Tri Pointe Homes Inc (Delaware) (TPH) 2017 Q4 法說會逐字稿

Greetings, and welcome to TRI Pointe Group Fourth Quarter and Full Year 2017 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the conference over to Chris Martin, Vice President of Finance and Investor Relations. Thank you, you may begin.

Good morning, and welcome to TRI Pointe Group's Earnings Conference Call. Earlier today, the company released its financial results for the fourth quarter and full year ending December 31, 2017. Documents detailing these results, including a slide deck under the presentations tab are available on the company's Investor Relations website at www.tripointegroup.com. Before the call begins, I would like to remind everyone that certain statements made in the course of this call, which are not historical facts, including statements concerning future financial and operating performance, are forward-looking statements that involve risks and uncertainties. A discussion of such risks and uncertainties and other important factors that could cause actual financial and operating results to differ materially from those described in the forward-looking statements are detailed in the company's filings made with the SEC, including in its most recent annual report on Form 10-K and its quarterly reports on Form 10-Q. Except as required by law, the company undertakes no duty to update these forward-looking statements that are made during the course of this call. Additionally, non-GAAP financial measures will be discussed on this conference call. Reconciliations of these non-GAAP financial measures to the most comparable measures prepared in accordance with GAAP can be accessed through TRI Pointe's website and its filings with the SEC.

Hosting the call today is Doug Bauer, the company's Chief Executive Officer; Mike Grubbs, the company's Chief Financial Officer; and Tom Mitchell, the company's Chief Operating Officer and President.

With that, I will now turn the call over to Doug.

Well, thank you, Chris, and good morning to everyone joining us on today's call. I will start by reviewing our fourth quarter and full year 2017 results and also provide some insight into where our business stands and where it is headed. Over the year, 2017 presented TRI Pointe Group with a unique set of opportunities and challenges. On the positive front, TRI Pointe Group benefited from a steady improving domestic economy, increased consumer confidence and strong housing fundamentals in the markets in which we build. Challenges included material cost increases, a scarcity of trade labor and weather-related events in both California and Texas that deeply impacted the (inaudible) in the affected areas. As evidenced by our full year results, TRI Pointe Group was able to make the most out of its opportunities in 2017, and found effective solutions to adversity when it arose. Highlights for 2017 included year-over-year net new home order growth of 19% and home sales revenue growth of 17%. We also reduced our SG&A expense as a percentage of home sales revenue 70 basis points to 10.1%, the lowest in our company's history. Additionally, we ended the year with a backlog dollar value of approximately $1 billion, which was an increase of 56% from the end of 2016. We are proud of our accomplishments in 2017 and believe that TRI Pointe Group can build on these successes in the coming years as we continue to capitalize on favorable industry fundamentals and execute our unique and differentiated operating strategy. TRI Pointe Group is different by design, and we believe that this mindset drives us to be an industry innovator and creates value for our customer and shareholders. While many in the industry look for ways to commoditize the home buying experience, TRI Pointe Group has taken the opposite approach. We believe that homebuying customers are looking for a unique experience, including the communities and homes that cater to their wants, needs and lifestyles. That is why we putting emphasis on thoughtful community planning and unique [homebuying] that center around the customer and location. We feel that this emphasis has been a driving factor behind our ability to generate average sales prices and new home order rates in excess of our publicly traded homebuilder peer group average. TRI Pointe Group also understand that each buyer's spend and their life stage is unique. New home features and community amenities that appeal to a millennial's young family are often distinctly different than things that appeal to empty-nester baby boomers. We are constantly studying the buying patterns and consumer preferences of the different homebuyer segments so that each of our communities reflect these distinct trends. Our research has resulted in truly innovative new home concepts that challenge the status quo in homebuilding from our attainable millennial-oriented Responsive Homes, which feature lock-off suites and cutting-edge home smart connected technology to our Life360 concept, which redefines how and where baby boomers spend the next chapter of their lives. We believe these innovative consumer-oriented concepts will continue to be a big driver of our success in each of our markets. Evidence of our value creation could be seen in our performance in a number of our markets for the fourth quarter. Our operations in California once again produced great results, with new home orders up 32% year-over-year. We broadened our product portfolio in San Diego to include more affordable home offerings and the response has been tremendous, resulting in company-best absorption rates and profit margins. Absorption rates and profit margins were also strong in the Inland Empire, where more value-oriented buyers have taken advantage of FHA loan limits. Demand for our homes in Northern California also continues to be strong, particularly, in the core Bay Area. We will continue to invest in the land-constrained California markets, including the start-up of our Sacramento division, which we believe is poised for growth. Quadrant Homes in Seattle market has benefited from strong local market fundamentals and the repositioning we embarked on a few years back. Deliveries, orders and profit margins were all up in the fourth quarter, and pretax income for the brand grew in excess of 200% year-over-year. Quadrant Homes is a perfect example of how thoughtful planning and innovative design coupled with healthy market fundamentals can lead to significant improvements to the bottom line. Our operations in the Southwest continue to perform well and produced solid order activity during the fourth quarter. The Las Vegas market has continued to improve, and we have seen strong demand at all price points. Fourth quarter gross margins in both Arizona and Colorado improved in excess of 200 basis points as compared to last year's fourth quarter. Las Vegas, Arizona and Colorado should see margin improvement as we introduce better located, more affordable communities in 2018. Fourth quarter gross margins also expanded year-over-year for Trendmaker Homes in Texas. Houston has shown great resilience following the devastation of Hurricane Harvey, and we're very optimistic about our prospects in this market as we head into the spring, thanks to the adjustments we made to our product and strengthening economy. In Austin, the difficult phase of establishing a new presence is behind us, and we see a real opportunity to increase our share of the new homebuilding market in this vibrant and growing city, especially, at the entry level. In the Mid Atlantic, we continue to experience improving market conditions. In 2017, new home orders were up 14% and deliveries were up 11% year-over-year. With our new leadership in place and the quality of our new land acquisitions, we are optimistic about the growth of Winchester Homes.

With that, I'd like to turn it over to Mike for more detail on our performance this quarter.

Thanks, Doug. Good morning, and welcome everyone to today's call. I'm going to highlight some of our results and key financial metrics for the fourth quarter and full year ending December 31, 2017. And then finish my remarks with our expectations and outlook for the first quarter and full year 2018. At times, I will be referring to certain information from our slide deck posted on our website that Chris mentioned earlier.

Overall, for the fourth quarter, marked a meaningful conclusion to 2017 with strong financial and operating results, including significant progress on our long-term California assets. Slide 6 of the earnings call slide deck provides some of the financial and operating highlights from our fourth quarter. Home sales revenue was $1.1 billion on 1,757 homes delivered at an average sales price of $639,000. Our homebuilding gross margin percentage for the quarter was 21.7% and our SG&A expense as a percentage of home sales revenue was 7.2%. Net income came in at $74 million or $0.49 per diluted share. Our fourth quarter net income included a $22 million tax charge related to the remeasurement of the company's net deferred tax assets as a result of the Tax Cuts and Jobs Act, which was signed into law during the fourth quarter. In addition, we recorded an pretax charge of $13.2 million related to the impairment of an investment in an unconsolidated entity. Excluding these charges, adjusted net income was $107.4 million or $0.70 per diluted share.

Slide 7 of the earnings call slide deck provides some of the financial and operating highlights from our full year. Home sales revenue was $2.7 billion on 4,697 homes delivered at an average sales price of $582,000. Our homebuilding gross margin percentage for the year was 20.5%, and our SG&A expense as a percentage of home sales revenue was 10.1%. Net income came in at $187.2 million or $1.21 per diluted share. Excluding the tax charge and impairment I previously mentioned, adjusted net income was $220.6 million or $1.42 per diluted share. We ended 2017 posting a 17% increase in our net new home orders for the fourth quarter on a 4% increase in average selling communities compared to the same quarter of 2016. For the full year, we posted a 19% increase in net new home orders on an 8% increase in average selling communities compared to 2016. During the year, we continued the development and the build-out of our long-term California assets, which we expect to become larger percentage of our orders and deliveries moving forward. During the fourth quarter, 14% of our net new home orders were from these long-term California assets, up from 12% in the same quarter last year. And for the full year, 17% of our net new home orders were from these long-term California assets, up from 11% in 2016. As for our active selling communities, during the fourth quarter, we opened 14 new communities, 9 in California and 1 each in Arizona, Maryland, Nevada, Texas and Washington. Of the 9 new communities in California, 4 were from the long-term California assets at our Weston community in San Diego, which opened in December to great success with 28 orders. We closed out of 11 communities during the (inaudible), resulting in an ending active selling community count of 130, of which 12 are from our long-term California assets.

Our active selling communities at the end of the year is shown by state on Slide 8. As I previously mentioned, for the fourth quarter, we reported a 17% increase in net new home orders, average community count that was up 4% from the prior year period. Our overall absorption rate increased 13% to 2.8 homes per community per month for the fourth quarter compared to 2.5 in the previous year period. For the full year, the company-wide absorption rate was 3.3 orders per community per month, up from 3 in 2016. You can see the historical monthly cadence of orders on Slide 33. As we roll forward into 2018, we continue to see strong demand. Through the first 6 weeks of this year, our net new home orders were up 15% year-over-year. We ended the fourth quarter with 1,571 homes in backlog, which was a 32% increase compared to the same quarter last year. The average sales price in backlog increased 19% to $657,000, and the total dollar value of our backlog increased 56% year-over-year to over $1 billion. During the fourth quarter, we converted 78% of our third quarter ending backlog, delivering 1,757 homes, which was a 23% increase compared to the same quarter last year. Our average sales price of homes delivered was $639,000, up 18% from the same quarter last year and up 9% from the last quarter. This resulted in home sales revenue for the fourth quarter of $1.1 billion, up 46% from the same quarter last year.

Our homebuilding gross margin percentage for the fourth quarter was 21.7%, which was on the higher end of our guidance range and an increase of 170 basis points compared to the same quarter last year. For the fourth quarter, SG&A expense as a percentage of home sales revenue was 7.2%, which was a 200 basis point improvement compared to 9.2% for the same period in 2016 and a 300 basis point improvement from the third quarter. Year-over-year improvement in our SG&A percent was largely due to increased leverage as a result of 46% increase in home sales revenue. During the fourth quarter, we invested $111 million in land acquisition and $137 million in land development. For the full year, we invested an aggregate total of $870 million in land acquisition and land development. The focus of our land acquisition strategy in 2018 is to target land for communities which will deliver homes primarily in 2020 and beyond as we currently own or control all of the land needed to meet planned deliveries in 2018, 95% of our planned deliveries in 2019 and over 70% of our planned deliveries in 2020. At quarter end, we owned or controlled over 27,000 lots, of which 60% are located in California. Based on the 2017 deliveries, the number of years of lots owned or controlled is 5.8. It is our continued goal (inaudible) to shorten the duration of our land pipeline to approximately 5 years by continuing to focus on accelerating our long-term California assets and investing in faster-turning communities in all of our market. A detailed breakdown of our lots owned will be reflected in our annual report on Form 10-K, which will be filed later today. And in addition, there is a summary of lots owned or controlled by state on Page 32 in the slide deck.

Turning to the balance sheet. At year-end, we had approximately $3.1 billion of real estate inventory. Our total outstanding debt was $1.5 billion, resulting in a ratio of debt-to-capital of 43.3%, and a ratio of net-debt-to-net capital of 38.1%. We ended the quarter with $875 million of liquidity, consisting of $283 million of cash on hand and $592 million available under our unsecured revolving credit facility. With respect to our stock repurchase program, we did not purchase any shares during the fourth quarter. For the full year, the company repurchased approximately 9 million shares at a weighted average price of $12.48 for a total aggregate dollar amount of $112 million. We've recently replaced our previous stock repurchase program with a new $100 million authorization, that will expire in March 2019.

And now I'd like to summarize our outlook for the full year and first quarter 2018. For the full year of 2018, we expect to grow average selling communities by 5% on a year-over-year basis from 2017, and deliver between 5,100 and 5,400 homes at an average sales price of approximately $610,000. The company anticipates its full year homebuilding gross margin percentage to be in the range of 20.5% to 21.5% and SG&A expense to be in a range of 9.9% to 10.3% of home sales revenue. The company anticipates its effective tax rate will be in a range of 25% to 26%. For the first quarter, the company expects to open 8 new communities and close out of 11 communities, resulting in a 127 active selling communities as of March 31, 2018. In addition, we anticipate delivering approximately 55% of our 1,571 units in backlog at the end of the year at an average sales price in a range of $630,000 to $640,000. The company anticipates its homebuilding gross margin percentage to be in a range of 21.5% to 22.5% for the first quarter, and SG&A expense to be in a range of 13% to 13.5% of home sales revenue.

But before I turn the call back over to Doug, I'd just wanted to make a comment about the increase in our SG&A guidance. It's primarily through the adoption in 2018 of the new revenue accounting standard ASC 606. Moving forward into 2018, certain office model upgrades and other marketing costs, which used to be capitalized through our projects [and rents through] cost of sales will now be running through selling expense, and although the impact is mainly geography on the income statement, when you look at the life of the project, it's really a net change to net margins, it's just a geography on the income statement, but because of the timing differences, some of these costs will be expensed at the opening of the project that used to be amortized over the life of the project. So it's impacting our SG&A percentage by about 20 to 30 basis points moving forward.

Now with that, I'd like to now turn the call back over to Doug for some closing remarks.

Well, thanks, Mike. Back in (inaudible) 2015, we hosted an Investor Day in Del Mar, California. During which we established a goal of delivering 5,100 to 5,400 homes in 2019. At the time, we were a little over a year removed from the closing of the transformative transaction with Weyerhaeuser Real Estate Company. We knew the potential inherent in each of our homebuilding brands to achieve this growth objective. Fast forward to today, and we believe we're in a great position to deliver on this potential, with over 1,500 homes in backlog to start of the year and a 130 actively selling communities from which to sell and deliver homes. Consistent with our favorable view of our industry, we continue to approach the business with a forward-thinking mindset and an eye towards the future, understanding that homebuilding is a constantly evolving industry and that we must evolve with it. Each of our homebuilding brands has room to grow in their respective markets and make incremental contributions to the top and bottom line going forward. Our results in 2017 was evidence that we continue to execute at a high level. And I am confident we will continue this trend in 2018.

Beyond 2018, we expect to continue to expand our operations through measured growth and responsible balance sheet and cash flow management, while continuing our disciplined acquisition activity. We have a clear vision of where we want to be and how we want to get there. Now it's up to us to execute on that vision. Finally, I want to thank all the TRI Pointe Group team members who made this year such a success. You are the ones who turn our company's vision into reality, and I'm appreciative of all of your hard work.

That concludes our prepared remarks. And we'll be happy to take your questions. Thank you.

(Operator Instructions) Our first question is from Alan Ratner with Zelman & Associates.

So obviously, you had the '18 guidance out there for several years, and I know back at the time, maybe there was some skepticism about your ability to hit it, and now as the market has obviously strengthened, we're sitting here today and you guys are in a great position. If I kind of look at where your backlog is right now and the guidance for '18, which obviously has remained unchanged on the volume side. It seems to imply that you're expecting a deceleration obviously from the very strong growth that you saw in '17 especially, the back half of the year. And I know there is a lot that goes into that, you guys open communities, you're closing out of communities, there is certainly a multi-year plan that kind of goes into your thinking there. But at the same time, there is some skittishness, I'd say, regarding rising rates and the impact that, that might have on demand especially, in some of the higher cost markets. So I was hoping you could just give a little bit more color, your orders are up 15% year-to-date, very solid, but January was up a bit more than that, so imply some deceleration. So can you just kind of walk us through a little bit about the demand outlook, what you're seeing right now? How much of that deceleration that you're expecting here is more a function of where the business plan is versus a view on demand? And any color you can give us, just in general around your homebuyer affordability patterns, what they're saying regarding the move-in rates? Just to give some more context to that?

Well, Alan, this is Doug. That's a -- I think about 10 or 15 questions. So listen, I don't actually look at it as decelerating. Actually, I'm quite pleased -- with growing our backlog 56%, we obviously have those sales and backlogs and lot of those people are all set ready to go. Obviously, there is timing differences between community openings and closings. But overall, when you see unit delivery, revenue and earnings growth in the double-digit fashion going into 2018 compared to 2017, we're very pleased and very excited about the growth from '17 to '18. As far as the demand, as we pointed out, the first 6 weeks we continue to see strong demand. Anecdotally, as we talk to our sales teams, some people are definitely going to hop off the couch and get into the sales office because of the perception that rates will continue to increase. Our buyer profile is less immune to interest rate changes compared to the entry level buyer. 30% of our activity is entry level and the balance is between move-up about 52% and the balance luxury. So we don't really feel that interest rate impinge right now, and historically, you see a nice little surge. And then as you look back into some of the previous cycles that I've seen, go back to 1999 and -- I'm sorry, 1999 and 1996, you tend to see a little bit of a decline, but then you see an increase in volume and -- with the demand-supply characteristics from the housing industry right now, we're very excited about this year and the growth potential. We've got a lot of new communities coming on in the second half of the year. Tom, do you want to add anything to that, it's a lot of questions from Alan.

Alan, I'd echo what Doug has reiterated on demand side. Really, across the board at all markets and all price segments where we're seeing strong demand from the consumer, and are really optimistic that it's going to continue through the spring selling season.

Our next question is from Stephen Kim with Evercore ISI.

This is actually Chris on for Steve. My first question is about your community count growth guidance. So obviously, it's much lower than what you initially anticipated at your 2016 Investor Day. And is there anything other than just faster-than-anticipated closings that are responsible for this? And are there any plans materializing to accelerate it?

Yes, this is Mike. I mean, I think we have started daylighting that back after our second quarter last year when we saw the increased absorption pace over -- beyond what we had been planning, is that the community count was just not going to be achieved from our 2016 Investor Day. And it's all directly driven by the faster close-outs. And so we saw that this year, and we're going to see that -- our last year in 2017, we're going to see that this year in 2018 as well. We still opened well over 65 communities this year. But we're closing a very large amount as well because of the accelerated pace that we've seen.

Okay. And then so you're seeing sort of heightened activity moving in-land in California with, obviously the Inland Empire and opening up in Sacramento. And assuming those -- obviously, those are more entry-level affordability orientated products. Are those producing similar margins to what you have in the higher ASP coastal communities, and is there sort of any impact on your full year margin guidance from growth in those Inland communities?

Well, and if I understand your question, you mentioned Inland Empire, I think. Inland Empire has continued to deliver margins in excess of the company average because of the basis that we have in that land out there from our transaction with Weyerhaeuser. But they do not deliver the same margins as our high-end California products -- from the long-term California assets. Those will generate margins in excess of that.

Our next question is from Mike Dahl with Barclays.

Just a follow-up on a comment there in the opening remarks about the long-term communities. Thanks for providing the details on kind of what it currently represents. How should we think about as we get out through 2018 by year-end? I think we should be at the point where you've got some nice openings on some of the long-term assets. What mix of your communities at year-end should we expect the long-term California assets to represent?

Hey, Mike, it's Mike. I think this year, we're delivering roughly about a 1,000 units from the long-term California assets. So when you look at the midpoint of the guidance, it's roughly a 20-plus percent or 20%. And community count, as I mentioned, at the end of '17 was 12 of the 130 were from the long-term California assets. And that number will be up probably slightly based on the year-end community number as a percentage basis.

Got it. Okay. And then just going back to the accounting change on SG&A. So it sounds like early in the community life, you have now some stepped-up expenses as far as recognition goes. How should we be thinking about what that means for kind of a steadier state SG&A beyond this first year that you apply those changes?

Yes, I think that'll be determined here pretty soon. But I think that roughly about 20 basis points, 20 to 30 basis points over what we had originally anticipated. So going into this year, we anticipated the range to be 9.7% to 9.9%, so let's call that in the midpoint 9.8% and now we're saying the midpoint is roughly 10.1%. I think about a 30 basis points difference is what you would see moving forward. Now effectively, as we open communities, we're going to get the impact of that up in our margin, right, because we're just moving costs from margin down to SG&A. So maybe not in year 1, but in year 2, you should get the corresponding bump in gross margin to offset that.

So I guess what I'm getting at there is, as the -- it sounds like community-life margins, if we're looking from an operating margin standpoint, shouldn't be affected. But should we think of kind of later life in the community as actually having stepped up margins as a result of this change kind of you've front-loaded and so the end of -- as you get towards the end of the communities, the margin profile is even better than what you would have previously thought, I guess, that's what I'm...

That's correct.

That's correct.

Our next question is from Stephen East with Wells Fargo.

Doug, maybe I'll start with what you said with your closing remarks. You all have a vision that you're driving toward. Maybe you could talk a little bit about what that vision looks like as we move beyond '18 into '19 and '20 and what's different in your vision than maybe what's going on today?

Yes, it's a good question. We continue to be very inquisitive primarily in the Southeast, the Northwest and Dallas. We look at this business over the next 5 to 10 years. And frankly, over this next decade, we like to see our top and bottom line actually double. But those are some ambitious goals, but we're going to maintain our vision inside our balance sheet, and we call it measured growth. As I mentioned earlier, when you look at deliveries, revenue and earnings for '17 to '18, well over double-digit growth, I'm very proud of that and hopefully, we can continue to see that. But you also have to have a mindset in this business having been doing it for 30 years that you're going to hit a bump in the road, you're going to hit a hiccup. So you always want to make sure you maintain a strong balance sheet and liquidity to take advantage of opportunities. So we'll be very disciplined as we continue to look at that vision over the next 5 to 10 years.

All right. Great. I appreciate that. And then on your orders, you all saw some significant price increases. I guess a couple of different questions here: One, could you talk about how much of that is mix, either product or geography, I assume a lot of it's geography versus real HPA and maybe what you're actually seeing in that price appreciation? And then on TRI Pointe, orders up 62%, how much of that was community growth versus running those hot? And what's the thought process if it is just running those hot?

As far as revenue growth, pricing growth, you're talking in absolute dollars, Stephen?

Yes, the order -- I'm sorry the order ASP, you jumped up pretty significantly. Just trying to understand how much of that is mix, either geographic or product versus real price appreciation and what you're seeing out there? And then on TRI Pointe orders, your units were up about 62%. So just wanting to understand that?

Got you. Yes.

Yes, Stephen, it's Mike. On -- community count was up about 15% in TRI Pointe. We really saw increased absorptions across the board in all of our TRI Pointe brands. Even more specifically, even in Colorado, we saw a good absorption in the fourth quarter. So absorptions were up 62% and communities 15% on an average -- average community.

And Stephen, this is Tom. As we've guided to, we expected a lot of that order growth as we were shifting our mix into more entry-level product. We opened several new communities at much more affordable price points that enabled us to have that outsized absorption.

Got you. Okay. So geographically though that, that -- your ASP went up a lot year-over-year, so -- in the orders. So just trying to reconcile those 2 thought processes?

Yes, I mean, average -- it's primarily mix when you look at ASPs. I mean, we do see price appreciation in a lot of our markets, but it's primarily driven by mix.

Our next question is from Jack Micenko with SIG.

This is Soham on for Jack this morning. My first question was on gross margin. So as we think about gross margin for the year, could you maybe give us the outlook for California deliveries mix and not just the long-dated assets, but entirely California since that's what usually drives the margins to the high or low end? Because it seems like with your first quarter guidance that there's been some push out of those deliveries in the first quarter with the 55% backlog conversion? So just trying to get a sense of what California could look like this year.

Yes, California. Let me do that math. I mean, typically, California is around 40% of overall deliveries. And I'll give you a more precise number, maybe on a follow-up to the call once I look at that. But typically, it's around 40%. Right, lot of the backlog that we have sitting there is California and some of the longer-dated assets and some of the larger ASPs, that's why our ASP is so high in backlog, and it's just taking longer to produce those homes, so they're maybe not converting as quickly as the product did last year.

Okay. And then I guess, Doug, on -- last quarter, you talked about becoming more capital efficient going forward. And so is there any update on the land development off balance sheet? And is there any formal ROE target that you guys are looking for this year?

We continue to interact with a number of land bankers, and we'll continue to look at that as an opportunity to focus on delivering and improving our ROA -- ROE into the mid-teens, is our long-term objective. So we'll continue to look at doing that, that has a long-term effect. But as we look at our land acquisition efforts to continue to grow, we want to be mindful of mitigating risk in cash flow management. So we will continue to pursue those activities as we go forward.

Soham, it's Mike. It's about 42% this year. California deliveries are about 42% of the overall, if you count that to the midpoint of the range.

Okay. And then could we just get some color on the charge in the quarter? Is that onetime in nature or ongoing?

No, that's a onetime charge (inaudible) which is a joint venture that's unconsolidated. It's been on the books since 1999. It's just had slow entitlements. It doesn't really impact our long-term plan. And it doesn't impact any of our California long-term assets at all.

Our next question is from Nishu Sood with Deutsche Bank.

Just following up on that discussion about the rate of backlog conversion. Mike, I think you've done a pretty good job of laying out the order surge that you've had in the past 5 or 6 quarters. So obviously a good problem resulting from that as well as the higher percentage of California closings, which take longer to deliver on. So that kind of -- is the backdrop you've given us for the slowing conversion of backlog. But it's been -- the slowdown has been worsening as we've gone along here, if we kind of look at the quarters through '17. At what stage do we find kind of the normal rate of backlog conversion given what you're doing with your portfolio in terms of these longer-term assets?

Well, I mean I think you've seen the success of our absorption rate, that's why backlogs are up in production. I'd say, our backlog is more dirt starts versus spec starts. We've moved away from a little bit of the spec starts in some of our markets. So it's just naturally taking longer to produce those because those aren't available at the sale. And then with our higher absorption rate, I'd say probably by 2019, as we get maybe a little bit higher cadence on our deliveries, it's probably going to level back out to what the 2016 rates were.

So does that imply some kind of bounce back? And I know you folks don't compute backlog conversion ratio to run your numbers, but obviously everyone models it that way. So does that imply somewhat of a bounce back? Or that we kind of stabilize in 2019?

No, I think it's more of a stabilization.

Got it. Okay. And also wanted to ask about -- obviously, the demand environment is terrific as we've seen in your absorption numbers. Tax reform would seem to add to overall growth. But folks have been concerned about the anti-housing nature of tax reform, the state and local and the property tax. And the one state where that would seem to impact most, of course, is California. Now it's way too early to even say what the longer term effects will be. So wanted to understand what work you folks have been doing in terms of looking at your buyer pool, what sort of effect it might have? How that might influence what sort of product you're putting out there? Or any other kind of thoughts you have on being ready for what that might bring, if anything?

Well, actually, as you look at the Tax Reform Act in California, it actually helps many of our homebuyers. Obviously, if you're a more -- move-up luxury, I should say, luxury buyer, Nishu, in the million-plus range, that person has more discretionary income and puts down, frankly, a larger down payment. So their purchase decisions are -- and we've done this research, aren't coming into the sales office based on SALT or property tax deductions, they're based on a family or a life-changing event. But for the rest of the portfolio, we continue to look at a good healthy mix of entry level and move-up. Our entry level mix is going up in the low 30% range, move-up is 50%. So we'll continue to look at that price point of entry level and move-up in California. Now that means you're going to build more attached -- attached program along the coastal parts of the state. And then obviously, in the Inland Empire, which is a market that we really dominate, our average loan amount there is $340,000 with our Inland Empire group. So we're not really affected by this Tax Reform Act because frankly, those people actually are having more disposable income with a higher standard deduction. So we continue to see pretty good order activity as we get into the first part of the year.

Nishu, this is Tom. One thing I'd add to that one area of product that we are really excited about this year is getting more into our age-targeted active adult offerings. So we see that as being really additive to our mix and are looking forward to that. And so far, it's something that we have all our sales team talking about with the buyers. We have not seen any negative impacts from the Tax Reform Act, and so far it's business as usual. But as you said, maybe too early to tell, but bottom line, we think it'll be more positive than negative.

Our next question is from Jay McCanless with Wedbush Securities.

So the first question I have and I've got a follow-up to it is kind of a 2-part question on pricing. Number one, what percentage of communities did you guys raise prices this quarter? And then can you talk about your ability to price through some of the rising input costs that everyone's been discussing?

Well, it's the first 6 weeks of the year. So it's -- we're gradually increasing pricing throughout all our communities in our markets. And we're kind of forecasting around a 4% pricing increase this year. Generally speaking, Jay, we're battling labor and material cost increases and offsetting them, and in most cases, we are. So the net impact is generally 1% to 2% if you're in a stronger market. But when you look at material labor cost increases last year, they range from a low of 2% to as high as 8%, on average about 5%, 5.5%. So you're constantly battling between offsetting those cost increases with the price increasing.

Okay. And then my follow-up question. One of your competitors made or is planning to make an acquisition of a builder that's in your backyard for -- in the Inland Empire and then also close to some of your Texas assets. What is the acquisition -- what's you all's acquisition outlook? What are you seeing out there? Or could acquisitions potentially help TRI Pointe move to the next phase or expand in some different markets?

Well, as I mentioned it to Stephen a little bit ago, Jay, I mean, as we look at the TRI Pointe Group next 5 to 10 years, we've got ambitious goal of -- in the next decade of doubling our revenues and income. So that's going to come through measured growth in our 6 brands with some of the organic growth we have as well as we'll be inquisitive about many of the market areas that we're in and some of the market areas we're not in. But we're going to be very disciplined. Sometimes it's better to be in second place when you look at maybe some of the acquisition activity that you've seen out there. We're very blessed to have a very strong land presence in the Inland Empire through the WRECO transaction. So we pretty much dominate that market and have a huge cost advantage on a land basis.

Our next question is from Mark Weintraub with Buckingham Research.

First just clarifying on the 20 to 30 basis points, the increase in SG&A. I understand that -- so that's now being expensed, whereas previously, if I understood correctly it was being capitalized and then would run through the gross margin. And so if I understood correctly as well you were saying that there is effectively a one-year type lag, so that this year we're seeing the 20 to 30 basis points increase in the SG&A, but we're not seeing the offsetting reductions in the gross margin, but that would start then showing up next year. Is that the right way to understand what's going on?

Yes, Mark, when you look at an individual project, right, the life of the project, there's no change to net margin. But at the early stage, when you're opening it up, the model complex, spending dollars, we typically have fairly upgraded models. You're seeing the impact of that hit SG&A in year 1, but then you're going to get the corresponding benefit of that in year 2 and 3 in margin, right, moving forward. So net, at the end of the day, there's no effect. For 2018, we're taking the immediate impacts, so we're having to do an adjustment to move those costs down below the line and so it's going to hit sales and marketing as well as the over 65 new communities that we're opening this year. There'll be some upfront costs associated with that but as well that there's no corresponding deliveries in '18.

So effectively, since you capture gross margin guidance constant with what it had been and your SG&A went up by just this 20 to 30, effectively, accounting change. So then the -- really the only impact was that you're looking for higher ASPs than what you had been previously from a fundamental standpoint. And so I just wanted to come back to, is that just because the higher costs you're expecting to (inaudible)? And/or is it actually a shift in mix from what you had been expecting a few months ago?

Yes, I mean we had a very tight range, again, this is Mike. We had a very tight range on our SG&A as a percentage of home sales revenue that we put out there at the end of 2016. So that was a tight range of 9.7% to 9.9%. But we had a very broad range on our margins, 100 basis points range in our margin. And so what we're saying is, we think there was going to be a 20- to 30-basis-point impact on our SG&A this year, that we did not expect in 2016. But within our margin, whatever benefit we might get from that is still within our 100 basis point range that we had in margin. So that's why do we didn't change our margin range.

Okay. And then just real quickly, I believe you're scaling back the land sales program significantly this year. Just wanted to get an update what expectations you have, if any on land sales?

Yes, I'm glad you asked that question. We do not anticipate any significant land sales moving forward over the next few years in any of our California assets.

Our next question is from Will Randow with Citi Group.

I guess just to follow up on cost inflation. Can -- and you guys hit on this in a few different ways, but can you talk about what's your experience in the fourth quarter relative to, call it, real price increases, meaning, was there incremental margin spread? And then for 2018, are you assuming that pricing power exceeds cost inflation or matches it, because I know historically you've assumed it matches it?

Will, this is Doug. For the year and I'll have to get back to you on the actual quarter, our labor and material cost increases across the company averaged about 5%, 5.5% increases and were generally offset by revenue in almost all our markets. And we're continuing to forecast roughly the same going into 2018. It's a very tough market out there. It's something that you need to have very strong operating teams, which with lots of experience, and we have those to do that.

Got it. And then on free cash flow conversion, given that you have most of your land locked up through 2020, obviously there's grading and development -- related development costs. Are you expecting your free cash flow conversion ratio to continue to step up over the next 3 years? Or could you kind of talk us through that from a modeling perspective?

Well, we were about a $100 million positive cash flow this year. We've been daylighting that.

Last year.

Last year, sorry, this year, still last year in my head. 2017, it was a $100 million positive cash flow. And we've been talking about it for a long time that we thought and moving forward from '18 since the development of our long-term assets that we ought to be able to generate positive cash flow moving forward. We still have those expectations. I would say that we did spend less money last year in land and land acquisition than we had anticipated. Our original range was $900 million to $1.1 billion. We spent about just below $900 million for the year. So some of that land development is going to roll into 2019, but our expectation is just to try to maintain positive cash flow moving forward.

(Operator Instructions) Our next question is from Alex Barrón with Housing Research Center.

I wanted to ask if you guys could comment on -- has there been any significant difference in the performance of your Texas division, the Houston versus Austin? Or can you kind of help us understand how the Austin division is doing so far?

Yes, I mean, definitely, when do a start-up, your entry cost and your execution won't be as generous as your operation that's been in business for, what, about 40, 50 years, so but that's behind us. And we're poised to take advantage of that market and that community. Our Austin team has been -- has focused and will continue to focus a little bit more on the market entry than you'll see in Houston. But Houston did enjoy margin increase over the last year, and I would expect Austin will this year. But it definitely lags -- Austin definitely lags Houston just in a start-up capacity over the last couple of years.

Got it. And I also wanted to ask, well, sneak in 2 questions. One was, what drove the Colorado performance this quarter. Usually, fourth quarter is lower than the rest of the quarters, but you had a pretty strong Colorado. And if I could ask also on Southern California, has there been any noticeable difference in the last few weeks in terms of orders given the rate increase versus coastal California?

Hey, Alex, this is Tom. On Colorado, as I mentioned, we were finally able to get some of those more affordable products performing in the marketplace in the fourth quarter, and that's really what led to the outsized absorption comparatively to the fourth quarter of 2016. So we're really excited about that. We feel we have a much better mix going forward to have -- drive higher absorptions. And on the California side, over the last couple of weeks, we really have not seen any dramatic change in absorption and demand levels and quite a consistent level of traffic as well.

Ladies and gentlemen, we have reached the end of our question and answer session. I would like to turn the call back over to Doug Bauer for closing remarks.

Well, thank you. And thank you to everyone joining us on today's call. We look forward to chatting with all of you next quarter. And hope you have a great day. Thank you very much.

Thank you. This concludes today's conference. You may disconnect your lines at this time, and thank you for your participation.