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Executives

Scott Stowell - CEO & President

Jeff McCall - EVP & CFO

Analysts

Ivy Zelman - Zelman & Associates

David Goldberg - UBS

Adam Rudiger - Wells Fargo Securities

Mike Rehaut - JPMorgan

Joel Locker - FBN Securities

Alex Barron - Housing Research Center

Standard Pacific Corporation (SPF) Q3 2012 Earnings Call October 26, 2012 12:00 PM ET

Operator

Good morning, and welcome to the Standard Pacific Homes 2012 Third Quarter Conference Call. Today's conference is being recorded.

Before we begin, I would like to direct your attention to the company's Safe Harbor statement and remind you that this conference call contains forward-looking statements, including statements concerning future financial and operational performance. Actual results may differ materially from those projected in the forward-looking statements.

For additional information regarding factors that could cause actual results to differ materially from those contained in the forward-looking statements, please see the company's SEC filings, including reports on Form 10-K and Form 10-Q under the heading, Risk Factors.

A question-and-answer period will follow today's prepared remarks. A recording of today's presentation will be available for replay a few hours after this call ends and will continue to be available on the company's website for 30 days.

At this time, I would like to turn the call over to Scott Stowell, CEO and President. Please go ahead.

Scott Stowell

Thank you, Tim and good morning everybody. With me this morning are Jeff McCall, our Chief Financial Officer and Mr. John Babel, our General Counsel. I would like to thank all of you for taking the time to join us today for the Standard Pacific Homes third quarter update.

To begin, I would like to provide you with a few brief comments about the housing market and our overall quarterly results before turning it over to Jeff who will provide additional detail about our financial performance.

The positive momentum we experienced during the first half of 2012 has continued. Our solid third quarter results reflect the execution of our strategy and the continued gradual improvement of the housing market. Throughout the year, home sales and prices have trended up steadily in most of our markets and this positive activity coupled with recent reports of falling unemployment, historically low interest rates and high affordability, have all helped to bolster confidence in potential home shoppers that the worst is behind us and it’s a good time to buy a home.

We believe that as the housing market and the economy in general continue to recover, there will likely be a further acceleration in the pace of home buying led by the move-up home buyer who has the advantage of being more financially secure, possess a stronger credit and aspires to own an upscale home in an amenity rich community.

While we are seeing many positive macroeconomic signs and significant year-over-year improvement in our own performance, we have always maintained that the housing recovery would likely be an uneven one. On the positive side, in addition to extraordinarily low mortgage rates, strengthening housing demand and rising prices, the number of homes listed for sale in the US has fallen by more than 40% from the peak in 2007 and nearly 20% in the past year alone.

Homes also remain extremely affordable with home prices 30% below their July 2006 peak. In addition, resale homes are selling more quickly reflecting the increasing demand we have been seeing across the country, including from buyers who are now three years or more removed from a short seller foreclosure who have chosen to reenter the market.

On the negative side, although the mortgage rates remain at all time historical lows, mortgage underwriting criteria remains stringent and regulatory headwinds continue to preclude any meaningful relaxation of these standards. In our view, the availability of mortgage credit will be one of the key factors that dictates the ultimate scope and pace of the housing market recovery.

Against this backdrop, we are working diligently to proactively improve our business with the goal of outpacing the recovery no matter how slow or unsteady. We remain committed to our growth strategy and are focused on identifying and acquiring land in A locations and providing industry leading architecture, construction quality and a premium customer experience to serve our move-up home buyers. We remain confident in our belief that this strategy has us well positioned for the months and years ahead.

Our positive third quarter results demonstrate the progress we're making against our strategy. We earned $21.7 million or $0.05 per share during the quarter, with new orders, deliveries and revenues up a healthy 29%, 24% and 32% respectively over the prior year period. And as we look forward, I am pleased by the 64% year-over-year increase in the dollar value and number of homes in our backlog to approximately $500 million or 1,400 homes. This backlog strength bodes well for the fourth quarter and leaves us well positioned as we enter into 2013.

Our average sales price rose to $369,000 during the quarter, an increase of 7% compared to the third quarter of last year and 9% over the 2012 second quarter. What is most notable about this increase is that it’s been driven almost entirely by the execution of our move-up strategy outside of California.

Comparing the three months ended September 30, 2012 to the prior year period, the average sales price of our delivered homes was up to 2% in California, but 5% in Arizona, 7% in the Carolinas, 17% in Texas, 27% in Florida and 30% in Colorado. We also achieved a 140 basis point improvement in our normalized gross margin from home sales during the quarter, achieving 20.2% in 2012 compared to 18.8% in the year earlier period. The gross margin of homes and backlog was up an additional 70 basis points to 20.9% as of the end of the third quarter.

Our industry leading EBITDA margins reached 16.2% in the quarter; our highest EBITDA margin since the third quarter of 2006. In the constant balancing act between margin and sales pace, we continue to emphasize margin with ongoing community-by-community evaluation of our core value proposition to tactically raise sales prices and reduce incentives as demand warrants.

During the quarter, we were able to raise base prices at over 85 communities and we are able to reduce incentives to their lowest levels in over three years while at the same time increasing our absorption rate to 2.1 per community per month up from 1.6 per community per month for the 2011 third quarter.

The downside to the significant year-over-year improvement of absorption rate is that we are selling out of our communities faster than anticipated resulting in a 2% decrease in our number of average active selling communities as compared to the 2011 third quarter.

As we look to 2013 and beyond, the combination of improved absorption rates and our focus on land opportunities with longer lead times to market that meet our strict underwriting criteria means that our community count growth rate will likely be flat to single digits in 2013 with growth accelerating in 2014 as our longer-term acquisitions come online.

We ended the third quarter with an average of a 156 active selling communities and plan to open an additional 15 communities during the remainder of 2012 totaling 49 new communities open for the full year. Looking forward, we already own or control 50 communities scheduled to open during 2013 and an additional 95 communities which will open in 2014 and beyond.

Turning now to our progress on our land strategy; we continue to actively target land purchases across the company with the goal securing a strategic land supply to fuel community count growth which will in turn drive topline results. We are fortunate to be to continue to leverage positive reputations and relationships of our (inaudible) local management teams and the technical expertise of our national land acquisition team to identify and acquire well positioned land to grow our community count in the A locations that appeal to our move-up homebuyers.

Given our strategic lot supply, land buying remains discretionary and opportunistic; through our capital allocation work, we have short, medium and long-term goals for deliveries and community count for each of our divisions; while, quarter-to-quarter land spend may very in dollar amount and geographic distribution. We are clear about the target and I am pleased with the progress we are making toward the market specific goals.

Having successfully exported our decades of proven master planning and land development expertise in California, where land acquisition has always been under most pressure and the most complex to all of our divisions across the country, we are able to secure highly desirable and often complicated land opportunities that others may not have the depth of experience or expertise to pursue.

Over the last few years, as our opportunities to acquire finished home sites in A locations that meet our underwriting criteria have diminished, visibility to acquire, plan and develop larger partially developed and undeveloped land parcels has provided a real advantage to us as we have worked to position ourselves for profitable growth.

During 2012 third quarter we spent approximately $246 million on land and development, acquiring approximately 3500 home sites. Included in this spending was the acquisition of two market making positions totaling nearly 2500 home sites in the supply constrained and highly coveted San Diego market. These projects are great examples of the master planning and land development opportunities we are able to execute on that we believe set us apart for many of the other builders. First transaction I would like to share with you which demonstrates our ongoing commitment to the San Diego market where we've operated for over 35 years is the acquisition of the approximately 1750 remaining home sites in Del Sur from our Black Mountain Ranch land development joint venture.

One of the most sought after developments in the area, Del Sur is known for environmentally friendly living with over a 1000 acres of open space, multiple parks, 18 miles of hiking and biking trails and is located in a highly desirable school district. Prices in the five communities actively selling in Del Sur today range from the high $400,000 to $1.2 million. Responsible for the master planning and all development activities for the joint venture since its inception in 2003, Standard Pacific Homes has successfully sold and completed five communities in Del Sur over the past several years and is now actively selling from two communities within this master plan. We plan to open an additional four communities in Del Sur in 2013 and will pace the release of 12 additional communities in 2014 and beyond, with the goal of having five to six actively selling communities open at any particular time carefully balancing supply and matching it with demand, strategically segmenting consumer targets and product offerings to maximize the market opportunity.

In the other market making transaction this quarter, we completed the acquisition of the undeveloped parcel that will become the 10th community, 140 home site Harmony Grove Village master plan, located in the A location in Northern San Diego County, near a newly opened $1 billion medical complex. Harmony Grove Village is another showcase of our master planning and land development capabilities. It is also a good example of effectively structuring the transaction to maximize the capital efficiency of our land spend. Auctioned from a private developer and a group of chicken farmers in 2009, we were able to delay the purchase of the land until after we had obtained the remaining entitlements, completed all of the engineering and were ready to begin development.

We closed the acquisition in September, grading will begin in November and we expect our first deliveries in the first quarter of 2015. Taking advantage of the strength of our balance sheet which was bolstered by our successful third quarter capital market transactions and the significant larger and longer term land opportunities that were presented to us during the initial stages of the current home building cycle, we have now acquired what we believe are nine market making positions in A location during the last two and a half years, consisting of nearly 9000 home sites and markets including Austin, Charlotte, Dallas, Orlando, Southern California and South Florida. These purchases will provide an attractive supply of home sites for years to come in amenity rich communities that we believe will appeal to the move-up home buyers we target.

As the year progressed, we have been fortunate to find more land transactions that meet our underwriting guidelines than we originally projected and looking forward, while our focus on larger land opportunities tends to make our land buying lumpy quarter-to-quarter and no deal is certain until it closes, we remain encouraged by the quality and volume of the potential land transactions we're working through our pipeline. While we continue to provide a diversified product mix the targets opportunities in each of our key geographic markets, we believe that our greatest advantage continues to be among those we have historically served best, the move-up home buyer. Many of these move-up home buyers are seeing the initial signs of economic recovery and have recognized the compelling home buying opportunity presented by the combination of today’s home values and historically low mortgage rates.

Approximately 70% of our customers are experienced fighters who had previously owned a home, even if they are currently renting and they recognize the benefits of home ownership. Our value proposition, the hallmark of our brand, which includes a library of completely new home designs, the opportunity to personalize each home with structural and design options, premier home sites located in amenity rich communities and our commitment to industry leading quality construction and customer service provides a differentiation that creates further urgency for these home buyers to move up the sidelines and chose a Standard Specific Home.

Now I would like to turn over to Jeff to share more details regarding our financial performance.

Jeff McCall

Thanks Scott. During the quarter, we reported home sales revenue of 317 million, up 31% from prior year and up 15% from prior quarter, driving the revenue growth was a 25% increase in the number of delivered, couple of with 7% in our average selling price. Geographically, our deliveries remain pretty consistent with approximately 42% from California, 24% from the southwest and 34% from the southeast. Our gross margin for the third quarter was 20.2%, up a 140 basis points from the same period last year after bagging up the impairment charges taken in the third quarter of ‘11. Excluding capitalized interest and impairments in cost of sales, our gross margin was 28.7% up 210 basis points from last year and down 70 basis points from last quarter.

Interest incurred in the third quarter was $36.1 million of which 34.4 million was capitalized and 1.7 million was expensed directly through the P&L. Our Q3 cost of home sales included $27.1 million of capitalized interest, equal to 8.5% of home sales revenue down 40 basis points from 8.9% last quarter. The amount of capitalized interest included in the cost of home sales for homes in our backlog expected to close in the fourth quarter is 7.6%. For comparison purposes the 7.6% compares to 8.1% at the beginning of backlog entering the third quarter.

SG&A for the quarter was $43 million representing 13.6% of home sales revenue, a 260 basis point improvement over the same period prior year and a 170 basis point improvement over the last quarter. At 13.6% our SG&A reached the lowest levels of the fourth quarter of 2007. G&A expense for the quarter increased 400,000 in Q2 largely attributable to increased insurance charges as a result of higher revenues and increased incentive compensation, partially offset by lower marketing expense.

In the quarter, the company achieved consolidated pretax earnings of $21.9 million from a 156 average active selling communities or $0.05 per fully diluted share. On slide 6 we breakdown our third quarter deliveries in a little more detail. The key driver to our deliveries are beginning backlog and the amount of homes sold and closed in the quarter. Our backlog is up 64% versus prior year and up 10% from the second quarter. In fact our backlog in terms of number of homes is at its highest quarter end level since the second quarter of 2008. Of the 1394 homes in backlog, 874 homes are currently schedule to close in the fourth quarter. We would expect that 874 will be adjusted down to the cancellations and changes to the targeted closing date of homes currently in backlog. If we go to past eight quarters that downward adjustment has averaged about 16%.

From that number you add the number of spec sold and closed in the quarter to get your Q4 deliveries. And we continue to closely monitor our spec strategy, balancing the availability of pre-build homes with the gross margin pressures associated with such homes. We’ve done a nice job over the last several quarters of shrinking the gap between the gross margin and pre-builds and to be built homes, reducing the differential from its high of 390 basis points on the third quarter of last year to 150 points in the third quarter of this year. As a roll of thumb, we would like to measure our start rate with our sales rate per community to ensure we have the appropriate level of pre-build homes available for the buyer who wants or needs to buy and move in quickly.

With a better then expected absorption rate for the first half rate of the year, we aired (inaudible) caution with regard to spec strategy, resulting in a lower number of pre-build homes available for sales in the third quarter. We were able to sell and close 41% of these pre-build homes consistent with our Q2 conversion rate. This high conversion rate was attributable both to the lower total number of pre-built homes available during the quarter and the generally low level of resell inventory available in the market place.

On page 7, we highlight our ASP in a little more detail. The increase on ASP of 7% versus prior year and 9% since last quarter is a result of our focus on the move-up buyer. In California, where we have historically been a high end builder, ASP is basically flat. However, Arizona, Texas, Colorado, Florida and the Carolinas ASP is trending up due to our focus on this move-up buyer. This trend should continue into 2013, as our initial projections of ASP going up in all markets except for California where ASP is expected to remain relatively flat.

During the third quarter, we’ve raised prices in over 85 communities and lowered our average incentives to 5.3% versus 6.1% in the second quarter of 2012 and to 8.2% in the third quarter of ’11. Our same plan, same community, ASP and homes closed was up 7% from prior year, and up 3% from Q2. And we are focused on increasing price in submarkets where we are seeing increased demand for our product.

The average selling price in our 2012 fourth quarter beginning backlog expected to close in the quarter was $371,000 which will be impacted up or down based on the mix of specs sold and closed in the fourth quarter. Our cancellation rate during the quarter was 14%, which is down slightly from 16% last year.

Slide eight presents our adjusted gross margin trends with and without capitalized interest. As noted earlier, our gross margin including capitalized interest improved 140 basis points versus the prior year and decreased 30 basis points versus the second quarter.

The 140 basis points improvement since last year is largely attributable to lower incentives and an increase in same plan ASP from raising prices in some of our fastest selling communities, a mixed shift in more profitable communities and is partially offset by a geographic mix shift to more deliveries in Northern California and less in Southern California which historically has been our highest gross margin region.

Our delivered gross margin is a mix of our gross margin at homes beginning backlog with the gross margin of specs homes sold and closed in the quarter. The gross margin of our beginning backlog expected to close in the fourth quarter is approximately 20.4% which is up from the beginning backlog of gross margin of 19.6% in Q3 and 19.9% in Q2.

On slide nine, we provide a breakout of our SG&A into the five main categories; G&A, insurance, incentive comp, selling expenses and severance and other charges. Overall, our SG&A as a percentage of revenue dropped to 13.6% down 260 basis points year-over-year due primarily to 31% increase in home sales revenue.

Our selling expense was $17.1 million represented in dark blue was approximately 5.4% of home sales revenue this quarter which is consistent with the third quarter of last year and down 50 basis points from last quarter. The decrease from last quarter is largely attributable to lower co-broker activity and fixed salaries spread over higher revenue. The percent commission paid to co-brokers has been flat to slightly down and the co-broker participation was 74% in the third quarter, yet another sign of a positive impact, the low level of resale homes we are having on the new home market.

Our incentive compensation is variable and fluctuates with profitability, actual form is a little more complex but for modeling purposes if you use approximately 10% of adjusted EBITDA, it should be in the ballpark. And insurance expense and G&A is fairly predictable and fluctuates directly with home sales revenue from about 1.2% to 1.4%. We experienced the $200,000 decrease in our fixed G&A compared with Q2, mostly from reduced spending in marketing and advertising. This is more of a timing issue rather than an actual permanent reduction.

We continue to timely control all expenditures and are relying on process improvements and enabling technologies to further streamline our business. As an illustration of the operating leverage inherent in our business, in the third quarter of 2012 we generated 31% more revenue than the prior year while lowering our company wide fixed G&A dollars by about $500,000.

On slide 10, we highlight our land acquisition and development spend over the past several quarters. In Q3, we spent $207 million on land acquisition and $39 million on land development. The combined $246 million represents our highest quarterly spent in the last five years. During the quarter, we acquired 3,497 home sites, raising our home sites owned to 23,974, up 2,605 from last quarter and we will raise our home size owned and controlled to 30,154, up 2,397 from last quarter.

From the graph on the right, you see our year-to-date land spend in terms of both dollar spend and number of home sites which heavily weighted in California resulting from the investments we made in two large master plan communities in San Diego that Scott addressed earlier.

While we generally target our lot acquisitions across our geographies about third (inaudible). These two large master plan developments represent a unique opportunity to sell us market making position in A locations which would provide us a strong lot pipeline for years to come in our San Diego market.

The timing of land acquisitions can vary significantly from quarter-to-quarter with more than $550 million already spent or committed and given the strong third quarter land spend in our robust pipeline of land deals, we're increasing our targeted total land and development spends for 2012 by $200 million, increasing our targeted land spend to between $600 million and $700 million for the full year.

On slide 11, we illustrate our current liquidity position and our debt maturities scheduled in next four years. We ended the quarter with approximately $500 million available cash and as announced last Friday, we also recently amended our unsecured revolving credit facility to provide us access to up to an additional $350 million.

During the quarter, we received approximately $240 million of net proceeds from a convertible senior note offering, $72 million of net proceeds from a common stock issuance and in October, we retired the remaining $40 million of debt we had coming due in 2011.

We had $500 million of cash and $350 million of availability under our revolving credit facility and only $35 million of public debt maturing in the next three years, we believe we have ample liquidity to continue to progress we are making against our strategies of acquiring well positioned lands and to grow our community count and ultimately drive continued profitability.

With that, I will turn the presentation back to Scott for his final remarks before we open the call up for questions.

Scott Stowell

Thank you, Jeff. As we shared with you in addition to our solid company results, we are encouraged by the improvements in the economy and housing market. More Americans are employed, consumer confidence has picked up, inventory levels are healthy and affordability remains attractive.

With that backdrop, we remain focused on our growth strategy and are particularly pleased with the progress we have made in our efforts to our acquire land in A locations and then attracting to move-up homebuyer. We would like to extend an invitation to each of you to join us for a tour of our newest communities when you are in town.

We have already had the opportunity to spend time with several of you to showcase our Del Sur and Harmony Grove Village master plans and would welcome others to see them first hand as well. But before we close, I would like to take a moment to thank the entire team of Standard Pacific.

I want to recognize them for their incredible talents, their enduring dedication and continuing contribution to our company’s success. I see an enormous sense of pride worn proudly on their sleeves as they deliver new homes to each of our customers.

It is their talent, dedication, sense of pride and their commitment to each other that makes our culture great. I truly believe they are a key source of our competitive advantage. Thank you everybody and well done.

With that I would like to now open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) And we will take our first question from Ivy Zelman with Zelman & Associates.

Ivy Zelman - Zelman & Associates

Scott, maybe you could just talk a little bit about the land spend that you are incrementally spending and you said kind of those (inaudible) and you need the opportunities to present themselves. Maybe if you could give us an idea of the total portfolio with the land spend you have accrued to the expense of this year. What percent would be new versus legacy and what would be the marked up portion of it, if you were thinking in percentage terms?

Scott Stowell

Okay, so for context, 60% of our spend year-to-date roughly is in California. It’s historically been that percentage and based upon how we are allocating capital and how review all of our markets we would expect that California will maintain that rough allocation and the balance would then be spread equally to the south east and to the south west.

With regard to what percentage of our deliveries today are coming out of new communities at 74% of our deliveries are coming out of our new communities. 26% of our inventory is finished today and of the land purchases we have made to-date, 22% of our land purchases have been finished and 19% of our total spend in the third quarter was finished, just to give you a sense of how the finished lot fits into our inventory.

And then we do have roughly 21% of our total lots owned and controlled in mothball status and roughly half of those are held to be sold because they are non-strategic in markets that we’re no longer serving or they are just real estate assets that are off our strategy, not targeted to move-up buyer and then the other half is on hold, waiting the right time to introduce those projects back into the market.

Jeff McCall

Just to adjust the numbers, Scott the 26% are finished lots, 26%, but we also have 10% with homes under construction, so actually the finished lot is 36%.

Ivy Zelman - Zelman & Associates

And maybe just digging a little further you talked about mix and we recognized California historically has had higher gross margins Southern versus Northern, when you think about the overall mix and your strategic growth with that mix; how do we think about gross margin on a go-forward basis even though you are benefiting from a step-up in move-up and I'm assuming you get more margins when the consumer is using options and upgrades which you probably are seeing some of that benefit margin too; so how should we think about the context of margins longer term with your growth strategy?

Scott Stowell

Okay, good question; just to provide some context to answer to the question, we are operating at normalized gross margins today in the early innings of this recovery and our pre-interest gross margins and our EBITDA margins still are very strong and lead the group and we are consistently focused on driving gross margins and maximizing profit on every home that's sold.

So if I were going to try to help you look forward into the fourth quarter as a starting point we would turn to the backlog and as Jeff mentioned our gross margins in backlog are improving and they are up 70 basis points from the prior quarter. And then the other backlog data point would be of all of the homes expected to close in the fourth quarter that are in the beginning backlog, they are also up 70 basis points higher than they were in the third quarter. So that's a steady positive trend that we've seen in our backlog gross margins.

Now from a historical perspective, home price depreciation is going to continue to contribute to our gross margin expansion and given the fact that we are looking at new communities that lever our land development expertise, we are producing higher margins in those raw projects than in our other projects about 300 to 500 basis points. We are also experiencing higher gross margins at the higher average selling prices and we are moving our total mix more in that direction than we certainly were in the last cycle, because we've got much stronger alignment around the strategy to target that buyer. We also like the gross margin potential that's embedded in our land buys as I said.

So we think that with our focus on gross margin, trying to capture every dollar of revenue that we can and the fact that we will continue to improve and focus on option revenue as you said, right now we are getting 10% to 11% of revenue in the option, and we should really grow that to 15% to 20% overtime as consumers become more confident. So we like the starting point and we believe that the continued market recovery will result in margin improvement as it has in every cycle. We just want to maintain our relative position.

Ivy Zelman - Zelman & Associates

That sounds great. I know there are probably a lot of people have questions, but just one, quick one, probably not quick, but you got cost pressures, but clearly the cost pressures are not eating into that improvement enough to concern you and I think people are mostly concerned about labor shortages and production and revenue falling short, at least of our expectations on closings, it had to do with effect, but how much of it is because of backlog conversion might be impacted on labor shortages or is that something that’s just intermediate concern?

Jeff McCall

I will take that. We're seeing some cost increase we had in the third quarter, our average base price on a home went up by about 3,400 bucks. That’s about little under 3% of direct cost. As far as delays from labor shortages, we still, we have not seen any material delays affecting our deliveries. Our deliveries, which I think, a little bit lower than some people were expecting for the quarter, really related to the lack of available specs to be sold and not a result of delays in the construction of homes that we're seeing to-date.

Operator

And we will take our next question from David Goldberg with UBS.

David Goldberg - UBS

My first question, I thought we could delve into the co-brokerage and the decline in terms of volumes coming through co-brokerage relationships, but also kind of your expectations for the incentive compensation that’s being paid out to co-brokers. And the reason I ask is that I would think that if there is less existing home inventory to compete with you would have to pay outside realtors less to convince them to come see your products. And so I guess I am kind of looking forward and saying is that kind of a level that we should expect to decline if inventory stays where they are and also in terms of volumes going to co-brokers how do you think that will kind of trend?

Scott Stowell

Our view is that we are working hard to reduce the amount of commissions we are paying brokers and it’s difficult to do given the current market environment; it’s still very competitive out there, but everyone is focused on managing that cost. And I would think that overtime David, we should find some incremental improvement there, but I can’t’ give you a sense of how fast we would do that.

And secondly, what was the second part of that question?

David Goldberg - UBS

Just about percent of sales coming through outside brokerage and I know historically it’s been about where it is now I think that’s come to 75% range and is it going to stay elevated as we kind of keep moving through the cycle?

Scott Stowell

Actually for us it’s much higher than we historically have had it because in California historically or haven’t been much broker participation and California is actually one of the highest states right now. I think what’s driving that is very low inventories, you think we would get people just automatically coming to our sales offices without brokerage, but it’s really not happening; these broker still are escorting home shoppers to our sales offices and we are kind of cooperating with them.

David Goldberg - UBS

Got it and thanks for the color. And then just to follow-up, I think you gave some great color about what’s driving on move-up buyers in the market and affordability and where rates are and I am just wondering if you ever kind of thought about what if we saw rates kind of tick up 50 basis points, a 100 basis points what do you think that would do to demand and I guess I am really trying to get an idea of it, do you think a little pull forward in demand at this point on the move-up buyers because then you look at great rates and great prices, I am worried about homes prices going up in the future, I am just going to buy now. What do you think is more of a consistent flow, we get into a rising rate environment and obviously it will be an initial bump when you see those, but is it kind of pass that. How do you think rising rates will affect the business we had 50 or 100 basis points?

Scott Stowell

Well, the rising at a kind of a slow measured taste, my view is that we won’t have a significant negative impact to demand. I think as the demand continues to grow mortgage rates are so low and prices are so low, I don't think it will negatively impact us. It certainly will have some affect on our ability that the pace at which were able to raise prices, there is a relationship between our price increases and mortgage rates.

Operator

And we will take our next question from Adam Rudiger with Wells Fargo Securities.

Adam Rudiger - Wells Fargo Securities

Just curious with the narrowing of the margin differentiation between the specs and the built-to-order homes, if there was going to be a change or if you got a little more confidence in the building specs in light of the slower backlog conversion this quarter?

Scott Stowell

As Jeff noted in his prepared remarks, we took a fairly cautious view early in the year on increasing our start rates. And we’ve got more confidence now that the this recovery is stable and we are going to try to increase our specs into reasonable levels. So we will definitely see that, and I think part of the reason we are able to narrow the margin spread is because we’ve had everybody focused on what the value is of the competed home. It’s more valuable than I think historically the industry has viewed it. So I think we've changed that paradigm as a company and that's contributing to the improvement there.

Adam Rudiger - Wells Fargo Securities

Can you offer us any guidance as to what we should be thinking about for backlog turnovers, if that's the way we all seem to do our models for the next say quarter or two?

Jeff McCall

We will give you as much guidance as we are willing to on just the fourth quarter, what's clearly scheduled to close in the fourth quarter from backlog and then that specs sold and closed. What I would say is that our spec opportunity in the fourth quarter is up only slightly only about 80 additional homes from our spec opportunity going into the third quarter and that spec opportunity we define it as either a completed spec or a spec that will be fully constructed within a few weeks of the end of the following quarter. So as far as the spec sales in the fourth quarter that spec opportunity is only about 80ish homes above the spec opportunity coming into the third quarter.

Scott Stowell

And Adam our conversion rate at the beginning of the backlog was 68% this quarter and historically in the last several quarters it was much higher than that. I don't think we see it changing much, given the fact that we are selling more to-be-built homes now that we have in the past.

Adam Rudiger - Wells Fargo Securities

And then going back to the gross margin discussion for a second, I think you mentioned 74% of your deliveries were from new communities, does that suggest and this is more of a question thinking not near term gross margins but ’13 and ’14 that there's not a huge tailwind right now from benefits from prior impairments given how many deliveries are coming from the newer communities.

Jeff McCall

We won't get a large benefit. I think when we look at our backlog gross margin on new community backlog gross margin’s a little over 100 basis points better than our old community backlog gross margin. So we get a little bit up but not a huge change.

Adam Rudiger - Wells Fargo Securities

I was thinking about the opposite way. I was actually wondering if you closed out of some legacy communities that you haven't impaired but prices rose and you are getting outsized margins now as you close out of those would they have a bundled negative impact that could offset some of the other positive benefits.

Scott Stowell

I mean in aggregate our older communities have a little bit lower gross margin than our newer communities so in aggregate no. That obviously was going to be a community or two but there is on the new side as well.

Operator

And we will take our next question from Mike Rehaut with JPMorgan.

Mike Rehaut - JPMorgan

Going back on the gross margins for a moment, I appreciate the guidance with the or the comments around what's in backlog, but given the thoughts around the new projects and the high risk ASPs, I mean any thoughts around 2013. Certainly you are still below the margins that you did at other points over the last 10 years. But the 20% to 21% if you exclude the outsized years of ’04 and ’05, 20% to 21% is kind of as good as you've got and this year you've kind of been in that 20% to 21% range. So do you expect some of these benefits from new projects higher ASPs to kind of push you above perhaps the 21% range including interest in 2013, and how much of that would come from amortized or the amortize interest versus excluding that?

Jeff McCall

Yeah, we do think that we're pretty close to normalize gross margin right now and, like you said in the 20 to 21 range. Looking forward, we think we’ve got a bit of upside. The real upside of the significantly higher gross margin that we've seen in the past, that pickups are really coming in when you got some pretty dramatic price increases. So I think there is some upside from where we are at, but we got to make sure that when these deals are producing, that's when we get sort of a little bit of upside.

Mike Rehaut - JPMorgan

You mentioned that (inaudible) pricing then, when you mentioned that and you got price increases in about 85 of your communities; can you give us a sense of the percentage raise of those communities during the past quarter and perhaps, the average company-wide range year-to-date?

Jeff McCall

Yeah, in the quarter, and we look at that as a percentage of base price, so that excludes [mock] premiums and options as (inaudible). But as a percentage of base price on the homes that we got increases in the third quarter, it was a 2.3% increase and looking for my year-to-date numbers, give me a second.

Scott Stowell

And the range, on those as well, he is looking at that. The range was from 1% to 11%, 12%.

Jeff McCall

And the best kind of year-to-date, I’d go back to our same store, same community ASP on closing was at 7% over the past and that was actually 12 months not just year-to-date.

Mike Rehaut - JPMorgan

But that also has a benefit of mix, correct?

Scott Stowell

That's same store.

Jeff McCall

That’s a same plan and same community.

Mike Rehaut - JPMorgan

Okay, and the 2.3% in the third quarter from the 85 then you have the other roughly 75 or so that are just more steady if any of those declined in price?

Jeff McCall

Yeah we do, we had one community that we took a price decrease during the quarter and we had nine communities where we had a couple of plans that took a decrease, but those will be pretty when you, that’s pretty minimal.

Mike Rehaut - JPMorgan

Okay and then one last quick thing, you said before about 80 specs more going into 4Q than you had going into 3Q, so you are just saying in other words the potential spec sales in 4Q could be something closer to 290 per say, just want to make sure I understand that.

Jeff McCall

No, that has not, there is 80 more spec opportunity and our conversion rate is above that 40%, 40% of that 80% just kind of [float] consistent with this quarter’s conversion rates.

Scott Stowell

So 30?

Mike Rehaut - JPMorgan

The 30 spec sales in total for 4Q ‘12 versus 210 in 3Q or 2009?

Jeff McCall

No, 30 higher than the 2009.

Mike Rehaut - JPMorgan

30 higher, okay thank you.

Scott Stowell

Yeah, 30 additional.

Operator

(Operator Instructions) We will go next to Joel Locker with FBN Securities.

Joel Locker - FBN Securities

Just curious about your order breakdown in each month of the quarter, if you guys have that handy?

Scott Stowell

Sure, orders in July, it was 324, it was 317 in August and it was 348 in September.

Joel Locker - FBN Securities

And any look into October, I mean is that change season, mild seasonal drop off or is there any, is it just kind of the held steady in the low 300s?

Scott Stowell

When we check this morning Joel, our orders were already up over last year and we still have another week of sales to report.

Joel Locker - FBN Securities

And then if you are looking at your tax rates going forward, I mean it’s been around 1% or so and just with the valuation allowance, do you plan to take that on back on balance sheet anytime soon or what is the latest?

Jeff McCall

I think as in every quarter we evaluate both the positive and negative evidence, (inaudible) valuation allowance. The profit in the third quarter we are now out of that often reference three year accumulated loss period. So we are looking from little bit more positive evidence in order to give that reversal back. Our [DTA] was $488 million at the end of the quarter. So I think we are starting to get closer we are making those agreements and hopefully we can bring that back on sooner rather than later.

Operator

And we will take our next question from Alex Barron with Housing Research Center.

Alex Barron - Housing Research Center

I was wondering if you guys had the number of lots that you guys own. Can you break it down between how many of those are legacy lots versus new lots acquired since ’09?

Jeff McCall

Yes, we can hold down. Of our non-mothballed assets, the new lots is something like 74%. Of our total lots owned and controlled 37% or pre-2009.

Alex Barron - Housing Research Center

Okay.

Jeff McCall

That's 11 of 30,000.

Alex Barron - Housing Research Center

My other question I guess is a two part question. I guess, one is the, what kind of accounted for the margin sequential even though it’s pretty small, what accounted for the sequential margin drop this quarter given that I guess most other builders seem to have had an increase what do you guys think accounted for that? And secondly, more philosophically if you guys encountered that other builders are not willing to push prices maybe as much as you guys because they want to push volume, I mean how do you guys think you will react to that or do you think you are not subject to what other guys are doing?

Scott Stowell

Alex, the explanation for the slight 30 basis points is attributable solely to mix. As we said, our backlog trend in gross margin is pretty steady been improving and then secondarily we are, we've always said we are focused on a margin over volume and there's builders that focus there and other builders that focus on volume. So we are just managing day-to-day knowing that we compete with both guys.

Alex Barron - Housing Research Center

Okay, is there like a threshold at which you guys kind of feel like its appropriate to raise our prices or it’s just, is there a rule of thumb?

Scott Stowell

We are raising prices at every threshold but certainly and we track it on a project-by-project and plan-by-plan basis. When we see sales rates in excess of three, we certainly are having conversations with our operators about their pricing strategy.

Operator

And that does conclude our question-and-answer session. I would like to turn the call back to our presenters for any additional or closing comments.

Scott Stowell

We would like to thank everybody for joining us on the call today and we look forward to follow-up calls and talking to you next quarter. Thank you.

Operator

That concludes today's conference call. We appreciate your participation.

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