M.D.C. Holdings, Inc.
Q4 2014 Earnings Call Transcript

Published: 28 Jan 2015

[Operator:]

Good afternoon, we are ready to begin the M.D.C. Holdings Inc. Fourth Quarter Earnings Conference Call. I will now turn it over to Bob Martin, Vice President of Finance and Corporate Controller. Sir, you may begin your call.

[Robert Martin:]

Thank you. Good morning, ladies and gentlemen, and welcome to M.D.C. Holdings 2014 Fourth 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. At this time all participants are in a listen-only mode. After finishing our prepared remarks, we will conduct a question-and-answer session, at which time we request that participants limit themselves to one question and one follow up question. Please note that this conference is being recorded and will be available for replay. For information on how to access the replay, please visit our website at mdcholdings.com. Before turning the call over to Larry, it should be noted that certain statements made during this conference call, including those related to M.D.C.'s business, financial condition, results of 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 actual performance are set forth in the Company's 2014 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 Web site with our webcast slides. And now, I will turn the call over to Mr. Mizel for his opening remarks. Larry?

[Larry Mizel:]

Thanks, Bob, good afternoon and good morning everyone. We’re pleased to announce the 2014 fourth quarter income of $14,600 or $0.30 a share, which completes our third consecutive year of profitability, after taking out the impairment of debt, its extinguishment charges during the quarter our net income was $20 million or $0.41 per share. During the fourth quarter our results continued to show impact of escalating land and construction cost as well as a moderately higher incentives, designed to spur sales activity in many areas. These conditions caused our gross margins to decline year-over-year, although they were unchanged on a sequential basis. We continue to make progress in capturing demand in the fourth quarter, as we saw our unit net orders increased by nearly 20% year-over-year. However, overall demand across the homebuilding industry remained weak by historical standards, with total new home sales across the country in 2014 showing only moderate improvement from the low in 2011. Given the relative weakness in the market, we have been diligent about operating our business in a very disciplined fashion. To help drive profitability we kept our overhead low for 2014 fourth quarter, and for the full year benefiting our overall operating margin. Additionally we have continued to operate with a conservative balance sheet focused mindset, only investing in new projects that we believe provide us the opportunity to turn our inventory quickly and generate solid risk adjusted returns. We have also made adjustments to our balance sheet for the benefit of the long term health of the Company. During the year, we’ve retired 500 million in senior notes and issued an additional $250 million, which not only extended our close to senior note maturity to 2020 but also reduced our overall interest burden. At the same time, we enhanced our homebuilding line of credit by increasing its size by $100 million to $550 million and extending its maturity by one year to 2019. With these enhancements in place, we ended 2014 with over 850 million in liquidity to support future growth opportunities for our Company. As we start 2015 with our outlook for homebuilding industry's mix, on one hand we cannot be certain about how issues such as falling energy prices or global economic weakness will ultimately affect our business. Additionally more industry specific issues such as cost increases and mortgage availability remain a concern. On the other hand we are encouraged by recent announcements that are positive for the mortgage industry, such as FHA’s recent announcement of changes to help expand credit availability, the increase in FHA low limits in certain areas, and the reduction in mortgage insurance premium for FHA loans. Furthermore the industry continues to find support from a low interest rate environment and improvement in key economic indicators such as consumer confidence and employment levels. While we cannot be certain about the direction of the overall homebuilding industry in 2015, we are well prepared to drive positive results for our Company. Primarily as a result of our land acquisition efforts over the past two years, we have set the stage for our Company's growth in 2015 by expanding both our active communities in our backlog year in. In combination with the balance sheet enhancements we made during 2014, these improvements provide us with the opportunity through top and bottom line expansion, in spite of the obstacles that remain for the housing market. Thank you for your interest. I’d like to turn it over to John who will be more specific on the financial highlights of the fourth quarter.

[John Stephens:]

Thank you, Larry. Before I get started on Slide 4, I just want to clarify our net income was $14.6 million for the fourth quarter of this year. Moving to Slide 4, we delivered 1,242 new homes during the quarter versus 1,252 in the prior year. The slightly lower delivery level was the result of a lower backlog conversion rate in 2014 as compared to the prior year period, despite selling in delivering more spec homes in the fourth quarter of 2014. Our spec deliveries for the fourth quarter were 51% versus 43% a year ago. However as we move into 2015, we expect our spec deliveries as a percentage of our total deliveries to migrate downward as we have intentionally reduced our total spec population. In particular, our total spec home count was down 25% year-over-year, and down 31% on a per community basis to 6.7 specs per active community, versus 9.7 per community a year ago. Our fourth quarter backlog conversion rate was 66%, which was consistent with the guidance provided last quarter. However, it was lower than the prior year period due to a lower percentage of beginning backlog under construction to start the quarter as compared to the year ago period. Based on our current backlog, our evaluation of homes completed and under construction and normal seasonality, we expect to see our backlog conversion rates for the 2015 first quarter to be in the mid 50% range. Our fourth quarter home sale revenues were up 7% over the prior year, despite slightly lower deliveries as result of higher average selling price. Our average home price was up 8% or nearly 30,000 per home to $397,000, which represented our highest quarterly average price in Company history and was primarily the result of a mix shift to higher priced submarkets. Year-over-year most of our divisions experienced increases in their average home price, with the West and Mountain segments experiencing the most significant increases at 13% each, while our East region was flat. Our gross margin from home sales excluding impairments was flat with the 2014 third quarter at 16.5% and was down 100 basis points as compared to the prior year fourth quarter. As discussed last quarter, the year-over-year decline and 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. And while our incentives as a percentage of our average home price were up year-over-year, they were flat with the 2014 third quarter. In addition, one other item worth point out as the absolute gross margin for home closing that we generated during the fourth quarter was higher both sequentially and year-over-year. This was a result of the higher average selling prices we generated from a shift in our product mix, which provided better operating leverage per home delivery despite a lower gross percentage. And while we have seen some pressure on our gross margin percentage over the last few quarters, our gross margin percentage and backlog at the end of the year was comparable with the gross margin percentage that we recorded during the fourth quarter. Furthermore our average home price and backlog was up 9% year-over-year and stood at $437,000. We generated favorable operating leverage during the quarter as our homebuilding SG&A expense rate was down 90 basis points from the prior year at 11.1% and down 140 basis points sequentially. The year-over-year improvement in our SG&A rate was driven by a 7% increase in home sell revenues coupled with lower compensation and legal expenses. The year-over-year absolute decrease in G&A expenses was partially offset by increased marketing spend related to supporting a higher average active community count during the quarter, as compared to the prior year period and higher priced product. Our sales commissions, which includes both internal and external commissions was flat with the prior year at 3.3% of home sale revenues. One additional expense I would like to make note of is that we wrote off approximately $2.3 million of land deposits and due diligence costs during the quarter related to projects that we have decided in that to pursue. This expense is included in the other expense line item of the income statement. Also as Larry noted earlier, we continued our streak of year-over-year quarterly order growth with our net new orders up 18% year-over-year to 887 homes while the dollar value of our orders was up 25% to $356 million. The increase in our net new orders represented our third consecutive quarter of year-over-year increases and was positively impacted by the 16% increase in our average activity communities. Within the quarter our net new orders were up in each month as compared to the prior year, with December marking our 10th consecutive month of year-over-year increases. And with respect to our monthly sales absorption rate, it was essentially flat with the prior year at 1.8 sales per community. As a result of the higher activity achieved over the last three quarters, our homes and backlog increased 20% on a unit basis to 1519 homes with a backlog value of 663 million, up 31% year-over-year. We believe the higher community count and backlog levels position the Company well for 2015. Our ending activity community count was up 9% over the prior year at 159 communities, but was down sequentially from the third quarter due to selling out of certain communities quicker than anticipated, coupled with the delay of activating certain new communities. And while we have noted in past quarters that new community openings and project closeouts can be somewhat volatile, we expect to see our community count increase sequentially in the first half of 2015 back to around the 170 range and depending on how the spring selling season and opening of new communities play out, our community count might taper slightly in the back half of the year. During the quarter we have acquired 528 lots, while for the full year 2014 we acquired about 4200 lots and spent approximately $605 million on land and development. As of the end of the year, we owned our controlled over 15,000 lots which represented a 3.5 year supply on a trailing 12 months delivery basis. We ended the quarter with $850 million in liquidity, which consisted of $310 million in cash and marketable securities, approximately $525 million in availability under our revolving credit facility and availability under our mortgage repurchase facility. In addition our net homebuilding debt-to-capital ratio was 31.0% after the payoff of $250 million of senior notes previously scheduled to mature in 2015. At this time we'd like to open up the line for questions.

[Operator:]

(Operator Instructions). Your first question comes from Ivy Zelman with Zelman & Associates. Your line is open.

[Ivy Zelman:]

I hope we can get this question articulated properly, but I want to understand, while there may be some opportunity to strategically move down into lower absolute priced homes, I know that your average price has continued to move up and you've benefited from the strength of the move up market, but it seems that there is a lot of the builders have crowded into this sliver of the market, given it’s been kind of the only game in town. But if you were to look at your orders as you go into fourth quarter and what’s in backlog, first maybe the question would be, how much of your orders are let’s say below $250,000 or at some low price point? And do you see that increasing strategically to benefit from improvement in credit availability and the ability to have high LTV mortgages, the 97% LTV out of Fannie-Freddie and certainly FHA lowering premiums or do you -- will you stick to the sliver of the market that has been move up and not as risky in terms of depending on credit availability. And maybe percentagewise how much will you bring in that lower price point, if at all. Sorry for the long winded nature of the question.

[Larry Mizel:]

I think it was 12 questions Ivy. I think -- we believe that we build a very fine product in the price points that we're at in the markets we're at. I always find that when asked the question, I said has one been to the field and looked dollar for dollar, square footage for square footage what we deliver and we're really, really proud what we do deliver as a real master builder. We expect to be in the price points we're in, and we continue to try to deliver even more value to the home buyer, and we do not expect to pursue other than what we currently are doing, lower price point market, and we will continue our focus on enhancing the value to the consumer in what we are doing.

[Ivy Zelman:]

Okay, very helpful. And my second pertains more to your return on equity. Right now your return on equity is amongst the lowest in the industry, in the single-digits and recognizing the strength of your balance sheet, are there steps that you can take to improve that, and not just wait for the housing market to improve?

[Larry Mizel:]

I think I am accurate to say that we have the highest dividend yield of anybody in the space, and through the prior good times, through the many years of bad times, and currently we maintain a dividend a $1 a share, and we think that is a great return for investors in the strong balance sheet in the additional liquidity. As the markets improve, which we believe that they will, after all housing is the only thing that seems to be dragging in the recovery. And eventually that deficiency of the units that haven’t been built that there is a demand for will be built. And if the world environment would stabilize for 90 days, I think we would see some changes. But we feel really good in where we are and what we're doing and we believe the best return for our shareholders, especially since we believe that we're the largest management owned interest in any of the major builders, and our interests are fully aligned with all the shareholders, that on a risk adjusted basis we are focused on the future and the present in growing, and as you heard from my prior comment, not only did we reduce our outstanding and repositioned for a new 10 year note, we also extended our revolver by $100 million and made it a full five years. It wasn’t too long ago that maybe we’ll be talking about it later this year, but we did issue $350 million of third year notes, and I think will look like a very important item on our balance sheet as sometime in the future, hopefully our country will enjoy a little bit of inflation, and the chairman I know is -- that’s the chairman of the Fed is anxious to bump or get started in moving rates up a tiny bit, even though they've indicated at least they’re not going to start at this time. So as we look forward, maintaining the integrity of an absolutely premier balance sheet is what we believe is the best interest to our shareholders, and maintaining the dividend, the commitment to do that of course subject to market conditions is what we’re going to do and we will and have the skills and the liquidity to take advantage of an expanding market when it does expand.

[John Stephens:]

Ivy just to add, just to give you a little perspective in term of maybe what we delivered during the quarter, about 15% were I would say in that $250,000 range.

[Ivy Zelman:]

Okay that’s helpful. And that would stay about the same, you're saying, going forward?

[John Stephens:]

Yes.

[Operator:]

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

[Michael Rehaut:]

It's Mike Rehaut, JPMorgan. Appreciate some of the comments, John, you made about trying to reduce -- or you expect spec as a percent of closings to come down in 2015. I was hoping if you could just give -- you gave the number of closings for 4Q. I was hoping you could just give that for the full year. And if you think it could come down by the 25% type of number in that type of at least neighborhood in 2015, and what the differential right now is -- are specs to your corporate average.

[John Stephens:]

Okay.

[Michael Rehaut:]

And in terms of margins, obviously thanks.

[John Stephens:]

I don’t have the -- Mike, I don’t have the full year but I can kind of give it to you by quarter to give you kind of an idea. It has been coming down. In the first quarter we ran at about 58% spec deliveries. Q2 was in the highest of year at 67%. We have 59% Q3 and then like I said earlier we're 51% for Q4. So it has migrated down a little bit there. And then in terms of the margin differential, as we’ve discussed over the last couple of calls, it has been a wider spread, probably around 250 range for the quarter. But again as we moved through some of these stocks, over time we would expect that number to come down especially when we’re heading into the spring selling season.

[Michael Rehaut:]

That's helpful, John. I appreciate it. And then, I guess just also, you mentioned that the backlog gross margin is similar to 4Q. And I assume that gives you a little bit of visibility, let's say, over the next couple of quarters. That -- at the same time, people have been increasingly concerned about the escalating land cost that I think is highlighted as a driver, at least on a year-over-year basis, of the margin compression. That would continue into 2015. So are we to interpret that at least for now or at least over the next couple of quarters, perhaps you're going to see the land cost stabilize? Or are there other offsets that maybe from a mix standpoint or -- that are going to allow you to deal with the land cost in a way that it would be offset?

[John Stephens:]

Yes, our gross profit margins Mike, as you know for the quarter they were really flat from Q3. And as -- we're not going to give forward guidance in terms of where we think the gross margin is going to for the full year, next year. But as I -- I did want to give you some color as you just pointed out, that our margins and backlog are pretty comparable to what we delivered. Now one of the things that keep in mind is, as you know the first quarters typically a lower delivery quarter for us, from a seasonality perspective. And as a result, depending on what you pull through during the first quarter, you might have a little more variability there as well as obviously as I mentioned earlier, if you pull through some more of those specs, in a lower delivery quarter you might see a little more variability there. But again, the other point I made too in my prepared remarks was that our -- our incentives were basically -- while they were up year-over-year, they were basically flat from Q3 to Q4. So -- and I think a lot of this will depend on how the demand is as we start to enter the spring selling season here.

[Michael Rehaut:]

That’s great. One last quick one if I could. If you could just kind of give maybe an update on regional color across Phoenix and California in particular, that’d be very helpful?

[John Stephens:]

In terms of just activity or?

[Michael Rehaut:]

I would just say, general demand trends. It has been different….

[John Stephens:]

Yes. I think you asked specifically about California and Arizona. Our absorption pace was little bit year-over-year in California and in Arizona as well. But we’ve actually -- for the full year, like in California we absorbed over three sales per community which is 3.22, which is higher than our Company wide average of 2.4 for the full year. We’ve also seen better absorption in the -- what we call kind of coastal or L.A. type areas, Mike. Obviously Orange County, the L.A. areas have done a little better the Inland areas. But our Inland communities, while there is little pressure there, we’re still selling over three homes per community for the full year at really most of those communities out there. So we’ve been encouraged by what we’ve seen in California thus far. And I would say Phoenix, we’re starting to see little more activity there as well. So I think things are a little better than they were, say few quarters ago.

[Operator:]

Your next question comes from Joel Locker with FBN Securities. Your line is open.

[Joel Locker:]

Just looking at your corporate expense, and it’s kind of flattened out around $25 million and what you think about that going forward? If it's going to get back in the high 20s or is this kind of a run rate that there was any -- that there's less stock comp year-over-year in the fourth quarter?

[John Stephens:]

Joel we’ve been -- as you mentioned for the last three quarters we’ve been hovering about that $25 million range. I would say going forward probably $25 million to $26 million. I'd probably lean more towards the $26 million target for the first quarter of next year.

[Joel Locker:]

And just a follow up question on -- interest and other income obviously came down with the cash balance coming down $2.2 million. And what do you expect going forward for that and if you had to breakdown, if there was any other income besides the interest in there?

[John Stephens:]

Well, we did liquidate some of our securities to basically fund the debt return that we did in October that we previously discussed. And you’re right. The year-over-year numbers are down a little bit. We would expect them to be down little bit because our cash and investment balances have come down. So it’s really going to tie to really how much additional cash and liquidity we have on the balance sheet.

[Operator:]

Your next question comes from Steven Jim with Barclays. Your line is open.

[Steven Jim:]

I wanted to ask a more general question to start off with. My sense is that a consistent aspect of your management philosophy has been to position the Company to be prepared to react very opportunistically whenever the industry encounters something unexpected. And if I look around at the housing market today, over the last year, year-and-a-half, I think that certainly has happened. We seem to be heading to a period where you have increasing sales volumes, not just you, but the industry overall, increasing sales volumes, builders positioned to have higher community counts, and so forth and yet declining margins. And my sense is that looking back over 20-25 years that hasn't happened very often. The only times you really see rising volumes and falling margins is when you're basically past the peak of the cycle and everybody kind of knows it. And so I guess my question, Larry is, in light of the fact that we are in one of these very unusual kind of environments, is there anything that you're thinking about over the next year or two which you are preparing, where you think that you might be able to take advantage of sort of a soft underbelly in the market, strategically, relative to your peers.

[Larry Mizel:]

Well, my peers are highly competitive, as all of us are, and I think the strategic nature, since we've been visiting for about two decades, we are focused on opportunities. And one of the opportunities we missed was Texas. But maybe that was an opportunity that we missed. The general demand in the new home sales has nominal pricing power, and even though one questions from time-to-time with a land pipeline of three plus years, how that strategy fits in, and what I think you will see is as the market ultimately picks up a little traction in new home sales and the competitive environment adjust to the land cost, pretty much line for all the builders, if you go back, we have the skill and the ability to make profits off of building and selling homes, not speculating in land, and after all these years I found that speculating in land is really good, except when it's not. And we've positioned ourselves to have the ability to create inventory turn and the ability to build and sell homes as a homebuilder and not a land speculator. And generally it's not really appreciated until there's [indiscernible] out there and then they -- one would say that's a pretty decent strategy. And of course, it's kind of painful when it looks like it's being too conservative. But as I said, if you go back, we have been able to make equal to or greater returns on equity for our shareholders during the times of exuberance, and we expect to participate and we are prepared to be as aggressive in every aspect that the market will allow. And you know -- remember the demand pull and the supply push? Homebuilding much of the time is supply push, and when it gets to demand pull, we are ready to roll. And that's the strategy we have maintained and maintaining the dividend throughout the entire period of time we think was best for our shareholders. And only the future will judge us and I am as anxious or more anxious than most to move on with the recovery. It just needs to start.

[Steven Jim:]

Right. Well, I appreciate that. Thanks for that. It kind of segues into my second question, which is the issue of margins. Right now if we look at your operating margins for example, there's a pretty noticeable difference between where you are at, what you are generating now versus let's say the early 2000s, pre-bubble. A lot of your peers have recovered margins to those levels or even higher. What's interesting is that yourselves, which are kind of land light and I think NVR also is down relative to those kinds of levels also, very land light builder. Given your comments about how you think that your returns on equity are going to be strong relative to peers, it would suggest perhaps that the difference we're seeing in your margins relative to your peers, when you compare them against early 2000s might be because your peers have more land profit embedded in their margins right now than you do. I first want to make sure that that's a correct presumption. And then secondly, second part of that is, going forward, would your expectation be that if you see a margin degradation across the industry due to falling land profits, that your margins will not suffer from that going forward, that you would be able to maintain your margins or even improve them, even if the world around you is seeing margins being pushed down due to rising land cost?

[Larry Mizel:]

I think rising land cost will bring all the ships to an equal level. And I don't distinguish that going forward when we think of what we're doing and why, it's really focused on making sure that the elements in place are there for an appropriate return and the couple of things that we don't have that others -- some of the others have, we don't really have any goodwill. Now, when you make acquisitions, from time to time people create goodwill because they pay, as you know, a little bit more than book and they ended up with goodwill. We have a nominal amount. From time to time, people historically have impaired some of their assets to the tune of hundreds and hundreds of millions of dollars, and you know when the impairments are over, during the time you're bringing those assets back to the market, you have a larger gross profit margin because you're starting at a lower base. From time to time you have fresh start accounting. So as being one of the older companies, we just struggle through doing it the way we've done it. But we're really, really Steve, focused on wishing to be competitive, on expanding our gross profit margins, increasing our sales, and the initiatives we’ve undertaken during the last period of years have really positioned us to be something of a -- I think of the quality of company that one wishes to participate with, and I am aware of the lower gross profit margins, and I can assure you from top to bottom, the focal point is to take all the gross profit that we're able to create, subject to market conditions that we're dealing with. And since you've watched us for at least 20 years, you know that we will sort it out and we're just looking for a tiny little bit of pricing power and just a little bit of tug, because with just a tiny little bit of pricing power and a little tug, we're looking for the V versus the U.

[John Stephens:]

Steve, one other thing I just wanted to add to Larry’s points, he just made two, is the other thing is all of our interest costs are capitalized to our inventory and are rolling through our gross margin line item. And I know that’s maybe not always the case with some of our other competitors too. So just another point, just to add.

[Operator:]

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

[Nishu Sood:]

I wanted to follow-up on that questioning earlier about the spec inventory. The pivot in your strategy that you're describing here for ’15, if we look back to ’14, given the uncertainty and the slowdown in home sales at the end of ’13, you made the decision to increase spec inventory and the year turned out to be somewhat of a disappointment. I'm just curious as to why you're now pivoting away from specs when your outlook for the year is still cloudy and uncertain?

[Larry Mizel:]

Well, I think that we see that the demand in dirt sales is increasing, and that as you pivot just a little bit in decreasing the spec inventory, you have I think three opportunities. One, you will sell your spec for more money. Two, you will sell your dirt starts for more money. And three, you won’t have everybody trading against you, and meaning that as the inventory tightens a little bit, you should be able to see a smaller spread between dirt and spec, a higher price for the dirt home, and a higher price for the spec home. So you really have a lot of things playing in your favor, if our seasonality evolves into something that could be stronger and last more than five months. And with feeling a tug, a tug in January, we won't get too excited. But it’s certainly a strong indication that what we've done is positioned correctly and next quarter you'll be able to judge us on at least three months of how it’s playing out and we’ll just see.

[Nishu Sood:]

Got it. That’s helpful. And then just on the outlook as well for ’15, you mentioned you are seeing things and there is a considerable uncertainty, potentially some tailwinds as you mentioned. You mentioned oil prices though as a risk. I would have thought as the only larger top 20 builder with zero exposure to Texas, the decreasing energy cost you would have viewed more as an unadulterated positive. So what’s you are thinking there, and you do seem to be at least less positioned to that risk than your peers.

[Larry Mizel:]

Well, my position is, you are in an energy area, Colorado, and we pay close attention to those elements that are part of our economy here. And I consider that that's something that we need to pay attention to and we do. We're very much on top of it. We received the benefit of a great fracking environment and we are dealing with an environmentally sensitive world. And the wonderful thing about Colorado and the government here is they're doing a good job. And for me to say that it's not a factor would be not accurate. It is a factor. But we believe that at this point it has not shown itself to be a material factor in the market, in the economy in Colorado. And as you said, I'm the only major guy that missed Texas. So maybe I'll be in favor for at least six months.

[Nishu Sood:]

All right. So you haven't seen anything yet in Colorado. That's helpful. Thank you.

[Operator:]

Your next question comes from the line of Stephen East with Evercore ISI. Your line is open.

[Stephen East:]

John, these questions may be for you, the first set of questions. When you look at the Mountain absorption rates and really strong, I'm trying to understand what was going on there and how sustainable they are? I saw the ASP dropped down a little bit. I don't know if that's just mix or you all are making a conscious decision to drive your absorption rate faster. And then in the mid-Atlantic, your community count has gone down a fair amount. Is that also by plan? Are you pulling back exposure to that market?

[John Stephens:]

In terms of the Mountain community, as Larry just indicated, we've done fairly well here in the Colorado market, and obviously it has a much bigger impact on the segment as a whole. It's so much larger for example than Utah. And with respect to the Mid-Atlantic, that's a market that actually has been a little bit softer, as we've talked about maybe over the last couple quarters. We are looking to add some additional communities in those places, but we've -- as you know, we've been buying more land in the west and in the Mountain region, really to support Colorado, because that's where we've seen stronger demand. And then in terms of your comment on the pricing, Stephen, I'm not sure I caught that correctly.

[Stephen East:]

Just looking at I think ASP in that region quarter-over-quarter went down a little bit.

[John Stephens:]

Okay.

[Stephen East:]

I'm just trying to really understand the big absorption rate increase, is that something you all are heavily focused on, or it was more a function of what the market was doing?

[John Stephens:]

Well, we have a lot of communities here. So we want to make sure we’re getting good absorption in our communities. But I wouldn’t say we were overly pressing that. I think it was just really trying to get what we can, what the market has to offer.

[Stephen East:]

Okay sure. I’ve got it. And then your community count growth has been really strong. Your lot count now is down just a little bit year-over-year. As you look at your underwriting, you’ve been underwriting more to that 17% to 18% gross margin versus 20%, what some other players are doing. Should we expect to see your lot count reaccelerate and your community count after tapering in the second half of '15 then reaccelerate, and I guess what goes along with that question is what do you expect to spend on land in development this year?

[Larry Mizel:]

Well, I think it’s pretty driven by the market pull through, and over the last year we were down a little bit from the year before and we’re -- we have the capital to increase the land spend, and I’d like to see the demand factor broadly speaking for new home sales to kind of click. You know a 1% shortage and a 1% surplus has all sorts of opportunities. As people speak about it in other parts of the world, they use deflation and inflation. This is the only unique time in history where everyone’s rooting for inflation. Of course that’s trying to get off of 0 to 2 or 1 or 3. And we are really focused on actively and aggressively, because our AMC meets weekly. We have a land team in every single market and we would like to be more aggressive, but we’re only good being as aggressive as we see the market. And if the market creates a tone, you have seen factually that we have the ability to accelerate quickly and we’re positioned and dressed for the dance. We’re just waiting for the music to start.

[Operator:]

Your next question comes from Ken Zener with KeyBanc. Your line is open.

[Ken Zener:]

John, could you -- this is a housekeeping question, but as I look at your interesting COGS, it rose to 3.8% of sales in ’14 from 3.3% in ’13. Given that it ended in 4Q at roughly 3.5%, do you have a comment on where that will trend on a percent basis?

[John Stephens:]

I touched on this a little bit last quarter. With the debt repayment that we did, as you can see it did drop off in Q4 and we would expect we've taken out about 12 million of interest from interest incurred standpoint. So assuming we operate at that same level of debt here in the near-term, we would expect to see it come down a little bit. But it’s not going to be a significant drop over the next quarter. It is going to take a little bit of time. But as you can see it is worked on and again with a lower interest incurred number, we would expect to see that come down a little bit.

[Ken Zener:]

So somewhere between 3% and 3.5% will be a reasonable percent of COGS basically?

[John Stephens:]

I think to get the 3$ in the near-term would be probably little more difficult.

[Ken Zener:]

Okay. My hearing, I just wanted -- if you could confirm, when you talked about 1Q conversion rate, you said mid-50. That’s 50, is that correct?

[John Stephens:]

Correct.

[Ken Zener:]

And with that type of conversion rate, could you talk about perhaps if there is a -- I realize there's less spec units, but could you talk about the -- what that means of forward conversion rates and perhaps as conversions equal closings, if you have a thought around where your SG&A margin will be for the year. I know you talked about that $26 million for the fixed cost component.

[John Stephens:]

In terms of our conversion rates, I think we were a little bit elevated, if you go back in the last several quarters, just because of the fact that we had more spec homes that we had an opportunity to deliver. In terms of the SG&A rate, we really haven’t given any guidance there other than maybe run rate on the G&A.

[Operator:]

Your next question comes from Adam Rudiger with Wells Fargo. Your line is open.

[Adam Rudiger:]

Can you elaborate a little bit more on the year-over-year change in incentives and just try to quantify it a little bit.

[John Stephens:]

Yes, the year-over-year -- well, like I said earlier, the quarter-over-quarter was flat and year-over-year was up about 130 basis points. And that probably had about a 50 basis points impact on our gross margin on a year-over-year basis.

[Adam Rudiger:]

And then the second question is the lot acquisition this quarter was abnormally low. Was that just a onetime phenomenon or is that some kind of reflection of your outlook?

[John Stephens:]

The acquisition, as you know Adam could be a little bit lumpy from time-to-time, and just the timing of when things close. But as Larry indicated earlier, the market will dictate in terms of how aggressively we will purchase and procure lots on a go forward basis. But as you can see before that Adam, that the prior four quarters we were kind of operating, purchasing over 1200 lots a quarter.

[Operator:]

Your next question comes from Jay McCanless with Sterne Agee. Your line is open.

[Jay McCanless:]

First question sticking on land, which markets are you seeing the largest price increases and are you seeing any markets where either finished or raw lot costs are coming down?

[John Stephens:]

I think in terms of price increases, obviously the markets where we've seen more robust sales, obviously certain markets in California, we're seeing strong sales. I think in Colorado we've seeing -- obviously there is more competition for those lots here. So those are markets where I think we've seen more robust pricing on the land side. What was the second question?

[Jay McCanless:]

Any markets where you're seeing prices coming down, where you're able to maybe buy parcels at little bit cheaper price than you could have last year?

[John Stephens:]

I think that’s part of the ongoing business. I think from time-to-time in markets if -- we will see that from time-to-time, but I would say at this time it’s not overly material, but we are -- I think people are going back -- as I mentioned earlier that we did write off some deposits, and we're going to be diligent about our land acquisition and make sure that we're going to get an appropriate return and go back and have those discussions with the sellers, if it’s appropriate.

[Jay McCanless:]

And then my follow-up question. And thank you for the color on the incentives for 4Q, but could you give us a sense of what you guys are willing to do for 1Q and possibly 2Q as well to continue moving through the specs that you're holding now?

[John Stephens:]

In terms of the incentives?

[Jay McCanless:]

Yes, I mean increased incentives, are you same level as what you did this quarter or is it going up?

[Larry Mizel:]

One could say, it might go down. Fourth quarter is end of the year and you're looking to do what you do at the end of the year, which is to try to get everything done you can. In the first quarter you start to feel more bullish again. So you would be less inclined to increase incentives. You would be hopeful that you can tapper a tiny bit. And that's certainly what our business objective will be, subject to market conditions.

[Operator:]

Your next question comes from the line of [indiscernible]. Your line is open.

[Unidentified Analyst:]

I was wondering about your outlook for 2015. Would you think that you're more likely to achieve growth based on your community count or based on increasing absorption?

[Larry Mizel:]

I think our growth will come from -- a tone in the market will have a little bit of increase in community count, and if it's just a tiny little breathing absorptions, as you model up everything, if you increase absorptions by a quarter or a half, a unit, a month, or you pick any number, the absorption is a major delta. And all of us, and I say all of us, everyone on the call, and everyone that works for us and everyone in this industry are looking for that little magic, which is a little confidence to carry through more than just the spring selling season.

[Unidentified Analyst:]

Got it. And as far as the deals where you guys flocked away, can you comment on what markets that was in and is that a view of your markets or a view that the sellers aren't negotiating the prices?

[Larry Mizel:]

I think each one is a transaction specific. There is nothing special about a transaction of changing your mind. We have the discipline if market conditions change or our perception that specific individual transaction changes, we're always willing to take our medicine and move on and that's the discipline we have, in working hard at building a balance sheet of assets that we believe are meaningful. There is no inactive land in the Company. Everything is active. And we are working -- you have active sub-divisions and then you have sub-divisions and there is different factors on how one defines them. We are busy and looking forward to a better tone in '15 and that's where we're headed.

[Operator:]

Your next question comes from the line Buck Horne with Raymond James. Your line is open.

[Jonathan Hughes:]

This is actually Jonathan Hughes on for Buck. I had a question about Maryland that was addressed earlier, but just wanted to clarify. I think I heard you mention that margins on spec homes were running 250 basis points below dirt margins, and I believe last quarter was roughly a 160 basis points. Just curious as to where the incremental gap came from, given you mentioned incentives were roughly flat sequentially.

[John Stephens:]

Well I think it kind of ties back into maybe what Larry said a little bit too, in terms of you get to the end of the year, you're trying to close out on certain communities without going project by project, because really that's what you would need to do to kind of analyze that. I think there were some specs that we decided to kind of move on or close out of a project and in fact in Maryland we did have a few closed out communities in areas that we're really not building in any more, that we've decided to go ahead and close those homes.

[Operator:]

There are no further questions in the queue at this time. I turn the call back over to the presenters.

[Robert Martin:]

Thank you. We appreciate everyone being on our Q4 call today and we look forward to speaking with you again after we finalize our Q1 results.

[Operator:]

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