M.D.C. Holdings' (MDC) CEO Larry Mizel on Q2 2016 Results - Earnings Call Transcript

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

M.D.C. Holdings, Inc. (NYSE:MDC)

Q2 2016 Earnings Conference Call

August 03, 2016 12:30 PM ET

Executives

Kevin McCarty - VP, Finance and Corporate Controller

Larry Mizel - Chairman & CEO

Bob Martin - CFO

Analysts

Michael Rehaut - JPMorgan

Nishu Sood - Deutsche Bank

Ivy Zelman - Zelman & Associates

John Lovallo - Bank of America

Will Randow - Citigroup

Alex Barron - Housing Research Center

Operator

Good morning. My name is Mike and I’ll be your conference operator today. At this time I’d like to welcome everyone to the M.D.C. Holdings’ Second Quarter 2016 Earnings Call. [Operator Instructions]

I will now turn the call over to Kevin McCarty, Vice President of Finance and Corporate Controller. You may begin your conference.

Kevin McCarty

Thank you. Good morning, ladies and gentlemen and welcome to M.D.C. Holdings 2016 second quarter earnings conference call. On the call with me today I have Larry Mizel, Chairman and Chief Executive Officer and Bob Martin, Chief Financial Officer. [Operator Instructions] Please note that this conference is being recorded and will be available for replay. For information on how to access the replay, please visit our website at mdcholdings.com.

Before turning the call over to Larry, it should be noted that certain statements made during this conference call, including those related to M.D.C.’s business, financial condition, results of operation, cash flows, strategies and prospects and responses to questions may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements involve known and unknown risks, uncertainties and other factors that may cause the company’s actual results, performance or achievements to be materially different from the results, performance or achievements expressed or implied by the forward-looking statements. These and other factors that could impact the company’s actual performance are set forth in the company’s second quarter 2016 Form 10-Q, which is scheduled to be filed with the SEC today. It should also be noted that SEC Regulation G requires that certain information accompany the use of non-GAAP financial measures. Any information required by Regulation G is posted on our website with our webcast slides.

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

Larry Mizel

Thank you, good afternoon. I’m pleased to announce the 2016 second quarter net income of $26.9 million, a 35% improvement over the prior year. The biggest driver of our increased income was a 24% increase in wholesales revenues to more than $570 million. Our 2016 spring selling season ended on a strong note, we recorded our ninth consecutive quarterly year-over-year growth and net new orders and achieved our highest second quarter monthly sales space since 2005. We believe that this is strong evidence of the quality of our communities and the healthy demand in the market for new homes.

We’re focused on generating higher returns for the company. First, by continuing to improve the performance of assets we already on a key measure of the improvement we’re looking for are return on equity which improved the year-over-year for the second consecutive quarter. As we entered the second half of 2016, our continued emphasis will be on accelerating backlog conversion which is key to sustaining year-over-year improvements in revenues, income and returns.

With that in mind we’re keeping a very close eye on our production levels, especially in light of the strain we see in our subcontractor base which has caused both cycle times and labor costs to increase. Our success in accelerating production can be seen in the increase in our second quarter home starts which are up 29% from a year ago. After three consecutive quarters of significant year-over-year improvement in starts activity the total number of homes completed or under construction excluding models is more than 15% higher than a year ago. The double digit increase to our units in production gives us further confidence in our ability to generate significant year-over-year revenue growth in the back half of the year.

The vast majority of our starts in overall construction activity is dedicated to units already sold to customers. As a result the percentage of our work in process units attributable to our homes sold continues to move higher reaching 87% at the end of the quarter. Operating in this manner helped us to preserve our high quality balance sheet and allows us to operate more efficiently by dedicating more resources to converting sold inventory into revenue. With that revenues already increasing, we continue to invest new assets that will be a source of future growth. To that and during the second quarter we spent a 166 million on land acquisition and development activity, including the purchase of more than a 11,00 lots across our markets.

As a result, our total controlled lot supply exceeded 15,000 at the end of the quarter which should support our ongoing efforts in improving top and bottom-line results. We appreciate the efforts of our dedicated employees and subcontractors in making our second quarter a success.

I'll now turn the call over to Bob Martin for more specific financial highlights of our 2016 second quarter. Bob?

Bob Martin

Thanks, Larry. Our home sale revenues increased 24% from the prior year to 571.2 million. As a result of a 13% in closings, couple of the 10% increase in average selling price. In recent quarters, our revenue growth has been driven almost exclusively by increases in our average selling price. So, we're pleased to see that unit growth also is now contributing in a more meaningful way. Our second quarter backlog conversion rate was down year-over-year from 51% to 41%. But that decrease is narrower than what we saw in the first quarter.

The 41% is also a sequential improvement relative to our backlog conversion rate of 39% in the 2016 first quarter. Backlog conversion will continue to be a focus for us in the second half of the year with an emphasis of cycle times, home starts and overall production levels. Typically, looking at the last 10 years of data, we see our backlog conversion rate decrease sequentially from the second quarter to the third quarter. However, for 2016, we expect our third quarter conversion rate to be approximately 40%, roughly flat relative to the 41% from the second quarter.

At that level, we would almost be even with the 42% level we achieved in the third quarter of 2015. Our gross margin from home sales percentage decreased by 20 basis points year-over-year, mostly as a result of 1.6 million in inventory impairments. Excluding inventory and impairment and warranty adjustments, our gross margin experienced 10 basis point improvement to 16.7%. Relative to the first quarter, our Q2 2016 gross margin from home sales, excluding inventory impairments and warranty adjustments was down by about 40 basis points. This was due in large part of the mix.

For example, our mid-Atlantic states which have gross margins that are lower than the company overall, were 13% of closings in Q2 versus only 8% in Q1. It's important to know that even though our gross margin percentage is flat, the gross margin dollars we are making per home closed is up 56,00 or 8% due to the gains we have made in average selling price. We are pleased to see improved operating leverage for the quarter as our SG&A rate filled by 60 basis points from a 11.9% to a 11.3% due to a significant year-over-year increase in our home sales revenues that we discussed earlier.

Our total dollar SG&A expense increased for the quarter driven by a $5 million increase in general administrative expenses. As was the case in the first quarter, the second quarter increase resulted from higher average headcount and additional stock option expense. Marketing expense and commission's expense both increased for the quarter as well, and these increases were directly related to our revenue growth for the most part.

The dollar value of our orders increased 15% year-over-year to 723 million. The increase in dollar value was due to an 11% increase in sales combined with a 3% increase in our average order price to a 439,200. Our net new orders for the quarter was up a 11% over the prior year driven by a 10% increase in our monthly absorption rate to 3.3 per community. As Larry noted earlier, this represent our 9th consecutive quarter of year-over-year order growth and a high second quarter absorption rates since 2005.

In part, the improvement is due to our efforts throughout the spring selling season to focus for and achieving target levels of unit activity, with gross margin being a secondary concern. We believe the accelerated pace when coupled with improvements in our production activities give us the best opportunity to improve returns for the company. The average selling price of our orders improved a modest 3% from the same period in the prior years, somewhat of a slower rate than at recent quarters.

Our increased focus on more affordable product somewhat tempered the increase on average selling price of net new orders. Looking across the country, California, Nevada, Washington, Colorado were our top markets from an absorption rate perspective, which we think is indicative of solid demand in these markets. Our most improved market was Virginia which rebounded from a somewhat depressed level of new home sales activity in the second quarter of 2015. Nevada's absorption rate was significantly lower year-over-year due to the sell-out of some very popular communities last year. However, their absorption rate is still higher than our company average.

Our homes and backlog at the end of the second quarter was 35 up 35% year-over-year on a unit basis to 3445 homes with a value of 1.61 billion which was up 42% year-over-year. We expected backlog to drive significant year-over-year revenue growth for the balance of 2016. Our cancellation rate increased slightly from 19% to 21% year-over-year, at a percentage of beginning backlog, our cancellation rate was actually down 200 basis points year-over-year to 14%. Active subdivisions increased modestly year-over-year to a 159 at the end of the 2016 second quarter.

In Colorado, our active subdivision count was down by 28%. However, this was driven by the timing of opening new communities versus closing out older communities and we expect our Colorado community count to rebound during the second half of 2016. The decrease in Colorado was offset by Nevada where active subdivision count has doubled in the past year. For the second quarter we acquired 1123 lots for a $107 million, an increase from the same quarter a year ago and sequentially from the first quarter of 2016.

The current quarter activity occurred mostly in California, Colorado and Arizona. We spent additional 59 million on development expenditures brining our total spend for the quarter to a $166 million. At the end of the quarter, we owner controlled 15,146 lots, which represented about a 3.3 year supply on a trailing 12 month delivery basis and a 3% increase from a year ago. We believe that this supplies a strong starting point as we look forward to the growth potential of our company in 2017.

The on lots were already control, we continue to see a healthy pipeline land deals across our market. We are pleased to report that our key production matrix have improved considerably year-over-year giving us confidence they can drive higher home deliveries in the back half of 2016. Our second quarter home starts were up 29%, marking the 3rd consecutive quarter of year-over-year increases in our home starts. Our homes completed or under construction excluding models at the end of the quarter increased 17% from the same period in the prior year. This increase is important as to make up a big part of what we can close for the remainder of the year.

In addition, consistent with our bills order strategy, 87% of the working process units you see here at the end of the second quarter already sold, compared to 72% a year ago. We believe the higher percentage sold increases the likelihood of closing these in process units by the end of the year. Additionally, we believe the high percentage sold also speaks the quality of our balance sheet, with winded speculation and unsold units. Bottom line improved product activity complementing our increase backlog at the end of second quarter we have set the stage for top and bottom line growth during the second half of 2016 with mindset focused on improving overall company returns. That concludes our prepared remarks.

At this time we would like to open up the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question is from Michael Rehaut from JPMorgan.

Michael Rehaut

Thanks. Good morning everyone and nice job on the quarter. First question I had was just on community count. Bob I think you mentioned that you expect some growth in the back half and I was just trying to get a sense of the degree of magnitude there if obviously ended the quarter a little lower than you began. So we expect to see that number get into the back end to 160s or even better than that?

Bob Martin

Yes that sequential decline you are talking about was almost on Colorado was down 12 sub-divisions sequentially. On our prior earnings call and the Q1 we had commented that we didn't expect much growth from there to the end of the year that’s we are 169 active communities. So, I still think that’s probably a pretty good ceiling for us for the year with additional Colorado communities coming back online, we have got a potential to get there. Of course it's all depended upon what the sales activity is over the next few quarters and how smooth the openings go.

Michael Rehaut

Great. Now that’s helpful and I guess just and also on the nice improvement in sales pace, if you look at the year ago comps 3Q and 4Q at least get a little bit tougher in terms of that you had some nice improvement there in the back half of 15 over 14, so I was just curious if you think this roughly 10% improvement in average sales pace is sustainable on year-over-year basis going forward or perhaps should that moderate a little bit?

Bob Martin

It's a good question and the sales activity we have to take on a month-to-month basis. But right now I think the activity that we saw in the second quarter there is nothing there to indicate that it was slowing down. In fact, looking at June that actually had the biggest year-over-year increase of three months in the second quarter, so I don't have the indication of that Mike.

Michael Rehaut

So you say June having the biggest increase you are referring to sales pace specifically?

Bob Martin

Just year-over-year improvement the level year-over-year improvement.

Michael Rehaut

Right. In sales pace so.

Bob Martin

In overall sales. But, you are active that division counts and absolutely going to vary a whole lot month-to-month.

Michael Rehaut

Right, okay, great, thanks so much for the help.

Larry Mizel

Sure thing.

Operator

The next question is from Nishu Sood from Deutsche Bank.

Nishu Sood

Thank you. I wanted to ask about, Larry the kind of strategic tilt that you mentioned in your opening comments the increase in the units that are under-construction obviously 80% of those I believe are already sold with a aim to improve your deliveries and your turnover ratios which is obviously depth in the last year. What are your targets there? I imagine you are thinking about getting the back to some sort of historic norms what period would you consider historic norms and I am just thinking along the lines of when you are working on your specs you gave us a great color about where you are trying to get those to that seems to be a wrapped up. I am just trying to get some sense of how long this process is going to be and what you would aim for in terms of getting back to norms?

Larry Mizel

I consider where we are today being really good and it's very competitive world out there. And you have to work really, really hard to have the level of performance that we are currently experiencing. I don't think our world has expected norms from prior history as we listen to things that are happening every day. It's certainly challenging and I don't have a recollection of worldwide negative interest rates and we are fortunate that we are in this country and we are in home building and so we are in there good industry with solid demand and my expectations are to continue to perform in the way we are as you comment on 87% of our width is pre-sales. It's a reinforcement of our balance sheet discipline as you know we don't speculate in the land we have a nominal amount of unsold inventory. The land we own is all active. Many of the assets that we own are already fully developed as you can see the options are almost 15% so what we have done is continued what you can expect us to do over the last decades and the last decades shows us we are a conservative builder that pays attention to basic business and we are proud of what we have achieved and we expect to subject to market conditions and the economy to have reasonable improvement in light of all the circumstances that all of us deal with daily.

Nishu Sood

Got it. I mean I guess just looking at some of the number the 2900 of your work in process units that are under-construction 87% are sold which means that you have got about three quarters of your ending backlog under-construction. So what’s going to give you the sense I mean is that how you are thinking about I imagine since you presented those stats that’s probably important part of your thinking but if three quarters of your backlog under-construction would you want that to go higher or how are you going to judge the success of this initiative Larry?

Larry Mizel

I think the success is always deals with market conditions. The current market conditions would lead one to believe that there is future growth in the top and the bottom line and we are focused on as we commented earlier increasing ROE and so you take an aggregate all the elements that create profitability and as you know we deal with each and every one of them and I believe that we have a management team that is very, very good and seasoned whereas you look at each of the markets that we are we are in some very attractive markets for not only the present but the future. So our desire to expand our footprint in the market we currently serve Bob didn't have a chance to mention but someone I am sure will ask about our new affordable efforts on the seasons we are rolling out and we will accelerate the roll out of a more affordable product which I believe that there will be an opportunity for reasonable expansion because of hitting an affordable number which of course is -- differs in each market.

So we are focused on the basic business. We are focused on the balance sheet and we are focused on growth and the growth we see is in our current markets with a more affordable product and those of you that are familiar with our product I encourage you to come see it. It's really, really good. And it's special because it's an attractive unit at reasonable pricing in the size in each market the pricing is different but our focus is on growth and I feel comfortable that subject to the volatility of the world we live in housing as an industry seems to be solid. There is the recent statistics that new home starts are running at a low level compared to higher levels in the past at about 0.57% of the US population and that means that there is substantial opportunity for expanding the housing market vis-à-vis our total population in our country and this is an opportunity not only for us but for the entire industry.

Nishu Sood

Got it. Thanks. Appreciate the thoughts.

Operator

And your next question is from Ivy Zelman from Zelman & Associates.

Ivy Zelman

Good afternoon. Good job guys. Congratulations. Larry, you just mentioned I was going to ask you about on the entry level seasons brand and the strategic decision to accelerate that product offering with that significant deficit for this country with a lack of affordable product. Maybe that explains your land spending up 25% year-over-year where most of the builders are maintaining a pretty steady pace of land buying. So maybe help us if that is the case and then also how do you overcome the impairments that others are complaining about with respect to generating enough of a return on dirt four and affordable price point because the things impact these another costs set. It seems to deter other from making that strategic decision. And I have a follow-up but sure that was a lot. But thank you.

Larry Mizel

It sounds like four question in the follow-up, so I will try to answer a couple of them and then maybe Bob will talk a little bit more on the product but our land spend is consistent with what we have done as a basic business and that is, our goal is approximately a three year supply of land and we have done that for decades because we believe that’s a risk factor and the balance sheet when people speculate in land and we don't do that. The issues of cost there is a good side and the bad side of cost.

The good side it lends for higher employment in the industry. It would not surprise me that in the entire country that almost every major builder or even minor builder had used 20% more labor and that's both a problem and opportunity. It's an opportunity for the country and it's not really a problem. It's what you manage to do. I would rather have stronger demand and be looking for expanding our subcontractor base than having less work and having to have not the issues of the land spend will over future periods reflect our desire and our intent to increase the work we are doing. The other builders that you have commented on and I am not familiar with which ones you are speaking about contraction and gross profit because of land cost I think you can go back to the last cycle and one of the things MDC demonstrated is that we were able to make a reasonable gross profit at that time without speculating in land and we made our profit by building and installing homes not speculating in land and so the market that we were in now we believe that there is a reasonable balance between cost and expected market value of your inventory and with good management you should be able to develop a reasonable rate of return for your shareholders which of course is what we focus on is creating value for our shareholders. Now Bob maybe you - Bob will answer your follow-up questions since I answered the three about the seasons to give idea everyone on the call a little more color of what it is and where we have done it and our expectations in it.

Bob Martin

Yes, I will comment on a couple of areas. First of all, the land spend that's been coming through this quarter it's not necessarily the more affordable stuff. It reflects anti-approvals that perhaps the management approval from the few quarters ago, but I think we are seeing increasingly that what we are approving are those more affordable deals and that will contribute more significantly land spend in future periods.

As for the just the season products itself that's one way that we are addressing affordability, first of all the incidents of sales of that product went from about 1.5% of our sales to 3% of our sales from Q1 to Q2. So still a very small part of what we are doing but it's starting to grow pretty quickly for us. Initially, we have built that product on sub-divisions that we already had in place, land that we already owned as a complement to product that we already had there. And Ivy asked, how do we combat increased cost the fees that are associated with some of these areas that are obviously bigger piece of the pie we are talking about more affordable product. And I think really it's being innovative about what we are doing Colorado is really our biggest market for seasons right now. And we did something that most builders don't do and we didn't build the basement in this product. Most homes in Colorado have the basement we said what in order to drive the affordability we think maybe there is first time consumer can do without and we think that still hits the mark. So it will take out quite a bit of cost by doing some of those things that maybe aren't the norm in the given market and drive affordability that way despite some of the other cost that become a bigger percentage of our overall costs. So I hope that helps a little bit as well.

Ivy Zelman

Absolutely. If I can take one more I know I asked a lot but if you had a vision in two to three years what percent of your business do you think would be the entry levels seasons brand and then I don't believe you said you have commented on market comment there with the various divisions. Can you give us some of your best performers within footprint versus what might be the weaker links if any please?

Larry Mizel

Right. So, in terms of how we look forward whether it's season or other more affordable product we have seen that our first time buyer the percentage for overall buyer kind of true entry level buyers has decreased to roughly 20% of our overall closing. I think overtime if you look in our history that piece of our overall pie has been closer to 14% type of number. So I think that's really the order of magnitude that we are thinking about provided that we do see the consumer continue to come back in a significant way. Ivy, that's how I would answer to that one.

With regard to market commentary the stronger markets that we have seen Colorado is certainly up there. It's our home market but it continues to perform very well for us. Observation rate higher in the company overall and I think the same can be said for Washington and then California is our highest observing market right now. I think it's fixed to just overall how lower the level production goes on in California relative to the rest of the market but also the fact that we have stayed relatively affordable I would say in that market and I think that has struck a pretty decent quarter in that market. And the other one I want to highlight is Las Vegas we have a very strong operation out there and even though we did see the observation rate come down little bit year-over-year in Las Vegas it consistently performed above the company average for observation rate perspective.

On the other end of the spectrum the one that I would say is on the lower end performance would our mid Atlantic market both Virginia and Maryland. I say with caveat it's one of our lower performers but performance has improved over the last year I think at this point last year it really seemed pretty depressed for us. It's up year-over-year. But I don't think we are out of that yet, we are focusing on that market constantly and of course we are mindful that we are in a political season here and that probably doesn't help things in the greater D.C. area.

Ivy Zelman

That was great, thank you, good luck.

Larry Mizel

Thanks.

Operator

The next question is from John Lovallo from Bank of America.

John Lovallo

Hi guys thanks for taking my call as well. The first question is Bob the first quarter call I think it indicated that the 2Q backlog gross margin was above 17.1 and we came in a little bit later than that in the quarter. Can you maybe talk about some of the puts and takes there and then also how you are thinking about the gross margin in the third quarter?

Bob Martin

Yes. We have talked a lot about it in the past and as you have heard from some of the comments that we had in the call we are de-emphasizing gross margin a little bit. If you look at gross margin before things like compartments and warranty adjustments, over the past five quarters it's been relatively stable. There is I think have been only 70 basis point difference separating the high and low and while I think there is room for improvement gross margin over time for the short term, my outlook would be for really just continued stability. So I don't think there is anything significant to report on that front.

With competitive land market and limited subcontractor availability driving our cost higher achieving margin expansion isn't uphill battle. We have been able to offset the higher cost by raising prices where sales will justifies it, but there is not a guarantee that we can continue raising prices in the future. So for now we are really focused on hitting our internal goals for unit volume and that's why if you heard us talk a lot about on this call about the drivers for unit volume observation rates, backlog conversion, production levels, cycle times. That focus on volume is really what gives us the best opportunity to improve our returns which is as Larry noted earlier have already moved higher alongside our revenue gains in the second quarter.

John Lovallo

Okay. I guess the second question would be in terms of the labor markets and also perhaps in terms of entitlement in general have you seen delays for labor have you seen further tightening sequentially and then I guess in terms of entitlements have you seen delays in further delays in any areas that are noteworthy?

Bob Martin

I would say there is not a whole lot of difference sequentially. Maybe still a little bit more in Denver but if you look at our cycle time overall sequentially it was stable from Q1 to Q2 so I think that's actually encouraging.

John Lovallo

And how about for the entitlement in general?

Bob Martin

I mean there is not a whole lot we do on the entitlement probably we don't take the time risk on balance sheet. So it's not as big of a concern for us but we are more kind of here out there in the market from people who are doing entitlement work for us I don't - nothing sticks out to me. It's always seems like it's the matter of the cities and just how busy individual jurisdictions might be in getting that processed.

John Lovallo

Okay. Thank you.

Operator

The next question is from Will Randow from Citigroup.

Will Randow

Hi guys and thanks for taking my questions.

Larry Mizel

Sure.

Will Randow

Like I said in terms of talking about the balance sheet with the step up in land investment as well as class close how are you thinking about leverage over the next year or two particularly with the balance of you guys have done a great job returning capital to shareholders for the dividend but you also have to fund that as well as land. So can you kind of talk about capital allocation and how should we think about cash flow from operations over the next year or two?

Bob Martin

I think it's been - it's pretty consistent and in line with what we are experiencing. It's we are able to find opportunities as you have seen by looking at our balance sheet. We have substantial liquidity. We have substantial unused line of credit. And we are always opportunistic and you should assume that whatever is good reasonable business judgment we will continue to execute on and that should give you the comfort of knowing that we are always looking to the future and judging the present.

Will Randow

And on related follow-up in terms of SG&A you guys have done a nice job particularly on marketing expenses leveraging those if you will. How much lower do you think you can run SG&A over the next year or two or how much leverage do you get until you kind of get the steady pace?

Bob Martin

Right. I think that you got fixed and variable and I think our fixed has likes to expand on the fixed and you will be able to leverage into hopefully continued reduction in that number at least in the short term we can see and the ability in gross revenue increase other than the variable expenses the fixed should be kind of constant and that's a reasonable opportunity to look at.

Will Randow

Thanks again guys, and congrats on the progress.

Larry Mizel

Thanks, Will.

Operator

The next question is from Alex Barron from Housing Research Center.

Alex Barron

Hi, good afternoon guys and good job on the quarter. I wanted to focus a little bit on the Colorado market. So, I understand you said you expect to see more community openings in the back half. I was hoping you can elaborate whether that is 3rd quarter or more weighted towards 4th quarter. And also last year in the back half of last year, the orders kind of dropped off a bit and I'm wondering if you guy are expecting to see a rebound in the back half relative to what we saw last year.

Larry Mizel

Yes, I guess, first of all I got I think you could see some increase in the third quarter for Colorado. There is a lot of subdivisions that we have. Some of them have already opened, some of them are on the verge of opening. So, a little of it depends on just the timing of when those occur and how much initial bossy that we get. So, I think there is a chance for it in Q3 but give us ourselves a little bit extra room, we've just really talked about the second half of the year.

As far as the orders go, as I noted with an earlier caller, we didn’t see any reason why we -- we didn’t see anything within the quarter I should say that would indicate that things were slowing from a year-over-year perspective and that that month of June was actually up a little bit more year-over-year than the other two months. So, we actually saw a little bit of acceleration throughout the quarter when you're talking about the year-over-year comparatives.

Alex Barron

Okay. I guess as it pertains to your comments on backlog conversion and your strategy of launching this new communities, particularly in Colorado. Are you guys going to be spec building some more those entry level houses as a way to try to improve the backlog conversion as it pertains to Colorado?

Larry Mizel

No, I think in and of itself just that product is much better from a cycle time perspective. Just early fairly on the project that we’ve built. We've built might be a three to four months cycle time versus overall for the Denver market. You're closer to a nine or 10 month cycle time. So, just by virtue of the fact is you can build it like we don’t feel the pressure to necessarily spec builded. And that's even beyond just our overall feelings about the spec building strategy.

Alex Barron

Okay. And if I could ask one last one, Bob, as it pertains to interest in cost of goods sold. I believe your interest incurred is running roughly at 13 million a quarter. So, should we expect that the interest in cost of goods sold is going to decrease or flatten out in terms of dollars and decrease as a percentage of revenues going forward?

Bob Martin

Yes. I think the more we're able to achieve higher unit volumes, higher absorption rates, that's one of the side effects, one of the very good side effects that occurring, as you could actually have some improvements to your merchant by virtue of better leveraging net interest, better leveraging construction overhead. So, I think that's a possibility to the extent that we continue to see pace expansion as well as revenue expansion.

Alex Barron

Okay. Thanks a lot.

Operator

[Operator Instructions] The next question is from Ken Zener from KeyBanc

Unidentified Analyst

Hi, good morning everyone. This is Adam on for Ken. First, we're looking at your three regions just in the context of relatively flat gross margins year-over-year. I was just wondering if you could provide an outlook for regional margins versus what we say last year. And second, I noticed that community is doing quite a bit in the East, we're more stagnant in the West and down quite a bit. In mountain, as you said due to Colorado, both the latter two most dear most profitable regions. Is this sort of a shift in regional strategy and or you guys thinking you can maybe unlock some profit potential of East and perhaps West out West, or is it just a result of community portfolio shifting around in the quarter? Thank you.

Bob Martin

Yes. So, I guess first of all, with a word to regional margins, we don’t provide a whole lot of color there. So, I don’t want to get a whole lot into the regional margin texture. But with regard to as allocation community allocation, yes, I think you did see a little bit more of an increase in the East. I think it's just really a function of last year. We're still trying to get a lot of communities going in the East, and they finally came to fruition and resulted in net increase count. And you're seeing a similar thing here in Colorado now, as I already commented, came down a little bit because some of the communities are just not coming online and haven’t reached that our magic number for active subdivisions which if five sales to be active.

And so, it's not indicative of a shift in strategy when you talk about the shift between East and mountains, I guess mountain's East in this case.

Unidentified Analyst

Thanks. So, when we kind of expect the kind of the closing mix to stay roughly the same between the regions? Let's say just as here.

Bob Martin

Yes. I don’t think there's any huge shifts that would lead you one way or the other. You can certainly kind of look at backlog and see how that's shifted. And I don’t think there's anything that necessarily drives me one way or the other when I look at backlog and the direction backlogs gone over the last year on a market-by-market basis. So, relatively consistent going forward, the only thing I will say is Maryland did pump up just a little bit here sequentially, went from 8% to 13% of closings. You might see that moderate a little bit, come down just a little bit.

Unidentified Analyst

Okay. Thanks, guys.

Operator

There are no further questions at this time. I will turn the call back over to the presenters.

Larry Mizel

Hi. We appreciate everyone joining us on the call today. And we look forward to talking with you again after we disclose the results of our third quarter.

Operator

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

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