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Executives

Erin Willis – Director, IR and Corporate Communications

Sheryl Palmer – President and CEO

David Cone – VP and CFO

Analysts

Adam Rudiger

Michael Rehaut

Nishu Sood

Jay Mccanless

Alex Barron

Taylor Morrison Home Corporation (TMHC) Q4 2013 Earnings Conference Call February 12, 2014 8:30 AM ET

Operator

Good morning, ladies and gentlemen, and welcome to the Taylor Morrison’s Fourth Quarter 2013 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. As a reminder, this conference is being recorded.

I would like to introduce Ms. Erin Willis, Director of Investor Relations and Corporate Communications.

Erin Willis

Thank you, and welcome to Taylor Morrison’s fourth quarter earnings conference call. With me today are Sheryl Palmer, President and Chief Executive Officer; and Dave Cone, Vice President and Chief Financial Officer. Sheryl will begin the call with an overview of our fourth quarter 2013 results. Dave will take you through a detailed financial review as well as our guidance for the first quarter. Then Sheryl will provide some detail around our land activity and outlook for the coming year after which we will be happy to take your questions.

Please note that some of our comments on today’s conference call refer to non-GAAP financial measures, which we believe provide useful information for evaluating our business performance. This information should be considered as supplemental in nature and should not be considered an isolation or as a substitute for the related financial information prepared in accordance with GAAP. In addition, these non-GAAP financial measures may not be the same as similarly entitled measures reported by other companies. Reconciliations to the most directly comparable GAAP financial measures are available on the Investor Relations portion of our website at taylormorrison.com and in our earnings release.

Finally, please keep in mind everything we cover during today’s call, including the question-and-answer session is subject to the Safe Harbor statement for forward-looking statements within the meaning of U.S. securities laws. This may include statements about our current expectations or forecast of market and economic conditions, our business activities, prospects, strategies and future business and financial performance. These forward-looking statements are not guarantees of future performance and actual results could differ materially from those suggested by our comments made during today’s conference call. I’ll call to your attention the description of risk that could affect our future results that is contained in our registration statement on Form S-1 and subsequent reports filed with the SEC.

Now, let me turn the call over to Sheryl Palmer.

Sheryl Palmer

Good morning, everyone. We appreciate you joining us today and are very pleased to share our fourth quarter and full year 2013 results, which continue to highlight our strong business performance and to support the success of our full cycle strategy of showcasing the outstanding execution in both, our U.S. and Canadian operations.

For the quarter we had earnings per share of $0.79, a net income of $96 million. It was an understatement when I say 2013 has been a remarkable year for Taylor Morrison, and it’s worth emphasizing just a few key accomplishments that have shaped our success. Most noteworthy for the company, as you are all well aware, one of our successful initial public offering in April; more important however, has been the strength of our capital structure and our rational long-term strategy which is centered on three things. First, is our focus on the move-up buyer in core locations. We believe these buyers are more able to qualify for our home purchase with healthier personal balance sheet, as well as being less sensitive to movements in interest rates.

Second, is our conscience [ph] cost discipline and operating efficiency. Our discipline yet flexible operating platform has enabled us to perform well, both during strong and challenging economic conditions and our financial results clearly reflect that. Third, is our company-wide attitude towards maximizing shareholder value by optimizing profit and volume. From our underwriting analysis through execution we maintain a bias towards profit as we seek to maximize the performance of each and every asset.

Furthermore, we successfully execute against our strategy of first identifying, and then developing and building in core locations within high growth market, continuing the trend of strong results in more than four years of operating profit. We also achieved one of the industry’s leading pre-tax margin rates of 15.2% in the fourth quarter while further strengthening our balance sheet with our quality short and long-term lending.

I here began with the acquisition of Darling Homes, and we could not be more thrilled with the quality and results demonstrated by the Darling team. Darling has integrated very nicely with Taylor Morrison, actually faster than I could have expected. We achieved synergies faster than anticipated, and were able to take the strengths of both Darling and Taylor Morrison operating model to arrive at what we believe to be an optimal outcome.

With a strong team on the ground, our disciplined approach, and the complimentary business model, in 2013 we were able to close more than 750 homes under the Darling plan and approved nearly 1200 lodge [ph] through our investment process to feed the future Darling business.

Okay, let’s move on to some of our results. I’m quite delighted to share that our net sales orders for the quarter represented the highest level of Q4 net sales since 2007. This was driven by our focused execution of 48% community count which underscores the extensive research used to identify the right sites in the right core location, as I had mentioned earlier. Meanwhile cancellations have remained stable, sequentially at 15.2% for the quarter on a company-wide basis.

As you know from our history, quarter operating philosophy, we remained keenly focused on operating the business efficiently. We are pleased to report that SG&A as a percentage of homebuilding revenue was at 8.7% in the quarter. Recognizing there was much attention around the health of the U.S. markets in the fourth quarter, it makes sense to share some significant highlights from my U.S. operations. Our home closings revenue increased 64% in the U.S. while closings were 39% higher compared to the prior year period. Our average sales price on closed homes in the U.S. increased at a rate of 18% or $66,000 year-over-year to nearly $425,000.

Our adjusted home closings gross margin, excluding capitalized interest increased to 180 basis points year-over-year to 25.1%. Despite some volatility in the macro environment, we continue to stay at the course. We remain committed to our operating strategy and our balanced business platform, both of which continue to service well. In fact, if you’ve heard me say before, we believe that this period has actually been very good for the industry in realigning expectations to more sustainable growth. Specifically this period has allowed the labor market and overall construction infrastructure to continue to ramp up to better meet the demand, although I would say we still have our ways to get there. For all of this we strongly believe Taylor Morrison remains well positioned to take advantage of a continued U.S. housing market recovery.

Moving to our Canadian operations, Monarch accounted for 22% of our closings for the quarter. The market in Ontario has continued to be far more stable than others thought possible. In fact, high-rise sales in the Greater Toronto Area or GTA exceeded economists’ projections by about 15% with 16,000 unit sales in the year despite early 2013 media reports of a projected oversupply of housing that remains less than one month of standing inventory in high-rise units in the GTA.

As expected we closed out three high-rise towers in Toronto this year. One building Couture closed out in the third quarter, and the other two, Ultra and Encore closed out in December. For the quarter these two towers delivered 318 units of which 115 were wholly owned and 203 were our proportionate share of joint venture towers, and therefore not included in our reported closings numbers. In actuality, Monarch built and delivered over 500 high-rise units recognizing that roughly 200 were for our JV partners and that’s not recognized in our unit counts.

All three towers had margins and expense of our underwriting assumptions. All units were delivered with less than 1% cancellations and in fact, total Monarch cancellations, inclusive of our single-family homes remained unchanged at less than 2% for the year due to stringent deposit and pre-qualification processes in Canada and one-sided full recourse sales contracts that favor the seller.

2014 is also anticipated to be a big year for our high-rise business which three towers deliveries, two of which are wholly out. 97% of those units in the three towers are already sold. Excellent results were achieved again this quarter by the operations due to the consistency of our community positioning strategy, despite some macroeconomic headwinds experienced in both, the U.S. and Canada. All this leads us to remain optimistic about Taylor Morrison’s ability to drive through the recovery although we remain aware that volatility and macro factors may create a bit of choppiness in sales, starts, and closings from time-to-time.

Now let me turn the call over to Dave Cone for the financial review.

David Cone

Thanks Sheryl, and hello everyone. I’m pleased to share with you our results for our fourth quarter and full fiscal year. As Sheryl mentioned, we had earnings per share of $0.79 on net income of $96 million in the fourth quarter of 2013 which includes certain tax benefits that I’ll cover in more detail in a moment. Excluding these tax benefits, adjusted earnings per share was $0.72.

Fourth quarter net sales orders in our U.S. operations improved 23% to 1,048 units. Our Canadian operations had 126 net sales orders and expected decline of 4% compared to the fourth quarter of 2012, mostly due to a lack of wholly-owned towers available for sale in the fourth quarter of 2013. This resulted in consolidated net sales orders of 1,174 units, representing a 20% increase when compared to the same quarter a year ago.

We continue to execute on our strategy, and we increased community count by 48% over the prior year quarter to 180. Community absorptions were flat sequentially from the third quarter at 2.2 per month. We continue to be encouraged by the consistency of our absorptions as they were in line with our expectations.

Total revenue for the quarter was $798 million, an increase of 43% compared to $557 million in the fourth quarter of last year. Home closings revenue was $780 million for the quarter, a 44% improvement year-over-year. The increase was driven by a 34% increase in homes closed to 1,870 during the quarter coupled with an 8% increase in average selling price to $417,000.

As Sheryl mentioned in the U.S., home closings revenue increased 64% while closed units increased 39% and the average selling price increased $66,000 or 18% year-over-year to nearly $425,000. In Canada, home closings revenue decreased 2%. Canadian closed units increased 18% as we closed 115 wholly owned tower units compared to only one unit in the fourth quarter of 2012.

Average selling price in our Canadian operations was down 17% year-over-year to $391,000 due to the increased proportion of high-rise closings and close outs of higher ASP single-family home communities. Breaking down the mix of closed homes this quarter, 49% were from the East region, 29% were from the West, and 22% were from Canada.

Consolidated adjusted home closings gross margin, excluding capitalized interest was 24.8% representing sequential improvement of 100 basis points over the third quarter of 2013. Relative to the fourth quarter of 2012, our U.S. adjusted home closings gross margin increased 180 basis points to 25.1% driven by benefits from both, price depreciation and a continued shift to more move-up buyers. This improvement also includes about 10 basis points of pressure from our Darling business as we continue to sell through the balance of work in progress that was written up in purchase accounting which resulted in lower margins on the homes that were under construction at the time of the Darling acquisition.

We’ve seen the anticipated moderation in our Canadian margin which has adjusted for capitalized interest decline from 30.3% to 23.7%. Similar to what we experienced in Q3 of 2013, we benefited from higher ASP and higher margin single-family home closings in 2012. This decline lead to an overall reduction in our consolidated adjusted home closings margins of 60 basis points to 24.8% in the fourth quarter of 2013. The Canadian margin will be a tough compare through the first half of 2014, however, as the anticipated growth in the U.S. operations outpace the Canadian business, we expect the overall impact on margins to diminish in the back half of 2014.

As for financial services, Taylor Morrison Home Funding generated $9.5 million of revenue during the quarter, 911 closings with an average loan amount of $319,000, representing a 25% increase in volume and a 15% increase in loan value over the prior year quarter. TMHF’s gross profit was $5 million.

SG&A on a company-wide basis was $68 million or 8.7% of home closings revenue for the quarter compared to 8.9% in the same quarter of last year. The 20 basis point improvement is mainly due to driving top line leverage which was partially offset by the higher operating expenses for Darling. Despite the slightly higher cost model for the Darling business, I’m pleased that one year after the acquisition, we worked through the integration and are seeing costs trend more in line with our legacy Taylor Morrison business.

We continue to focus on maximizing overhead efficiency and this is one of the key strengths in driving higher operating profit. As Sheryl mentioned, our Canadian high-rise business played a larger role on our results this quarter.

Equity income from our joint ventures increased to nearly $17 million as compared to $11 million in the same period last year. The increase is primarily due to 203 closings in our joint venture high-rise towers as compared to only one in the fourth quarter of last year. Our income before taxes was $122 million or 15.2% of revenue compared to $92 million for the same period last year. Income taxes totaled $25 million representing an effective tax rate of 20.9%.

As I mentioned, the fourth quarter income tax expense included certain tax benefits. First, $11 million due to the reversal of a portion of our valuation allowance on deferred taxes. At year end, we have $40 million of deferred tax assets that remained fully reserved. In addition, we reached a favorable settlement on certain state tax issues on behalf of our former parent company. As the former parent company had indemnified us against this tax exposure in connection with our acquisition in July of 2011, we reversed a portion of the tax in indemnification receivable. This included a benefit of $11 million for the reversal of the tax indemnification which was partially offset by a $4 million charge for deferred taxes on interest in Federal benefit of state tax deductions related to the tax position. At year end, we have approximately $5 million remaining on our tax indemnification receivable. As a reminder, the fourth quarter of 2012 included a $296 million tax benefit for the reversal of the valuation allowance on deferred tax assets.

Now turning to our annual results, for the year we had earnings per share of $1.38 on net income of $95 million. It’s worth repeating that during the year we incurred certain charges related to the IPO and the reversal of the tax indemnification receivables, as well as the reversal of the valuation allowance on deferred tax.

As detailed in the second quarter results, we incurred $200 million of other charges in addition to the fourth quarter tax related items I discovered. Excluding these items, we had earnings per share of $1.42 for the year. Net sales orders in our U.S. operations improved 34% to 5,018 units. Our Canadian operations had 596 net sales orders, a decline of 20% compared to 2012, mostly due to a lack of wholly owned towers available for sale in 2013, as well as the moderation in the pace of our single-family homes to a more normalized level. This resulted in a consolidated net sales orders of 5,614 units for the year, representing an increase of 25% over 2012.

The U.S. backlog value was up 38% year-over-year to $988 million with a 19% increase in average selling price to $456,000. Our Canadian backlog was $259 million, down 38% as we closed 421 high-rise units during the year compared to only two units in 2012. Given the longer construction cycle, high-rise units typically sit in backlog for a few years but then come out in large chunks as we are generally able to close a tower out over a six week period. Total backlog at year end was valued at over $1.2 billion, which represents a 10% increase in value year-over-year.

Total revenue for the year was $2.32 billion, an increase of 62% compared to $1.44 billion last year. Home closings revenue was $2.26 billion, a 65% improvement year-over-year. The increase was driven by a 54% increase in homes closed to 5,829 during the year, coupled with a 7% increase in average selling price to 389,000.

In the U.S., home closings revenue for the year increased 88% while closed units increased 61% with an increased average selling price of $58,000 or 17% year-over-year to nearly $394,000. In Canada, home closings revenue increased 6%. Canadian closed units increased 31% as we closed 421 wholly owned tower units compared to only two units in 2012.

Consistent with our business plan, the average selling price in our Canadian operations was down 19% year-over-year to $366,000 due to the increased proportion of high-rise closings and close outs of higher ASP single-family home communities in 2012. Breaking down the mix of closed homes for the year, 50% were from the East region, 31% were from the West and 19% were from Canada.

Adjusted home closings gross margin, excluding capitalized interest was 23.9% representing a 50 basis point improvement over 2012 driven by the benefits from both, price appreciation and the shift to more move-up buyers. This improvement also includes about 40 basis points of pressure from our Darling business as we continue to purchase accounting.

As for financial services, Taylor Morrison Home Funding generated $30 million of revenue during the year on 2,828 closings with an average loan amount of $302,000, representing a 40% increase in volume and a 14% increase in loan value over the prior year quarter. TMHF’s gross profit was $14 million.

SG&A expense was $234 million or 10.3% of home closings revenue for the year which is flat compared to 2012. We were able to drive top line leverage; however this was partially offset by slightly higher operating expenses added through the Darling business model.

Equity income from our joint ventures increased to over $37 million for the year, as compared to $23 million in the prior year. The increase is primarily due to 433 closings in our joint venture high-rise towers. Our income before taxes was $98 million for the year, which is inclusive of the one-time charges related to the IPO and certain tax benefits. Income tax expense was $3 million for the year; this includes tax benefits of $90 million for the reversal of the tax indemnifications which was partially offset by a $9 million charge for deferred taxes on interest and federal benefit of state tax deductions related to the tax position. In addition, we recognized a tax benefit of $11 million due to the reversal of a portion of our valuation allowance on deferred taxes.

Turning to the balance sheet, we ended the quarter with $414 million of cash, including $25 million of restricted cash. Our net debt to cap ratio was 38% at year end and we had no barrowings under our $400 million unsecured revolving credit facility.

We ended the year with homebuilding inventories of $2.3 billion. We had 3,438 homes in inventory at the end of the year compared to 3,156 homes at the end of the prior year. Homes and inventory at year end consisted of 2,220 sold units, 275 model homes and 943 inventory units of which only 192 were finished.

Thanks, I’ll now turn the call back to Sheryl.

Sheryl Palmer

Thanks Dave. As we have just heard, we had an excellent quarter to end a very eventful year. Our business all starts at the individual market level. Homebuilding is a local business, and we are located in the market in the U.S. and Canada, with strong fundamental that support home ownership demand with expected employment and population growth. Within our adjoining [ph] footprint, we carefully select our strong market and community positioning to align with consumer demand. We believe that communities properly match to their intended audiences in core locations that are approximate to employment, good schools, and desirable services, will outperform at all phases of the cycle.

We have a number of exciting communities in a few of our different geographies that I would like to spend a moment highlighting. The first is Riverstone in Houston. After a successful presence in Telfair, one of the best master plan selling communities in Houston, we found the opportunity to acquire Riverstone. Selected to be Telfair’s replacement, Riverstone is located nearby and as the same prestige as Sugar Land [ph] as well as excellent accessibility and schools [ph].

In 2011, we purchased a 184 acres and developed more than 400 single-family lots with our three more exclusive Avalon product lines. In December 2012, we acquired the remaining undeveloped in Riverstone, 575 acres, or nearly 1,200 lots with the intent to continue our success in capturing the upscale family buyer and segment the community further by bringing additional product lines, as well as the Darling brand to increase overall community absorption.

In 2013, we sold over 290 homes between the three Avalon product line at base prices ranging from the mid 300 in our smallest product, and up to the high 500 for base prices in our large product offering. All of our Texas markets performed well through the fourth quarter with the ASP among some of the highest in our U.S. market, and we believe our positioning has created a unique competitive advantage.

And maybe our standing [ph] community, 37 degrees North in Sunnyvale, California is a legacy site well located in the Silicon Valley. The project was originally intended for our podium-style condo development. Our northern California team expertly re-planned the site, changed to a traditional town-home product with a total of 132 units that would align more with the needs of our home buyers and enable desired multi-generational family living. We began sales there in 2012. In 2013, we sold 60 homes and closed 77 with base prices starting in the 800 to 1,000 [ph]. This reposition allowed us to bring more successful product to market and to achieve well over 30% margins. We have less than 30 units left to sell there.

Although we saw a slight reduction in activity in California in late summer and early fall, we experienced strong traffic and sales through the fourth quarter and have seen a steady start in the New Year.

Getting to Florida, we are very excited about the variety of new communities coming to market this year and believe they offer us the ability to continue to differentiate ourselves as a builder of exceptional, well segmented lifestyle community. One such project The Overlook at Hamlin, just recently grand opened in the Orlando area, and offers four product lines on Lake Hancock. We purchased the initial 380 lot project in 2011 when few builders in the Orlando area were purchasing small draw [ph] position. The team negotiated to close after the parcel was fully entitled.

In early 2013, we expanded the position adding another 260 lots. The community opened for pre-sales in December and has sold 30 units through January. This centrally located community when fully developed will offer residents the opportunity to live the lake life in a master plan centered on a waterfront town center village which is accessible by both, boat and foot.

When we talk about Florida, it’s also worth mentioning the strength of our active adult business we have seen from [indiscernible] enabled. We have seen a strong presence from this buyer group as the season kicked off late last year. We built many different types of communities and these are just a few examples. We have dozens of other unique community opening set for this year that we believe will contribute to another successful year.

In order to position ourselves for the future, we spend $302 million in land purchases and development during the fourth quarter, and nearly $1 billion for all of 2013. As the market exhibit some headwinds this year, some builders pulled after land acquisition efforts, while we took the chance to be opportunistic and add quality land positions in key sub-markets.

For use of our proprietary tools and our rigorous underwriting processes, we evaluate the investment held at each of our markets and our intended consumer groups which have continued to differentiate us over the last five years. As I have already mentioned, we believe that the long-term fundamentals are still in place, even though there might be some choppiness from quarter-to-quarter.

The North American total landing as of December 31 was over 45,000 lot owned and controlled, excluding lots held and unconsolidated joint ventures which were predominantly help in Canada and Austin. For distribution of lots acquired in 2013 includes, 41% in Florida, 30% in Texas, 11% in California, 12% in Phoenix Arizona; 2% in Denver Colorado, and finally 4% in Canada single-family. The percentage of lots under control was 25%, almost 75% of the company lots owned. Our land bank had approximately 7.8 years of supply at December 31 based on trailing 12 months wholly owned closing.

As we look to 2014, we anticipate we will spend over $1 billion in land acquisition and development. Approximately one-third of that continues to be planned development spend. As Dave mentioned, we anticipate 2014 to be another year of leading community count growth with expected growth of 25% to 30% year-over-year. This is the combination of our land acquisition effort in recent years, as well as a testament to our local team’s ability to execute on the operation.

As I have mentioned in some of these examples, I am excited about the quality communities that are coming to market this year, and I believe we have the right team in place that has the expertise to get these assets ready to come to market. As we look further ahead to 2015 and beyond, we believe the business is well positioned, allowing us to be selective and opportunistic in reinvesting in our portfolio. We own or control most of what we need in order to execute in 2015, and are focusing primarily on 2016 and 2017. We believe the economy is still in recovery and need to ensure that we keep suitable lot in the right locations in front of the business in order to move future demand.

Let me wrap up my comments with a quick comment to my fellow Taylor Morrison team members. Although I want to start by sharing my genuine thanks for an incredible year, it’s more important to share my personal appreciation and gratitude in working with such a uniquely talented group of people. I am honored to be part of a team that has such genuine commitment and passion to each other and our customers. I look forward to a 2014 in which I Taylor Morrison is poised for continued success.

Thank you and we will now open the call to questions. Operator, please provide instructions to our callers.

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. (Operator Instructions). Our first question comes from Steven Eve. You may go ahead.

Unidentified Analyst

Thank you. Good morning and congratulations guys. Sheryl, you talked some about the trends and all of that, but could you talk a little bit more about what you saw as you move through the quarter, what we’re seeing now? And you touched a bit on the regional demand and active adult which – we’ve got a lot of interest in right now. So if you wouldn’t mind elaborating on that too.

Sheryl Palmer

Yes, hi Steven, you got it [ph]. As far as the quarter, fourth quarter, we saw the momentum pick up candidly each and every month, and then we saw that normal kind of slowdown, the first couple of weeks in January and then saw the momentum continue. So I would say it gave us the signal that they are pretty normalized market. As far as the active adult business that I mentioned, we have – we’ve added a number of active adult communities within the portfolio but most delighted with some of the positions in Florida, it was Florida where we really seen the resurgence of that active adult buyer come back and help you make success in those openings.

Unidentified Analyst

Okay. And then if we – just looking at that more, your gross margin, your SG&A, as we look out over 2014 you talked about it being flat. Is that due to lower capitalized interest following through or do you see it being able to have your underlying gross margin actually move up a bit, what I guess what’s going on there. And just how much do you think – you talked about little bit of SG&A leverage, how much do you all think is practical as you go through 2014 given that – if that significant community growth ahead of you?

David Cone

This is Dave. As far as the margin, really what we’re seeing is a lot of strength on the U.S. market. So, as we look at the backlog, I have visibility through – about the mid second quarter and we generally expect a U.S. accretion in the first half, which is coming off the strong point. As we move to the second half for the year, the comparison being tougher on the U.S. side, so that kind of facility to drive margin at that point will largely depend on the market but let’s kind of getting us through the flag [ph] at the 2013, that’s the comparison that we’re going to see in Canada throughout the year. As you know, we’re coming off some pretty high margins; especially I want to commensurate [ph] some at the first half of 2013. So as we move to spring selling season, last [indiscernible] the margins going forward and more so on the back half of the fall.

Sheryl Palmer

And then SG&A –

David Cone

Yes, the SG&A, we do run a lean structure, we are in a position that we think we’re going to be able to drive something under 10% relative – SG&A relative to our homebuilding revenue. We’ll probably be somewhere, maybe the high-rise has been through the year.

Unidentified Analyst

Okay, thanks. I appreciate that, if I can sneak in one last one. You had a great ASP move; I’m just trying to understand how much of that was mixed versus pricing power, and sort of how are you all thinking about it as you go into 2014?

David Cone

Yes, I think for the first half of that from – it’s more towards the price. At second half it’s been kind of 50-50 pricing mix. You get some pretty good price pick up, obviously in the first half of the year, and mostly in those closings now, so it’s definitely more towards the price than the move-up buyer.

Sheryl Palmer

Yes, as you move into 2014, we have a tendency [ph] to shift through that first and second move-up buyer. We still think we’re going to see some movement from the overall sales price through the organization, certainly we’re seeing it in U.S., I would tell you it’s probably a little closer to the last. But in total, we expect that to see it probably this year.

Unidentified Analyst

Okay, thanks a lot.

Sheryl Palmer

You bet, have a great day.

Operator

Our next question comes from Ivy Zelman. You may go ahead.

Unidentified Analyst

Hi, thank you. This is Ryan McKevin [ph] on for Ivy this morning. Congratulations on the quarter. First thing, in terms of absorptions, in the past you mentioned you’re expecting them to come down, given that mix shift to move up, plus the price increases. I guess with the fourth quarter absorption pace flat sequentially, would you say there is additional company specific initiatives to reduce that pace into next year or would you expect to see us now of your absorption to align more closely with the industry at this point?

Sheryl Palmer

You know Ryan [ph], the way we look at it, we don’t compare it to the industry or really even to prior performance; it’s really about the lineup of the deals as we underwrite them. So we don’t work to achieve a specific mix except to make sure that we achieve the underwriting expectations that we outline. As we have articulated in the past, when we continue to move up to that second time buyer, we generally aren’t seeing ourselves underwriting those deals at what I would consider – what you might be referring to as the industry average, it’s that two to two-and-a-half a month. So the absorptions are really – I mean, it’s quite different from where the company was a year ago which is why these low tunes [ph] is probably more in line as we look forward.

Unidentified Analyst

Okay, thank you. And, in terms of the community openings, obviously, there is some significant growth there. I was just wondering if you could provide some commentary around what you’re seeing with these new community openings and how these have performed to this point versus your expectations.

Sheryl Palmer

As I try to say in my prepared comments, I mean we’ve had some that have just opened in these last few weeks that even through the winter conditions that you normally wouldn’t talk about, but we’ve had some of those these past few weeks. We’ve actually seen nice success. So all the positions that we’ve brought to market we’re feeling really good about. The next – I would tell you Ryan [ph], probably eight to ten weeks, we have a number of new communities opening. But if indications based on early interest or some things we felt pretty strong about it [ph].

Unidentified Analyst

Thank you.

Sheryl Palmer

Thank you.

Operator

Our next question comes from Adam Rudiger. You may go ahead.

Adam Rudiger

Hi, sorry to ask the same question kind of twice, but just to make sure I understand if you are talking about an absorption pace closer to two that suggests a – first, I mean last when you were over three in the first two quarters. So, should we expect a decent slowdown continued into the first half?

Sheryl Palmer

Just to make sure that I – and if I misstated that, what I said is we underwrite community that can go anywhere from one in a half to four, to be honest. But what you’ve seen us settle in at is, somewhere closer to that two to two-and-a-half. So that really would be our expected absorption.

Adam Rudiger

And so you’re talking about some full year when you say that?

Sheryl Palmer

Yes.

Adam Rudiger

Okay. And then my second question is, in terms of Canada, can you offer any little more granularity on what you expect for intra-year orders and deliveries, just given what you have – what’s available and when you expect those towers, two of our own towers to close?

Sheryl Palmer

Yes, we can definitely walk you through the towers because as we look to 2014 we have three towers, they are all lining up in the fourth quarter.

Adam Rudiger

Okay.

Sheryl Palmer

We might see some of them start – no, actually we might start some deliveries in September but really those are going to be – generally at the fourth quarter.

Adam Rudiger

Okay. And how are you approaching new projects and trying to – given what you talked about little supply there?

Sheryl Palmer

The same way we always have, one deal at a time. We’ve – from a single-family detached perspective we continue to look at new opportunities, and same on the high-rise. So, you know, no different than we would in the U.S., I mean our very lands in straight markets. We have teams on the ground, and we have candidly JV partners that we work very closely with earning control, many opportunities that we look at, and we enter right then, and if they meet our overall expectations we go ahead and contract for them. I think the difference in what you see in our Canadian business from a land acquisition standpoint is the way we’re able to structure deals in Canada is very advantageous. We’re able to tie land up for quite sometime, work with land sellers on the entitlement process, and then get very attractive terms and how we take those lands down.

Adam Rudiger

Okay. Thank you for taking my questions.

Sheryl Palmer

Thank you, Adam.

Operator

Our next question comes from Michael Rehaut. You may go ahead.

Michael Rehaut

Thanks. Good morning, and congrats on the quarter.

David Cone

Thanks Michael.

Michael Rehaut

First question on – I thought that’s here, thought on that a little bit later. If you could just go through looking at the gross margin progression throughout the year, and as the – any impact from mix in the U.S. and how you expect that to change in 2014. I guess particularly what I am thinking about is, in a regional and versus product mix, if there is any difference there that maybe impacted particularly in the fourth quarter, and as we look into 2014?

David Cone

I think for 2013, by quarter we saw a nice steady progression on the U.S. side as far as margin accretion. We did – taking a little bit benefit from Canada in the first quarter which impacted that overall but then, we started out margin compression there. And as we look into 2014 and we still expect the strength of the U.S. margin, just as you get through some of the price appreciation that’s going to help – sorry, the price depreciation in 2013 is going to lend it throughout to 2014. And then from a region standpoint, it’s a little bit of a mix obviously where we saw the price appreciation and some of the greater spots – our last year might not repeat and solve this year. So that will continue to shift around a bit.

Sheryl Palmer

Yes, and I think the only other thing I would add to that because you’re right Dave, it was the overall mix issues. You also do have in some parts of the country like Texas, finished lots as part of our portfolio which intends not to be as higher as our business. So we really have to apply some [indiscernible] if you could imagine Michael.

Michael Rehaut

Of course. And then I guess, second question on pricing, trends in the market right now. If you could give us a sense of in the fourth quarter, perhaps what percent of communities in the U.S. were you able to raise prices versus third quarter? And how incentives have been trending in the back half for the year and into 2014 so far?

Sheryl Palmer

Yes, when we look at the fourth quarter, I would tell you that close to half of the communities across the organization had some sort of base increase. I think the difference in what you saw in the fourth quarter is that the quantum of that increase was very different than what we saw early in the year. And having said that, we had some communities that you could have raised price to $500, you could have some where you raised to $10,000, so a little bit of everything. From a discount standpoint, I would tell you that we continue to use discounts the way we always have. We see them on certain specs, challenging lots, close-out communities, but all in all, when I look at our discounts and then I look at our incentives, interestingly enough as I compare back to 2012, Q2 of 2012 was our highest incentive quarter, as a percentage of base revenue it was running about 10%. By the time we got to Q4 of 2013, that’s just about half, it was about 5.2% for the quarter, and you think about in ASP that’s up 20%, so both on a percentage basis and pure dollars, significantly down year-over-year.

Michael Rehaut

Okay. And, so just to – I appreciate that Sheryl, it’s very helpful. And just to get better perspective on that 5.2%, and half of the communities that you increased, could you give some type of sense of what that was in the third quarter?

Sheryl Palmer

The third quarter of 2013?

Michael Rehaut

Yes.

Sheryl Palmer

I can. No, it looks that up for you [ph] Michael, so we might need just a second.

Michael Rehaut

I cannot be the only one with applause when I was asking your question.

Sheryl Palmer

I appreciate that. Actually third quarter was just slightly higher, so it went from 5.6% to 5.2%.

Michael Rehaut

And is that on closings or orders?

Sheryl Palmer

That would be on closings as a percentage of base revenue.

Michael Rehaut

Thanks so much Sheryl. Best of luck in 2014.

Sheryl Palmer

Well, thanks. I appreciate that. You take care.

Operator

Our next question comes from Nishu Sood. You may go ahead.

Nishu Sood

Thanks. I wanted to ask first question about SG&A. Dave, you mentioned earlier, SG&A should dip below 10, I think you said in the high 9’s. That is already, a pretty impressive number, and especially in light of that kind of recessions you were having earlier, right absorptions, I want to understand what do you think normalized would be for that number? How much further it could go down and what the main leverage drivers are going to be in getting in to that?

David Cone

I don’t have a specific target. I would say that, each and every year we’re looking to just drive to leverage just across the business. You know just given our cost on a cost structure, we are pretty lean, so there is not a big weathers [ph] that we’re going to go out there and pull. But for us, I think as we approach each year making sure that we don’t overinvest, ramp up headcount unnecessarily, the folks that we bring on, we want to make sure that there is a purpose there and everyone has been fully affected. So, for – I guess the way I look at it, going beyond 2014 is – as the top line grows, and given our cost structure which is pretty much kind of a 50-50 mix between fixed and variable, we’re going to be able to continue to drive leverage.

Nishu Sood

Got it. So even from these levels you’ve been continue to experience the same sort of leverage yield you have in the last couple of years?

David Cone

Well, the magnitude is obviously going to decrease overtime, just given the dollars, but yes, I think that we’re going to be able to drive some form of accretion – sorry, some form of leverage as we move out.

Nishu Sood

Got it, great. And, on your closings guidance, so that will increase 15% to 20% in 2014, what kind of order growth or absorption pace are you assuming on that?

Sheryl Palmer

You know it’s kind of what I said before in the issue. I think as we look at 2014, and we look at our average sales rate, excuse me, I have used sales price, and the composition of the communities that we have underwritten, that have come in the market. We expect somewhere in that 2, 2.5 [ph] range.

Nishu Sood

Perfect. And one real last quick one, the JV balance on the balance sheet increased noticeably in the fourth quarter. What was driving that?

David Cone

It was a joint venture that we have in our off-scene [ph] market that – we actually had on our books at one point but given the changes around the terms of agreement that we have with our partner, we decided to reclassify the JV, so in that matter it doesn’t change the overall operations that was just more movement on the balance sheet.

Nishu Sood

Perfect, thanks.

Operator

Our next question comes from Dane Oppenhieve [ph]. You may go ahead.

Unidentified Analyst

Thanks very much. I was wondering if you could just talk a little bit more in terms of the expectations for margins in 2014. Were those comments in terms of the – as you look, a lot of those as pre-interest margins you’re reflecting and I talked about we have certain backlog right now based on pricing from 2013. Would you say that the current margins – and I guess it would be great to see if it’s pre-interest suppose there is a margins in backlog and where those would be relative to foresee margins?

David Cone

Yes, when I – this kind of stand was kind of pre-imposed – you know just where we are from a capitalized interest standpoint but more specifically on number without interest is kind of where we’re focused there. And relative to our backlog, our backlog margins are strong and that’s what’s given us confidence basically in the first half of 2014.

Unidentified Analyst

Then, in 2012 it was a significant year in terms of land activity, in terms of purchases and such, how much of that will start come through in 2014 versus beyond? And how do you think about the impact for land and margins for this year?

David Cone

We – 2012 or 2013 from our land –

Unidentified Analyst

Right, 2012 was pretty big in terms of land activity.

Sheryl Palmer

Yes, I meet some other big communities Dane than you’re seeing open in 2014, the space that we bought in 2012, recognizing that finished lots of a very small piece of the overall mix. So you are starting to see land – from 2012, come through and 2014 you are seeing some space that we bought last year early in the year that will get open this year. But generally, you’re seeing a lot of that stuff from 2011 and 2012, now make its way into the business.

Unidentified Analyst

Great, congratulations on 2013.

Sheryl Palmer

Thanks so much.

Operator

Our next question comes from Jay Mccanless. You may go ahead.

Jay Mccanless

Good morning, everyone. I wanted to ask again on the unit closing growth for 14% to 15% to 20%, does that include JV units? And can you walk me through kind of the thought process to get to that growth estimate?

David Cone

First, it does not include out of JV, this is just the ones that we have wholly owned.

Sheryl Palmer

And it was 15% to 20%, not 20%.

David Cone

Yes, 15% to 20% was our range.

Jay Mccanless

Okay, so that does not include the JV closings.

David Cone

Those don’t get reported in our metrics, that’s just the wholly owned.

Jay Mccanless

Okay. And then just secondly, I wanted to get a sense of pricing, growth and expectations for 2014 because if I understand what’s in the release correctly, gross margins are expecting to be flattish on a year-over-year basis because of the puts and takes versus Canada and the U.S. but you’re expecting the SG&A percentage to come down. So that what I would assume, I mean that pricing is going to move up pretty steadily. Can you talk about your expectations there?

Sheryl Palmer

Yes, like I said, I mean as we look at the mix of land that we’re bringing to market – in the U.S., we are expecting to see some price movement with a higher end product profile. And in Canada I would expect based on the mix we’re going to see a little bit of compression on the ASP. But all in all, in North America we still expect our closing average sales price to slightly go up.

David Cone

And if you think about 2013, we saw a price depreciation throughout the year. So as you go into 2014, we’re ending at a higher place than we were at the beginning of 2013. So we’re getting that benefit into 2014 as well.

Sheryl Palmer

And I think one last thing I would add to that too, following onto Dave’s point, is recognize that as you move into where we are now with so much in backlog, we do have pretty good visibility of that, average sales price and so you don’t have an entire year of unit to impact many price improvement because you have – we’re coming into the organized backlog.

Jay Mccanless

If I could sneak one more in, talking about the visibility in that backlog, what’s your average cycle time now? I mean, do you have six months of visibility, nine months of visibility, how is that trending?

Sheryl Palmer

That varies by division but I would say, on average we are in pretty good shape for our first quarter and we’re making good headway on our second, and you’ve had a little bit of – I mean, you’ve certainly got community in your third quarter but it really starts showing the length from there.

Jay Mccanless

Okay, thank you.

Sheryl Palmer

Thank you.

Operator

Our next question comes from Alex Barron. You may go ahead.

Alex Barron

Good morning, and great job on the quarter guys. I wanted to ask you with regards to incentives, I know you already talked about incentives for closings. Can you comment on the trend and incentives on orders for the last couple of quarters?

Sheryl Palmer

Yes, I can. I may not have the same level of visibility, and obviously those numbers because contracts continue to be updated with options and things. But I would tell you that we use incentives, like we always have, we tend to use them in closeout communities by staffing [ph], we tend to use them on challenged lots. But we are using incentives and I don’t have specifics with respect to what those percentages are at time of contract yet.

Alex Barron

Okay. And then I guess with regards to the towers you talked about, you expect that I believe you said three towers closed this year. Do you have any projects that are opening for sale that you can talk about this year?

Sheryl Palmer

We are looking at potentially going to market for sales on our high-rise tower, yes, that will be early this year.

Alex Barron

Okay, and then if we can focus on margins a little bit, I guess we’re rather in a unique situation that you have a lot of land that you incur before your IPO. And as compared to other guys who maybe have to buy land in more just in time basis, so would you expect your margins to – I guess be more, sustainable or ability to withstand this year? In other words, is the only limitation to your margins more the cost of materials rather than the cost of land, would you say that’s fair?

David Cone

Well, I’d go back. We actually didn’t compare bunch of land before the IPO. What actually happened is, through the acquisition in July of 2011 we marked our book to fair value, so in that case we did – in the U.S. we did bring some land value down, actually in Canada, our land values went up a little bit. So I think from a pricing perspective on our land our focus is pretty clean. But to your second point, the sustainability of it, we feel that obviously that’s going to be primarily market driven and what happens with costs as well. But we’ve actually had some higher margins, I think maybe relative to the peers that – with the last year or two, but we still think we’re going to produce some of that accretion there on the U.S.

Alex Barron

Okay, thanks a lot.

Operator

And we have no further questions at this time.

Sheryl Palmer

Well, thank you. I appreciate everyone joining us today. And wish you a wonderful day.

Operator

Thank you, ladies and gentlemen. This concludes today’s conference. Thank you for participating. You may now disconnect.

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