MDC Holdings Inc (MDC) 2016 Q2 法說會逐字稿

Good morning. My name is Mike and I will be your conference operator today. At this time I'd like to welcome everyone to the MDC Holding second-quarter 2016 earnings call.

(Operator Instructions)

I will now turn the call over to Kevin McCarty, Vice President of Finance and Corporate Controller. You may begin your conference.

Thank you, Mike. Good morning, ladies and gentlemen. Welcome to the MDC Holdings 2016 second-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.

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 them 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 operations, cash flows, strategies, and prospects and responses to questions, may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements involve known and unknown risks, uncertainties, and other factors that may cause the Company's actual results, performance or achievements to be materially different from the results, performance, or achievements expressed or implied by the forward-looking statements. These and other factors that could impact the Company's actual performance are set forth in the Company's second-quarter 2016 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 your our website with our webcast slides. Now I will turn the call over to Mr. Mizel for his opening remarks.

Thank you. Good afternoon. I'm pleased to announce the 2016 second-quarter net income of $26.9 million, a 35% improvement over the prior year. The biggest driver of our increased income was a 24% increase in home sales revenues to more than $570 million.

Our 2016 spring selling season ended on a strong note. We recorded our ninth consecutive quarterly year-over-year growth in net new orders and achieved our highest second-quarter monthly sales pace since 2005. We believe that this is strong evidence of the quality of our communities and the healthy demand in the market for new homes.

We're focused on generating higher returns for the Company first, by continuing to improve the performance of assets we already own. A key measure of the improvement we are looking for is return on equity, which improved year over year for the second consecutive quarter.

As we enter the second half of 2016, our continued emphasis will be on accelerating backlog conversion, which is key to sustaining year-over-year improvements in revenues, income, and returns. With that in mind, we are keeping a very close eye on our production levels, especially in light of the strain we see in our subcontractor base, which has caused both cycle times and labor costs to increase.

Our success in accelerating production can be seen in the increase in our second-quarter home starts, which were up 29% from a year ago. After three consecutive quarters of significant year-over-year improvement in starts activity, the total number of homes completed or under construction, excluding models, is more than 15% higher than a year ago. The double-digit increase to our units in production gives us further confidence in our ability to generate significant year-over-year revenue growth in the back half of the year.

The vast majority of our starts and overall construction activity is dedicated to units already sold to customers. As a result, the percentage of our work-in-process units attributable to homes sold continues to move higher, reaching 87% at the end of the quarter. Operating in this manner helped us to preserve our high-quality balance sheet and allows us to operate more efficiently by dedicating more resources to converting sold inventory into revenue.

With revenues already increasing, we continued to invest in new assets that will be a source of future growth. To that end, during the second quarter we spent $166 million on land acquisition and development activity, including the purchase of more than 1,100 lots across our markets. As a result, our total controlled lot supply exceeded 15,000 at the end of the quarter, which should support our ongoing efforts in improving top- and bottom-line results.

We appreciate the efforts of our dedicated employees and subcontractors in making our second quarter a success. I'll now turn the call over to Bob Martin for more specific financial highlights of our 2016 second quarter. Bob?

Thanks, Larry. Our home sale revenues increased 24% from the prior year to $571.2 million as a result of a 13% increase in closings, coupled with a 10% increase in average selling price. In recent quarters our revenue growth has been driven almost exclusively by increases in our average selling price. We're pleased to see that unit growth also is now contributing in a more meaningful way.

Our second-quarter backlog conversion rate was down year over year from 51% to 41%, but that decrease is narrower than what we saw in the first quarter. The 41% is also a sequential improvement relative to our backlog conversion rate of 39% in the 2016 first quarter.

Backlog conversion will continue to be a focus for us in the second half of the year, with an emphasis on cycle times, home starts, and overall production levels. Typically, looking at the last 10 years of data, we see our backlog conversion rate decrease sequentially from the second quarter to the third quarter. However, for 2016, we expect our third-quarter conversion rate to be approximately 40%, roughly flat relative to the 41% from the second quarter. At that level, we would almost be even with the 42% level we achieved in the third quarter of 2015.

Our gross margin from home sales percentage decreased by 20 basis points year over year, mostly as a result of $1.6 million in inventory impairments. Excluding inventory impairments and warranty adjustments, our gross margin experienced 10 basis point improvement to 16.7%.

Relative to the first quarter, our Q2 2016 gross margin from home sales, excluding inventory impairments and warranty adjustments, was down by about 40 basis points. This was due in large part to mix. For example, our Mid-Atlantic states, which have gross margins that are lower than the Company overall, were 13% of closings in Q2 versus only 8% in Q1. It's important to note that even though our gross margin percentage is flat, the gross margin dollars we are making per home closed is now [$5,600], or 8%, due to the gains we have made in average selling price.

We are pleased to see improved operating leverage for the quarter as our SG&A rate fell by 60 basis points from 11.9% to 11.3%, due to the significant year-over-year increase in our home sales revenues that we discussed earlier. Our total dollar SG&A expense increased for the quarter, driven by a $5 million increase in general and administrative expenses. As was the case in the first quarter, the second-quarter increase resulted from higher average headcount and additional stock option expense. Marketing expense and commissions expense both increased for the quarter as well, but these increases were directly related to our revenue growth, for the most part.

The dollar value of our orders increased 15% year over year to $723 million. The increase in dollar value was due to an 11% increase in sales combined with a 3% increase in our average order price to $439,200.

Our net new orders for the quarter were up 11% over the prior year, driven by a 10% increase in our monthly absorption rate to 3.3% per community. As Larry noted earlier, this represented our ninth consecutive quarter of year-over-year order growth and our highest second-quarter absorption rate since 2005.

In part, the improvement is due to our efforts throughout the spring selling season to focus first on achieving target levels of unit activity, with gross margin being a secondary concern. We believe the accelerated pace, when coupled with improvements in our production activities, give us the best opportunity to improve returns for the Company.

The average selling price of our orders improved a modest 3% from the same period in the prior year, somewhat of a slower rate than in recent quarters. Our increased focus on more affordable product somewhat tempered the increase in our average selling price of net new orders.

Looking across the country, California, Nevada, Washington, Colorado were our top markets from an absorption rate perspective, which we think is indicative of solid demand in these markets. Our most improved market was Virginia, which rebounded from a somewhat depressed level of new home sales activity in the second quarter of 2015.

Nevada's absorption rate was significantly lower year-over-year, due to the sellout of some very popular communities last year. However, their absorption rate is still higher than our Company average.

Our homes in backlog at the end of the second quarter were 35 -- up 35% year over year on a unit basis to 3,445 homes, with a value of $1.61 billion, which was up 42% year over year. We expect this backlog to drive significant year-over-year revenue growth for the balance of 2016.

Our cancellation rate increased slightly from 19% to 21% year over year, but as a percentage of beginning backlog our cancellation rate was actually down 200 basis points year over year to 14%.

Active subdivisions increased modestly year over year to 159 at the end of the 2016 second quarter. In Colorado, our active subdivision count was down by 28%. However, this was driven by the timing of opening new communities versus closing out older communities and we expect our Colorado community count to rebound during the second half of 2016. The decrease in Colorado was offset by Nevada, where our active subdivision count has doubled in the past year.

For the second quarter we acquired 1,123 lots for $107 million, an increase from the same quarter a year ago, and sequentially from the first quarter of 2016. The current quarter activity occurred mostly in California, Colorado and Arizona. We spent an additional $59 million on development expenditures, bringing our total spend for the quarter to $166 million.

At the end of the quarter, we owned or controlled 15,146 lots, which represented about a 3.3 year supply on a trailing 12-month delivery basis, and a 3% increase from a year ago. We believe that this supply is a strong starting point as we look forward to the growth potential of our Company in 2017. Beyond the lots we already control, we continue to see a healthy pipeline of land deals across our markets.

We are pleased to report that our key production metrics have improved considerably year over year, giving us confidence we can drive higher home deliveries in the back half of 2016. Our second-quarter home starts were up 29%, marking the third consecutive quarter of year-over-year increases in our home starts.

Our homes completed or under construction, excluding models, at the end of the quarter increased 17% from the same period in the prior year. This increase is important as these units make up a big part of what we can close for the remainder of the year.

In addition, consistent with our build-to-order strategy, 87% of the work in process units you see here at the end of the second quarter are already sold, compared to 72% a year ago. We believe the higher percentage sold increases the likelihood of closing these in-process units by the end of the year.

Additionally, we believe the high percentage sold also speaks to the quality of our balance sheet, with limited speculation in unsold units. Bottom line, the improved production activity complimenting our increased backlog at the end of the second quarter, we have set the stage for top- and bottom-line growth during the second half of 2016 with mindset focused on improving overall Company returns.

That concludes our prepared remarks. At this time, we would like to open up the call for questions.

(Operator Instructions)

Your first question is from Mike Rehaut from JPMorgan.

Thanks. Good morning, everyone, and nice job on the quarter.

First question I had was just on community count. Bob, I think you mentioned that you expect some growth in the back half. I was just trying to get a sense of the degree of magnitude there. Obviously, you ended the quarter a little lower than you began, so should we expect to see that number get into the -- back into the 160s or even better than that?

Yes, that sequential decline you're talking about was almost all Colorado. It was down 12 subdivisions sequentially. On our prior earnings call, end of Q1, we had commented that we didn't expect much growth from there to the end of the year. At that point we were at 169 active communities.

I still think that's probably a pretty good ceiling for us for the year. With additional Colorado communities coming back online, we've got a potential to get there. Of course, it's all dependent upon what the sales activity is over the next two quarters and how smooth the openings go.

Great. That's helpful. I guess just then also on the nice improvement in sales pace, if you look at the year-ago comps, 3Q and 4Q at least get a little bit tougher in terms of that you had some nice improvement there in the back half of 2015 over 2014. I was just curious if you think this roughly 10% improvement in average sales pace is sustainable on a year-over-year basis going forward or perhaps should that moderate a little bit?

It's a good question and the sales activity we have to take on a month-to-month basis. Right now I think the activity that we saw in the second quarter, there was nothing there to indicate that it was slowing down.

In fact, looking at June, that actually had the biggest year-over-year increase of three months in the second quarter. I don't have any indication of that, Mike.

When you say June having the biggest increase, you're referring to sales pace specifically?

Just the year-over-year improvement, the level of year-over-year improvement.

Right. In sales pace, though?

In overall sales. But your active subdivision count isn't necessarily going to vary a whole lot month to month.

Right. Okay. Great. Thanks so much for the help.

Sure thing.

The next question is from Nishu Sood from Deutsche Bank.

Thank you. I wanted to ask about, Larry, the kind of strategic tilt that you mentioned in your opening comments. The increase in the units that are under construction, obviously 80% of those, I believe, are already sold.

With the aim to improve your deliveries and your turnover ratios, which has obviously dipped in the last year, what are your targets there? I imagine you're thinking about getting them back to some sort of historic norms. What period would you consider historic norms?

I'm just thinking along the lines of when you were working on your specs, you gave us great color about where you're trying to get those to. That seems to be wrapped up. I'm just trying to get some sense of how long this process is going to be and what you would aim for in terms of getting back to norms.

I consider where we are today being really good and it's a very competitive world out there and you have to work really, really hard to have the level of performance that we're currently experiencing. I don't think our world has expected norms from prior history as we listen to the things that are happening every day. It's certainly challenging and I don't have a recollection of worldwide negative interest rates.

We're fortunate that we're in this country and we're in homebuilding, and so we're in a good industry with solid demand and my expectations are to continue to perform in the way we are. As you comment on 87% of our whip is presales, it's a reinforcement of our balance sheet discipline.

As you know, we don't speculate in land. We have a nominal amount of unsold inventory. The land we own is all active. Most -- not most but many of the assets that we hold are already fully developed, as you can see. The options are almost 15%. What we've done is continued what you can expect us to do over the last decades and the last decades show that we're a conservative builder that pays attention to basic business and we're proud of what we've achieved and we expect to, subject to market conditions and the economy, to have reasonable improvement in light of all the circumstances that all of us deal with daily.

Got it. I mean, I guess just looking at some of the numbers, the 2,900 of your work-in-process units that are under construction, 87% are sold, which means that you've got about three-quarters of your ending backlog under construction. What's going to give you the sense -- I mean, is that how you're thinking about it? I imagine since you presented those stats that, that's probably an important part of your thinking. If three-quarters of your backlog is under construction, do you think would you want that to go higher or how are you going to judge the success of this initiative, Larry?

I think the success always deals with market conditions. The current market conditions would lead one to believe that there's future growth in the top and the bottom line and we're focused on, as we commented earlier, increasing our ROE.

You take in aggregate all the elements that create profitability and as you know, we deal with each and every one of them and I believe that we have a management team that is very, very good and seasoned, where as you look at each of the markets that we're in, we are in some very attractive markets for not only the present, but the future. It would be our desire to expand our footprint in the markets we currently serve.

Bob did not have a chance to mention, but someone I'm sure will ask about our new affordable efforts on the seasons. We are rolling out and we'll accelerate the roll-out of a more affordable product, which I believe that there will be an opportunity for reasonable expansion because of hitting an affordable number, which of course as you know differs in each market.

We're focused on the basic business. We're focused on the balance sheet. We're focused on growth. The growth we see is in our current markets with a more affordable product.

Those of you that are familiar with our product, I encourage you to come see it. It's really, really good and it's special because it's an attractive unit at reasonable pricing and as I said in each market the pricing's different. Our focus is on growth and I feel comfortable that subject to the volatility of the world we live in, housing as an industry seems to be solid.

There's some recent statistics that new home starts are running at a low level compared to higher levels in the past at about 0.57% of the US population and that means that there is substantial opportunities through expanding the housing market vis-a-vis our total population in our country. This is an opportunity not only for us, but for the entire industry.

Got it. Thanks. Appreciate the thoughts.

Your next question is from Ivy Zelman from Zelman & Associates.

Good afternoon. Good job, guys. Congratulations.

Larry, you just mentioned what I was going to ask you about on the entry-level Seasons brand and the strategic decision to accelerate that product offering with that significant deficit for this country with a lack of affordable product. Maybe that explains your land spend being up 25% year over year, where most other builders are maintaining a pretty steady pace of land buying. Maybe help us if that is the case.

Also, how do you overcome the impediments that others are complaining about with respect to generating enough of a return on dirt for an affordable price point because of things like impact fees and other costs that seem to deter others from making that strategic decision? I have a follow-up. I'm sure that was a lot, but thank you.

Sounds like four questions and a follow-up, so I'll try to answer a couple of them and maybe Bob will talk a little bit more on the product. Our land spend is consistent with what we've done as a basic business. That is our goal is approximately a three-year supply of land and we've done that for decades because we believe that's a risk factor in the balance sheet when people speculate on land and we don't do that.

The issues of cost, there's a good side and a bad side of cost. The good side, it lends for higher employment in the industry. It would not surprise me that in the entire country that almost every major builder or even minor builders could use 20% more labor and that's both a problem and an opportunity.

It's an opportunity for the country and it's not really a problem. It's what you manage to. I would rather have stronger demand and be looking for expanding our subcontractor base than having less work and having that not be an issue. The land spend will over future periods reflect our desire and our intent to increase the work we're doing.

The other builders that you've commented on, and I'm not familiar with which ones you're speaking about, contraction in gross profit because of land cost, I think you can go back to the last cycle. One of the things MDC demonstrated is that we were able to make a reasonable gross profit at that time without speculating in land and we made our profit by building and selling homes, not speculating in land. The market that we're in now we believe that there's a reasonable balance between cost and expected market value of your inventory and with good management you should be able to develop a reasonable rate of return for your shareholders, which of course is what we focus on, is creating value for our shareholders.

Now, Bob maybe you -- Bob will answer your follow-up question, since I answered the three, about the Seasons to give Ivy and everyone on the call a little more color of what it is and where we've done it and our expectations in it.

I'll comment on a couple areas. First of all, the land spend that's coming through this quarter, it's not necessarily the more affordable stuff. It reflects AMC approvals, our asset management approvals, from a few quarters ago. I think we are seeing increasingly that what we are approving are those more affordable deals and that will contribute more significantly to land spend in future periods.

As for the -- just the Seasons product itself, that's one way that we're addressing affordability. First of all, the incidence of sales of that product went from about 1.5% of our sales to 3% of our sales from Q1 to Q2.

Still a very small part of what we're doing but it's starting to grow pretty quickly for us. Initially, we had built that product on subdivisions that we already had in place, land that we already owned, as a complement to product we already had there.

Ivy, you asked, well, how do we combat increased costs, fees that are associated with some of these areas that are obviously a bigger piece of the pie when you're talking about a more affordable product. I think really it's being innovative about what we're doing.

Colorado is really our biggest market for Seasons right now and we did something that most builders don't do and we didn't build a basement in this product. Most homes in Colorado have a basement. We said you know what, in order to drive the affordability we think maybe this first-time consumer can do without. We think that still hits the mark.

We're able to take out quite a bit of cost by doing some of those things that maybe aren't the norm in a given market and drive affordability that way despite, some of the other costs that become a bigger percentage of our overall costs. Hopefully that helps a little bit as well, Ivy.

Absolutely. If I could sneak in one more. I know I asked a lot. If you had a vision in two to three years what percent of your business you think would be the entry-level Seasons brand? I don't believe you've commented on market commentary, various divisions. Can you give us some of your best performers within the footprint versus what might be the weaker links if any, please?

Right. In terms of how we look forward, whether it's Seasons or other more affordable product, we have seen that our first-time buyer, the percentage of our overall pie of kind of true entry-level buyers has decreased to roughly 20% of our overall closings. I think over time if you look in our history, that piece of our overall pie has been closer to a 40% type of number. I think that's really the order of magnitude that we're thinking about provided that we do see this consumer continue to come back in a significant way. That's how I'd answer that one.

With regard to market commentary, the stronger markets that we have seen, Colorado is certainly up there. It's our home market but it continues to perform very well for us, absorption rate higher than the Company overall. I think the same can be said for Washington.

California is our highest absorbing market right now. I think it speaks to just overall how low of a level of production goes on in California relative to the rest of the market, but also the fact that we have -- we have stayed relatively affordable, I would say, in that market. I think that has struck a pretty decent cord in that market.

The other one I would highlight is Las Vegas. We have a very strong operation out there. Even though we did see the absorption rate come down a little bit year over year in Las Vegas, it has consistently performed above the Company average from an absorption rate perspective.

On the other end of the spectrum, the one that I would say is on the lower end of performance would be our Mid-Atlantic market, both Virginia and Maryland. I say it with a caveat. It's one of our lower performers, but that performance has improved over the last year.

I think at this point last year it really seemed pretty depressed for us. It's up year over year but I don't think we're out of the weeds yet. We are focusing on that market constantly and of course we're mindful that we're in a political season here and that probably doesn't help things in the greater DC area.

That was great. Thank you. Good luck.

Thanks.

The next question is from John Lovallo from Bank of America.

Thanks for taking my call as well. The first question is, Bob, the first quarter call I think you indicated that the 2Q backlog gross margin was above 17.1%. We came in a little bit lighter than that in the quarter. Can you maybe talk about some of the puts and takes there and then also how you're thinking about gross margin in the third quarter.

Yes. We've talked a lot about it in the past and as you heard from some of the comments that I had in the call, we're de-emphasizing gross margin a little bit. If you look at gross margin before things like impairments and warranty adjustments, over the past five quarters it's been relatively stable. There's I think been only a 70 basis point difference separating the high and low.

While I think there is room for improvement in gross margin over time, for the short term my outlook would be for really just continued stability. I don't think there's anything significant to report on that front.

With the competitive land market and limited subcontractor availability driving our costs higher, achieving margin expansion is an uphill battle. We have been able to offset the higher cost by raising prices where sales velocity justifies it but there's not a guarantee that we can continue raising prices in the future.

For now, we're really focused on hitting our internal goals for unit volume. That's why you've heard us talk a lot on this call about the drivers of unit volume, absorption rates, backlog conversion, production levels, cycle times. That focus on volume is really what gives us the best opportunity to improve our returns which, as Larry noted earlier, have already moved higher alongside our revenue gains in the second quarter.

Okay. I guess the second question would be in terms of the labor markets and also perhaps in terms of entitlements in general, have you seen -- for labor, have you seen further tightening sequentially? I guess in terms of entitlement, have you seen delays, further delays in any areas that are noteworthy?

I would say there's not a whole lot of difference sequentially. Maybe still a little bit more in Denver, but if you look at our cycle time overall, sequentially it was stable from Q1 to Q2. I think that's actually encouraging.

How about for the entitlement in general?

I mean, there's not a whole lot we do on the entitlement front. We don't take entitlement risk on balance sheet, so it's not as big of a concern for us, but from what we kind of hear out there in the market and from people who are doing entitlement work for us, I don't -- nothing sticks out to me. It always seems like it's a matter of the cities and just how busy individual jurisdictions might be in getting that processed.

Okay. Thank you.

The next question is from Will Randow from Citigroup.

Hi, guys. Thanks for taking my questions.

Sure.

In terms of thinking about the balance sheet with the step-up in land investment as well as cash flows, how are you thinking about leverage over the next year or two, particularly with the balance of you guys have done a great job returning capital to shareholders through the dividend but you also have to fund that as well as land. Can you kind of talk about capital allocation, how we should think about cash flow from operations over the next year or two?

I think it's been pretty consistent, in line with what we're experiencing. If we're able to find opportunities as you have seen by looking at our balance sheet, we have substantial liquidity. We have substantial unused line of credit.

We're always opportunistic and you should assume that whatever is good, reasonable business judgment, we will continue to execute on and that should give you the comfort of knowing that we're always looking to the future and judging the present.

On an unrelated follow-up, in terms of the SG&A, you guys have done a nice job, particularly on marketing expenses or leveraging those, if you will. How much lower do you think you can run SG&A over the next year or two or how much leverage do you get until you kind of get to steady state?

I think that you've got fixed and variable and I think our fixed is -- has legs to expand on the fixed and you'll be able to leverage into hopefully continued reduction in that number, at least in the short term, we can see an ability as our gross revenues increase. Other than the variable expenses, the fixed should be kind of constant and that's a reasonable opportunity to look at.

Thanks again, guys, and congrats on the progress.

The next question is from Alex Barron from Housing Research Center.

Good afternoon, guys, and good job on the quarter. I wanted to focus a little bit on the Colorado market. I understand you said you expect to see more community openings in the back half.

I was hoping you can elaborate whether that is third quarter or more weighted towards fourth quarter? Also, last year, in the back half of last year, the orders kind of dropped off a bit and I'm wondering if you guys are expecting to see a rebound in the back half relative to what we saw last year?

Yes, I guess first of all, I think you could see some increase in the third quarter for Colorado. There's a lot of subdivisions that we have. Some of them have already opened. Some of them are on the verge of opening. A little bit of it depends on just the timing of when those occur and how much initial velocity that we get. I think there's a chance for it in Q3 but to give ourselves a little bit of extra room, we've just really talked about the second half of the year.

As far as orders go, as I noted with an earlier caller, we didn't see any reason why -- we didn't see anything within the quarter, I should say, that would indicate that things were slowing down from a year-over-year perspective and that, that month of June was actually up a little bit more year over year than the other two months. We actually saw a little bit of acceleration throughout the quarter when you're talking about the year-over-year comparatives.

Okay. I guess as it pertains to your comments on backlog conversion and your strategy of launching these new communities, particularly in Colorado, are you guys going to be spec building some more of that entry level -- some more of those entry-level houses as a way to try to improve the backlog conversion as it pertains to Colorado?

No, no. I think in and of itself, just that product is much better from a cycle time perspective. Just early on, the product that we've built might be a three to four month cycle time versus overall. For the Denver market, you're closer to a 9 or 10 month cycle time. Just by virtue of the fact you can build it quicker, we don't feel the pressure to necessarily spec build it and that's even beyond just our overall feelings about the spec building strategy.

Okay. If I could ask one last one, Bob. As it pertains to interest and cost of goods sold, I believe your interest incurred is running roughly at $13 million a quarter. Should we expect that the interest in cost of goods sold is going to decrease or flatten out in terms of dollars and decrease as a percentage of revenues going forward?

I think the more we're able to achieve higher unit volumes, higher absorption rate, that's one of the side effects, one of the very good side effects of that occurring is you can actually have some improvement to your margin by virtue of better leveraging that interest, better leveraging construction overhead. I think that's a possibility to the extent we continue to see pace expansion as well as revenue expansion.

Okay. Thanks a lot.

(Operator Instructions)

The next question is from Ken Zener from KeyBanc.

Hi. Good morning, everyone. This is Adam on for Ken. First, when looking at your three regions, just in the context of relatively flats gross margins year over year, just wondering if you could provide an outlook for regional margins versus what we saw last year.

Second, I notice that communities grew quite a bit in the East, were more stagnant in the West and down quite a bit in Mountain, as you said, due to Colorado, both the later two your most profitable regions. Is this sort of a shift in regional strategy? And were you guys thinking you can maybe unlock some profit potential out east and perhaps less out west? Or is this just a result of community portfolio shifting around in the quarter? Thank you.

I guess first of all, with regard to regional margins we don't provide a whole lot of color there. I don't want to get a whole lot into the regional margin picture.

With regard to asset allocation, community allocation, yes, I think you did see a little bit more of an increase in the East. I think it's really a function of last year, we were still trying to get a lot of communities going in the east and they finally came to fruition and resulted in that increased count.

You're seeing a similar thing here in Colorado now, as already commented, came down a little bit because some of the communities are just now coming online and haven't reached that -- our magic number for active subdivisions, which is five sales to be active. It's not indicative of a shift in strategy when you talk about the shift between East and Mountain, or I guess Mountain to East, in this case.

Thanks. Would we kind of expect kind of the closing mix to stay roughly the same between regions, let's say just this year?

I don't think there's any huge shifts that would lead you one way or the other. You can certainly kind of look at backlog and see how that's shifted. I don't think there's anything that necessarily drives me one way or the other when I look at backlog and the direction backlog's gone over the last year on a market-by-market basis. Relatively consistent going forward.

The only thing I will say is Mid-Atlantic did bump up just a little bit here, sequentially. It went from 8% to 13% of closings. You might see that moderate a little bit, come down just a little bit.

Okay. Thanks, guys.

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

All right. We appreciate everyone joining us on the call today and we look forward to talking with you again after we disclose the results of our third quarter.

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