The Ryland Group's CEO Discusses Q4 2013 Results - Earnings Call Transcript

Jan.30.14 | About: Ryland Group (RYL)

The Ryland Group, Inc (NYSE:RYL)

Q4 2013 Earnings Call

January 30, 2014 12:00 PM ET

Executives

Drew Mackintosh - VP, IR and Corporate Communications

Larry Nicholson - President and CEO

Gordon Milne - EVP and CFO

Dave Fristoe - SVP, Controller and CAO

Analyst

Ivy Zelman - Zelman & Associates

Michael Rehaut - JP Morgan

Stephen East - ISI Group

David Goldberg - UBS Investment Bank

Adam Rudiger - Wells Fargo Securities

Dan Oppenheim - Credit Suisse

Eli Hackel - Goldman Sachs

Stephen Kim - Barclays

Ken Zener - KeyBanc Capital Markets

Nishu Sood - Deutsche Bank Securities

Joel Locker - FNB Securities

Will Randall - Citigroup

Buck Horne - Raymond James

Alex Barron - Housing Research Center

Operator

Good day, ladies and gentlemen, and thank you for standing by, and welcome to the Ryland Group Incorporated’s Fourth Quarter 2013 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we’ll conduct a question-and-answer session and instructions will be given at that time. (Operator Instructions) As a reminder, today's conference call maybe recorded.

It’s now my pleasure to turn the floor to Drew Mackintosh. Sir, the floor is yours.

Drew Mackintosh

Thank you. Good morning and welcome to Ryland's fourth 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, Gordon Milne, Executive Vice President and Chief Financial Officer, and Dave Fristoe, Senior Vice President and Controller.

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 conference call.

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

Larry Nicholson

Thanks Drew. Good morning and thank you for joining us today as we go over our results for the fourth quarter and full year of 2013. In addition to our prepared remarks today, we have posted the slide deck in the Investor Relations portion of our website, under the heading Events & Presentations that provides an overview of our Company’s performance.

For the fourth quarter, Ryland reported net income of $72 million, or $1.27 per diluted share. Net income for the full year came in at $379 million, or $6.79 per diluted share making 2013 our most profitable year since 2006.

2013 was a great year that was marked by an accelerated sales base, rapid price appreciation and margin expansion in the first half of the year followed by a slowdown in sales in the second half of the year as buyers weighed the impact of higher mortgage rates and higher home prices.

Despite the softness in the market, pricing remained strong in the back half of the year as evidenced by the upward trajectory of our average sales price and homebuilding gross margins both of which reaches new highs for the year in the fourth quarter. We continue to be optimistic about the future of homebuilding as we begin 2014. Based on the trends we see unfolding at both the national and local level.

At the macro level favorable demographics and improving economy and better employment picture, are key drivers of household formation that should lead to an increase in demand for new homes. At the micro level the tight supply of new and existing homes for sale, in the markets in which we build and still compelling home affordability dynamic relative to longer term averages gives us reason for optimism.

Combined those factors with Ryland specific positive such as 22% more active communities opened to start of the year, excellent market positioning in the best MSAs in the country and new home designs tailored specifically to meet the wants and needs of the local home buyers and one can argue that the long-term outlook for homebuilding and in particular for Ryland is very favorable.

We have increased our share of new home market over the last few years, growing both organically and via acquisition. And based on our existing pipeline of recently acquired land we expect the trend to continue into 2014. Ryland is poised to improve on the results we delivered in 2013, provided the housing recovery continues to unfold.

With that here are some highlights from the quarter and the year.

For the fourth quarter the homebuilding segment generated 81 million in pre-tax income, compared to 32 million in the year ago period. Revenues increased 60% year-over-year, thanks to a 39% increase in closings and a 16% rise in the average closing price. We converted 65% of our beginning backlog in the quarter, our best conversion rate of the year. The average closing price of $314,000 also represented a high watermark for 2013. As did the average price in backlog of $326,000 and the average new order price of $328,000.

Average homebuilding gross margins came in at 21.9%, a 190 basis point improvement over the fourth quarter of 2012. Once again we derived the bulk of our margin expansion from our ability to grow revenues at a faster clip in our labor and material cost. Land as a percentage of housing revenues came in at 25.6%, essentially flat with the year ago period.

SG&A as a percent of revenue hit a low for the year in the fourth quarter coming in at 11.3% as cost containment continued to be a focus for us. The combined improvements to gross margins and SG&A leverage resulted in a 400 basis point year-over-year expansion to our operating margin allowing us to eclipse the 10% benchmark for the first time since the recovery began. We continue to believe that further margin expansion is possible, largely driven by our ability to leverage the fixed component of our cost structure as volumes improve.

For the full year the homebuilding segment generated 204 million in pre-tax income, compared to 64 million in 2012. In a testament to our geographic diversification, each of our homebuilding regions contributed significantly to the total. The Southeast region led the way with 32% of the profits followed by the North region with 26%, West region with 23% and Texas with 19%.

Home closings for the year came in at 7,027, a 46% increase over 2012. While this total is a considerable improvement over our closing volumes that we experienced at the trough of the downturn, it is still well below the levels we achieved at the peak of the last cycle.

New orders for the fourth quarter came in at 1,428, a 4% decline from the fourth quarter of last year, excluding the 102 homes in backlog we recorded as new orders at the close of the Trend Homes acquisition last December, orders were up 3%. Sales activity stayed relatively flat throughout the quarter with 459 new orders in October, 514 in November and 455 in December. The cancellation rate was 20% of gross sales or 11% of beginning backlog.

Consistent with normal seasonal patterns the sales pace ticked down from the third quarter as potential home buyers turned their attention to other endeavors during the fourth quarter. Instead of increasing incentives or lowering base prices to go after this smaller pool of buyers we opted to hold pricing firm and focus our sales efforts on the upcoming selling season.

New orders for the full year came in at 7,262, a 27% increase over 2012. Our Houston division contributed the most to the total number of orders, followed by our divisions in Indianapolis, Chicago and Orlando. Our divisions in Chicago, Atlanta, Washington DC and Denver posted the best year-over-year increases to net orders with growth rates in excess of 40%. We ended the year with 10% more homes in backlog than we did in 2012. On a dollar value basis our backlog increased 29% year-over-year. Similar to our profit profile for 2013, the backlog on a dollar basis is fairly evenly spread across our four regions.

We increased our inventory balance by 54% in 2013 to $1.6 billion, land under development accounted for 61% of the total, sold inventory represented 21%, and spec and model homes made up the rest. We ended the quarter with 977 started and unsold homes or 3.4 per community. The number of finished specs per community stood at 1.6.

We made significant investments in each of our homebuilding regions in 2013. With a considerable capital commitment to our West region where our inventory balance grew by a 114%. The combination of improving local economies, low inventory levels and rising prices made our divisions in the west ideal places to put our capital. Our year-end inventory balance in our Texas region grew by 65, or grew to 65% largely driven by acquisition of the LionsGate Homes in Dallas. Inventory levels grew by 35% in our South region and by 26% in our North region.

We continue to allocate capital to the areas of the country in which we generate the best returns while maintaining our geographic diversion. We ended the year with 23,540 owned lots and 14,602 lots controlled via option for total owned and controlled lot count of 38,142, a 35% increase over 2012. Our active community count grew 22% from the start of 2013 bringing our total to 290 to begin the New Year. We anticipate that community count growth will again exceed 20% in 2014 and currently have 213 communities in various stages of development in the pipeline.

All of our planned closings for 2014 are expected to come from land that is already under contract, this land also accounts for 79% of our planned closings for 2015 with the remaining 21% coming from land that has been identified but not yet approved. We made these considerable investments in land in 2013 without putting our balance sheet at risk. As we ended the year with 631 million in cash, 1.4 billion in debt and 908 million in stockholders’ equity for a net debt-to-capital ratio of 46%.

Our weighted average cost of debt remained below 5% and our interest coverage ratio grew to a healthy 4.1 times for the year. Our next maturity comes due in 2015 with remaining outstanding balance of 126 million.

Our financial services segment recorded a pre-tax profit of 2 million in the fourth quarter, compared to 6 million in the year ago period. For the full year the mortgage company generated 20 million in profits, a 53% increase over 2012. The trend away from FHA loans continued in the quarter as only 18% of our buyers opted for one of these loan programs. Of the remaining buyers that utilized our mortgage company, 65% chose a prime loan, 16% qualified for a VA loan and 2% utilized a rural housing loan. The average FICO score in the fourth quarter was 736 and the average down payment was 11%.

In summary, we are pleased with our Company’s performance in 2013. We achieved both year-over-year and sequential improvements in revenues, homebuilding gross margins, SG&A leverage and operating income in each successive quarter, ending the year with peak results for each of those metrics in the fourth quarter.

Looking ahead to 2014, we believe that we can improve on these results, provided that the economy in the housing market continues to progress and the interest rate environment remains stable.

We begin 2014 in a better position than 2013 with 22% more active communities opened and a sold backlog value that’s 29% higher than the previous year. Combining those factors with a strong macro trends that point to the eventual need for additional housing in this country and you have an environment that bodes well for Ryland.

Finally, I would like to thank all of our employees for a job well done this year. We set some ambitious goals for the Company at the beginning of 2013 and through your hard work and dedication we were able to achieve these goals. Based on our current positioning, we have once again set ambitious goals for 2014 and I’m confident that we have the right team in place to carryout success into the future.

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

Question-and-Answer Session

Operator

(Operator Instructions) And it looks like our first question on the phone will come from the line of Dan Oppenheim with Credit Suisse. Please go ahead. Your line is now open. Pardon me sir, your line is open. Please go ahead. Alright, we’ll go to our next questioner then. Our next question in queue will come from the line of Ivy Zelman with Zelman & Associates. Please go ahead. Your line is open.

Ivy Zelman - Zelman & Associates

Thank you. Good afternoon. Good quarter guys.

Larry Nicholson

Thank you.

Ivy Zelman - Zelman & Associates

Now Larry, you’ve talked confidently about your outlook for ’14 and you are well position and strong community count growth, maybe for just a few housekeeping items if you talk about the breakout of your focused entry level versus move up and then just a little color on where are the markets that’s you’re probably most excited about. I mean, we saw some definite softness in the fall into the seasonally slower period in Vegas and in Phoenix and whereas we’ve heard about strength in Texas. So maybe just take us around your footprint and tell us what your thoughts are and where you think the most potential for the best performance for Ryland and what markets?

And then where you’d probably be the most concerned and we’ve heard some softness in some of the southeastern markets and Charlotte, Riley and maybe you’re not, but San Antonio so just love to hear your big picture thoughts and breaking down the price point focuses of the Company where you weighted the greatest?

Larry Nicholson

Well, I would say we’re more focused on the first move-up and the second move-up than we are on the entry level. Right now, if you look at the lots we acquired over the last 18 months, the entry level continues to be a fairly sizable part of our business, but I do think that the first time move up continues to be the best opportunity for us. We look geographically around the country. I would say we have differing events happening in almost every city. Overall, we feel real good about every city, but I think we had some timing issues that getting development finished up in a couple of markets, DC would be one of those where we have a lot of communities opening in the third half of the year. And we would expect to have the best year we’ve had in 6 or 7 years in DC, so we’re really excited about that.

We continue to grow our California business, coastal California in particular. And we’ve had very good response there and good sales activity, good margins. Phoenix, we opened a lot of communities in the first quarter and the second quarter. There is some softness in certain parts of Phoenix, but I would say it’s more on the parameter right now that it is in the main, what I would call the main market, and we don’t really have any permanent locations so not overly concerned there. Vegas continues to do extremely well, margins are still very high, sale paces are still north of probably for a community, so while I would say Vegas moderated a little bit in the fourth quarter it’s still performing at a very high level.

Texas, all continues to do extremely well. You mentioned San Antonio, I would say San Antonio is probably flat would be the best way to assess it, but we expect to see -- again we open a fair amount of communities there in the fourth quarter and in the first quarter, so we would expect to see some improvement there. The Southeast, Atlanta has been good. Charlotte has gotten better. Riley has gotten better for us. Florida, we were a little slower in Florida, but some of that was driven by selling out of some communities not getting stuff open and really managing price. If there was a market we push price in, Orlando is probably the hardest of any of them. So we’ve really controlled pace there and really maximized margin. We have a couple of neighborhoods there that are just irreplaceable and we’re going to continue to do that.

Tampa, I just call it more timing, saw the market soften a little bit in the fourth quarter. Tampa was a market we saw some incentives occur in the fourth quarter by a couple of our compatriots, but we just decided that we’d let them take that little bit of volume that was there and hold out. Washington we talked about. Baltimore, Baltimore South of the city is good, north of the city is a little slow. Midwest Indianapolis continues to be extremely well. Chicago is doing extremely well. Twin Cities have slowed but that’s really a weather, I mean their weather has been absolutely horrid for the last two months. And we were unfortunate that we did miss pave in a couple of neighborhoods it will have to wait till spring, we got some units to sell but we have limited inventory there.

Ivy Zelman - Zelman & Associates

I think that’s really great and helpful. And one of the other questions for you is was maybe it’s more market specific, we have heard that there is still real labor constraints in some of the Texas markets and in Phoenix and whether it be framers or getting drywallers, are you seeing that ease a bit and you’ve obviously had a much stronger conversion of your backlog. So, it appear that you are improvement in cycle times and maybe you can help us appreciate is it market specific or do you feel good about getting, subs are getting ramped up and just a little color there please?

Larry Nicholson

I think if you look at it today versus 12 months ago, I think we are in a much better position. And the Texas market, Houston probably is the most constrained and obviously the largest market in the country. In most other places we have made improvements over the second half of the year on our sub-contractor base to address that issue, so I think we feel pretty good right now. We will see with the season selling, with anticipation of big selling season we could run in to labor problems again somewhat mid-year. But right now I think we are pretty comfortable that our cycle times will be at or better than what they were last year.

Ivy Zelman - Zelman & Associates

Very well, I have got to get back in the queue Larry, thank you. Congratulations.

Larry Nicholson

Thank you.

Operator

Thank you, Ma’am. And our next question in phone will come from Michael Rehaut with JPMorgan. Please go ahead. Your line is open.

Michael Rehaut - JP Morgan

Thanks. Good morning to you guys on the West Coast. First question on the gross margins, obviously great improvement there and I guess a combination of price and mix. As you think about 2014 on an annual basis versus ’13 would you expect margins to continue to improve and is it based on your outlook for mix or some incremental price improvement or a combination?

Larry Nicholson

I would say we expect some improvement through ’14 not based on price appreciation though just on mix and what we see in the pipeline and what’s opening for sale.

Michael Rehaut - JP Morgan

And to be more specific would that be improvement from 4Q ’13 levels or more of a full year-over-full year basis?

Larry Nicholson

Year-over-year.

Michael Rehaut - JP Morgan

Okay. And just thinking about gross margins in terms of how they have turned out in 2013, can you give us a sense of what the result was versus your original underwriting. And I know most builders look at obviously from a return basis the underwriting criteria, but I mean you can perhaps give us a sense of generally what that boils down to from a gross margin standpoint and if that’s changed at all over the last year or two?

Larry Nicholson

Well let me make sure I understand your question. So, if you look at what our expectation were for ’13 and where we finished up I would say we did a little better than anticipated. But we haven’t changed any of our underwriting standards on the dirt deal. So, that’s what you are referring to.

Michael Rehaut - JP Morgan

Yeah, I mean I guess put it another way, for example if the underwriting kind of implied at 20% gross margin and many builders exceeded what they thought they would get in the original underwriting in 2013, if that 20% gross margin hasn’t changed going forward I think it’s kind of what people are thinking about to the extent that home price appreciation more normalizes over the next year or two, is I think kind of a bigger question about how gross margins might fallout over the next four to eight quarters?

Larry Nicholson

Well, again I think we see improvement, I mean I think there is, we again as the volume picks up your leverage, your SG&A, you look for other opportunities to take cost out of the business. I mean I think it gets harder to grow margin on a go forward, you start getting to a point where it’s growing at slower pace, but I still think there is opportunities and there is places within the business that we can shave some cost out of and continue to try to improve the margins.

Michael Rehaut - JP Morgan

Great. And one last one if I could, the community count growth very encouraging, how do you think about that over the next two to three years with your balance sheet. I mean is this kind of a sustainable rate or would you expect it to more normalize overtime?

Larry Nicholson

Well, I mean I think there is -- we are projecting this will be the third year of 20 plus growth on the community count side. I think the goal is to continue to grow the Company profitably if the opportunities are there we will take them and they have been there fortunately for us. And I think that as long as we can see the opportunity we will continue to grow the business. 20% is a pretty stiff rate, but again in a lot of markets we still see great upside. We will continue to push hard.

Michael Rehaut - JP Morgan

Great. Best of luck in ’14.

Larry Nicholson

Thanks Mike.

Operator

And it looks like our next phone question will come from the line of Stephen East with ISI Group. Please go ahead. Your line is now open.

Stephen East - ISI Group

Thank you. Good morning guys. Larry when you look at and just to follow-on Mike’s question very quickly, you talked about mix and new communities and should be able to drive your margins moving forward. Should we expect any type of margin improvement coming from the acquisitions that you have had over the last 18 months. And also anything on the cost side plus or minus that you all expect in ’14?

Larry Nicholson

I think the acquisitions are providing consistent margins that what we would normally produce. If you integrate those things and obviously you are underwriting it. So they didn’t really create any upside for us, but they just added to the overall mix. And what was the second part, I am sorry Steve?

Stephen East - ISI Group

Just if you are looking at any cost swings either direction in ’14?

Larry Nicholson

No I wouldn’t say anything, it’s fine tuning I guess is the best way to put it.

Stephen East - ISI Group

Fair enough. And then when I look at the last couple of quarters your absorptions have fallen fairly sharply. You have had some tough comps going against it, are you -- how much of that is the market what’s going on in the market versus you all trying to price more aggressively that type of thing. And are you trying to reverse that as you move into ’14, either with greater incentives or any other efforts?

Larry Nicholson

Well I think as you saw incentives were down a little bit quarter-over-quarter, we just didn’t think there was that much elasticity in the market to start discount and to pick up that many more sales. And the other thing is that lot of it is the timing of what you have left in a community, while we may have lots left, they may not all be the best lots. And what’s replacing it might not be already open. So some of it is timing I mean we would expect absorptions to go up a hair in ’14 but we don’t expect them to go up to 3.5 up a month or anything. So we do expect absorption improvement in ’14 versus ’13. So we see nothing that tells us any different so far.

Stephen East - ISI Group

I got you, okay thanks and then just one last question. Land spend in light of what’s going on with the market does the slower pace et cetera, how do you all view land spend in 2014?

Larry Nicholson

We see it about the same as this year, I think we spent somewhere around $950 million on land and development, for a net of about 550 or something. And I would see about the same net spend this year.

Stephen East - ISI Group

Okay thanks a lot guys.

Larry Nicholson

Thank you.

Operator

Thank you, sir. Our next question will come from David Goldberg with UBS. Please go ahead. Your line is now open.

David Goldberg - UBS Investment Bank

Everybody.

Larry Nicholson

Morning.

David Goldberg - UBS Investment Bank

My first question Larry was actually a follow-up to Ivy’s question earlier about labor. And I thought it was interesting that you talked about, I don’t know if you used the phrase making some changes to the labor pool and making some adjustments. But can you give us an idea of how you drive that efficiency on kind of a local market basis? Is it bringing in new crews? Is it approaching the crews you already have and saying hey guys, we have got to cut down some of the waste in the process. How do you actually go about making those adjustments? Because I think it’s a little bit opaque from our perspective.

Larry Nicholson

Dave if you are going to make me give up all our secret sauce?

David Goldberg - UBS Investment Bank

Some of the secret sauce.

Larry Nicholson

I think it’s a couple of things; one it’s going to the existing vendor base and giving them steady pace in a reasonable price to do it. Some of it is bringing vendors in from other places. The other thing we focused on that is on the apartment industry we have seen some of -- those started slowed down. So some of those trades have now become available if we can give them a guaranteed amount of work.

So we have gone back to some trades that were maybe outside of our market and then are willing to come back as they see that pipeline. Especially garden apartment production, we see that that’s kind of peaked and we are through in most cities, through what I would call the, getting it under cover stage. So the framers are starting to free up. And you will see that pace all the way through. So it’s a mix and a match and it’s a local deal, it’s not something that we can control nationally. It’s the local purchasing guys putting together their plan and beating the streets and finding better opportunities for us.

David Goldberg - UBS Investment Bank

Makes a lot of sense, and hopefully it wasn’t painful.

Larry Nicholson

No.

David Goldberg - UBS Investment Bank

The other question I had actually in the remarks but I thought it was really interesting and I think we have seen this from a lot of builders about kind of trying to hold price in the back half of last year and trying to kind of say look this is in a high demand period so we’re going to hold the pricing. I think everyone is optimistic about the selling season, but you also kind of talked about gearing up for the selling season, maybe can you talk about kind of what your sales teams are doing in January as we kind of get into the selling season. What kind of preparations, will that mean to be gearing off and how do you think you get an edge? And the reason I ask is it seems to me like some of the slowdown at the end of the year was clearly from the buyer side but some was maybe the builder is not pushing as hard as you kind of mentioned. So what do you do to push a little bit harder other than promotions and incentives right now?

Larry Nicholson

Well I think you got to work your -- obviously your prospect base and you got to communicate with them on a regular basis. I still think there is a pricing power in some markets, so obviously use price as a lever that price is going to go up. We spend a lot of time looking at that throughout ’13 and how do you move price? When do you move price? So I think that’s one. Other places we have made some adjustments in our sales teams. Some places maybe that they had one person a year ago it might now have two, because there is enough traffic to warrant it to make sure we’re capturing all that traffic.

But I mean, we’re standing -- we've got to be stand and fall get all of our communities open. We have to have good lots available. And I think that’s where we are today. But it’s a week-by-week deal Dave and we’re not looking at incentives right now, we’re looking at trying to push price and keep pace. And obviously the selling season starts on Monday, after the Super Bowl, so we’ll evaluate that every week. And I think you’ve heard from some of the previous guys have reported I don’t think anybody is using incentives. They were used on a limited basis in the fourth quarter in a couple of markets. And I think everybody is going to hold price, and I think that bodes well for all of us.

David Goldberg - UBS Investment Bank

That’s probably that’s actually great color I really appreciate it.

Larry Nicholson

Yes, the one other thing Dave I’d tell you is when you look at discount in the fourth quarter if you discount in the fourth quarter you come out in the first quarter to disadvantage because the customer knows that. And that’s another thing you don’t really didn’t want to do because we wanted to come out strong, sell from strength not from weakness. And I think we’ll have the opportunity to do that.

David Goldberg - UBS Investment Bank

Yes. I feel that psychology has benefited by not cutting?

Larry Nicholson

Yes.

David Goldberg - UBS Investment Bank

Thank you very much.

Larry Nicholson

You’re welcome.

Operator

And it looks like our next question will come from Adam Rudiger with Wells Fargo Securities. Please go ahead. Your line is open.

Adam Rudiger - Wells Fargo Securities

Hi. Thanks for taking my question. I wanted to circle back to your comment on absorptions, potentially your expectations for them being up a hair in 2014. I think in response to one of the other questions that was asked about the declines year-over-year you’re seeing. It seems like some of that might be also a result of the way you accounted for last year’s acquisitions. So, the question I had was, do you in front of you or can you get us the, what you think is probably the right adjusted absorption pace for the full year ’13, excluding the acquired backlogs and changes in community count and stuff? I’m just trying to think about the benchmarks to set my expectation.

Larry Nicholson

Yes. Someone -- Drew will back to you Adam we don’t have that right now.

Drew Mackintosh

Yes, in our slide deck I don’t know if you had a chance to take a look at that where we sort of breakout what the acquired backlog was for this year and last year and then we…

Adam Rudiger - Wells Fargo Securities

Because you need the community count through that?

Drew Mackintosh

Yes, we’ve given out community count quarter, I can get it to you if you need it.

Adam Rudiger - Wells Fargo Securities

Okay. Secondly, can you -- you've touched on it a little bit, but just talk about how the acquisitions are performing, not just in margins but in terms of the integration, the culture, sales pace, all that kind of stuff and if -- what your appetite is for more acquisitions?

Larry Nicholson

We did roughly four acquisitions over we’ll say 18 months, the first two which was Timberstone in the Carolinas is fully integrated, no problems performing like we would expect it to. Second one was Trend Homes in Phoenix we did that a year ago in December. They are integrated, hitting the ground, getting a lot of new communities opened. So we’re expecting great things there this year. And really has performed probably at a little higher level than we anticipated from our land positions.

LionsGate in Dallas, again we hit the ground running there. They’ve bought some additional lots selling units in a very good market, so we’re real happy there. Still go through integration there and getting that all final audit. And then lastly was Cornell, which happened, I guess, that was in the summer. So we’re still integrating that. But again we’ve purchased quite a few communities that will be getting open this year. So, we’re trying to push the gas pedal there a little harder.

But I would tell you overall as far as the acquisitions go, we’re extremely happy with what we’ve done and how they’ve performed, and how they’ve integrated into our organization. And as far as future opportunities, we’re always looking for an opportunity. So if we could find the right one then we would continue to take that. We have done a good job of growing both organically and via acquisition we grew about 90% organically and 10% via acquisition. So I think we are open-minded to the opportunities that are out there.

Adam Rudiger - Wells Fargo Securities

Great, thank you.

Larry Nicholson

Thank you.

Operator

Thank you. And it looks like our next question will come from the line of Dan Oppenheim with Credit Suisse. Please go ahead. Your line is now open.

Dan Oppenheim - Credit Suisse

Very much, I was wondering if your comment on margin in terms of just some potential for improvement in terms of ’14 I guess we will look at the southeast and the west look to be best in terms of margin performance but if we look at the sort of mix of orders here in terms of the trends and orders the mix shift will shift away from those reasons. Should we think about that as having sort of a negative impact on margins as the backlog comes through in terms of closings here?

Larry Nicholson

No. I mean I think, I mean we’ve got good communities in all cities so it all depends -- it’s not just a city issue it’s a community issue. And so we’ve got lots of communities opening and I think we’ve got 60 communities opening in the first quarter. Every community has a different margin, every city has some strong margin communities and some are strong. So it’s a real mix out there and it’s a combination of all. And I guess the average of them all as we see margins will be up in 2014 over ’13.

Dan Oppenheim - Credit Suisse

So the regional mix of margins in terms of what you have been reporting for a margin revision, should we -- that will be changing over ’14 then in terms of more strengthening the north and Texas relative to the southeast and west?

Larry Nicholson

I guess we don’t look at it that way, when we looking at a community and then every city and since the margins are and so if sales pickup in one region margin should get better in those regions if sales pickup should have a stronger backlog from the margin. So, lot of the homes we haven’t sold yet, we’re speculating on this year that just when we had it all up, we can see margins, we expect to be up this year.

Dan Oppenheim - Credit Suisse

Okay. Thank you.

Operator

Thank you, sir. Next question in queue will come from Eli Hackel with Goldman Sachs. Please go ahead with your questions please.

Eli Hackel - Goldman Sachs

Thanks very much. Just two quick questions, one, have you guys seen any impact at all and changes in mortgage standards or from the implementation of QM or maybe just delays in terms of proving people if there is any timing on that? And then just one other quick one is, what was the split between land and development spend in the quarter?

Larry Nicholson

Okay. I’ll answer QM. I would tell you that I think we’re still a little early. We’re seeing a little bit of more difficulty in reviewing files and making sure that, I would tell you it hasn’t made a significant impact as of today. As far as land, 191 million land purchases, 73 million site development in the quarter.

Eli Hackel - Goldman Sachs

Okay. Thank you very much.

Operator

Thank you, sir. Next question in queue will come from Stephen Kim with Barclays. Please go ahead. Your line is open.

Stephen Kim - Barclays

Hi guys, thanks very much. Maybe Gordon, this is a better question for you. It relates to interest expense and the previously capitalized portion that’s amortized the cost of goods sold. I was wondering if you could give us a sense for how you expected that to trend as we go forward and maybe if you could in your comments talk about what you expect sort of total interest expense to be relative to interest incurred if that’s a better way of looking at it?

Gordon Milne

I guess we’re capitalizing on our interest, so that’s clear now. And then because our interest rates have gone down our inventory has grown, the amount of interest we’re capitalizing is going down so the expense associated with running capitalized interest with the income statement are through margins is getting better because it’s less interest capitalized per unit closed. So, I think everything is real positive on the interest capitalized front.

Larry Nicholson

For example interest capitalized as a percentage of -- in the inventory was 5.4% at the ’13 versus 8% in ’12.

Gordon Milne

It’s quite an improvement.

Stephen Kim - Barclays

I guess what I was looking for is in terms of dollars, the interest expensed and amortized portion it seemed like it’s been running a little bit below your interest incurred. And I was curious as to whether you thought that that would actually close the gap and start running in terms of dollars closer to the interest incurred or even above it to work…

Gordon Milne

Yes. Our inventory is going up and our interest cost although they are really low have gone up as we added some more debt last year, but our interest for home is going down. But when you are closing 50% or 60% more units or in dollar terms our interest cost certainly aren’t going up 50% or 60% so it’s really a positive for us that capped interest is getting lower per unit. I think that is an important thing.

Stephen Kim - Barclays

Okay. Yes, that’s fine. And then I guess broader picture, I thought you mentioned that your average FICO score was around 730 and your average down payment was I think either 9% or 11%. Those are statistics which strike me as being relatively strong credit statistics for your average customer and probably stronger than what we’ve seen in the past. And I guess I’m just curious Larry, do you anticipate that for the next couple of years that the buyers who you will be selling to will exit the credit statistics roughly like that or do you think that you might find that your buyer mix will have credit statistics that are, let’s say, maybe drift down into the high 600s or even mid 600s. Do you think there is the potential for that and if that potential exists would you go for that or would you intentionally stay where, up in the 700s?

Larry Nicholson

Well I mean I think, I don’t think there is anything wrong with a 690 credit score and I’ve said previously that we would hope to see that number start to trend down as the credit box opens up a little bit. And I think that there has been some conversation that people are starting to see things loosen up a little bit. I don’t think we’d say we’ve seen a lot of that yet, but I do expect over the year that I think the credit box will open a hair and I think make it a little bit easier, so I would expect that maybe to come down.

I don’t think it’s going to drop to 690 this year, but I think that we will see improvement, an opportunity there and that just means we can write more business. I’ve always believed that there is a lot of people out there that would love to own a house that are just precluded because they got a thing on their credit and I think it’s wrong, I mean I think that there is great opportunities out there and it moves the economy to help create jobs and there is no reason we should be have such a box that so tight for these folks.

Stephen Kim - Barclays

Got it, great. Thanks very much, I appreciate it.

Larry Nicholson

Thank you.

Operator

And our next question will come from Ken Zener with KeyBanc Capital Markets. Please go ahead. Your line is open.

Ken Zener - KeyBanc Capital Markets

Good morning, Larry, Gordon.

Larry Nicholson

Hey Ken.

Ken Zener - KeyBanc Capital Markets

You talked about your view that you think absorption might go up a little bit but it is not going to be a big kick, but we’ve been asking builders about this. It’s our view that the things are seasonal not cyclical right now. So it looks like your absorption has slowed about 15% in quarter-to-quarter in the fourth quarter. Historically they improved 10, 12 years here or there about 45%, is that kind of the benchmark that you are using when you guys think about what a normal seasonal world is within a year that you’re not having increasing absorptions overall?

Larry Nicholson

I am not sure we understand the question. You are saying…

Ken Zener - KeyBanc Capital Markets

You generally have -- go ahead.

Larry Nicholson

The absorption was down about 15% fourth quarter over third quarter, and then they bounced back in the first quarter.

Ken Zener - KeyBanc Capital Markets

Yes, about 45%. Is that kind of your expectation based on normal seasonality because, you must have some benchmark that you use.

Larry Nicholson

Yes, I mean the first quarter would be an improvement obviously. Second quarter is usually the highest absorption quarter and then it starts trending back down in normal seasonality. So we use less of normal seasonality than we do just bottoms-up. We’ve got these communities that will be opened. We’ve been selling at a certain pace. We expect them in the spring to sell a certain place. I know when you're modeling and you don't have all the detail, you have to use the numbers, but we do a bottoms-up approach as a…

Ken Zener - KeyBanc Capital Markets

Perfect. Just that’s alright. I mean just some builders have talked about you having a benchmark. But it is growing up above that in terms of what they have seen in January. So I just wanted to give you an opportunity to comment there. Another builder talked about Phoenix which they said was kind of slowing and they have highlighted the rising existing inventory. And obviously some of that inventory is coming up because people aren’t underwater as much, but there in fact places like Phoenix on the outer areas especially where there is a lot of investor activity. Could you comment on perhaps how you are seeing, how the market in terms of existing inventory hampering growth as supply comes on and/or your new communities which you have many, just not being affected by that, if that’s the case? Thank you.

Larry Nicholson

Yes, well ironically I was in Phoenix on Tuesday. So, inventory in Phoenix right now is running at about a 3 to 3.5 month pace. So again I think at equilibrium, I think there was a huge amount of investor activity through the downturn, but if you go look where that investor activity is. It is in the sea markets, it would be on the far West side, the far South side, not in what we would consider the main markets.

So I think, as I said in the prepared remarks that some of the outlying areas are seeing some softness, but the core market I think is still strong. There are more communities open today in Phoenix than there were a year ago and there is probably a few more coming on. So competition is stiff. But I didn’t see anybody with any major discounting going on. And we’re still selling houses, and margins are good. So I think we just got to watch it. But I do think the outlying areas are definitely seeing a slowdown.

Ken Zener - KeyBanc Capital Markets

Thank you.

Operator

Thank you, sir. And our next question will come from Nishu Sood with Deutsche Bank. Please go ahead, your questions please.

Nishu Sood - Deutsche Bank Securities

Thanks, so your community count growth guidance for ’14, I think recently you’ve been saying 15% and now you’re saying 20%. So given that a lot of your communities are tied up already, I was just wondering late in the year, what would have driven the pickup in that number. I mean are you having success opening them more quickly, development going better than expected, so what drove the pickup in that so late in the year?

Larry Nicholson

I think a couple of things, you get better visibility the later you get into the year, when things are going to open. Like in ’13 I would say we were probably more back half loaded on our community count. This year we feel a little bit better than it is more evenly spread throughout the year. As Gordon said we will open a fair amount of communities in the first quarter. We did buy some additional stuff that gave us opportunity to get opened also that we didn’t have the last time we talked, but it’s kind of a -- it’s a mix of both.

Development has been tough this winter, in a lot of markets because of weather conditions. But our folks have done a good job and we’re still very optimistic, we will get that number open. And it’s again I think that, at half way through the year, we will be a good portion to getting to that number. So we’re excited about it.

Nishu Sood - Deutsche Bank Securities

Great. And you gave the monthly color which we appreciate. Any comments on January?

Larry Nicholson

It’s gotten better on a weekly basis. Traffic is extremely qualified and we have great traffic.

Nishu Sood - Deutsche Bank Securities

Okay, great. And just one another one if I could, first time buyer, a couple of folks have referred to this already, easing credits, the first time buyer is a little bit under-represented in your profile, I think about a third compared to, I think it’s usually higher than that 40% to 50%. If the first time buyer does come back to a market in greater numbers and help in terms of your order levels what kind of implications does that have? Is your land pipeline appropriate for that? Can you open up in other communities that are appropriate for to capture that demand and also would there be any financial implications, ASP-wise or margin-wise?

Larry Nicholson

Well, I think we make about the same margin on an entry level and move up obviously your average sales price is sold more or less expensive homes it would go down, but your volumes would go up and so, I can’t think of any way that could be a negative, it sold more homes. And if you’re making appropriate margins and we do, as far as land goes, you saw in the fourth quarter we’re still 1.7 per community, we’d like to sell at 3 or 4, so we’ve got lots of communities that sell entry level homes that could definitely pick up the pace, if that the pace is there to be picked up, so we’d be very excited about the first time home buyer coming back into the market in bigger numbers, it’s got to be very positive for the whole industry.

Nishu Sood - Deutsche Bank Securities

Okay, great, thanks.

Operator

Thank you. Next question in queue will come from Joel Locker with FNB Securities. Please go ahead. Your line is open.

Joel Locker - FNB Securities

Good morning guys, just nice quarter and wanted to talk to you about your direct cost, you mentioned that gross margin improvement you benefited from that, and what was it up per square foot on a year-over-year basis?

Larry Nicholson

Direct costs were up about…

Gordon Milne

It was 8% for the full year.

Joel Locker - FNB Securities

8%...

Gordon Milne

Fourth quarter over fourth quarter.

Joel Locker - FNB Securities

Fourth quarter fourth, what about sequentially versus the third quarter?

Gordon Milne

I don’t have that number.

Joel Locker - FNB Securities

Okay that’s okay. I can follow-up with that. And just, it sounded like your community count growth is it going to be linear like the 20% growth in 2014 or do you think it’s for...

Larry Nicholson

Well of course I did it’s more front-end loaded this year than last year, so we have got a lot of communities opening in the first quarter and you will see pretty significant growth in the first quarter and then just kind of even throughout the year.

Joel Locker - FNB Securities

Even throughout the year. And just the last question on it, what was your tax valuation allowance at the end of the quarter?

Larry Nicholson

Deferred tax valuation allowance?

Joel Locker - FNB Securities

Kind of just -- do you have anything off balance sheet to tax valuation allowance?

Larry Nicholson

There’s nothing left, it’s all been reversed.

Joel Locker - FNB Securities

Right, so it’s all been reversed, alright, thanks a lot.

Operator

Thank you. And our next question will come from Will Randall with Citi. Please go ahead. Your line is open.

Will Randall - Citigroup

Thanks. Good morning in the West Coast and thanks for taking my question.

Larry Nicholson

Good morning.

Will Randall - Citigroup

I was just curious, in terms of other demand indicators that you look at that make you feel bullish about the spring selling season, is there anything else like web traffic or things on the ground that we might not notice from our purview?

Larry Nicholson

Yes, what I would say is, when I quote traffic usually I quote both foot traffic and web traffic and web traffic has also been up dramatically so those are probably two biggest. I mean our sales people are extremely optimistic, the quality of the people they’re working with is very good and they all feel like they got a good backlog of customers and they’re waiting for the next sale to walk in the door they’re working multiple people that they know they can convert, it’s just getting them to the finish line. So right now we feel real good and don’t see anything that would concern us.

Will Randall - Citigroup

Thanks for that, and I would definitely agree, on the land pipeline in your slides up on the web, you talked about and you highlighted this before for planned closings for existing communities, about 90% in ’14, dropping down to 35% in ’15, do you expect that to augment margin in any way in ’15?

Larry Nicholson

Well I don’t want to give any kind of guidance for ’15 and we wouldn’t expect it to have a major negative effect, I guess I’d said that. And I think what, when you look at that slide which is slide 10 through 15, those communities are all contracted though, if you look at that 79% number, so I mean really, we own most of them, they’re contracted, it’s just getting them to the development stage, so we see that number out there in ’15 so we feel pretty good and again our underwriting standards are going to stay the same, so we wouldn’t expect any deterioration.

Will Randall - Citigroup

Thanks again for taking my question, next quarter.

Larry Nicholson

Thank you.

Operator

Thank you. Our next question will come from Buck Horne with Raymond James and Associates. Please go ahead, your questions please.

Buck Horne - Raymond James

Hey thank. I was curious to ask about your finished lot position and I’m curious going into 2014, if there is a way you could give us some color and maybe divide your current finished lot positions into, if you characterized them as A sub markets, B sub markets or Cs, and I guess I’m curious, how would you characterize the overall market in terms of the constraint that’s out there on finished lot availability in A, B and C sub markets, what’s going on in land development this year?

Larry Nicholson

As far as our finished lots that we’re buying I would consider they’re all of A quality, A to A minus, I mean we haven’t bought a C lot in an eternity. I don’t think we actually really even own a C lot anymore, so it’s been difficult, I mean as the year has gone on it’s been harder and harder to find those option lots in pretty much every market, and I think it’s pretty tough today and I think you’ve heard some of our other compatriots say kind of the same thing.

So there are some opportunities in certain parts of the country and we’ll continue to pursue those but I think going forward we’re going to have to develop more dirt and that’s just no different than any other cycle I’ve been through in the last 25 years. We just to make sure that, I mean the good thing we’ve been able to continue to buy finished lots through 2013 which allows us to get some of that stuff open very timely. And that’s really what we’re kind of focused on right now is, is there anything else we can buy and get opened in ’14 and we had a land meeting last week and we bought a couple of deals that we will have sales in ’14, so that’s great.

Buck Horne - Raymond James

Do you still think there is plenty of opportunity in the land you’re buying it’s still primarily be focused on those A submarkets?

Larry Nicholson

Yes, I mean, we just -- we’re not excited about and there is a lot of dirt out there. The problem is, is trying to underwrite it. And when you look at the current market that’s there, I mean Phoenix is a great example because everybody is talked about Phoenix, right. If you’re trying to underwrite a deal today on the edge it just doesn’t work.

Buck Horne - Raymond James

And one last one on your spec strategy it looks like you’re carrying a little bit more spec inventory per community than you traditionally do. Do you plan on keeping it at about the current levels or would you continue to grow that spec inventory based on the trends you’re seeing in the spring so far?

Larry Nicholson

Well I think what we wanted to do is make sure we had enough spec available for the spring selling season. And we’ll monitor that and ramp it up if we need to, but we don’t want to too much inventory because margins on specs have improved dramatically through ’13 and we don’t want that to start seeing that reverse either, I think couple of other builders have said the same thing, spec margins have improved dramatically. So we got to manage it. And again, I think, we got a hair more than what we would have had a year ago but not dramatically.

Buck Horne - Raymond James

Alright, thank you.

Larry Nicholson

Thank you.

Operator

Thank you, sir. (Operator Instructions) And our next phone question will come from the line of Alex Barron with Housing Research Center. Please go ahead. Your line is now open, your questions please.

Alex Barron - Housing Research Center

Good morning guys and good year. I guess I wanted to talk about 2014, I think you guys mentioned that you thought margins could expand due to mix, but I also wanted to approach the subject of margins from a perspective of prices I think obviously prices went up a lot last year. Mortgage rates are pretty favorable. This year obviously that’s a little bit more of a challenge. So I’m wondering if you guys think that there is a potential that margins could contract if home prices don’t keep rising?

Larry Nicholson

I think our margins are based current pricing, so not overly concerned about that. We would expect to see 3% to 5% appreciation this year which I guess you’d call more normalized. So I don’t think we’re at risk of our margins being impacted by if pricing stayed static we should be fine.

Alex Barron - Housing Research Center

Okay and then I was wondering if you guys had how many orders you guys get from the last two acquisitions you did, Cornell and LionsGate during the quarter?

Larry Nicholson

Yes, we’ll get that. Drew can get that to you.

Alex Barron - Housing Research Center

Okay. Thanks.

Larry Nicholson

Okay, that’s it. Thank you.

Operator

Thanks you, sir. And presenters, at this time there appear to be no additional phone questions at this time. I would like to turn the program back over to management for any additional or closing remarks.

Larry Nicholson

Well, thank you for joining us today and we appreciate all your input and we look forward seeing you next quarter. Thank you.

Operator

Thank you, presenters. And thank you ladies and gentlemen. Again this does conclude today’s call. Thank you for your participation and have a wonderful day. Attendees, you may now all disconnect.

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