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MDC Holdings, Inc. (NYSE:MDC)

Q3 2007 Earnings Call

October 25, 2007, 11.00 AM ET

Executives

Joseph H. Fretz - Secretary and Corporate Counsel

Larry A. Mizel - Chairman and CEO

Paris G. Reece III - EVP and CFO

Analysts

Michael Rehaut - J.P. Morgan

Dennis McGill - Zelman & Associates

Daniel Oppenheim - Banc of America Securities

Stephen Kim - Citigroup

David Goldberg - UBS

Randy Raseman - Durham Asset Management

Timothy Jones - Wasserman and Associates

James F. Wilson - JMP Securities

Rashid Dahod - Argus Research Corp.

Presentation

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the MDC Holdings 2007 Third Quarter Earnings Teleconference. At this time, all participants are on a listen-only mode. Later, we will conduct a question-and-answer session. Instructions will be given at that time. [Operator Instructions]. As a reminder, this conference is being recorded.

I would now like to turn the conference over to our host, Mr. Joe Fretz. Please go ahead, sir.

Joseph H. Fretz - Secretary and Corporate Counsel

Before introducing Larry Mizel and Gary Reece, it should be noted that certain statements made during this conference call, including those related to MDC's anticipated home closings, home gross margins, backlog value, revenues and profits and responses to questions may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements involve known and unknown risks, uncertainties and other factors that may cause the company's actual results, performance or achievements to be materially different from the results, performance or achievements expressed or implied by the forward-looking statements. These and other factors that could impact the company's actual performance are set forth in the company's 2006 Form 10-K and 2007 Second Quarter Form 10-Q.

It should also be noted that SEC Regulation G requires that certain information accompany the use of non-GAAP financial measures. Any information required by Regulation G will be posted on our website, mdcholdings.com.

I will now introduce Larry Mizel, Chairman of the Board and Chief Executive Officer of MDC Holdings.

Larry A. Mizel - Chairman and Chief Executive Officer

Thank you, Joe. Good morning and welcome to MDC's 2007 third quarter conference call and webcast. As most of you are aware, difficult conditions for homebuilding have intensified over the last three months. The well documented fallout in the mortgage industry and the subsequent turmoil in the overall credit markets have weighed heavily on consumer confidence and the demand for new homes.

We have continued to take responsive actions to sell homes at a pace permitted by this highly competitive environment. However consistent with the first half of this year, our primary focus has been to enhance our investment grade balance sheet, strengthen our financial position and improve the efficiency of our business. During the third quarter, we achieved a number of successes in each of these areas. Our centralized asset management committee comprised of senior officials of the company has continued to keep our land acquisitions to a small fraction of prior year amounts.

Recently, we expanded the scope of this committee to scrutinize all cash outflows for land development and home starts. Their actions have helped us reduce the number of lots we control by more than 40% year-over-year and generate $740 million in operating cash flow over the last 12 months, including more than $130 million in the third quarter alone. As a result, our total cash on hand at quarter end, rose to almost $730 million with no balance outstanding on our $1.25 billion line of credit.

Our cash in available borrowing capacity has grown by 45% from this time last year. Our approach to improving the operating efficiency of our business is twofold. First, we have realigned our organizational structure combining a number of operating divisions and rolling our employee headcount by almost 40% from the peak levels. These rightsizing efforts enabled us to realize 23% year-over-year reduction in SG&A in the third quarter. Second, throughout this downturn, we have focused on making key improvements in our business that we believe will not only enhance our prospects for future profitability, but also improve relationships with our customers and strengthen our subcontractor base.

We have designed new products that better meet current buyer preference at a lower cost per square foot. Our nationwide customer experience initiative remains a high priority with the objective of continued improvement in every aspect of the home buying process. We have attacked aggressively the cost side of our business working diligently with our subcontractors and suppliers to unbundled our hard costs while tightening our processes for managing each phase of construction. At the same time, we have continued to preserve the integrity of our brand as we position our company both financially and operationally for an eventual recovery.

Going forward, we will continue to maintain the discipline and patience that our senior management has learned in leading our company through the past 35 years. With almost $2 billion in cash and available borrowing capacity and debt and inventory levels among the lowest in the industry, we are confident in our ability not only to weather this downturn, but also to emerge as an even stronger and better company when the demand for new homes rebounds.

I'd now like to turn this call over to Gary Reece, our Chief Financial Officer, who will describe more specific financial highlights of our 2007 third quarter.

Paris G. Reece III - Executive Vice President and Chief Financial Officer

Thank you, Larry. Just running through some of the numbers here. Our net income for the quarter or actual net loss was $155.4 million or $3.40 of share on revenues of $686.7 million. This compares to net income for the quarter a year ago of $448.7 million or $1.6 a share on $1.81 million in revenues.

Our pre-tax loss for the quarter of $251.3 million is essentially comprised of the impairments and project banner cost that we recognized during the period of $254 million. The same is true for the nine months as a whole where we recognized the pre-tax operating loss of $566 million comprised of $566 million of impairments.

We turn to the year-over-year comparisons. We are down year-over-year in terms of profitability primarily due to the impairments as I said, but also lower quarter wins, lower home gross margins, lower prices, and these declines were offset by lower SG&A cost. Also contributing to our lower profit is lower earnings from financial services primarily our mortgage lending process.

In terms of... I'd like to come back to impairments and we'll discuss those in detail here in a minute. Turn to closing levels, we closed 1963 homes in the quarter. This is down 34% in 2955 homes we closed a year ago. It's only attributable to the fact that we began this quarter with a backlog that was down 36%. We did convert 48% of that backlog, which is up 46%... from 46% a year ago. All of our markets in terms of closings were down but most notably in Nevada, which was down 56%, California as well as Colorado was down 34%.

From our home gross margins standpoint, our margins for the quarter were 14.1% compared to 22.5% a year ago. Margins were down pretty much across the board with the exception of Colorado and Delaware due to higher incentive levels, which produced higher incentive levels and lower prices as well. This caused our land costs as a percentage of revenues also to increase by a couple of hundred basis points.

Our average selling prices were down 7%, $331,700 on average for the quarter compared to $355,000 for the quarter a year ago. Most of our markets reflected lower average selling prices really narrowing in Arizona, bringing the highest declines. We did see several markets show increases in average prices with Utah being up $42,000 per unit reflecting sales that occurred nine months to a year ago when market conditions there were stronger as well as in Colorado, which was up $56,000 per unit.

The SG&A declines were approximately 23% as Larry mentioned. We had total SG&A in the quarter of $129 million. This is down almost $40 million from where we were a year ago. With the bulk of the declines coming in relationship to commissions, which are variable due to the decline in revenues as well as declines on the G&A side. We look at our G&A for the quarter. Total G&A for the company was $76.5 million. This was down $23 million, 23% from $100 million that we recognized in the quarter a year ago.

Most of this decline is really attributable to lower salary, sponsors that benefits that result from our rightsizing efforts as well as our efforts, as mentioned in the press releases. Over the last year, we had reduced the number of active divisions across our company from 27 to 17, and so the deduction in cost related to that are also reflected here. We look at financial services. As we mentioned, our financial services profits were down fairly significantly, approximately 60% from where they were a year ago, really attributable to lower mortgage lending profits, which stem primarily from lower gains on sales and mortgage loans.

These lower gains were a result of lower number of loans to sell due to the reduced number of closings, the low average selling price and a slightly lower capture rate. In addition, we started selling our loans at a faster pace. So we really significantly reduced the amount of time we hold the loans in our books, which produced a lower level of gains on sales would also significantly reduced our risks. And that's a shift that continues to occur in our financial services area in the mortgage lending business.

As we shift the risk pro forma of our portfolio from one that... and much higher level of Alt-A product to this quarter where 86% of the loans that we originated are prime loan products with the remaining 14% being government products, no Alt-A or subprime products initiated or originated during this period. And this compares to a year ago when only 68% of our product was prime and 35% was Alt-A.

We have seen our fixed rate product increase significantly in this quarter. 87% of the loans we originated were fixed rate loans. That's up from 83% in second quarter and up from 53% from a year ago. Also, the loans with seconds that we have originated this quarter, only 20% of the loans that we originated had seconds compared to almost 60% a year ago.

As a result our loan to value ratio has declined from very close to 90% in the third quarter a year ago to just over 82% in the current quarter. Our FICO scores continue at very high levels actually slightly above where we were a year ago in the low 730 range. And obviously with the issues in the mortgage market, it has become much more difficult to originate mortgage loans on the jumbo side. From our standpoint, we have been able to find homes for the jumbos and a mix of the loans we have originated, jumbo products has continued in the 14% to 15% range, which is consistent with where we were a year ago. Now today we do broker a larger percentage of those than we did a year ago, but were still able to meet a substantial part of that demand.

We move back to impairments. We actually recognized in the quarter $249 million of impairments, 76% of that was in our Western markets... in our Western segment in California, Nevada and Arizona with California being the largest piece of that at 33%, Nevada being 25% and Arizona 18%. California really being in the areas we discussed last quarter, the Antelope Valley, the High Desert, Southern Riverside County, up North and Central Valley, Fairfield and Brentwood.

The other markets comprised 24% of our impairment primarily in Florida, Maryland, Chicago and Colorado. All totaled, we impaired this quarter some 7100 lots and 132 subdivisions, 73 of these subdivisions had been impaired in previous quarters. The pre-impairment value that was impaired was $1.1 billion approximately, and post impairment, the value was $873 million. So the assets impaired, 22% of the value was impaired. To this point, we have impaired approximately 50% of our... actually, in this quarter, we impaired approximately 50% of the assets that we own. That including 60% of our land and about 35% of our work-in-process.

On year-to-date, we have recognized impairments of $551 million and over the last five quarters, we have impaired assets to the tune of $663 million. At this point, 55% of the 18,500 lots that we own today that including lot zone as well as homes under construction and work-in-process have been impaired over the last five quarters.

From an order standpoint, our orders were down as well this quarter some 42%, 1,228 net orders were taken compared to 2,120 a year ago. The average value of the estimated sales value of those orders was down 46% to $365 million roughly, reflecting an average selling price of $297,000. That's on a net basis. Now the gross sales that we received that quarter were quite a bit higher than that and there is a mix issue that kind of gives rise to this answer, but that is the net effect of the cancellations orders and closings.

Our order were actually down in all of our markets this quarter except for Chicago and Virginia. Virginia was actually up 7% over last year on a net basis. The largest decline coming in Utah, down some 84% of all-time highs as we recognized in this quarter a year ago. We are also down in excess of 40% in Arizona, California, and Nevada and Maryland. And in Maryland and California in particular have been impacted by difficulties in our buyers in obtaining jumbo mortgage loans. Colorado was also down some 22%.

The can rate for the quarter, the estimated cancellation rate was just about 57% compared to 48% a year ago. Our average percentage of our beginning backlog rate was approximately 40%, which is somewhat in the range of what we have been seeing over the last several quarters. Due to the lower orders, our backlog is down some 40% to 3399 units with a future sales value of $1.2 billion. Every market but Chicago is down. The average selling price of our backlog is $356,000.

The real progress made by the company as Larry mentioned is on the side of the lot supply, the balance sheet, the cash flow. On the lot supply standpoint, we continue to have one of the industries lowest. At 17420 lots, we are down 45% from where we were at this last year owning 13427 lots, which is down 35% and we have just under 4000 lots under option, which is 64% below where we were last year. Of these 4000 lots, we only have $16 million of risk and we have another $4 million in capitalized expenses as well that could potentially be at risk. So a relatively nominal risk with respect to our outstanding option lots.

Our spec inventory continues to run at very low levels. We are at 1550 units, which is slightly above where we were in the second quarter as well as slightly above where we were in the third quarter of last year, and we only have 493 finished specs in the whole company plus all of our markets. The next slide is a summary of our free cash flow. As you can see this has been relatively significant in this quarter, as well year-to-date.

We had produced cash from operating activities in the quarter of $136 million as compared to $70 million a year ago, primarily due to reductions in our land inventories and our mortgage loan inventory. We have generated free cash flow in the quarter of $118 million. For the year-to-date we've generated cash flow from operations of $335 million and over the last 12 months, as Larry mentioned, we've generated cash flows of $740 million from operations.

This cash flow has enabled us to strengthen our balance sheet and our cash position. Our cash is up over 400% where it was at this time last year at $731 million, which has enabled us to increase our cash and available volume capacity by 45% to $1.960 million from where we were last year. We don't have anything outstanding on our homebuilding line of credit in terms of outstanding balances.

The only debt outstanding is your public debt and while our equity level has declined slightly, our debt-to-cap ratio continues to be one of the lowest in the industry, including all debt and all capital. We stand now at 37%, which is only up slightly from what we were last year, and if we eliminate the mortgage debt and exclude the net to cash against it, this quarter the ratio would be 0.13 as compared to 0.28 at this time last year.

That concludes our summary remarks. We'd like to open the call to questions and again I'd like to just ask your indulgence as we've other calls for other builders today that people need to get to, to keep your questions to one question and a brief follow-up on that. And then if you get back in the queue if you have others. And I will be available to answer any questions for if you want to call me later in the day.

Question And Answer

Operator

[Operator instructions]. Our first question comes from Michael Rehaut of J.P. Morgan.

Michael Rehaut - J.P. Morgan

Hi, thanks. Good morning.

Larry A. Mizel - Chairman and Chief Executive Officer

Hi, Mike.

Michael Rehaut - J.P. Morgan

First question relates to the regions that you've been operating on and if you could comment in particular in terms of the more challenged conditions over the last three months. Which markets have really slowed down incrementally the most in regards to that? I mean I see that Utah has really fallen off and that obviously areas like California and Arizona and Nevada remain pretty challenged? That's my first question. And in regards to that more difficult market, what you've seen in terms of incremental price deterioration?

Paris G. Reece III - Executive Vice President and Chief Financial Officer

Well, Mike, since you answered you own question, you can ask another and we won't be charged, and you won't charged the question.

Michael Rehaut - J.P. Morgan

Okay.

Paris G. Reece III - Executive Vice President and Chief Financial Officer

Just kidding. I mean the markets you mentioned are the markets that we are most challenged. The level of impairments we talked about pretty much reflect what has happened in those markets in the last 90 days, and those that have the largest level of impairments have the largest movement in pricing. And so we have seen California and Nevada and Arizona to a certain degree. Really California first, Nevada second and Arizona third. Utah has started to experience some of it... the same symptoms that the other markets have, although we haven't seen any impairments their and we are still, from a margin standpoint has not been affected quite as much primarily because they did not see the same level of price appreciation as the rest of the country or these other Western markets at least. But it has come off from a tie. And Florida has been a difficult for a lot of people and it's tough for us as well, but our exposure there is relatively limited.

Michael Rehaut - J.P. Morgan

Second question. Thank you, Gary. The second question just related to the continued strong balance sheet, and congrats on that. And the question is with regards to what you are seeing out there in the market. You have mentioned that... you are one of perhaps one of those two builders that are knocking on doors in terms of land deals and seeing what's out there and certainly while maybe the prices in right yet. Could you talk about which markets perhaps you're seeing land prices come down the most, and with another kind of midsized private build of bankruptcy in Newman [ph] homes? Are there some deals coming out at the market right now that are what you consider appropriately priced or how are you looking at that?

Paris G. Reece III - Executive Vice President and Chief Financial Officer

Mike, you can see from our balance sheet we haven't spend much in the way of land acquisitions so far even though we are on the hunt... actively on the hunt. I don't know that there is any market right now, certainly in the West that we've seen a significant amount of movement actually taking any action. The few lots that we purchased has come in Colorado for example. Colorado just... Colorado has been difficult for a long time but it hasn't deteriorated as much and there's still pockets of lots in great locations where it does make sense to buy. Same thing holds true in the Mid-Atlantic region and in Delaware where... or the Delaware Valley. Those markets have not deteriorated as much of late and so those are areas that we've seen limited amounts of opportunities but at this point, it's been very limited.

Michael Rehaut - J.P. Morgan

Okay. One last question, if I could.

Operator

Thank you.

Joseph H. Fretz - Secretary and Corporate Counsel

Follow up, Mike?

Operator

Our next question comes from Dennis McGill of Zelman & Associates.

Dennis McGill - Zelman & Associates

Hey guys. How are you?

Larry A. Mizel - Chairman and Chief Executive Officer

Hey, Dennis.

Dennis McGill - Zelman & Associates

My first question, I think Gary last quarter, you guys have talked about the impairment benefit on the gross margin line being somewhere around 270 basis points, is that right?

Paris G. Reece III - Executive Vice President and Chief Financial Officer

I believe that's correct.

Dennis McGill - Zelman & Associates

Do you have a comparable number this quarter and can you briefly explain what that represents on how you calculate it?

Paris G. Reece III - Executive Vice President and Chief Financial Officer

Well, the... I guess it's probably not and to back up a minute, the last quarter we speak of it in terms of impairments related to assets that closed during this period that we had claimed previously. It's not really a benefit necessarily, but we do disclose in the pressure leases the amount of the impairment related to homes that close during the quarter. And that number is $36.4 million this quarter.

Dennis McGill - Zelman & Associates

So that, that's kind of really my question. It's not necessarily reversal. It's basically the amount that if you had not impaired any of the homes you have closed this quarter, your gross margin will be that much lower?

Paris G. Reece III - Executive Vice President and Chief Financial Officer

That's correct.

Dennis McGill - Zelman & Associates

Okay.

Paris G. Reece III - Executive Vice President and Chief Financial Officer

It's related by the homes that had we not taken an impairment in prior quarters, we would have had essentially negative margins.

Dennis McGill - Zelman & Associates

Right, okay.

Paris G. Reece III - Executive Vice President and Chief Financial Officer

And that's the purpose... that's the effect of the impairment.

Dennis McGill - Zelman & Associates

Right. But it's not a reversal of a prior impairment, it's just the value going through.

Paris G. Reece III - Executive Vice President and Chief Financial Officer

That's right.

Dennis McGill - Zelman & Associates

Okay. The other question I had, just thinking about your land position and assuming that in lot of these markets you are not getting the adjustment land prices that you would like, and eventually that's very likely to happen. But how long could you sit there in some of your markets realizing you have a lead time of community plan and so forth where you have to begin acquiring land again. Is that... are you essentially protected through '08 and you could sit on your hands, if you wanted to through next year?

Larry A. Mizel - Chairman and Chief Executive Officer

Dennis, I am glad you asked that question. It gets asked a lot when I talk to people. And first you should understand that we don't have to buy lots in time ever. We are going to buy lots when it makes sense in the market, when the price makes sense and the market conditions are right. Even though we are ready willing and able right now, the fact is that we have a substantial amount of lots that can carry us through in most of our markets next year. We have over 13,000 lots, over 18,000 unclosed lots right now but we have to close houses, and so in most... some markets have more on a relative basis than others. But in most markets where we are running lower than others, we will only buy lots there when it makes sense and not because we need to maintain some level of presence. We will continue to shrink it down. Everything is variable, and we will right size until that point in time when it makes sense to gear up again. And at this point if we had no lots there, it still takes a substantial amount of time for us to work through what we have and so... in our presence in most of these markets is pretty substantial. We are not going anywhere in these markets for a while.

Operator

Thank you. Our next question comes from Dan Oppenheim of Banc of America.

Daniel Oppenheim - Banc of America Securities

I was wondering if you can talk about the SG&A a little more. You talked about the decline to go bring it down. But as you think about SG&A as a percentage of revenue, do you have any goals in terms of where you would like that to be if we look out to '08 towards the fourth quarter of this year ?

Paris G. Reece III - Executive Vice President and Chief Financial Officer

Dan, we would like it to be lower for sure. It's high and one of the reasons it's high is that when you unwind a number of divisions as we have, there are costs associated with terminations of leases with severance related to terminated employees, and also transition costs related to combinations of information on our systems and making sure that we follow through and transition to the next level of activity in the right way, and don't leave anything... any stone unturned. So during the transition period, we are running at a much higher level than we believe its acceptable. And whether it's a percentage for the next quarter, the next year is probably premature. All of we know is that we're too high and we're... we know we're going to be lower going forward. We believe we will be because we have some costs that are hangovers from actions we've already taken that will run their course for the balance of this year and then we'll have a much cleaner looking company to begin next year.

Daniel Oppenheim - Banc of America Securities

Thanks. And just one follow-up. Then on terms of the operation, what's your report [ph] doing more on the pricing side just to adjust more to increase your revenue base here. I know obviously it worked through the land more rapidly there, but do you anticipate doing more to find the market and generate more orders there?

Paris G. Reece III - Executive Vice President and Chief Financial Officer

Dan, our goal is to continue to sell houses at a pace that is appropriate in the market. We're not in a position like some of our peers where there is a large backlog of inventory that needs to be worked through. We really don't have that inventory overhanging and our goal is to maximize the profit that we make on our house well at the same time taking whatever actions that are necessary to sell houses at the same pace as our competition. Whatever the market bares. We are not pushing to sell four a month in a market where the... where all of our peers are selling two a month. We will price it to sell two a month.

Operator

Thank you. Our next question comes from Stephen Kim of Citigroup.

Stephen Kim - Citigroup

Thanks guys. Good job given the environment.

Larry A. Mizel - Chairman and Chief Executive Officer

Thanks Steve.

Stephen Kim - Citigroup

I guess I had two questions related to the land market, if I could. First of all we see from some of the other builders that they are starting to look to, to sell some parcels of land and at least we see something showing up in terms of the income statement, so obviously they're selling some parcels here or there, although not many. And so I guess my question relates to what you're seeing in terms of the counterparties, the ones who are looking to sell land, as obviously builders to consider and then there are other entities. Given your position of taking a lot of dirt and checking out the market. Could you give us a sense for where you're seeing... what is the nature of the resistance to reduce the prices? And what in your opinion would it take, or will it take for the land sellers and if you could talk about it by group, if you like, to actually reduce the selling prices to a level than you think is appropriate in the market?

Paris G. Reece III - Executive Vice President and Chief Financial Officer

That's an interesting question, Steve. What is causing the resistance is probably as much a function of not wanting to go too low, too fast, maybe not enough pressure to take action at this point and until they get pressure from their partners or those that are financing them, maybe their motivation isn't to go... isn't desperation as yet. And in this market, the prices have to go quite a bit lower to be attractive, particularly in the Western markets in Nevada, Arizona and in California in particular. So in terms of... I think just pressure from the banks, pressure from their partners to liquidate to monetize to do something other than sit on the ground because nobody's a buyer. Steve, we sold some land too here in the quarter, sold few lots in California and some lots in Arizona. But these... but they were at pretty distressed prices and they were lots that had special attributes to them that would make it not feasible for us to perceive with any development or certainly try to build on those lots. And so we were... somebody got a very good deal with us on those lots, and so until these land sellers recognize they are going to have to make it worthwhile for the builders who already are flushed with inventory most of them to come of the fence and spend dollars, I don't know that's going to happen.

Stephen Kim - Citigroup

Okay.

Larry A. Mizel - Chairman and Chief Executive Officer

Steve, the... I think you are going to see starting next year, we forget that a substantial majority of our housing is built by non-public builders and I'd say the non-public builders as their interest reserves expire and as the private banks, the non-capital market financial sources recognize the conditions of the builder, then at that time we will see land opportunities and land opportunities, I'd guess will be more substantial as we go through next year and we focus on the fact that the regulators and the auditors need to mark-to-market for the non-public builders and we always talk about the public builders. But there is... probably most of the land is held in the non-public builders and the lenders to that market are just now dealing with those issues and those opportunities will take place, I would assume sometime next year, but that's just conjecture. It's all a matter of market forces and we are standing by.

Stephen Kim - Citigroup

Okay. I appreciate that. My next question on land relates to what you think might happen once some of those opportunities eventually do arrive. Obviously, we went all the way back to 1990 or coming out of last downturn, there were a number of years where you all were trying to pair down your inventory of land, those days are well behind now. As I look at it ever since you got your land basis down, so that wasn't... really wasn't a problem. You kind of stuck to maybe a 3.5 or less, really more like 3 over last years worth of supply controlled if we use the trailing 12 month closing to the metric as a guide. And my question is when these opportunities do arrive, can you give us a handle on maybe what you're thinking is in terms of sort of an upper limit of years owned or controlled of land might be? Are you willing to lever up to buy land if the opportunities are ample and plentiful to a level well beyond three years owned, controlled of land?

Paris G. Reece III - Executive Vice President and Chief Financial Officer

No.

Stephen Kim - Citigroup

Okay.

Paris G. Reece III - Executive Vice President and Chief Financial Officer

It will be less, not more.

Operator

Thank you. Our next question comes from David Goldberg of UBS.

David Goldberg - UBS

Thanks. Good morning.

Larry A. Mizel - Chairman and Chief Executive Officer

Hey David.

David Goldberg - UBS

I was hoping to follow up on Steve's question and I realize it varies by region and the country, but how far away are land sellers the more you think it would be an attractive price and maybe kind of give a range on how much more land prices need to come down from where they are today?

Larry A. Mizel - Chairman and Chief Executive Officer

Substantially.

Paris G. Reece III - Executive Vice President and Chief Financial Officer

Yes, it's hard to give you, to peg it, in a lot of markets, it's not even close. It's not just price, it is price in term [ph] and we believe there is a big difference between price and terms. Price is just one component and we will see... as we have always operated with a little bit different paradigm, you should assume that we will also change how we deal with the market opportunities next year and going forward.

David Goldberg - UBS

I guess my follow-up question will be about any markets you are seeing where reduce in pricing isn't stimulating demand kind of no bid market, if you are seeing that and if so, how pervasive is that?

Larry A. Mizel - Chairman and Chief Executive Officer

I would say everything is responsive to pricing.

Paris G. Reece III - Executive Vice President and Chief Financial Officer

There would be an odd community here or there that maybe... you would experience that on a temporary basis but pretty much we are... the price adjustments that we make, we see the desired response.

Operator

Thank you. Our next question comes from Susan Berlin [ph] of Bear Stearns.

Unidentified Analyst

Hi, good morning. I know you guys are obviously in a great liquidity position, I was just wondering if you can help me. I know you haven't gone back to your bank and I was just wondering if you can come and walk us through what you tangible net worth cushion is now.

Paris G. Reece III - Executive Vice President and Chief Financial Officer

Susan, I know you are trying to be a safe man here today but actually we did file an 8-K last night and included in that 8-K was our earnings release as well as an amendment that we executed yesterday with our banks in regard to the tangible net worth test having... it's something that was not... obviously, not required now. We had a substantial cushion. It's a number that we have not disclosed publicly but what you can see relative to our shareholders' equity, which stands just above $1.8 billion that we reset the floor for our tangible net worth test at $1 billion for '05.

Unidentified Analyst

Okay.

Paris G. Reece III - Executive Vice President and Chief Financial Officer

And that's really... the starting point. Obviously, the tangible net worth is a little different from what our shareholders' equity is but on a relative basis you can see the substantial gap there. And you should understand that the test, this tangible net worth test to which the $1 billion for '05 applies that test is not result in a default under our agreement. It sets into works of terms [ph] that occurs over an 18 month period.

Unidentified Analyst

Great. That helps a lot. Thank you. I'm sorry I missed that.

Paris G. Reece III - Executive Vice President and Chief Financial Officer

Not a problem.

Operator

Thank you. Our next question comes from Randy Raseman of Durham Asset Management.

Randy Raseman - Durham Asset Management

Hi, can you guys talk a little bit about sort of what you think kind of normalize gross margins would be in this environment? And then within that question, I'd also like to kind of understand between the revenue line and the gross margin line, breakout the components between how much of that cost is materials and labor? How much is land and then whatever else maybe buried in there?

Paris G. Reece III - Executive Vice President and Chief Financial Officer

Oh, that's something that maybe we want to talk about offline a little bit. If you want to give me a call later or I can give you a call.

Randy Raseman - Durham Asset Management

Okay.

Paris G. Reece III - Executive Vice President and Chief Financial Officer

To get into too much specifics. But in terms of a normalized margin, we have been hard pressed to really determine what a normalized margin is because there is such a large swing in terms of margins and certainly we've experience it over the last couple of years. Right now we're near the low end of where we've seen margins for our company. And so what's normalized... we certainly have taken steps to try to raise the bar on what that average might be when an average is out. But it is something that's really is hard to... be hard to quantify. Now in terms of the margins between the... values in between, our land cost is running around 27% of revenues with difference... you have got some financing cost that run in the 1% to 2% range and in terms of closing costs and the rest of it is just sticks and bricks.

Randy Raseman - Durham Asset Management

Are those percentages of current ASP or percentages of peak ASP?

Paris G. Reece III - Executive Vice President and Chief Financial Officer

Current.

Randy Raseman - Durham Asset Management

And then just one last question. Of the when you guys talk about your backlog of 3399, how many homes do you have in width right now?

Paris G. Reece III - Executive Vice President and Chief Financial Officer

We have 15100 homes in width right now of which just over 1500 are unsold.

Operator

Thank you. Our next question comes from Timothy Jones of Wasserman and Associates.

Timothy Jones - Wasserman and Associates

Hi, Gary. Hi, Larry.

Paris G. Reece III - Executive Vice President and Chief Financial Officer

Hi, Tim.

Larry A. Mizel - Chairman and Chief Executive Officer

Tim, how are you?

Timothy Jones - Wasserman and Associates

I'm fine. How are you?

Larry A. Mizel - Chairman and Chief Executive Officer

Good.

Timothy Jones - Wasserman and Associates

I'll ask a couple of questions. The one thing I have been asking all the builders are can you give me what's your total and headcount and especially the headcount from just the building operations is now and where it was last year on both sections?

Paris G. Reece III - Executive Vice President and Chief Financial Officer

Splitting it between the mortgage company --

Timothy Jones - Wasserman and Associates

Mortgage company and anything out there under state building. I'm trying to get sale for employee and seeing who's doing what ? Probably better on sale for employee underwater?

Paris G. Reece III - Executive Vice President and Chief Financial Officer

I don't have a breakdown in front of me, but in total we have about 2500 employees right now.

Timothy Jones - Wasserman and Associates

Probably about 350 in the title and so forth [ph]?

Paris G. Reece III - Executive Vice President and Chief Financial Officer

We've got... we got our corporate employees. We've got the title company --

Timothy Jones - Wasserman and Associates

Sort of inclusive --

Paris G. Reece III - Executive Vice President and Chief Financial Officer

It's not a lot there.

Timothy Jones - Wasserman and Associates

I include... I include the corporate really with the builders, I think especially... okay. And do you know what it was last year?

Paris G. Reece III - Executive Vice President and Chief Financial Officer

I am sorry.

Timothy Jones - Wasserman and Associates

Do you know what it was? Was it down from last year?

Paris G. Reece III - Executive Vice President and Chief Financial Officer

Yes, it is. It was around 3500, I believe a year ago.

Timothy Jones - Wasserman and Associates

Okay. The other question is, and I am sorry if I missed this but I was called off for about 5 minutes. This reduction if we're just putting back home again of you divisions from 27 to 17, what happened to the other managers and how much has that cost you?

Paris G. Reece III - Executive Vice President and Chief Financial Officer

The other managers are, I would say, most of them are no longer with the company. We have... and it's been a combination as we grew. We not only had 27 divisions, we had 6 regions, so in addition to division presidents, we had regional presidents that we had... as we have shrunk, we have moved more to a structure that is more of a direct reporting relationship. We still do have several regional presidents that pretty much function not only as regional presidents but division presidents as well for certain divisions. And the division presidents for the divisions that are no longer there, those managers are, for the part are no longer with us.

Operator

Thank you. Our next question comes from Jim Wilson of JMP Securities.

James F. Wilson - JMP Securities

Thanks. Good morning, guys.

Larry A. Mizel - Chairman and Chief Executive Officer

Hi, Jim.

James F. Wilson - JMP Securities

Most of my questions have been answered, but I was... taking through regional profitability and I know obviously you X out the impairments but they have a lot to do with it. Where are margins still at reasonable levels or could you discuss them a little bit. Any parts of the country, I am thinking maybe those were California parts of Virginia and what are those look like at the moment and maybe contrast with some of the poorer regions?

Paris G. Reece III - Executive Vice President and Chief Financial Officer

We really, Jim, we haven't disclosed margins by region. We talk about profitability and I think we do have --

James F. Wilson - JMP Securities

You want to tell us where it is more profitable without telling us what the numbers are, that would be helpful?

Operator

Thank you.

Paris G. Reece III - Executive Vice President and Chief Financial Officer

Let me respond to Jim's question. Jim, I guess you could say that right now, the greater level of profitability excluding impairments certainly is probably on a relative basis in our mountain region here in Colorado and in Utah. Utah is still reasonably profitable and in Colorado, it's been holding its own. It hasn't deteriorated nearly to the degree over the last couple of years that we've seen in the West and the East. And the other markets are I would say California... the Western region is difficult pretty much across the board with California being the toughest. Nevada is still very difficult as well and Arizona, there are certain parts of Arizona, Tucson in particular that Tucson is not doing too badly, but Phoenix... certain parts of Phoenix, some of the outlying area more difficult. And certainly Maricopa and Kelsey Graham [ph] some of those outlying areas are very difficult as compared to some of the inner markets in that city. Maryland is also a market that has continued to do reasonably well relative to some of the other markets around the country. Does that help you?

James F. Wilson - JMP Securities

Yeah. That's great. All right thanks.

Operator

Thank you. Our next question comes from Alex Barron with Agency Trading Group [ph].

Unidentified Analyst

Hi Garry. Hey Larry. Some other builders have been talking about some communities being, I guess, priced in elastic and I guess Larry you said everything was responsive to pricing, so I'm just trying to understand what is your strategy when you start running into very few or no sales. You just keep cutting the prices or what is part of the minimum sales that what you are trying to achieve?

Larry A. Mizel - Chairman and Chief Executive Officer

We try to balance our assets with a reasonable degree of velocity predicated on the markets, and we found that price adjustment, incentive adjustment, product adjustment and even sales personal adjustment, almost always has a positive result and all these things are very, very intensely managed at the home office. We are very hands on and we are analyzing on the continuous basis... on a continuous basis each and every subdivision.

Paris G. Reece III - Executive Vice President and Chief Financial Officer

And Alex, this is... when Larry says it's being managed very tightly, we are looking at this all the time. And the impairment process has brought a higher degree of sensitivity at this level in terms of what pricing is doing and what make sense. When you look at what it takes to build a house in some of these communities and you run through a residual cash flow analysis, you see that in a given community here or there might produce a result because of competitive pressures that maybe temporary in a particular submarket where continued reductions in pricing just don't make sense from a financial standpoint. You end up selling houses with a residual land that's lower than what it costs to develop the lot. And it may lead you to a different conclusion on what you do with those lots, which was kind of the case with these parcels that we sold during the third quarter, not a large part of our business certainly but certainly an example of what as these impairments are gotten larger, the sensitivity that we have to these changes has led us to react differently than just okay let's keep lowering prices and selling houses at loss. Sometimes it makes sense to do something with the lots themselves.

Unidentified Analyst

But if other builders are just lowering, becoming more desperate because they have got liquidity issues or whatever, I realize sort of what you are saying but is there any other alternative to just trying match what they are doing or it's what you are saying basically just sell the land for whatever you can get for it.

Larry A. Mizel - Chairman and Chief Executive Officer

I think one of the key elements in my earlier comments is we believe there is a value in protecting our brand. We are not the low cost producer. We are not the mass marketer. We believe that we have a reputation and an image of a quality builder and we intend to maintain that through this market period and we have been very selective on how we handle everything. Since we don't a lot of specs, we're not forced to making decisions that are not in the interest of the company. As you can see, we've created a very substantial amount of cash flow from our management skills and we will continue to do that for the benefit of not only the short one of a large cash flow, but also with preparing ourselves for the future commented on the programs that we have going on the customer initiative. We're very focused to make sure that our customers are leaving with a good impression that we provide a better product and that our operations are in a manner consistent with where we expect to be going forward versus these current difficult conditions, but having been through this for about 35 years, this is just a little bit more rapid market adjustment than in the past, but it's well within our skill set and we expect to deal with it in a proper way.

Operator

Thank you. [Operator instructions]. We have a question from Michael Rehaut with J.P. Morgan.

Michael Rehaut - J.P. Morgan

Hi, thanks. Just a couple of quick follow ups. First on the tangible net worth, we appreciate Garry you pointing out some of the details from the 8-K. You said that you reset the floor to $1 billion for '05. What was the original floor and you said that even if you fall below it that doesn't represent a technical default.

Paris G. Reece III - Executive Vice President and Chief Financial Officer

Mike, the original floor was set in September of '05 at $1.36 billion and of course it's been adjusted up from there based on earnings subsequent to that date and proceeds from issuing stock, and things of that nature in accordance with the terms of the agreement.

Michael Rehaut - J.P. Morgan

So the new floor is from here on out, it's works for the [ph] $1.4 billion roughly.

Paris G. Reece III - Executive Vice President and Chief Financial Officer

$1.405 billion is the new starting point to the extent that we recognize profits in the future. 50% of that will increase. On the other terms, pretty much stay the same, including the $300 million available with respect to repurchasing stock subsequent to September 30th.

Michael Rehaut - J.P. Morgan

And if you have losses on a net income basis, 50% of those losses get applied to the floor or lower the floor?

Paris G. Reece III - Executive Vice President and Chief Financial Officer

No, they do not.

Michael Rehaut - J.P. Morgan

And like you said before, you said that if you do fall below, it does not constitute a default?

Paris G. Reece III - Executive Vice President and Chief Financial Officer

That's correct. If you fall below, it starts to term out of the facility over an 18-month period.

Michael Rehaut - J.P. Morgan

Okay. Second question just on the SG&A. you mentioned in the beginning of the call that you had some good year-over-year declines and headcounts and you have reduced the number of divisions, but I was wondering if you could kind of give us what you have done in this quarter from the end of 2Q? What incremental have you done in the last 90 days and what I'm trying to get at is that, if there is any incremental benefit from the $105 million, which you hit in the third quarter, which is obviously a nice reduction.

Paris G. Reece III - Executive Vice President and Chief Financial Officer

The changes that we've had made, Mike, are not going to be even for some of things we did in the second quarter and not going to be visible in their entirety until after the first of the year because we made the decision earlier in the year, even before this third quarter to combine four divisions in Southern California into one over this last period of time. We have spent the time vacating offices. That's something that we accomplished during the quarter, which created certain termination, lease termination cost and there have been some people that have left. We have undergone a large conversion of our information base in that market into once new company, combined company. A lot of these things throughout these markets are not going to manifest themselves until the impact of the severances have occurred, which are primarily targeted to the end of this year.

Michael Rehaut - J.P. Morgan

Can you give some idea of perhaps what incremental savings you might be looking forward too in '08 versus '07 regarding the actions you have taken?

Paris G. Reece III - Executive Vice President and Chief Financial Officer

No, Mike it's... I can't put a specific dollar figure on it. I just know that all these things are... they are somewhat diluted by the fact that our... the cost of project write-offs have been higher this year than last and those things run through G&A as well. And so I can't really put a dollar figure on it. I just know that as we have shrunk the company, this line item is going in the same direction, perhaps not at the same pace but hope to pick up the pace and create additional leverage beginning first quarter next year.

Operator

Thank you. [Operator Instructions]. Our next question comes from Rashid Dahod of Argus Research.

Rashid Dahod - Argus Research Corp.

Hi, thanks. Regarding pricing in the adjustment that you may make, what impact does that have on backlog and how do you handle that?

Paris G. Reece III - Executive Vice President and Chief Financial Officer

That's a very good question. In certain markets depending on how deep the cut is and whether the adjustment is deemed to be appropriate to base prices versus special incentives for spec homes, if we cannot distinguish them from what's in backlog, there have been times that we've had to go to our home owners and be proactive and make some adjustments. But it's really... it varies community by community and I would say in a lot of cases, these adjustments relate to our attempts to move spec houses and we generally can distinguish those home in terms of location or what's included in those homes to avoid a mass impact to the backlog. But there are circumstances where we had to go back to the other home buyers in backlog and make some adjustments.

Rashid Dahod - Argus Research Corp.

Okay. Thanks. And then your cash flow assumption, are they based on your current state or you also build in what may happen if you have to take further adjustments?

Paris G. Reece III - Executive Vice President and Chief Financial Officer

In terms of debt for accounting purposes.

Rashid Dahod - Argus Research Corp.

Yes for impairment purposes or just your... what you are expecting to generate for the year and hope for the quarter?

Paris G. Reece III - Executive Vice President and Chief Financial Officer

We haven't disclosed what we expect to generate and that's a different question. When we do our impairments, we pretty much assume what's going on in the marketplace today and that may involve reductions below where we are priced today, but only because we haven't found the market based on what we are pricing houses at today. So if we are not selling houses at the pace we anticipate, we have to estimate where the market is and where we are going to have to lower prices in the future in order to hit where the market is today.

Operator

Thank you. Our next question comes from Sangam Segarney [ph] of Goldman Sachs.

Unidentified Analyst

Thank you. Sangam Segarney. I have two questions. First question, when you look at your write-offs, what sort of pricing environment are you expecting for 2008? Are you assuming flat pricing 5% down, 10% down, 5% up if you could help me with that? Thanks.

Paris G. Reece III - Executive Vice President and Chief Financial Officer

We are assuming no change in pricing. Generally, our projects have a couple of year duration and over that couple of years, we are assuming no change in pricing. When we start getting into the few projects that we have that are longer term, we will... starting in 2010, if we go beyond that point, we assume there is a nominal increase in net pricing starting in that year but there are really few subdivisions that are impacted by that.

Unidentified Analyst

Okay. So if we were to assume 5% price decline next year, what will that do to your inventories? The book value of inventory?

Paris G. Reece III - Executive Vice President and Chief Financial Officer

It will depend on where the price, if you assume and across the board there --

Unidentified Analyst

Across the board, yes.

Paris G. Reece III - Executive Vice President and Chief Financial Officer

Yes, there would obviously... there would be some additional impairments. The impairment is a very bright line.

Unidentified Analyst

Right.

Paris G. Reece III - Executive Vice President and Chief Financial Officer

If you have a dollar of positive cash flow, you're... there is no impairment. If you have a dollar of negative, it would drop over the cliff and our inventory is a mix of assets that are now on the positive side of that line after these impairments but there are some that are closer than others. And I can't tell you... it's not something that we get into because pricing is not the only assumption.

Unidentified Analyst

Right.

Paris G. Reece III - Executive Vice President and Chief Financial Officer

That impacts it. There are... obviously absorptions are important as well as the discount rate that's applied and so we have stayed away from even getting into that. But obviously, you can see that with the level of impairments we've taken, we've impaired a substantial amount of the assets that we can. And so relative to others in our industry, I think we'll probably on the high side there, which puts us further down the road as this thing hopefully comes to an end at some point in the future.

Unidentified Analyst

Okay, great. And second question when you look at your land bank, you had mentioned earlier that the pricing environment is still pretty high for land sales up. How does that compared with the book value of your land versus where the market is right now?

Paris G. Reece III - Executive Vice President and Chief Financial Officer

I am sorry. Run that by me one more time?

Unidentified Analyst

You had mentioned earlier that land prices, land sales are still very optimistic in the market. So I am wondering how did your land price, book value of your land compares to the transaction out their in the marketplace or the prices that are being quoted for land bank out there?

Paris G. Reece III - Executive Vice President and Chief Financial Officer

It's a mixed bag. Obviously, the book value of our land is at a level that we believe based on today's market.

Unidentified Analyst

Right.

Paris G. Reece III - Executive Vice President and Chief Financial Officer

Is at a level that will enable us to be profitable. And for those assets that we have impaired, which constitute more than half of our loss, we believe that our land values are at a level that will enable us to produce a reasonable rate of return, somewhere between as our discount rates range from 10% to 18% averaging approximately 15%. So it's going to be somewhere in the 50% return standpoint, which depending on the stage of the asset will yield a wide range of margins. But nevertheless, we will produce some level of profits going forward.

Unidentified Analyst

Okay, thank you.

Operator

Thank you. I am showing no further questions at the time, sir. Please continue.

Larry A. Mizel - Chairman and Chief Executive Officer

We would like to thank you again for joining our call today. We look forward to having the opportunity to speak with you in January, following the announcement of our 2007 fourth quarter and full year results. Everybody have a great day. Thank you.

Operator

Ladies and gentlemen, this conference will be available for replay after 4 PM today through November 25 at 11:59 PM. You may access the AT&T teleconference replay system at any time by dialing 1800-475-6701 and entering the access code 889130. International participants dial 320-365-3844. Those numbers again are 1800-475-6701 and 320-365-3844, with the access code of 889130. That does conclude our conference for today. Thank you for your participation and for using AT&T executive teleconference. You may now disconnect.

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