THE GROSS MARGIN PERCENTAGES PUBLISHED in May 2004 (“Fortified Financials”) for MDC Holdings (provided by Reuters) don't provide a realistic picture of the home building business. Reuters published 14.5 percent for MDC in 2003 and a 13.5 percent five-year average. We at MDC believe the more accurate and relevant figures are 24.1 percent for 2003 and 22.4 percent for the five-year average. It's based on the following formula: “Revenue from home sales” minus “home cost of sales” divided by “revenue from home sales.”

In our opinion, there are two major errors in the Reuters calculation:

  • The proper expense figure to use in the calculation is “home cost of sales,” which includes direct costs such as land, materials, and labor. Reuters incorrectly includes indirect costs of home construction such as selling, general, and administrative costs in its calculation, thus causing the gross margin percentage to be artificially low.
  • Reuters also includes the financial services part of our business in its calculation. We believe this can be misleading because gross margin is not a useful measure of financial services profitability; it is difficult to separate the direct and indirect costs related to financial services revenues. The exclusion of financial services numbers from gross margin is standard throughout our industry.
  • Additionally, we have determined that Reuters is not reading our SEC filings correctly because our income statement looks different from some other builders' statements. Reuters should take steps to correct its erroneous methodology, but we have been unable to persuade them to do. As a result, the table in your article calculates gross margins for the different builders in an inconsistent manner.

    One other factor may contribute to an inconsistent result for gross margin. Accounting rules allow each builder to choose whether or not to include interest expense in the “home cost of sales.” If we did not include the interest in our formula, our 2003 and five-year average gross margin would be 25 percent and 23.6 percent, respectively, instead of the after-interest margin figures (shown in the first paragraph). As you can see, the choice of accounting method can cause a 1 percent difference in the gross margin figure.

    Hopefully the above discussion will help you arrive at more consistent, accurate figures for gross margin in the future.

    Bob Martin, CPA
    Manager of Financial Analysis, MDC Holdings Denver