MDC Holdings Inc (MDC) 2016 Q3 法說會逐字稿

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

Thank you, Kelly. Good morning, ladies and gentlemen, and welcome to the MDC Holdings 2016 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 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 third-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 our website with our webcast slides. And now I will turn the call over to Mr. Mizel for his opening remarks.

Thank you. I'm pleased to announce 2016 third-quarter net income of $26.4 million, a 78% increase over the prior year. The improvement was driven mostly by a 27% growth in home sales, with revenues more than $575 million.

Generating higher returns has been a key focus for us. Looking at our return on equity, on a rolling 12-month basis, we have now seen for four consecutive quarters of improvement, the 2016 third quarter, we increased this metric by 200 basis points over the prior year.

The expansion of our income, revenues, and returns are rooted in a disciplined philosophy, focusing on strong execution of our build-to-order model. We believe that this approach gives us the best opportunity to sustain our operations through the inevitable cycles of the home building industry, while limiting our exposure to risk.

Our build-to-suit model has allowed us to focus on construction activity on units already sold to customers, resulting in the percentage of our work in process, units attributed to sold homes reaching 87% at the end of the quarter. Operating in this manner not only helps us to operate more efficiently, by dedicating more resources to sold inventory, but also reduces the risk associated with our work in process units.

Our cycle times continued to increase during the quarter, based on limited subcontractor availability in some of our larger markets. Improvement in cycle times will remain a key theme for the Company as we close out the year. However, subcontractor availability issues are largely out of our control, and unlikely to resolve quickly, so we are in the process of working on other initiatives to help our construction process.

The most prominent example of these efforts is the development of our Seasons collection, which we have discussed in prior quarters. This new product, designed with affordability in mind for the first-time homebuyers has a more simplistic design, and a shorter construction time than most of our other plans. As this product becomes a more significant part of our business, it should have a positive impact in our overall cycle times.

We believe that our Seasons collection has been well received by our customers. Already in the third quarter, our results include a notable contribution from this collection, even though it is still in the very early phases of its rollout. In total, order results were positive, as we recorded our 10th consecutive quarter of year-over-year growth in net new orders, and an increase in our monthly sales pace by 15%.

Given the initial success we have seen for the Seasons collection, we have increased our overall spending on communities that feature this product. Overall, during the third quarter, we spent $150 million on land acquisition and development activities, including the purchase of more than 1,000 lots across our markets. Our total controlled lot supply was almost 15,000 at the end of the quarter, which we believe is sufficient to support our ongoing efforts to improve top and bottom line results.

As 2016 draws to a close, our outlook is positive. We are delivering higher revenues, income, and returns than a year ago, with a balance sheet that remains among the best in the industry. Against this backdrop, we have continued to reward our shareholders with a strong consistent dividend payment since 2005, with a yield that ranks as the highest in our industry.

In addition, we believe that our strong backlog to end the third quarter gives us the opportunity to continue delivering year-over-year improvement to our operating results in the fourth quarter. Thank you for your interest, and now I'd now like to ask Bob Martin for more specific financial highlights.

Thank you, Larry. Our home sales revenue increased 27% from the prior year to $575.7 million, as a result of the 20% increase in closings, which was our highest year-over-year increase in closings in 12 quarters. We also had a 6% increase in average selling price.

Our third-quarter backlog conversion rate was down year over year, from 42% to 38%. Although that decrease is narrower than what we saw in the second quarter, it still fell short of our expectations. Limited subcontractor availability in certain of our larger markets continued to negatively impact our cycle times, especially in Colorado, Southern California, and Washington.

Without any clear signs that subcontractor availability will improve in the short term, we believe that our backlog conversion rate will continue to fall short of our prior-year performance in the fourth quarter. However we do expect sequential improvement, with the goal of achieving at least a 400 basis point increase from the third to the fourth quarter.

Our gross margin from home sales percentage decreased by 90 basis points year-over-year, mostly as a result of $1.8 million of warranty adjustments, and higher land and construction costs in certain of our markets, most notably Nevada. Excluding impairments and warranty adjustments, our gross margin was down [50] basis points to 16.7%.

We took $4.7 million of impairment during the quarter, compared with $4.3 million for the same quarter a year ago. The impairment during this year's quarter was mostly related to one asset in our Virginia division. In addition, we had one more minor impairment in Florida.

Looking at the sequential trend, relative to the second quarter, our Q3 2016 gross margin from home sales, excluding inventory impairments and warranty adjustments, was flat. It's important to note that even though our gross margin percentage is down year over year, the gross margin dollars we made per home close was flat, due to the gains we have made in average selling price.

We were pleased to see improved operating leverage for the quarter, as our SG&A rate fell by 180 basis points from 12.6% to 10.8%, due in large part to our significant year-over-year increase in home sale revenues.

Our total dollar SG&A expense was up for the quarter, driven by a $3.7 million increase in commissions, and a $2.8 million increase in marketing. These increases were primarily due to the growth in our closing unit volume, and home sales revenues. The higher commissions and marketing expenses were partially offset by a $2 million decline in general and administrative expenses, primarily due to the lower stock-based compensation expense.

Outside of SG&A, there were a couple of other variances on our income statement I'll give a little additional detail on. First, other expense for the third quarter was a bit on the high side, increasing by about $1.2 million year over year. The increase was related to the write-off of several option deposits in Virginia, for products we decided not to move forward with during the quarter.

The impact of those write-offs was more than offset in several other areas. In particular, interest and other income was about $1 million higher for our third quarter versus a year ago, and our other than temporary impairment of marketable securities was about $2 million lower.

The dollar value of our orders increased 17% year over year to $570.3 million. The increase in dollar value was due to a 17% increase in sales, driven by a 15% increase in our monthly absorption rate, to 2.72 per community. As Larry noted earlier, this represented our 10th consecutive quarter of year-over-year order growth, and our highest third-quarter absorption rate since 2005.

Our affordable Seasons collection is starting to become a much more significant part of our business. For the 2016 third quarter, this product offering accounted for 5% of total orders, despite being offered in only seven subdivisions, across two of our divisions. In these two divisions, Seasons accounted for more than 10% of all orders in the third quarter.

The average selling price of our orders was almost unchanged from the same period in the prior year, at roughly $440,000. This is the first time in quite a while that we have not seen a year-over-year increase, and that's driven by a shift in mix to lower price communities that was partially offset by price increases in many of our communities. Specifically, again our Seasons collection is having much bigger impact. Excluding the sales from our Seasons collection, our average order price would have risen by 2% year-over-year.

Looking across the country, California and 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 Colorado, which had a particularly strong performance from our Seasons collection, as well as other products in more affordable areas.

Our homes in backlog at the end of the second quarter were up 33% year over year on a unit basis, to 3,448 homes, with a value of $1.61 billion, which was up 37% year over year. We expect this backlog to be a primary driver of year-over-year improvement in home sales revenues in the 2016 fourth quarter. Our cancellation rate was flat year over year at 25% for the 2016 third quarter. As a percentage of beginning backlog, our cancellation rate was down 100 basis points year over year to 13%.

Active subdivisions increased modestly year-over-year to 159 at the end of the 2016 third quarter. In Colorado, our active subdivision count was down 24%. However, this was driven by the timing of opening of new communities versus closing out older communities, and we still expect our Colorado community count to rebound. The decrease in Colorado was offset in part by Nevada, where our active subdivision count has increased significantly over the past five quarters.

For the third quarter, we acquired 1,056 lots for $81.9 million, a decrease from the same quarter a year ago, and sequentially from the second quarter of 2016. The current quarter activity occurred mostly in California, Colorado, and Nevada. We spent an additional $68.3 million on development expenditures, bringing our total spend for the quarter to $150.2 million. This is the first quarter that we purchased lots specifically underwritten for our Seasons homes, with more than 20% of the lots we acquired dedicated to this product.

At the end of the quarter, we owned or controlled 14,759 lots, which represented about a 3.1 year supply on a trailing 12-month delivery basis, and a 6% decrease from a year ago. While our supply is down year over year, it is still in line with our strategic range. 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're pleased to report that our key production metrics continue to improve year over year, giving us confidence that we can drive higher home deliveries in the 2016 fourth quarter. Our third-quarter home starts were up 18%, marking the fourth consecutive quarter of year-over-year increases. 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 current year, and during the first quarter of 2017.

In addition, consistent with our build-to-order strategy, 87% of the work in process units you see here at the end of the third quarter are already sold, compared to 76% a year ago. We believe the high percentage sold also speaks to the quality of our balance sheet, with limited speculation in unsold units. Given where we stand from a backlog and production standpoint, we expect top and bottom line growth during the last quarter of 2016, with a continued focus on improving overall Company returns.

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

(Operator Instructions)

Alan Ratner of Zelman & Associates.

First one, just thinking about the orders versus the backlog conversion dynamic going on here. You put up a great order number this quarter, but continuing to see pressure on backlog conversion and cycle times. And I think one thing we hear from a lot of builders is they are reluctant to sell too far out in their backlog, because A, they don't have visibility into their costs in that situation. B, it increases the risk of cancellations.

And I'm just curious where you are in that dynamic today? If there's any risk or are there any markets or communities where you are actually having to tell buyers, or turn buyers away because the backlog is too far extended? And if not, at what point do you hit that threshold?

I would say it is something that we look at, and that we are concerned with. And it's not the dynamic where we are just letting demand go without check. We are doing things to respond to the fact that we are having positive results in our orders, one of them being we are increasing prices. And in doing so, of course that helps us cover future cost increases that might occur. In fact in the third quarter, we increased prices in about 60% of our communities.

As far as stopping sales altogether, we haven't done that for the most part. There are limited circumstances where that might be the case, but for the most part, we haven't completely shut it down, though there are some cases where we limit the lot releases.

The other thing I think to realize on our orders for the quarter is that some of that increase is related to the fact that we have increased our sales of our new Seasons product line. So we're really reaching out and servicing a customer that's been largely underserved over the past few years. So we think it's a prudent thing, to make sure that we are capturing that demand.

Thank you, Bob, for that, that's a good segue into my second question on Seasons. So it sounds like you are seeing a lot of good traction there. You mentioned the cycle times at the Seasons are shorter than the traditional business. I was curious if you could quantify that?

And with the Seasons now representing, I think you said 10% of orders, just curious, what's the margin differential on that product versus the traditional business, as well? And should we expect to see any type of mix impact on margin? You did mention pricing power, which is good to see, but is that going to be offset by the Seasons contributing a greater percentage closings going forward? Thank you.

Yes, I think for Seasons, first of all as it relates to cycle time, it depends by market. We've got it in Colorado right now, and we've also got it in Arizona. Colorado, right now, cycle times are 9 to 10 months.

We could see it being closer to, say, five months for the Seasons product. Now you have the caveat that we haven't closed a whole lot of those yet, so there's that caveat out there, but we do have that potential. And in Arizona market, where the cycle times are already much more compressed than that, the differential is much less.

As for the second part the regarding margins on the Seasons product, so far we have not seen any deterioration on the gross margin percentage, really. And keep in mind, we have mostly released it right now in subdivisions where we had previously been operating. So when you compare it to our traditional product versus bringing out the new Seasons product, we have not seen gross margin degradation. But certainly, we will update you as to what we're seeing, as it becomes more prominent in future quarters.

And then last thing I want to say is just to make sure it's understood that Seasons product was 5% of our overall orders for the entire Company, and it was north of 10% in each of those two markets I just mentioned, Colorado and Arizona. So just to clarify there.

Stephen Kim of Evercore.

Thanks for all the info here on Seasons. When you talk about the fact that you are increasing prices in certain markets, I think you said 50% of your communities, as a result of backlog being a little far out there, I was wondering if this makes you feel a little different about the potential weighting that margin can play in your ROE initiatives going forward? Last quarter, for example, you were pretty clear that you felt you were going to move the focus much more towards turns and away from margins, but just was curious if you could revisit that?

I'd be happy to, Steve. I think you have got it ice cold on what our mindset is. We have to be sensitive to margins to a degree, because it does filter into the discussion on profitability. But I do think that making sure we've got a good drum beat on unit volume is perhaps even a little bit more important, as we look at returns.

And there's a couple reasons for that. If you're getting unit volume, you've got a better potential to turn your inventory more quickly, which has an a positive impact on your return on equity. If you look at even gross margin itself at higher absorption levels, gross margin tends to increase to some degree, simply because you're leveraging things like interest and cost of sales your construction overhead and things like that more efficiently. So for reasons like that, I think it's prudent to have a little bit of a tilt towards that unit volume.

And as for the gross profit margins, really what we've seen there is stability. If you look over the last six quarters at our gross profit margin, there's really not been a whole lot of variation, about 70 basis points. Once you take out the impairments and warranty adjustments, only about 70 basis points from high to low over that six quarter period. We still feel pretty good about where we stand from a margin perspective.

Okay, great. Appreciate that color. One area where you did better than we were expecting was actually on the SG&A line, and in particular, I think you went through and I didn't hear anything that sounded of a one-time nature, but I thought I'd revisit it and ask. Was there anything there that you think if we were to peel the layers back, we would say, that's something that may not recur in the fourth quarter and beyond?

Yes the biggest reason for the change in our absolute level of G&A was stock-based comp, which decreased year-over-year. In terms of one-time items, there's nothing that comes to mind in particular that's very significant. I always like to get the caveat that you can always have things plus or minus in future periods, adjustments to your reserves and one-time items on legal and things of that nature. But there was nothing really like that in the third quarter.

All right, excellent. Thanks very much, appreciate it.

Nishu Sood of Deutsche Bank.

So on the Seasons product, I mean the way you have configured it at shorter cycle times, simplified product, and I think most people would assume that from a marketing perspective, that would be attracting the entry-level millennial or first-time buyer. But in a lot of cases, I think builders have found some move down, some affordability-driven buyers, given the price appreciation on the closer-in areas.

What have you found so far in Arizona and Colorado on the product? Is the buyer set as you expected from a marketing perspective? Or have there been any variations from that?

I think it's a good question, and I think for the most part, we see a lot of appeal from that first-time buyer. I do think you've hit on something there though, in that we do see that it does serve double duty to a degree. You do have people who want a smaller home.

These houses in the initial release are really from a 1,400 to 1,800 square foot range. You've got some nice ranch plans that are smaller that appeal to an older consumer, a move down type of consumer. So we have seen some of that as well, and it's really a great story for us, because it can serve both purposes.

Got it. Second question I wanted to ask was on the backlog conversion ratio. So at the beginning of the year, you folks and many others had expected some improvement in backlog conversions and cycle times. Some builders have seen that. I think on balance, they are flattish year over year.

I just wanted to dig into the specific drivers. I think Denver had been a big part of it but your Denver numbers are actually, I think, flattish on a year-over-year basis. What -- it looks like in Nevada and California, the problems are a little bit more pronounced. How would you characterize it?

Is this in certain communities, is it a widespread problem across your communities where it's a -- some delays in all of your communities? And a difficult question to answer, but what do you see happening? And obviously is an area of focus for you for 2017, but what do you think it will take to get those problems to ease, as you are seeing it across your portfolio?

Yes, I think in terms of how widespread it is, I don't think it's the same in every market. I do think in a market like Colorado, it's a little bit more widespread, and Colorado is a place where you've seen really the lowest backlog conversion of all our markets. Clearly it just happens to be our biggest market, so it has a relatively bigger impact on our operations relative to our average peer, I would imagine. So there's that dynamic, too.

And as you get to some of the other markets, I would say, we also mention Southern California and Washington being impacted, and maybe a little bit less so than Colorado. And Phoenix and Las Vegas to a certain degree we saw it, but I would say that was a little bit more isolated, where we saw that occur. And of course, as you look at what happens when you have those labor issues, you tend to get bunched up in other places, as well. If you have an issue with framing, maybe you get bunched up somewhere down the line, but there's other things that have been a little bit of a challenge for us.

Even things like getting appraisers on-site on a timely basis. Something as basic as that isn't as easy as it used to be, just in terms of the time it takes to get those people on-site for appraisals. There's a variety of different things, but that's really the overview.

Great, thanks.

Michael Rehaut, JPMorgan.

First question I had was just, wanted to get a little bit more on some details, thinking about the fourth quarter. I believe last quarter, Bob, you outlined or shared an expectation to end the year community count wise at around 169, if I have that right. And maybe seeing just slight growth in the third quarter. So you're about flattish in the third quarter, and from a quarter-end standpoint, do you still expect the 169 by year end? And with lots down year-over-year, how should we think about community count growth for 2017?

Yes, as far as the 169 goes, I think last quarter, I described that as really a feeling for where we could expect to be by the end of the year. And [mid-year] at 159, given that we are in the fourth quarter where [more] activity typically is the lightest. It's tough for me to commit to 169.

I think a lot of it depends on how quickly some of the orders come through in Colorado, where I mentioned we are down about 24% year over year. But we think that's somewhat temporary. It's just a matter of whether or not those new subdivisions come online in the fourth quarter, or if it ends up being the first quarter of next year.

As far as next year's average community count growth potential, I think there's potential still there. I'm not ready to give a range at this point. I think we still have some time here in the fourth quarter to influence what happens there, and it's a little bit more impactful for us what happens in the fourth quarter, just given our lower level of land supply overall.

Okay. No, that's helpful. Secondly, just going back to Seasons for a moment, and there was a question earlier on the impact of gross margins. Just wanted to clarify there. You said I think that in Colorado, Arizona, it hasn't had a deteriorative effect on gross margins, but obviously, it's just a very, very small portion of closings.

So I wasn't sure if you were referring to that, because I think the bigger question is just the product itself. Typically this type of product carries a lower gross margin, versus, let's say the corporate average or the move-up product, and just wanted to be clear what exactly you are referring to, because I think you said it's similar, or there was really no impact. But I wasn't sure if that was just because it was such a small piece of the business, if you were to look at it apples-to-apples.

No, I get your question, and let me just clarify that. I'm talking about gross margin percentage here.

Yes.

And based on the full body of information I have right now, whether that's closings our backlog or sales, just overall I'm not seeing that they are coming in a lot lower than other product in the subdivision. If that makes sense. I'm not seeing it, so other stuff with the same land bases in some cases. I think right now we don't see that, based upon the information we have out there or experience, that it has any degradation to the gross margin percentage.

But again I caveat that with, this is all in subdivisions that we had previously operated in with other product. It doesn't include yet subdivisions that were specifically underwritten to the Seasons product, and it is still pretty limited experience overall. Even though it's increasing, it's still only 5% of our orders. So as we expand the footprint of the Seasons collection, we will see if that continues to hold true.

Great. If I could just squeeze in one more, just a couple of housekeeping items. How should we think about the tax rate for the full year? This quarter is a touch under 31%.

Just thinking about the full year and maybe what the run rate would perhaps be for next year? And when you also refer to the stock-based comp in 3Q and the SG&A line being lower year-over-year, just curious if that's something that would carry over as a benefit into 4Q, or if that was one of the drivers in the really good leverage that you had in the quarter, as compared to the last couple quarters.

Sure. So in terms of the second part of your question, first, on stock-based compensation, we had a relatively high charge going through there related to A, option grant that occurred in May of 2015 and that expense was going through for really the third quarter of 2015 through the second quarter of 2016. So after the second quarter of 2016, that expense is done. So third quarter of 2016 was the first time we didn't have that in a year.

So there's nothing else out there right now that directly substitutes for that. All else equal, we would not expect that expense to recur in the fourth quarter. And then the other part of your question, I'm sorry, what was the other part of your question, Mike?

Oh, I'm sorry, the tax rate. On the tax rate, it was a little bit lower in the third quarter, and that was -- there was a discrete item that came through. But I think for the full-year, you can look to the nine-month information to see the expectation for the full year, I think we were right around 32.5% for the nine months. So that's really indicative of what we expect flowing into Q4. We would expect the same rate, unless we get additional discrete items that we have not yet identified at this time.

Stephen East from Wells Fargo.

Bob, turning back to the gross margins for a minute, could you tell us what is the gross margin in the backlog? And then on your warranty and impairments cost, on the warranty, what was going on there? Any more to come on that? And same thing on the impairments?

Sure, in terms of backlog gross profit margin, we actually stopped giving out that information a few quarters ago. We really just found it wasn't being useful to our users, so that's not a number I'm going to give out. I would reiterate that, as we look over the last six quarters, the delta between high and low on our margins before impairments and warranty adjustments has only been about 70 basis points. So we would characterize the gross profit margin as pretty stable.

In terms of the warranty adjustment and the impairment, taking the warranty adjustment first, we do an analysis of our warranty adjustment every quarter. Naturally, for every closing that we book, we're booking warranty expense there. But then we do an overall analysis, and it really involves some very complex calculations, and a lot of different factors.

So where we end up at the end of the third quarter is where we expect to be short-term. There's always the potential for adjustments up or down in future quarters. But none that we can point to, as of the end of the third quarter.

Impairments is a similar thing. We review it every quarter. I think the good news here is really, it related mostly to just one asset in the mid-Atlantic, and that's a place where we already have discussed it's been a little bit weaker than some of our other markets. So it's not a widespread thing as far as the third-quarter impairments go, but we will evaluate it again at the end of the fourth quarter, and go from there.

Okay, all right, thanks. Turning to the returns, could you tell us what you all are looking at when you talk about returns, how you define it? Maybe what's your target? And if your cycle times, I appreciate getting volume, but if your cycle times are extended and you're not able to deliver, you deliver at a slower pace than what you are selling, that's not helping your return anyway. So I guess my question is, why wouldn't you try to bump up price to at least match your delivery pace and your sales pace?

Right, no, and I think first of all, return on equity is really what my focus is. I wouldn't say there's necessarily a particular target right now, other than improving where we've been over the last 12 months and that's what we saw, we were able to accomplish in Q3.

As far as the dynamic, I think it's a legitimate point on the price. That's why we did increase prices in about 60% of our subdivisions. We found that appropriate we look at it every week, if not every day, where the pricing is going. If we do see that absorption rates are starting to get up there in a particular community, we do increase price, and that decision is made on a community by community basis.

John Lovallo of Bank of America.

First question is, I think just maybe semantics, but last quarter you were talking about your backlog driving significant year-over-year revenue growth, in the back half. I think this quarter you are talking about generating year-over-year growth, and you had a pretty strong quarter in terms of revenue growth. But I just wanted to see, A, am I splitting hairs here, or are you incrementally more cautious given what's going on with labor, and so forth?

I think in the backlog, units is up 33% year over year, and 37% year over year in dollars. So I think that gives us some pretty good confidence in the potential for year-over-year growth in Q4. I don't know that there's a huge change in tone there. It's the backlog is higher. Offset to some degree by the fact that we know our cycle times have moved up a little bit, too.

That's helpful. Moving on, we were under the impression that the federal NOL was exhausted in the second quarter of 2016. There appeared to be about a $3.5 million deferred income tax add back in the quarter. So I guess the question is, is this driven by state NOLs? And if so, do you anticipate a similar run rate in the fourth quarter?

I think it's just energy credits, maybe, that you are seeing go through there. So once that all kinds of nets out in the wash, I think fourth quarter based on what we know right now ends up in the neighborhood of 32.5% type, of number percentage for our tax rate. And then going into next year, however, we don't necessarily have those energy tax credits in 2017, so that could be a deduct with a caveat that they might announce, the government might announce those are back on the table. They just haven't done it yet. So 2017 you might see an impact of those coming off the table.

Okay, thanks.

Will Randow from Citigroup.

In terms of thinking about cash flow from operations, it looks like you're [set to turn] positive this year. Just wanted to make sure that was the case, and particular are you looking to ramp up land spend any time soon and similarly what are your priorities for cash flow from operations, assuming it does turn positive over the next year or two?

First of all, it's a little bit lumpy how the land ac occurs in any given quarter, so I don't know that I can give you certainty one way or the other, where the cash flow is going to be over the next couple of years. But we are trying to make sure that in line with the mindset of increasing our returns, that we are being thoughtful, as far as our -- as far as the assets that we acquired, and making sure that we are operating them efficiently.

Use of cash in future periods, we still, if we are generating that cash flow, I think what we really want to do first and foremost is invest in the business, grow the business. I think that is very important for us. We have talked about the first-time consumer, and how we think that the first-time consumer is really a consumer base that can grow, that can increase new home sales overall nationally. And we wanted to make sure we are participating in that level of growth, to the extent that it occurs.

And I would also just throw in there that we do have a dividend that ranks the highest in our industry. Dividend has been very consistent for our Company throughout the downturn, since 2005. So that is something that we have put quite a bit of our cash flow into. In fact, the number is nearly $500 million over the course of the past 10 years. So that dividend has remained a priority for us.

As a follow-up, to dovetail on the discussion on the first-time homebuyer product, it seems like the pie is obviously big enough for all the participants that are stepping up their presence in the space. Can you talk about any experiences where you are stepping up your Seasons product, where existing other builders are still stepping up their first-time homebuyer product, if that's impacted price, absorptions, or incentives in any way?

It is a pretty limited to only seven communities across the country, and really just in two markets right now. So it is a pretty limited experience set. What I will say is I do think there is some uniqueness to our Seasons product, and that it is not just an absolute stripped-down model, designed for only the entry-level consumer. It is a product that really has some neat features associated with it, in the standard house.

If you go through the models, if you ever have the opportunity, you would see what I mean. Higher ceilings being one thing that you would notice right away than other entry-level product. So I would say on the margin, it is just a little bit nicer than what we see from the competition, when they describe an entry-level product.

The other thing you get out of our products is really the ability to customize it. Still build-to-order even though it is designed for the first-time consumer, and I do not think that is as prevalent with some of our competition. So we think we have a little bit of edge there in terms of competitive prospects for the product.

Thank you for the time.

Alex Barron from Housing Research Center.

Going back to the issue of backlog conversions and labor availability, I am wondering, to what extent can some of these issues, what is your opinion to what extent some of these issues can be solved, I guess just by paying more to these subs? Or do you think some of this is more reflective of your change towards less specs and more build-to-order?

There is to that, if you do not have as many inventory homes out there, it has an impact, and we have talked about that. But in terms of paying people more and taking other actions to try to fill the gap on the subcontractor side, that piece is really difficult to quantify. I think it is a valid point in that the best thing we could be doing right now is being very attentive to what is happening with our subcontractors, being very in touch with our purchasing personnel.

That may be the case where they need a little bit more from a price standpoint, from a cost standpoint, in order for them to get back in our jobs. It maybe something else that we need to give to them, just a little bit of a better visibility in terms of what number of homes we have available for them to build. But staying really close to those subcontractors is going to be very key for us, even though it is difficult to quantify exactly what impact that will have.

Right, yes. I am just trying to figure out how to model next year with all the moving pieces. Now, any other comments you can make as we move into next year? Obviously with backlog growing, your revenue should be growing. What do you think we can expect as far as further SG&A leverage? And also the interest flowing in cost of sales, is that likely to come down as a percentage of revenues?

Well I think it is all one and the same question because it all hinges behind that ability to grow revenue. And part of the revenue story is whether or not we can decrease our cycle times. And like I said, I think it is very difficult to quantify at this point how much exactly we can, or if we can at all, decrease our cycle times, going into 2017.

I only say that because some of that is out of our control, in terms of the absolute number of subcontractors in any given market. So it does hinge around that, and I think the notion that we are added to the backlog, that we are seeing still strong demand is an important point, too, because that also helps us to ultimately increase our revenues year-over-year.

Okay well best of luck. Thanks.

Michael Rehaut from JPMorgan.

Just a couple of quick ones here. Bob, you mentioned in your prepared remarks, regarding the fourth quarter backlog, you still expect that to be down year-over-year, the backlog conversion, sorry. But you said it should improve sequentially, and I thought you might have given a rough sense of the sequential improvement, or I thought I heard you say the word by a quarter. If you could clarify.

Yes, sequentially, from the third to the fourth quarter, we have a goal of increasing by at least 400 basis points.

Okay, that is helpful, thank you. And also, in terms of thinking about Seasons going forward, right now it is 5% of your orders, seven communities, two markets. How should we think about what that might become in 2017?

Obviously I would assume directionally, as you said, you put out a 20% of lots purchased in the most recent quarter to Seasons. Can it reach that type of a number in 2017, in terms of your mix? And related to that, what is the typical absorption per month for Seasons, versus the rest of your business?

I guess I did not quite get what target you were thinking about for 2017.

You had referenced the 20% of lots purchased I believe in this quarter.

Yes, I mean, it is a big move from 5% to 20%, and given that it is only in two markets right now, only actively selling in two markets right now, I think it is tough to say. Right now, if we can get to that level, that 20% level in 2017, but we already went from 2% to 5% in the course of a quarter. So I think that gives you an idea of the emphasis that we put on the product.

As I look at absorption rates for the product, it is substantially higher than in our more traditional product. And again, I have to caveat with it is a more limited set of information that we are dealing with here, only seven communities that we're talking about here. But it is substantially higher than our traditional product.

All right. On that, Bob, obviously again appreciate it is only seven communities, but are we talking more like in the -- right now your corporate average is around a little under three for this quarter, three per month. Are we talking something like double that, or above 10 per month, or what is the degree of magnitude here?

Obviously, it depends on the individual communities, but versus three per month I would say we are offering Seasons, you go up to more like say six or month or so. So double is probably a good number.

Great.

Still very early though.

Great.

Andrew Berg from Post Advisory Group.

Just going back to the land acquisition comments you made before, and discussion on free cash flow. Can you give some indication of where you see land spend coming out in 4Q, and expectations for next year? Both land acquisition and development.

Yes, it is not a number we give out because it is difficult to time these interactions with the land sellers. I would say, we are looking to, pending the development of the overall housing market, we want to grow as a Company. So we are not looking to necessarily spend less as a Company as we move forward, but we haven't put out any specific targets.

Okay. Any reason to believe the fourth quarter should replicate third quarter in terms of order of magnitude of the delta, though? You spent less than this year than last year. That just a timing issue?

In the second quarter, we spent more year-over-year in the second quarter and then it is down year over year in the third quarter. So again, it is really just dependent upon the timing of some of these transactions. And again our outlook is positive, so we would, all else equal, rather be adding assets to our portfolio, if they make sense.

Understood. Thank you.

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

Great. Thank you very much for being on the call today, and we look forward to speaking with you again, after our fourth quarter earnings call.

And this concludes today's conference call. You may now disconnect.