MDC Holdings Management Discusses Q3 2013 Results - Earnings Call Transcript

| About: M.D.C. Holdings, (MDC)

MDC Holdings (NYSE:MDC)

Q3 2013 Earnings Call

October 29, 2013 12:30 pm ET

Executives

Robert N. Martin - Vice President of Finance and Business Development

Larry A. Mizel - Executive Chairman and Chief Executive Officer

John M. Stephens - Chief Financial Officer, Principal Accounting Officer and Senior Vice President

Analysts

Michael Jason Rehaut - JP Morgan Chase & Co, Research Division

Ivy Lynne Zelman - Zelman & Associates, LLC

Daniel Oppenheim - Crédit Suisse AG, Research Division

Nishu Sood - Deutsche Bank AG, Research Division

Stephen F. East - ISI Group Inc., Research Division

Kenneth R. Zener - KeyBanc Capital Markets Inc., Research Division

Adam Rudiger - Wells Fargo Securities, LLC, Research Division

Eli Hackel - Goldman Sachs Group Inc., Research Division

James McCanless - Sterne Agee & Leach Inc., Research Division

Joel Locker - FBN Securities, Inc., Research Division

Alex Barrón - Housing Research Center, LLC

Operator

Good afternoon. We are ready to begin the M.D.C. Holdings, Inc. Q3 Earnings Conference Call. I will now turn it over to Bob Martin, Vice President of Finance and Business Development. Sir, you may begin your call.

Robert N. Martin

Thank you. Good morning, ladies and gentlemen, and welcome to M.D.C. Holdings 2013 Third Quarter Earnings Conference Call. On the call with me today, I have Larry Mizel, Chairman and Chief Executive Officer; and John Stephens, Chief Financial Officer. [Operator Instructions] Please note that this conference is being recorded and will be available for replay. For information on how to access the replay, please visit our website at mdcholdings.com.

Before turning the call over to Larry, it should be noted that certain statements made during this conference call, including those related to MDC's business, financial condition, results of operation, cash flows, strategies and prospects and responses to questions may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements involve known and unknown risks, uncertainties and other factors that may cause the company's actual results, performance or achievements to be materially different from the results, performance or achievements expressed or implied by the forward-looking statements. These and other factors that could impact the company's actual performance are set forth in the company's 2013 third quarter Form 10-Q, which was filed with the SEC today.

It should also be noted that SEC Regulation G requires that certain information accompanying the use of non-GAAP financial measures. Any information required by Regulation G is posted on our website and with our webcast slides.

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

Larry A. Mizel

I'm pleased to announce the third quarter income of $36,300,000 or $0.73 per share, marketing -- marquee-ing -- marking our seventh consecutive quarter of profitability. The improvement was largely the result of our homebuilding operations, as our gross margins improved year-over-year for the fourth consecutive quarter and our homebuilding pretax operating margin expanded by 300 basis points to 6.1%.

Significant topside growth for our company contributed heavily to our improved metrics. In the third quarter, our home sales revenues grew by 35% year-over-year, reflecting increases in both unit volume and prices as the housing market improved over the past few quarters. Our total net home orders for the third quarter declined year-over-year based on a decrease in our active community count, which was down both sequentially and year-over-year. Despite the increase in interest rates we saw during the quarter, our monthly rate of net orders increased by 14% year-over-year.

Although some of our communities have not opened as quickly as originally anticipated, hindered by issues such as a delayed plan approval from the local municipalities, we still believe we are at a position to grow our community count as we drive towards the start of the spring selling season next year. Across the country, we have continued to acquire land at a healthy pace. During the third quarter, we spent approximately $165 million to acquire more than 2,100 lots and 55 communities, 31 which are new. This level of land acquisition activity drove a 52% year-over-year increase in our lot supply to a total of more than 15,800 lots. Given our acquisition activity thus far this year, we believe that we have the lots we need to drive volume gains and improve pretax profits in 2014, and we are on track with the lot supply we need for further improvement in 2015 as well.

Although we continue to dedicate considerable resources and investing in new communities, the increased economic uncertainty surrounding the government shutdown and debt ceiling earlier this month highlighted the prudence of maintaining a strong financial position, which is the center of our operating strategy. The pace of home price increases moderated during the quarter, and the intensity of competition for land acquisition diminished to some degree. We continue to believe that the homebuilding industry is experience -- experiencing a solid recovery and should continue along a positive trajectory. However, we also believe there is considerable value in our strategy of maintaining a solid balance sheet and focusing on operational excellence for the long-term benefit of our customers and shareholders, rather than relying on land speculation to drive profits. With over $800 million of cash and investments at the end of the quarter, a strong but conservative land supply and improved operating margins, our company is solidly aligned with this strategy, which should help us in our efforts to deliver solid risk-adjusted returns in the coming quarters.

Thank you for your interest and intention. I'll now turn the call over to John Stephens for more specific financial highlights of our 2013 third quarter. John?

John M. Stephens

Thank you, Larry. Our closings were up 21% to 1,257 new homes with most of our markets experiencing year-over-year increases, which was driven by higher beginning backlog levels and higher spec deliveries. The largest contributors to the increase in homes closed were from our Colorado, Washington, Maryland, Virginia and Florida operations. Our backlog conversion rate of 60% remained steady with the past few quarters. However, with a higher percentage of backlog and spec homes under construction, we believe we have the opportunity to generate a higher fourth quarter backlog conversion rate.

Our average selling price was up 12% or $36,000 per home year-over-year to $345,000 due to our efforts of raising prices and lowering incentives over the past several quarters. And sequentially, our average home price was up 2% or $7,000 per home. Pricing power over the last year has been strongest in the West, up 17%, with Nevada seeing the largest year-over-year price gains. Our average selling price was also positively impacted by a slightly higher mix of homes delivered from our Colorado, Maryland and Virginia operations, which all have higher average selling prices than our company-wide average.

Our gross margins continued to improve with our focus on balancing home pricing increases in sales pace. As a result of these efforts, our gross margin from home sales, including capitalized interest, increased 260 basis points year-over-year to 18.1% and was flat versus the 2013 second quarter after the inclusion of a $350,000 inventory impairment.

Excluding interest and cost of sales and impairments, our gross margin from home sales was 21.8%, up 360 basis points over the last year and up 50 basis points sequentially, which represented 4 consecutive quarters of sequential increases and demonstrate that we have been able to generate improving gross margins on a more current land spend. And while we continue to actively manage our pricing in each of our communities, we have experienced some moderation in pricing over the last couple of months as we move into the slower selling season and as a result of rapid pricing gains, we experienced over the past year, combined with recently higher interest rates experienced during the third quarter.

I would also like to make the point that all of our projects are either actively selling or under development. And as a result, all the interest that we are incurring is being capitalized to inventory and included in our gross margin line item. And as we deploy our capital in the future, we would expect to have more inventory to capitalize these interest cost-overs.

Our homebuilding SG&A expenses as a percentage of home sale revenues were down 70 basis points to 13.3% versus 14% a year ago. The improvement in our SG&A rate was driven primarily by greater operating leverage from a 35% increase in home sale revenues. The year-over-year increase in our G&A expenses was largely attributable to an increase in incentive-based compensation expense resulting from a significant improvement in our pretax operating results, higher headcount due to increased volumes and anticipated community growth, as well as higher legal-related expenses in 2013. In particular, the 2012 third quarter benefited from 2.2 million of legal recoveries, whereas 2013 third quarter included an additional $1.2 million legal accrual charge. Our commissions expense increased 28% year-over-year, which was consistent with the increase on our revenue and delivery volume, while our marketing expenses were fairly flat.

Our monthly sales absorption rate was up 14% over the prior year to 2.3 sales per community, while the dollar value of our orders was up 2%, mainly due to our ability to raise home prices over the last year. However, the absolute level of our net new orders was down 8% year-over-year, largely due to a 19% decline in our average community count. Our orders slowed sequentially in the third quarter due to a rapid rise in interest rates and significant year-over-year price increases coupled with normal seasonality.

Our orders were softer in the first 2 months of the quarter and improved in September. In fact, September was the highest order month of the quarter and was higher than the prior year despite a substantially lower active community count. Our absorption rates were higher in nearly all of our markets, with the West generating the highest absorption pace, with Arizona, Nevada and California each generating close to 3 net sales per community per month. We believe that the key to future order growth lies in our ability to open the communities that we have already purchased, which should help us expand our community count in time for the spring selling season.

As of the end of the quarter, our backlog stood at 1,762 homes with a backlog value of $677 million, a slight increase over the prior year. The increase in backlog value was primarily the result of price increases generated over the last few quarters, partially offset by a decline in orders.

Our average home price in backlog was up 15% year-over-year or $50,000 per home to $384,000 and it represented a 3% increase sequentially. Our active community count fell modestly from the second quarter to 134 communities. And as we stated last quarter, there's an element of volatility with opening new communities, including obtaining all necessary governmental approvals and permits and other construction-related issues. However, our soon to be active communities, which represents communities with construction activity that have not yet been sold 5 homes, continues to build and exceeded our soon to be inactive communities by 16, the largest spread we have seen since June of 2011. And so far, through October, we have seen our active community count move up notably during the month. As a result, we believe the acceleration of our land acquisition activities and the substantial increase in our soon to be active communities during the quarter should bode well for us as we seek to grow our community count before the spring selling season.

Our land acquisition efforts continued at a solid pace during the quarter, as we acquired over 2,100 lots. Of these lots, approximately 45% were finished, down slightly from 50% finished in the second quarter of 2013 and down meaningfully from the 75% finished lots acquired in the first quarter of 2013. As of the end of the quarter, we owned or controlled over 15,800 lots, which represented a 3.4 years supply based on our last 12-month delivery pace and a 52% year-over-year increase.

And after the purchase of nearly 9,000 lots over the last 12 months, the company continues to maintain a strong balance sheet with liquidity of approximately $800 million in cash and marketable securities, book equity approaching $1.2 billion and a net homebuilding debt-to-cap ratio of 20%. We believe that the balance we have achieved between growth and financial discipline gives us a unique ability to succeed in our industry, even in a more uneven housing market recovery.

At this time, we'd like to open up the call for questions. Jazmine?

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Michael Rehaut from JPMorgan.

Michael Jason Rehaut - JP Morgan Chase & Co, Research Division

On the comments around moderation of pricing over the last couple of months, I was hoping you could just elaborate on that a little bit. Does that refer to the rate of price increases slowing? Or also, just to discuss trends around incentives or discounts throughout the quarter, or if it also refers to perhaps in some selected areas or not reducing price outright?

John M. Stephens

Hey, Michael. This is John. I think what it refers to is really -- we did see a pretty healthy price increases amongst a lot of our communities over the last 3 or 4 quarters, and we saw it -- the number of communities we increased prices during the quarter declined a little, but we still had over 40% of the communities that we -- where we increased prices throughout the quarter. And I'd say the rate of price increase was not as strong as maybe it was the past several quarters. So we still did raise prices during the quarter, and we continue to be very disciplined, kind of doing a weekly review of all of our subdivisions through all of our communities. But clearly, it's come down a little bit, but overall, we have not really reduced prices much. In terms of incentives, the number really hasn't moved much. It's still had a pretty healthy level or low level, I should say, and -- But we have fixed spots here there, a very targeted -- if we need a incentive here or there, but nothing widespread at this point.

Michael Jason Rehaut - JP Morgan Chase & Co, Research Division

Great. That's very helpful. And just secondly, your comments around an improvement in September with orders actually being up year-over-year, curious if you have a sense of what really drove that. Certainly in the last 6 weeks, rates have come back a little bit, but if it was any type of change in consumer trends or -- also, you mentioned that, I believe, throughout the quarter, during the quarter, you had an improvement in community count. And so if any of that was tied to new community openings, which typically can have a kind of -- you generally want to start those off with this little bit of a stronger sales pace and a movement. So any thoughts around the drivers in September?

John M. Stephens

Well, I think interest rates obviously moved up pretty rapidly early on -- earlier in the quarter, and we did see them taper off recently, too. We don't have any particular color as to why September was better than August. We weren't really running any additional promotions or anything. I think it was just demand came back, I think sellers -- excuse me, buyers start coming back, and we saw an uptick in September.

Operator

Your next question comes from the line of Ivy Zelman from Zelman & Associates.

Ivy Lynne Zelman - Zelman & Associates, LLC

I wanted to just focus in a little bit on the communities that you're opening, and maybe you can help us a little bit on the progression of growth year-over-year and throughout '14. And I know you've had some delays, but you're on track, if you can give us some guidance on what rate of growth we should see in community count through as it progresses throughout the year? And as your opening the new communities, are you seeing strong reception? And are you opening at the prices that you underwrote them to, and are they coming in as expected? Or are you seeing, actually, better pricing, given the acceleration in the market when you originally underwrote them?

John M. Stephens

Hi, Ivy. It's John. In terms of the community count growth, we did talk about a 10% number by the end of the year last quarter. I think what we said today was that we believe that our community count growth will increase probably similar to those levels by the time we get to spring. We have seen that kind of push a little bit in some of the delays we've experienced. And as far as growth for '14, we really haven't provided that information at this point, Ivy. I think we could provide some information on that as we move into next year. And in terms of underwriting, I think that was another one of your questions. We are starting to see these communities open, and I'd say the gross margins are pretty similar to what we underwrote them to. And they're pretty similar to what we're seeing in our company-wide gross margin as a whole. So obviously, some of you do better and some maybe don't open up quite as strong as you'd like. But I think overall, we're pleased with the communities we've opened to date.

Ivy Lynne Zelman - Zelman & Associates, LLC

Great, and then just one follow-up. There is some expectation that at the end of the month, the FHA may lower loan limits across the board from the 4 17 in all markets and the 6 25 plus in the high-cost markets. Assuming you see that type of a cut, let say it's, like, 5% is what it's being discussed to be done, what do you think the impact would be on your overall business? And I know it's hard to gauge, but obviously, would make the need for private capital to step in and throw us out. I don't know, Larry, if you have any thoughts on that.

Larry A. Mizel

I think that no one can be sure what the regulators are going to do, what magnitude they're going to do with and what effect we'll deal with. I guess my best answer is over 4 decades, whatever happened, we figured it out. And if this changes, we'll just deal with it. And it's homebuilding, what else can I say?

Operator

Your next question comes from the line of Dan Oppenheimer from Crédit Suisse.

Daniel Oppenheim - Crédit Suisse AG, Research Division

Can you talk a little bit in terms of the number of spec homes that you have? If you look at this year, it's gone from the end of first quarter from 7 36 to 8 13 at end of June now to 11 42 as the environment's been slowing a bit. How -- are you thinking about the level of spec activity? Or should we think about that as you get to the end of the year?

Larry A. Mizel

I think that we found that our gross profit margins for more immediate delivery have increased. If you go back a couple of years, it was completely backwards in the sense that whatever was a spec was worth less. And so we concentrated on new sales, good starts. And now we see that whatever is a spec is worth more versus less, and the the consumer wants delivery, possession, a mortgage. And even though rates have gone up and down a little bit, historically, these rates are very low on historical basis. And even in this short cycle, we've seen continued, as you might call it, volatility with the interest rates just in the last 60 days. It used to be -- we looked at housing cycles, then we looked at the season, seasonality adjustment. And now within the season, we have volatility. So housing is a part of the element that the government plays within they deal with the elements of consumer confidence. And whatever it is, we just have to adjust to it. And we try to stay on top of what's happening in the marketplace on an active basis, and we also pay attention to what's happening politically and economically on a broader base.

Daniel Oppenheim - Crédit Suisse AG, Research Division

Okay. I guess I understand the comments there in terms of the cycles and such and the margins there. But I guess it sounds as though you are -- this has been -- there's not much of an effort to bring that down, then I guess just wondering, if so in the sense that if those margins come if there's home sale. But at what point would you look to bring that down during the seasonally slower time of the year?

Larry A. Mizel

Well, we plan on growing our company. So if you're going to grow your gross sales and your mix is higher profitability for spec, we anticipate going with the market. And whatever that is best execution, that's what we're going to do.

Daniel Oppenheim - Crédit Suisse AG, Research Division

Okay, and then I guess just a little -- the community count has comes down, so it's more per community. But looking -- moving on from that, just looking at the increase in lands during the quarter, looks as though a lot of that was in California. Can you comment in terms of where you're buying within California in terms of coastal versus a bit more inland?

John M. Stephens

Hey, Dan. It's John. We're buying in, we're buying in both. We're buying coastal where we've got a big presence in Inland. We've also got in Northern California, we've been increasing our positions out there over the last 1.5 years or so. So it's across the board in terms of those markets in California.

Operator

Your next question comes from the line of Nishu Sood from Deutsche Bank.

Nishu Sood - Deutsche Bank AG, Research Division

I wanted to ask about the land spend, the lots that you're putting under control here. Another good quarter in terms of the number of lots you put under control. Last quarter, you described the reversal in terms of in 2012, you were picking up mostly finished lots, and in 2013, you've gone more towards development deal. So I was just wondering if you could give us an update on those percentages and whether that trend continued in the third quarter?

Larry A. Mizel

Well, I think that we're in a interesting market where the competition for land has diminished a little bit. We feel fortunate we're in a position to continue to look opportunistically at the land market. Some of the builders, whether it's public or private, have picked up kind of those transactions that utilized their allocated capital for the year. And I see us looking at both the finished and unfinished land kind of opportunistically versus any other basis. Our preference of course is finished and that which has a long tail on it. It's a complex high capital utilization development transaction that extends for a period of years is not something we look towards. As you know, our goal is approximately a running 3-year average of land under either control -- either owned or optioned. And of course, as our sales increase with the market conditions allowing it, then we will grow into whatever opportunities that fit our risk-adjusted return guidelines.

Nishu Sood - Deutsche Bank AG, Research Division

So should I take it, then, from your comments about the market conditions easing up for the land market that you, on balance, shifted back towards finished lot deals?

Larry A. Mizel

No, you should take it that we're open for business and we want to see deal flow. And if you see deal flow, then you're able to upgrade your opportunities as they come in. And we'll see what comes through the door over the next couple of months. But we're very comfortable on where we are as we commented for '14 and moving into '15. And as you roll forward on 36 months, you can kind of sense on your own what we're going to do.

Nishu Sood - Deutsche Bank AG, Research Division

Got it, great. follow-up question just on the community count. You mentioned the delay in sequentially increasing community counts because of the delays with the municipalities, et cetera. What -- I wanted to dig into that a little bit. What specifically was happening broadly that was a surprise relative to what you've been expecting? And so what -- what specifically caused you to kind of miss the 10% up by the end of the year?

Larry A. Mizel

Well, the -- I think the biggest problem through the growth markets is -- is we all looked back. The biggest dip in sales were those markets that are the most robust and the municipalities really guided much of their bureaucracy on planning and zoning and construction permit processing. So with all of the builders kind of rushing in at the same time, then markets like Las Vegas where we used to do it 10 or 12 months or less, raw ground, it's now 15 to 18 months or at least 15 to 16 months.

So these are pretty much problems. You might call good problems. Because business is good. But at the same time, the municipalities have to gear up again to handle the volume of work. Of course, they're gearing up at a time when their budgets are either have been cut or in the process of being cut as everyone has dealt with the pressure of what happened in the revenue receipts throughout the country. And so when you look into the markets that we have good growth in, these are the markets that the municipalities have to rebuild what they're doing, and we're providing sitters. So what's a sitter? It's a guy that sits out there in the building department, and sits and sits. And pretty soon, they either throw them out because it's the end of the day, or maybe someone will move it from one desk to the next, so we can have a little headway. But whatever it is, we're dealing with it.

Operator

Your next question comes from the line of Stephen East from ISI Group.

Stephen F. East - ISI Group Inc., Research Division

Larry, maybe I'll sign up for that sitter. I think I can do that. You all talked about September being your strongest month. And then as we get into October, we have the government shutdown. Consumer confidence got hammered pretty hard, and it started to come back fairly nicely. One, what are you seeing with the October trends? And also, on mortgage availability, we continue to hear that the banks are saying they're going to loosen up credit, et cetera. Are you all seeing any of that yet?

Larry A. Mizel

Well, credit is still challenging. The entities that are providing most of the credit seem to be getting hammered by the government for one crime or another. Whether it was or wasn't, I don't know. But the legacy distractions that are taking place are not good for our country and they certainly aren't good for industry. The tone with traffic is pretty good and we see with these mortgage rates backing off. And it looks as though at least for the next short period of time, that trend will increase. And there's a desire amongst the mortgage market to increase production because of how profitable it was and to the extent that it provides income. Most of the big mortgage lenders of course have let a substantial amount of staff go. So first, they let them go. Then of course, business builds up, than they've got to hire them again. It's kind of the normal. But I would say considering if the average consumer would not read the newspapers or watch TV, I think things would be a lot better. But taking that into account, we might have what some call new normal. And whatever we're all experiencing across the industry and maybe even many industries, the new normal is going to be a lot lower growth than we have had during prior recoveries, and so you adjust your business to new normal. I read a word someplace. They call it torque. Some of you probably read it at the same place. But this is the torque that is being applied in where and how all of these are running our businesses, and that will continue. But we're homebuilders, so we're optimistic, and there's buyers coming in the door. They have higher credit scores to start with in the prior periods because those that have the low scores realized that there's less funding available, and they might be better off running that house till their credit improves enough in order to buy that house or another one. So I would say, in balance, things are okay.

Stephen F. East - ISI Group Inc., Research Division

Okay, thanks. Along those lines of the new normal and slower, another builder talked about that last week, that they expected, after we get through this, slower volume, et cetera. You all have been pretty aggressive buying land. You have a lot of cash. Your balance sheet is in great shape. If we are in a new normal, do you start slowing your purchases in 2014? And if so, what do you do with your cash? Are you still in the cash burn, or do you think you start to generate and you have other options?

Larry A. Mizel

I think the market will tell us what to do since we run a very, very conservative-type inventory. We've demonstrated to the market, we always knew ourselves that we could expand acquisition of land lots when we needed to, and we could contract when we needed to. And I think we've done a great job on both bases, and I'm still optimistic. I'm positive. I believe the housing cycle is early, and I believe it's solid. And we're fortunate to be -- there was quite a few years, it wasn't as much fun to be a homebuilder. It's pretty good now to be a homebuilder, and I expect that to continue to grow on a solid basis. That might not be a 25% per year compounded growth. But we will have, in my view, in my desire, fully informed, I think we'll have reasonably good growth for the next period of years, and we're acting accordingly.

Stephen F. East - ISI Group Inc., Research Division

Okay. If I could ask one more quick one. The mid-Atlantic and California are important markets for you all. Those markets seem to have pulled back more than some of the others during the last 3 to 6 months or so. Are you seeing those markets start to recover at any meaningful pace that's maybe a little bit better? In other words, getting a better bounce back, or is that not happening yet?

Larry A. Mizel

I think the mid-Atlantic has had some emotional turmoil that's some of the other builders and the market has seen. In California, I think after all, I see they have a surplus of $6 billion. So I expect them to do just fine, both the coastal of the inland is got a defined type of purchaser as far as the economic level. And I don't consider either of those markets to be anything other than just normal volatility. I use the word volatility because that used to be the financial world. Those of you that live in it hour to hour, day to day and didn't always apply it to homebuilding. But we have to deal with the emotional volatility, while we continue to execute on a risk-adjusted basis, which is how we run our business, so it's just fine with me.

John M. Stephens

Hey, Steve. Just to add to Larry's point on California, our absorption pace there, it's the third highest in the company. So albeit it did come off maybe the higher levels we saw earlier in the year, it's still pretty healthy level at almost 3 per community. And in terms of the absolute orders there, our community count, we sold out very quickly in some of these communities. So we're in the process of replenishing. And we would expect our community count to grow there as we've been buying land there, as of we have these other markets that have been better over the last 12 to 18 months.

Operator

Your next question comes from the line of Ken Zener from KeyBanc Capital Markets.

Kenneth R. Zener - KeyBanc Capital Markets Inc., Research Division

Just a follow up on the last question there at the West, you do have a higher absorption pace versus your other markets, whereas it many builders actually are using the term managing pace to get price out West for advanced constrained, price gains have been robust. Can you comment perhaps on your idea of higher rates in the West moving through the communities, and how that might play in the gross margin trends that you're seeing versus the industry?

John M. Stephens

Well, again, we're monitoring our pace there too, I mean probably monitoring at there more than anywhere because we've seen the highest demand in those markets over the last period of quarters. So we want to make sure we're getting a good pace, absorption pace at all of our subdivisions in all of our markets, but -- so we continue to monitor there. We're not just taking prices down so we can increase the absorption pace. We want to make sure we have a good balance there.

Kenneth R. Zener - KeyBanc Capital Markets Inc., Research Division

Okay. And then perhaps this is in view of -- we're in a pause, higher rates, prices, people recalibrating, which is one view. And then there's the other view which is you mentioned seasonality, and we have to view at their seasonal trends, not cyclical trends in place, which is kind of bearing out. If look at your absorptions quarter-to-quarter, they're down about mid-to-high 20%, which is kind of your long-term average. Is it just the FICO scores that the people are coming up? Is it the fact there is still a lot of qualified buyers where there's FICO, or the cash payments, the percent down they're putting in? Or is it just really the low level of construction that we're all aware of historically, because we are seeing so normal seasonal trends? I mean, what is that pent-up demand that you're tapping in this, just that we have low levels of construction, low absorptions?

Larry A. Mizel

I think until we look backwards at what we've experienced, we won't be able to rationalize why all of this just as we're in the middle of a period of time. It's like any sales organization, you keep score by the day, the subdivision, the market, the month, the quarter. And all we can do is try to give you a little color of what we see and how we feel. Probably backwards, we can analyze why it happened the way it did. And right now, as I commented, the tone in October is not as bad as it could be considering all the activities in Washington, which looks as though they'll continue for the next -- I don't know, maybe forever. Who knows? But at least for the next couple of months to the next fiscal issue in January. And of course they'll have to work that in between whatever new things come up tomorrow. So that's the best answer we can give you.

Operator

Your next question comes from the line of Adam Rudiger from Wells Fargo Securities.

Adam Rudiger - Wells Fargo Securities, LLC, Research Division

One question I have is on the orders per community. I mean, the rest of builders we have heard from last week and even the guys who reported their I think August results, you had declining orders per community. So I wonder what you attributed your improvement to explain the difference. Can -- particularly, could you talk about Florida where it was pretty robust? And then also following on the heels of an earlier question, could some of that due to the soon to be active communities and that kind of skews that metric a little bit? I'm just trying to get a handle on what trends really are.

Larry A. Mizel

I think what we continue to try to do is improve our sales process. And I'd like to give credit to increased per-community activity to the efforts of the management team on better execution. And all of us, and I say as I'm speaking of the community, are receiving decent gross traffic. And it's a matter of the ability to convert that gross traffic to closings, and each of us are working hard at doing it. And I think that we have a little sample of our improving execution abilities.

Adam Rudiger - Wells Fargo Securities, LLC, Research Division

Okay, then following on up on that, then. Are you willing to share those some of changes you made or some of the successes that you had? And when did you think those successes started flowing through the results? Just I am kind of curious when we start anniversarying what you think are the management-led improvements?

Larry A. Mizel

I think we work on them every day. And I wish it would be as easy to put my finger on it, other than we are very hands-on management organization. And sales, we don't talk about it that much, but the execution of the sales process receives high priority here. And nothing specific I wish to share other than we're working really, really, really hard for best execution. And obviously, since we've had uncontrollable delays in opening new subdivisions and we need more sales out of the ones that we have that are open, and that allows senior management to focus even more tightly on the process.

Operator

Your next question comes from the line of Stephen Kim from Barclays.

Unknown Analyst

It's actually Peter Juan [ph] for Steve. The first, you had an interesting commentary on the land acquisition activities were repeating throughout the quarter to some degree. And so we've also heard commentary from other builders that because pricing -- the pricing trajectory may be falling down so out of next few quarters as well, certain costs are rising up. But that gross margins may actually peak relatively sooner than expected in the next 2 to 3 quarters. What are your views on that? How does that square with your views on what you're seeing in the land market?

Larry A. Mizel

Well, I think that I give the land sellers 100% credit for, let's call it, unusually robust perfect execution. And now that, that is a little bit behind us, now, we'll see their gross profits be adjusted. Because of the builder has certain expectations and they're not going to transact outside of those boundaries. And the land sellers have done a very good job of pricing it to perfection. And I think some of that is a little blow back, which is not much different than the consumer. When the builder raises prices too aggressively, the consumer backs off and things slow down a little bit. And here, the land sellers were aggressive, and I think the buyers backed off. And as usual, over a period of time, whether that's 2 quarters or a year, it kind of sorts itself out and we're just going through the normal process of the cycle.

Unknown Analyst

Okay, that makes sense. And then just on the pricing side, you mentioned that a good portion of that 12% increase was partly due to a mix shift the business higher-priced homes and communities in states such as Colorado. How sustainable is that kind of mix shift, just given a lot of talk about mortgage credibility opening up and potentially ushering in some more entry-level buyers?

John M. Stephens

Well, I think our mix shift is -- has -- we're comfortable with where we're at. And about 75% of the price increases we experienced during the quarter were due to real price appreciation, and another 25% or so of that increase was relative to the shift. And again, we expect to add communities, and we'd expect our mix to be more heavily weighted towards the West and Colorado, obviously, our home market. That's where we're seeing the most demand and that's what we work we bought some most land, and we would continue to see the mix shift that way.

Operator

Your next question comes from the line of Eli Hackel from Goldman Sachs.

Eli Hackel - Goldman Sachs Group Inc., Research Division

Just 2 quick questions. Just in terms of gross margins, I am just wanted your view. Obviously, I want to talk about where they were declining, these are the declining rate increase in prices, what that means for gross margins for the industry. I wonder if you can comment on specifically for MDC. And then there's for the community count. I just wanted to get your confidence level and your view that up 10% or so by spring selling season. Does everything that needs to happen for those communities entitlements, permits already done, so there really shouldn't be any delays on that front?

John M. Stephens

Eli, on the community count, I think we're comfortable that by the spring that we would meet that target. I think things just did shift. Some of the delays that Larry talked about earlier, just taking a whole longer to get them open. But I think we're comfortable with that by the time we get to this spring selling season. So the first question, you were talking very fast. Quite frankly, I'm not sure I got it all.

Eli Hackel - Goldman Sachs Group Inc., Research Division

So I can repeat it. It just relates to gross margin. Obviously, just in terms of the industry, some fears about year-over-year prices starting to slow down the growth, maybe some -- you guys benefited from some 90 above [ph] earlier in the cycle. Potentially, we know what does that mean for gross margin for MDC, if price growth slows down for you guys?

John M. Stephens

I think Larry touched on it too, earlier, in terms of he talked about the land sellers perfecting pricing and executing there. And I think we've seen a little bit of pushback there. As you mentioned, the consumer has too a little bit. I think we've also seen -- so we've seen the land costs, what will those end up and maybe they're leveling off. Same with I think the material costs and construction costs. If we saw those kind of spike up earlier latter part last year, first part of this year. And we've seen that kind of level off a little bit here as we've moved through the balance of the year. So I think like Larry said, it's homebuilding. We do it everyday. And we will continue to adjust and execute and stay focused and disciplined on trying to -- our goal to increase margins over time.

Operator

Your next question comes from the line of James McCanless from Sterne Agee.

James McCanless - Sterne Agee & Leach Inc., Research Division

First question is on SG&A. With headcount additions you made this quarter, will that headcount take you through to 2014? Or should we expect just a faster rise in SG&A going forward as you have to add more people?

John M. Stephens

James, it's John. We did add some people from where we were a year ago, and I think that was an anticipation of, really, the growth that we've experienced, both from an order kind of delivery standpoint, as well as the community growth. I don't expect us to add a lot of incremental headcount at the current levels. Now if that changes over time, we would adjust accordingly. But I think we're kind of -- we're set up for 2014 and all the communities that we have in the hopper. So we do not anticipate a lot there.

James McCanless - Sterne Agee & Leach Inc., Research Division

Okay. And then just a question about the traffic that you saw in September and October. How much in the neighborhood do you seeing buyers who may have gotten priced out by rates earlier this summer, maybe come back and try to put in front of the contractor, you haven't success bringing some of those people back? Or is that traffic you're seeing now new traffic, new buyers, et cetera?

Larry A. Mizel

I think it's probably a mix of both. A good salesperson kept track of the person that walked away, and that was whether it's consumer confidence or just any of the financial elements. And I don't think there is any magic to it other than a combination of both.

Operator

Your next question comes from the line of Joel Locker from FBN Securities.

Joel Locker - FBN Securities, Inc., Research Division

Just a question on the, I guess amortized interest. It was 360 basis points or so, and it rose 43 basis points sequentially. And I was wondering going forward, where do you expect that to run at now that capitalized interest?

John M. Stephens

Joel, it's John. We did see amortization of interest tick up a little bit during the quarter. I think over the last couple of quarters, it hasn't. And part of that is what lots we're delivering, the age, aging of the lots that we're delivering, that we're pulling through. As well as we did take on -- we issued some new debt earlier in the year. So the inventories are tracking a little more interest than maybe it was year ago. I think over time, as we move through some of the projects that we had that have been out there a little bit longer, we would hope that -- for inventory turn to continue at the same rate or at a better rate, that it would come down over time. And also it's also going to be dependent upon how quickly we increase our inventory spend. So obviously, our fixed -- our interest costs are with the we spread that over more inventory, it's less that would roll through the interest and cost of sales line item. So it's hard to give you a number exactly where it's at, but that's just some color around it.

Joel Locker - FBN Securities, Inc., Research Division

And you guys mentioned that gross margins are still better on specs. What would you say they were in the third quarter on a differential in a between the third sales and the spec sales of closings?

John M. Stephens

Well, we actually we've been very happy with the margins we've been generating on our specs, really, over the last year or so. We are seeing that tighten a little bit, so it's kind of converged quite a bit. But again, still generating good margins on our specs.

Operator

Your next question comes from the line of Michael Rehaut from JPMorgan.

Michael Jason Rehaut - JP Morgan Chase & Co, Research Division

Just wanted to clarify, make sure I heard you guys right, that the community count, you expect to hope to increase roughly 10% sequentially from the quarter-end number that you have. Is that over the next 2 quarters essentially or over the next 1 quarter?

John M. Stephens

I think what we said is that we have really kind of pushed that out a quarter. So yes, it's really over the next 2 quarters. I think, again, things have just taking a little longer than we originally had anticipated. So by the first quarter, we believe that -- our community count will grow by then to that level.

Michael Jason Rehaut - JP Morgan Chase & Co, Research Division

Okay. Yes, I just wanted to make sure the clarity there. And also, you mentioned that 75% of the closing ASP gain was driven by price and the balanced mix. And I was just wondering, looking at your gross margins sequentially, they really didn't increase that much in comparison to some of your peers, and -- but at the same time, you're getting a lot of pricing. So I was just trying to solve for why perhaps you didn't get as much sequential improvement, if you have any thoughts there.

John M. Stephens

Well, I think one of the previous callers had asked about it. I think we have a little more interest rolling through this quarter than we did some of the previous quarters. So that's part of it, but nothing really materially other than that.

Operator

Your next question comes from the line of Alex Barron from Housing Research Center.

Alex Barrón - Housing Research Center, LLC

I was wondering if you could comment I guess on the specs strategy. You guys mentioned that you're getting the higher margins now. If the interest rates stay where they are at and let's say pricing kind of flattens out, would you expect that relationship to stay the same where the specs get better margins than third starts? Or would you think it will grow back to more traditional historical relationship?

John M. Stephens

I think that we'd like to see them be fairly close. Obviously, that will be our preference. I think that if demand is still there, I think we can continue to generate good margins out of our specs. We're not going to -- just as we've increased our spec level intentionally a little bit, we're not going to go ahead and wholesale of those to move them. I think we've been very cognizant of which communities we are adding the specs and at which markets, and it over time, third sales have typically done a little better, better than specs, and that may kind of come back into play. But as of now, our specs and dirts are fairly consistent.

Alex Barrón - Housing Research Center, LLC

Okay, and John, can you also comment on the impairment? What was that related to and what market?

John M. Stephens

There's a more detailed disclosure in our cubit , but it was in Maryland. It was a smaller project. It's something that we've needed to deal dealt with and that was dealt with.

Operator

And there are no further audio questions.

Larry A. Mizel

Thank you very much for being on the call today. We look forward to speaking with you again, following the announcement of our Q4 results.

Operator

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

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