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The Ryland Group, Inc. (NYSE:RYL)

Q4 2012 Earnings Conference Call

January 30, 2013; 12:00 p.m. ET

Executives

Larry Nicholson - Chief Executive Officer

Gordon Milne - Executive Vice President & Chief Financial Officer

Dave Fristoe - Senior Vice President & Controller

Drew Mackintosh - Vice President of Investor Relations

Analysts

Adam Rudiger - Wells Fargo Securities

Ivy Zelman - Zelman & Associates

Ken Zener - Key Bank

Michael Rehaut - JP Morgan

John Coyle - Barclays

Stephen Kim - Barclays

Stephen East - The ISI Group

Dan Oppenheim - Credit Suisse

David Goldberg - UBS

Nishu Sood - Deutsche Bank

Will Randall - Citigroup

Joel Locker - FBN Securities

Alex Barron - Housing Research Center

Michael Trica - Oakum Bay Capital

Buck Horne - Raymond James

David Williams - Williams Financial (ph)

Operator

Good day ladies and gentlemen and welcome to the Ryland Group Inc., fourth quarter earnings conference call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will be given at that time. (Operator Instructions).

I’d now like to turn the conference over to your host, Mr. Drew Mackintosh, Vice President of Investor Relations. Please go ahead sir.

Drew Mackintosh

Good morning and welcome to Ryland’s fourth quarter 2012 earnings conference call. Today’s call is being transmitted live over the Internet and could be accessed through the Investor Relations section of the website at ryland.com.

In a moment I’ll be turning over the conference call to Larry Nicholson, Ryland’s Chief Executive Officer. Also joining us today are Gordon Milne, Executive Vice President and Chief Financial Officer; and Dave Fristoe, Senior Vice President and Controller.

Before I begin, please be aware that certain statements in this call are forward-looking statements based on assumptions and uncertainties that include general economics, business and competitive factors, as well as the factors set forth in the company’s press release. These factors and others may cause actual results to differ from statements made in this conference call.

With that out of the way, I’ll now turn it over to Larry Nicholson.

Larry Nicholson

Thanks Drew. Good morning and thank you for joining us today as we go over our results for the fourth quarter and the full year of 2012.

What a difference a year makes! On our fourth quarter call last January, we reported our first operational profit in five years, a gain of $0.03 per share. We were able to achieve this profitability despite the continued softness in the housing market through a combination of cost cutting initiatives and strategic reinvestment in our business.

We began 2012 with the renewed sense of optimism, thanks to year-over-year increases in backlog, community count and operating margins. Today we are pleased to report that these trends persisted throughout 2012 and culminated in a fully diluted earnings per share of $0.88 for the year.

The fourth quarter proved to be our most profitable quarter of the year with earnings of $0.56 per share. We are pleased with our results for this quarter and for 2012, but are more excited about our future; thanks to the strategic positioning of the company and our potential to generate better results should the housing market continue its upward trend.

Similar to last year, we entered the first quarter with year-over-year improvements in backlog, community count and operating margins. With mortgage rates near record lows, rental occupancy rates at near-term highs and new and existing inventory levels diminished, the housing environment is as favorable as it has been in several years.

Ryland Homes has a geographic footprint, the financial wherewithal and the homebuilding expertise to capitalize on this improved environment. With that, here are highlights from the quarter.

Net income from continuing operations totaled $30.3 million or $0.56 per diluted share. Homebuilding revenues came in at $428 million compared to $255 million in the fourth quarter of 2011. Land sales contributed $3.8 million to the total. This 68% jump in revenue was driven by a 59% increase in closing volume and a 6% improvement in average closing price.

The volume increase was broad based and each of our divisions closed more homes as compared to the year ago period. The higher average closing price was a result of a bigger percentage contribution from high priced markets such as Denver, Washington D.C. and Southern California, as well as a general upward trend in prices in most of our markets.

Average homebuilding gross margins were 20% in the period, compared to 18.1% in the fourth quarter of 2011. A lower cost of labor and materials as a percent of revenues was again the main driver of this year-over-year margin expansion.

While we have experienced price increases in both labor and materials in select markets, we’ve managed these increases by our ability to raise prices and scale back incentives. Sales concessions as a percent of revenue declined to 8.7% compared to 10.7% in the fourth quarter of last year.

Production overhead also declined as a percent of revenue, providing 50 basis points of margin expansion. SG&A as a percent of revenue came in at 13.4%, a 300 basis point decline from the same period last year. Higher closing volume was the main driver behind this improvement.

The variable cost defined as both internal and external commissions and incentive compensation represent 40% of our SG&A expense, while fixed costs such as division and sales and marketing overhead accounted for 60%. Going forward our greatest opportunity for margin expansion will come from our ability to leverage the fixed components of our cost structure.

Home sales, net of cancellations totaled 1,493 units in the fourth quarter, an increase of 64% as compared to last year. Excluding the acquisition of Trend Homes in Phoenix, which contributed 113 homes to the total, new home sales increased 52%. We averaged 2.1 sales per community per month significantly higher than the 1.4 sales pace we averaged in the fourth quarter of 2011.

Divisions posting the best sales volume in the quarter were Houston, Orlando, Indianapolis, Las Vegas and Tampa. These five divisions also garnered the most sales for the full year as well. Other divisions that generated significant year-over-year sales improvement in the quarter included Washington D.C., Southern California, Charlotte and the Twin Cities.

In December we announced the acquisition of Trend Homes, a well-positioned homebuilder in the Phoenix market. After years of a difficult housing market conditions following a downturn, Phoenix has reemerged as one of the best homebuilding markets in the country. Thanks to a rapidly improving existing home inventory picture and a jobless slate rate well below the national average.

With Trend Homes we not only acquired over a thousand well-located home sites in a key MSA, but also inherited an excellent management team that has a local market knowledge and expertise to make Ryland a significant homebuilder in and around the city. I want to personally welcome all of the former Trend employees into the Ryland Homes family.

Turning now to the balance sheet, we ended the quarter with $615 million in cash, $1.1 billion in debt and $504 million in stockholders equity for a net debt to total capital ratio of 51%. Our cash balance declined $185 million for the third quarter of 2012, due in part to our decision to keep loans underwritten by our mortgage company, on balance sheet until they are sold, as opposed to utilizing our repurchased credit facility.

During the quarter we determined that the company had sufficient liquidity to fund the growth and day-to-day operations of our homebuilding business and temporarily hold our mortgage, which totaled $108 million at the end of the quarter. It is important to note that the counter parties have already committed to purchase all of these loans pending final approval. The credit facility remains in place and readily accessible should our cash requirements change.

The main reason for the reduction in cash this quarter was our increased activity in the land market. We spent $190 million in land acquisition and $39 million in site development during the period, bringing our full year totals to $388 million in land acquisition and $127 million in site development.

The fourth quarter totals include the acquisition of Trend Homes, while the full year numbers include both trend in the acquisition of the assets of Timberstone in North Carolina. For 2013, we expect to spend a similar amount of land acquisition and development.

We ended the period with 17,781 lots owned and 10,524 lots under option for a total controlled lot count of 28,305, representing a 31% increase over the fourth quarter of last year. While the land market continues to be competitive, our divisions have consistently found land parcels that meet and exceed our internal underwriting standards.

Our total inventory balance at the end of the period was just over $1 billion. Our land assets are spread fairly evenly throughout the country, maintaining the geographic diversion that has been a hallmark of Ryland for years.

Equally important only 6% of our inventory is considered inactive, defined as either mothballed or held for sale. The active nature of our assets plays an important role in our return on capital focus strategy.

Community count at the end of the year stood at 238, a 13% increase compared to the end of 2011. Based on our current internal projections we believe we can achieve a community count growth in excess of 20% in 2013.

Our financial services segment recorded a profit of $6.2 million in the quarter compared to a $437,000 in the year ago period. The larger profit was largely due to a 43% increase in loan origination volume. The average combined loan to value for the homebuilders that used our mortgage company was 90% and the average FICO score was 736.

The guidelines recently put forth by the consumer financial protection bureau essentially left underwriting standards unchanged. All of the loans we originated in 2012 would have qualified under the new criteria. There are still several questions surrounding the proposed 3% loan origination fee cap as it relates to affiliated mortgage companies and we look forward to being part of that discussion over the course of the year.

In summary, our results for the fourth quarter represented a satisfying end to our first profitable year in six years. We generated both our highest fourth quarter sales volume and biggest year-end backlog in five years. We improved our operating margins by almost 500 basis points in the quarter compared to last year, through a combination of cost containment, incentive reductions and price increases.

We increased our community count 13% by increasing our geographic footprint both organically and via acquisition. All of these factors have left us in a great position to build on the success we enjoyed in 2012, provided the market conditions remain stable.

Finally and most importantly, I would like to thank our employees for making 2012 such a great year for Ryland. It’s been six long years since we reported a net profit for a calendar year. A lot of hard work went into bringing our business back into the black and are appreciative of your efforts. Ryland is poised to produce even better results though the housing market continued to improve and I know our employees look forward to sharing in that success.

That concludes our prepared remarks and we’ll be happy to answer questions.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from Adam Rudiger of Wells Fargo Securities. Please go ahead.

Adam Rudiger - Wells Fargo Securities

Thanks very much. Looking at I think the backlog conversion its been a bit more consistent relative to your peers, just as I look at year-over-year trends. I’m just wondering if you thought that was kind of a run rate and if 2013 should look the same?

Larry Nicholson

Yes, I think somewhere 50% to 60%, maybe first quarter, closer to the lower end of that range, but I think that we’ve been consistent in that 50% to 60% range.

Adam Rudiger - Wells Fargo Securities

Okay. And then just thinking about the potential for more margin expansion, what’s a normal level of incentives or where you think you’d expect those to level out at?

Gordon Milne

I think historically we would say normal is more around the 5% range.

Adam Rudiger - Wells Fargo Securities

Okay, great. Thanks very much.

Gordon Milne

Thank you.

Operator

Our next question comes from Ivy Zelman of Zelman & Associates. Please go ahead.

Ivy Zelman - Zelman & Associates

Thank you. Can you hear me, Larry?

Larry Nicholson

Yes, we can.

Ivy Zelman - Zelman & Associates

Congratulations. Very exciting for you guys. A lot of people are seeing the strength that you guys are seeing and I think it would be helpful Larry to talk about your view, if you would have learned anything over the last six years during this downturn and going forward with everyone feeling a lot better out there.

What are some of the things that you put in place that could maybe have structural changes, that would allow you to have greater leverage from volume going forward or to look at SG&A as a percent of revenue and say what the opportunity used to be (inaudible) kind of trying to say you got the 10% as a percent of revenue for SG&A, you were in Nevada.

Are we limited to that Nevada, is that right or (inaudible) is going to repeat its old mistakes and maybe pinpoint, take pictures of the things you guys you have put in place to mitigate, sort of receiving some of the unfortunate problems that caused or contributed to the losses.

Larry Nicholson

Well, let’s hope that we don’t make some of the same mistakes we made in previous times, but I think the biggest thing Ivy we learnt through the last five or six years of the downturn is this business is extremely local and with that I mean that our local relationships, our local ability to hire good people is very important and so what we try to do is run the decentralized model that allow our guys and gals in the field to run their business and be the most profitable and have that discipline and I think we saw that through the downturn.

I think we were somewhat disciplined, before the downturn became more disciplined, but I think the only way to grow the business is that we have to give those people the opportunity and that leverage and I think our ability to move quicker than some of our competition I think gives us a leg up a lot of times, because we don’t have a lot of bureaucratic red tape in our organization. We try to give our people in the field the power to negotiate in land and on product and I think that does give us a little bit of a benefit.

The other thing I would tell you we learned through the downturn is the market has changed from a buyer perspective. It’s dramatically different, especially in certain parts of the country. You have multiple demographics that are different today than they were five years ago and used in Southern California, the Chinese buyers, the dominant buyer today; five years ago that wasn’t the case. So that means your product has to change, your marketing has to change and I think that just means we have to be more nimble and just can’t do one size fits all and I think that’s really the difference in where we see we have a better opportunity going forward.

Ivy Zelman - Zelman & Associates

Larry, that’s very helpful and if I could just follow-up with that as it relates to one of the concerns that the analyst community may have is that right now there’s a land grab going on out there and there’s significant capital being allocated to underwriting finished lots for grab, you name it and some of the problems that we heard from the prior upturn was that there were a lot of local decentralized operators that were underwriting land, just because they knew if they didn’t get the land they wouldn’t get a bonus and they wouldn’t be able to go to the local markets and there were beauty contests with underwriting that got crushed at every limit.

How do we get assured with your incremental investment that those problems won’t become apparent again or where we’ll start to see the local guys pushing it just to get the land replenished?

Larry Nicholson

Well, in an improving market the land environment’s always extremely competitive. I think a couple of things are different this time. Outside of the public builders, the cost of capital for the private guys are substantially more, so I think that gives us a huge chance to gain market share.

A lot of those guys can’t even get money. I don’t think I can remember the last time we lost an opportunity to a private builder. I think the publics are pretty much in control of most of the land markets around the country and what I would say is probably not a lot different than what we got in the past, is 50% of those deals are bids and 50% are negotiated, but it’s going to continue to be competitive and we just we think we can get our share.

We’ll be real happy with what our people have brought to us in the last I’ll say 12 months and what we see on the horizon we’re working on. There’s still opportunities out there that work and meet all of the criteria and will give us lots and the difference today are deals are getting a little bigger. There is not a lot of developed lots everywhere, but again in an improving market we would expect to see that. So we feel pretty good about our land position and our ability to continue to buy land.

Ivy Zelman - Zelman & Associates

Best wishes. Good luck. Congratulations.

Larry Nicholson

Thank you.

Operator

Our next question comes from Ken Zener of Key Bank. Please go ahead.

Ken Zener - Key Bank

Good morning.

Larry Nicholson

Good morning.

Ken Zener - Key Bank

Larry, I wonder if you could comment, the normalized absorptions that you guys saw, I mean if you had 2.1 in 2012, that’s well below the “normalized range” of cost 3.8 to 4 you saw from 2004.

Can you talk to us, what’s going to really move that up and how you think about what the restraints might be in there, because you guys are so far below the normalized range? I mean are your communities smaller because you did more in-fill projects or was 80 lots and what could really move that, because that seems to me where there’s going to be a lot of volume increase as opposed to already your high community count growth.

Larry Nicholson

Well, I think through the downturn Ken, we did do smaller communities. I just think as we get through an improving market and consumer confidence continues to grow, prices continue to move, rents have gone up that we see just a steady improvement in that number and I would expect that at the end of this year the number is better than it was last year.

When do we get back to that 3.8 to 4? It could happen as soon as this year, it could be next year. The homebuilding industry kind of has a heard mentality and once it starts it could move very quickly and there’s a lot of different opinions out there.

What we are really focused on is making sure that we are improving our community count, our margins are consistent and that we are not selling lots too cheap where we can’t replace them. I think so it’s a balanced attack. Some places you want velocity, other places you don’t want velocity, but right now we see opportunity to maximize profit and that’s what I think we need to do.

Ken Zener - Key Bank

Okay, and then I guess when you talked about the community growth rate, was that for the fourth quarter and as well as how much did your price per foot go up, if you can separate that from mix, that would be useful, and your interest expense in COGS. I mean with land turning quicker, it seems as though you might have a lower interest expense. Is that the case and the impact on gross margins? Thank you.

Gordon Milne

Let me give you the answer to the – our cost per square foot fourth quarter to fourth quarter, up $2.70. What was the other question, sorry?

Larry Nicholson

On the interest expense it is down. I don’t have a number for you, but it’s definitely down.

Ken Zener - Key Bank

Is that going to be a material benefit next year, this year though as you’re turning assets faster?

Larry Nicholson

It helps.

Gordon Milne

Yes, it helps.

Ken Zener - Key Bank

Thank you.

Operator

Our next question comes from Michael Rehaut of JP Morgan. Please go ahead.

Michael Rehaut - JP Morgan

Thanks. Good morning and good quarter everyone. First question I had was around the gross margins. Real nice improvement over the first half of the year, but flat sequentially and some of your peers have demonstrated sequential improvement 3Q to 4Q. How are you thinking about 2013? I would assume that you’d be looking for more expansion into the first half as you’ve seen price appreciation continue throughout this year, but any remarks or color directionally would be helpful.

Larry Nicholson

Well, I think our margins are very respectable first off. I mean at 20%, I mean I think at some point you’ve got to decide what’s a normalized margin going forward and we’ve had this discussion, you and I before.

Hey, we had good improvement in previous quarters. I don’t expect and I haven’t heard any other builders come out and say that they expect to have huge margin improvement in ‘13. I mean, in an improving market you got cost pressures on labor, you got it on material, you have it on land. If we can continue to underwrite at 20% and grow our business and make our overhead go down, obviously that’s what we are focused on doing.

Now we expect to have a little bit of margin improvement, but there’s a lot of variables in that Mike, so I don’t think you can really just go out there and say, ‘hey, your margins will be 21% or 22% at the end of the year,’ because that’s just a tough spot right now.

Michael Rehaut - JP Morgan

Right. No, I appreciate that and certainly the margins where they are and the growth is a big part of that equation. Second question, on the land, you mentioned that you expect land spend in ‘13 to be similar to ‘12, yet you’ve grown your communities materially. This year you expect an even greater growth rate, next year. I would have thought perhaps you’d actually be increasing the land to support the bigger business and assume growth in ‘14 and ‘15.

So any thoughts around that? Is it just that you have certain acquisitions that you made in the back half of this year that are going to play through and add to that or how are you thinking about increasing the land spend to support the up cycle?

Gordon Milne

Couple of things; I think we said on our call we replaced our lots this year, plus added 30% to our lot count, so we had a terrific year. But we had two acquisitions in that number where we don’t plan on acquisitions in ‘13. We might have some, but we don’t forecast them, because we don’t know what they are yet.

So regarding the same numbers of spend without the acquisitions and that’s a hard number. I mean if we can spend more, we’ll definitely spend more, but at this point in the year what we are looking at is about the same number. They could grow as the year goes on. So we are hoping to find more deals and expand at an even faster pace, but I think for right now around $500 million is kind of a number we’re comfortable with. Hopefully it goes up.

Michael Rehaut - JP Morgan

And certainly you don’t have issues in terms of finding land as you’ve been pretty successful over the last 18 months, 24 months?

Larry Nicholson

We are real happy with what we’ve been able to purchase and what we have in the pipeline.

Michael Rehaut - JP Morgan

Great thanks.

Larry Nicholson

Thank you.

Operator

Our next question comes from Stephen Kim of Barclays. Please go ahead.

John Coyle - Barclays

Hi guys, it’s John Coyle filling in for Steve. I just wanted to touch base on the Trend Home expedition. Can you give us an idea of what effect there was on the gross margin due to purchase accounting?

Gordon Milne

Well just the whole trend acquisition, there’s only I think 23 homes closed in the quarter, so it really had no meaningful effect on the quarter.

John Coyle - Barclays

Got it, got it, okay. And since it seems like across all the builders that increase in material cost is a theme, can you maybe give us an example of an action you’ve taken in order to control these costs? Just any color around that would be really helpful.

Larry Nicholson

Well I think you do a couple things. One is, is you try to negotiate longer term contracts with some of your major suppliers, so you have price protection and then secondly, you’ve got to go out to the subcontractor base and negotiate with them, commit work so that they know they have plenty of work and that their prices, they have no issue with how many crews they are going to have on jobs and they can forecast what they can do, so.

I mean it’s going to get tough. I mean unfortunately there’s builders on our job sites trying to hire our guys away on a daily basis, offering them more money and that’s part of as we said earlier, an improving market, but I think we have a lot of long term relationships with a lot of contractors and you work with them. But it’s a struggle right now, because there’s a lot of pressure across the markets, but we’ll just keep fighting it every day.

Stephen Kim - Barclays

Sorry, it’s actually Steve; I did hop on. If I could just follow on John’s question, one of the things that’s been an offset to the rising material cost has been the fact you’ve been able to obviously raise prices on your Homes. In the past one of the things that has often been believed is that you make more money as a percentage, your profit margin is higher on higher end Homes or Homes that are a little bit larger or a little bit fancier, because they tend to go together.

Can you help us understand, to what degree your margin improvement that you’ve seen here over the last couple of years has been aided by an improvement in mix? I don’t mean geographically. I mean within Markets.

Larry Nicholson

Well, I think your point is right, Steve. The bigger houses usually obviously the construction cost is less, there’s leverage in them. So I think as you get out of the entry level market a little bit more, the first move up and the second move up market, it does help your margins.

Your prices are higher, you get a little bit more latitude, those people buy more options, which are higher margin product than just a straight, where an entry level buyer might put $10,000 worth of options in, a move up buyer might put $60,000 in and at a 40% margin, a huge difference, so…

But I think, again we’re still market driven and if we find opportunities for entry level housing and we underwrite it all the same. So the goal is that it all comes out about the same, but you’re correct. And then you get to the higher price markets and obviously we got a lot more of that this year, so that will be a benefit to us.

Stephen Kim - Barclays

Okay. Well, great. Thanks very much guys. Good quarter.

Larry Nicholson

Thank you.

Operator

Our next question comes from Stephen East of The ISI Group. Please go ahead.

Stephen East - The ISI Group

Thank you. Good morning guys.

Larry Nicholson

Hi, Steve.

Stephen East - The ISI Group

Larry and Gordon, you all talked a lot about your lands moving forward, what your lands strategy is and basically saying, hey, we’re still not -- we would still look at acquisitions if they come out. Right now your leverage is at about -- your net debt to total cap is 51%. How comfortable or how far will you push that and still be comfortable with that?

Larry Nicholson

Yes, I think a couple of things this year. One, we expect to put the deferred tax asset back on our books in either the second or third quarter. So that’s going to add quite a bit to undo a lot of the leverage that’s on there now.

And also at the end of this quarter we kept the mortgages on our books. So there’s $100 million worth of cash that was not there, that we could have easily just borrowed that money in the mortgage company and it would have showed up in our leverage, so most of the things make quite a difference so…

I’m really comfortable with where our leverage position is. If you look at our ratios in the fourth quarter for interest coverage and things, I mean we’re really getting back to some much, much better numbers than we’ve had for the last several years; I think that’s important. We did the convert last year, so even though the debt shows up it’s a very low cost of debt, so don’t think there’s any issue at all with the leverage of the company and like I said, lots of things we can do to make it better if we need to.

Stephen East - The ISI Group

Okay, that’s extremely helpful on that. And then Larry, I appreciate what you’re saying about the gross margin that, hey, how far do you push it etc, and 20% is a very respectable gross margin and I agree with that.

I guess what I’m more interested in, you had a lot of moving parts in your gross margin this quarter and if I back out interest expense, year-over-year you’re only up about 60 bips and yet you all talked about incentives dropping 200 and cost as a percentage of house price coming in a little bit and getting some leverage.

Can you help me bridge those two views and what I’m missing I guess and why I would have expected gross margin to have a better pick up excluding interest?

Larry Nicholson

Well, one thing that I think, if you look at the incentives going down 2%, we opened -- I’m just pulling a number, but I think it was like a hundred communities last year. We opened those at lower incentive, so when you take the average incentive it’s not that we had all of the same communities as we had a year ago and we’ve dropped it all from 10% to 8% or something. It’s the new communities we’re putting on. We are not starting at 10 and going down to eight and so part of that is just the newer communities have less incentives to start with, so I think that’s part of it.

And we include interest in all our numbers. I mean it is just part of our land costs. So I think we never look at it; I know other analysts do. We never look at our land costs excluding interest capitalized and kind of go, gee, what’s happening to margins. That’s just part of the numbers, so it’s just a different way to look at it.

Stephen East - The ISI Group

Okay, I appreciate that. If I can sneak just one more in; it sounds like I’m beating on a lot of negatives, but I think you all had a great quarter. I’m just wondering on the Texas market where orders just didn’t really move, was that a function of burning through those communities or what was going on there?

Gordon Milne

Well yes, I think we sold at a higher pace in certain markets and we do have new communities coming in Texas and we’ve been fairly aggressive in Texas, so we would expect to see a little bit of improvement there. But we have focused on a lot of other markets. I mean we’re in a lot of markets, we see a lot of opportunities which is really good, because now we’re seeing across all those geographies everybody is doing better, so.

And as you know in Texas, it’s margin tough. I mean it’s not going to be -- in the good times everybody else was 20%, Texas was 17%, maybe 18%, so there are some better opportunities elsewhere, but Texas is a huge part of our business and will continue to be a huge part of our business and we expect to see growth in Texas.

Stephen East - The ISI Group

Okay, thanks a lot guys.

Gordon Milne

Thanks Steve.

Operator

Our next question comes from Dan Oppenheim of Credit Suisse. Please go ahead.

Dan Oppenheim - Credit Suisse

Thanks very much. I was wondering if you guys were talking with a lot of confidence in terms of the overall environment and acquiring several builders here. Ryland certainly has been much more focused in terms of the affordable segment.

As you think with this confidence, how will this impact land acquisitions going forward? Will you be willing to do more in terms of just some of the land deals, in terms of the higher price point in more coastal areas, are you willing to go a bit further inland as the market, as the strength expands? How are you thinking about that overall in terms of just what you think about for land in ‘13 and ‘14?

Larry Nicholson

Well, market by market Dan, some examples would be in Houston we’ve gone inside the Beltway and are doing in-fill which is higher and smaller communities, something we haven’t historically done. We also did a high-end deal in Houston. We’ve picked up multiple communities like that around the country in divisions, where we saw an opportunity to grow the business in that segment.

So I think we just have to be opportunity driven. It’s not one size fits all and we see opportunity and if we’re going to continue to grow the business and garner market share, we have to be more aggressive in those Markets.

Dan Oppenheim - Credit Suisse

Great. Thanks.

Gordon Milne

Certainly in Southern California Dan, we’re going into coastal markets that we wouldn’t have touched years ago. So I think you’ll see us having a broader footprint certainly here.

Operator

Our next question comes from David Goldberg of UBS. Please go ahead.

David Goldberg - UBS

Thanks. Two quick questions here. I was wondering Larry, if you could talk about on the M&A front, about the willingness of private builders to sell in terms of price expectations.

I would think that as we go into the upturn and they read and see more and more about things getting better in their markets, they eventually want very higher and higher prices. I don’t know if maybe they are unreasonable or reasonable, but I’m wondering if your just seeing any changes in the way that private builders are thinking of what their businesses are worth and what they are willing to sell for.

Larry Nicholson

I guess what I’d tell you Dave is, I’ll just use a number. We talked to 30 guys, we got three to the finish line, and so 27 had unrealistic expectations or they didn’t have what they said they had.

Every deal is negotiated and I think the biggest opportunity for us comes in when people have equity partners that just want to get out of the business and the guys that are left running the business like the Trend Group, it’s an exceptional opportunity for us, because we had no presence in the market. They did have outside sources of capital and they were willing to exit and every deal is negotiated; it’s not a multiple.

We sit down with guys and guys start talking about multiples and we kind of just go, ‘hey, look we’re going to value what you have and we’ll give you a fair price. If it works great why don’t we move on?’ And I think that’s how we’ve approached it.

But I think there’s a lot of builders out there in the same boat, that have capital or having trouble getting capital, signing personally, and they’re just looking for -- it’s going to be another year or two years before they can get capital and they may not exist at that point. So they see an opportunity to come into a big organization and run their business the way we do set our business up as I said earlier, being decentralized, it’s a huge benefit for us. So I think there will continue to be deals and every deal stands on its own.

David Goldberg - UBS

Got it, and then just my follow-up question is about internal infrastructure at Ryland and the reason I ask is, if you talk about 20% community count growth year-over-year and you talk about the absorption pace getting -- even if it doesn’t get back to normal, right, even if it’s just three homes a month, right, you’re talking about massive growth in 2013 and I’m just wondering if you feel like you have the right infrastructure in place to control that kind of growth. I mean it’s going to be taxing for an organization to grow 50%, 60%, 70% right?

Larry Nicholson

Well, I mean you want us to grow slower?

(Cross Talk)

Larry Nicholson

Well I think what we’ve learned through the downturn is we’ve revised our structure, we’re in all the right geographic markets and when you think about opening communities and as Gordon said, we opened a hundred, usually we have the main management structure in place, so that’s not an issue. It’s really hiring a sales person who is super intendant to build it.

So we don’t see that growth as being a big problem. We’ve done it before. We understand what we have to do and we think there’s plenty of good quality people out there we can hire. So I think I’m excited about that challenge. I think it’s a great opportunity for the company. It’s a great opportunity for our divisions and we look forward to it and I just…

Gordon Milne

If you think back to a few years ago, I mean we did 16,000, 17,000 units at the peak. The management structure at corporate hasn’t changed very much and we got down to under 4,000 and we got back some of that last year. But even with 50% growth if that’s what happened to be, I’m not forecasting that, but it still gets us probably half where we used to be, so can we handle it? Yes, we’d love to handle it. I think the only issues out in the field like Larry said. We think those people we’d need to get back are available.

David Goldberg - UBS

Okay great. Thank you very much.

Larry Nicholson

Thanks, David.

Operator

Our next question comes from Nishu Sood of Deutsche Bank. Please go ahead.

Nishu Sood - Deutsche Bank

Thanks. So as we look ahead, rising demand environment, you folks are clearly going to continue to have pricing power. But as a couple of other folks have pointed out, your absorption is being at 2.1, there’s plenty of scope there to grow as well. So kind of classic price versus pace issue here, recognizing that it’s not either/or. If you look out over the next 12 to 18 months, which one is the higher priority?

Larry Nicholson

I would say it’s a balance, because again where you can’t replace lots, it’s going to be pace, where lots are readily available to be priced and you just keep moving through, so. But I think the benefit we have right now is we’ve opened a lot of newer communities, so we don’t have a lot of legacy land.

So while we have to manage pace, because those lots that we bought last year are more expensive today and especially in the shorter term positions where you bought 40 lots and you thought you’re going to get through them in 12 months and now you get through them in seven months, I think we have to maximize the value.

Nishu Sood - Deutsche Bank

So if newer lots or the ones bought post downturn are the ones where you’d be prioritizing price. What would be the general characterization of the ones where you’ll be prioritizing pace?

Larry Nicholson

Well I think where you have an opportunity to get out of a community that’s a legacy community, obviously you want to get out faster and get rid of the overhead and move on to something that’s more productive, so those places we want to keep moving volume and then we’re still sensitive to margin.

I mean we not going to give things away, because again with demand being where it is, I don’t think we need to give anything away anywhere. But in some of your longer-term legacy positions you move a little quicker. You want to get through them, but right now I mean we’re managing space everywhere.

Nishu Sood - Deutsche Bank

Got it, and just a follow-up question on a different topic, on your land purchases. If I compare you folks to other builders, obviously you’ve got a nice growth trajectory here in community count and land acquisitions. More of your growth has come from options than your peers and that runs kind of counter to the notion that massive land grab out there, you would think that optioning would be the more difficult strategy.

So just wanted to get some color on that. How have you been able to be relatively more successful than peers in terms of using options as they relate to the acquisitions or what’s driving that?

Larry Nicholson

Well, I think it’s a couple things. One as we talked about earlier, relationship and individual markets and being able to sit across from a land seller and tell them what you can and can’t do, they feel a little bit more comfortable; and two is, that’s where our guys start on a deal.

It starts as an option deal and they work as hard as they can to get it and we’ve been very successful doing it and it’s across most of the markets, but there’s markets where we just got to buy raw dirt and we can’t buy an option lot just like everybody else. And I think the other thing is that we, through the downturn we worked with a lot of developers and I think that’s given us some benefit coming out of the downturn.

Nishu Sood - Deutsche Bank

Great. Thanks a lot.

Larry Nicholson

Thanks.

Operator

Our next question comes from Will Randall of Citigroup. Please go ahead.

Will Randall – Citigroup

Good morning and thanks for taking my question. The question for you in terms of, is there any way you can quantify or qualify your input cost increases and kind of broken down into three buckets; lots, labor and materials and when do you think kind of the prices you’re seeing today annualize? I guess that’s the first one.

Gordon Milne

Boy, I don’t think we got that break down right here. I mean we said cost per square foot were up $2.70 last year, $2.70 a square foot, but I don’t have a break down between those three categories on that. A lot of costs are -- the framework brings the number to some places. It’s hard to break it all down exactly to those three, so I’d have to get back to you later. Just don’t have those numbers.

Will Randall – Citigroup

Thanks for that and then you mentioned that only 6% if I got the number right, of your communities are inactive or mothballed. Can you talk about your current active community count, how much of its legacy versus how much of it was bought in the count of the last three years?

Larry Nicholson

70% of sales, 60% of closing on community count.

Gordon Milne

Yes, I think the 6% was $1 inventory, not of communities.

Will Randall – Citigroup

Oh, got it. Okay.

Larry Nicholson

Sorry 70% of sales, 60% of closings is new communities.

Will Randall – Citigroup

Perfect. Thank you for that and great quarter guys.

Larry Nicholson

Thank you.

Gordon Milne

Thank you.

Operator

Our next question comes from Joel Locker of FBN Securities. Please go ahead.

Joel Locker - FBN Securities

I was curious on your 238 open communities. What’s the median lot count would you say in those open communities that you have remaining?

Larry Nicholson

Oh boy! I think we might have to get back to you on that one, Joel.

Joel Locker - FBN Securities

All right, I’ll just go on. The other thing on your financial revenue as a percentage of homebuilding revenues up I think, up 2% or up 3% or so versus I think it was 2.5 last year and in the last couple weeks has that MBS margin spread been coming down with the increase in the rates, increase of tenure rates and what not?

Gordon Milne

I haven’t noticed any difference yet. Can’t give you an updated number on that.

Joel Locker - FBN Securities

I guess just housekeeping questions on interest expense, where do you see that in the first quarter as that had a bump up and also what’s your total spec count?

Gordon Milne

Well, we borrowed some money in the fourth quarter obviously, so interest expense went up from what you would have thought. As we start to capitalize more interest, as our inventory balance grows, I think you’ll see less hitting the expense line and by the middle of the year and probably third quarter we’ll have no interest expense; all will be capitalized.

Joel Locker - FBN Securities

Right.

Larry Nicholson

Spec count Joel would be a total 724; 280 those are finished, 444 unfinished.

Joel Locker - FBN Securities

All right. Thanks a lot guys.

Operator

Our next question comes from Alex Barron of Housing Research Center. Please go ahead.

Alex Barron - Housing Research Center

Yes, thanks. Good job guys. I wanted to talk about the margins and where you think they are going to go. I guess in some markets it seems like land prices are going higher and then there’s obviously talk about higher costs, labor, materials, etc. But so far this year it seems like you guys are seeing margin expansion and I’m guessing it’s because you’re building on land that you bought in 2010, 2011. So I’m kind of trying to figure out where do you guys think is the outlook for margins like 2014 and beyond?

Larry Nicholson

Well, it’s tough to project what 2014 is. We’ll talk about ‘13. As we said a little earlier, it’s a tough sledge on the margin side. Being at 20% we don’t see a lot of upside. The communities we’re opening, they are all underwritten the same way, so we wouldn’t expect to see a huge improvement and then costs are still an issue today and while we can continue to raise price, we don’t know if that trend will continue, we hope it will. So we are not making a whole lot of statement on margin moving forward.

Alex Barron - Housing Research Center

Okay, and then on the topic of Phoenix and the trend acquisition, obviously you guys made a good decision to exit the Phoenix market a few years back and now you’re I guess reentering this way. Can you comment on roughly what the size of the deliveries trend in 2012 was and it seems to me that Phoenix kind of started to show some signs of slowing towards the end of the year. So just kind of wondering your thoughts on whether that was just temporarily?

Larry Nicholson

Yes, I do think it was temporary. I think that what happened was, the sales pace in Phoenix got so overheated the guys were burning through lots very quickly. Everybody decided to slowdown and we were running out of positions. So I think there was limited release in most of the markets and I think on a go forward with the trend acquisition it gives us a great opportunity in Phoenix.

Obviously we have lots, we are out there actively buying lots. We got a great management team that understands the market and has been there. The management team has been together for a long time, so it was a great opportunity for us to reenter that market via the acquisition, because there’s no way organically we could have done what we’ll do with that thing in the near term and we’re really excited about our opportunity there.

Alex Barron - Housing Research Center

As far as the size of (inaudible) last year?

Larry Nicholson

We might have to get back to you. I’ll say I think it was like 160 or something, but again on a growth plain to move up, so Drew will get back to you.

Alex Barron - Housing Research Center

Okay, thanks.

Operator

Our next question comes from Michael Trica of Oakum Bay Capital. Please go ahead.

Michael Trica - Oakum Bay Capital

Good morning guys and congratulations on the quarter. A two-part question and more kind of a macro perspective. Generally in your largest markets of Texas and North Carolina, two of your largest markets. Generally land prices today, could you give color on where we are in terms of new prices and new land deals today, versus where we stood in 2005, 2006?

Larry Nicholson

Well, I’ll talk more general Mike. I think in a lot of markets we are back to seeing the prices that are not un-similar to what we saw in 2005. Prices have moved up, fortunately pricing has moved up also, but some markets it’s extremely competitive. We have seen communities come across that are more expensive than the peak, so it’s hectic.

Gordon Milne

In Texas prices of homes didn’t go down very much and so you wouldn’t expect the land went down very much either and so looking back to where we were when home prices are probably the same as they were in 2005, it probably wouldn’t be much of a surprise. Carolina is probably a little different than that.

Michael Trica - Oakum Bay Capital

Great, thanks guys. And the second question is more along the lines of more of a macro call. Assuming the next up-turn started last year, regarding generally location versus where we stood in the late 1999 period, 2003 period, the deals that are coming to market, I mean I got to believe that they tend to be less desirable areas, closer to highways and so forth, whereas certainly in the last cycle the opportunities were certainly more desirable.

So do you see that a lot of the activity in your markets, especially Arizona and Texas, more of these houses that are 40, 50, 60 years old, one-offs, teardowns and maybe your buyer constituency 10 years ago is more focused on these one off deals and tearing down 40, 50 year old houses and just building one-off lots.

Larry Nicholson

No, I mean I don’t think that’s what we are working on. We are working on places similar to that, but where there might be a strip, an old abandoned strip center that we can buy the piece and knock the whole strip center down and build 40 or 50 houses, seeing a lot of that.

There’s still a lot of opportunity in good locations around employment centers in most of the markets. There was a big delta between what I would say at the beginning of the turn down of the A communities and really what we are seeing, the E communities, there was a lot of land in between that obviously that’s available. So I think there’s still good opportunities, both on the perimeter of towns, but also think there are some great opportunities a little closer in.

Michael Trica - Oakum Bay Capital

And just kind of the delta versus 10 years ago, you don’t see the opportunity set to be any less desirable?

Larry Nicholson

No, I mean I think you got to look at this business historically. We’ve always been able to buy lots and build houses I mean and for all the rhetoric you hear, nobody wants to live in the suburbs; that’s going to continue to be a trend.

Employment centers, that’s the other thing we are seeing a lot of activity being created and I’ll use Orlando as an example, out on the East side of town Medical City which 10 years ago wasn’t even a thought is three hospitals, 30,000 high paying jobs. It has created an environment in that section of town that you could have never envisioned four or five years ago. So I mean those things are happening all over the country. Everything is not being built at in the urban core. So I think there’ll continue to be those opportunities.

Michael Trica - Oakum Bay Capital

Great guys. Thanks very much for your time.

Larry Nicholson

Thank you.

Operator

(Operator Instructions). Our next question comes from Buck Horne of Raymond James. Please go ahead.

Buck Horne - Raymond James

Thanks. You mentioned how challenging it is on a day-to-day basis to maintain some of the work crews and some of the challenges with guys coming in and trying to hire your crews away. Can you talk and will you be able to quantify what kind of impact you may have in terms of cycle times, your construction cycle times in the field and if that’s starting to creep up and in terms of the number of days it takes to build a house, is there any impact there?

Larry Nicholson

I would tell you Buck, what we see right now is about a week of time, that’s it, so it hasn’t had a major impact.

Buck Horne - Raymond James

Okay. What’s your average cycle time now though, just for context?

Larry Nicholson

I can get it to you. It’s somewhere between 70 and 75 days.

Buck Horne - Raymond James

That’s perfect. And also just quickly, do you have the count for the number of finished lots you have owned and finish lots you have auctioned?

Larry Nicholson

I think Orlando was two-thirds were finished, option that’s rented, but there was a lot of options that’s unfinished, that is under development, but…

Buck Horne - Raymond James

Okay, that’s all guys. Thank you.

Larry Nicholson

Thank you.

Operator

Our next question comes from David Williams of Williams Financial (ph). Please go ahead.

David Williams - Williams Financial (ph)

Thank you. Good morning guys, nice quarter. I just wanted to ask real quick about the ASP growth and what maybe your thoughts are going forward as far as maybe the sustainability of the trends that we’re seeing. With 6% plus growth, three quarters in a row, is that something that you think can continue going forward, thinking about the size of houses and maybe the mix shift and even the pricing environment that we are seeing. How do you think those trend over the longer term?

Larry Nicholson

Well, I think you’ll continue to see price move up. I think both from a mix perspective and just from a pricing strength perspective, so we would expect to see that continue.

David Williams - Williams Financial (ph)

Would you expect to maybe see the type of leaks that we are seeing today, the 6% or do you think that moderates at some point where we’re getting back to a more normalized environment of maybe 1%, 2%, 3% over the longer term?

Gordon Milne

Part of it, it’s hard to tell, because we are doing more homes in California and Washington this year as a percent and so those are more expensive homes and so just as in price increases like inflation, it’s the mix and so as we build out the two coastal areas more, the prices are going to go up and then we’ve got price increases generally. So we’re pretty confident prices will continue to go up, while your exact numbers are much more difficult to predict.

David Williams - Williams Financial (ph)

Sure. Well thanks for that, and you had mentioned earlier that the cost per square foot was about $2.70 on the year. Do you have that, what the sales was on a cost per square foot basis increase?

Gordon Milne

Yes, I think costs were up about 5% and revenues were up about 8%.

David Williams - Williams Financial (ph)

Great. Thanks again guys. I appreciate it.

Gordon Milne

Thank you.

Operator

I’m showing no further questions at this time and I’d like to turn the conference back over to Mr. Larry Nicholson for any closing remarks.

Larry Nicholson

Well, thanks for joining us today. We appreciate it and we’ll look forward to seeing you next quarter. Thank you.

Operator

Ladies and gentlemen, this does conclude today’s conference. You may all disconnect and have a wonderful day.

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