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Ryland Group, Inc. (NYSE:RYL)

Q3 2012 Earnings Conference Call

October 25, 2012 12:00 p.m. ET

Executives

Drew MacKintosh – VP of Investors Relations

Larry Nicholson – CEO

Gordon Milne – EVP & CFO

Dave Fristoe – SVP & Controller

Analysts

Rob Hanson – Deutsche Bank

Ivy Zelman – Zelman & Associates

Stephen East – ICI Group

Will Longhorn – JP Morgan

Stephen King - Barclays

Kenneth Zener – KeyBanc

Dan Oppenheim – Credit Suisse

David Goldberg – UBS

Megan McGrath

Alex Barron – Housing Research

Joel Locker – FBN Securities

Joshua Pollard – Goldman Sachs

Buck Horne – Raymond James

Operator

Good day, ladies and gentlemen and welcome to the Ryland Group Third Quarter Earnings Conference Call. (Operator Instructions) Later, we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions) As a reminder, this conference call is being recorded.

I would now like to turn the conference over to your host, Mr. Drew MacKintosh. You may begin.

Drew MacKintosh

Good morning and welcome to Ryland’s third quarter 2012 earnings 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 conference call to Larry Nicholson, Ryland’s Chief Executive Officer. Also joining us today are 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 economic, 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 will now turn it over to Larry Nicholson.

Larry Nicholson

Thanks, Drew. Good morning and thank you for joining us today. The third quarter of 2012 provided further evidence that we are seeing a recovery in housing. Sales trends bucked the usual seasonal pattern of a second half slowdown as absorption rates in many cities came in equal to or better than the sales rates in the first half of the year. Home prices continued their ascent as the combination of price increases, reduced incentives and product mix led to our highest average closing price in five years. Margins expanded, demonstrating the significant operating leverage that occurs when activity levels and revenues improve. Given the increase in sales activity, our industry is finally enjoying the benefits of demand driven by new household formation, population growth and the elimination of existing housing stock.

We believe that many families who deferred the decision to purchase a home for several years are starting to move out of their rental units and look to buy a new home. In many markets owning a home has a reduced cost when compared to renting. Given the passage of time, previous of homeowners who had been kept out of the market due to credit issues are eligible for a mortgage again. These factors together with pent-up demand resulting from an unprecedented downturn in housing are driving a resurgence in the housing industry today.

As evidenced by our results for the third quarter, Ryland is taking full advantage of the upturn in home sales activity. The company posted growth rates in excess of the broader market thanks to the strategic repositioning of our communities to better locations in the markets where we build. More importantly, we managed this growth while posting our best performing operating margins in over five years. We are extremely pleased with our results this quarter and are again more excited about posting our first profitable year since 2006. If the current trends and demand for new housing continue, we will return to the performance demonstrated in the past that makes us a leader in the homebuilding industry.

With that, let me share some of the details from the quarter. Net income from continuing operations totaled $10.4 million or $0.21 per diluted share. Excluding early retirement of debt cost of $9.1 million and write-offs of $3.5 million, the company’s net income was $23.1 million or $0.45 per diluted share. Net home sales for the quarter came in at 1,500, a 56% increase over last year. Our West region once again posted year-over-year order growth in excess of 100%. Thanks to an absorption pace well above the company average and strong community count growth. Our division in Las Vegas, Denver and Southern California capitalized on the pickup in demand by periodically raising prices in several communities throughout the quarter, resulting in significant margin expansion.

The South region’s sales grew by 99%, aided by the acquisition of Timberstone Homes and a healthy improvement in absorptions. Each of our divisions in the South region had better sales and higher margins than a year-ago period, with particularly strong results coming out of Tampa and Orlando.

The North region garnered 21% more sales than last year and was our most profitable region excluding the write-off thanks to strong contributions from Indianapolis and the Twin Cities. The Texas region sold 12% more homes than a year-ago period and continued to be a steady contributor of both volume and profits.

We ended the quarter with 2,465 homes in backlog, 58% more than last year. On a dollar basis, backlog increased 61% thanks to a 5% increase in average price. The cancellation rate remained flat at 20% of gross sales.

Revenues from our Home Building segment came in at $249 million, a 45% increase over the third quarter of 2011. This significant jump in revenues was driven by a 37% increase in closings and a 5% improvement in the average closing price. Better absorptions in a number of our communities led to steady price increases throughout the quarter. Sales incentives and price concessions as a percent of sales totaled 9% compared to 11% in the third quarter of 2011.

In addition, we experienced fewer instances of appraisal issues that previously limited our ability to push pricing during the period. These factors along with our ability to better leverage the fixed cost portion of our cost-to-sales resulted in average home building growth margins, excluding charges of 20%, which was 220 basis points higher than the year ago period and 130 basis points better than the second quarter of 2012.

We did experience some cost increases with respect to labor and materials in a number of regions and expect these pressures to persist as activity levels accelerate. However, we feel confident that we can stay ahead of these increases by locking in long-term contracts when possible, periodically rebidding work to ensure that we’re getting the most competitive price available and passing through price increases in communities where demand allows.

While the increases in volume had a big impact on our gross margins, it had an even greater impact on our SG&A as a percentage of revenue, which came in at 13.8%, representing a 460-point basis improvement over last year. The incremental cost associated with opening and staffing the new communities we brought online in the quarter were minimal compared to the incremental revenue we generated. Excluding commissions to fix portion of our home building SG&A expenses were essentially flat with year-ago period.

Turning now to the balance sheet, we ended the quarter with $800 million in cash, $1.1 billion in debt and $472 million in equity for net debt-to-capital ratio of 41%. In July, we redeemed the remaining $167 million outstanding our 6.875% senior notes due in 2013. Two months later, we issued $250 million of senior notes due 2022 with a coupon of 5.375%. And that affect of these two transaction resulted in a weighted average cost of debt below 5.7% and an average weighted debt maturity profile of six and a half years. We now have ample liquidity to meet all of our working capital needs for the next couple of years while continuing to pursue the growth initiatives that drive our strategy for the future. Our next maturity comes due in 2015 and has a remaining outstanding principal of only $126 million.

We spent $82 million on land acquisition and $36 million on site development in the quarter bringing our year-to-date aggregate land spend total to $286 million. Our lot count at the end of the period was $26,307, a 20% increase over last year with a breakdown of 16,350 own lots and 9,957 option. Thanks to our aggressive land acquisition over the last few quarters, almost all of our divisions control the land needed to hit their 2013 sales targets and many have a head start on 2014.

Community count grew 11% year-over-year to 235 active communities as we closed out of 22 projects and opened 48 during the quarter. Next quarter we expect to add another 10 communities, thereby ending the year with an active count of 245 communities. Looking into 2013 based on our forecast for project opening, we feel confident that, again, we will grow our community count. However, the magnitude of the growth will largely be a function of the sales pace, which will determine whether or not we close out projects sooner than expected.

Our Financial Services segment recorded a pre-tax gain of $3.4 million in the quarter compared to $2 million in the year-ago period. Increase in our loan lot pipeline and mortgage origination volumes were the two main drivers of the higher profits. Of the buyers that secured a loan through our mortgage company, 50% used a prime loan, 47% opted for a government loan and the remaining 3% qualified for a USDA. loan. Average FICO score was 730, and the average loan to value was 90%.

In summary, I’m extremely pleased with how we executed in the quarter. We posted year-over-year growth rate in excess of 35% for sales, closings and backlog. We expanded gross margins through the combination of price increases, incentive reductions and tight cost controls. We grew our community count by 11% and ended the period with 22% more lots under control than we had at the beginning of the year. We improved on an already solid balance sheet by replacing a near term maturity with a new issue with a lower coupon and longer maturity. We were very appreciative for the results of a highly successful quarter, and we’ll seek to maintain this growth and performance in the future quarters as we strategically grow our business.

Finally, and most importantly, I want to thank all of our employees for all their hard work this quarter. You have performed exceptionally well during this time of remarkable growth in construction delays, cost overruns and supply chain breakdowns are all too common. I’m truly grateful for your dedicated efforts. That concludes our prepared remarks, and we’ll be happy to take your questions. Thank you.

Mimi, I think we’re ready for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question comes from Nishu Sood of Deutsche Bank. Your line is open.

Rob Hanson – Deutsche Bank

Thanks. This is Rob Hanson. I’m for Nishu. I just wanted to kind of clarify, your orders include 141 from the backlog of Timberstone. And then how many order during the quarter did Timberstone give you guys this quarter? And also what was the impact on closings this quarter from Timberstone as well?

Gordon Milne

Yeah. Let me cover the question about units. We had in Charlotte – we’re including them together because our Charlotte operation before Timberstone wasn’t that large. But in total we had 227 sales in Charlotte; Raleigh this quarter, 141. If you take that away, we had 86 sales during the quarter. So maybe, Larry, want to comment on the number?

Larry Nicholson

Yeah. I think the good sign out of that is, is we made some decisions when we closed that operation to slow down a couple of communities and then made some exchanges in product for a couple of reason. One is, is some of the product that was being built in this community is we didn’t have the right to use. Secondly, a lot of it didn’t meet the energy guidelines of the houses we’re building today, so we had to put in some new product in a lot of those. So basically I would say a lot of those sales units got closed down for a month or two. But I think the good thing is it indicates that the rest of the market’s extremely strong.

Gordon Milne

As far as closings go, Charlotte and Raleigh were only 7% of our total for the quarter so it didn’t have a very big impact on closing for the quarter. The good news was we made money in Charlotte in the quarter. The gross margins for the new units were about the same as our existing units. And obviously it helped in the SG&A part by having more closings in a market for us. So again, I think we’re very happy with it. And in sales now that we’ve got the new models opened, things changed around, sales in Charlotte are picking up.

Rob Hanson – Deutsche Bank

Okay. And then on your gross margins, you’ve kind of hit the important 20% level. I guess I wanted to see if there was any upside from here and where would it come from? Would it come from mostly the lower capitalized interest? And with some of the debt refinancing it seems like maybe that would come down a little bit.

Gordon Milne

Well, that takes a while for lower interest costs to come through the income statement. But I think in the near-term, hopefully it’s pushing prices. Prices hopefully can go up faster than cost. But it’ll take time to work its way through all these things. I mean we did have a good month this quarter; very pleased with it.

Rob Hanson – Deutsche Bank

All right. Thank you, guys.

Operator

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

Ivy Zelman – Zelman & Associates

Good afternoon. Great quarter, guys.

Larry Nicholson

Thank you.

Ivy Zelman – Zelman & Associates

Larry, you talked about your law position and your increase in land spend. And maybe just to clarify, you talked about the breakdown between owned and option. Maybe you could just talk about what’s finished versus roughly what’s partially developed. And then of that, what percent is mothballed? And then I have a follow-up.

Larry Nicholson

Well, what I would tell you is we have a very small percentage of our lots mothballed today. Dave’s looking for the number but, you know, what we’ve seen Ivy is we’ve seen good activity on the sales side. We had a land meeting a week ago. It was our biggest land meeting of the year so far. We continue to find opportunities for option deals. I know everybody’s saying there’s not a lot of option deals, but we’ve continued to find them. Beyond the option deals, it’s the full array of partially developed to totally undeveloped, and we’re just evaluation those on case-by-case basis.

Ivy Zelman – Zelman & Associates

No, no, no. I’m sorry, Larry. I wasn’t talking about your incremental land send. I’m saying in total, for your total lots you have on the balance sheet, what percent is finished versus...

Larry Nicholson

Oh, about 65% is finished.

Ivy Zelman – Zelman & Associates

Okay.

Larry Nicholson

I’m sorry, Ivy, but mothball’s about 57 million.

Ivy Zelman – Zelman & Associates

Fifty-seven million. Okay. And with respect to one of the tougher questions to answer, Larry, but if you can give us sort of your initial thoughts, if you think about the challenges of, you know, getting the consumer interested in housing again. And where you have desirable locations, there’s concern by the investment community that there’s a lot of legacy lost that are on the peripheral that you own and that totals and controls 26,000 lots, despite your sort of averaging down and incrementally buying more desirable parcels.

Is there any way for you to just give us a sense of, you know, is the peripheral those C locations where it’s going to be a much stronger housing market before those we see those get utility? Would you say it’s a small percent for you guys and that you are within the reins of the employment center in the majority of cases, because I think that’s where people say their concerned that the builders still have all this land that might have been written down and/or mothballed, but it’s crap?

Larry Nicholson

Well, that’s a great a question, and I think that we feel very confident that we have very little land in C locations today. We continue to bring on mothballed locations as pricing improves and aren’t concerned at all with the long term of those positions that they’re still, I would say, the other thing I would tell you is we impaired all those positions, so we’re in pretty good shape in our opinion.

Ivy Zelman – Zelman & Associates

Right, so if you impaired them, a lot of the, I guess, interpretation might be that you might have overpaid for them based on where thought absorptions were or what pricing was at the time versus where it is today, but you didn’t necessarily buy in the peripheral. Or is that you’ve burned through all the peripheral and what’s left is the stuff that was impaired that’s in desirable locations? Can you clarify?

Larry Nicholson

We got rid of the peripheral stuff very early in the downturn, Ivy. We took our pain early, moved on and just really I’m extremely confident that we don’t have a lot of overhang on that part of the business.

Ivy Zelman – Zelman & Associates

Okay. Well, congratulations again. Thank you, guys.

Larry Nicholson

Thanks.

Operator

Thank you. Our next question come from Stephen East of ICI Group. Your line is open.

Stephen East – ICI Group

Oh, thank you. Good morning. Larry, if you look at your land pipeline that you’re seeing now. You said you had a big meeting. You know, where are you primarily seeing it? Are these first geographically, and then are these A, B type lots? You know, we hear a lot that, hey, there just aren’t very many finished lots out there. What’s the availability that you’re seeing, because it sounds like your doing a little bit of everything on it?

Larry Nicholson

And I think it varies by geography for sure, but I would say we’ve been buying lots across the country. You know, probably the only place we haven’t bought a lot of lots in the last couple of quarters would be the mid-Atlantic, because we have a lot of stuff that we already invested in, in the mid-Atlantic. But everywhere else, in Indy, Twin Cities, the Southeast we’ve been buying a fair amount of stuff, Texas we continue to replace lots.

You know, Texas is probably the most competitive market today, I would say, for buying lots, because obviously it’s been a very good market for a long time, and there are some option opportunities there which makes it that much more competitive. But we’ve grown our west lot positions and continue to try to grow that west opportunity, because as you know, we shrunk it to next to nothing through the downturn. So we think there’s some good opportunities, but we feel pretty good about the opportunities we’re seeing.

We feel pretty good about what we see coming for the next month coming in the pipeline. And the other thing is deals are starting to get a little bit bigger than what they were before which, you know, I’d say our average deal a year ago was 50 lots and today it might be 75 or 80, so we’re seeing some better opportunities. And the other thing we’re doing that’s different probably in the past is there’s some sharing of communities with other builders that allows you to take the bigger positions and split them between two guys where we normally wouldn’t buy that today.

Stephen East – ICI Group

Okay. Is most of that land, do most of it you need to develop?

Larry Nicholson

With the builder deals, I would say yes. The other stuff, I don’t know what the mix was last week, but again, we continue to increase our option lot count. So we’ve moved that number up every quarter so that gives you an indication that we’re still finding option deals.

Stephen East – ICI Group

Okay. All right, and then just a question on the pricing cost equation, you know, everybody’s saying their seeing land and construction costs go up. And we’ve gotten mixed messages. Some are getting significantly better pricing that not only offsets but drives the gross margin. Others are just barely offsetting. One, what’s your dynamic that’s going on there? And then two, your pricing went down sequentially in all the regions. I know you all are moving up the price scale, so is that just a seasonality shift or what’s going on there?

Gordon Milne

Let me take the last one. Prices are going up. I know it came out in the numbers that I think it was just minor numbers like 10 to 1,000. We expect fourth quarter closing price to be up over third quarter closing price, so when people actually get through and finish ordering all the things they need in a home, I think that the average sale prices will continue to go up.

Stephen East – ICI Group

Okay. All right.

Gordon Milne

Part of it is, like in the West, we saw a lot more homes in Las Vegas right now than we are as a percentage in some of the other markets. The average sales prices is lower there than say Denver or Southern California, so it changes the mix. It doesn’t mean prices are going down anywhere. It just means the city that they’re in changes a little bit.

Stephen East – ICI Group

Okay, and then on your cost and pricing dynamic?

Larry Nicholson

Again, I think different by market, but in most markets price is going up faster than cost. And I think the good thing is, is that we’ve opened a lot of new communities, so we had a lot of guys locked in on the cost side. So when we start a community, obviously, we try to get pricing protection for some period of time. So in some places we have not experienced as bad as other places, and it really is dramatically different market by market, because in some places it’s framers. Other places, it’s drywall guys. Other places, it’s electricians and plumbers. But, you know, as I’ve always said in the past, I always think we have the ability to raise price to cover cost.

Stephen East – ICI Group

Okay.

Larry Nicholson

It’s happening to all of us, obviously. You’ve heard it in the previous calls today, and that’s just part of an improving market.

Stephen East – ICI Group

All right. Thank you. Great quarter, guys.

Larry Nicholson

Thanks, Steve.

Operator

Our next question comes from Michael Rehaut of Chase JP Morgan. Your line is open.

Will Longhorn – JP Morgan

Hi, it’s actually Will Longhorn for Mike. How are you guys?

Larry Nicholson

Good, Will. How are you?

Will Longhorn – JP Morgan

Good. I was wondering if you could talk about order trends currently in October, and if you think it’s sort of following normal seasonality?

Larry Nicholson

They’re better than we would expect, and they’re not following normal seasonality.

Will Longhorn – JP Morgan

Great. Also, my second question is, can you talk about the current availability of mortgage credit? Do you think on the margin it’s tightening, staying the same or improving currently?

Larry Nicholson

I think it’s pretty flat. I don’t think it’s getting any worse. I’m hoping that over the next, you know, four quarters it’ll get a little bit better, but it’s still pretty tough. And if you’ve got any kind of ding on your credit, it’s hard to get the people written into the finish line.

Will Longhorn – JP Morgan

Okay, great. Thank you.

Operator

Our next question comes from Stephen King of Barclays. Your line is open.

Stephen King – Barclays

Great. Thanks a lot, guys. Yeah, congratulations on a good quarter. In particular I wanted to talk about your operating margins really, and the opportunity for your operating margins to get back up into the high single digits. Longer term, we thought about your operating margins maybe getting into the low teens, which is a level that you reached before. Is there anything that would prevent that from happening again in your view given what you’re seeing on the ground within the next two to three years? We’re talking about getting your operating margin from, I guess it was 5.2% this quarter up somewhere into the double-digits.

Gordon Milne

Well, as volumes continue to improve, we’ll definitely – that SG&A, we think there’s upside on that side. As far as, you know, incentives went from 11% to 9%. We hopefully over time, we get that 9% down to a number we’d call more normal at 5%, so hopefully some upside there. Hopefully there’s some recovery on prices. You know we get flood costs that are fixed. We got a four-year supply of land. Hopefully that as prices go up on homes, we get our margins get better. But it’s a guess on how it’s going to play out over the next few years but there’s certainly the opportunities are there. We’re not forecasting them yet but there’s certainly opportunities to see growth.

Stephen King – Barclays

And I should have mentioned that because you guys show up really well on our land study in terms of the value of your land holdings, it would seem that, that would also be a bit of a tailwind for you. If I look at your company relative to your peers, one of the things that stands out is the breadth of your geographic footprint and in a lot of those markets you don’t really have what most builders cherish as like a top three or four position. Can you talk to us about what your strategy is as you see it? Clearly it hasn’t impeded your ability to tie up good parcels and enough of them on good terms. So can you talk to us a little bit about your view of concentration within your markets? How important is that? And are you going to be taking definitive steps to significantly increase your position in those markets relative to your other public peers?

Larry Nicholson

Well, I think when we look at it, Steve, we want to be a top five builder in the market. So in today’s environment, in 10 of the markets we’re in, we’re a top five builder. Now in certain markets we’re not going to be a top five for reasons like in Southern California we’re just not going to employ the capital necessary to be a top five because that’s just not the way we run our business. D.C. would be another one of those. So we have some room to work but we really believe we have opportunities in every one of those divisions to organically grow those divisions substantially and that’s what we’re focused on.

When you think about the Timberstone acquisition, it really just was an asset purchase. It just brought us lots really. And that’s what we really want. We got an operation in Raleigh out of it but it really boosted Charlotte from really a number nine or number 10 builder to a top five builder. So we’re focused on getting in the top five. We don’t think even market offers you that opportunity, but that’s still kind of the focus.

Stephen King – Barclays

Okay. Great. Thanks very much, guys.

Larry Nicholson

Thanks, Steve.

Operator

Our next question comes from Ken Zener of KeyBanc. Your line is open.

Kenneth Zener – KeyBanc

Good morning.

Larry Nicholson

Good morning.

Kenneth Zener – KeyBanc

With your land pipeline – this is going to be a question as it relates to community count in terms of two possible outcomes. But with your land pipeline in 2013 already set, can you give us kind of two branches of thought process as it relates to kind of how you think about what your community count might be? First, if absorptions kind of stay where they are, or maybe go up a little bit, would you expect kind of perhaps growth like we saw in 2012? And second, is it really around your absorption pace? So if the rise is 30%, you actually could be – that’s just so you sales pace goes up so quickly, you deplete your community. Is that really where your thought process is? And how would you respond?

Larry Nicholson

The answer to the first question is yes, we would expect to see community count grow similar to this year. Absorptions go up, obviously we need to – we have lots. I mean it’s not like we’re out of lots. So we do need to pick up the pace, obviously, if absorptions do pick up. You got short-term; you just got to make sure you don’t get caught short-term. I don’t think we’re at a position we would be caught with a problem short-term anywhere. Longer term, yeah, you would need some lots, but I’ll take that problem if absorptions pick up.

Kenneth Zener – KeyBanc

Right.

Larry Nicholson

That means the business continues to get better. And obviously we talk about leverage. When absorptions pick up, leverage gets dramatically better.

Kenneth Zener – KeyBanc

Well, I think it’s interesting related to the fact that there’s uncertainty tied to the absorption pace, A, and you talked about actually the communities that you’re taking down are larger, which in and of itself supports higher absorptions. So I guess on the mothballed piece is the dollar value. What is the lots? It seems it’s just about 2,300 mothball lots of you assume $25,000 a lot.

Gordon Milne

Couldn’t give you that number off the top of our heads.

Larry Nicholson

Yeah. We can get it for you but we don’t have it right here.

Kenneth Zener – KeyBanc

All right. Thank you.

Larry Nicholson

Thanks.

Operator

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

Dan Oppenheim – Credit Suisse

Thanks very much. I was wondering just – there were the comments about wanting to be top five in the marked and the acquisition strategy. When you think about land and lots going forward, how do you think of just the overall market position in terms of where you’re offering now versus new markets? Or you content so we’ll see new markets coming out? Or is it going to be trying to add some chunks so you will get to more significant presence in some of the markets where you are?

Larry Nicholson

Well, I think first and foremost, bigger presence in the existing markets, but we do expect to open some additional markets, but we do expect to open some additional markets over the next 12 to 24 months.

Dan Oppenheim – Credit Suisse

Any sense where any regions where this would be?

Larry Nicholson

I don’t think we really want to say that right at this point. You know, you can think about where we’ve exited through the downturn. We’re not in Dallas anymore. We’re not in Phoenix anymore. So that would be obviously would be two that would be on our radar first. You know, Jacksonville we exited. That’ probably not on the radar. We want to grow, Raleigh’s relatively new, so we want to grow that business. But I would expect to see something over the near term that will open up somewhere else.

Dan Oppenheim – Credit Suisse

Great. Thanks very much.

Operators

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

David Goldberg – UBS

Thanks. Good morning, everybody. My first question, Larry, very interesting about you guys are still finding option deals. Clearly, and I think you said in your comments there’s a lot of conversation from builders and in the investment community that this is hard to find land and certainly hard to find option deals on well located lots. But what I’m trying to get an idea of is when you’re going in and finding these deals, is there a lot of competition, such that you’re paying a premium for the right to buy an option on the land? I mean, in other words, are there cash buyers that are out there and you say, hey look, we’ll pay a little bit more because we want the option? Or is it kind of, you know, an uncrowded territory that the option premium isn’t really that significant?

Larry Nicholson

Well, I think the competition today for lots, Dave, is very high. And I think what we look at is, in a lot of cities we get opportunities, we think that we them first and, like all the other guys, they think they get them first. Right. So we think there’s some opportunities that we just negotiate up front that we get, and then there’s a large portion of those we do bid on, and some we win, some we don’t.

So it’s kind of a mixed bag, but in some markets in particular, there’s just a lot more option opportunity that we continue to see. You know, Indianapolis is a good example. We get a fair amount of option opportunities there, where in Twin Cities we don’t. We’re developing most of our dirt there. Chicago, we’ve picked up a bunch of option deals over the last probably 90 days, I think we’ve picked up four or five option deals, well located, good lot pricing, so we’re excited about those. Vegas actually, we’ve picked up some option deals which has not historically been the norm.

David Goldberg – UBS

Is it fair to say, though, that there’s not necessarily a premium that you’re paying for those options, for the right to have an option on that land versus if you were to buy it for cash outright if there was another cash buyer out there?

Larry Nicholson

We don’t think so, no.

David Goldberg – UBS

Okay. My second question has to do with M&A, and it kind of, you know, following the timber selling deal. And the question I have is, and there’s a reason I talk to public builders about, you know, going out and acquiring privates. One thing that I consistently hear is in up markets, the expectations from private builders in terms of takeout premiums and what their land is really worth get very, very overinflated, and it makes it hard to get a deal done because you want to buy someone who has a good land position but they think the land is worth dramatically more than it really is. Have you seen any kind of change in the up market in the last few months, since Timberstone closed, from potential M&A candidates where it’s just hard to get to a number because a private wants two-and-a-half times book and you can just develop the land cheaper?

Larry Nicholson

Yeah, I think that you get one to the finish line for every 10 or 15 you look at. And you’re right. There’s please with unrealistic expectations of what their companies are worth. But there are some people out there that have a lot of in their business and maybe they’re getting older or they don’t want to sign personally anymore, so there’s a lot of variables I think that are driving some of these guys to make decisions to sell their businesses. And the other thing they see is that we’re buying all the lots. I mean I can’t remember the last time we lost a lot deal to a private builder. And I think if you went across the spectrum of all the public guys, I think they’d all tell you the same thing. So it’s just getting more difficult for them to operate right now, which is really putting a crimp in their business.

David Goldberg – UBS

Great. Thank you for the color.

Larry Nicholson

Thanks, Dave.

Operator

Our next question comes from Megan McGrath with (inaudible). Your line is open.

Megan McGrath

Thanks. Good afternoon. A little bit of a corollary question around your land position and planning into 2013. We’ve had a couple of builders talk about today that they’re actually starting to restrict pace for different reasons. I’m wondering if you are doing the same thing in any of your communities? And do you see a point at which you would do that looking into 2013 in order to maximize price?

Larry Nicholson

Absolutely. I think you look at it on a week-by-week basis and what you’re selling and when your absorptions start to hit that four a month, you raise price and you limit releases, especially in a position that you can’t replace, if you’re in a neighborhood or a part of town that there’s really not much other activity. So it’s on a case-by-case basis but you got to maximize the value of good lots in today’s environment because, as you’ve heard, it’s getting tougher and tougher to find good lots. So we want to make sure we’re getting the most out of it.

Megan McGrath

So are you doing that already? Or you just do that potentially?

Larry Nicholson

Yeah, we’re doing it already.

Megan McGrath

Yeah. Okay. And then a quick one. You mentioned in your opening comments about renters coming back into the market. Are these different renters this time around than we’ve seen before? Are these sort of move-up renters, so to speak, that are going after this mid-priced product? Or are they really first-time buyers?

Larry Nicholson

I think it’s a little bit of both. I think you’re seeing some of the younger folks that are waiting a little bit longer to buy their first house and maybe are buying a move-up home. And then I think you’ve got the normal renter that’s maybe either had changed jobs or had a problem in their previous housing history but we’re seeing those folks, we’re seeing a good movement out of the rental. And rents keep going up so that’s the other thing. Rents keep going up so that’s the other thing. Rents keep going up. Mortgage rates are flat and you can fix your housing price for a long period of time versus a 10% increase every year plus you got a little bit more room and you got a garage and you got a yard. So I think there’s just a lot of favorable things in our favor right now that are moving people out of the rental communities.

Megan McGrath

Okay. Great. Thanks very much.

Larry Nicholson

Thanks, Megan.

Operator

Thank you. (Operator Instructions) Our next question comes from Alex Barron of Housing Research. Your line is open.

Alex Barron – Housing Research

Hey, thanks, guys. Good job on the quarter. I wanted to ask you I guess a slighter different version on the renter question. I’m interested in the people who are coming out of foreclosures and who went through a foreclosure or short sale have been renting. Do you guys track that? And if so, what percentage of the traffic would you estimate that represents? And what percentage of your sales this quarter would you say that represents?

Gordon Milne

We don’t track the number. We’ve heard from the mortgage company that people are now – especially short sale people have got their credit repaired and are coming through but we haven’t tracked the number of people coming through.

Alex Barron – Housing Research

Okay. My other question has to do with your balance sheet. Obviously it’s in a very strong position but I’m just kind of wondering if you look out over the next two, three years, what do you guys envision all this cash going to be for? Just to pay down other debt as it comes due? Or to reinvest and potentially double the size of your current landholdings?

Gordon Milne

Yeah, it’s to invest in the business, not just – we’re not borrowing now to pay off the 2015s. That would be very expensive to hold money for two years just to pay off debt. So it’s definitely to grow the business. I mean, we’re not going to use 800 of it to grow the business but we plan on expanding over the next couple years.

Alex Barron – Housing Research

Okay. Thanks. I’ll get back in the queue.

Operator

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

Joel Locker – FBN Securities

Hi, guys. Just on the community count, I guess a better way to ask it maybe is how many communities to have slated to open in 2013?

Larry Nicholson

Well, we have 61 not yet opened but not all of those would be 2013. We think it’s – do we have that number? Hold on.

Gordon Milne

It’s a big number. We always look at the net increase we’re talking about but it’d be well over 100 communities that open next year and then you get obviously a whole bunch that are going to close next year.

Joel Locker – FBN Securities

Right. But is it 100 or 120? Or just the planned openings?

Gordon Milne

I don’t have the number right here.

Larry Nicholson

Yeah, we’re kind of giving guidance in the 15% to 20% range is what we’re talking about.

Joel Locker – FBN Securities

Right. And then also, historically you guys used to buy back, you know, a third of your net income used to go towards stock buybacks, and I was wondering if you started looking at that again now that you’re profitable.

Gordon Milne

I think it’s too early to start looking at that. I mean, you know, we’ve got to make more than what we’re making now before we start buying shares back again, so there will come a time but it’s not now.

Joel Locker – FBN Securities

All right. Thanks a lot, guys.

Operator

Thank you. Our next follow-up question comes from Alex Barron of Housing Research. Your line is open.

Alex Barron – Housing Research

Yeah, hi. I guess just kind of focusing on land and the impact on margins. I’ve heard in some markets, I guess, some that you guys are not in like Phoenix, land costs are up quite a bit relative to, I guess, how much home prices are at. And some people say that land doesn’t sell. Are you guys, you know, seeing some things like that in some of your markets? And are you concerned that margins could start feel some compression in 2014 and beyond?

Gordon Milne

You know, we just had, Larry mentioned we had a land meeting this month where we approved quite a few deals. They’re all done based on current prices for land, obviously, that we’re buying and current sales prices. So deals don’t have to pencil based on current prices. They are up, but you know, so is sales prices, and the penciling we do is the same as we’ve been doing for the last few years. And so we’re not getting squeezed yet. We’re still able to find deals and pencil at current prices for land.

Larry Nicholson

You know, that’s not to say there’s not some deals that just don’t work. I mean, our guys work on a lot of deals that never get to the finish line.

Alex Barron – Housing Research

Okay, that’s fine. Thanks.

Larry Nicholson

Thank you.

Operator

Our next question comes from Joshua Pollard of Goldman Sachs. Your line is open.

Joshua Pollard – Goldman Sachs

Hey, thanks for taking my question. This is a very quick one. What level of absorption is too high where you guys begin to think it makes a heck of a lot more sense to raise prices?

Larry Nicholson

You know, again, depending on the community, but if you start getting to three a month, you’ve got to start looking at inching up prices. If you’re getting to four or five a month, it’s definitely going up, and then you’re limited to number of houses that are being sold. It’s on a community by community, Josh, but at three we ought to be raising prices. And I mean, it might not be a big price increase, but we should be raising prices.

Joshua Pollard – Goldman Sachs

Okay, great. That’s very helpful. Thank you, all. Have a great afternoon.

Larry Nicholson

Thanks, Josh.

Operator

Follow-up question. Ken Zener of Keybanc. Your line is open.

Kenneth Zener – KeyBanc

Thank you again. I just wanted to clarify that when you said 15% to 20%, the comment, I believe was related to community count, could you clarify if that’s correct, A, and if that’s an average for year or year-end count? Thank you.

Larry Nicholson

Yeah, it was 15% to 20% end of year.

Kenneth Zener – KeyBanc

Thank you.

Larry Nicholson

Thanks.

Operator

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

Buck Horne – Raymond James

Yeah. Hi. Just wondering, are you going to have to make some new investments in your corporate SG&A as you’re looking to expand your footprint and maybe expand your community count? How much leverage do you have with your current corporate infrastructure before you need to add some resources?

Larry Nicholson

We don’t think we’ll have to add any. We think we’re – I mean we have a staff that can handle more. And from a management perspective, we had all the senior managers that we need to move it forward. And then we got our Home Building group which oversees the operations. So we wouldn’t expect to have to hire really anybody. And if it is, it’s an accountant to handle things like payables, so its low-level jobs; no high-level jobs. So very minimal.

Buck Horne – Raymond James

Okay. Great. Thank you.

Larry Nicholson

Thanks, Buck.

Operator

Just a follow-up question from Joel Locker of FBN Securities. Your line is open.

Joel Locker – FBN Securities

Just following up on the SG&A. I know you combined the corporate in there but can you just quantified a breakdown of the $40.3 million of what’s fixed and what was corporate and what’s just in variable?

Gordon Milne

Well, the corporate would’ve been 5,100, $5.1 million (inaudible) broken it out.

Joel Locker – FBN Securities

And then – just the remaining $43.2 million. How much of that is just fixed costs versus...

Gordon Milne

Well, look, 4.5% is commissions, internal and external. And the rest...

Larry Nicholson

A small portion is fixed but a lot of that would be – I mean a small portion would be variable, but the rest would be fixed.

Gordon Milne

Yeah.

Joel Locker – FBN Securities

All right, so 4%, 4.5%. All right. Thanks a lot, guys.

Operator

Thank you. I’m showing no further questions in the queue at this time. I’ll hand the call back to management for closing remarks.

Larry Nicholson

Well, thanks for joining us today. We look forward to seeing you after the fourth quarter. Thank you.

Operator

Thank you. Ladies and gentlemen, this concludes the conference today. You may all disconnect and have a wonderful day.

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