M.D.C. Holdings, Inc.
Q3 2016 Earnings Call Transcript

Published: 1 Nov 2016

[Operator:]

Good afternoon. We are ready to begin the M.D.C. Holdings Incorporated Third Quarter Earnings Conference Call. I will now turn it over to Kevin McCarty, Vice President of Finance and Corporate Controller. Sir, you may begin your call.

[Kevin McCarty:]

Thank you, Kelly. Good morning, ladies and gentlemen and welcome to M.D.C. Holdings 2016 third 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 were 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 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 third quarter 2016 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 turn the call over to Mr. Mizel for his opening remarks.

[Larry Mizel:]

Thank you. I’m pleased to announce 2016 third quarter net income of $26.4 million, a 78% increase over the prior year. The improvement was driven mostly by 27% growth in the home sales with revenues more than $575 million. Generating higher returns has been a key focus for us. Looking at our return on equity on a rolling 12-month basis we’ve now seen for four consecutive quarters of improvement. The 2016 third quarter we increased this metric by 200 basis points over the prior year. The expansion of our income revenues and returns are really in a disciplined philosophy focusing on strong execution of our build-to-order model. We believe that this approach gives us the best opportunity to sustain our operations through the inevitable cycles of the homebuilding industry while limiting our exposure to risk. Our build-to-suite model has allowed us to focus on construction activity on units already sold to customers. Resulting in the percentage of our work in process units attributed to sold homes reaching 87% at the end of a quarter. Operating in this manner not only in helps us to operate more efficiently by dedicating more resources to sold inventory, but also reduces the risk associated with our work in process units. Our cycle times continue to increase during the quarter base on limited subcontractor availability and some of our larger markets. Improvement in cycle times the remaining key thing for the Company as we close out the year. However subcontractor availability issues are largely out of our control and unlikely to resolve quickly. So we are in the process of working on other initiatives to help our construction process. The most prominent example of these efforts is the development of our Seasons Collection which we have discussed in prior quarters. This new product designed with affordability in mind for the first time homebuyers has a more simplistic design in a shorter construction time than most of our other plans. As this product becomes a more significant part of our business. It should have a positive impact in our overall cycle times. We believe that our Seasons Collection has been very received by our customers already in the third quarter. Our results include a notable contribution from this collection. Even though it is still in the very early phases of its rollout. In total order results were positive as we recorded our 10th consecutive quarter of year-over-year growth in net new orders and an increase in our monthly sales pace by 15%. Given the initial success we have seen for the Seasons Collection, we have increased our overall spending on communities that feature this product. Overall during the third quarter we spent $150 million on land acquisition and development activities including the purchase of more than 1,000 lots across our markets. Our total controlled lot supply was almost 15,000 at the end of the quarter which we believe is sufficient to support our ongoing efforts to improve top and bottom line results. As 2016 draws to a close our outlook is positive, we are delivering higher revenues income and returns than a year ago with the balance sheet remains among the best in the industry. Against this backdrop, we have continued to reward our shareholders with a strong consistent dividend payment since 2005 with a yield that ranks as the highest in our industry. In addition, we believe that our strong backlog to end of the third quarter gives us the opportunity to continue delivering year-over-year improvement to our operating results in the fourth quarter. Thank you for your interest. Now I’d ask Bob Martin for more specific financial highlights.

[Robert Martin:]

Thank you, Larry. Our home sales revenues increased 27% from the prior year to $575.7 million as a result of a 20% increase in closings, which was our highest year-over-year increase in closings in 12 quarters. We also had a 6% increase in average selling price. Our third quarter backlog conversion rate was down year-over-year from 42% to 38%. Although that increases narrower than what we saw in the second quarter it's still fall sort of our expectations. Limited subcontractor availability in certain of our larger markets continued to negatively impact our cycle times especially in Colorado, Southern California and Washington. Without any clear sign that subcontractor availability will improve in the short-term, we believe that our backlog conversion rate will continue to fall short of our prior performance in the fourth quarter. However, we do expect sequential improvement with the goal of achieving at least the 400 basis point increase from the third to the fourth quarter. Our gross margin from home sales percentage decreased by 90 basis points year-over-year mostly as a result of $1.8 million of warranty adjustments and higher land and construction cost in certain of our markets most notably Nevada. Excluding impairments and warranty adjustments our gross margin was down 50 basis points to 16.7%. We took $4.7 million of impairment during the quarter compared to the $4.3 million for the same quarter a year ago. The impairment during this year’s quarter was mostly related to one asset in our Virginia division. In addition we have one more minor impairment in Florida. Looking at the sequential trend relative to the second quarter, our Q3 2016 gross margin from home sales excluding inventory impairments and warranty adjustments was flat. It’s important to note that even though our gross margin is down year-over-year. The gross margin dollars made per month was flat due to the gains we have made in average selling price. We were pleased to see improved operating leverage for the quarter as our SG&A rate totaled by a 180 basis points from 12.6% to 10.8% due in large part for our significant year-over-year increase in home sale revenues. Our total dollar SG&A expense was up for the quarter driven by a $3.7 million increase in commissions and a $2.8 million increase in marketing. These increases were primarily due to the growth in our closing unit volume and home sales revenues. The higher commissions and marketing expenses were partly offset by a $2 million decline in general and administrative expenses primarily due to the lower stock-based compensation expense. Outside of SG&A there were a couple of other variances on our income statement that I will give a little additional detail on it. First, other expense for the third quarter was a bit on a high side, increasing by about $1.2 million year-over-year. The increase was related to the write-off of several option deposits in Virginia for projects we decided not to move forward during the quarter. The impact of those write-offs was more than offset in several other areas. In particular, interest and other income was about a $1 million higher for our third quarter versus a year ago and our other than temporary impairment of marketable securities was about $2 million lower. The dollar value of our orders increased 17% year-over-year to $570.3 million. The increase in dollar value was due to a 17% increase in sales driven by a 15% increase in our monthly absorption rate to 2.72 per community. As Larry noted earlier, this represent our 10 consecutive quarter of year-over-year order growth and our highest third quarter absorption rates since 2005. Our affordable Seasons Collection is starting to become a much more significant part of our business. For the 2016 third quarter this product offering accounted for 5% of total orders despite being offered in only seven subdivisions across two of our divisions. In these two divisions, seasons accounted for more than 10% of all orders in the third quarter. The average selling price of our orders was almost unchanged from the same period in the prior year at roughly $440,000. This is the first time in quite a while that we have not seen a year-over-year increase and that’s driven by a shift in mix to lower price communities that was partially offset by price increased in many of our communities. Specifically, again our Seasons Collection is having a much bigger impact. Excluding our sales from our Seasons Collection, our average order price would have risen by 2% year-over-year. Looking throughout the country, California and Colorado where our top markets for an observation rate perspective which we think is indicative of solid demand in these markets. Our most improved market was Colorado which had a particularly strong performance from our Seasons Collection as well as other products in more affordable areas. Our homes and backlog at the end of the second quarter were up 33% year-over-year on a unit basis to 3448 homes with a value of 1.61 billion, which was up 37% year-over-year. We expect this backlog to be a primary driver of year-over-year improvement in home sales revenues in the 2016 fourth quarter. Our cancellation rate was flat year-over-year at 25% for the 2016 third quarter. As a percentage of beginning backlog, our cancellation rate was down 100 basis points year-over-year to 13%. Active subdivisions increased modestly year-over-year to a 159 at the end of the 2016 third quarter. In Colorado, our active subdivision count was down by 24%. However, this was driven by the timing of opening new communities versus closing out older communities and we still expect our Colorado community count to rebound. The decrease in Colorado was offset in part by Nevada where active subdivision count has increased significantly over the past five quarters. For the third quarter, we acquired 1,056 lots for $81.9 million, a decrease from the same quarter a year ago and sequentially from the second quarter of 2016. The current quarter activity occurred mostly in California, Colorado and Nevada. We spent additional $68.3 million on development expenditures brining our total spend for the quarter to $150.2 million. This is the first quarter that we purchased lots specifically underwritten for our season zones with more than 20% of the lots that we acquired and dedicated to this product. At the end of the quarter, we owner controlled 14,759 lots, which represented about a 3.1 year supply on a trailing 12-month delivery basis and a 6% decrease from a year ago. While our supply is down year-over-year is still in line with our strategic range. We believe that this supply as a strong starting point as we look forward to the growth potential of our Company in 2017. Beyond the lots we already controlled; we continue to see a healthy pipeline of land deals across our markets. We are pleased to report that our key production metrics continue to improved year-over-year giving us confidence they can drive higher home deliveries in the 2016 fourth quarter. Our third quarter home starts were up 18%, marking the 4th consecutive quarter of year-over-year increases. Our homes completed or under construction excluding models at the end of the quarter increased 17% from the same period in the prior year. This increase is important as these units to make up a big part of what we can close for the remainder of the current year and during the first quarter of 2017. In addition, consistent with our bills order strategy, 87% of the working process units you see here at the end of the third quarter already sold, compared to 76% at year ago. We believe the higher percentage sold also speaks the quality of our balance sheet with limited speculation and unsold units. Giving where we stand from a backlog in production standpoint we expect top and bottom line growth during the last quarter of 2016 with continued focus on improving overall company returns. That concludes our prepared remarks. So at this time, we would like to open up the call for questions.

[Operator:]

[Operator Instructions] Your first question comes from the line of Alan Ratner of Zelman & Associates. Your line is open.

[Alan Ratner:]

Hi, guys, good afternoon. Thanks for taking the questions. First one, just thinking about the orders versus the backlog conversion dynamic going on here. You put up a great order number this quarter, but continuing to see pressure on backlog conversion and cycle times. And I think one thing we hear from a lot of builders is they are reluctant to sell too far out in their backlog, because A, they don't have visibility into their costs in that situation. B, it increases the risk of cancellations. And I'm just curious where you are in that dynamic today? If there's any risk or are there any markets or communities where you are actually having to tell buyers, or turn buyers away because the backlog is too far extended? And if not, at what point do you hit that threshold?

[Larry Mizel:]

Well, I would say it is something that we look at - and that we're concerned with. It's not the dynamic where we're just letting demand go without check and we are doing things to respond to that we are having positive results in our orders. One of them being we are increasing prices and doing so of course that helps us cover future cost increases that might occur or in fact in the third quarter we increased price is about 50% of our communities. As far as stopping sales altogether we haven't done that for the most parts and there are limited circumstances where that might be the case. But for the most part we haven't completely shut it down though there are some cases where we limit the lock releases. The other thing I think to realize on our order for us with the quarter is that some of that increase is related to the fact that we have increased our sales of our new Seasons product lines. So we're really reaching out and servicing a customer that’s been largely underserved over the past few years. So we think it is a prudent thing to make sure that we are capturing that demand.

[Alan Ratner:]

Thank you, Bob, for that, that's a good segue into my second question on Seasons. So it sounds like you are seeing a lot of good traction there. You mentioned the cycle times that the Seasons are shorter than the traditional business. I was curious if you could quantify that? And with the Seasons now representing, I think you said 10% of orders, just curious, what's the margin differential on that product versus the traditional business, as well? And should we expect to see any type of mix impact on margin? You did mention pricing power, which is good to see, but is that going to give offset by the Seasons contributing a greater percentage closings going forward? Thank you.

[Robert Martin:]

Yes, I think for Seasons first of all is it relate to cycle time. It depends by a market we’ve got it in Colorado right now we’ve also got it in Arizona. Colorado right now cycle times are 9 to 10 months. We could see it being closer to say five months for the Seasons product you have to caveat that we haven’t closed a whole lot of those yet. So there is that caveat out there, but we do have that that kind of potential. In an Arizona market where the cycle times are already much more impressed than that, the differential is much less. And so the second part regarding margins on the Seasons product. So far we have not seen any deterioration on the gross margin percentage really and keep in mind we've mostly released it right now in subdivisions where we had previously been operating. So when you compare it our traditional products versus bring out the new Seasons product, we have not seen gross margin degradation. But certainly we will update you as so what we're seeing as it becomes more prominent in future quarters. And then last thing I want to say is just to make sure it's understood that Seasons product was 5% of our overall orders for the entire company and it was north of 10% in each of those two markets I just mentioned Colorado and Arizona, so just to clarify there.

[Operator:]

Your next question comes from the line of Stephen Kim of Evercore. Your line is open.

[Stephen Kim:]

Yes. Thanks very much guys. And thanks for all the info here on Seasons. When you talk about the fact that you are increasing prices in certain markets, I think you said 50% of your communities, as a result of backlog being a little far out there, I was wondering if this makes you feel a little different about the potential weighting that margin can play in your ROE initiatives going forward? Last quarter, for example, you were pretty clear that you felt you were going to move the focus much more towards turns and away from margins, but just was curious if you could revisit that?

[Robert Martin:]

Yes. I’d happy to, Steve. I think you've got it ice cold on where our mindset is. We have to be sensitive to margins to a degree. Because it does filter into discussion on profitability, but I do think that making sure we've got a good drum beat on unit volume, is perhaps even a little bit more important as we look at our returns. And there is a couple of reasons for that, if you're getting unit volume you’ve got a better potential to turn your inventory more quickly which has positive impact on your return on equity. If you look at even gross margin itself at higher absorption levels, gross margin tends to increase to some degree, simply because you're leveraging things like interest in cost of sales, your construction overhead and things like that more efficiently. So for reasons like that, I think it's prudent to have a little bit of a tilt towards that unit volume. As for the gross profit margins really what we've seen there is stability, if you look over the last six quarters at our gross profit margin there is really not been a whole lot of variation about 70 basis points, once you take out impairments and warranty adjustments it's only about 70 basis points from high to low over that six quarter period. So we still feel pretty good about where we stand from a margin perspective.

[Stephen Kim:]

Okay, great. Appreciate that color. One area where you did better than we were expecting was actually on the SG&A line, and in particular, I think you went through and I didn't hear anything that sounded of a one-time nature, but I thought I'd revisit it and ask. Was there anything there that you think if we were to peel the layers back, we would say, that's something that may not recur in the fourth quarter and beyond?

[Robert Martin:]

Yes. The biggest reason for the change in our absolute level of G&A was stock stock-based comp which decreased year-over-year. In terms of one-time items there's nothing that comes to mind in particular that’s very significant. I always like to give the caveat that have you can always have things plus or minus in future periods on adjustments to reserves and one-times on legal and things of that nature. But there is nothing really like that in the third quarter.

[Stephen Kim:]

All right. Excellent. Well, thanks very much guys. Appreciate it.

[Operator:]

Your next question comes from the line of Nishu Sood of Deutsche Bank. Your line is open.

[Nishu Sood:]

Thanks. On the Seasons product, I mean the way you’ve configured it with a shorter cycle times simplified product. I think the most people would assume that from a marketing perspective that would be attracting the entry level millennia or first time buyer. But you know in a lot of case I think builders have found some move down, some affordability driven buyers given the price appreciation on the closer in areas. What have you found so far in Arizona and Colorado on the product? Is the buyer set as you expected from a marketing perspective or have there been any variations from that?

[Larry Mizel:]

I think it's a good question and I think for the most part we see a lot of appeal from that first time buyer. I do think you said on something there though in that we do see that it does serve double duty to a degree. You do have people who want a smaller home and these houses in the initial release are really kind from a 1,400 to 1,800 square foot range. You’ve got some nice range plans that are smaller than appeal to an older consumer and move down type of consumer. So we have seen some of that as well. It's really a great story for us because it can serve both purposes.

[Nishu Sood:]

Got it. Second question I wanted to ask was on the backlog conversion ratio. So at the beginning of the year, you and many others had expected some improvement in backlog conversions and cycle times. Some builders have seen that. I think on balance, they are flattish year over year. I just wanted to dig into the specific drivers. I think Denver had been a big part of it but your Denver numbers are actually, I think, flattish on a year-over-year basis. It looks like in Nevada and California, the problems are a little bit more pronounced. How would you characterize it? Is this in certain communities, is it a widespread problem across your communities where it's a some delays in all of your communities? And difficult question to answer, but what do you see happening? And obviously is an area of focus for you for 2017, but what do you think it will take, to get those problems to ease, as you are seeing it across your portfolio?

[Larry Mizel:]

Yes. I think in terms of how widespread is, I don't believe it's the same in every market and I do think in a market like Colorado it's a little bit more widespread and Colorado is a place where you are seeing really the lowest backlog conversion of all our markets. Clearly this happens to be our biggest market, so it has a relatively bigger impact upon our operations relative to our peer, I would imagine. So that’s the dynamic to it. As you get this on the other market, I would say it also mentioned Southern California and Washington being impacted and maybe a little bit less than Colorado. And then Phoenix and Las Vegas to a certain degree we saw that, but I’d say that was a little bit more isolated where we saw that occur. Of course, as you look at what happens when you have those labor issues, you tend to get bunched up in other places as well if you have an issue with framing maybe you get bunched up somewhere down the line. And there is other things that have been a little bit of a challenge for us even things like getting appraisers onside on it on a timely basis, something as basis as that isn’t as easy as it used to be just in terms of the time it takes to get those people onside for appraisal. So there's a variety of different things, but that's really the overview.

[Nishu Sood:]

Great. Thanks.

[Operator:]

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

[Michael Rehaut:]

Thanks. Good morning everyone. First question I had was just wanted to – a little bit more on some details thinking about the fourth quarter. I believe last quarter Bobby, you outlined or share an expectation to end the year community count wise at around 169, if I have that right. And it may be seen just slight growth in the third quarter. So you're about flattish in the third quarter and from a quarter end standpoint? Do you still expect the 169 by year-end and with lots down year-over-year? How should we think about community count growth for 2017?

[Robert Martin:]

Yes. As far as the 169 goes I think last quarter I described that is really a feeling for where we could expect to be by the end of the year and sit here in a 159 and given that we're in the fourth quarter where quarter activity typically is the latest. It’s tough for me to commit to 269 I think a lot of it depends on how quickly some of the orders come through in Colorado where I mentioned we're down about 24% year-over-year. But we think that some whatever temporary it’s just a matter of whether or not those new subdivisions come online in the fourth quarter or if it ends up being the first quarter of next year. As far as next year's average community count growth potential, I think there is potential still there. I'm not ready to give a range at this point I think we saw some time here in the fourth quarter to influence what happens there and it is a little bit more impactful for us what happens in the fourth quarter just given our lower level of land supply overall.

[Michael Rehaut:]

Okay. No, that's helpful. Secondly, just going back to Seasons for a moment, and there was a question earlier on the impact of gross margins. Just wanted to clarify there. You said I think that in Colorado, Arizona, it hasn't had a deteriorative effect on gross margins, but obviously, it's just a very, very small portion of closings. So I wasn't sure if you were referring to that, because I think the bigger question is just the product itself. Typically this type of product carries a lower gross margin, versus, let's say the corporate average or the move-up product, and just wanted to be clear what exactly you are referring to, because I think you said it's similar, or there was really no impact. But I wasn't sure if that was just because it was such a small piece of the business. If you look at apples for apples.

[Robert Martin:]

No, I get your question and let me just clarify I’m talking about gross margin percentage here. And based on the full volume information I have right now whether that’s closings or backlog or sales. Just overall I am not seeing that are coming in a lot lower than other product in the subdivision. If that make sense. I’m not seeing it, so other stuff with the same land bases in some cases. So I think right now we don’t see that based up on the information we have out there or experience that it has any degradation to the gross margin percentage, but again I caveat that with this is all on in subdivisions that we had previously operated in with other products it doesn’t include yet subdivisions that were specifically underwritten to the Seasons product and it is still pretty limited experience overall. Even now its increasing it still only 5% of our orders so. As we expand the footprint of the Seasons Collection we will see if that continues to hold true.

[Michael Rehaut:]

Great. If I could just squeeze in one more, just a couple of housekeeping items. How should we think about the tax rate for the full year? This quarter is a touch under 31%. Just thinking about the full year and maybe what the run rate would perhaps be for next year? And when you also refer to the stock-based comp in 3Q and the SG&A line being lower year-over-year, just curious if that's something that would carry over as a benefit into 4Q, or if that was one of the drivers in the really good leverage that you had in the quarter, as compared to the last couple quarters?

[Robert Martin:]

Sure. In terms of the second part of your question first. On stock based compensation we had a relatively high charge going through there related to a option ground that occurred in May of 2015 and that expense was going through for really the third quarter of 2015 through the second quarter of 2016. So after the second quarter of 2016 that expense is done. So third quarter of 2016 was the first time we didn't have that in a year. So there is nothing else out there right now that directly substitutes for that. So all those equal, we would not expect that expense to recur in the fourth quarter. And then the other part of your question. I'm sorry what was the other part of your Mike.

[Michael Rehaut:]

Well, I am sorry the tax rate.

[Robert Martin:]

On the tax rate, it was a little bit lower in the third quarter and that was - there was a discrete item that that came through. But I think for the full year, if you look to the nine-month information to see the expectation for the full-year I think we are right around 32.5% for the nine months. So that's really indicative of what we expect going into Q4. We would expect the same rate unless additional discrete items that we have not yet identified at this time.

[Operator:]

And your next question comes from the line of Stephen East from Wells Fargo. Your line is open.

[Stephen East:]

Thank you. Bob turning back to the gross margins for a minute. Could you tell us what the gross margin in the backlog and then on your warranty and impairments costs. On the warranty what was going on there any more to come on that and same thing on the impairments?

[Robert Martin:]

Sure. In terms of backlog gross profit margin. We actually stopped giving out that information a few quarters ago, we really just not - it wasn't being useful to our users. So that’s not a number I’m going to give out. I would reiterate that as we look over the last six quarters, you know the delta between high and low on margins before impairments and warranty adjustments is only been about 70 basis points. So we would characterize the gross profit margin as pretty stable. In terms of the warranty adjustment and the impairments, I guess taking the warranty adjustment first. We do an analysis of our warranty adjustment every quarter naturally for every closing that we book. We are booking warranty expense there. But then we do an overall analysis and it really involves some very complex calculations and a lot of different factors. So where we end up at the end of the third quarter is where we expect to be. Short-term there's always the potential for adjustments up or down in future quarters but none that that we can point to as of the end of the third quarter. Impairments is a similar kind of thing, we review it every quarter. I think the good news here is really it related mostly to just one asset in the mid-Atlantic and that’s a place where we already have discussed that. It's been a little bit weaker in some of our urban market. So it’s not a widespread thing as far as the third quarter impairments go. But we will evaluate again at the end of the fourth quarter and go from there.

[Stephen East:]

Okay, all right, thanks. Turning to the returns, could you tell us what you all are looking at when you talk about returns, how you define it? Maybe what's your target? And if you're cycle times, I appreciate getting volume, but if your cycle times are extended and you're not able to deliver, you deliver at a slower pace than what you are selling, that's not helping your return anyway. So I guess my question is, why wouldn't you try to bump up price to at least match your delivery pace and your sales pace?

[Robert Martin:]

Yes. I think first of all return on equity is really what my focus is. I wouldn't say there's necessarily a particular target right now other than improving where we've been over the last 12 months and that's what we saw where it will accomplish in Q3. As far as the dynamic I think it's a legitimate point on the price and that's why we did increase pricing about 60% of our subdivision we found that appropriate as we look at it every week, if not every day where the pricing is going and if we do see that absorption rates are starting to get out there in a particular community. We do increase price and that decision is made on a community by community basis.

[Operator:]

And your next question comes from the line of John Lovallo, Bank of America. Your line is open.

[John Lovallo:]

Hey guys. Thank you for taking my call this afternoon. First question is, I think just maybe semantics, but last quarter you were talking about your backlog driving significant year-over-year revenue growth, in the back half. I think this quarter you are talking about generating year-over-year growth, and you had a pretty strong quarter in terms of revenue growth. But I just wanted to see, A, am I splitting hairs here, or are you incrementally more cautious given what's going on with labor, and so forth?

[Robert Martin:]

Well, I think into the backlog it was up 33% year-over-year and 37% year-over-year in dollars. So I think that gives us some pretty good confidence in potential for year-over-year growth in Q4. I don’t know if there is a huge change in tone there. It's a backlog fire and offset to some degree by the fact that we know our cycle times have moved up a little bit too.

[John Lovallo:]

Okay. That's helpful. Moving on, we were under the impression that the federal NOL was exhausted in the second quarter of 2016. There appeared to be about a $3.5 million deferred income tax add back in the quarter. So I guess the question is, is this driven by state NOLs? And if so, do you anticipate a similar run rate in the fourth quarter?

[Robert Martin:]

I think it’s just energy credits maybe that you are seeing go through there. So once that all kinds of nuts out in the washer I think fourth quarter based on what we know right now and they were up 32.5% type of number, percentage of our tax rate. And then going into next year, however, we don’t necessarily have those energy tax credits in 2017, so that could be a deduct with the caveat that they might announce, that the government might announce that those are back on the table. They just haven’t done it yet. So 2017 you might see an impact those coming out the table.

[John Lovallo:]

Okay. Thanks guys.

[Operator:]

Your next question comes from the line of Will Randow from Citigroup. Your line is open.

[William Randow:]

Hi guys. Thanks for taking my questions. I guess in terms of thinking about cash flow from operations, it looks like your land spend turned positive this year. Just wanted to make sure that took place, and particularly are you looking to ramp up land spend anytime soon and similarly what are your priorities for cash flow from operations, assuming it does turn positive over the next year or two?

[Robert Martin:]

Yes. Well, I guess first of all it’s little bit lumpy how that land act occurs in any given quarters, so I don't know that I can give you certainly one way or the other where the cash flow is going to be over the next couple of years. We are trying to make sure that in line with the mindset of increasing our returns that we are being thoughtful as far as our – being thoughtful as far as the assets that we acquire and making sure that we are operating efficiently. Use of cash in future periods, we still if we are generating that cash flow I think what we really want to do first and foremost is invest in the business, grow the business. I think that’s very important for us. We’ve talked about the first time consumer and how we think that the first time consumer is really – the consumer base that can grow that can increase new home sales overall nationally. And we want to make sure we're participating in that level of growth to extend that it occurs. And also just going there that we do have dividend that ranks the highest in our industry. Dividends has been very consistent for our company throughout the downturns since 2005. So that is something that we’ve part of our half flow into that the number is nearly $500 million over the course of the past 10 years. So that dividend has remained a priority for us.

[William Randow:]

Okay. And as a follow-up, to dovetail on the discussion on the first-time homebuyer product, it seems like the pie is obviously big enough for all the participants that are stepping up the presence in the space. Can you talk about any experiences where you are stepping up your Seasons product, or existing other buildings are still stepping up their first-time homebuyer product? If that's impacted price, absorptions, or incentives in any way?

[Robert Martin:]

Okay. It was pretty limited, only seven communities across the country and really just in few markets right now. So there is pretty limited experience that and what I will say is I do think there is to our Seasons product in that it's not an absolute strip down models design for only the entry level consumer. It's a product that really had some neat features associated with it in the standard house. If you go through the models if you ever have the opportunity you see what I mean higher ceilings being one thing that you notice right away than other entry level product. So I would say on the margin it’s just a little bit nicer than what we see from the competition when they described an entry level product. The other thing you out of our products is really the ability to customize it. Still Delta order even though it’s designed the first time consumer. And I don't think that's as prevalent how it's of our competition. We think we're a little bit of edge there in terms of the ahead of prospects both product.

[William Randow:]

Got it. Thank you for the time.

[Operator:]

Your next question comes from the line of Alex Barron from Housing Research Center. Your line is open.

[Alex Barron:]

Hi, Bob, hi, Larry. I guess going back to the issue of backlog conversions and labor availability. I'm wondering I guess to what extent are can some of these issues you know what's your opinion - to what extent some of these issues can be solved. I guess just by paying more for these subs or do you think some of this is more reflective of your change towards less specs and more build to order?

[Robert Martin:]

I mean there is - to that if you don't have as many inventory owns out there, it has an impact and we've talked about that. But in terms of paying people more and taking other actions try to fill the gap on the subcontractor side that piece is really difficult to quantify. I think it is a valid point in that. The best thing we can be doing right now is being very attentive to what’s happening with our subcontractors being very in touch with our purchasing personnel, that may be the case where they need a little bit more from a price standpoint, from a cost standpoint in order for them to, if you get back on our jobs, it may be something else that we need to give to them just a little bit of a better visibility in terms of what number of homes we have available for them to build, but staying really close to those subcontractors is going to be very key easy for us even though it's difficult to quantify exactly what impact that will have.

[Alex Barron:]

Right, yes. I am just trying to figure out how to model next year with all the moving pieces. Now, any other comments you can make as we move into next year? Obviously with backlog growing, your revenue should be growing. What do you think we can expect as far as further SG&A leverage? And also the interest flowing in cost of sales, is that likely to come down as a percentage of revenues?

[Robert Martin:]

Well, I think it’s all kind of one in a same question because it all hinges behind that ability to grow revenue. And part of the revenue story is whether or not we can decrease our cycle times. And I think it is very difficult to quantify at this point how much exactly we can or if we can it all decrease our cycle times going into 2017. I only say that because some of that is out of our control in terms of the absolute number of subcontractors in any given market. So it does hinge around that and I think the notion that we are added into the backlog that we are seeing still strong demand is an important point to because that also helps us to ultimately increase our revenues year-over-year.

[Alex Barron:]

Okay. Best of luck. Thanks.

[Robert Martin:]

Thank you.

[Operator:]

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

[Michael Rehaut:]

Hi. Thanks for taking my follow-up. So just a couple of quick ones here. Bob you mentioned in your prepared remarks regarding the fourth quarter backlog you still expect that to be down year-over-year, the backlog conversion. But you said it should improve sequentially and I thought you might have given a rough sense of the sequential improvement or I thought I heard you say the word by a quarter. If you could clarify…

[Robert Martin:]

Yes. Sequentially from the third to the fourth quarter we have goal of increasing by at least 400 basis points.

[Michael Rehaut:]

Okay. That's helpful. Thank you. And then, also in terms of thinking about Seasons going forward, right now 5% of your orders, seven communities, two markets. How should we think about what that might become in 2017? Obviously, I would assume directionally as you've said when you put out a 20% of lots purchased in the most recent quarter Seasons. Can it reach that type of a number in 2017 in terms of your mix and kind of related to that what is the typical absorption per month for Seasons versus the rest of your Business?

[Robert Martin:]

I guess I didn’t quite get what target you are thinking about for 2017.

[Michael Rehaut:]

You had referenced the 20% of lots purchased even in this quarter.

[Larry Mizel:]

Yes. I mean it’s a big move from 5% to 20% and you’ve given that as only in two markets right now, only actively selling in two markets right now. I think it’s tough to say right now if we can get to that level, that 20% level in 2017 and we already went from 2% to 5% in the course of the quarter. So I think that gives you an idea of the kind of references that we put on the product. As I look at absorption rates for the product, it’s substantially higher than our more traditional product. And again I have the caveat with – it’s a more limited set of information that we're dealing with here only seven communities that we are talking about here. But it is substantially higher than our traditional product.

[Michael Rehaut:]

On that Bob, obviously again appreciated, it’s only seven communities, but are we talking more like in the – I mean right now your corporate average is around a little under three for this quarter, three per month. Are we talking something like double that or above 10 per month or what's the degree of magnitude here?

[Robert Martin:]

Obviously, it depends on the individual communities, but versus three per month I’d say we are offering Seasons you go off to more or like say six a month or so. So double is probably a good number.

[Michael Rehaut:]

Great, thank you.

[Operator:]

And your next question comes from the line of Andrew Berg from Post Advisory Group. Your line is open.

[Andrew Berg:]

Thank you. Just going back to land acquisition come you made before and discussion of free cash flow? Can you give some indication of where you see land spend coming out in 4Q an expectations for next year - of land acquisition and development?

[Larry Mizel:]

It's not a number we get out because it's difficult times these interactions with the land sellers. Yes, I do say we're looking to pending the development of the overall housing market. We want to grow as a company. So we're not looking to necessarily spend less as company as we move forward, but we haven't put out any specific targets.

[Andrew Berg:]

Okay. Any reason to believe the fourth quarter should replicate third quarter in terms of order of magnitude of the Delta though and you spent less this year than last year, not just a timing issue.

[Larry Mizel:]

I mean in the second quarter we spend more year-over-year the second quarter and then it down year-over-year in the third quarter. So again it’s really just depend on the timing of some of these transactions. And then again our outlook is positive. So we would all is equal rather be adding us it to our portfolio if that make sense.

[Andrew Berg:]

Understood. Thank you.

[Larry Mizel:]

Thanks. End of Q&A And there are no further questions at this time. I’ll turn the call back over to the presenters.

[Larry Mizel:]

Very well, thank you very much for being on the call today. And we look forward to speaking with you again after our fourth quarter earnings call.

[Operator:]

And this concludes today’s conference call. You may now disconnect.