The New Home Company Inc.
Q2 2018 Earnings Call Transcript

Published: 3 Aug 2018

[Operator:]

Greetings and welcome to The New Home Company's Second Quarter 2018 Results Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Drew Mackintosh, Investor Relations. Thank you. You may begin.

[Drew Mackintosh:]

Good morning. Welcome to The New Home Company's earnings conference call. Earlier today, the Company released its financial results for the second quarter of 2018. Documents detailing these results are available in the Investor Relations section of the company's website at nwhm.com. Before the call begins, I would like to remind everyone that certain statements made in the course of this call, which are not historical facts, are forward-looking statements that involve risks and uncertainty. A discussion of such risks and uncertainties and other important factors that could cause actual operating results to differ materially from those in the forward-looking statements are detailed in the Company's filings made with the SEC, including in its most recent Annual Report on Form 10-K and in its Quarterly Reports on Form 10-Q. The Company undertakes no duty to update these forward-looking statements that are made during the course of this call. Additionally, non-GAAP financial measures may be discussed on this conference call. Reconciliations of these non-GAAP financial measures to the most comparable measures prepared in accordance with GAAP can be accessed through The New Home Company's website and in its filings with the SEC. Hosting the call today is Larry Webb, Chief Executive Officer; and John Stephens, Chief Financial Officer. Also on the call is Leonard Miller, Chief Operating Officer. With that, I will now turn the call over to Larry.

[Larry Webb:]

Thanks, Drew, and good morning to everyone joining us on the call today. The second quarter of 2018 proved to be a positive step for The New Home Company as we continue to diversify our Company, both in terms of product offering and location, increased our community count significantly year-over-year and grew our wholly-owned lot count by 77%. Many of our new lower-priced communities have been well received in the marketplace, which helped drive a 98% increase in net new orders in the quarter. Equally encouraging is the fact that these successful communities are spread throughout our geographic footprint, suggesting that demand for our more moderately priced product is broad-based. While we only manage to generate a slight profit in the quarter, we believe we are well positioned to deliver materially better results in the second half of the year, thanks to a strong finish to the spring selling season, which culminated in a 66% increase in homes in our backlog to end the quarter compared to one-year ago. This quarter marked another chapter in our Company's evolution and based on the performance of our new communities thus far, we're excited for what the future holds. With that here some high-level comments regarding our operations. In general, the overall new home market feels good, with healthy consumer confidence, strong local economies and low inventory levels driving solid traffic and demand. Our order activity in the second quarter started off strong in April, tapered off a bit in May and rebounded in June. July continued at a solid pace for this seasonal time of the year with a monthly absorption pace of 2.3, resulting in order growth of 200% year-over-year, albeit, versus a relatively easier comparison. Labor and material costs in the quarter were higher versus last year, but seem to have stabilized over the last two to three months, particularly with lumber coming down off its recent highs. As far as local market color, demand within Southern California is definitely strongest at lower price points. Our more affordably priced Azure community in Rancho Mission Viejo and Seville in the Inland Empire were particular standouts from a sales-pace perspective. With a limited inventory of homes priced below $1 million in desirable zip codes. Young, affluent buyers have gravitated to these relatively affordable communities. The Southern California market generally feels a bit softer crises above $1 million, as affordably becomes an issue, and competition for these buyers has heated up. There are still opportunities for success at these price points, provided you with the right products in the right location. Our Seabluff community in Playa Vista is a perfect example of this, as we sold at a pace of over six homes per month during the quarter with an average price of just under $1.2 million. Another example is our Sky Ranch at Covenant Hills community in Ladera Ranch, where we sold seven homes in July at an average price of $2 million before auctions without the benefit of finished-model homes. Our absorption pace was best in Northern California in the second quarter, fueled by healthy market fundamentals and a lack of inventory across the region. In the Bay Area, we continue to see strong demand for our homes even when we raised prices at each and every new phase. In the Central Valley, our Tidewater community benefited from an influx of buyers looking for more affordable housing options, which drove a sales pace of over five homes per month in the quarter. The Sacramento market is likely benefiting from the same inward migration trend, creating a healthy level of demand, particularly at prices below $750,000. Finally, our operations in Arizona continue to hit their stride with two wholly-owned communities open for sale. Similar to our other markets, we experienced better demand trends at our move up community, Beaumont, as compared to the higher-end ICON, Silverleaf. Next year, however, we plan on opening six new affordably priced communities in the Phoenix area, giving us much needed scale in this market. Now I will turn it over to John for more details on our financial results for the quarter.

[John Stephens:]

Thank you, Larry and good morning. As Larry indicated, we continue to make progress towards diversifying our geographic footprint and price points. Through the first half of the year, we opened seven new communities and have steadily been rebuilding our backlog. We believe the progress we have made to date is positioning us well in the second half of the year. During the 2018 second quarter, we generated net income of $115,000 or $0.01 per diluted share compared to net income of $1.5 million or $0.07 per diluted share in the prior year period. The year-over-year decrease in net income was primarily due to 140 basis point increase in our selling and marketing expense rate, attributable to the ramp up of seven new communities in the first half of the year, a 100 basis point decline in gross margin, stemming for the closeout of some lower-margin communities and to a lesser degree, a decrease in fee building revenues and joint venture income. These items were partially offset by a 21% increase in home sales revenue and a 70 basis point decrease in our general and administrative expense ratio. Home sale revenue for the second quarter was up 21% to $117 million compared to $97 million in the prior year. The year-over-year increase was driven largely by a 52% increase in deliveries, which was partially offset by a 20% lower average selling price of homes delivered. The change in average selling price was most pronounced in Southern California where our ASP was down 43% to $1.4 million as compared to $2.5 million a year ago. The decrease in Southern California was largely due to a mix shift, with deliveries at five communities with ASPs priced below $800,000 in the 2018 second quarter as compared to just one in the 2017 second quarter. Based on the homes in our backlog, we expect to see a meaningful dip in our third quarter average selling price to approximately $850,000. For the full-year 2018, we are anticipating our average selling price to be between $975,000 and $1 million. We are lowering our full-year home sales revenue guidance range by $20 million to between $580 million and $620 million, with approximately 45% to 50% of our home sales revenue expected to deliver in the fourth quarter. The change in guidance is primarily attributable to lower volume than previously anticipated at three higher priced communities in Southern California and Arizona due to slower-than-anticipated sales absorption pace. Our gross margin from home sales for the second quarter was 12.6% as compared to 13.6% in the prior year period. The 100 basis point decline in gross margin was primarily due to a product mix shift and an increase in interest and cost of sales due to higher borrowing costs. The product mix shift was driven by delivering homes at three lower margin higher-priced closeout communities in Southern California during the 2018 second quarter. In addition, the 2017 second quarter included a $1.3 million impairment charge compared to no impairments in the 2018 period. Excluding interest in cost of sales and impairments, our gross margin from home sales for the 2018 second quarter was 15.8% as compared to 16.7% in the prior year period. We expect to see sequential improvement in our margins in the third and fourth quarters, with our third quarter gross margin anticipated to be approximately 150 basis points to 200 basis points higher than the second quarter and in the low to mid-14% range, as we begin to see the benefits from some of our newer communities. For the full year of 2018, we are lowering our gross margin guidance by 30 basis points to between 14.2% and 14.7%. The reduction in guidance is primarily attributable to a mix shift, as we anticipate delivering fewer homes from certain higher-priced communities in Southern California and Arizona. Our SG&A rate as a percentage of home sales revenue for the second quarter was 13.1%, as compared to 12.4% in the prior year period. The 70 basis point increase was primarily due to higher selling and marketing costs related to the ramp up of new community openings and higher co-broker commissions. These items were partially offset by a lower G&A, largely resulting from higher revenues. For the third quarter, we expect our SG&A rate to be in the high 12% to low 13% range. And for the full year of 2018, we expect our SG&A rate to be in the high 10% range. Our share of joint venture income for the 2018 second quarter was a loss of $120,000, compared to income of $200,000 in the prior year period. The reduction in JV income was primarily the result of lower gross margins and the mix of joint venture deliveries. We are projecting 2018 full-year joint venture income of between $500,000 and $1 million with approximately $100,000 of income anticipated for the 2018 third quarter. Net new orders for the 2018 second quarter were up 98% over the prior year, which was driven by a 100% increase in average community count. Our monthly sales absorption rate for the 2018 second quarter was 3.2 per community compared to 3.3 sales per community in the prior year. Our monthly sales absorption rate was strongest in Northern at 3.7 per month, followed by Southern California at 3.1 per month and Arizona at 2.2 per month. We ended the 2018 second quarter with 20 active communities, which represented a 122% increase over the 2017 second quarter. We expect to end 2018 with 18 active communities. The number of homes in our backlog at the end of the quarter was up 66% over the prior year period and our ending backlog value totaled $291 million. Our average home price in backlog at the end of the 2018 second quarter was down 48% to $948,000 as compared to $1.8 million a year-ago. The lower ASP in backlog was largely due to the mix shift in Southern California to expand our product portfolio. Our fee building revenue for the second quarter was $38 million as compared to $47 million a year-ago. The decline in fee revenue was primarily the result of a decrease in a number of units under construction in 2018 as compared to the prior year. Our fee building gross margin for the quarter was $1.1 million or 2.8% versus $1.3 million or 2.7% in the prior year period. We are raising our guidance for our fee building revenue for the full-year 2018 to between $140 million to $160 million and expect our fee building gross margin percentage to be approximately 3% for the last two quarters of the year. Our effective tax rate was 36.8% in the 2018 second quarter as compared to 39.4% in the 2017 second quarter. Excluding discrete items, our effective tax rate was 24.7% in the 2018 second quarter compared to 38% in the prior year second quarter. The year-over-year decrease was primarily the result of the lower federal corporate tax rate effective for 2018. We are currently projecting our full-year effective tax rate of approximately 28.5% to 29%, including discrete items; and one percentage point higher, excluding the discrete items. As of June 30, 2018, we owned or controlled over 6,800 lots, which included 3,200 lots for our wholly-owned business, approximately 26% through joint ventures and over 1,000 fee building lots. Of the 3,200 lots controlled through our wholly-owned business, approximately 65% were controlled through option contracts. With respect to our balance sheet, we ended the quarter with $91 million in cash, $470 million in real estate inventories and $354 million in debt, including $35 million outstanding under our $200 million revolving credit facility. During the quarter, we spent $27 million on land and expect to spend approximately $240 million for the full-year 2018. Also during the quarter, the Board authorized a $15 million stock repurchase program. We purchased approximately 205,000 shares during the quarter under the plan at an average price of $10.08 for an aggregate repurchase of $2.1 million. We ended the quarter with a gross debt-to-cap ratio of 57.8% and a net debt-to-capital ratio of 50.4%. We expect the third quarter to be the high point from a leverage perspective for this year and then anticipate our leverage to decline as we generate significant operating cash flow in the fourth quarter. Now I'd like to provide you with some additional color regarding the 2018 third quarter. We are estimating home sales revenue of between $110 million and $130 million, fee building revenue of between $20 million and $30 million and our quarter-ending community count of 19 for our wholly-owned business and seven for our joint venture business. I'll now turn the call back to Larry for his for his concluding remarks.

[Larry Webb:]

Thanks John. In conclusion, I'm pleased with the progress we made this quarter. We generated year-over-year order growth of nearly 100%, replenishing our backlog and setting the table for a strong second half of the year. We grew our wholly-owned lot count by 77% year-over-year providing us with a healthy pipeline of lots for continued growth. Finally, we continue to diversify our company by expanding our operations, both in terms of product and geography, furthering our goal of becoming a more balanced and complete builder. This transition into more affordable housing is a strategy that will continue to read benefits during the second half of 2018 and beyond. As our company continues to evolve, we will remain true to our company's core mission of creating unique and differentiated places to live and delivering best-in-class customer service to our home buyers. It's been our focus since our founding nine years ago and will continue to be selling into the future. Finally, I'd like to thank our hardworking team members for being the engine that drives The New Home Company to new heights. Your entrepreneurial spirit and dedication to our mission is what make company unique, I am appreciative and extremely proud of your efforts. That concludes our prepared remarks. And now we'll be happy to answer and take any of your questions. Thank you.

[Operator:]

Thank you. At this time, we will be conducting the question-and-answer session. [Operator Instructions] Our first question is coming from the line of Michael Rehaut with JPMorgan. Please proceed with your question.

[Elad Hillman:]

Hi. This is Elad Hillman on for Mike. Just to start off on sales pace. What would you attribute – I appreciate all the color you gave, but you mentioned there was the strong April, which tapered off in May and then rebounded in June. What would you attribute the slowdown in May to? And also, given the revised guidance in revenue gross margin with some of the mixed effects that you called out, how should we be thinking about the pace for the rest of 3Q and for the full-year? And it sounds like July 2.3? Did you say that was 200% year-on-year? I heard you right. And if you expect that to continue into August and September.

[Larry Webb:]

This is Larry. And thanks for the question. Maybe we were so granular that we missed the big picture with everyone here. We had the best second quarter in the history of the Company in terms of sales. May was a little less than April and June, but that was primarily because of sales releases and nothing else. We've entered into this transition that is just starting to get some traction on being into more affordable price ranges of housing. And I think our sales paces and the results that are beginning to show up are a result of that. July was clearly slower, but we're in the middle of the summer season. And when I say, or when John mentions we're 200% ahead, we feel very good about our July sales pace. And it basically matched what we had projected and hoped to do. Moving forward, if history is any indicator, and I think it usually is, August is historically a slower time. And then in the fall, you pick up again. And right now, we're tracking for getting the sales we need for this year as well as building a backlog for the first quarter. So I expect to have a slightly slower absorption pace in August, I believe that what we've put into place, this new strategy, will help us compete and hit solid absorption figures moving forward. And I think John wants to add something to that.

[John Stephens:]

Yes. I think I'll add to that. In terms of July, we were up 200%, 2.3 per community. It was an easy comp, as we noted in the script. But I think the point was, at 2.3 per month in July, slower time of the year, we're actually pleased with that. And then in terms of why the dip from April to May, part of that was, as Larry said, sales releases and the timing of that. But the fact that we had a very strong April, some of that did pull into April. And again, we had a very strong June. So I think it was just sort of the timing of sales releases within the quarter, but nothing that we would consider sort of a negative. Again, we're very pleased with the order growth in the second quarter in many of these communities. And like Larry said, I think we've continued it into July at a very solid pace, consistent with our expectations.

[Elad Hillman:]

Great. That’s really helpful and makes sense. And then secondly, could you comment on what you saw across the footprint in terms of pricing and incentive? What percent of communities were you able to raise prices by how much? And then lastly, was any of the gross margin provision to your full-year related to cost inflation? Or have you been pretty effective on offsetting any cost inflation with pricing?

[Larry Webb:]

Well, why don't we let John to answer the margin question, and then I'll turn it over to Leonard on sales.

[John Stephens:]

Yes. In terms of pricing and incentives, we're able to increase our prices in about 75% of our communities. It's probably about 1.5% on average across those 75% of communities and slightly lower than what we did in Q1. But still, the vast majority of our communities, we did increase. In terms of the cost side, we did see an increase in anywhere from 1% to 3% on our directs per square foot. But again, with our directs only being 30% of our ASP, we were able to absorb that with our price increases. And so I would say that the reduction in the margin guidance was not really driven by cost increases. It was really driven by, I'd say, revenue declines at three higher-priced communities that I mentioned in the prepared remarks that two in Southern California, one in Arizona were – we're seeing a little lower sort of volume at those communities, and the margin was affected accordingly. I don't know, Leonard, if you want to add to that?

[Leonard Miller:]

Yes, I think the only other point, I think, the question you may have asked was related to incentives. And I think incentives have been pretty consistent. We really haven't seen that we've raised incentives in communities to really drive that absorption. I think, in all of our markets, I would say at the higher end of luxury market. In urban, we are seeing other builders offer more incentives at price points above $1.3 million. So that's the one part of the market where we are seeing more incentives. Other than that, the market feels really healthy, and we're not seeing the incentives at lower price points.

[John Stephens:]

And I think the good news on Irvine comment is that we just don't have as much exposure as we did in the past. We have two Irvine communities now with the Irvine Company at a higher price point. One is selling pretty well at over two month, I think 2.2 for the month – for the quarter. And the other one's a little slower. But again, I think our exposure at Irvine at the higher price point has been coming down over the last several quarters. So I think that's a real positive as we have shifted to our strategy to some more affordable product.

[Elad Hillman:]

Thank you.

[John Stephens:]

You’re welcome.

[Operator:]

Our next question is coming from the line of Thomas Maguire with Zelman and Associates. Please proceed with your question.

[Thomas Maguire:]

Hey, guys. Good morning. Nice job on the quarter and great to see the buyback. Just wanted quickly draw in there. Obviously, you guys are in hyper growth mode right now. Sounds like, despite some month-to-month variation and maybe a little difference by price points, still positive on the business. How do we think about allocating capital to growth and investing, kind of, Inland in the business here versus buyback or current valuation is? And I understand that the dollar amount was fallen in the first quarter but going forward, just how does that discussion evolve, kind of at the management board level?

[Larry Webb:]

Well, let me take the first half of that, Thomas. This is Larry. And then turn it over to John. From our perspective, there are still real opportunities for us to get solid land acquisitions in the markets we're in. And in particular, when we're looking at opportunities, we think the Inland Empire offers significant growth for us and positive results. And our first project, which we discussed very briefly, called Seville reopened and are showing extremely strong margins in sales phase. And we are opening a master-planned community in Corona in – at the end of the third quarter that over time was 1,600 lots, and we are pretty excited and bullish about what we think we can accomplish there. The Bay Area, we continue to be strong and land continues to be constrained. And Phoenix, in particular, seems like there are opportunities for us to get into more affordable housing and expand our division significantly. John, you can take the second half?

[John Stephens:]

Yes, I would just say, kind of adding what Larry indicated there. 65% of our lots right now are under option. So a chunk of our capital is already allocated to those lots that we're buying as we're selling through those communities. So we will be continuing to extend land, and we'll heavier land spend in Q2 and Q4. I think for the full-year, we’re anticipating $240 million and we’ve spent maybe roughly $79 so far for the first six months of the year. So we need to make sure we balance our capital to buy those lots as well as the stock buyback, we have limitations on how much we can buy, sort of on a daily basis, based on volume activity. But at these sort of weaker levels, the returns on that stock buyback are pretty attractive from an ROE perspective. And at these weak levels, we will be in the market. And again, we have a $15 million authorization. We've used up about $2 million of that so far. So it's a balance, managing lot purchases, our leverage and sort of, limitations of what we can and can't do in the market. But we will continue on that front.

[Thomas Maguire:]

It makes sense. Thanks. And then just a quick question, flipping gears to sales environment, understand the shifts to lower price points. I definitely think that's going to dividends. But you called out some softer transit at the higher price points and just hoping to get some color there. We've seen headlines at California, regarding foreign buyers, maybe pricing getting a little ahead of its SKUs or tax rate changes having effect on demand. Can you talk about what you're seeing on the ground, specifically at the high-end, and any drivers of slowdown you can put your finger on?

[Larry Webb:]

Sure. Let me deal with the foreign buyer question first. I believe that there has been a reduction in the foreign national the foreign national buyers. But I think that has been quite over-exaggerated in terms of its influence. For California in particular, the foreign national in particular, Chinese foreign nationals, have predominantly been centered in Irvine. And if [70% to 80%] of our buyers in Irvine historically have been Asian, only 15% of those, approximately, have been for nationals. So even with a reduction in foreign nationals, it only has minimal impact on our business. And as John mentioned, we are lowering our emphasis in the Irvine market intentionally because it's very difficult to get into the more affordable price ranges, given land cost there. So while there probably is a reduction in foreign nationals, it really has only a minor impact on our business. To look at the market as a whole, in Southern California, the success or weakness of houses priced above, let's say, $1 million or $1.2 million is very much on a location-by-location basis. We have a community and South Orange County in Ladera, which I mentioned, which we have had great success in just crammed opened. We've recently presale grand open and sold seven homes without models in the month of July, very, very significant and very positive. In Irvine, we had two communities, one selling extremely well at about $2 million and the second one with much slower sales, only about 3 or 4 miles away. So the success or failure of that upper end market is very, very much location and school district specific.

[John Stephens:]

And I'd say that on the flip side of those positive stories there, I think the ones I was referring to were, we have one in Arizona. It's a higher end. It's about a $2 million price point there, in Scottsdale. Models aren't open yet. They're going to be open in November. So we're selling out of a, really, a sales office. And that's been a little bit slower. It's about a $2 million price point. And then also, we have in-sale location in Orange, about $1.5 million to $2 million it's a little slower and then one in Rancho Mission Viejo. So those are the three I was referring to. And those were new – really all new communities opening this year. So that's what's sort of impact the guidance in terms of the revenue slippage into the next year as well as a little bit of an impact on margin.

[Larry Webb:]

I would also – I have read negative articles about California. And I would say that the people writing those articles don't necessarily understand what's happening in our marketplace. Land is still constrained. New jobs are still being created. We do have an affordability issue, but that's been part of our long-term strategy to tap into lower-priced homes for the last 18 months. And I feel that California is still a very, very good place to be a homebuilder. And any investor or any analyst who would like to come out here, we'll three around, and we'll show you, very, very successful communities right now in every market we're in.

[Thomas Maguire:]

Got it. Thanks guys.

[Operator:]

Thank you. The next question is coming from the line of Scott Schrier with Citigroup. Please proceed with your question.

[Scott Schrier:]

Hi, good morning. I'm curious if you could talk a little bit about how you're viewing price versus pace as you implement this strategy over the last 18 months of getting into more affordable products, and if there's anything changing there. I'm just thinking, looking at for instances Southern California, you're at [3 1] for the region. You talked about Playa Vista at 6. And just trying to think of – see how do you view the price versus pace in this part of the market. And also, as you're doing it, what do you think about community size? Is there anything evolving in terms of how you're sizing the communities as you develop them?

[Leonard Miller:]

Yes. This is Leonard. I’ll take a shot at this point. Price versus pace, it's clearly neighborhood-by-neighborhood. We have a targeted absorption that we established by each neighborhood that, looking out, how many homes the trades can basically build for us, the typical phase and that flow. So we're going to find the market, and we expect to sell anywhere from two to four to five homes per neighborhood, depending on price point, location and all those things. Now what I will say is, there's places that we could do higher pace, but we're not going to do that within an environment of cost pressure where we know we can't start those homes for a few months, based on other construction activities. There's other places. If we're a little bit below pace, then we're going to go and do some things to basically find that pace through pricing and those other things. But it's neighborhood-by-neighborhood and going to look for that.

[John Stephens:]

And in terms of community size, I think, as we move down price point, the community – the lot count for each of the communities is getting larger. But it is very specific in each community in price point. So again, as we move down price points, the Inland Empire, some of those communities, let's say, our lot counts are higher than, maybe what we’ve done in Orange County. We might have a 40- or 50-lot in Orange County, maybe it's a 70- to 80- to 90-lot community in Inland Empire, Sacramento or things like that.

[Larry Webb:]

In a perfect world, we probably would like our lot count to be between 18-month and 2-year supply of land at one location, and it varies based on affordability and what we think, is a reasonable sales pace. One of the strengths we've had is, we are in the middle of a land constraint set of markets. But we've been able to lever our personal relationships with land sellers to get auctions on properties as opposed to have to pay all cash for it. And that's really helped us. I would also like to reiterate, on the price versus pace, we are well aware that our margins need to improve. We are raising prices very aggressively on a face-by-face basis. Leonard and our sales team or taking a very good lead with this with our division President. And as you heard, our margins are going to go up over the next six months and go up more than that over the next 18 months.

[Leonard Miller:]

Yes. To that point, Larry, I want to make it clear that we're managing that week-by-week. We meet with each of the divisions, we go community by community, and we look at price, and we take every opportunity. I think, across the board, if you look at this, we're up between 4% and 5% year-to-date. And we'll continue to do that to make sure that we basically recapture those costs and improve margins.

[Scott Schrier:]

Got it. Thanks for all that color. And then just wanted to touch on your comment on the cost side of things. You had commented earlier that lumber inflation has eased a little bit. Can you just walk through what you're seeing in some of the other buckets from various materials, what you're seeing in terms of pricing for land option contracts and of course, labor, the availability and pricing and also, anything you're seeing in terms of construction cycle times?

[Larry Webb:]

Well, let me take the first crack at that. On the labor and scheduling question, both Bay Area and Phoenix are clearly the most impacted by limitations in labor and on construction schedules. And we're dealing with that and those issues on a case-by-case basis. We feel as if we have schedules now that we can meet. Over the last year, I would say, in the Bay Area, our schedules have increased roughly 60 days from original projections, and in Arizona, probably about the same. On the cost side – in Orange County we’re – and Southern California, we're between our fee business and our wholly owned and JVs, we're one of the largest business there. We have quite a bit of leverage with our trades, and I feel as if we've gotten it both cost and schedules dialed in quite well. Sacramento, while there's a labor shortage. We again are one of the stronger players. And so we've been able to control our costs and schedules on a pretty solid basis. This rise in lumber prices over the first six months of this year was the highest I've seen in my whole career. But that has gone down. Regarding other costs increases, Leonard, I don’t know if you have anything to add.

[Leonard Miller:]

Yes, you’ve touched on labor, which I think – I mean lumber 40% year-over-year, we’ve seen that back off, things like steel are moderate increases. Labor continues to be see one that we see, kind of, continued increases. To give you some chance I think, quarter-over-quarter of cost are direct between 1% to 3%, I would expect it to be probably in the 5% range. But as Larry said, it depends on each of the markets that we're looking at. In Southern California, we have great scale from our fee business. So we don't see the percentage increase we may see in the other markets, and we've taken some in those other markets in the way we pay our trade partners, the way we go about bidding our projects and growing a larger trade base that we're seeing that – some success in the area. As far as land goes, I think it'd be consistent probably that from what you hear of builders in all markets, there's a short of land and supply of land, especially very few finished lots or blue top lots, so it's a very competitive environment. And you're seeing significant increases in the cost of land on a year-over-year basis with how competitive the land market is.

[Scott Schrier:]

Great, thanks for all that color. If I could ask one more on SG&A. Obviously, you called out. It is a bit elevated you expect it for Q3. You have a lot of these start-up costs with respect to Arizona and some of these other communities. I'm curious how we can think about that, maybe going into 2019, taking into account the fact that you've acquired a lot more land, so we should be opening up more communities and having more of these start-up costs. And to your earlier point on larger communities, which maybe have some overhead associated with them, how we can think about SG&A, the trajectory of it, maybe, heading through 2019? Thanks.

[John Stephens:]

Yes I mean I think obviously we did spend a lot of money upfront to grand open a lot of these communities. Get everything to setup and running. I think, the other thing is a minor impact of change in revenue recognition for expensing a lot of these costs upfront that were, in the past sort of capitalized and amortized. As we move through the balance of the year, we would expect our selling and marketing costs to come down as a percentage of revenues, obviously, just because of that fact as well as our revenue increasing. So moving to 2019, we’re very focused on getting the SG&A rate down. But whether we can take another 20 basis points or 30 basis points or 40 basis points off, I think it remains to be seen in terms of where we think we're going to be on revenues for the year. But I think as we get a little bit more skill, and as you said, more lots per community, we would like to see that come down. Having said that, our average selling price has come down quite a bit, if you go back two years ago, we were at $2 million for delivery and if you fast forward this year, we're $1 million, and maybe next year, we're going to be sort of in the $900,000 range. So as a percentage of the sales price, the marketing cost is a little bit more. But again, we're growing our topline. So the idea is there that we keep it flat to see some improvement moving forward.

[Scott Schrier:]

Great, thanks for taking the question, and good luck.

[John Stephens:]

Thanks a lot.

[Operator:]

[Operator Instructions] Our next question is coming from the line of Alex Barron with Housing Research Center. Please proceed with your question.

[Alex Barron:]

Hey guys. Good morning. How are you?

[Larry Webb:]

Good.

[John Stephens:]

Good morning, Alex.

[Alex Barron:]

I was hoping you could elaborate on your Inland Empire. I guess, you guys just started there, and you said you had pretty good sales. Just trying to understand more specifically, what price point are you guys, kind of, starting at and I don’t know if it's possible to elaborate how good of the sales pace that is. And the master plan, you said you're about to launch. Where is that going to start in terms of price point? Do you have any, like attach product, the kind of thing? If you can just give us a sense of where that's going?

[Leonard Miller:]

Yes, Alex. This is Leonard. I'll start with the first community we opened up was in a U.S. master plan called Park Place. We've been really pleased with the results. We're over – we found an absorption between 4 or 5 between a month there. It's a price point in the low $500,000, which really in that market is an affordable home. So that’s our first offering there. The second part of your question at Bedford with the master plan there is three programs that will open up in September that Larry referred to. We're on the upper end of that master plan and the price point will be starting in the low $600,000 range. And then we have many – we're in the works of really opening several communities over the next 12 to 18 months there at lower price points that we're very excited that really will address the FHA and first-time homebuyer.

[Larry Webb:]

And we're going to have both attached and detached housing programs. There will be two to three other builders there as well is us. We're planning on grand opening last week of September. Alex, I know you see more houses then anybody who ever lived. And I'd love you to come out and to our community because I think it will, I believe, that will be the best master plan that the Inland Empire has ever seen.

[Alex Barron:]

I guess, you mentioned that you are taking on the higher price points. I'm curious why you didn't choose to – I mean, you know guys built really nice homes and you do have a specialty in higher-end homes, but I'm curious why you didn't take more, like, the higher volume, potentially lower-priced homes in that…

[Larry Webb:]

As we sit here today, there's – on our first three housing programs, we felt that it made a lot of sense for us to build at the start, Phase I, at the higher end because we felt we could of any builder that we knew, we could do the best job, and we could raise the value of the entire community by how we created homes, how we build homes, how we design homes. We also have plans, however, to also be near the lower end. So in the perfect world, if there's going to be four housing programs each phase, we would like to have one housing program at the lowest end and one at the upper end and help lift everything together. And really, that's our plan. From a timing perspective, for Phase 1, we took the upper end. But we'll be at both the lower end and the upper end if we can in each phase of the 1,600 lots. That’s our goal.

[Alex Barron:]

Got it. So presumably than your margin trajectory, as you start to build more and more of these wholly-owned projects, should start to see, I guess, the more material difference than what we've seen being part of more like the Orange County master plan there?

[Larry Webb:]

Yes, that would be the idea. And for example, our Seville project, which we just opened is that John, what would you say we are with our gross margin on that project?

[John Stephens:]

We're in the high teens there, 18%, 19% and yes, you're right, Alex. Our goal and our projections as we currently sit here is that we’ll see meaningful appreciation in our gross margins as we move into next year. And Irvine Company's becoming the smallest percentage of our mix. And they have a very high profit participation, which does have an impact on our gross margin percentages.

[Alex Barron:]

And John, just to confirm that 18%, 19%, you're talking about, that's inclusive of interest?

[John Stephens:]

Yes, and yes, that’s the one community we have opened in Inland Empire today and again, we have another one grand opening in the first part of September.

[Alex Barron:]

Okay. Well great. That’s folks and look forward to seeing you. Thank you.

[Larry Webb:]

Thanks a lot. End of Q&A

[Operator:]

Thank you. It appears we have no additional questions at this time. So I would like pass the floor back to Mr. Webb for any additional or concluding comments.

[Larry Webb:]

I want to thank you all for taking part in this call. We have been in the middle of a major transition in a company and we feel like the sales results that you're seeing in the land acquisition that you're seeing will reap significant benefits as we move forward over the next 18 months. I'm as enthusiastic as I've ever been in terms of where we're going. And I believe our shift into being in the more affordable price ranges primarily will prove to be a very smart and profitable move. And we again, as I've mentioned a couple of times, I really encourage a lot of you, any of you would like to come out, we love to show you our new housing programs. And we'd like to prove to you that what we're saying is not just the right thing to do, but it's the smart thing to do. Thank you very much.

[Operator:]

Ladies and gentlemen, this does conclude today’s teleconference. We thank you for your participation. And you may disconnect your lines at this time.