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Executives

Drew Mackintosh – VP, IR

Larry Nicholson – CEO

Gordon Milne – EVP and CFO

Analysts

Michael Rehaut – JPMorgan

Eli Hackel – Goldman Sachs

Ivy Zelman – Zelman & Associates

Stephen East – ISI Group

Dan Oppenheim – Credit Suisse

David Goldberg – UBS

Adam Rudiger – Wells Fargo Securities

Jay McCanless – Sterne Agee

Ken Zener – KeyBanc Capital Markets

Nishu Sood – Deutsche Bank

Stephen Kim – Barclays

Joel Locker – FBN Securities

Buck Horne – Raymond James

Alex Barron – Housing Research Center

The Ryland Group, Inc. (RYL) Q3 2013 Earnings Call July 25, 2013 12:00 PM ET

Operator

Good day, ladies and gentlemen, and welcome to the Ryland Group Incorporated Third 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 follow at that time. (Operator Instructions) As a reminder, today's conference call is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Mr. Drew Mackintosh, Vice President of Investor Relations. Sir, you may begin

Drew Mackintosh

Thanks, Mary. Good morning and welcome to Ryland's third quarter 2013 earnings conference call. Today's call is being transmitted live over the Internet and can be accessed through the Investor Relations section of the website at ryland.com. In a moment I'll be turning over the call to Larry Nicholson, Ryland's Chief Executive Officer, and Gordon Milne, Executive Vice President and Chief Financial Officer.

Before we begin, please be aware that certain statements in this conference 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 the statements made in this 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 most recent quarter. The Ryland Group posted its most profitable quarter since the housing recovery began generating net income of $53.6 million or $0.95 per fully diluted share for the third quarter of 2013.

Several key metrics hit new near-term highs including the number of homes closed, the average closing price and net operating margins. The third quarter marked a new face in the housing recovery as mortgage rates rose rather sharply of their historic lows.

This phenomenon combined with the normal seasonality of our business and the price increases we’ve implemented resulted in a slowdown in the pace of activity. While the slowdown impacted our sales in the short-term, it did not altered our outlook on the housing recovery over the long-term provided the economy continues to improve and the employment levels returned to healthier levels.

Inventories of new and existing homes remain at low levels in most of our markets and we expect the demographic drivers of household formation to result in the need for new homes for years to come.

For several years now, we are focused on rebuilding our company to take advantage of the upturn in housing and we continue this trend in the third quarter ending the period with a 49% more lots under than we had in the same period a year ago. We expanded our presence in several existing markets and established a foothold in a new market through the acquisition of Philadelphia based Cornell Homes.

These purchases were made with an eye towards the future while being rooted in the current market conditions of today. We are pleased with both our profitability and market positioning as we head into the end of the year.

With that, here are the details for the quarter. The Home Building segment generated $55.2 million in pre-tax profits in the third quarter, compared to $20.8 million in the year ago period.

All four of our Home Building regions made positive contributions to the total with the south region generating the highest profits followed by the north, west and Texas.

Home Building revenues rose 61% to $563 million, thanks to a 44% increase in closings and a 13% increase in the average closing price. We closed 51% of our beginning backlog, a number that was negatively impacted by worst weather conditions in several of our markets and by the fact that we had a relatively young backlog at the beginning of the quarter with homes closer to start than finish.

We anticipate our backlog conversion rate will be closer to approximately 60% in the fourth quarter. Average Home Building gross margins expanded to 20.6%, the majority of this expansion was attributable to home price increases staying ahead of building material cost inflation as our land cost grew more in line with revenues.

SG&A as a percent of revenue also improved over the year ago period declining 190 basis points to 11.9 as we continue to keep fixed cost in check while our business grows.

We believe that operating margins will expand from current levels providing the closing volumes continued on an upward trajectory.

Backlog increased 37% on a unit basis or 62% on a dollar basis. We sold 1592 homes in the quarter net of cancellations, an increase of 6% over last year.

It should be noted that orders grew 56% in the third quarter of 2012 making for a difficult comparison. Despite this comp, the dollar value of new orders increased 33%. Excluding the one-time benefit associated with the acquired backlog from last year’s Timber Stone acquisition, and this year’s Cornell acquisition, yearend sales increased 10%.

While the traffic on our website and our models remained solid throughout the quarter, the number of potential buyers willing to move forward with the purchase declined relative to the levels we had seen prior to the rise in rates.

Markets that experienced strong sales in spite of the rate increase included Las Vegas, Southern California, Atlanta and Chicago. Our cancellation rate as a percentage of sales came in at 23% for the period. However as a percentage of backlog, the cancellation rate actually declined year-over-year from 16% to 13%.

Sales activity remained flat throughout the quarter with 491 homes sold in July, excluding the acquired backlog, 508 in August and 496 in September. On the absorption front, I think there are numerous factors that need to be looked when assessing our quarter.

For the first time in five years, we experienced normal seasonality along with a 100 basis point interest rate move inside of 30 days. We also made decisions to push prices in certain markets where we felt we could maximize values on lots that would be hard to replace.

Examples of this would be Charleston, Orlando, Houston, Phoenix and Las Vegas. We also had cities with limited lot availability and late new community openings that contributed negatively.

We feel some of these events are temporary and leaving out in the upcoming quarter. That being said, I think it is important to look at the dollar growth of our backlog, which demonstrates that we are balancing pace and price. We did still have positive order growth and our dollar order growth this quarter has been among the best in the industry.

Turning to the balance sheet, Ryland ended the quarter with $604 million in cash, $1.4 billion in debt, and $837 million in stockholders’ equity for a net debt-to-total cap ratio of 49%. We spent $230 on land acquisitions and $76 million on site development in the quarter bringing our 2013 totals to $498 million on land and a $184 million on development.

Total lot counts stood at 39,070, a 49% increase over the third quarter of 2012. 16,671 of our lots were controlled via option agreement or 43% of the total and the remainder were lots we owned.

We had $1.6 billion in total inventory at the end of the quarter with sold inventory accounting for 29% of the total. The markets with the largest inventory balances were Washington DC, Southern California and Houston. Our capital remained evenly spread throughout the country with no one market accounting from more than 10% of the total.

Number of spec counts in the quarter rose to 978 units or 3.4 per community with 405 of those units being more than 120 days from start. This increase is consistent with normal seasonal patterns, as we started a higher percentage of homes to close out the year and four foundations in advance of winter in our northern markets.

We ended the quarter with 284 active communities, a 21% increase over the third quarter of 2012. Our north, west, and Texas regions grew community count by over 30% year-over-year, bolstered by the acquisitions we made in the last 12 months, while our southeast regions’ community count remained essentially flat. Community count should continue to grow at a healthy clip over the next few quarters, as we had 213 communities in the pipeline at the end of the period. For the full year 2014, we are projecting community count growth of 15%.

Our Financial Services segment reported a pre-tax profit of $6 million in the quarter, compared to $3.4 million in the year ago period, 57% of the mortgages we originated in the quarter qualified as prime loans, 41% were government loans and the remainder were rural housing loans. While we have begun to see signs of some credit easing on behalf of lenders, the average FICO score for the quarter actually ticked higher to 733. The average downpayments stayed relatively constant for our buyers at 10%. We hope to see further credit easing as the mortgage market continues to evolve.

In summary, while the sharp move in interest rates took some of the momentum out of our sales pace in the quarter, we were pleased with the progress we made in several areas. We posted significant year-over-year increases to both home prices and unit volumes, resulting in our most profitable quarter in over six years.

We spent over $300 million on land acquisition and site development, giving us increased confidence in our ability to grow our community count in 2014 and beyond. We maintain a strong balance sheet with favorable credit metrics. In spite of our recent capital expenditures with over $600 million in cash, an interest rate coverage ratio of 4.4 for the quarter and a cost of debt of below 5%.

In short, this quarter we maximized our near-term profitability, by bolstering our long-term growth prospects in a financially prudent manner. For the fourth quarter, we are anticipating another year-over-year improvement in gross margins and SG&A leverage, Home Building revenues of approximately $665 million and an earnings per share ranging from $1.10 to $1.20.

Finally, I would like to thank our employers for another great quarter. You’ve done an excellent job staying focused on the task at hand as this housing cycle continues to evolve. I truly appreciate your efforts.

That concludes our prepared remarks and now we will be happy to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Michael Rehaut from JPMorgan. Your line is open.

Michael Rehaut – JPMorgan

Thanks, good morning everyone.

Larry Nicholson

Good morning, Mike.

Michael Rehaut – JPMorgan

The first question I was hoping you could discuss the gross margins, I appreciate the comments about your outlook for year-over-year improvement in the fourth quarter. I was wondering if that also would include improvement on a sequential basis. And, given that the improvement slowed a little bit sequentially in 3Q versus 2Q how you are thinking about that trajectory over the next several quarters?

Gordon Milne

The trajectory is not even in each quarter, but I think – we saw sequentially margins moving up in the fourth quarter.

Michael Rehaut – JPMorgan

Okay, and just about, looking a little bit past that, there has been talk about how to the extent that price inflation moderates and over the last 18 months, land inflation has been pretty heaty. If that would have an even potentially negative impact on margins in 2014 at some point?

Larry Nicholson

We wouldn’t anticipate that, Mike, based on what we see in our land pipeline. We think our margins will improve.

Michael Rehaut – JPMorgan

Okay, and just one last one if I could. The sales pace you mentioned and correct me if I am wrong, I believe you said that sales pace excluding the acquisitions this year and last year were up about 10% year-over-year. Is that’s something that has continued throughout the quarter and would you expect in 4Q?

Gordon Milne

You know, we don’t give a lot of guidance on the fourth quarter, but I mean, we haven’t seen a dramatic change in anything so far this month.

Michael Rehaut – JPMorgan

All right, great. Thank you.

Operator

Thank you. Our next question comes from Eli Hackel from Goldman Sachs. Your line is open.

Eli Hackel – Goldman Sachs

Thanks, good morning. I just wanted to better understand the order numbers a little bit. To any degree you had lower absorptions, due to the fact that you opened maybe in some higher price point communities, which maybe had lower absorptions. So maybe there is a mix shift impact. And following just on that point, obviously order price was up pretty significantly year-over-year. Maybe you can just talk about that trend, whether it’s mix or just price increase as you are putting into your communities? Thank you.

Larry Nicholson

Well, I think that's a little of all of it. I think that in places where we could maximize price, we may have slowed the pace now. As I said in the prepared remarks, we have certain neighborhoods that we don’t feel that we can replace those lots at the margins and we can continue to show on the responding of opportunities.

So we are trying to maximize those. We do have some higher price stuff that opened in Southern California. That’s contributing more positively to the business, obviously Washington is a little higher priced. So, we are seeing some areas that we do have higher prices and looking out into the fourth quarter.

What I tell you is, the Cornell acquisition will help on average sales price to push it up a little bit as will the Phoenix and the Dallas acquisition. So we would expect to see average closing price continue to increase and we are comfortable with where we are from a price perspective moving forward.

Eli Hackel – Goldman Sachs

Thanks, and just one more. I just wonder if you can go a little bit more detail about, you mentioned seeing a little bit credit maybe what type of easing – you are seeing and how faster, how slow do you think that will continue as we move into next year?

Larry Nicholson

Well, I think you have seen as most of the banks have eased their credit score threshold down a little bit, 20 to 40 basis points, I think depending on the bank or on the FICO score rather. So, to say that we’ve seen a dramatic shift so far, I would say no, but we are – the lenders we do deal with, we are seeing that. So we would expect to see some of that start to filter through this quarter.

Eli Hackel – Goldman Sachs

Great, thank you very much.

Larry Nicholson

You are welcome.

Operator

Thank you. Our next question comes from Ivy Zelman from Zelman & Associates. Your line is open.

Ivy Zelman – Zelman & Associates

Thank you. Good afternoon guys. Gordon, maybe you can talk about how the acquisitions are doing relative to expectations and are they coming in, in line with where you originally acquired them in terms of how you underwrote them and or in fact are they accretive in thinking about the margin mix contribution near-term and sort of going into 2014 and what the opportunity would be with those new entities joining the Ryland Company.

Larry Nicholson

Great question. I think we are extremely happy with the acquisitions. We are in the process of integrating all those through and that’s a pretty fluid process right now. But so far they contribute very credibly. They are all profitable this year, which is great and we expect to see better profitability over next year as we’ve expanded their lot positions. Phoenix, Philadelphia, we’ve expanded those lot positions dramatically to where we will have a lot of stuff opened in the fourth quarter and the first quarter. Dallas continue to be a steady performer for us. So we’ve been very happy with the acquisition, had no negative drag on margins. So, all has been good.

Ivy Zelman – Zelman & Associates

Great and on margin contribution going forward will it be margins above street average or with in line going forward?

Larry Nicholson

I would say in line.

Ivy Zelman – Zelman & Associates

Okay and then, Larry, just switching gears a little bit, you provided some good color on your on tenants average selling price for this quarter where we expect the closings on prior quarters.

Can you talk a little bit about incentives as it relates to what you are dealing on orders if any at all, and how you see the competitive landscape? Is that pace slowing and builders, some of them getting panicky, there is concern in the market that that will pressure margins going forward. So I want to hear your perspective.

Larry Nicholson

Well, I mean, discounts for the quarter were 6.4% versus 9% a year ago. We always say that we expect a normalized to somewhere around 5%. So, I think we are very close to that. I think what we are focused on right now, is what’s going on in the competitive market and what’s going to get a buyer to the finish line.

Obviously, rates coming down, we expect to see a little bit better traffic. We have not seen anybody act irrationally. Obviously there is an inventory in the market today and you have some guys that will be – everybody will be closing out their year-end. So I would expect you’ll see inventory get a little bit more aggressive.

But I think, we are still able to raise prices in a fair amount of locations and we evaluate that on a weekly basis. So we are still seeing places where there is opportunity. So right now, I think it’s just a community-by-community event on a week-by-week event and what do we need to do to make a sale. But we are not concerned about our margins at this point. We’ll do what we need to do to make sales, but we don’t see it having any negative impact on our business.

Ivy Zelman – Zelman & Associates

Great, thanks a lot guys.

Larry Nicholson

Thank you.

Operator

Thank you. Our next question comes from Stephen East from ISI Group. Your line is open.

Stephen East – ISI Group

Thank you. Larry, if you could talk a little bit about earlier question about the acquisitions and all of that. I guess, a couple of different perspectives. One, looking at the acquisitions that you made, did they have any impact on the backlog conversion.

Or your absorption rate slowing or was that just from your core business? And then I am more interested in as you’ve looked at how these acquisitions have performed for you and you’ve integrated them. Has your appetite changed for more M&A or what does the market look like out there for it?

Larry Nicholson

Well, I think from, when we look out over the headlights and what’s happened, I would say no negative effects from the absorption perspective. They performed pretty much as expected.

I think the key there was trying to get in with these – get them close and get their land pipeline set up. As you know, most of their guys we bought were capital constrained and it gave us an opportunity to push their growth rate at a faster pace which we been able to do.

As I said earlier to Ivy’s question, we got a lot of communities open in the Phoenix, we got a couple that are opening in Philadelphia near term and Dallas pretty fluid. But I mean, everything so far has been a pleasant and a good experience for us. I think that every one of them is a little bit different, just based on where they were in their lifecycle in the market, what their capital situations were.

But overall, I think we are extremely happy. As far as an appetite going forward, I think we continue to look at an acquisition with open eyes and continue to speak with other people and if there is an opportunity out there that makes sense, that similar and be accretive to us, we’ll jump on it.

Stephen East – ISI Group

Okay, and then, as you look at potential M&A versus land, I guess given the land market has cooled a little bit and seems a bit more rational. How do you all worked back and forth between making a decision between what’s going on in the land market now and what you think in the future and potential M&A that you’ve got, that you at least see out there?

Larry Nicholson

Well, I think the good thing with the footprint that we have today in most of the major markets, we can now push the accelerator with the existing organizations we have and leverage that overhead.

I think the M&A today, if you did it in existing market, you just be looking to buy assets I think so. I think Seattle and Nashville are still the only two top twenty markets were not in and we continue to explore opportunities in those markets. But I think right now, we are focused, as we have been, I think even throughout this year on the organic growth side of the business, because we have all those people in place. We have the structure there.

They know the hurdle rates, they know how to get it executed. So I think, we don’t need to do an acquisition in 2014. We can grow our business very handily with what we have today in the existing markets we are in and that’s where we always look for us first because that's the most efficient and cost-effective way of doing it. So, I think, really we will continue to look at just on a deal-by-deal basis.

Stephen East – ISI Group

Okay and then the actual land environment, what you are seeing out there now?

Larry Nicholson

We are still seeing opportunities to buy – I think there is probably some price resetting in some markets that were very heated as what’s – I think all the builders have said somewhat that they see the land environment a little bit more inviting than it’s been. There is opportunities out there. We continue to buy lots. We purchased 6000 lots in the quarter. So, we have not had a problem in finding lots. So, we are well situated for 2014 and beyond. So, – and the good thing right now is, we can be selective in the deals we do.

Stephen East – ISI Group

All right, great. Thank you.

Larry Nicholson

Thank you.

Operator

Thank you. Our next question comes from Dan Oppenheim from Credit Suisse. Your line is open.

Dan Oppenheim – Credit Suisse

Thanks very much. I was wondering if you can talk a little bit about the – what are you doing in terms of the pricing you just mentioned through the slowing in terms of the impacts of rates and then also the seasonality and such that you are still pushing prices in Phoenix and Vegas, Charleston and Houston I think you named, but you also said that you expect more of a push from competitors that have moved to minimum rate at the end of the year.

As you think about the strategy here, as you go through the fourth quarter, is there going to be less announcements there on price and in terms based on essentially more competition in the market to get sales there?

Gordon Milne

Well, I think we face that all the time and there will obviously be some challenges in the fourth quarters, people try to push inventory out the door and get some specs.

I think Larry said it earlier, we are just looking community-by-community and week-by-week to see where we got opportunities to push price and where we don’t and try and keep the sales pace up and just maximize profitability. But I don’t think there is any magic to it other than just really keep focused on it.

Dan Oppenheim – Credit Suisse

Okay, thanks and then in terms of the comment on margins up sequentially for the fourth quarter, I guess, – that when you said the third quarter backlog conversion was a little bit low with the majority or the basis on backlog being a bit young. At this point, given this where we are now probably the backlog has been – or this reflects some of the orders came in sort of late spring, early summer is that sort of what’s driving the higher margins as we go for fourth quarter closings?

Gordon Milne

Yes, it seems so, yes.

Dan Oppenheim – Credit Suisse

Thank you.

Operator

Thank you. Our next question comes from David Goldberg from UBS. Your line is open.

David Goldberg – UBS

Thank, good morning everybody.

Larry Nicholson

Good morning, Dave.

David Goldberg – UBS

I just wanted to start and make sure I understand, Larry, the comments you made about margins and margin growth and your expectations. Can you kind of just help us with the timeframe about what you are talking about and should I think the interpretation is, something we’ll think there might be an inflection in margins, given that land costs are going up and home prices are rising quickly.

If you look out to late 2014, 2015, there is potentially an inflection above normal, above where you underwrite, but still an inflection from a rising margin perspective. Would you kind of give me short-term guidance in terms of margins or where do you think margins are headed or was it a little bit longer term as you think about it?

Larry Nicholson

Well, as I look at it today, obviously we are sailing into 2014 now, I think – we think margins can improve in 2014 based on what we see today. Now, beyond 2014, I am not even going to take a shot at that one. So, I mean, I think we see that there.

But again, and I think, Gordon, you got to kind of move the puzzle pieces around, but, I mean, your margins are approaching the 21%, 22% range and I think we’ve always kind of said that we thought normalized margins were somewhere around 22%.

And so, I mean there is not a lot of room for us to really grow and if we get into a normal appreciation mode, obviously, you would expect that to slow at some point. But right now, we see improvement out over the headlights.

David Goldberg – UBS

That’s great, the clarification. And then, just my second question, we talked about this last quarter, eventually as you go through the cycle, Ryland becoming more of a balanced company in terms of capital distribution. You guys have obviously been very focused on both M&A and also land acquisition which I think has positioned you well.

Does this slowdown make you think at all differently about the way you are underwriting land deals or potentially capital distribution or capital – what’s priority for capital at this point as you look forward, do you think about maybe being a little less aggressive and returning more cash to shareholders. Just give me in terms of framework that I am thinking about it?

Larry Nicholson

Well, I think, we always run our business based on employing our capital where we can get returns. So if we have places in the country that the market slows down and that we don’t think there is opportunity there, we have 19 other guys we can move the money, which I think is a big benefit. So, I think we invest our capital based on the returns we can get and if we don’t see those returns have been acceptable then we won’t invest.

Like I said, we have plenty of lots for 2014 and 2015, so I think we are at a very good point in the cycle that we can be selective and everything we do is just a little bit extra to 2014 and 2015.

And as far as the land deal, there is still opportunities out there. So we have not seen – it slows down when prices peak, right and then it takes 30, 60 days for it to just, which it has. And the deal flow will start, but we are not unhappy with our lot position or what we are seeing at all.

David Goldberg – UBS

And then certainly it was implied, second is that you can make any changes to your underwriting hurdle rate and you kind of adjust with the uncertainty at that point?

Larry Nicholson

No, I mean, we had the same hurdle rates for in – here and really it didn’t changed them through the downturn and the guys know what they are and we work within those. When I look at – it’s funny – we were just looking at a huge – before the call and when I look I go back to Q1 of 2011 to Q3 of 2013 and look at the lots we bought and the IRRs and the VC, everything is extremely consistent.

So, I mean, that tells me that we are doing what we say, we’ll do is that, with the IRR is going to be x, the margins are going to be y and we’ve been pretty consistent with that. And the good thing is that we’ve been very successful with what we’ve opened it stuff performing at or above feasibility.

David Goldberg – UBS

That’s great. Thank you very much for the color.

Operator

Thank you. Our next question comes from Adam Rudiger from Wells Fargo Securities. Your line is open.

Adam Rudiger – Wells Fargo Securities

Hi, thinks for taking my questions. I want to ask about SG&A for a second, it looks like the sequential and year-over-year kind of incremental SG&A per sales is close to that 9%, almost 10%. How much – is that a good run rate going forward? Or is there some acquisitive related expenses in there that means that should moderate?

Gordon Milne

Well, I think there is more leverage to come in the SG&A. There is not a lot of cost from the acquisitions that go in there that would be meaningful in the analysis I don’t think. So, I haven’t done at the way you’ve done. So I’m not quite sure, but I just know the run rate going forward should keep coming down as we get volumes up.

Adam Rudiger – Wells Fargo Securities

Okay, in the way I was doing it was just $8 million, I think $8 million in sequential growth in SG&A, $84 million in sales, it’s almost 10% and so that would tell you that your leverage line and half you leverage on SG&A would bottom out at around 10% then if that was the run rate. Let’s just try and get out.

Gordon Milne

Yes, well, that’s probably fair.

Adam Rudiger – Wells Fargo Securities

Okay, the second question was related to the fourth quarter guidance and my math, which it gets me to not very significant, 30, 40 basis points of pre-tax margin expansion relative to this quarter. Is that consistent with your expectations or am I doing something wrong?

Gordon Milne

Well, we haven’t given margin guidance for the fourth quarter. We said it’s going to be up in the third quarter. I know we gave out a revenue number in earnings, but there is a few other items in those lines and because that you ask so, at this point we don’t give any more specific guidance on margins.

Adam Rudiger – Wells Fargo Securities

Okay, can you – last question and that’s untaxed to guidance in the fourth quarter and if so, when should we start using the tax rate on models?

Gordon Milne

Well, we kind of reserve that when we did the tax for the year you have to preserve enough tax room to – tax basically for the rest of the year. So we are doing that. I think every other builder is going to do exactly the same thing. Come next year, it will be fully taxed from day one.

Adam Rudiger – Wells Fargo Securities

Okay, thank you.

Operator

Thank you. Our next question comes from Jay McCanless from Sterne Agee. Your line is open.

Jay McCanless – Sterne Agee

Good morning everyone. First question I had, just like in the 2013 and the community count growth in 2013, if you exclude the acquired communities, what do you think your organic growth rate was for this year? Or what was that being for this year?

Gordon Milne

Well, I forgot the number. If you took out Cornell and Timber Stone, we are up 10% in the quarter, right. I don’t know, do you want to exclude more things on that or…

Jay McCanless – Sterne Agee

Community count just… yes, the community count, just trying to get a frame of reference for the guidance you given for 2014 or 2015

Gordon Milne

If you took out the two we acquired this year, we ended up the quarter at the 11 in Philadelphia and 15 in Dallas. So we got 10% without the two acquisitions.

Jay McCanless – Sterne Agee

Okay, so roughly 10% organic growth for this year?

Gordon Milne

Yes.

Jay McCanless – Sterne Agee

Okay. And then, I also wanted to ask, what – could you give us what the spec count was last year. I can’t find that on my records or for last year’s third quarter.

Gordon Milne

687 was the total spec count.

Jay McCanless – Sterne Agee

Okay. And then, one last question just, picking up where Dan left off, if it seems like the growth rate may be slowing, consumers maybe a little slower to come in and buy a home, but you have the land already bought for 2014 and 2015 at margins that you like, what prevents you from not going ahead and maybe reinstate, you got a share buyback already authorized, why not go ahead and return some more cash to shareholders until buoyant market swings back in your favor and you can be a little bit more aggressive there.

Gordon Milne

Yes, that’s always a thought, I think, as we obviously said this year, I think we spent, I think we said over $600 million, close to $700 million this year and increasing inventory and buying inventory. So, it’s been a big number. We are seeing lots of projects. We’ve been very aggressive buying land., At some point, when that slows down and it looks like there is just lot of cash flow and be able to look at the alternative using some to buy shares back, but we still think it’s premature based on the opportunities we see. I think our better investment is to buy land or buy shares.

Jay McCanless – Sterne Agee

Okay. Great, thanks guys.

Gordon Milne

We will come as time goes.

Jay McCanless – Sterne Agee

Okay. Thank you.

Operator

Thank you. Our next question comes from Ken Zener from KeyBanc Capital Markets. Your line is open.

Ken Zener – KeyBanc Capital Markets

Thank you. Larry, obviously, the builders have the view that this is a pause, versus just a flattening and I think that’s – or if you could maybe expand on it, I mean, because the higher FICO score is the quality to buyers the low level of home construction as you extract prices. And if that’s the case, I mean, is this seasonality is in place right now, does that really imply next year’s closings is just going to move by community count?

Larry Nicholson

Well, I think, as you get the economy improving and you get through all the debt ceiling and all the other miscellaneous noise that’s out there. I mean, you continue to see consumer confidence improve which I think bodes well for the home building industry. I think household formations look like they are moving in the right direction.

I don’t see anything that tells us that the market is not going to continue to grow and then if you look at permits are still under 1 million. So there is room for permits to grow without it really putting pressure on anything. I don’t think we are near bubble pricing anywhere.

So I think there is room on pricing. I think affordability is great. Rates are back to 4%. So, I see a lot of positive things there to keep the train moving and I believe that will happen.

Ken Zener – KeyBanc Capital Markets

Okay and then just to clarify your community count, is that 4Q 2014-over-2014 and then, given that the industry has restructured its SG&A to be profitable at such a low level of absorption. Could you maybe just a point on, how that might impact – kind of how the industry is operating, because you are so much more profitable at lower absorption pace it is within communities?

Larry Nicholson

Well, I mean, the community count is 12/30/13 to 12/30/14, so growth. As far as economy is, hey we are a lot more efficient than we’ve ever been for a lot of different reasons. I think the real key there is to stay focused to make sure we don’t lose any of that efficiency.

We can build more houses with what we have existing today in the field at a run rate of two to three per community we can sell four and build four. So we have plenty capacity there. So we think there continues to be huge efficiencies in this business and I think, through the downturn, we learned a lot of things we didn’t need to do and we just need to stay focused on it. But I think there is good leverage there.

Gordon Milne

Just like – we expect in the year of 25% still, so, it’s going to be the number based at the 15% at the end of the year.

Ken Zener – KeyBanc Capital Markets

Year-over-year, correct?

Gordon Milne

Yes, year-over-year we expect to be and in the fourth quarter of this year up 25% and then next year up 15%.

Operator

Thank you. Our next question comes from Nishu Sood from Deutsche Bank. Your line is open.

Nishu Sood – Deutsche Bank

Thanks, so Larry, you were talking about the resumption of normal seasonality in the third quarter and the reaction to rising rates. So, in light of that, I was wondering if you could give us kind of month-by-month color as well as what you might have seen into October?

Larry Nicholson

Well, month-by-month is the sales were – there wasn’t a dramatic difference. They were all pretty flat. So, I mean, I don’t think we saw a lot difference month-by-month. Historically, you would always expect August to fall-off, because that’s when kids go back to school, but it didn’t, so that was a good sign. And September chugged along at the same number. So, usually the numbers are going down every month from like July, right. That's a good sign. And as far as October, I mean we’ve seen the similar results though the first month so far. But again, as we said, traffic continues to show up on the stores and people are interested with rates starting to tick down. We are cautiously optimistic hopefully it will pick up.

Nishu Sood – Deutsche Bank

Got it and in terms of the recent rate decrease, I mean, the first 50 to 60 basis point increase in rates and the better beginning of the summer, it didn’t seem to have that dramatic an effect on demand. The second 50 to 60 seem to be much more damaging and there is kind of mixed reports of what’s happening since the decrease in rates in the last couple of weeks. So, maybe if you could just give us your broader thoughts on what model, trying to understand consumer or home buyer housing demand kind of explains the trajectory of how the market has reacted to the fluctuation in rates?

Larry Nicholson

Well, if you can figure that out, I’d love to hear it, because, it’s always a different affair, but I think, our opinion of it is and I wouldn’t distribute with what you said, I think the first 50 basis points where we started hover around 4% didn’t have a tremendous effect, I think once we got above four, we kind of looked at the perfect storm kind of mentality where you had seasonality, you had rates jumping up.

You had, at that point Syria was going on, and then you had the debt ceiling. I think there was a lot of distractions out there. And I think, most of that has settled down and I think that, and I was just reading this morning ironically about the resale market has picked up dramatically in the last two weeks.

Now, I know it was down in September a bit, all of a sudden, it looks like that resale market is picking up again which would indicate to me that we would see our business pick up the same way. So, again, I think affordability is still great and I think there is great opportunities for people to buy a home today and I think prices are going to continue to go up.

Nishu Sood – Deutsche Bank

Great and just a modeling question, the diluted share count, Gordon, jumped in this quarter. And I was just wondering if you could help us understand the drivers that are going to influence and how – what we should expect in the coming quarters?

Gordon Milne

Well, I mean the converts been up there now, so obviously against last year it’s up because we didn’t have that convert out last year and we do this year. I can’t think anything others significant other than just the new converts.

Nishu Sood – Deutsche Bank

Got it. So should we expect it to stay at this current level in the next couple quarters?

Gordon Milne

Right, yes.

Nishu Sood – Deutsche Bank

Thanks.

Operator

Thank you. Our next question comes from Stephen Kim from Barclays. Your line is open.

Stephen Kim – Barclays Capital

Thanks very much guys. A question for you, first question on land, you gave us the land spend numbers appreciate that sort of suggests that your spend, relative to your burn rate is higher than a lot of your peers this quarter. So obviously you're finding some good deals out there.

I guess my couple of questions around that. One, can you tell us roughly what percent is finished? I know in the past you've said it’s maybe around 60%, but I was wondering whether you were buying more raw lots recently and so whether that's coming down. And also whether that land spend number that you give, I think it was $306 million this quarter or something like that, whether that includes anything from acquisitions?

Gordon Milne

So, yes, the numbers we gave, I think have the acquisitions in on there – the acquisitions be out in the Q the amount was roughly $20 million for the acquisition. So, it’s not a large component of it. But it’s there.

Stephen Kim – Barclays Capital

Okay. That's great.

Larry Nicholson

Yes, on the option side, Steve, we are at about 43% of our lots controlled or options, we were probably, I think 44% last quarter. So, that would tell you we bought a few more raw deals. And, in the quarter, if you think about it like in the Cornell acquisition.

I think I quoted 6000 plus or minus lots in the quarter about 1800 of that came in that acquisition. So one big chunk there. But, I mean, again, I think we are – when I look out over the headlights and look at the pace and what we control, if you think about what we’ll close this year is about four years and if you expect to continue grow that number is going to shrink.

So, the one thing we want to be sure is we don’t get caught shored short and I think that's what we've been focused on and again, real happy with our lot position and the opportunities we had. Don’t think we’ve been overly aggressive and don’t think we’ve been under aggressive.

Stephen Kim – Barclays Capital

Great, Okay, well, thanks for that. Appreciate it. Let me switch gears with my second question, it's related to foreign buying. Obviously, we've heard a lot on the West Coast particularly over the last year-and-a-half particularly, sort of an influx or a lot of strength in foreign buyers.

And I was curious if you could comment a little bit on that, what your thoughts about the resilience of that market is maybe in the quarter or over the last several months as we have seen a little bit of a slowdown in some of the overall activity. Has that buyer segment been relatively more resilient or a little bit more or did they pull back equal or more than the regular buyer traditional buyer?

Larry Nicholson

I would say they’ve been steady. We’ve seen in Southern California, the performance continue to be good and that’s where the highest portion and I am assuming you are talking Asian Meyer and in Southern California, that’s continued to be a strong part of the market and we have not seen a pullback at all in that buyer profile.

So, the depth of it we feel it’s pretty deep and again, we are not overexposed to it any one place that we’d be concerned. But, we are starting to see it show up in other markets though too. I mean, that’s the other thing is that, it’s just not Southern California anymore, you are seeing a lot of different demographic changes in a lot of the other markets. And I would expect you will continue to see that.

Stephen Kim – Barclays Capital

All right. Well, great thanks very much.

Operator

Thank you. Our next question comes from Joel Locker from FBN Securities. Your line is open.

Joel Locker – FBN Securities

Hi guys, just I had a question on the – you mentioned the communities modest amount or decent amount increased prices. Can you quantify that on what percentages and what organic price increase in those communities would you say from June 30 to September 30?

Larry Nicholson

Probably 40% of them, we may guess.

Joel Locker – FBN Securities

40% and is it more like a 1%, 2% increase or?

Larry Nicholson

It will range, but, obviously the size of price increases slowed down, where we might have been getting five, we might be getting 2500 today, but it definitely slowed down.

Joel Locker – FBN Securities

Right, and just getting under construction costs guess that hasn't been talked about much. What is your cost per square foot on your third quarter closing say versus a year ago?

Gordon Milne

Well, we got the number up, need to be exact on this direct cost are up 9%.

Joel Locker – FBN Securities

About 9% year-over-year? And just on just the Cornell acquisition how many communities did you have or did they have opened when you acquired?

Gordon Milne

Cornell, has 11.

Joel Locker – FBN Securities

Had 11 communities? All right. Thanks a lot. I'll jump back in the queue.

Operator

Thank you. Our next question comes from Buck Horne from Raymond James. Your line is open.

Buck Horne – Raymond James

Hey good afternoon. I was wondering if we could talk a little bit about the specs. 3.4 specs per community seems like one of the highest numbers I can remember you all running at, going back some number of years, was there anything unusual in the quarter that spiked the cancellation rates that affected that?

And how do you think about that, is there potentially some margin drag going into the back half or tail-end of this year due to the spec count you have?

Gordon Milne

Well, let’s go to the – I’d like to clarify the – we didn’t really have a spike in cancellations. When your sales slowdown you got a big backlog and it looks like you’ve got more cancellations than you do and that’s what we brought up our cancellations as a percentage of backlog was actually better than last year even though the number based on sales results.

So, that's not an issue for us as part of the specs growth. I think there is companies always run around three community ever since I have been here over the last 15 years. So I think, 3.4 going into the fourth quarter is not unusual certainly, we are not doing anything. We proceed differently, we do put some foundations in the northern market as we mentioned, but, I see this is very similar and very consistent with what we’ve always done on specs.

Buck Horne – Raymond James

Okay, it just seems like to me going back a few years you were closer to 2 instead of 3. Maybe it's been around 3 for the last couple years but maybe my data's wrong but…

Gordon Milne

No, I think the 2 to 3 number, I mean, 3.4 I wouldn’t say is way off for our communities.

Buck Horne – Raymond James

Okay, and then just little switching gears, going back to your – the replacement of your active communities I'm wondering, how many of your communities are in locations where you don't think there is a viable close by replacement in where you're intentionally holding down the absorption to try to get that price?

And I guess related to that, how do you see the environment shaping up next year between first-time buyers versus move-up buyers and where you focusing your land spend on what type of buyer next year?

Larry Nicholson

I don’t think we have an exact count on, the communities. What you do, as you look at what your land bases are what your margins are and what everybody else in the resale market is, and what your competitors are so if you can drive price which we do. And I can think a half dozen off the top of my head that fall in that category. But to give you an exact number, I probably couldn’t do that.

And what was the second part of your question?

Buck Horne – Raymond James

The mix between, how you are thinking about next year the mix between the first-time buyers and move up and how does – how are you positioning your land portfolio given the mortgage market? The MBA Association is out there saying, purchase activity is only going to be up 9% next year. So it doesn't sound like the people in the industry are forecasting a big shift in credit availability. So how do you guys think about it?

Larry Nicholson

Well, I mean, I think you got to see the entry-level market grow a little bit especially if credit eases a bit. So that’s going to bring some folks back into it. So I think you have to be prepared for that. I still think the first move up is where the meet of the market is going to be, when you look at what’s listed in the resale market today and I think we’ve focused on that in a lot of markets.

And I think the other thing that’s become – will become more viable in the near-term will be multi-family as prices creep up, when we went into this downturn, there was a fair amount of markets that had multi-family disappeared during the downturn because affordability on single-family got so great.

So I think that will drive some more of the entry-level product also. So I think, you got to be poised to be able to do both and that’s a market-by-market decision and that’s what our guys and girls in the field do, they do the market research. The know all that. But I do think the entry-level market will pick up in 2014.

Buck Horne – Raymond James

Okay, thanks.

Operator

Thank you. Our next question comes from Alex Barron from Housing Research Center. Your line is open.

Alex Barron – Housing Research Center

Hey, good morning guys. I guess I was trying to get your thoughts on, kind of going back to the ability to raise prices, relative to sales pace, kind of wondering how you're thinking about it in terms of how many homes you need to sell per month to feel comfortable raising prices.

And also now that we're in the fourth quarter it seems like a lot of other guys have set back there level of incentives for year-end. And just kind of wondering if you guys are having to do the same to be competitive and what do you guys think works best? Is it options, rate buy downs or actually even cutting price a little bit or how do you guys think about that?

Larry Nicholson

I tell you it’s interesting, rate buy downs really haven’t worked at all and it doesn’t, there is not that much spread I think right now, that makes a big difference and I think it’s just really the consumer confidence side. The rate buy downs are not big part. It’s different by city, we do options in some places, its closing cost and high closing cost markets. Some of it’s just straight discount, you use it how you want to use it.

What we really tried to focus on is trying to get the transparent pricing. So there is not a lot of incentive. This is your best price and it gives your closing cost. But, we still haven’t seen anybody go out and do, there is some discounting on inventory, but it’s not – I mean if it was 3000 a week ago, it might be 4000 this week.

But we’ve also seen a lot of guys increase incentives but raise price at the same time. So price went up five and incentives went up the same. So, again, case-by-case event community-by-community if we are selling three houses a month, we think we have the opportunity to raise price and then again, that’s community-by-community.

But there are places still that we can raise price and we’ll continue to take that opportunity. The key thing is just to make sure that we are performing at the feasibility number that we read, that’s our expectation. So, a lot of this stuff we bought back in 2011 and 2012 was at sales rates at two per month.

So at two per month, we can make very good money and get good returns. So, we look at all that when we consider, but we are still extremely optimistic about what we have today and where it’s going.

Alex Barron – Housing Research Center

Got it. Okay.

Operator

Thank you. I show no further questions at this time and I would like to turn the conference back to management for closing remarks.

Larry Nicholson

Great, thanks for listening in and we appreciate all your input and we look forward seeing in the fourth quarter. Thank you.

Operator

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program. And you may all disconnect at this time.

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