M.D.C. Holdings, Inc.
Q3 2014 Earnings Call Transcript

Published: 30 Oct 2014

[Operator:]

Good afternoon, we are ready to begin the M.D.C. Holdings Inc. third quarter earnings conference call. I will now turn the call over to Mr. Bob Martin, Vice President of Finance and Corporate Controller. Sir, you may begin your call.

[Robert N. Martin:]

Thank you. Good morning, ladies and gentlemen, and welcome to M.D.C. Holdings 2014 Third Quarter Earnings Conference Call. On the call with me today, I have Larry Mizel, Chairman and Chief Executive Officer; and John Stephens, 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 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 2014 third quarter Form 10-Q, which is scheduled to be filed with the SEC today. It should also be noted that SEC Regulation G requires that certain information accompany the use of non-GAAP financial measures. Any information required by Regulation G is posted on our website with our webcast slides. And now, I will turn the call over to Mr. Mizel for his opening remarks. Larry?

[Larry A. Mizel:]

Good morning. This morning, we announced third quarter income of $515 million or $0.32 per share, continuing our record profitability since homebuilding market recovery began in 2012. Following a period of significant home price increases, we have seen escalating land and construction cost during the past few quarters. In addition, we have offered moderately higher incentives to spur sales activity in many areas. As a result, in the third quarter, our gross margins declined both sequentially and year-over-year. While the downward pressure on our margin is disappointing in the short-term, the longer-term trend has been positive, with more than 300 basis points of improvement since the low of 2011. We believe that the long-term trend will continue to be positive as the volatility we have seen in our industry gives way to a more sustained level of healthy demand. We have already seen some evidence of a rebound, with the margins in our backlog showing a slight improvement during the quarter. We continue to believe that the housing market is poised for a long-term growth. However, obstacles remain on the path to recovery. Among the most prominent is the process for originating mortgage loans. Lower federal housing authority loan limits have already taken a toll on housing demand, especially for the first time segment. This has reduced mortgage availability to an important pool of potential buyers. Additionally, underwriting standards for qualified mortgages have caused issues for the industry, not only reducing mortgage availability for some creditworthy buyers, but also increasing the overall time required to obtain loan approval. We are encouraged that the government appears to be focused on the mortgage issue, as evidenced by the FHFA's recent announcement of changes to help expand credit availability. Given the importance of the housing market to the overall health of the economy, we're hopeful that further focus in this area will relieve some of the impediments, which currently challenge creditworthy customers. Any changes coming from the government may take time to materialize, which increases the importance of ongoing efforts to expand our presence in our existing markets. We have set the stage for growth, as evidenced by the 27% year-over-year increase in our quarter end active community count. The expansion of our active community count has already produced positive results, driving a 17% year-over-year increase in our net new home orders. It has also led to our first year-over-year increase in quarter-end backlog since the second quarter of 2013. These improvements provide us with the opportunity for top and bottom line expansion in future periods, in spite of the obstacles that may remain for the housing market. As always, our balance sheet has been a key focus for us. For much of the past years, we have focused on enhancing our liquidity with over $600 million of debt offering, and the establishment of $450 million line of credit. I should comment that $350 million of our debt offerings, 30-year fixed-rate financing, I think, it's the only transaction of its kind in our industry. And I believe, in the future, it will turn out to be most significant. More recently, just a few days ago, we redeemed our final near-term senior note maturity of $250 million about 9 months early. The early redemption decreases our overall interest burden, benefiting not only our credit profile, but also, our future gross profit margins. With the redemption behind us, we have no further senior note maturities into 2020, and we still have significant liquidity at our disposal to pursue new homebuilding assets that can help us grow. While we're cautious in the underwriting of new assets, we believe that moderation and demand over the past few quarters may create an opportunity for new land at increasingly attractive terms and prices. Thank you for your interest and attention. I will now turn the call over to John Stephens for more specific financial highlights of 2014, '13 -- third quarter. John?

[John M. Stephens:]

Thank you, Larry. Before I get started on Slide #4, I just want to make 1 clarification. Our net income for the quarter was $15.5 million. So moving to Slide 4. We delivered 1,093 new homes during the quarter, a 13% year-over-year decline. The decrease in deliveries was primarily the result of having a 10% lower beginning backlog to start the quarter. Our spec home deliveries continued to be a high percentage of our overall deliveries, with 59% of our third quarter deliveries representing spec homes versus 47% last year. However, on a sequential basis, we delivered a lower percentage of spec homes during the 2014 third quarter, as compared to the 2014 second quarter, including fewer spec homes that were both sold and closed during the quarter, which accounted for the sequential decline in deliveries as compared to Q2 of 2014. Our third quarter backlog conversion rate, which is typically lower than our second quarter conversion rate, came in at 58%, and was slightly below the prior year's third quarter conversion rate, but was still higher than our historical average. Based on our current backlog spec inventory levels and normal seasonality, we expect to see our backlog conversion rate tick back up in the fourth quarter, closer to the mid-60% range. Our average selling price was up 7% year-over-year to $371,000. This increase was primarily the result of a mix shift to higher price sub markets, and to a lesser extent, price increases taken during 2013. Year-over-year, all of our regions experienced increases in average home price, with the West experiencing the most significant increase at 11%, and our Mountain segment up 10%. Our California division generated the largest home price increase at 23%, which was due, in large part, to a higher percentage of deliveries from Orange and Los Angeles Counties, as compared to the prior year period. Our gross margin from home sales was 16.5% for the third quarter, down 160 basis points year-over-year and 60 basis points sequentially. The year-over-year and sequential declines in our gross margin percentage was primarily the result of additional incentives used to stimulate demand for new homes in certain markets, combined with higher direct construction and land costs. While we have seen some pressure on gross margins over the last couple of quarters, our margins and backlog are comparable with what we recorded during the third quarter. In addition, with the early extinguishment of debt that we completed earlier this week, we expect to see a lower absolute amount of interest being capitalized to our inventory going forward, which should provide a minor improvement to our gross margins in future quarters. Our homebuilding SG&A rate was down 80 basis points from the prior year despite a 7% decline in home sale revenues. The year-over-year improvement in our SG&A rate and total G&A expense was largely attributable to lower compensation-related expenses, including incentive-based compensation and lower legal expenses. The decrease in G&A expenses was partially offset by higher marketing spend related to supporting a 27% increase and a number of active selling communities, as compared to the prior-year period. Our sales commissions, which includes both internal and external commissions, held fairly steady, as compared to the prior year, at 3.4% of home sale revenues. Our net new orders were up 17% year-over-year to 1,081 homes, while the dollar value of our orders was up 33% to $432 million due to increased orders and the impact of a 13% higher average selling price. The increase in our net new orders represented our second consecutive quarter of year-over-year increases and was positively impacted by the 20% increase in our average active communities. Within the quarter, our net new orders were up in each month as compared to the prior year, with September marking our 7th consecutive month of year-over-year increases. While our monthly sales absorption rate was essentially flat with the prior year at 2.2 sales per community. As a result of our higher community count and orders over the last 2 quarters, our homes in backlog were up for the first time since the second quarter of 2013. In addition, the dollar value of our backlog was up 17% to $792 million, and our average home price in backlog was up 10% to $423,000. We believe the increase in our community count and the corresponding order and backlog growth positions the company well as we finished out the year and head into 2015. Our ending active community count was up 27% over the prior year at 170 communities and represented our 4th consecutive quarter of community count growth. Community count increased most in the West, with California and Arizona experiencing the highest growth. We also experienced solid community count growth in Florida, Nevada and Colorado. In addition, our soon to be active communities continue to exceed our soon to be inactive communities, which on a net basis, was up by 11 and it should be positive bias for our community count through the balance of the year. During the quarter, we acquired nearly 1,300 lots and spend approximately $169 million on land acquisition and development. Year-to-date, we have spent approximately $460 million on land and development, and acquired approximately 3,700 lots. As of the end of the quarter, we owned or controlled over 16,300 lots, which represented approximately a 3.7-year supply of lots on a trailing 12-month delivery basis. We ended the quarter with nearly $1 billion in liquidity, which was before the redemption of $250 million of our Senior Notes due July 2015. And liquidity consisted of $538 million in cash and marketable securities, and approximately $425 million in availability under our revolving credit facility. In addition, our net homebuilding debt-to-capital ratio was 31.7%, one of the lowest in the industry. And in connection with the early redemption of our Senior Notes due July 2015, the company funded the retirement of such debt with the sale of marketable securities that resulted in a $4.3 million impairment, that was recorded in the third quarter and is reflected as a separate line item in our income statement. At this time, we'd like to open up the call for questions.

[Operator:]

[Operator Instructions] Our first question comes from the line Michael Rehaut from JPMorgan.

[Michael Jason Rehaut:]

First question, I just was hoping to get a little clarification on gross margins. I think in Larry's remarks, Larry mentioned gross margins and backlog would be showing a slight improvement versus 3Q. And I think, John, you said, more similar or comparable, I don't know if we're just splitting hairs here, but just wanted to get a sense of who's more you expect, if the margin's backlog are flattish indeed or up a little bit, let's say, 50 bps. And also, perhaps what you expect the interest expense, lower interest expense amortization, what type of benefit that might yield in 2015?

[John M. Stephens:]

Sure. Thanks, Mike. On the backlog margins, they are up from where were a quarter ago. But I think, the point I just wanted to make was that, we would expect what we have in our backlog to be comparable to what we're going to deliver for the fourth quarter. And then with respect to the interest reduction, it's about a 20 basis point pickup that we'll get as a result of retiring that debt.

[Michael Jason Rehaut:]

Okay. And then, on the spec strategy, I guess, maybe, Larry or -- can talk to the broader spec strategy here. I guess, you guys are a little bit heavier on spec than some of your peers, and over the last couple of years, I think have leaned more heavily towards spec. And just thoughts around whether or not at this point, given the margins where they are, if you feel that's still the correct approach with maybe demand not as strong as you would've liked to have seen it, if you feel that, that might make you a little bit more vulnerable to incentives and discounts and having to get your products through the door. Any thoughts to that, and if it make sense, maybe, to ease off a little bit on specs, in general, in a maybe less robust demand environment than you've been hoping?

[Larry A. Mizel:]

I think your last comment is accurate, and that is the direction that we're moving in. And you will see that over the next period of time, a turn to reduction of specs, as the momentum has changed a little bit and the incentive environment has changed. There is a decent tone, in general, and we feel comfortable that maybe some of the volatility, maybe that's too much to hope for, and the marketplace, in general, would stabilize. And with the prepayment of $250 million of debt and the expansion of our new subdivisions, and the growth of our backlog, we believe that we're setting a tone for the future. And as you know in this business, the future is a little bit slower versus quicker. But as I commented, the $350 million of 30-year debt feels -- it's going to feel really good a couple of years from now. And so we're doing what we always do. We're positioning our balance sheet. We're focused a little bit more longer term versus shorter term. And we will execute in that manner. And I feel comfortable of where we're going.

[Operator:]

Our next question comes from the line of Ivy Zelman from Zelman & Associates.

[Alan Ratner:]

This is actually Alan on for Ivy. I was hoping to get a little bit more color on the incentive trends, because we heard from some of your competitors that mentioned incentives were fairly stable in the quarter. And you obviously, highlighted as a driver of the margin decline. So I was hoping you can, a, quantify exactly what your incentives are running at and how that compares to last quarter; and b, just talk a little bit about whether your decision to increase the incentives, if that was reactionary based on what you're seeing from other builders, or whether it was a function of you being more proactive to try to drive additional sales, maybe given your spec supply?

[Larry A. Mizel:]

I think that incentives are part of a competitive market. As you look towards everyone adjusting their inventories coming to the end of the year, you will act and react according to what the market dictates. And the one thing that one can see is assuming there's follow through in the tone in the market, then you will see a reduction in the incentives. The exact amount, I don't think, we communicate that as clearly, or maybe John wants to add a little clarity to that point.

[John M. Stephens:]

Yes, I can just follow up on the first part of your question, Alan. The incentives, on a year-over-year basis, were up about 110 basis points. And then, from their previous quarter, they were up about 20 basis points. So that's kind of where they stood on a relative basis.

[Alan Ratner:]

Great, that's really helpful. And if I could just sneak one other one. The average order price that was trending up pretty solidly in the quarter, and I'm not sure if that's -- it would seem to be mix-driven. But with the community count growing significantly, how should we think about the mix of product, either product or geographic as you open up these new communities. Should they be weighted a little bit towards higher price points than we've been seeing delivering over the last several quarters?

[John M. Stephens:]

Yes, I think that's the primary driver. It's not as much the price appreciation. We have seen that, obviously, Alan, in certain communities and markets where we see a little more strength, but it's really more of a mix issue. And for example, like in California, for example, I mentioned earlier, we're doing more in Orange and L.A. counties, which carries a higher price point than the Inland empire per se. And then like in Florida, for example, we do have South Florida project now that's got higher prices, which is kind of driving that up as well. So it's more of a mix issue, than an absolute kind of price increase.

[Operator:]

Our next question comes from the line of Ken Zener from KeyBanc.

[Kenneth R. Zener:]

I wonder if you could perhaps just give us a commentary on within the macro of home price appreciation kind of slowing year-over-year versus the highs it had last year. And obviously, your gross margins being somewhat behind peers, who seem to be flattening. And putting that in the context of kind of your stock valuation, which trading it near book seems to imply, I was being farther into the cycle than I think we actually are. Can you kind of address how you're thinking about capital allocation when -- if you're issuing debt or investing in the business, it's just -- with the valuation on your margin set, how should we think about the risk profile for your ability actually generate kind of higher gross margin, as we see many of your peers kind of moving either flat or perhaps in the opposite direction tied to things like, incentives and higher cost? Just trying to connect the seeming disconnect between where we are in the cycle in your guys valuation?

[Larry A. Mizel:]

Well, I think that, first of all, first of all you asked about 20 questions...

[Kenneth R. Zener:]

Sorry about that, Larry. It's a tough one, though. You know you are 1x booked, and it's just not where, normally, it would be.

[Larry A. Mizel:]

Well, you have to see -- go back about 5 years and see the transition of where we were and how we slowly deployed capital. And we've repositioned the price the stock sells at is really the market. But what we've done is we have a conservative long-term strategy, and if you go back to 2005, which was a superior year, that as the cycles evolved, we have the ability to have a highly competitive performance in line of where the markets are and move around. But where we are now is in a rebuilding mode, and we've been in that mode for a couple of years. And we are accelerating a rebuilding mode, and that takes time and it also takes away from margin as we deploy capital. Several years ago, where we were longer liquidity and shorter land, we are now balancing that out. And you will see the company, over the next period of times, realign itself really in market conditions. And we are confident that the general housing tone is good, and we will expand our growth into a more stable market. And the financing we did was looking for the future and positioning ourselves to leverage into the future appropriately. So time and patience, we have, and the performance vis-à-vis our competitors, we've been at this for a while. And don't judge us on just the short-term performance, but we'll look back on this. It might be an opportune time, depending on market conditions. So have patience.

[Operator:]

Our next question comes from the line of Adam Rudiger from Wells Fargo Securities.

[Adam Rudiger:]

Question. I noticed on the website that you have a -- you've extended your national sales event into October. So I was wondering if you could talk about some of the more specific incentives you are offering, what might be working, what wasn't working, and kind of what the elasticity towards that was.

[John M. Stephens:]

Well, Adam. It is very specific to every market, obviously. Certain markets might need a little more nudging from time-to-time than others. And it comes in various different forms. It could be a waived origination fee on a mortgage loan or could be -- it varies by market. But -- and I wouldn't say that we've gone overly deep on the incentive. I think the point is just it did have an impact during the quarter. So I think it was more kind of pointing that out. And I think the other thing that we talked about on the gross margins is, land costs are up a little bit year-over-year, as our material costs. And the subcontractor base in certain markets you look at, we do about 28% of our deliveries come out of the Denver market. And there's, obviously, been a lot more pressure on the subcontractors here. So those are things that are impacting the margins. But the incentive side, it really does vary from mark-to-market, subdivision-by-subdivision.

[Adam Rudiger:]

Okay. And then, following up on that comment on land cost, can you talk a little bit more about that? From what I can tell, it looks like markets like Arizona, California, maybe in Florida a little bit, where you went the most aggressive in buying lots, was mid-'13, maybe, a little bit earlier, right, when the market was still frothy. So can you talk about those lots that you acquired in that period, and how they may or may not be impacting kind of that pressure you're talking about. Is it specific to those markets where you went to deepest at that time?

[John M. Stephens:]

Well, I think it's probably wherever we bought land, obviously. The pricing in the markets has, obviously, leveled off, which a lot of people have been talking about. And our land cost do have an impact on that. And clearly, we know Arizona has been a little bit softer. California has been a pretty strong market for us in terms of absorption pace and how we're doing there. I think moving to more coastal communities, we see a better pace there than we have kind of in the Inland markets. And then Colorado is a market where we continue to be the largest player here. So we've seen pretty good pace there. I think the land cost comment sometimes gets a little overblown, and I think it is up a little bit. But it's -- if you add that plus material cost, plus a little bit of incentive, all that kind of hits the margin together. So it's not 1 item, in particular, that's overly driving it.

[Operator:]

Our next question comes from the line of Joel Locker from FBN Securities.

[Joel Locker:]

Just want to reiterate on the land pricing. And just a conceptual question on. Do you think you're further ahead in the cycle of seeing the higher price land come to the balance sheets, since you're more of a merchant builder and focused on finished lots and it's just something the industry hasn't experienced and may next year?

[John M. Stephens:]

That's a good point, Joel. I think the fact that we do carry a little bit shorter supply relative to some of our peers, that we really don't have a lot of legacy land that's been impaired. The land we bought has really been in the last 1.5 years or so, last couple of years. And I think it's more of a just-in-time delivery of lots. And I think it does tie into more of a retail pricing-type of model. We typically like to buy more finished lots, as available, because it's more of a risk adjusted return we're looking at. But as you know, over the last couple of years, there's not as many finished lots in the locations that we would like, so we purchased about 50% of our lots have acquired some sort of development. But the point is, everything we're delivering now is stuff we bought in the last couple of years. So it is more of a real-time pull-through of lot costs.

[Joel Locker:]

Right. And just to follow-up on your communities that you plan to open. And -- how many do you plan to open in the fourth quarter and then in 2015, maybe a ballpark range?

[John M. Stephens:]

I think one of the things we -- I mentioned earlier was kind of our -- one of the things we look at is our soon-to-be active communities, Joel, versus our soon-to-be inactive. We have a positive bias there. It might be up a few in the fourth quarter. In terms of next year, we're not really going give guidance on that yet. We're kind of in the process of refreshing our business plans. And I think, when we do our year-end call, we'll probably have a little more color on that for you guys. But the point is, we definitely have been adding land and has resulted in active community count increases.

[Operator:]

Our next question comes from the line of Nishu Sood from Deutsche Bank.

[Nishu Sood:]

Larry, so as a significant owner of the stock, and with the stock trading at or slightly below book value, are you thinking about share repurchases here? It just seems to be a good use of cash when your balance sheet is still in very good shape.

[Larry A. Mizel:]

First of all, many years ago, we authorized 4 million share repurchase. And if we plan to do it, you'll read about it. I think our intent, currently -- and currently is as of today, of course, is our balance sheet, our structures to build a more robust business where we are. And we are going about doing that with the increased confidence that we have in the marketplace. So that would be how I would answer that question.

[Nishu Sood:]

Got it, okay. And second question, in terms of the -- you'll continue to invest, as you're describing, into the business. The 16-ish percent gross margin, I would imagine, is below what you're targeting on your new land purchases. And John, I think you mentioned 50% of them requiring some development. So just wondering if you could give us an update on the new land that you're purchasing. How the pro forma gross margin compare to where you are now?

[Larry A. Mizel:]

Well, it's -- as you know, it's competitive. The one thing that, I think, I would comment on is that all the builders that are buying land, buy the land, somewhat in line with one another. Their costs are somewhat in line with one another. And as you look forward, your gross profit margins, usually, kind of line up with each other. And as you transition from a merchant builder in the sense of someone in our business model, of being short land, there's always a period of time that being short land affects your gross profit margin. And when I say short land, I'm speaking of 3 to 3.5 years. I think, there's another builder that has a more aggressive model on shorter land supply, and we've always been kind of 1 step in the middle. As the velocity picks up, then you will see the alignment in the industry as we have in the past, and we certainly, as a goal, is -- expect to make a reasonable return on our equity in line with others that speculate more in land. And since our business model is a shorter land supply, it deals with a little bit later in the market cycle than where we are. And I think we're at a perfect place to expand. Someone said, “Well Larry, where are you and what inning are we in, in this cycle?" And I feel very comfortable we're in the beginning third of the game. And so there's -- it looks as though that the economy in the country is stabilizing. And I certainly hope that the political situation stabilizes. And all of those things will come together. And I feel comfortable that we will grow and accelerate from where we are at this time.

[Operator:]

Our next question comes from the line of Eli Hackel from Goldman Sachs.

[Eli Hackel:]

First, just Larry, do you have some good detail about mortgage underwriting, how difficult it is? Are you seeing things get incrementally more difficult, or is it staying the same? I mean, the things like FHA loan limits have been in for a little bit now. Just sort of your updated views there would be great.

[Larry A. Mizel:]

Well, they've had some new guidelines on putbacks and defaults. And everyone's always concerned about early payment defaults over 3 years ago and 5 years ago. So the government -- the tone out there is better. We had a change in January, where there was new regs came in, new overhead, new people, new process. And now, we have banks. I think there's more money coming into the residential housing market. There's people that are beginning to do some securitization of less than conforming. So I think, we can see, over the next period of time, a substantial expansion of the mortgage availability, which will take -- which will really bring a lot of sales to fruition that had been canceled because of mortgage issues. So I'm looking forward to, with the political season at least being over for the short term coming up, that next year, you're going to see a lot of activity that's going to be very positive in the mortgage market for both -- those of us that originate ourselves, but really for everyone. And it'll create its own momentum. I also think it's a good message to the consumer, that you can actually get a mortgage. We can finance you for 3.5% down, 5% down, you don't really need 20%. It's -- there's such a large amount of mixed messages, but it's all coming through, as I said. The tone is getting better. And the mortgage availability, in the last short period of time, you've seen publicly some of the super-regional banks are now getting in the mortgage business. That might be easier for them than making commercial loans today. So these are all things heading in the right direction.

[Eli Hackel:]

Have you -- just a follow-up, have you seen banks going to accept lower quality, lower FICO yet? Or is that still something you're waiting for?

[Larry A. Mizel:]

I think it's a mixture. One of the things that was investigated was people that charged higher rates for lower quality credits. So there's 1 particular institution I heard the following concept. And this is a concept. They said, "We spend 1/3 of the time with the regulators just beating on us. We spend 1/3 of our time, and I'm talking about our people, with new regulations being issued. And then, we spend about 1/3 of our time of people trying to get us to increase our availability of financing to those that aren't as fully qualified as one might expect." So it's kind of an interesting circle. 1/3 wants them to make more loans, and the other third is trying to figure out how to litigate against them for the loans they made in years passed. So hopefully, this kind of craziness for the banks and the lenders will subside, but this is not something that we really are involved with. And I'm only giving you a concept of what's going on.

[Operator:]

Our next question comes from the line of Stephen East from ISI Group.

[Stephen F. East:]

John, maybe first question for you. Could you just -- in your gross margin hit, could you just sort of rank order? You talked about incentives being 110. Could you give us an idea of what land inflation hit you, and what construction cost hit you on that? And I assume on the construction cost, we're talking primarily labor on that. And then also with that, just sort of what your SG&A targets are, as you look a little bit longer term.

[John M. Stephens:]

Okay. In terms of the land and construction cost, the land is anywhere 100 to 150 basis points. And I think, on the directs, it's probably -- construction cost is in the 100 to 120 basis point range. Obviously, there's a lot of ins and outs there, Stephen, and -- that go through when you deliver that many homes. But that kind of gives you a sense of what's going on. And as I mentioned earlier, we still do have some markets where we've had some strength. We have continued to push the prices where it makes sense to try to mitigate some of these increases on the material side. What was your second question on the SG&A run rate, I think, it was?

[Stephen F. East:]

Yes. Just sort of your target as you look out.

[John M. Stephens:]

Yes. The third quarter was a little bit lower, because we had a reduction in some of our incentive compensation accruals. But moving forward, probably in that $26 million range, from the just G&A standpoint. And as you know, the commissions are variable and then the marketing cost kind of move with kind of our community counts. So $26 million kind of in the G&A run rate.

[Stephen F. East:]

Okay. All right. Fair enough. And then Larry, I know you've sort of been asked this question a couple of times, and maybe I'll frame it a little bit differently. But as you look at your business and you look versus your peers, I think you've got a very valid argument about just-in-time land versus legacy and written down, et cetera. But even by your standards, if we would throw out the incentives and just sort of look at where your gross margin is running, even that is not really where, I would assume, where you all are trying to target also. So as you look at your business and how you're running it differently versus your peers, how do you get that gross margin back from, call it, 17.5 without the incremental incentives, back up to that 20 range? Or is that not your target? Will you underwrite to a lower to an 18%-type run rate, instead of more of an 8%-type of op margin, that type of thing?

[Larry A. Mizel:]

As you make a general comment, as I said earlier, the land market is competitive. And what you underwrite to, really gives us an indication of what you're willing to pay for an asset. And since you've got to 5 guys willing to do the same, these things, ultimately, realign themselves with execution. And I think that our ability to execute is very, very good, and we run a highly focused-type business. And as you roll through some of the assets that we acquired more recently and the other builders are working on the same assets at the same time, I really think everything. The prior history is a good place to look for numbers. And so it was commented from time-to-time, we compete with builders that have previously impaired land, which means that they have a less than a market basis in it. And so we just have to walk through a little bit of time as those assets are utilized in their business, which is appropriate. And like I said, history's a good place to look on where the industry can go during normal times. And over the next period of time, I think things will become more in line. Even though we will be adjusting for our just-in-time business model, it really is with an increasing velocity, one that we can exercise in a very competitive way, making ultimately the ROE, which is the measurement versus the GP. And that's what we will be looking for, will be a risk-adjusted ROE, and that number is yet to be defined at this point publicly.

[Operator:]

Our next question comes from the line of Jay McCanless from Sterne Agee.

[James McCanless:]

First question I'm going to ask. I believe earlier in the call, you discussed how orders were up on a month-over-month basis, I think, for the 7-month in a row as of September. I wanted to see how that compares to your underlying markets. And maybe not a mark-by-market run down, but do you guys believe you're taking share and doing better, in most cases, than the underlying market? And if not, why?

[John M. Stephens:]

I think we are trying to take our fair share of each of the markets that we’re in. We want to be a larger participant. We don't need to be the largest, but we want to be a larger participant in the markets we're in, in a meaningful way. I think, Colorado's a good example, that we have a large market share here and I think we take our share here. And I think we just want to make sure that we're competitive and we're offering a great product, which we think we do. And that we're offering it at a price that's competitive, that we can get a reasonable absorption pace, Jay. So we think we are competitive in each of our markets that we serve.

[James McCanless:]

Okay. And then, the second question. Was there a special push by the company this quarter to move through some aged specs or some other older homes? And I apologize. I got on late, so I apologize if I missed this. But I didn't know if the gross margin was abnormally affected by a desire to move through some aged inventory, or if this is just normal sales, and what we should expect going forward.

[John M. Stephens:]

Jay, on the spec margins, they've really kind of stabilized over the last several quarters. There's a difference, obviously, for a dirt margin. Typically, you would expect to see higher gross profit margin, which we are on those. And on the specs, it's about 160 basis point difference. So -- and that's actually kind of been consistent over the last couple of quarters. So it wasn't both an over -- there wasn't an abundant amount of impact from that, I would say.

[James McCanless:]

Okay. And then, just one more if I could sneak it in. In all the discussions that have been, that you guys have talked about with strategy, et cetera, could you discuss what your mix of entry-level is versus move-up right now? And does it make sense to continue to push with neighborhood growth and more entry-level neighborhoods, when clearly, the government doesn't have any interest in financing the entry-level buyer?

[Larry A. Mizel:]

We're not focused on the entry-level buyer by traditional description of who it is, because today's entry-level buyer that can get financed and you can build a product for is at a higher price point than the previous demographics. I think there's a couple of builders that are working on projects that are more affordable first time. And we'd like to say, we're at first time, first time move up, but that's just at a higher price point. So the circumstances changed as far as the average prices, that new homes are being delivered in different parts of the country. There are places that it's more affordable than, certainly, the mid-Atlantic and the West Coast. Even in South Florida, it gets to be very pricey. So as we had commented earlier, it really deals with the mix versus seeing that there's a first-time market of any size, because that's really defined in each. Each market, what we do could be defined as either first time or first time move up as to what's available to be built.

[Operator:]

Our next question comes from the line of Michael Rehaut from JPMorgan.

[Michael Jason Rehaut:]

Actually, my follow-up question was -- has been answered.

[Operator:]

Our next question comes from the line of from Buck Horne from Raymond James & Associates.

[Buck Horne:]

I was wondering if you could talk a little bit about Phoenix, in particular, and how did the Phoenix flooding maybe impact sales during the quarter. Or did it affect your community openings or closing activity in Arizona? Just trying to understand if the weather had any impact there?

[John M. Stephens:]

It really didn't. I read your note this morning, Buck. Really, what we were referring to there was, obviously, the start of the year was a little bit harsher winter weather conditions like in our mid-Atlantic markets. And so I think, in terms of getting some of our communities kind of up and rolling, took a little bit longer. As well as really in Denver, it's kind of interesting. We've actually had a much higher kind of rainfall this summer than we have historically. So that does impact our production here in Denver because we're building basements and it does just takes some extra time. We are getting rain off and on throughout the summer. So that was really the comment there. Phoenix really not an impact.

[Buck Horne:]

Okay, that's helpful. And I guess, my last comment is related to the dividend. Do you guys still feel like maintaining the dividend at these levels, $1 a share. It's now kind of like a 4% yield. Is that the appropriate best use of capital right now, given your -- given where balance sheet is levered and the expected growth in the inventory and kind of reinvestment in the business? Do you feel confident in maintaining the dividend? Or would you potentially reassess that policy?

[Larry A. Mizel:]

We technically reassess it every quarter. We absolutely feel it's appropriate. And we're very confident each time we declare the dividend, which we have for many years.

[Operator:]

[Operator Instructions] Our next question comes from the line of Joel Locker from FBN Securities.

[Joel Locker:]

Just a follow-up on your gross margin differential between spec and dirt sales in the third quarter, or closing?

[John M. Stephens:]

Yes, I mentioned that earlier. It's about 160 basis point difference, Joel. Again, that's been pretty consistent for the last several quarters now.

[Joel Locker:]

Right. Sorry, I missed that. And just a last one on...

[John M. Stephens:]

That's okay.

[Joel Locker:]

Just the -- I've seen your commissions went up to 3.4% from 3.3%, or it ticked up. I was wondering if you were just offering outside brokers a higher fee, or there was more transactions involved.

[John M. Stephens:]

No. That -- nothing really material there, Joel. I think, obviously, there's a mix, depending on the number of brokers you're co-brokering with as you're selling these homes. But nothing -- we're not giving outside broker commissions. As I know, some of our competitors have, maybe gone there, but we really haven't.

[Operator:]

Our next question comes from the line of Michael Rehaut from JPMorgan.

[Michael Jason Rehaut:]

I actually did think of one last one that I think is kind of important. In looking at the community count growth and the composition of it over the last 4 quarters, a huge area of growth has, obviously, been Arizona. And obviously, that's also kind of coincided with the weakness this past year in pricing. So I was just kind of curious if you guys have looked at in terms of the sequential decline in gross margins so far this year, if you've kind of looked at it from a geographic perspective. And perhaps like, essentially, how much of that gross margin decline, let's say, it was running in the low 18s 4 quarters ago, and now, it's at 150 bps or more or less than that, how much of that you might estimate is just solely attributable to your exposure to Phoenix in Arizona?

[Larry A. Mizel:]

I would say, Phoenix market was a little disappointing, would be a nice way of saying it. Michael, one thing about Phoenix -- and I think we've been there for, I don't know, 30 years at least. It's a great place. It's a beautiful city. And the tone there moving into the season here. And there was probably -- you go back several years, they had a glut of foreclosures and products that traded really cheap, and then it's come back on the market. And then the new home sales have been slow and resales. But it's -- in all these years, it pretty well rightsizes itself. And I think, you'll look at Phoenix, that this was just a little bit more follow-through from a prior weakness. But it's self-correcting, as homebuilding, as you know, does self-correct. And we look forward to a much better year next year in Phoenix. And you can feel it. It's a great place to live.

[Operator:]

There are no further questions in queue at this time. I turn the call back over to our presenters for any closing remarks.

[Robert N. Martin:]

We appreciate you being on the call today. And we look forward to speaking with you again following our Q4 results announcement.

[Operator:]

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