mostly driven by what was happening in the economic news. And it was a tough quarter.

Operator

Your next question comes from James McCanless.

James McCanless

Two questions for you. The first one is some of the lots under control in Florida and Nevada increase in 3Q to 4Q. Can you give a little color behind that and what you’re seeing in those markets?

Christopher M. Anderson

Well, some of those lot increases are just us exercising option contracts. So as we open up new subdivisions or new phases of a subdivision we’ll take on more lots as we build through those. And the biggest piece I think has already been talked about in the call. We did do an acquisition there, a small one.

James McCanless

My other question, the increase in the order ASP’s was pretty impressive. How much of that do you believe you’ll be able to take to the closing table, given competition, foreclosure, etc?

Christopher M. Anderson

Any analysis on that, Jay, on orders really you have to look at that almost on a division by division basis and subdivision by subdivision. So year-over-year part of that increase is driven by a pretty low sales order number in the Phoenix division last year. And that was because it had an exceptionally high cancellation rate. So our expectation is that from sale to close we’re focused on increasing that success rate with our buyers. And we expect to take as you can see from our past experience we expect to take a fair amount of that to the closing table.

Operator

Your next question comes from [Adam Reder].

Adam Reder

Larry you said earlier that you look forward to the rebound and that you’re hoping to be I think you said a more important builder or take share in the rebound when it comes. I look at some of your markets places like Maryland, Virginia, and Florida. You have less than a year’s supply on a trailing 12 month basis. When that rebound does come that relative supply would be even shorter so I was wondering what’s the risk that the rebound comes faster or more readily than we expect and you’re left with not enough inventory in those markets to monetize the rebound and become the more important builder that you want to be?

Larry A. Mizel

Without commenting on where specifically we might be as to market, in my experiences in the real estate world there’s never been a shortage of land if you have money. And as you look back the last decade everyone was worried that from time to time someone would run out of land and my comments were and are that as long as you have liquidity, you’ll have all the land that you need. And I think over the last three years is almost every piece of land that anyone owns regardless of when they bought it that had less value than what they paid for it. And we had previously operated as close as we could and just in time delivery of the acquisition of land.

I think history shows correctly that at least amongst the public builders that whether its land you own or options you paid for, the value of that element in the cost of goods for a home has either directly or indirectly been impaired. So I look forward to the challenges of increasing the velocity of our acquisition of those assets on a demand basis versus a supply basis.

Operator

Your next question comes from [Steven Kim].

Steven Kim

My question relates to what you guys might be doing in response to any housing stimulus that is put forth. We don’t obviously know what that’s going to be yet but my question is are you going to be leaving the promotional activity or sort of the marketing activity around that program to the local divisions? Or is there something that you’re going to be doing on a company-wide basis directing in an attempt to sort of maximize your response?

Larry A. Mizel

You should assume that we will do it on every level as aggressively as possible. And the marketing – our marketing is centralized and we have a very good proactive, reactive in the sense of timeliness, communications to our divisions and to the market. And as soon as we know what it is that we can tell the buyer, we will have it in the sales centers and through our home buyer resource and on our website to communicate to everyone the opportunity. And we look forward to whatever Congress does, to their leadership in order to help our industry.

Steven Kim

Sort of as a follow-on to that, let’s assume that there is either some sort of a reduced mortgage rate component or a rebate component to the program if it passes, how much time do you think it will take to be able to gauge whether or not the stimulus is working? In other words, do you think that within a week you know that very first weekend or the weekend after that that there might be a meaningful increase in your activity? Or is it your experience that something like this will take longer for people to respond to and therefore we should hold off any kind of judgment as to the success of it for let’s say a month or something like that?

Larry A. Mizel

Well, I think a month is reasonable. Here’s what’s kind of floating out there. Many prospective buyers aren’t transacting because they don’t want to lose the investment tax credit and what might be a reduced interest rate. So while Congress has been actively working on it, I think knowledgeable home buyers are kind of waiting. It would be a shame if you closed a home yesterday and the tax bill becomes effective Monday and you don’t get the benefit of it. Because we don’t know if it’s going to go backward or forward.

I think one of the good things that’s been discussed is that it’s only going to be for a 12 month period. And of course they can extend it, but we need to create some urgency. We need to create - the interest rates are helpful, the reduced interest rate. I think the number one thing in my view maybe it’s two is consumer confidence, we need to – and that deals with whether it’s auto sales, retail, or almost every segment of our economy.

The home buyer needs to know that they’re going to have a job. They need to know that whatever they buy today isn’t going to be worth less tomorrow. So I think the macro issues will drive part of the momentum. I’m not sure you’d use the word rebate. I believe what you meant was the investment was the tax credit. The utilization of the tax credit is open for clarity. So there’s a group of things, Steven, that aren’t really sure yet.

No matter what they do, I believe it will be helpful and the fact that it’s out there and it will be communicated I would assume every builder will communicate it sometime later the same day as soon as they know what it is to their sales centers and to their sales people. And it can only help. As to how you should measure how it’s going to work, I can’t give you an answer on that. And I really haven’t developed a view.

You know, being moderately aggressive I’d probably start measuring it later that day. So that would probably be referred back to the home office as being unreasonable.

Operator

Your next question comes from Jim Wilson.

Jim Wilson

Was just wondering if you could give a little more color on gross margins and maybe what you saw not on the impairment reports but what you saw geographically during the quarter? Did they flip a little bit from the third quarter? We know marketing conditions are very tough. Anywhere they were hurt more or any other trends you can kind of give some detail on?

Christopher M. Anderson

Jim, it’s a little bit tough to make great commentary on margins by division, just because of the impact of impairments and in my remarks that I said if you said that there were no impairments on a particular subdivision, then we would have ended up with some negative margins. So the impairments have really been the largest driver on margins. In California we took some pretty significant impairments early on, so sequentially they show some improvement. But you have to really get through some little bit more complicated math for backing out impairments and the interest charges to get to that answer.

And so I think overall our prepared comments were there’s not price appreciation that’s driving any kind of margin improvement. We’re continuing to focus on driving out costs and sizing and pricing our products to the market in the best way that we can.

Operator

Your next question comes from [Joe Walker].

Joe Walker

Just on the land buying, how wide are the asset spreads? Obviously in the past they’ve been really wide. And just on top of that are the banks kind of waiting for the stimulus plan kind of thinking that they’re going to be bailed out by one thing or another and get their land priced higher than they would be willing to sell it for right now or could sell it for right now? What’s your overview on what the banks are thinking right now with this plan?

Christopher M. Anderson

I think the banks don’t know what the rules are going to be. And everybody is kind of waiting to see how TARP works and so if one was a potential recipient of government money and you sold an asset for $0.40 and the government would have given you coverage at $0.80, probably someone would be unhappy with you for having not waited to see what the rules are going to be. And again the availability of assets on as we could call it on the bit side is unclear. Land component or lot component as we would describe it is a function of the cost to goods sold. It’s only worth so much.

And if you hold it as the lender you have to decide can you hold it forever? Can you reserve it? Can you take write-offs against it? Or maybe you can trade it into what will be a good bank, bad bank. Or maybe you can securitize it. The banks don’t know what the rules are and we are sitting very patiently waiting for the market to tell us when it’s most opportune to transact.

Joe Walker

Are you fearful? Say you guys at MBR were – the government’s artificially going to prop up land prices and it’s going to penalize the more conservative builders as yourself and MBR and are you fearful of that kind of scenario?

Larry A. Mizel

No. Not whatsoever. The banks can’t prop up any price. There’s a clearing price that will take place whether it’s ourselves or other builders and it doesn’t matter all the other builders, no one’s going to pay more than what they can make a profit at. Some builders have some existing land that it still has to be adjusted down to market values for creating a nominal return. So the banks they don’t have that opportunity, if they want to create a liquidity event which they do. All of them.

You know one of the things that is missing in all the conversations is called velocity. And our economy and our country you can pump in $1 trillion and you have a one time turn or a five time turn, and until we both stimulate it and create confidence and you need confidence to create velocity, not much is going to happen.

I am comfortable that the government is acting aggressively and I am comfortable that the consumers in this country will react earlier than other parts of the world. The United States was early in the slowdown and I believe it’ll be the leader in the recovery worldwide. And we just need a little bit more patience and let the system work, because whether you look at libor prices or high yield prices, you’re seeing in many segments of the financial world movement of rates. Because there is movement and liquidity being re-established and we look forward to participating in it.

Operator

Your next question comes from Michael Rehaut.

Michael Rehaut

Just a couple of quick follow-ups. First your cash flow generation obviously down year-over-year and sequentially and certainly a big function is the declining backlog. As that backlog continues to shrink, can you comment on your expectation for a continued positive cash flow in ’09?

Christopher M. Anderson

Michael, we have traditionally not commented on forward expectations. We did say though that a big driver for cash flow in 2009 will be this tax refund that we get here in Q1.

Michael Rehaut

Yes. I guess I mean Chris I was referring to outside of that. I believe in ’08, I’m pretty sure you did –during 2008 M.D.C. expressed their view – correct me if I’m wrong but that you expected to continue to be cash flow positive. Outside of the cash tax refund any commentary for ’09?

Christopher M. Anderson

No comment.

Michael Rehaut

Second question just on if there’s been any change to your approach to pricing during the quarter? You did have well certainly this could be a function of mix or a geographic or product mix, but it did appear that your owner ASP was up sequentially in the year-over-year and sort of wanted to know if you guys held back on lowering price to the market rate. And if there’s any change in approach to incentives or discounts during the quarter relative to your competitors?

Christopher M. Anderson

Michael, we price competitive to the market so we’re looking and shopping prices weekly, monthly and we’re going to price our columns competitive to the market. I did make the comment earlier just on the analytics on the order price. There is a Phoenix anomaly from Q4 of last year where that sales order price was very low so it distorts last year’s comparison a little bit. But as far as competitiveness we haven’t had any significant change in the way that we price our product.

Operator

Your next question comes from [Alex Barrons].

Alex Barrons

I was wondering I guess given the increased presence of the REO’s in a lot of your markets, I was wondering if there’s any markets or submarkets where the prices of those REO’s are getting so low that you guys are maybe considering it’s better to just not build anymore since maybe you can’t cover your hard costs?

Larry A. Mizel

I don’t think that we’re in any specific subdivision that that’s a direct issue.

Alex Barrons

The other question was I was wondering I think you guys talked about the “improvement in gross margins” being attributed to I guess previous impairments. Did you give the actual dollar amount or basis point improvement that was due to benefit from previous impairments?

Christopher M. Anderson

Actually on page 10 of the earnings release, Alex, we actually provide those numbers for you. So for the fourth quarter that was about $67 million came through in the fourth quarter. You’ve got the numbers for the three and 12 months just in footnote three.

Operator

Your next question comes from Michael Rehaut.

Michael Rehaut

You also give and I apologize if this is in the footnote, the benefit from prior impairments in the gain and land sales line.

Christopher M. Anderson

Michael, I’m not sure if that’s not – I’m going to ask Bob to help me out.

Robert N. Martin

Yes, we do disclose that math.

Christopher M. Anderson

That’s in the press release then.

Operator

There are no more questions in queue, sir.

Larry A. Mizel

Thank you very much. We look forward to visiting with everyone at our next conference call after we have an opportunity to review the first quarter. Let’s hope for the benefit of our industry and our country that Congress acts on something. Thank you.

Operator

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

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Source: M.D.C. Holdings, Inc. Q4 2008 Earnings Call Transcript
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