MDC Holdings Inc (MDC) 2015 Q3 法說會逐字稿

Good afternoon. We are ready to begin the MDC Holdings Incorporated third-quarter earnings conference call. I will now turn the call over to Kevin McCarty, Vice President of Finance and Corporate Controller. Sir, you may begin your call.

Thank you. Good morning, ladies and gentleman, and welcome to the MDC Holdings 2015 third-quarter earnings conference call. On the call with me today I have Larry Mizel, Chairman and Chief Executive Officer, and Bob Martin, Chief Financial Officer.

(Caller Instructions)

Please note that this conference is being recorded and will be available for replay. For information on how to access the replay, please visit our website at mdcholdings.com.

Before turning the call over to Larry, it should be noted that certain statements made during this conference call, including those related to 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 third quarter 2015 Form 10-Q, which is scheduled to be filed with the SEC today. It should also be noted that SEC Regulation G requires that certain information accompany the use of non-GAAP financial measures. Any information required by regulation G is posted on our website with our webcast slides.

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

Good morning. This morning, we announced our 2015 third-quarter net income of $14.8 million, or $0.30 per share. The industry demand continues to be supported by improving or already strong ratings for many key economic indicators. Such as employment levels, consumer confidence, household formation and income growth.

In addition, anticipated interest rate increases have not yet materialized supporting affordability for homebuyers, even as prices rise. From a supply standpoint, both new and existing single-family home inventories have remained at historic lows. While the favorable supply demand dynamics are encouraging for our long-term growth prospects, they also have hindered our ability to convert backlog into deliveries in the short term.

With builders across the industry continuing to ramp up production during the quarter, we saw closings delayed because of limited subcontractor availability. Plus, we are delivering more dirt homes now than a year ago, which has increased our overall sales to close cycle time.

While the pressure on our subcontractor brace should decrease over time, we expect that this dynamic will have a continued impact on our conversion rate, at least for the next few quarters. However, I am pleased to see that operational improvements in several of our key performance indicators for our business.

Our pre-impairment gross margin percentage has continued in a positive direction, increasing notably both year-over-year, and from the 2015 second quarter. Furthermore, when coupled with a robust increase in the average sales price of our homes delivered, our pre-impairment gross margin per home closed for the quarter was just over $70,000 per home, our highest level since 2006.

From a sales standpoint, we experienced an 8% year-over-year increase in our monthly sales absorption rate. Despite the price increases, we have implemented many of our communities throughout 2015. Our ending active community count improved only slightly from the 2015 second quarter, but further improvement is expected by the end of the year.

The pace of our land acquisitions quickened during the quarter, as we spent $145 million in acquiring more than 1,800 lots and 45 communities. As a result, our lots under control at the end of the quarter increased 6% from the end of the second quarter in support of our long-term growth objectives.

Our backlog at the end of the quarter reached nearly $1.2 billion, up 49% year over year. Even with the slow down in our conversion rate, this level of backlog gives us good visibility to continued year-over-year revenue improvements for the upcoming quarters.

Thank you for your interest and attention. I will now turn the call over to Bob Martin for specific financial highlights.

Thank you, Larry, and welcome to everyone on the call. Turning to slide 4.

We delivered 1,080 new homes during the quarter, versus 1,093 in the prior year. Our third-quarter backlog conversion rate came in at 42%, which was lower than the 58% for the same quarter last year. As Larry already mentioned, the decrease is largely due to the intentional reduction of our spec inventory over the past year, which has increased the average time from sale to close for our homes.

The conversion rate was also negatively impacted by limited subcontractor availability, which had a bigger impact on third-quarter closings than we originally expected. The subcontractor issue is having a significant impact on our Colorado market.

As we discussed on our last earnings call, higher than average rainfall totals throughout the first half of the year in Colorado has pushed more construction activity to the back half of the year, placing more pressure on the already strained contractor base.

Other markets have also been impacted, but to a lesser degree. In some cases, competition for qualified labor is coming from both single-family and multi-family construction projects.

Looking forward, our fourth-quarter backlog conversion rate should increase sequentially, which is our normal seasonal trend. However, the magnitude of the increase is difficult to gauge given the subcontractor issues we have highlighted.

Additionally, this will be the first quarter that will be impacted by the Tila-RESPA integrated disclosure rule. Which could cause additional delays that impact closings that may otherwise be completed by the end of the quarter. Recognizing those risks, I currently do not expect a fourth-quarter backlog conversion rate any higher than 50%.

Our average price increased by 14% or $51,000 per home to $421,000. Primarily the result of a mix shift to high-priced sub-markets, combined with some price increases that were implemented earlier in the year. The increase in average price more than offset our 1% decline in closings, and as a result, our third-quarter home sale revenues were up 12% year over year to $455 million.

Next slide? Due to a $4.4 million impairment during the quarter, our gross margin from home sales decreased slightly, both sequentially and year over year. However, our gross margin from home sales excluding impairments was 17.3%. Which was 80 basis points higher than the 2014 third quarter, and 70 basis points higher than the 2015 second quarter.

Both the year over year and sequential increases in our gross margin were primarily driven by the increased percentage of our deliveries coming from dirt homes, which typically have a higher margin than spec sales. Combined with improved margins on the spec homes we did deliver. Additionally, our interest in cost to sales as a percentage of home sale revenues decreased for both periods.

Our margin progression continues to be hampered somewhat by an increase in both land and construction costs. But we have minimized the impact of these factors by increasing home prices.

The impairments we saw during the quarter mostly came can from a few communities in the mid Atlantic, which has been one of our weaker geographic areas over the past year. Our estimated gross margin in backlog at the end of the quarter moved slightly lower on a sequential basis. Q4 margins will depend on, among other things, the mix of units that pull through and the impact of specs that sell and close during the quarter.

Turning to slide 6. On the SG&A front, our home building SG&A expense rate of 12.6% for the 2015 third quarter was almost unchanged year over year.

Looking at individual categories. General and administrative expense increased by $5.4 million year over year, which is partly due to additional stock option expense, resulting from a grant to senior executives earlier this year. Also, due to a downward adjustment to potential payout amounts under our executive incentive plan last year, there was no accrual for this program in the third quarter of 2014. Whereas, we had a more typical accrual in the third quarter of 2015.

Marketing expense did not change year over year, but commissions were up by $1.4 million. That entire increase is attributable to our increase in home sale revenues, as our sales commissions rate of 3.3% was actually down slightly from 3.4% the same quarter a year ago.

Even though we did not achieve improvement in our SG&A expense ratio this quarter due to closing delays, our core home building operating margins improved by about 70 basis points year over year to 4.7% on the strength of improvement in our pre-impairment gross profit percentage.

Turning now to orders. Our net new orders for the quarter were up 3% over the prior year, which represented our 6th consecutive quarter of year-over-year order growth, and our highest third-quarter order level since 2007.

Our monthly absorption rate of 2.37, was up 8% from the prior-year period. A solid result, given that we have increased prices in most of our communities during the year. However, the increased absorption rate was partially offset by a slight decline in our average active community count.

The dollar value of our orders increased 13% year over year to $489 million. The increase in dollar value was mostly the result of a 10% increase in our average order price to $441,000 due to the price increases I mentioned in most of our active subdivisions during the year, coupled with a shift in the mix of net new orders to higher priced communities.

From a regional perspective, we experienced the most strength in our California and Nevada operations. With monthly sales absorption rates of 3.1 and 3.0 respectively for the quarter. California and Washington showed some of our largest average price movement, with increases of 35% and 21% respectively.

Our homes in backlog to end the quarter were up 38% year over year on a unit basis to 2,587 homes. With a value just under $1.2 billion, which was up 49% year over year. Even with the potential for continued closing delays due to limited subcontractor availability, the magnitude of the backlog increase provides some visibility to revenue growth in the coming quarters.

We have not seen an increase in our cancellations for the quarter. Despite a much larger number of units in backlog, which is encouraging given the closing delays that we have seen. As a percentage of gross orders, our cancellation rate was down slightly year over year to 25% in the third quarter. And as a percentage of beginning backlog, our cancellation rate for the same period was down 600 basis points year over year to 14%.

Turning to slide 8. Our ending active community count was at 157, up slightly from where we were at at the end of the second quarter. On the chart to the right, know that our soon-to-be active subdivisions still exceed our soon-to-be inactive subdivisions by 17. We still expect to see our year-end community count to be up compared to 159 count that we had at the end of 2014.

And moving now to slide 9. During the quarter, we acquired 1,806 lots for approximately $145 million. We spent an additional $61 million on development costs, bringing our total spend for the quarter to $206 million.

At the end of the quarter, we owned or controlled 15,777 lots, which represented about a 3.6 year supply on a trailing 12-month delivery basis. This level of land acquisition was our highest since the third quarter of 2013, and it moved our total supply of lots owned and controlled up on a sequential basis for the first time in five quarters.

We did not reduce our underwriting standards to achieve this increase in land acquisition activity. Rather it's the culmination of several quarters of sourcing and due diligence from our land teams across the country. The bulk of the activity for the third quarter came in markets where sales velocity and returns have been among the Company's highest, specifically California, Nevada, and Colorado.

We continue to see a good pipeline of deals coming in for review, and we are carefully evaluating each one for the appropriate balance between risk and return. That concludes our prepared remarks. At this time, we would like to open up the call for questions.

(Operator Instructions)

Michael Rehaut, JPMorgan.

Thanks, and good morning, everyone. The first question I had was going back to community count for a moment.

We understand that your comments included an expectation for 4Q to be up sequentially -- average community count to be up sequentially versus 3Q. But I think earlier you had talked about a year-end community count goal up 5% to 10%. Is that something that you still expect to achieve, or given some of the delays, we should be thinking something a little more modest relative to that number?

Hello, Mike, it's Bob. It's a good question, and you're right on the prior statement. I would say at this point, we still have an opportunity to get to somewhere around that 5% increased level. And 10% seems a little bit too optimistic at this point. So closer to the 5% appears more reasonable.

Okay. That's helpful, Bob. Appreciate that.

And also on the interest amortization and COGS. Obviously, this quarter on the year-over-year basis driving really I guess the improvement in terms of the reported gross profit margin, ex-impairment. So just trying to get a sense, given your current debt levels and inventory and perhaps we are looking a little bit into the future here, but how should we think about that trend into next year?

Would you expect that impairment, I'm sorry the interest amortization, to continue to come down and drive some of the improvement? Or would you expect improvement, if you expect improvement at all, would that be driven more through a pre-interest improvement around either mix or pricing or better land purchases?

Well, I guess on the interest and cost of sales, for the third quarter we were at about 280 basis points. On a historical basis, we have seen it a lot lower than that.

So I think there is potentially room for improvement of that number, but it does depend on velocity, both what we are experiencing currently and what we expect to experience. So that one comes with a caveat.

In terms of other gross margin improvements, we really don't forecast a number our there. Certainly, we have been very focused on balancing price increases with an absorption pace to try to see if there is additional room to improve the gross profit margin. And we will continue that focus as we move forward.

As for the land purchases, as I indicated in my prepared remarks, and we have been very cognizant. We do not believe we have reduced our underwriting standards for the new stuff that we have bought. So we will see how those ones turn out.

Stephen Kim, Barclays.

Thanks very much, guys. First question related to a comment I think, Bob, that you made regarding your backlog, sorry your margin in backlog being little lower sequentially. I guess I was curious if you could shed a little more light into that. Specifically, because I would have thought that your backlog maybe would have had a bigger mix of Colorado units, because you had mentioned that as the area you had a lot of labor constraints.

And you had also indicated the Colorado margins or returns in that market are very good. I think when you were talking about your land spend. So trying to reconcile those two factors, why do you think your margin in backlog is trending down when you have that favorable tailwind?

That's a good question, Steve. There's a couple things. First of all, the comment was with respect to the margins in backlog at 6/30 versus the margins in backlog at 9/30, September 30. Just to be clear.

And it's not a dramatic decrease, I described it as slight, Steve. There is a little bit of mix going on. You've got Colorado in there, but we've got fairly decent margins in Las Vegas, and that moved down a little bit, so that's part of it. We also saw spec margins move down just a little bit of backlog as well. So those are two of the factors.

Okay. That's helpful. And then I guess the second question would be related to the pace of sales in light of labor constraints. It seems that your absorptions were pretty good, improved, and it was just that you didn't have as many communities open. But I was curious if the longer cycle times are encouraging you in any noticeable way to reduce the level -- or intentionally slow the pace of sales, essentially, either through raising prices or whatnot? If you could shed a little light on that.

We commented in the second quarter, specific to Colorado, that we actually limited lot releases to slow down sales to a certain degree in that quarter. Third and fourth quarter, the activity is not as robust anyways. So it's a subdivision by subdivision look at things, certainly production levels, and how many units we have in backlog come into account as we are talking about that.

And I think as we get into the fourth quarter, but especially as we get into Q1 and Q2, we will continue to see how that story plays out and how aggressively that we want to increase prices. But it is a part of the equation, the level of backlog no doubt about it, along with just our overall absorption pace. It's certainly a balancing act.

Ivy Zelman, Zelman and Associates.

Thank you. Good afternoon, guys. If you could take a bigger picture view of the world and recognize there seems to be a lot of panic in housing related equities right now, and some of that is related to misses on revenue, obviously, constraint around labor, delivering backlogs. We saw Pulte, and now we saw you guys.

And curious with respect to inflation that you are going to see as a result of these labor constraints, and really looking out and not putting a definitive number. But is this going to result in contraction in growth enough that or moderation in growth that we won't even see growth? I think having some of your perspective, Larry, that allow for some of that optimism that you spoke at the beginning of the call with all the metrics, whether you cited the pointing in the right direction, house [inflammation], employment and affordability.

I think people are running for the exits on the presumption that growth is actually not only going to moderate, but we're going to see contraction in housing. And I think having some of your views as it relates to the constraints, and what it will do to growth. Is it something that is a structural change now because that we have unfortunately no longer illegal in immigrants working for the home-building industry and therefore it can't be fixed?

Give us some of your perspective on what we can see for growth with these constraints. Or some perspective that will frame it for us, because I think a lot of people are panicking based on the equities are trading. Thank you.

I think we are in a period of time that all the factors are coming together that I believe will signal a strong housing market. As to the numbers of whether you are going to do 600,000 sales or 800,000 sales or 540,000, it is not fully clear. But one thing is clear.

The market has a good tone that the majority of builders have good demand that the mortgage market is certainly opening more and more every month. There is a new lender coming in, so we are able to expand the perspective -- the mortgage supply to the buyers. We see the aggregate unemployment rate in our country continuing to contract.

I think the building business as a business is going to as an industry is going to improve on a very solid basis. There is not a lot of speculation going on. The markets that we are in are -- we're very focused when you look at the West Coast.

You look at the salient places, whether they are Colorado, Arizona improving, Nevada continuing to perform. Utah, you look at the unemployment rate, and I think it's like 3% and change and we are expanding there. Washington, everyone kind of knows what's happening there, and California is pretty robust.

We are very pleased with our absorption rate. We are pleased that we have continued to expand our land acquisition in light of the fact that we have controls that take us in the level of three 3 to 4 years of the land supply, and we are expecting to be able to meet those objectives.

I think this is a unique time for the industry. Usually, it's not always where you have plenty of money, you have a good demand. There is no drama going on per se in the United states, other than maybe a presidential election which will be interesting.

So I would say individually and as a person in the industry, this is pretty good. And you give it time for execution over the next couple of years, I think people will be very pleased with the performance of this industry as it regains its traction from a decade ago.

That's helpful, Larry. But let me follow up with one more question to drill in a little bit further because of the labor constraints, and Denver is definitely a market where we appreciate the labor constraints are the greatest. Does this work itself out over time, and do you see the industry figuring out how to bring in more labor?

Or is it about rotating out where jobs are being lost into construction-related jobs? Is it something that will be an impediment for growth, or is this labor issue something that will work itself out? And to the labor inflationary costs, are they going to negatively impact margins or are they offset with commodity deflation and home price appreciation?

I think the home price appreciation will mitigate the labor supply. In all the years that we have been in the business, it's only natural that we have a labor shortage when we have a demand. Usually, we have too much labor when there's no demand.

So does it work itself out? The one thing about labor in this country, even though there is a shortage in our industry, it follows pricing. And when you aren't able to get adequate labor at $18 an hour, maybe at $25 an hour there is migration from other parts of the country to those parts of the country where there's a demand factor. And this is in several of the trades.

But I think it is all good. It is better to have a labor shortage with a strong demand, than to have something that was different that we previously experienced over the recession. So these are all good problems, and like everyone, we will solve them because that is what our job is.

John Lovallo, Merrill Lynch.

Hey, guys, thanks very much for taking my call. First question is, can you quantify to what degree build times have extended on a year-over-year basis?

On dirt builds, you are probably talking in the neighborhood of 5% to 10%, just very roughly.

Got you. And then -- I guess as my second question is, if we think about just the progression of the quarter just given the September print in new home sales. Was there any decline in demand that you guys saw throughout the quarter, or how was the cadence throughout the quarter?

We really saw the opposite. We saw more activity towards the end of the quarter, both sequentially and year over year.

Will Randow, Citigroup.

Hello, guys, and thanks for taking my question. I guess in terms of when you think about the potential for constraints on growth and waiting or proactively waiting for the labor issues to work themselves out, how do you think about the balance sheet?

In a lower growth environment, maybe you level off the balance sheet, think about a potential stock buyback, increasing the dividend. Just what are your thoughts there in terms of how can you be proactive while the labor issue sorts itself out?

We expect to be proactive on an active basis, so all the elements that one should be doing we are doing. We have, from a decade ago, a authorization for buying back stock. I think it's been -- what year was the year that we bought back stock?

2003.

2003, so it's something that was thought of, but anyway it's a factor. The dividend, we are proud that we were able to maintain the dividend through a difficult period.

And we are sensitive to making a return for our shareholders, and we are focused very diligently on the growth of the Company and the profitability and all the options are always on the table. And we will always evaluate them for whatever is the best for the shareholders.

And I guess just as a follow-up on the land market as well as some of the other building materials outside of lumber which is pretty visible. What are you seeing -- are our prices backing off for good lots and good locations given the construction constraints, or are there any other derivative effects to think about?

Well one of the effects that no one has really articulated is is the banks, the regional banks, have opened the credit market to land developers, and where for many years all they had was problems. You are now seeing the development of land beginning to open up and to come to market.

And I think that's really positive, because it's demand pulled, it isn't supply driven. So we are able to see that this is an area that I believe will be properly supplied, and there's a reasonable amount of transparency. There is reports available from different public sources of availability of lots, finished lots, land and development.

So over the next period of years, I expect to see the supply of land priced appropriately. And the reason why it has to be priced appropriately, because if there is not a reasonable rate of return, the builders just won't buy it. And these are factors for those people that are in the business every day, are pretty easily obtainable as far as the information and the metrics of how one should transact.

Stephen East, ISI.

Thank you. Actually this is Paul Shebilski on for Stephen. The first question I had, it relates to your marketing expense.

It was flat on a dollar basis. But last year, I believe your community count was up nearly 27% and this quarter it was down 8%. Can you add any color on that? Is that indicative of a community growth, at 5% didn't sound like it was too robust, or what was driving that number this quarter?

The only thing I can really think of is our preferred marketing dollars per home has trended up over the course of the past few quarters. But it's not something we really focused on as a major driver.

Okay. And then Denver orders were a little bit softer than what we were expecting, and it doesn't sound like you were putting a governor on them like you did last quarter. Has the market overall slowed, or is it a community count issue? Anything you could add to that?

Well I think for Denver, there's a lot of factors that come into play. I think they are managing it on a community-by-community basis. And depending on where they are at, they do some things that might slow down orders a little bit depending on the circumstances.

But it didn't strike us as really anything in particular that's an issue in Denver. Obviously, prices have moved up quite a bit. That's always going to have some impact. But given that it's the third quarter, it's really not the time period that we hang our hat on. We are really just focused on the build cycle at this point.

Jay McCanless, Sterne Agee.

Thanks. Good morning, everyone. First question I had, could you discuss how cancellation rates have trended at the beginning of fourth quarter, and how the compare to last year's 28%?

I don't think I'll comment on the fourth quarter at this point. Especially given since we haven't even been through a full month at this point.

As I indicated, we were actually down slightly for the third quarter. I think that's a really good sign, because you have such an increase in your backlog, beginning backlog, over the same period. Beginning backlog or cancellations as a percentage of beginning backlog, were down 600 basis points.

Got it. The second question I had, could you discuss in percentage terms or day terms how much longer the cycle times are now versus where they were last year? And is MDC having to pay out incentives to keep people in the backlog and keep that cancellation rate from spiking higher?

I think I'd answered the first one earlier. It's about 5% to 10% increase in cycle times. And the answer on giving extra incentives is no. We are not seeing that. We really don't need that to keep people in backlog.

Nishu Sood, Deutsche Bank,

Thanks. The first question I wanted to ask, there are some reports from the field that you folks are planning to reintroduce a first-time buyer product specifically. So I just wanted to get your thoughts on that, what you are seeing that is driving that position? How has demand been amongst your current existing product that might be focused more towards the first-time buyer? And also, was that part of the increase in the lot count in the third quarter?

I think first of all, one of the big factors that we look at is just the overall increase in sales price. And it has gone up, for us, it's gone up quite substantially across most of our markets. And that's partly a shift to a higher-end mix, and that consumer segment has been pretty good to us. So we can't complain about that.

At the same time, we do think it's wise to also have product available for more of that first-time buyer. And specifically, we have also -- we are also aware that there's a millennial generation that's been delayed in coming to market, they've been getting married later, having kids later. And I think the development of that kind of product is in response to that potential demographic becoming more active in the home-buying process as well.

It's too early to say at this point how it's doing. We really haven't rolled it out broadly anywhere at this juncture, but it will go into production here in the next couple quarters. But certainly, we are looking for land positions that support those kind of projects.

Got it. Great, appreciate the color. And second question, you mentioned the impairment being focused on the mid Atlantic market, and so a significant impairment. I was wondering if you could give us a little more color on what sort of communities and whether there are any further in lie from the mid Atlantic area.

And also, against the absorption increase, if I remember correctly for Maryland, was quite strong. So did the impairment allow for pricing to drive absorptions. Were those two correlated? Because the absorption stands at odds with the, obviously as you folks describe, the relative weakness of that market compared to others.

Yes, there is a lot of questions in there. But I guess first of all, I'd be happy to give you a little bit more color.

And with regard to any future impairments, we did a really thorough analysis for Q3. And that's how we came up with the $4.4 million of impairments. Any impairment in future periods will depend on that the facts set in place when we update our analysis at that time. So I want to make that clear.

As far as the impairments go, again, most of it was on three assets in the mid Atlantic. And it has been a weaker segment of the country for us over the last few quarters. There was a few other assets that were impaired, three more, but the bulk of the remaining impairment was just a couple assets that we had designated for sale for a couple different reasons. Nothing very significant.

With regard to your comment on absorption pace getting a little bit stronger in the mid-Atlantic. I think Maryland, you said specifically.

I think that's necessarily contrary to the story. First of all, it was coming off of a fairly low base. But second of all, certainly, in those markets and in certain subdivisions, including the ones that we impaired. We recognized the need to decrease prices to drive absorption pace, so to a certain degree that goes hand in hand in this case.

Michael Rehaut, JPMorgan.

Thanks for taking my follow-up. Just wanted to focus on the ASP for a second and your demographic exposures. Obviously, in the $400,000s or mid $400,000, depending on how you look at ASP or price in backlog. Probably a bit higher than I would assume you guys ever thought you would get to, given your legacy in terms of more having a pretty strong focus on the first time.

So I just wanted to get a sense of, as you look at your demographic mix today, what is your percent of first time versus first time move up? And second time move up, and maybe other, you could put luxury or active adult in there? And within first time, is it really more of that better financed or higher qualified millennial that has waited 10 years? Obviously, it doesn't seem there's a lot of first-time traditional what you would think would be more on the entry-level side.

Yes. I get the question there, Mike. I think first time in the quarter was about 25% of what we did. And I would characterize that first-time buyer as maybe a little bit more on the higher end.

There's another category of starter home, I would call it, and we don't focus on that as much. You have about 50% that's in that first time move up category, and then the balance, about 25%, would be in that second move up category.

Okay. So within the first time then, of that 25%, not much of that is really that entry-level product that like a DR Horton is going after? Or that perhaps in the past, that was more of a typical product for your portfolio?

I wouldn't say that's been typical in the past. I think we have always been -- tried to do a little bit of a nicer house than the comparison that you brought up. That express type of house.

We have done, I think, a little bit better product than that throughout. But certainly our mix has shifted towards a little bit more of a move up type of house as we indicated based upon the increase in our ASP for closings and sales.

Alex Barron, Housing Research Center.

Yes, thank you. Hey, guys. Sorry about that. This is more of a higher level type question.

I was looking back almost 14, 15 years ago at the last time you guys had similar type revenues. And it looks like the deliveries were roughly half of -- I'm sorry, twice where they are today, and prices were half of there they are today. But I was more interested in looking at the margins.

So the margins before the housing bubble were in the 19% to 23% range, and today they are about 15%, 16%, 17% range. And I'm trying to understand, what is the difference in the environment today? Is the land higher?

Is the labor higher? Or is everything just higher? I guess what I am trying to get at is where do you guys think normalized operating margins are going to be, and what's it going to take to get there?

Well I think that it looks, first of all, it's tough to compare the analytics of 15 years ago just off the top of my head. But to give a little tone of where we have seen the sales momentum is building, the price of course of everything over 15 years has certainly changed. I think the ratio of land to the sales price has increased as things have become more complicated in development.

So as everything the government's influence starting from the local city for zoning and tap fees and all these various costs and the regulatory world, it's just like many industries. It's changed a lot, but so have the incomes. The affordability factor I think is one of the higher affordability factors in many, many years.

So these things are all balancing out. As you see where gross profit margins, we are improving ours and others are adjusting as to the balance between land that had not been previously or land that had been previously impaired and large parcels of land that had a speculative factor. We're very focused on executing a plan, and the plan deals with appropriate absorptions which I think the market is moving in that direction.

And the rate of return to the shareholders is in line -- our objectives are in line with that as reasonable within our industry. And we expect to do a little bit better, and we are on track for doing that. We've got more than adequate liquidity at this time for what we are doing.

We are very pleased with the absorption rate. And when you look at Colorado, Nevada, and California, we are able to attract maybe a third of the lots are finished, and two-thirds require development.

And you put all those factors together and you add to it or be sensitive that our net debt to cap is about 34%, which is very healthy. Which shows that we have an adequate balance sheet for growth. And that is what our desire and our objective is.

Right, and I agree your balance sheet is very strong. But regarding the absorption rate, it seems to me that roughly half of where I see most builders would like to be, which is roughly four for a month, and right now we are closer to two a month.

So you mentioned affordability, do you foresee that in the coming years the volumes are going to do back up higher, or do you think because where ASPs are today, that a lot of people with student debts and stuff like that are prevented from qualifying. Somebody was just telling me the other day that the FHA just passed some new regulations that are making it more difficult with people with student loans to qualify. Any comments on that?

I think the absorption that we are doing is moving towards three. I think the industry is not much greater, except in certain markets. The affordability is at an all-time attractive level and the mortgage market is improving.

I believe if you have a job, you have good credit, and you have a down payment, and you have a full set of documents you are going to find a loan for the person. And the variable in some cases made be the down payment, but the mortgage market is opening up and it's opening up on a sequentially improving basis.

More people are changing their credit requirements, and even the government in some form, is trying to help. And the underwriting requirements, there is some new regs that have gone into effect, but every one of us that are in the industry will comply. And that's just part of the government world that we live in.

We are in a regulated mortgage market for certain products, and all of us are obligated to conform to whatever it might be. We will follow.

(Operator Instructions)

Ken Zener, KeyBanc.

Good afternoon, gentlemen. What I've started to do is look at the builders margins by regions, and I wonder if you -- obviously, you have talked about the collective gross margin. I wonder if you could give a little flavor to your EBIT segment margins.

I kind of just did it LTM, so you are basically running 7% EBIT in the West and Mountain, and maybe about 1% in the East. Could you talk about how those regions the EBIT that you guys reported in the Q is different based on gross margin and or SG&A, which can obviously be impacted by price points. I would appreciate that. Thank you.

We don't comment on individual market gross profits, at least at an absolute level. Our 10-Q will be coming out a little bit later today, and I think you will see the dynamics in play in there in our MD&A section.

Okay. And then, Larry, you had mentioned how land prices ultimately need to move to a point that satisfy their customer's ability to be profitable and sustain themselves. How do you think you guys got impacted, perhaps, does that imply 20% margin for you all collectively? Would that be an assumption that we could make?

And then second, how do you think builders that are forced or have made choices to go after land distort that market, given that pricing is strong? So there's, including yourself and some that reported last week have pointed to this labor issue.

It doesn't really -- I'm not sure how the land guys care about the labor issue. If they have a limited land supply relative to what the builders might need to do given other inflationary elements?

Well, I think first of all, on the land front. We don't know what will happen with land prices, generally speaking. But it is going to be dependent upon what demand is out there. And if we do have more limited production capacity, I think you see builders who have bought land in the past may be anticipating higher levels of turnover or higher levels of overall volume in the short term will no longer necessarily be as hungry for that land going forward.

So I think that affects the balance on the land front. As for us, we continue to try to move our margin equation from our land acquisition standpoint asset by asset, and we are going to continue to be very careful about the underwriting.

Thank you. There are no further questions at this time. Presenters, I turn the call back to you.

Great. Thank you very much for being on the call today. We look forward to being with you again for our fourth quarter earnings call.

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