M.D.C. Holdings, Inc.
Q2 2017 Earnings Call Transcript

Published: 1 Aug 2017

[Operator:]

Good afternoon. Thank you for standing by and welcome to M.D.C. Holdings’ Second Quarter Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] I would now like to hand the floor to Kevin McCarty, Vice President of Finance and Corporate Controller. Thank you, Mr. McCarty, I hand the floor to you.

[Kevin McCarty:]

Thank you, LaTonya, and good morning, ladies and gentlemen. Welcome to the M.D.C. Holdings’ 2017 second quarter earnings conference call. On the call with me today I have Larry Mizel, Chairman and Chief Executive Officer; and Bob Martin, 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 the 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 operations, cash flows, strategies and prospects and responses to those 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 second quarter 2017 Form 10-Q, which is scheduled to be filed with the SEC today. It should also be noted that SEC Regulation G requires that certain information accompany the use of non-GAAP financial measures. Any information required by Regulation G is posted on our website with our webcast slides. And now, I will turn the call over to Mr. Mizel for his opening remarks.

[Larry Mizel:]

Thank you. I’m very pleased to announce our 2017 second quarter net income of $33.9 million or $0.64 per share, which is 26% increase over the prior year. We were able to achieve this improvement by better leveraging our overhead with another solid quarter of home sale revenues growth. For the second consecutive quarter, we’ve realized the year-over-year improvement in our backlog conversion rate, which helped drive an increase in our home sales revenue to almost $650 million. We achieved this improved backlog conversion rate based on stabilizing our build-to-order construction cycle times, which decreased sequentially for the first time in almost two years. Our strong top and bottom line performance over the past year has driven significant improvements in our returns, which remain a key focus for us. At the end of the second quarter of 2017, our last 12 months return on equity improved by 340 basis points year-over-year to 9.3%. On a pretax basis, our last 12 months return on equity not only significantly improved over the prior year, but was also the highest level since the 2006 fourth quarter. Our active community count was down slightly year-over-year. This was partly due to the strong rate of sales activity we experienced in most of our markets over the past year. However, with our returns rising and our liquidity reaching nearly $1 billion, we have been able to focus increasingly on sourcing new projects to drive further growth in our community count. In the second quarter alone, we have proved more than 3,300 lots for acquisition far exceeding the activity for any other quarter over the past three years. As a result, our lot acquisition approvals during the first half of 2017 exceeded the total we approved for all of 2016. In addition, at the end of the quarter, our total lots controlled were 12% higher than a year ago. Our continued belief is that the first time home buyer will serve as a significant source of growth for new home sales nationwide. Given the recent success of our Seasons product line, our acquisition activities have maintained a focus on affordability. To that end, at least 20% of the lots acquired in each of the last four quarters were underwritten for The Seasons Collection. This product line is now selling in four states and accounted for just over 10% of the total net new orders during the quarter. We have remained committed to our build-to-order operating strategy with the vast majority of our starts and our overall construction activity being dedicated to units already sold to customers. As a result, the percentage of our work in process units attributed to sold homes at the end of the quarter reached 92%. The highest level in the company history operating in this manner helps us to preserve our high quality balance sheet and allows us to operate more efficiently by dedicating more resources to converting the sold inventory into revenue. As we turn our focus into the second half of the year, uncertainty remains at the forefront of the domestic political environment. Regardless, we continue to view the home building industry positively bolstered by a solid macroeconomic environment and favorable dynamics of the balance between housing supply and demand. I’ll now turn the call over to Bob Martin will go over the specifics.

[Bob Martin:]

Thank you, Larry. Our home sale revenues increased 13% from the prior year $648 million, primarily due to an 11% increase in closings. We achieved our highest number of second quarter closings in 10 years driven by 8% increase in beginning backlog and the 100 basis point improvement in our backlog conversion rate of 42%. This is only the second time in 12 quarters that we saw year-over-year improvement in our backlog conversion rate with both of these quarters coming in 2017. The progress was driven mostly by the stabilization of our build-to-order cycle times, which were flat year-over-year as a big improvement in Colorado was offset by increases in several of our other markets. On a sequential basis, cycle times improved both for the company as a whole and in each of our markets. Our third quarter backlog conversion rate will be impacted by the I-Joist recall Weyerhaeuser announced in July. In total, we had 222 homes impacted by the recall including 23 already closed and 199 under construction or complete but not yet closed. All of these homes are in Colorado. Including the impact of the recall, we believe a reasonable goal for a backlog conversion rate in the 2017 third quarter is 36%. Our average selling price for the quarter of $458,700 was up a modest 2% year-over-year. The increase would have been about 4% without our Seasons product, which comprised about 6% of our closings during the second quarter of 2017. In the same quarter last year less than 1% of our closings related to Seasons homes. Our gross margin from home sales percentage was up year-over-year from 16.4% to 16.8%. The difference is mostly impairments and warranty adjustments at the 2016 second quarter included $1.6 million of inventory impairments and a $300,000 increase to our warranty accrual. There were no such adjustments during the 2017 second. We are pleased to see improved operating leverage for the quarter as our SG&A rate fell by 40 basis points from 11.3% to 10.9% due in large part to our significant year-over-year increase in home sale revenues. Our total dollar SG&A expense was up $6.3 million for the quarter with a big part of the change driven by $2.8 million increase in commissions, in line with our increase in home sale revenues. Selling and marketing expenses increased by $2.6 million, partly due to the increase in our closing levels, but also due to an increase in the rate of our deferred marketing spend per home closed and higher sales and marketing headcount. We also saw a $900,000 increase in general and administrative expense, primarily driven by an increase in our headcount for our overhead departments. The dollar value of our orders decreased 2% year-over-year to $710.6 million. The decrease was primarily due to 3% decrease year-over-year in the number of units, which was mostly the result of a 4% decline in the number of average active communities. However, our absorption rate improved slightly to 3.4 net orders per average active subdivision per month. Our Seasons collection accounted for 11% of total orders for the second quarter, up 300 basis points sequentially and 800 basis points year-over-year. The rollout of this product continues to be a key focus for the company. However, as I have stated previously, the increase in unit volume will be gradual as many of the communities we have recently purchased for the Seasons product need to complete development activities and community setup procedures during the coming quarters. We ended the quarter with an estimated sales value for our homes in backlog of $1.68 billion, which was up 4% year-over-year. The increase was both the result of a 2% increase in the number of units in backlog to 3,510 homes and a 2% increase in our backlog average selling price. Our cancellations as a percentage of beginning backlog was down year-over-year from 14% to 10% and, as a percentage of gross sales from 21% to 17%. Active subdivision count decreased to 153 at the end of the 2017 second quarter from 159 a year ago. We saw a decreases in most of our markets but the largest percentage decreases occurred in Maryland and Virginia, where we previously disclosed the lower level of investment due to returns that did not meet our expectations. Colorado was an exception, however, with a 57% year-over-year increase in active subdivision count. To end the quarter, we had roughly seven fewer subdivision in the category we call soon-to-be active than in the soon-to-be inactive category. In other words, we continue to be a little heavier in subdivisions that are on the verge of sellout relative to those that are just opening. That tells us that our active subdivision count could continue to decrease in the third quarter relative to where we ended the second quarter. However, the spread between soon-to-be active and soon-to-be inactive has decreased sequentially, and we believe we can increase our active subdivision count by the end of the year relative to where it was at, at the end of the second quarter. For the 2017 second quarter, we acquired 1,582 lots, up 41% from a year ago. This was also the highest number of lots that we’ve acquired since the third quarter of 2015. The second quarter activity occurred largely in Arizona and Colorado, though we purchased lots in four other states as well. We acquired the lots for $126 million, adding additional $69 million for development expenditures. Our total land spend for the quarter was $195 million. The lots we acquired in the second quarter were in 30 communities, including 22 new communities and 44% of the lots are finished. Also, 25% of the lots were for Seasons product. Consistent with what Larry discussed earlier, we approved 3,342 lots for acquisition during the quarter. Nearly every state was well represented in this total. We even approved a limited number of lots for acquisition in Virginia, where we have recently seen an uptick in sales activity. At the end of the quarter, we controlled 17,094 lots, up 13% year-over-year and 16% sequentially. This represents a 3.1-year supply on a trailing 12-month delivery basis, which is down slightly from 3.3 at the end of the same quarter a year ago but up notably from 2.8 at the end of our 2017 first quarter. With the significant amount of lot approvals during the quarter, the percentage of our lots controlled via option increased to 30% at the end of the 2017 second quarter from 17% at the same point a year ago and 20% at the end of 2017 first quarter. Our last 12-month return on equity is up 340 basis points year-over-year and 40 basis points sequentially to 9.3% at the end of the second quarter of 2017. This demonstrates the strong impact of the operating leverage that we established starting in the back half of 2016. It is also noteworthy that the increase in our return on equity occurred even as some of our key risk measurements improved. This includes net-debt-to-capital, which decreased by 920 basis points year-over-year to 23.3%; and our overall investment in unsold homes, which is down 42% to approximately $68 million. Additionally, our liquidity has increased by more than $200 million over the past year to almost $1 billion at June 30, giving us more than enough resources to fund new growth opportunities. That concludes our prepared remarks. At this time, we would like to open up the call for questions.

[Operator:]

Thank you. [Operator Instructions] And your first question comes from the line of Alan Ratner of Zelman & Associates.

[Alan Ratner:]

Good afternoon. Thanks for taking my questions. So my question is on the pickup in land activity this quarter. You mentioned in the release that the fact that your returns have improved really gave you the confidence to go out and be a little bit more aggressive on the land side. I’m curious – as I look at that nice improvement you had in return over the last year, a lot of it has been driven by some improvement in your backlog conversion and really delivering the large backlog you had. Because if I look at your absorption rate, it’s roughly flat year-over-year. Your margins are pretty flat, and you’re benefiting from SG&A leverage. But I was curious, is there something specific you’re seeing in the marketplace today as far as demand is concerned that’s giving you added confidence to go out and buy more land? Or is it really more as function of the more of the improving Company’s specific metrics?

[Bob Martin:]

Well, I think there is both. I think we’re certainly encouraged by the improvements we’ve seen. Specifically, we cited return on equity up 340 basis points, which is a great thing for our company, also up 40 basis points sequentially. But overall, I would say, in most of our markets, we feel pretty good about where we’re at. And I would say our confidence in those markets is further bolstered by the initial success that we’ve seen with our Seasons product as well as some other product that we’ve developed to address the issue of affordability. So with all those items in play, we feel really good.

[Alan Ratner:]

Thanks, Bob, appreciate that. And kind of a follow-up on that point. So you mentioned the Seasons rollout and being pleased with how that’s going, and certainly, we see similar activity at the entry level. I guess I’m a little bit curious. If I look at your absorption rate, basically flat year-over-year. I would have perhaps suspected that would have shown a little bit more improvement given the mix shift to more entry level, which you’ve mentioned typically are underwritten to higher sales paces. And your absorption rate is certainly very strong from a company-wide perspective, but is there something else that’s holding that absorption rate back from really accelerating? And should we expect to see that absorption rate improve on a year-over-year basis as more of these new land deals start to open up?

[Bob Martin:]

Yes. I think we’re seeing higher absorption rates with the Seasons product. I think, without it, you would have seen the absorption rate be a little bit lower. It’s only 11% of our net orders right now. So as you see some more communities come online with the Seasons product, if the experience is similar to what we’ve seen over the past couple of quarters, we would expect that to continue to help our absorption rate. But all that depends upon where market conditions are when we get those communities open.

[Operator:]

Thank you. Your next question comes from the line of Stephen East of Wells Fargo.

[Paul Przybylski:]

Thank you. Actually, this is Paul Przybylski on for Stephen. Bob, you had mentioned that the lot purchases this quarter were pretty broad-based. I was wondering if you had any more color where those occurred geographically and when they will translate into community count growth. And then what type of gross margin was assumed on those? And why the uptick from 1Q to 2Q in land buying?

[Bob Martin:]

Yes. So in terms of actual lot acquisition, the most lots that we acquired was in Colorado. Second was Arizona. Then I believe as well we had four other states that were represented. Some of the largest – larger in there were Nevada and California, I believe. In terms of the overall lots added, the total number of lots approved for the quarter, a much larger number. That was across – more across the board, pretty good representations in all of our markets. I think Colorado was still the largest represented in that category, but it was a little bit less dominant in that representation. What was the second part of your question?

[Paul Przybylski:]

When do you expect the lot acquisitions to translate into communities? And what gross margin was assumed on those lots?

[Bob Martin:]

Okay. So in terms of when they come online, about 44% of what we actually acquired during the quarter is finished. Those are the ones that would come online most quickly even with a shot of selling yet here in 2017. But as you well know, that comes with a lot of things you have to do before you get those up and running. The remainder, the 56% of the lots represented would open in 2018. A couple of those may be a little bit later. As far as the underwriting criteria, we really haven’t changed our underwriting criteria. It is not static for every deal. It depends upon the risk metrics involved with each individual deal.

[Paul Przybylski:]

Okay. Can you remind me what’s the gross margin on the Seasons versus your traditional product? And then also, I think, because you said Seasons is in four markets, what incremental markets do you want to take that, expand that product to?

[Bob Martin:]

In terms of gross profit margin, we haven’t disclosed the exact number, but it is higher than our overall average gross profit margin. In terms of other markets we would like to see it in that we have not yet seen sales in, we already have in Arizona, Las Vegas, Colorado and Florida. I think pretty much every one of our other markets would be a target to some degree. California is one that has come up in conversation. Virginia has been one that’s come up that we’re looking at. We even look at markets like a Washington, for example, to see if it would work there, although it’s a little bit tougher there just because of the typical topography you have to deal with in that market. So it remains to be seen whether or not it’s truly applicable to that market. Utah as well is one that I didn’t mention that we have our sights on. Even if we don’t – aren’t able to apply Seasons directly, that exact product, I think in each of the markets where we maybe can’t apply it widely, we would still be looking for another answer to affordability.

[Paul Przybylski:]

Great, I appreciate it. Thank you.

[Operator:]

Thank you. Your next question comes from the line of Will Randow of Citigroup.

[Will Randow:]

Hi and thanks for taking my questions. I want to drill into – you talked about labor improvement, particularly in Colorado. Is that something that you are specifically doing? Or has the labor market opened up there? And have you done anything specifically to improve cycle times? If you could elaborate on that.

[Bob Martin:]

Clearly, it’s been a focus of management, knowing that Colorado cycle times have been among the highest in our company. And sort of it’s our home market, so it gets a lot of attention. I think we have seen a little bit of a better subcontractor availability, but it’s still very tight in the Colorado market. We’ve also made an effort to improve our reporting on cycle times as a way of driving further accountability to our Colorado division, so I think that’s been helpful as well.

[Will Randow:]

Thanks for that. And then just on the recall you mentioned that’s impacting, I believe, 222 homes, is there any risk of closing supply disruptions going forward? Or if you could talk about that, that would be great.

[Bob Martin:]

In terms of supply disruption, I guess, there’s always a risk, but I have not actively heard of that as an issue. I think Weyerhaeuser has product to put in our homes, whether it be for new starts or to address homes that we’ve already identified to have the issue.

[Operator:]

Thank you. Your next question comes from the line of John Lovallo of Bank of America.

[John Lovallo:]

Guys, thank you for taking my call. The first question is on the community count guide, Bob. I think that previously, you talked about maybe kind of flattish community count, and now it seems like maybe it could be actually down a little bit year-over-year. I mean, is that a fair assumption?

[Bob Martin:]

Yes, I would say there’s a higher risk for that. I think getting back to even is still a possibility, but there’s a high risk at this point is how I would characterize it.

[John Lovallo:]

Okay. And then just to make sure I understood the answer to Alan’s question. I totally understand that the improvements at the company, you guys are – you’re feeling good about that. But is it also fair to say that you’re feeling perhaps better about the recovery in general from – in the industry? I mean, is there anything that made you more confident as of late to kind of explain some of the land activity?

[Bob Martin:]

I don’t know that there’s much incremental. It’s been a relatively good market for us from an absorption rate perspective for a while now. I think when we look internally at our return on equity and our gross profit margins, I think if you go back in time a year or maybe even two years ago, there was a wider spread between us and our peers, and we see that spread collapsing, which I think we find encouraging. So I think that gives us a little more confidence as well.

[John Lovallo:]

Okay, thank you, guys.

[Operator:]

Thank you. Your next question comes from the line of Nishu Sood of Deutsche Bank.

[Tim Daley:]

Thanks. This is actually Tim Daley on for Nishu. So my first question, I wanted to dig a bit into the stabilizing build-to-order construction cycle times that were cited in the press release and the prepared statements. I was just wondering, could you put some numbers around, I guess, the trends that you’ve been seeing in these cycle times? And as well, could you break out the comparison for Seasons versus more traditional product, if there is a large difference?

[Bob Martin:]

Well, on your first question, quantitatively, it’s literally flat year-over-year, 0% change on cycle times. Sequentially, we were down, I believe, about 3% overall for the homebuilding enterprise. As far as Seasons versus non-Seasons, I don’t know that we’ve calculated it overall across the industry at this point and at 6% – or across our operations at this point. And at 6% of our closings, I don’t know it would have a whole lot of meaning right now. But I think when we see what the potential is for that product, a number of that in Colorado, given that it does not have a basement and our other product does, you could see cycle times decrease by 40% or even more. But again, we don’t have a huge number coming through our closings yet. So I think that will be a little bit more meaningful as we move forward in future quarters.

[Tim Daley:]

That’s very helpful. And then, I guess, just looking into the cancellation rate, so down 400 basis points year-over-year, 100 basis points quarter-over-quarter to 17%. This is – 17%, I think, is the low that you’ve ever hit. And just looking at a kind of two-quarter cumulative rolling average, this is the lowest you’ve ever hit, period. What is going on? What’s the difference here? Is it higher-quality buyers? Is it the way that you’re marketing to them? And as well, how should we think about the cancellation rate? Is this a new kind of lower normal? Or will it tick back up in the latter half of the year and going forward? Thank you.

[Bob Martin:]

Well, I always am cautious to call anything normal just because as soon as I do it changes to a new normal. But I would say, first of all, if you look across our markets, in those fair markets, prices are increasing. So if you buy a house today and you’re going to close three, six, nine months from now it’s likely that you’re going to have built-in equity, so why would you walk away? I think there’s that element to it. We’ve also done some things proactively to try to make sure that our buyers are serious about the investment in a new home. For example, we have increased the amount of deposits we’re taking from our buyers. So a year ago, we were probably at about, say, 1.5% of the sales price in terms of deposits from our homebuyers. That’s increased to about 2.1% today. So in this market, we’ve found the ability to make sure that we’re kind of further validating that consumer seriousness about buying the home just through some additional deposit.

[Operator:]

Thank you. Your next question comes from the line of Stephen Kim of Evercore ISI.

[Chris Shook:]

Hi, good afternoon. This is Chris actually on for Steve. I noticed in the press release that there’s a 24% decrease in California new orders and all of that was recent reduction in community count. I was just wondering if that reduction is due to the reduction in community count or if there’s anything kind of market specific that you saw driving that decrease.

[Bob Martin:]

Yes, you’re right, I think 24% year-over-year. I looked at that. The 5.33 that you saw a year ago was actually a pretty high mark. The next thing I did, I looked at Q1 of 2017, which was 4.1%, so sitting close to 4.6%. It actually accelerated a little bit going from Q1 to Q2. So given that it’s above for a month, in fact, it’s our highest-absorbing market in the country, there’s not much I really attribute to that. Oftentimes, we do have a situation where depending upon how many committees are coming off and going on, you may have something that’s not actually included in the active subdivision count at the end of the period that actually did contribute sales. So sometimes, that can cause a little bit of volatility. But by everything I can see, California seems to still be a strong market for us.

[Chris Shook:]

Okay, great. And then I also noticed that there was a significant increase in the percentage of your option land. I believe you’re now at 25%, which is up from 40% year-over-year. I was just wondering, do you guys have sort of target for owned/option land ratio? Or kind of what’s really driving this apart from improving inventory turns?

[Bob Martin:]

Well, I think part of its timing. We ended up approving a lot of transactions during the quarter. So until we actually – from the time we approved them to the time we actually purchased them, they remain in the under option category. So since we have our biggest quarter in quite some time in terms of lot approvals, that drove the option number up quite handily for the quarter, and that’s both on a sequential basis and year-over-year. The number I had was about 30% of our overall lots controlled. As for a target for option lots, really, I wouldn’t say there is one. We like to buy as many lots as we can in an option structure. It’s just that the markets – depending upon the market. It doesn’t always allow us to buy in that manner. Part of it depends upon the strength of our counterparty, our sellers and whether or not they can afford to roll those lots and a lot of other different factors, what the price of the land is and other things. So while we’d like that percentage to be higher, we don’t really have any assurances we can drive it that way.

[Operator:]

Thank you. Your next question comes from the line of Michael Rehaut of JPMorgan.

[Michael Rehaut:]

Thanks. Good morning, everyone. The first question, I was curious, just going back to the community count for a moment. Obviously, you talked about, given the soon-to-be inactive versus active, it could drift down a touch more in the third quarter. It’s kind of in contrast to what I was expecting just given the increase in lots approved for sale, the increase in lots controlled overall, et cetera, et cetera. So I think you said that you still – you’re thinking maybe 4Q could get back to or above 2Q. But when would you actually start to see meaningful sequential growth? I mean, obviously, that implies a little bit in 3Q, but still down year-over-year. So how are you thinking about 2018, particularly given just the step up in land activity that you’ve highlighted?

[Bob Martin:]

Yes. Well, first of all, I think when we say 3,500 lots that were approved, virtually none of the subdivisions associated with those lots – I think it was roughly 44 subdivisions that are associated with those 3,300 lots. None of those would be included in the soon-to-be active count at this point. It’s only considered soon-to-be active if you have some level of construction activity actually going on. So much of that hasn’t even hit at this juncture. So that’s the first thing that I would say. Secondly, with regards to the timing, as I indicated, with seven more going off than coming on, that gives you an indicator that Q3 is maybe not likely to increase and could even decrease a little bit from the end of Q2. And given my comment about still increasing by the end of the year, you would expect most of the growth to come in the fourth quarter. And I’ll certainly tell you that driving community count in the fourth quarter is not the easiest thing in the world just given that it’s our lowest quarter for sales activity generally speaking. However, I think probably the more important piece of the equation is that we get those subdivisions open as much as possible before we get to the 2018 spring selling season. And right now, it looks like we’ve got a good shot at doing that for many of the subdivisions that we hold right now. Looking forward to 2018, certainly, if we continue to maintain this level of land acquisition and lot approval activity, we would have the potential to further increase our subdivision count year-over-year in 2018. But it’s a little bit early to put any more specific numbers on that at this point.

[Michael Rehaut:]

Okay, that’s helpful, Bob. And I guess, just going back to the – also the backlog conversion rate. You gave a number, which is obviously very helpful, around 36% for 3Q due to the issues with the Weyerhaeuser I-joist. Is that something that we should think about that is more of a one-quarter phenomenon? I mean, we had, late last week, another builder talk about it potentially impacting a couple of quarters. Just trying to think about 4Q and if we should expect a similar type of decline in backlog conversion if this is more than just a one-quarter fix.

[Bob Martin:]

Well, first of all, I think it’s unclear at this point what impact it will have on the fourth quarter at this point. I will tell you we do have homes that were originally scheduled to close in the fourth quarter that are impacted by this issue. If you look at the factors, we highlight the third quarter because that’s the closest and we know a little bit more about what’s going to happen in the third quarter. So the fourth quarter, you may have some that you pick up that you didn’t close in the third quarter, but you may still have some that gets pushed out from the fourth quarter into 2018. So it’s not clear at this point, but we do have more time to deal with those units as we currently sit right here. So I don’t want to mislead you and say that there’s no impact on the fourth quarter.

[Operator:]

Thank you. Your next question comes from the line of Alex Barron of Housing Research Center.

[Alex Barron:]

Thanks. Hey, guys. Just to, I guess, clarify again, Bob, on the joist issue. I heard a number, 222. Was that homes in backlog that have this potential impact? Or was that the overall that you’ve closed and that have a potential issue?

[Bob Martin:]

That includes closed. There’s 23 of that 222 that have already closed before we were aware of the issue.

[Alex Barron:]

Got it. And is there any financial potential impact about this? Or is Weyerhaeuser picking up the bill for disruption to those people that are closed already?

[Bob Martin:]

Currently, we believe Weyerhaeuser will cover all the costs we incur related to the issue.

[Operator:]

Thank you. Your next question comes from the line of Andrew Berg of Post Advisers.

[Andrew Berg:]

Just a follow-up on the lot question or comment from earlier. When you look at the lots acquired or intending to be acquired on the quarter on the slide, I believe it was Slide 10, of 3,342 versus the actual acquired, the 1,582, in the period, how should we think about that as you roll forward into Q3? I think last year you, had a little less than 1,100 lots that you purchased in that quarter. Should we think of that 3,300 as fully capturing both 2Q and 3Q lot acquisitions? Or should we think that those would be incremental to the roughly 1,100 lots that you bought in 2Q last year – or 3Q last year?

[Bob Martin:]

Gosh, I’m not sure if I fully understand the question. That 3,300 number is far in excess of where we were a year ago. And I guess that would lead us to believe that our actual acquisition activity in the upcoming quarters would be higher than it was a year ago. I would say that the caveat to that is sometimes, these closings get to be a little bit swirly, just some small detail that holds up the closing. So that can impact the timing in one way or the other.

[Andrew Berg:]

Let me try asking it maybe in a totally different way and clarify it. You acquired just under 1,600 lots. You approved 3,300. So there’s roughly 1,700 lots difference between the two figures. Should we think about 3Q as that sort of being the figure for lots to be acquired? Or would you still have lot acquisition level still more along the lines that you had in 3Q last year and it would be incremental to that?

[Bob Martin:]

I guess I’m still not sure I understand it completely, but we obviously approved a lot of lots in the second quarter of last year as well. So I mean, I guess, one way of looking at it is you could look at the extent to which the number of lots that we put under contract – number of lots we approved is up year-over-year to get a sense for how acquisition activity might increase in the coming quarters, but that would just be an approximation. I think if you look at this quarter a year ago, just looking at the figure here, I want to say that we’re on the order of magnitude of double where we were a year ago in terms of actual lot approvals.

[Operator:]

Thank you. Your next question comes from the line of Buck Horne of Raymond James.

[Buck Horne:]

Good afternoon. I wanted to zoom in a little bit on Colorado, if we could, for a second here. Just noticing that the absorption rate in Colorado declined, it looked like, double-digit percentage despite the significant investments you guys have been making there. And I realize there’s probably a lot of new communities opened, but maybe you could add a little commentary to what you’re seeing on the ground in terms of demand in Colorado. Should we read anything into that 11% decline in absorption there?

[Bob Martin:]

Yes. It’s always something we monitor, but I think you hit it talking about opening new communities. I think we have had a lot that are coming online, and just noting the 57% increase year-over-year in communities, getting some of those communities up and running, Colorado being somewhat of a test case for some of our new product, whether it be Seasons or the product that we’ve – one product we’ve mentioned in the past called Cityscapes. There’s certain logistical issues in getting those up and running. I think we’re still very encouraged in Colorado, just knowing that we’ve had a good response to that more affordable product. I think it’s still a very, very healthy market for us.

[Buck Horne:]

Okay. And going back to the Seasons product line, just some of the rollout there. If I heard you correctly, it sounded like you’re getting higher margins on Seasons than the company average and it’s also producing a faster absorption rate than the company average. So the question, I guess, would be, why wouldn’t you be devoting a lot more of the incoming land acquisition spend to Seasons land? And if not, is that a function of the scarcity of land that’s available right now for Seasons product?

[Bob Martin:]

I mean, I think it is competitive. It’s a very competitive space for the entry-level products. I would also say we’re not ignoring the other segments of our markets, so we’re still continuing to make acquisitions in our more traditional product. We do have a version of our more traditional product that we call Landmark, so it’s a more affordable version of that traditional product. In Colorado, for example, it still has a basement, but it’s just a bit more affordable than we’ve historically seen. So part of the answer is simply that we are continuing to invest more heavily in other segments of the market as well. But I think it’s a great thing. That 25% mark of the lots that we acquired in the quarter is really a high watermark for the Seasons. We expect it to be a pretty big percentage going forward.

[Operator:]

Thank you. Your next question comes from the line of Ken Zener of KeyBanc.

[Ken Zener:]

Good morning, gentlemen.

[Bob Martin:]

Good morning.

[Ken Zener:]

I wonder if – given the lots that you’ve done this quarter, given the still relatively, the way we look at it, seasonal order trends and the pace quarter-to-quarter, just thinking about like – realizing you’re not going to give FY2018 guidance, but the margin mix, given your – the Mountains had about 10%; and the West, the other 25% of EBIT, is kind of in that six-handle range, it varies. Could we expect your margins largely to be driven simply by your regional closings, A? And then could you discuss the, perhaps, gross margin differences you have within your different regions or if it’s mostly just price driving SG&A leverage that defines the EBIT differential? Thank you.

[Bob Martin:]

That’s a lot in one question, but I’ll try to tackle it [indiscernible] okay, I think we don’t talk a lot about the margins on individual states. We don’t talk about it really much of anywhere. I would say we actively look at our closings, the results that we’ve experienced most recently in all of our markets and use that as a guide to where we might want to invest in the future. As we’ve indicated with Virginia and Maryland, for example, we decreased our investment in that market because the returns weren’t as good as we expected. So we’re always balancing moving our capital to markets that are experiencing better results. It’s one advantage of being a builder with a lower supply of land. So that’s really how we look at it. Those divisions that are able to prove to us that they’re able to get the returns that they put forth in their performance and their approval packages we tend to give a little bit more capital to. Certainly, there are regional differences, don’t get me wrong, and we tend to perform, in a lot of cases, a little bit better where we start to see more volume, although that’s not always the case. The margin question is always a tough one in this environment simply because, yes, we are able to increase price, and I think that’s one thing that gives us an opportunity to increase our margin. But then again, we are faced with cost increases, more or less across the board, whether it be labor, materials, land. All of that are issues that we’re facing what’s right now. So right now, I think we’re happy to be able to say that we’ve been able to balance to cover our cost increases with price increases, still a risk for the future. And overall, the word for our margins is stability. That’s what we’ve seen sequentially year-over-year. Even if you look over the past nine quarters, it’s really been a pretty stable margin environment for us.

[Ken Zener:]

Thank you.

[Operator:]

Thank you. You next question comes from the line of Michael Rehaut of JPMorgan.

[Michael Rehaut:]

Thanks for taking my follow-up. Just wanted a little bit more on the modeling side, just to get a sense. On the tax rate and share count, more how to think about the back half of the year. Your share count went up about 800,000 sequentially to 52.4 million. Is that a number that we should be using in the back half? And similarly, how should we think about tax rate for the second half and the full year?

[Bob Martin:]

Yes. I think, on the share count, it’s influenced by what the stock price is, so you have to keep that in mind. So if our stock price is close to where it is right now, you’re probably more likely to be around the diluted share count that you’re at. Right now – so I would give you guidance – that guidance on that part. As far as the tax rate, I think what you saw in Q2 is really what you can probably expect going forward, except for – that is to say in both Q3 and Q4, except for there is one item in Q4 that we’ve talked about. It’s a discrete item, and it relates to the expiration of stock options. And that would add about $2.7 million of additional income tax expense in the fourth quarter than would otherwise be implied by applying the rate that we have already disclosed in Q2.

[Michael Rehaut:]

Great, thanks. That’s helpful, Bob. And then just secondly, also kind of looking into the back half of the year. With the backlog conversion implying closings, it looks like, in the back half kind of flattish, which, if you look at closing prices drifting up a touch, it would imply low-single digit revenue growth for the back half. As a result, should we be thinking about SG&A leverage being pretty minimal or marginal with an accompanying minimal amount of revenue growth? Or would there be any other type of discrete items from a cost management or any type of other element that would allow you guys to still achieve some level of more meaningful SG&A leverage to the tune of what you saw in the second quarter?

[Bob Martin:]

I think that the G&A rate specifically that we saw in the second quarter, that’s probably as good as any rate to use going forward, that amount of overall G&A that we experienced in the second quarter, with the caveat that accruals on a lot of different things could move it up or down. But based on the information we have right now, it’s a reasonable run rate for Q3 and Q4. So I think in answer to your question, if we’re looking at single-digit increases year-over-year in revenue, by your math, then that would imply that there would be a lesser opportunity for SG&A rate improvement year-over-year, but it’s certainly something that we’re still focused on. We are getting down to levels that are much closer to what we had in the early 2000s, which is a great thing. But then again, in terms of cost savings, we have to recognize that as much as we always are good stewards of our capital and try to keep our expenses low, in this kind of market with the homebuilding business doing better, a big part of our overhead is costs associated with our personnel, and that’s not cost that’s likely to go down in the short-term.

[Operator:]

Thank you. At this time, I would like to return the floor for closing remarks.

[Bob Martin:]

Thank you very much. We appreciate everyone being on the call today and look forward to speaking with you again following the disclosure of our third quarter earnings.

[Operator:]

Thank you. This concludes today’s M.D.C. Holdings’ second quarter earnings conference call. You may now disconnect.