M.D.C. Holdings, Inc.
Q4 2017 Earnings Call Transcript

Published: 1 Feb 2018

[Operator:]

Good afternoon. My name is Matthew, and I will be your conference operator today. At this time, I would like to welcome everyone to the M.D.C. Holdings 2017 Fourth Quarter Earnings Call. [Operator Instructions]. Kevin McCarty, Vice President and Corporate Controller, you may begin your conference.

[Kevin McCarty:]

Thank you, Matt. Good morning, ladies and gentlemen, and welcome to the M.D.C. Holdings 2017 fourth 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. [Operator Instructions]. 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 MDC's business, financial condition, results of operation, cash flows, strategies and prospects and responses to questions, may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements involve known and unknown risks, uncertainties and other factors that may cause the company's actual results, performance or achievements to be materially different from the results, performance or achievements expressed or implied by the forward-looking statements. These and other factors that could impact the company's financial actual performance are set forth in the company 2017 Form 10-K, 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 pleased to announce 2017 fourth quarter net income of $24.6 million or $0.43 per share. Note that our income this quarter was impacted by few unique items, including a sizable charge related to the enactment of Tax Cuts and Jobs Act in December. More detail on these items is available in the press release we issued earlier this morning. 2017 was a very successful year for us on many levels. We generated $2.5 billion in home sales revenues and $142 million in net income, both of which were significant increases from the prior year. Our strong top and bottom line performance has improved our returns, as evidenced by more than a 500 basis point improvement in our pretax returns on equity for 2017. Perhaps more importantly, given the strong industry conditions we have seen in most of our markets, we took steps to prepare for the future growth of our company. We approved almost 10,400 lots for purchase during 2017, which was more than double our total in 2016. We ended the year with our controlled lot supply up 32% year-over-year and at its highest level since the third quarter of 2007. The accelerated lot approval activity will require us to invest additional capital in our homebuilding operations. Even though our balance sheet was already equipped to handle additional land purchases, we took steps to further enhance our financial position. During the year, we added $150 million to our senior notes due January 2043, bringing the total amount outstanding to $500 million. In doing so, we pushed our average senior note maturity to almost 15 years, which we believe is a strong advantage as interest rates have started to rise. In addition, we expanded the capacity under our unsecured line of credit from $550 million to $700 million and extended its maturity to December 2022. These capital market activities, combined with the cash flow from our earnings for the year, pushed our liquidity to nearly $1.25 billion at the end of 2017, an increase of almost 40% over the prior year. Supported by solid economic and industry fundamentals, home prices rose across the country in 2017. Increasingly, we have focused on projects targeted to the first-time homebuyers' segment, including our Seasons series. Customer interest in this series has continued to grow. In the fourth quarter, these homes accounted for 15% of our home sales, up from just 5% for the same quarter a year ago. This helped to drive a 23% year-over-year improvement in our fourth quarter net orders in spite of a lower average active community count. With this strong result, we ended the year with a backlog sales value 16% higher than a year ago, setting the stage for growth in 2018. For almost 25 years, we have consistently paid dividends as part of our strategy to provide risk-adjusted returns for our shareholders. Given our positive outlook and strong financial position, we were pleased to enhance our industry-leading dividend. We declared an 8% stock dividend in the fourth quarter and a 20% increase in our cash dividend at the start of 2018 first quarter. On an annualized basis, the new cash dividend equates to $1.20 per share. This demonstrates our confidence in our business prospects and our continuing commitment to our shareholders. I'll now turn the call over to Bob Martin for more specific financial highlights of the 2017 fourth quarter. Bob?

[Robert Martin:]

Thank you, Larry, and good morning. Before we leave the overview slide, I want to highlight a few unique items that were in our release. First of all, tax reform clearly has been a big topic for this quarter. The enactment of the Tax Cuts and Jobs Act in December 2017, combined with 2 other items that are outlined in our earnings release, resulted in the addition of $9.3 million in charges to our tax line for the 2017 fourth quarter. Looking forward, our preliminary estimate for our 2018 full year effective tax rate is in the range of 25% to 27%. This excludes the potential impact of any discrete tax items that may be recognized during the year. We reckon it as a preliminary estimate simply because the legislation is only a month old, and we believe there is the possibility that certain aspects of the act could be interpreted differently as it is put into practice this year. I also wanted to point out that our ending and average shares and all per share amounts for all periods have been adjusted to reflect the 8% stock dividend that was paid in December. Moving on. Our home sale revenues for the 2017 fourth quarter were down 2% to $702.6 million, primarily due to a 2% decrease in homes closed to 1,556. Our backlog conversion rate was 45%, slightly lower than the prior year rate but higher than the 43% to 44% range we discussed on our previous call. We believe that closing levels and backlog conversion rate could have been modestly higher. We lost about 35 closings for the 2017 fourth quarter due to the Weyerhaeuser joist issue in Colorado. For the year, we lost about 120 closings due to this issue. Looking forward to the 2018 first quarter, we should pick up many of the Weyerhaeuser delayed closings. However, the issue impacts build times not only to the homes with the defective joists, but also for other homes in backlog due to the strain that the replacement process places on our subcontractor base overall. In part due to this ongoing dynamic, we believe that our backlog conversion rate for the 2018 first quarter will be in the 38% to 40% range, which is lower than the 44% backlog conversion rate we achieved in the first quarter of 2017. The lower conversion rate is also the result of the unseasonably strong sales we experienced in the fourth quarter as most of these homes are in our year-end backlog but are not likely to close in the first quarter. Average cycle times, defined as days from start to finish, decreased by about 5% year-over-year company-wide with improvement shown in most of our markets. However, cycle times increased by about 5% sequentially partly due to the Weyerhaeuser issue and the impact of the hurricanes in Florida earlier this year. As for product mix, 9% of closings for the fourth quarter were from our Seasons collection versus only 2% a year ago. We had Seasons closings in our Colorado, Arizona, Florida and Nevada markets. Our average selling price for the quarter of $452,000 was flat compared to the prior year. However, with our Seasons product closings, average selling price would have been up about 3%. Our gross margin for home sales percentage was up 120 basis points year-over-year from 16.1% to 17.3%. The difference is partly due to impairments as we recorded $3.9 million of impairments in the 2016 fourth quarter versus just $0.6 million of impairments in the 2017 fourth quarter. Additionally, our margins benefited from price increases that we realized in many of our markets, which were partially offset by increases in labor and material costs. With the higher margin percentage and flat average selling price, the dollar amount of gross margins that we generated per closing rose by about $5,200 to $77,900 in the 2017 fourth quarter. We are optimistic about our gross margin percentage going into 2018 as the gross margin percentage in our backlog to end the year exceeded the 17.3% we realized for our 2017 fourth quarter closings. However, it should be noted that the actual gross margin level we actually realize from our backlog in future periods could be impacted by cost increases, cancellations, impairments, reserve adjustments and other factors. Our positive outlook on margins is partly a function of the strength we have seen in the economy and the industry overall, which has allowed us to limit incentives and increase prices in the majority of our subdivisions. It is also worth noting that our Seasons collection is having a positive impact, representing 12% of the units in backlog at the end of 2017 and having a higher gross margin percentage than the backlog as a whole. Our total dollar SG&A expense for the 2017 fourth quarter was up $13.4 million from last year. The increase primarily was related to a $12.4 million increase in our general and administrative expense. The 2017 fourth quarter included $5.4 million of charges that I would describe as infrequent, incurred to account for accrual adjustments and the execution of tax planning strategies. The remainder of the increase was driven primarily by increases in headcount as we continue to prepare for the future growth of our business. On a sequential basis, from the 2017 third quarter to the 2017 fourth quarter, the increase in general and administrative expense was $6.6 million, which is mostly explained by the $5.4 million of infrequent charges that I just mentioned. The dollar value of our net orders increased 23% year-over-year to $574.3 million, driven by a 31% increase in our monthly absorption rate as we saw solid demand in most of our markets across the country. The acceleration of our absorption rate was offset somewhat by a 7% decrease in our average active subdivision count. The average price of our net orders was $458,700 for the quarter, up only slightly from the same quarter a year ago. As Larry mentioned earlier, we have been successful in marketing our Seasons product to buyers looking for affordable homes. For the 2017 fourth quarter, Seasons accounted for 15% of net new orders, up from only 5% a year ago. We ended the quarter with an estimated sales value for our homes in backlog of $1.6 billion, which was up 16% year-over-year based on an increase on both units and average selling price. Overall, our cancellations as a percentage of beginning backlog were down slightly year-over-year from 11% to 10%. And as a percentage of gross sales, cancellations dropped from 27% to 22% because of the strong level of gross sales activity. Active subdivision count was at 151 at the end of the 2017 fourth quarter, down slightly from 154 at the end of the 2017 third quarter and down 8% from 164 a year ago. We continue to see the largest decreases occurring in Maryland and Virginia, where we previously disclosed a lower level of investment due to returns that did not meet our expectations. Washington also saw a large decrease year-over-year due to strong sales activity during the year that resulted in subdivisions closing out more quickly than anticipated. Additionally, competitions for the acquisition of new subdivisions in Washington has been strong, resulting in the acquisition of fewer new communities than planned. Colorado is the most significant offset to these decreases with a 29% year-over-year increase in active subdivision count. Looking at the graph on the right. For the first time since the 2016 third quarter, we had more subdivisions in the category we call soon-to-be active than in the soon-to-be inactive category to end the quarter. In other words, we have more subdivisions that are just opening relative to those on the verge of sellout. This tells us that there is a greater likelihood of an increase to our subdivision count over the next couple of quarters compared with our active subdivision count at the end of 2017. With that positive indicator in mind, we are targeting 10% active subdivision growth from December 31, 2017, to December 31, 2018. For the 2017 fourth quarter, we acquired 1,898 lots, up 68% from a year ago. We acquired lots in almost every state we operate in, with the heaviest concentration in California, Nevada, Arizona, Florida and Colorado. Acquisition spend for lots was $143 million. After adding in an additional $76 million for development expenditures, our land spend for the quarter was $290 million. The lots we acquired in the fourth quarter were in 42 communities, including 22 new communities, and about 64%, rather, of the lots are finished. Looking at product mix, over 30% of the lots we acquired during the 2017 fourth quarter are intended for our Seasons collection. That percentage is higher than any other quarter since we introduced the product. We approved 2,566 lots for acquisition during the quarter with each state represented in the total. This was a 64% increase from the prior year. At the end of the quarter, we owned or controlled 19,312 lots, up 32% year-over-year. This represents about a 3.5-year supply on a trailing 12-month delivery basis, which is up from 2.9 at the end of the same quarter a year ago. With a significant amount of lot approvals during the quarter, the percentage of our lots controlled via option increased to 33% at the end of the 2017 fourth quarter from 20% at the same point a year ago. Our last 12-month pretax return on equity is up 510 basis points year-over-year to 16.9% at the end of the fourth quarter of 2017. Even without the $52 million gain recorded in the third quarter related to the sale of investments, our 12 months return on equity would still have been 15.2%, up 330 basis points over the prior year. Turning now to some of the key measures of our financial position. Our net debt-to-capital decreased by 430 basis points year-over-year to 22.3%. Overall liquidity grew by more than $350 million year-over-year to $1.25 billion, driven by the $150 million increase in our line of credit to $700 million and a $150 million add-on issuance of senior notes. With higher liquidity in backlog to start the year, we feel optimistic about our prospects for growth in 2018. That concludes our prepared remarks. At this time, we would like to open up the call for questions.

[Operator:]

[Operator Instructions]. Your first question comes from the line of Nishu Sood of Deutsche Bank.

[Nishu Sood:]

Larry, I wanted to ask a question about land spend. And obviously, the ramping up of land spend that you had last year is going to serve you very well in '18 with demand having accelerated. We are getting later in the cycle though. And I can't help to think back to the last cycle when in 2004, 2005, you were amongst the first management teams to say, "Hey, this has gone a little bit too far, and we're pulling back." So here we are leaning into '18 and that will obviously serve you well. What are you going to be on the lookout for, kind of warning signs wise that it's again time to pull back, especially since we're a little bit later now in the cycle?

[Larry Mizel:]

I don't believe we're later in the cycle. I believe we're in a very strong period of time. The elements that we identified in 2005 that gave us concern don't give us concern at this time. I think we're very fortunate to be in this economic period, not only in the United States, but elsewhere in the world. The capital markets are healthy. The desire and demand for housing is not speculative like it was in '05. We have a solid quality mortgage market where the circumstances were much different. We do not see the speculators buying homes for good ideas. What we see is people that desire and want a place to live to raise a family. As the new generation of young people come into their late 20s and early 30s and decide that it's time to get married and have a family and move out of the those apartments into a real home, that's what we're providing. We're providing homes for people. And everyone has been -- they said, "Well, Larry, if this was baseball, how would you say what inning we're in?" And my guess because, of course, there's nothing scientific about it, but I would put us in about the fourth inning.

[Nishu Sood:]

Got it, great. I appreciate your thoughts. And another question, kind of drawing on your long experience in the industry. Lower corporate tax rate obviously generates a higher post-tax profit and profit margin for the builders. Now typically, when there's excess profit in a new home construction chain, it ends up with land sellers, obviously, as you see with the rising home price appreciation. And so clearly, that debate now is where does it end up? Does it end up at land sellers? Or since many builders use pretax IRRs, does it rather stay with the builders? You obviously lived through the last time the corporate tax rate was cut, I believe. So what happened then? What are your thoughts about where the windfall from their corporate tax rate cut might end up?

[Larry Mizel:]

Well, I think we publicly demonstrated what M.D.C. has done since we focus on shareholder value by increasing our dividend 20%. So the results of our business judgment was to give to our shareholders an additional return on the dividend, and we think that's a preferable way. I believe there's a great discipline amongst the builders and what they pay for the land, and the discipline is deals with affordability in the housing market. As you can see, we went from 5% to 15%, and we're moving and focusing quickly on affordability. So as the housing market improves, the focus really deals with affordability throughout the country in all the markets. So I see this very clearly. I don't see land speculation because the developers of the land don't have the ability to get financing when the economics don't take place. The builders are responsible. They know that there's a necessity that provide quality return to their shareholders. And I don't see the builders as an industry speculating. There's -- as you know, there's some builders that are more aggressive in land than we are because we try to be conservative in everything we do. But we're in a very good environment, and the tone in the industry and in the market is strong and we're fortunate that the economy also is strong.

[Operator:]

Your next question comes from the line of Will Randow of Citi.

[Will Randow:]

I guess, in terms of the joist issue and cycle times in particular, do you see 2 quarters down the line a point where this will become a nonevent or nonissue? And what type of tightness are you seeing on the trades and what buckets, meaning cement, lumber? Obviously, it sounds like repair for these joists is a big deal.

[Robert Martin:]

It certainly is a big deal. It's a big undertaking. We do believe that a lot of the homes we have remaining to close will be closed in the first quarter. There may be some that extend out to the second quarter, but we expect it to be the minority of the 120 that are left to close as of the end of the year. In terms of the subcontractors, certainly, those who install the joints is -- put strain on that group, even though we've tried to identify additional parties to help us with that. It also impacts folks like electricians who have to come in and reinstall a number of different items in the house after they are done replacing the joists. All that said, we think it's something that we can recover from a few quarters down the line, but it's something that we're going to continue to keep an eye on.

[Will Randow:]

Then in terms of pricing relative to inflation, how should we think about that from a gross margin perspective for this year? And more ethically, if you can talk about it by some of your larger submarkets.

[Robert Martin:]

I don't know that I would even go so far as to break it down by submarket. I mean, what we're experiencing across the country is, generally speaking, we have been able to increase prices. If you look across the country with increased prices just in the fourth quarter and about 2/3 of our subdivision, and that's something that we view as healthy. Relative to cost increases, clearly, the goal first and foremost is can we increase -- can we cover the cost increases with our price increases? And so far, the answer has been yes. And the commentary about the backlog gross profit margin at the end of the year being higher than the 17.3% that we realized through closings in the fourth quarter, I think that partially reflects the notion that we've been able to increase prices to not only cover costs but a little bit more than that. So whether or not that continues into 2018 is -- would be purely a guess.

[Operator:]

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

[John Lovallo:]

First question is on, I guess, the 10% community count growth by year-end. How should we kind of think about that throughout the year kind of cadence?

[Robert Martin:]

It's a good question and it's always tough to nail on a quarter-by-quarter basis. And the reason is because you always have a little bit of give and take in terms of the timing of the opening of the subdivisions. I think we've got some chance of seeing it. We have a goal to get as many as we can open during the spring selling season. But we'll have to kind of wait and see if we get there.

[John Lovallo:]

Okay, okay. And then in terms of headcount past two quarters, there's been some G&A expense attributable to that. How should we think about that heading into 2018? And do you expect a continued kind of ramp in headcount?

[Robert Martin:]

I would say there's always the chance for increase of headcount when you're in an expansionary type of mindset. With that said, the increase in headcount for 2017, just on the G&A line, I'm not talking about sales folks or construction folks who go through other lines on the income statement. But just for the G&A folks, it's up about 15% year-over-year. I would be surprised at this point to see it increase by that much more in 2018, but we'll continue to update you on that on a quarterly basis.

[Operator:]

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

[Stephen Kim:]

Wanted to ask you a little bit about your build-to-order model relative to an increasing amount of spec activity that we're seeing some of the larger competitors are doing. I guess, first of all, could you talk at all about whether you think, over the last, let's say, decade or so, we've seen an increasing receptivity on the part of buyers to a preselected type of product? Or do you believe that the buyer today is as inclined and willing to pay for choice in much the same manner as they always have?

[Larry Mizel:]

I would say, first of all, our discipline of building to order is part of our risk-adjusted return concept as we run our enterprise. We believe there's a lower risk factor in building a presold home versus a spec home. We also believe that in our -- in the manner in which we run our enterprise, we also believe there's a larger gross profit margin on a dirt built versus a spec. There's different cycles when a standing spec, because someone will pay a premium, is worth more than someone having to wait a period of months. These are cycles that come and go in different times, in different markets, but we found over decades that we're better off with dirt starts, which makes the quality of our work in process very, very high. And it also sets us up with very good latitude on being able to measure the amount of capital that we need for land. The market that looks to everything's included, which is multiple builders now, I think, is a real market. And there's certainly buyers that find that, that's an acceptable way to buy a home. We believe a preferable way to buy a home, which is the manner in which our company operates, is people would like to figure out what they would like to have in their home, as to colors and finishes. And this truly is something that's special, and we find that the consumer's willing to pay a little bit more for what we deliver in the sense of a quality home that's customized to that decor extent that's not available in a home where everything's preselected. So we find that what we're doing is the way we do it just like we do and controlling our risk on land and the other elements of what we believe is a preferable way to run an enterprise.

[Stephen Kim:]

Yes, I appreciate that, Larry. If I can follow-up a little bit on that though. You had talked about the fact that there are certain points in the cycle where perhaps, one, a customer might be actually willing to pay a premium for a spec because they could move right in. Given your comment or your response to Nishu's question about where we are in the cycle, I think you said maybe fourth inning or something like that. It would seem like maybe we're in the portion of the cycle where you might actually be more tolerant of specs because the customer might be, at this time, willing to pay more. And then the second half of my reaction to what you just said was you talked about a conservative approach to the business. And absolutely, that's been the linchpin or the very consistent aspect of your company for the last decade. But wouldn't you think that there's more concern around land inventory rather than home inventory in terms of when you think about your overall risk profile? And you're carrying more land in your supply then you were in the last cycle, about three years versus, let's say, two years. And so I was wondering if you could reconcile your thinking about conservatism and with your land position given what I just said.

[Larry Mizel:]

I think you're asking about 6 questions in one breath. I'll do my best to comment on some of them. On the spec market, there is several very large builders that their business model is mostly spec and that's maybe what you need to do to have super high volume and they do it well. We're not in the super high volume of doing 25,000, 30,000 homes a year, so we're able to manage what we do more carefully. And the time that a spec gets a premium is specific as to certain markets at different times, and they really deal with the facts on the ground. But that's usually a limited period of time and limited, I can't define because it's always different. One thing about this industry is each time, it's different. As to your comment, we believe that our land inventory is one of the most conservative in the industry. If we make -- our usual guideline has been between two and three years. And as we see the market expand and we believe that there's opportunities, we may look at two or three years difference in our projections and in someone else's projections. After all, we did increase our capital available and our authorization for additional lots, which should be a clear indication that we believe that the market is on a positive trend. And we expect to take advantage of that trend as long as it's in place.

[Operator:]

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

[Neal BasuMullick:]

This is Neal BasuMullick on for Mike. So I guess, starting with the community count guidance up 10% at year-end and with a little bit more contribution from Seasons, I guess, what's your expectation for absorption rate improvement?

[Robert Martin:]

That's not something that we project. As we said on prior calls, we have seen that Seasons has produced a higher absorption rate, but we're not going to project going forward.

[Neal BasuMullick:]

Okay, that's helpful. But I guess, so you're talking about kind of reinvesting in the business and growing community count. Can you add a little bit on your entry into Portland? I'm not sure if it's in your prepared remarks.

[Robert Martin:]

Yes, not much there. We do have a couple of communities that are in due diligence out there but nothing that we've actually acquired at this point. So that's still a greenfield work in progress, so not a huge impact to the quarter, in the fourth quarter.

[Operator:]

Your next question comes from the line of Alan Ratner with Zelman & Associates.

[Alan Ratner:]

So on the absorptions, I know you're not going to guide there, but the increase was really strong, especially compared to what you printed the first 3 quarters of the year. I know the comp was a little bit easier. But I was hoping you could maybe just identify what you see as the main drivers for that strong acceleration. I know you mentioned the Seasons offering several times. So was curious, is that just a function of your portfolio now mixing more towards the entry-level where the demand is strongest? Or did you, in fact, really see a strong acceleration in buyer demand across your entire footprint during the quarter? And if that was the case, what do you think really drove that?

[Robert Martin:]

Yes, quite simply, I think the market's better. We are in a very good housing market. I think the economy supports that. You've seen what has happened with the stock market. We see changes to the tax code that are beneficial to us and others going forward. The whole picture right now is coming together and that the margin we have reached out to appeal to that consumer that's looking for affordability. And I think that just adds to what we're offering and what results we've been able to achieve.

[Alan Ratner:]

Got it. And then just with that type of growth rate, I think that a lot of other builders have kind touted the spec strategy as not only from a consumer demand perspective, what's strongest today, but also helping them from a labor perspective, talking about the fact that the trades like the predictability of the starts and whatnot. And absent that, there had been some concerns that maybe growth could be capped at something like 10% just across the industry because of the labor constraints and lack of availability there. So given the fairly volatile or lumpy nature of your growth rate here, how do you think about that as far as your labor? Do you feel like your labor relationships right now can handle this type of growth as now your backlog seems to be expanding at a pretty dramatic clip compared to where you've been previously?

[Larry Mizel:]

I think our labor supply is steady with quality relationships, and they have demonstrated an ability to continue to grow as we grow. Additionally, we're able to attract additional subcontractors and suppliers. It -- we're able to keep all of our trade very busy. So there's -- this is a steady strong market and the trades are also growing. And many people left the industry and many of them are coming back. The wages that one is able to make in the construction world are reasonable. And I think that has -- bode well for general unemployment in our country. More people are getting into the job force, higher percentage and more of them are employed. And this goes up and down the economic chain. And housing, I think, in the many years in the past, they would say that it was between 4% and 5% of the GDP and that deteriorated during the recession to -- I don't know whether it was 1% or what the number was, but it was very low. So you're seeing the housing industry grow even though we're substantially less than where we were at not only the peak, but also at the normal run rate. We're still below the normal run rate, but trades are coming back into the marketplace and we're able to capture that, which is necessary in order to produce a quality home.

[Operator:]

Your next question comes from the line of Dan Oppenheim from UBS.

[Daniel Oppenheim:]

Just wanted really to ask about the Seattle market where you have a lower community count plus also a more limited land supply and had noted that, that was -- there's some competition in terms of subdivisions there. And I guess, as it relates to the questions about where we are on the cycle time in terms of just buying land and such, it seems that you did pull back there or at least weren't buying so much. And so how do you view that relative to the other comments in terms of just it being an opportune time to be buying land?

[Robert Martin:]

I think we view the Seattle market very positively. With Seattle, we have had very good absorptions. It's up year-over-year and sequentially actually from an absorption rate standpoint. And the market is, I would say, healthy to the point where it's really difficult to find new land acquisitions, new subdivisions to buy. So that has weighed more recently on our subdivision count out there. But we have been able to approve the acquisition of some new transactions during Q4 and we will continue to work on that going forward. So we remain very committed to that market and very interested in expanding our presence there.

[Daniel Oppenheim:]

In terms of approvals, that's something where we should like to see the lot count, whether owned or controlled, being up than -- as we look at the first -- end of the first quarter or the second quarter?

[Robert Martin:]

I wouldn't time it, but it's certainly our intent to grow our presence in that market.

[Operator:]

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

[Kenneth Zener:]

Bob, I wonder if you could talk to the orders. I think, Larry, you made a comment about this. Your pay sequentially was almost flat when normally, the last three years, it's usually about a 18% decline seasonally and 21% year-over-year, 20 years of data. Was there -- what would happen again to lead to that higher absorption in these communities? And the reason I ask is because you picked up so much, do you think normal seasonality would prevail in the first quarter as well given that seasonality is usually pretty observable in an objective delta?

[Robert Martin:]

Yes, I think I know what you're saying. Again, when we talk about -- you're absolutely right. It was roughly flat, the absorption rate, going from Q3 to Q4 in the normal. What you would expect to see, if you looked at all the data for the last 20 years, is maybe a 20% decline. And again, I would say, we're in a market that we feel is better, and we're seeing the demand out there. So it is bucking some of those seasonal trends. As to how that translates to Q1, I would not hazard a guess on exactly how that [indiscernible]

[Kenneth Zener:]

Right, no, I get it. So you would think seasonality will be better this quarter, would persist, it sounds like as well? No reason to assume it wouldn't.

[Robert Martin:]

Yes. I mean, we had very positive results for Q4 for orders, and that's kind of what we're going with right now.

[Operator:]

Your next question comes from the line of Alex Barrón with Housing Research Center.

[Alex Barrón:]

I wanted to ask about the balance sheet and the decision to raise long-term capital. Can you just kind of discuss your thinking, why is it better to take on 20-something-year maturity at 6% versus some shorter term, maybe 5 or 10 years at lower coupon given that the -- your expectation is the cycle is still in the fourth inning?

[Larry Mizel:]

Having been around the industry for about 5 decades, I can't think of very many periods of time that you can get a 30-year fixed-rate unsecured debt at 6% that wasn't a good transaction. This will put us in a very, very strong position as the expansion of the economy in our country and interest rates, whether it's 2 years now or 5 years from now, will trend back into what was perceived as more normal historically. And I think it's a major asset of the company to have this capital in place, especially allowing us to grow in a manner that makes us less dependent upon the future cycles within our industry and within the economy in general. I believe we are the only builder and certainly, in the last decade, that has been able to access this long-term fixed-rate market, and we believe it's a significant asset of the company.

[Alex Barrón:]

Got it. And then, I guess, just to kind of reiterate the thinking around particular markets. So in the Seattle, Washington market, your community count is down because of strong demand, and I'm assuming that's going to go back? And then part B is on the other Washington, Washington, D.C., meaning Maryland and Virginia, your investments have been down. But did I understand you correctly, they're down because the competition for land is very strong? Or just because you don't feel the market is -- the returns are good enough because of demand? Which one is it?

[Robert Martin:]

Sorry, let me back up for a second here because we're talking a lot of Washingtons. So I'll refer to the first Washington at Seattle just for clarity's sake. And the Seattle market has been strong, continues to be strong, and it's a market where there is a lot of competition for land. And I think that's one of the biggest contributors for the decrease in our subdivision count. That, combined with the fact that we've had very good orders in that market, and it causes us to sell our subdivisions more quickly than we otherwise might have. The other Washington, Washington, D.C., the Northern Virginia kind of area, that market is a market where we have deliberately reduced our investment. And we've talked about this in our Qs and Ks for the past -- the greater part of the last two years. It's a market where we didn't see as good of returns. However, it's still a market that we're active in. More recently, the absorption rates in that market have improved. And I alluded to in my prepared remarks, but you might not have caught it, we did approve new lot purchases in that market during the fourth quarter. So it is certainly not, by any stretch of the imagination, a market that we're not committed to.

[Operator:]

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

[Truman Patterson:]

This is actually Truman Patterson on for Stephen. So I just wanted to dig into gross margins a little bit further. For about 6 consecutive quarters, previously, you guys were running in the 16% range. And now, including first quarter '18, it looks like you're all 3 quarters above 17%. What has really been the driver of this change? And could you talk about the sustainability of this as we go through 2018? And then just a general market question, most builders suggest that the owned versus optioned gross margin spread on lot purchases is usually about 200 to 300 BPS. Is this pretty similar with what you guys see?

[Robert Martin:]

So a couple of questions in there, I guess. First of all, with regard to dissecting the margins a little bit, I want to go back to a comment I made with regard to sales, which is we think the market's better and that means that we have had the ability to increase prices. And that has outpaced a little bit the increase in costs. So I think you're seeing a little of that -- a bit of that in there. Looking forward, you talked about the sustainability in 2018. Certainly, it's not possible for us to predict what cost increases versus price increases will be going forward. But the notion that our backlog at the end of 2017 is higher than our Q4 closing gross profit margin of 17.3% certainly gives us some optimism in terms of what we think 2018 could be.

[Truman Patterson:]

And any update on kind of the owned versus optioned gross margin spread?

[Robert Martin:]

No, I don't know if there's really a standard you can apply consistently. It can depend on other factors as well, which submarket the asset is in and other factors. So I think it's hard to make that generalization about that other than the fact that having a deal that you can buy on auction potentially improves your IRR, and that is something that we look at as a measure by which we decide whether or not we are going to do a deal or not.

[Operator:]

Your next question comes from the line of Andrew Berg with Post Advisory Group.

[Andrew Berg:]

I just want to go back to your comment on SG&A and growth in that figure. So I hear you properly in saying that it would grow, but perhaps not any faster than 15%, which should imply, if you strip out the $5.4 million of infrequent charges in the fourth quarter, growth of like $40 million in SG&A over the course of 2018?

[Robert Martin:]

I don't know if that map that you just talked about really works. What I said is 15% was the growth rate of employee headcount that relates to the G&A line during 2017. And I'll let everyone kind of make their estimates in terms of how that translates into G&A in 2018. What I did say is I don't think you're going to see that rate of increase in employee count necessarily in 2018, although some level of increases to employee count during 2018 is possible.

[Andrew Berg:]

Okay. I thought you were commenting on the overall dollar amount. Would you care to comment or help us frame out how we should think about SG&A as a percentage of home revenues in '18 as it's certainly been growing a little bit here?

[Robert Martin:]

Yes. Well, we don't give out specific revenue numbers. I think the purpose in talking about $5.4 million of general and administrative expenses that are infrequent were to give you an idea of some of the expense level in our fourth quarter number that may not recur. So I think using that, you can come up with an estimate. And then of course, as you look at the other elements of SG&A commissions typically as a direct relationship to whatever your home sales revenue estimate is. And then marketing does not have as much of a direct correlation, but has a little bit of a direct correlation to your home sales revenues, although that even gets a little bit confusing going forward because there's a couple of changes in the accounting literature that go into effect for 2018.

[Operator:]

And your last question comes from the line of Buck Horne with Raymond James.

[Buck Horne:]

Just quickly going to the Seasons product line. I think you guys commented that so far, Seasons homes are actually generating higher gross margins than the corporate average right now. So I guess, I'm curious, what's different about maybe the production process or the building process that's allowing that? And also, just how quickly can you ramp up that Seasons community mix and what do you think the mix looks like in 2019?

[Robert Martin:]

Yes. Well, 2019 seems so far away. I guess, first of all, with regard to what is happening, what makes it more efficient, what makes it potentially a higher-margin product, I think just a few things. First of all, it's less complex to build. So when you're estimating the cost for the Seasons and bidding it out to your subcontractors, it's a little bit more of a simplistic process. We have maybe a better visibility to what the costs are there. It's quicker to build. I think that gives you some efficiencies in terms of some of your overhead costs that end up running through the gross profit line and interest cost that runs through the gross profit line. So there's some elements of that there. The other element is simply the demand for that kind of product. And I think it's worth saying that even though we frequently refer to it as a first-time product, it's really not just a first-time product. It also appeals to a moved down buyer that's looking for a smaller house but yet still a nice house that they can customize and still have a yard. So it appeals to that consumer as well. And because it appeals to multiple types of consumers, I think that helps support pricing increases on that product, that lower price level. And what was the second part of your question?

[Larry Mizel:]

2019.

[Robert Martin:]

2019. How can I forget? So for 2019, again, I don't have an exact number for you. What I would refer you back to is just in the last quarter, it represented about 30% of our overall land acquisition, also represented 30% of the lots that were approved during the quarter. So if that continues long term, you could certainly see it trending towards that level. But the timing gets a little bit murky when you get out that far.

[Buck Horne:]

That makes a lot of sense. I appreciate that. And just, I guess, speaking about different types of consumer groups, have you guys thought about expanding or coming up with a similar kind of affordable product for the active adult or an age-targeted segment to go after the older demographic in addition to the first-time buyer?

[Robert Martin:]

Yes. The great thing about Seasons in our existing communities is we think we already captured a lot of that demand. I think when you get to active adult and age restricted, you start talking about other issues, other complexities, other risks that we really would rather not deal with. So we're probably not going to venture, at least at this time, into something that is actually age restrictive.

[Operator:]

We have no further questions at this time. I'll turn the call back over to the presenters for any closing remarks.

[Robert Martin:]

Great. Well, we thank you very much for being on our fourth quarter call, and we look forward to talking with you again as we release our first quarter 2018 results.

[Operator:]

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