MDC Holdings Inc (MDC) 2014 Q4 法說會逐字稿

Good afternoon. We are ready to begin the MDC 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.

Thank you. Good morning, ladies and gentlemen, and welcome to MDC 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 MDC's business, financial condition, results of operation, cash flows, strategies, and prospects, and responses to questions may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements involve known and unknown risks, uncertainties, and other factors that may cause the Company's actual results, performance, or achievements to be materially different from the results, performance, or achievements expressed or implied by the forward-looking statements. These and other factors that could impact the Company's 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 website with our webcast slides.

And now I will turn the call over to Mr. Mizel for his opening remarks. Larry?

Thanks, Bob. Good afternoon and good morning, everyone. We're pleased to announce the 2014 fourth-quarter income of $14,600 (sic -- see press release, "$14.6 million") or $0.30 a share, which completes our third consecutive year of profitability. After taking out the impairment of debt, 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 increase by nearly 20% year over year. However, overall demand across the home building 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 retired $500 million in senior notes and issued an additional $250 million, which not only extended our closest senior note maturity to 2020, but also reduced our overall interest burden.

At the same time, we enhanced our home building 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 is mixed, 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 FHFA's recent announcement of changes to help expand credit availability, the increase in FHA loan 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 and our backlog year end. In combination with the balance sheet enhancements we made during 2014, these improvements provide us with the opportunity for 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.

Thank you, Larry. Before I get started on slide 4, I just wanted 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 and 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 rate 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 a 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 price sub-markets. 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 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. 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 pointing out is the absolute gross margin per 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 margin percentage.

While we have seen some pressure on our gross margin percentage over the last few quarters, our gross margin percentage in 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 in backlog was up 9% year over year and stood at $437,000.

We generated favorable operating leverage during the quarter, as our home building 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 sale 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 not 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 active 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 in backlog increased 20% on a unit basis to 1,519 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 active 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.

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 acquired 528 lots, while for the full-year 2014 we acquired about 4,200 lots and spent approximately $605 million on land and development. As of the end of year, we owned or controlled over 15,000 lots, which represented a 3.5-year supply on a trailing 12-month 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 home building debt to capital ratio was 31% 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 calls -- for questions.

(Operator Instructions)

Your first question comes from Ivy Zelman with Zelman & Associates. Your line is open.

Thank you. Good afternoon, guys. I hopefully can get this question articulated properly; but I want to understand why there may be some opportunity to strategically move down into lower absolute-priced homes. I know that your average prices continue to move up, and you've benefited from the strength of the move-up market. But it seems as if a lot of the builders have crowded into this sliver of the market, given it's been the only game in town.

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 in $250,000 or 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 dependent on credit availability? And maybe percentage-wise, how much will you bring in that lower price point, if at all? Sorry for the long-winded nature of the question.

I think that was 12 questions, Ivy.

I'm sorry. I warned you.

I think that 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 of 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.

Okay. Very helpful. And my second question 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?

I think I'm 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 of $1 a share and we think that is a great return for investors. And the strong balance sheet and the additional liquidity, as the markets improve, which we believe that they will. After all, housing's 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's 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 and growing.

As you heard from my prior comment, not only did we reduce our outstanding and reposition 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 30-year notes. And I think that 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.

Thank you. Very thorough, Larry. Appreciate it. I'll come back at the end.

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

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

Yes.

Okay. Thanks.

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

Hi. Thanks. 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 you 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.

Okay.

In terms of margins, obviously. Thanks.

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 of it has been coming down. In the first quarter, we were running about 58% spec deliveries. Q2 was the highest of year at 67%; we're at 59% in Q3, and then, like I said earlier, we're at 51% for Q4. So it has migrated down a little bit there.

Then in terms of the margin differential, as we've discussed over the last couple calls, it has been a wider spread, probably around the 250 range for the quarter. Again, as we move through some of these specs over time, we would expect that number to come down, especially when we're heading into the spring selling season.

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?

Our gross profit margins, Mike, as you know for the quarter, they were really flat from Q3. Ands as we -- we're not going to give forward guidance in terms of where we think the gross margin's going to be 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 in backlog are pretty comparable to what we delivered.

Now, one of the things to keep in mind is, as you know, the first quarter is 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, as the other point I made, too, in my prepared remarks was that our incentives were basically -- while they're up year over year, they were basically flat from Q3 to Q4. So, and I think a lot of it's going to depend on how the demand is as we start to enter the spring selling season here.

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

In terms of just activity or -- ?

I would just say general demand trends. There's been different --

Yes. I think you asked specifically about California and Arizona. Our absorption pace was down a little bit year over year in California and Arizona as well, but we've actually -- for the full year, like in California, we absorbed over 3 sales per community, 3.22, which was higher than our Company-wide average of 2.4 for the full year. We've also seen better absorption in the -- what we call coastal or LA-type areas, Mike, obviously Orange County, the LA areas have done a little better than the inland areas.

Our inland communities, while there's been a little pressure there, we're still selling over 3 homes per community for the full year at really most of those communities out there. So we've been encouraged what we've seen in California thus far. And I would say Phoenix, we're starting to see a little more activity there as well. So, I think things are a little better than they were, say, a few quarters ago.

Great. Thanks so much.

You're welcome.

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

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

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 -- or this year, I should say.

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

Well, we did liquidate some of our securities to basically fund the debt retirement 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 a 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.

Thanks.

Your next question comes from Stephen [Jim] with Barclays. Your line is open.

Thanks very much. 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 positioning to have higher community counts, and so forth, and yet, declining margins.

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 knows it.

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 a soft underbelly in the market, strategically, relative to your peers?

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're 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 adjusts to the land cost, pretty much in 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've 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 an oops out there, and then they -- one would say that's a pretty decent strategy.

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 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 in maintaining the dividend throughout the entire period of time we think was best for our shareholders. 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.

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're at, what you're 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 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, the 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 was seeing margins being pushed down due to rising land cost?

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 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 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 stayed 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.

Great. Thanks very much, Larry. Appreciate it, good luck.

Hey Steve, one other thing I just wanted to add to Larry's points he just made too, 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 of some of or other competitors too. Just another point just to add.

That's fair. Yes. Thank you for that, John.

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

Thank you. Wanted to follow up on that questioning earlier about the spec inventory. The pivot in your strategy that you're describing here for 2015, if we look back to 2014,given the uncertainty and the slowdown in home sales at the end of 2013, 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.

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 position 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.

Got it. That's helpful. And then just on the outlook as well for 2015, you mentioned you're seeing things and there's a considerable uncertainty, potentially some tailwinds, as you mentioned. You mentioned that 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 your thinking there, and you do seem to be at least less positioned to that risk than your peers.

My position is you're 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 receive 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.

As you said, I'm the only major guy that missed Texas. Maybe I'll be in favor for at least six months.

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

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

Thank you. 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, or are you pulling back exposure to that market?

In terms of the mountain community, we've, as Larry just indicated, we've done fairly well here in the Colorado market, and obviously has a much bigger impact on that segment as a whole, because it's so much larger, for example, than Utah.

With respect to the Mid-Atlantic, yes, 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 regions, 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.

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

Okay.

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?

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 it. I think it was really what -- trying to get what we can, what the market has to offer.

Okay. Sure. I 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%, 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 2015, then reaccelerate? And I guess what goes along with that question is what do you expect to spend on land and development this year?

I think it's pretty well 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.

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 what 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 going to be 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.

Fair enough. Thank you.

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

Good morning, gentlemen.

Good morning.

John or Larry, could you -- this is a housekeeping question, but as I look at your interest in COGS, it rose to 3.8% of sales in 2014 from 3.3% in 2013. Given that it ended in 4Q at roughly 3.5%, do you have a comment on where that will trend on a percent basis?

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 or two. It's going to take a little bit of time. But as you can see, it is worked down. And again with a lower interest incurred number, we would expect to see that come down a little bit.

So somewhere between 3% and 3.5% would be a reasonable percentage of the COGS basically?

Yes. I think to get to 3% in the near term would be probably a little more difficult.

Okay. And I just -- my hearing -- I wondered if you could confirm, when you talked about 1Q conversion rate, you said mid-50%. That's five, zero, is that correct?

Correct.

And with that type of conversion rate, could you talk about perhaps if there's a -- I realize there's less spec units, but could you talk about the -- what that means about 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. Thank you very much.

Okay. 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've 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 kind of a run rate on the G&A. So --

Thank you.

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

Hi. Thanks for taking my question. Can you elaborate a little more on the year-over-year change in incentives and just try to quantify it a little bit?

Yes.

Just what the magnitude of it was.

Yes, the year-over-year -- like I said earlier, the quarter over quarter was flat and the year-over-years 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.

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

I think the acquisition, as you know Adam, can be a little bit lumpy from time to time and just the timing of when things close. As Larry indicated earlier, the market will dictate in terms of how aggressively we will purchase and procure lots on a go-forward basis. As you can see, before that Adam, the prior four quarters we were kind of operating -- purchasing over 1,200 lots a quarter.

Okay. Thanks for taking my questions.

You're welcome.

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

Good morning, everyone. 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?

I think in terms of price increases, obviously the markets where we've seen more robust sales, obviously certain markets in California we've seen strong sales. I think in Colorado we've seen, obviously there's 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?

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

I think that's part of the ongoing business. I think from time to time in markets, 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, 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.

Okay. 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 are willing to do for 1Q and possibly 2Q as well, to continue moving through the specs that you're holding now?

In terms of the incentives?

Yes. Increased incentives, are you same level as what you did this quarter or is it going up?

One could say it might go down. Fourth quarter is the 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 taper them a tiny bit, and that's certainly what our business objective will be, subject to market conditions.

Okay. Thank you.

You're welcome.

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

Thanks. Good afternoon. 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?

I think our growth will come from a tone in the market. We'll have a little bit of increase in community count, and if -- there'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, 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.

Got it. And as far as the deals where you guys walked 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 their prices?

I think each one is a transaction specific. There's nothing special about a transaction of changing your mind. We have the discipline if market conditions change or our perception of 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's no inactive land in the Company; everything's active, and we are working. You have active subdivisions and then you have subdivisions, and there's different factors on how one defines them. We are busy and looking forward to a better tone in 2015, and that's where we're headed.

Thanks.

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

Hi, this is actually Jonathan Hughes on for Buck. 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 160 basis points. Just curious as to where the incremental gap came from, given you mentioned incentives were roughly flat sequentially.

Well I think it kind of ties back into what maybe Larry said a little bit too, in terms of you get to the end of the year, you're trying to close out of certain communities, without going project by project. Because really that's what you would needs to do to analyze that.

I think there were some specs that we decided to move on our close out of a project. And in fact, in Maryland we did have a few closeout communities in areas that we're really not building in anymore that we've decided to go ahead and close those homes.

Okay. All right. Thanks a lot.

You're welcome.

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

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.

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