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MDC Holdings (NYSE:MDC)

Q3 2012 Earnings Call

November 01, 2012 12:30 pm ET

Executives

Robert N. Martin - Vice President of Finance and Business Development

Larry A. Mizel - Executive Chairman and Chief Executive Officer

John M. Stephens - Chief Financial Officer, Principal Accounting Officer and Senior Vice President

Analysts

Joshua Pollard - Goldman Sachs Group Inc., Research Division

Alex Barrón - Housing Research Center, LLC

Will Randow - Citigroup Inc, Research Division

Alan Ratner - Zelman & Associates, LLC

Stephen F. East - ISI Group Inc., Research Division

Adam Rudiger - Wells Fargo Securities, LLC, Research Division

Joel Locker - FBN Securities, Inc., Research Division

Kenneth R. Zener - KeyBanc Capital Markets Inc., Research Division

Nishu Sood - Deutsche Bank AG, Research Division

Michael Jason Rehaut - JP Morgan Chase & Co, Research Division

Operator

Good afternoon. We are ready to begin the MDC Holdings Inc. Third Quarter Earnings Call. I will now turn it over to Bob Martin, Vice President of Finance and Business Development. Sir, you may begin your call.

Robert N. Martin

Thank you. Good morning, ladies and gentlemen, and welcome to MDC Holdings 2012 Third Quarter Earnings Conference Call. On the call with me today, I have Larry Mizel, Chairman and Chief Executive Officer; and John Stephens, Chief Financial Officer. [Operator Instructions] Please note that this conference is being recorded, and will be available for replay. For information on how to access the replay, please visit our website at mdcholdings.com.

Before turning the call over to Larry, it should be noted that certain statements made during this conference call, including those related to MDC's business, financial condition, results of operation, cash flows, strategies and prospects and responses to questions may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements involve known and unknown risks, uncertainties and other factors that may cause the company's actual results, performance or achievements to be materially different from the results, performance or achievements expressed or implied by the forward-looking statements. These and other factors that could impact the company's actual performance are set forth in the company's 2012 third quarter Form 10-Q, which was filed with the SEC today.

It should also be noted that SEC Regulation G requires that certain information accompany the use of non-GAAP financial measures. Any information required by Regulation G is posted on our website with our webcast slides. And now I will turn the call over to Mr. Mizel for his opening remarks.

Larry A. Mizel

Good morning. I'm pleased to announce our third quarter income.

[Audio Gap]

our focused management team with taking advantage of improved market conditions to achieve these favorable results. On the strength of a 47% improvement in home deliveries, we grew home sales revenue by 57% during the quarter. This was accomplished without increasing the homebuilding SG&A cost, resulting in an 860 basis points decline in our SG&A rate. Plus, we saw meaningful improvement in our gross profit margin, which expanded by 130 basis points sequentially from the second quarter. We are encouraged by the progress we have made in these areas, which allowed us to generate more than $10 million in pretax earnings from our homebuilding operations during the quarter.

At the same time, we also believe that we have the opportunity to further improve our gross margin and our operating leverage to enhance our homebuilding profitability in future periods based on both the increased units and margins we see in our backlog.

Looking at financial services, our $9.3 million in earnings for the quarter was an exceptional result, achieved in part by capitalizing on favorable market conditions and increased loan volume. We also have benefited in this area from the strong execution of our management team who has skillfully managed and reduced expenses for this part of our business.

Our home sales process continue to evolve during the quarter, with an emphasis on raising prices and reducing incentives, where possible, in response to growing consumer demand. Even though we increased our prices in many of our subdivisions, we still achieved a 69% year-over-year increase in net home orders, driven by 78% growth in our sales pace.

Also, our cancellation rate dropped by 1,700 basis points to 27%, as the quality of our backlog has improved from a year ago, and improving market conditions has installed confidence in our buyers. With the acceleration of our sales pace during the first 9 months of the year, we have seen a modest decrease in our community count, as certain communities have sold out more quickly than originally anticipated. However, we have also accelerated the pace of our new land acquisitions.

During the third quarter, we approved the acquisition of nearly 1,500 lots in 31 communities across various markets. As a result of our continued focus on new communities, combined with our increased absorption pace, we believe that we already control enough lots to drive meaningful top line growth in 2013. Keep in mind that we don't have any mothballed communities and nearly 85% of the roughly 9,000 lots we currently own are finished, a high percentage more than most of our competitors. On a finished lot basis, our lot supply in years actually exceeds many of our peers, positioning us well for increased closing in future periods.

As we look to buy lots in the future, we bring a strong balance sheet with net liquidity and an overall financial position ranked by the rating agencies as one of the best in the industry.

Thank you for your interest and attention. I would like to thank our dedicated employees for their hard work throughout the year, as they have made it possible for us to report such positive results today.

I will now turn the call over to John Stephens for more specific financial highlights of our 2012 third quarter.

John M. Stephens

Thank you, Larry. First off, before I get into my comments, I just wanted to apologize. We think that some of the comments related to the forward-looking statement disclosure might not have been entirely received on your end, so we encourage you to review the Slide #2 in our webcast that we provided and that is on our website too. So just want to make sure you guys have that.

Moving onto Slide #4. Our closings were up 47% to 1,039 new homes, led primarily by our increased deliveries from our west markets, specifically our Nevada, California and Arizona operations. The increase in deliveries was driven largely by a higher number of homes in our beginning backlog as compared to the prior year due to an increased net new order activity in the first half of 2012.

Our backlog conversion rate was 51% for the 2012 third quarter, and was representative of our shift to more presold dirt sales in the first half of the year. Our average selling price for the 2012 third quarter was 6 -- was up 6% year-over-year, increasing in nearly all of our markets due to either accelerating prices and reduced incentives or a mix shift to better located communities. Increases were particularly strong in each of our 4 west region markets, as well as our Virginia market, which all showed double-digit year-over-year improvement.

During the quarter, we increased prices, on average, by about 2% in over half of our communities. This was on top of a 3% to 4% price increase that we experienced on half of our communities in the second quarter of this year.

Our gross margin from home sales was up 70 basis points year-over-year to 15.5%, and up 130 basis points on a sequential basis over the 2012 second quarter. The 2011 third quarter included a 360 basis point benefit related to $6.4 million in adjustments recorded in connection with a construction defect settlement claim and project closed at adjustments, as well as a $1 million warranty accrual reduction. These benefits were partially offset by a $4 million in inventory impairments in the prior year, while the 2012 third quarter did not include any inventory impairments. The improvements on our gross margin percentage was driven by delivering more presold dirt homes, which generally generate higher margins than speculative homes and price increases and reductions in incentives in many of our communities across our operations. Although our specs are still generating lower margins than dirt sales, we have seen increased demand for spec homes in many of our markets, and consequently, the margin spread between the 2 has fallen by nearly 300 basis points on a year-over-year basis.

Excluding inventory impairments, warranty adjustments and interests in cost of sales, our gross margin from home sales was 18.2% during the quarter. And as Larry mentioned, we continue to remain focused on balancing home sales rates with reducing incentives and increasing prices where possible. As a result of these efforts and improved market conditions, our margins and backlog have continued to improve.

Our homebuilding SG&A expenses, which includes our corporate segment, were $44.8 million versus $46.4 million for the year ago third quarter, and our SG&A as a percentage of home sales revenues was down 860 basis points to 14.0% versus 22.6% for the 2011 third quarter. The substantial improvement in our SG&A rate was driven by greater operating leverage, resulting from a 57% increase in revenues, coupled with cost reduction efforts that were instituted over the past several quarters. The year-over-year decrease in our G&A expenses to $24.3 million was largely driven by decreases in salaries, other overhead expenses and a $2.2 million legal recovery. And on a sequential basis, our G&A expenses were higher than the 2012 second quarter due to a higher incentive-based compensation accrual, resulting from increased profitability, as well as an annual stock option grant to our directors. Plus, the second quarter was lower in part due to a $3.8 million legal recovery. Our commissions expense, which is a variable cost and was 3.5% of home sale revenues for the 2012 third quarter, increased $3.8 million or 51% on a year-over-year basis, which was in line with the 57% increase in our home sale revenues.

Our net new orders for the quarter were up 69% on a year-over-year basis. The increase in orders reflected the overall improvement in most of our markets, better execution and changes in our sales process and strategy and a greatly reduced cancellation rate, which fell to 27% in the 2012 third quarter from 44% in the 2011 third quarter. And on a per community basis, our sales rates were up 78% year-over-year to 2.0 sales per community per month compared to 1.1 per community in the 2011 third quarter.

On a sequential basis, our orders were down 28%, which is slightly more than our normal seasonal decline, however, keep in mind that the sequential increase we saw from the 2012 first quarter to the second quarter was also far better than we normally experience. To some degree, the success we had in the second quarter impacted the third quarter, as certain subdivisions sold out quickly -- quicker than expected and decreased our community count slightly in the third quarter. In addition, the seasonal decline was impacted by our increased focus on maintaining the appropriate level of balance between sales pace and increasing prices where possible.

Our active community count declined by 4% during the quarter from 173 at June 30 to 166 at September 30. For the fourth quarter, we may see a similar decline, but we have the opportunity to grow our community count in the first half of 2013 before the spring selling season based on our current pipeline and the recent pace of land acquisition activity.

As you can see from this slide, our land acquisition efforts have accelerated significantly, with the third quarter resulting in the purchase of over 1,200 lots, more than doubling what we purchased in the second quarter, and more than triple what it was a year ago in the third quarter. In addition, of the lots purchased during the quarter, roughly half were in the important desert markets of Arizona and Nevada.

With respect to our lot supply, we currently own or control over 10,000 lots, including lots under construction, which represented a 3-year supply based on our last 12-month delivery pace and a 2.6-year supply based on our last 12-month order pace. On a sequential basis, this represented our first increase in total lots in 6 quarters. And in addition to the lot supply we show here, we also have more than 2,000 lots in feasibility that have not yet been approved by our land committee.

We believe we are well-positioned to take advantage of land opportunities with our strong balance sheet that included over $800 million of cash and marketable securities at the end of the third quarter and an equity balance of over $900 million before realizing any portion of our $263 million or $5.51 per share net deferred tax asset, which has a full valuation allowance against it.

Here, on this next slide, you can see that our profits for our financial services operations have improved dramatically over the past 5 quarters, with our pretax profit of $9.3 million in the 2012 third quarter versus a loss of $0.5 million a year ago with our mortgage company being the primary contributor. Much of the improvement is attributable to the increase in the volume of loans locked and originated related to the increase we've seen in the overall homebuilding activity, combined with favorable overall mortgage market conditions.

In addition, both the third and fourth quarters of 2011 included significant charges related to increasing loan loss reserves, as we settled claims with several financial institutions. We've also held the line on expenses, restructuring certain aspects of the mortgage operation to keep our costs down. And the management team has executed well in managing our risks, while maximizing our ability to take advantage of current market conditions. While the margins for this line of business may moderate in future quarters, we still believe it can remain a reliable quality earnings stream for us in the future.

At this point, we'd like to open up the floor for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Joshua Pollard from Goldman Sachs.

Joshua Pollard - Goldman Sachs Group Inc., Research Division

The first thing I want to ask you all to do is describe in as much detail as you can the changes you've made in your sales organization and your sales process over the last year. Can you walk the investment community through the timing of those changes, the impact on margin so far, what the future impacts are? I think folks haven't gotten a full grasp of how you guys have changed your approach to the business over the last year or 2.

John M. Stephens

Hey, Josh. It's John. Yes, I will give you all little color on that. Really, I think, about a year ago, the company decided to make some changes in the way that the sales process was kind of executed. The first thing that the company did was there were larger kind of promotional-type activity that would occur to try to drive some more demand to our sales offices, and what we saw is that some of the quality, being with the traffic that was coming through, we saw high cancellation rates after we had these larger promotions. So now we're very focused on a community-by-community basis, really getting out and spending time with our sales kind of associates, our people that are interfacing with our customers kind of on a kind of routine basis that, hey, we need to attack this kind of community by community. The other thing we did is we're looking at -- we're kind of doing what we call a green read or we're looking at people that come in who want to a buy home, and we're doing more upfront diligence on the qualification before we count it as an order. So our cancellation rate has also declined as a result of that. And I think the other thing we're doing, too, is we're -- before, we were selling homes with maybe not as much in the home, and having to give more incentives to kind of get people when they go in their Home Gallery to buy these options and whatnot, what we've done is we've included more standard features in our homes, and we've reduced the amount of incentives. So we're trying to show what the value proposition of what it is that we're offering to the home buyer rather than how much of an incentive we're going to give away to them. [indiscernible] Go ahead, Josh.

Joshua Pollard - Goldman Sachs Group Inc., Research Division

I guess, the other question is the 130 basis point sequential improvement income in gross margins, you guys called out that your backlog is looking better. Are we wrong for assuming another 100 to 200 basis points over the next couple of quarters? Maybe not at 130 basis points per quarter clip, but is it unreasonable to assume that there's material improvement still left over the next year or so?

John M. Stephens

Well, we did go back and look at what our backlog was at the beginning of the second quarter and what it is now, and we have seen it improving and we're seeing it. We're monitoring the sales, and as we mentioned multiple times in our presentation, that we're trying to balance pace with getting price. And we know that we want to be able to capture as much of the price increases and demand in the various markets. So with -- like we said, we are seeing improvement, and we're continuing to see improvement even as we work through October in terms of margins, but we're not going to give out a percentage of what our gross margin increase is, Josh, at this point. But it is -- has improved and is continuing to improve.

Joshua Pollard - Goldman Sachs Group Inc., Research Division

Okay. And if I could just sneak one last one in here. Interest expense, should that continue to be 0, going forward, with the increases in inventory? And is this 1.3, 1.2 to 1.4 book-to-bill ratio, in other words the number of lots that you're bringing on relative to your orders, is a greater than 1 number what we should expect on a go-forward basis?

John M. Stephens

Well, that's what it was for the quarter, and we also alluded to the loss we have, what I call, in feasibility. We had over 2,000 lots in feasibility, and some of those will fall out. But in an improving market, we would expect our pull-through ratio to improve. So we would hope that we're building our lot supply quicker than we're taking in orders. There may be bumps within quarters, when these land deals come in, as you know, but we would expect to see increased land activity as our -- as demand continues to improve and our order growth continues to improve.

Operator

Your next question comes from the line of Alex Barrón from Housing Research Center.

Alex Barrón - Housing Research Center, LLC

I was just trying to understand, I guess, the -- on the SG&A portion, how much sequential increase was due to -- have you guys started hiring more people?

John M. Stephens

No, not really. I mean, we -- for sales offices or areas that -- we are hiring a few people, but it's really not kind of back office or what I'd call G&A-related. We might add a land person here or there in a market where we think we need to supplement what we currently have with our professionals out there, but we're not really planning on adding a bunch of people in overhead. I mean, we think that, right now, Alex, we're selling at 2 sales per community per month, and we think that we could increase that volume level without increasing our back office. And we've also centralized some of our functions here in Denver with our back office accounting function and some other kind of back office functions. So if volumes increase -- if they doubled, we might see some increases in a few spots, but we don't really have any current plans to add headcount, per se.

Alex Barrón - Housing Research Center, LLC

Okay, so what is the -- what accounts for the $3 million increase in the G&A sequentially?

John M. Stephens

Well, part of it is -- remember, last quarter, we had a legal recovery in the third quarter of last year, which was more than what we had in this quarter. So that was about $1.6 million of it. We also -- we did increase some of the incentive compensation accruals based on our profitability increasing and tied to those metrics, as well as we had a stock option grant for our Directors, which that hit the P&L as well which -- because we had to expense those as we granted those options so that's all coming through now. I think last quarter was probably a little bit lower because of this legal recovery that was probably bringing it down a little bit more artificially. So I think $24 million is probably kind of the range we would expect it to be, in the $24 million, $25 million.

Operator

Your next question comes from the line of Will Randow from Citi.

Will Randow - Citigroup Inc, Research Division

I had a question for Larry. I remember, about 2 quarters back, you said there's only bee, call it, a couple of months of rosy. How are you feeling about the housing market right now?

Larry A. Mizel

I'm highly confident that things are looking better.

Will Randow - Citigroup Inc, Research Division

Understood. And then in terms of, specifically, lots. You guys have a significant amount of finished lots, which a lot of your peers are probably is in the same shape. How do you think your cadence in gross margins -- I know you don't want to give a specific guidance, but how do you think about the appreciation of those lots qualitatively? And what markets are you seeing kind of the hottest incremental activity versus last quarter?

Larry A. Mizel

I think that, historically, lot prices, for us, is really tied somewhat in a range of percentage to sales. And as home values have increased generally, those lot costs have increased. One of the things we did is we went back quite a few years to see different periods the ratio of lot to sales price. And sometimes, it's a lead indicator and sometimes, it turns out to be an indicator of what has happened versus what's going to happen. So I think the best tone that we can give you is we're active in the markets, and we have a high level of sensitivity of at what level we can make a profit, and we keep that in mind. And our goal is to, over the next period of time to, to the extent possible, rebuild the profitability of our operation as the market allows us to do it. And the lot supply, lots always seem to be available if you can write a check, and it's a matter of balancing at what level that cost is to the sale of the home. And since we've been doing this for 3 or 4 decades, I'd think one should assume that we're able to utilize our capital in an efficient way.

Operator

Your next question comes from the line of Ivy Zelman from Zelman & Associates.

Alan Ratner - Zelman & Associates, LLC

It's actually Alan, on for Ivy. I was hoping to ask about the increase in land acquisition this quarter. I know you guys have historically been focused primarily on purchasing finished lots, and one of the things we've heard from other builders recently, really, over the past few quarters is that the supply of finished lots in A-locations has declined pretty significantly. And a number of your peers, I think, have gotten more aggressive, buying up either raw land or land that's partially developed. So I was curious in terms of the 1,200 lots that you acquired this quarter, how you would kind of characterize the -- those lots, whether it's more finished lots in B and C locations, and you've had to move out because of a lack of supply or whether you're taking on a little bit more development risk than you have historically.

Larry A. Mizel

We're not moving out to inferior locations, and we feel comfortable that the mixture between development requirements and finished lots is one that will serve our needs. Everybody has a view of what price they can pay, what terms it is on. And we all know as the market accelerates, the availability of exactly what you want at the price you want isn't necessarily in line, but we have found and we have demonstrated for a long time, and you are able to see the expansion of our gross profit margins. And as we reposition the company for what I believe will be -- someone asked a prior question what do I see in the trend of the business in the industry and our company. I am very comfortable and confident in where the industry is and where our company is. This is the beginning of what, in my opinion, at this time, is a cycle that should last for a period of years, and we are acting in that manner.

Alan Ratner - Zelman & Associates, LLC

So the follow-on to that then is, I guess, going forward, given your confidence in the market, if the decision ultimately came between maybe taking on a bit more development risk versus moving out as the land market becomes more competitive, which is kind of the more important factor? Is it location or development status on the lots?

John M. Stephens

I think location is number one and if the choice is between taking a development risk versus not for an A-location, we'll take the development risk. We are in the business of developing land in most of the markets, not all of them, but over the years, I don't know what the count is, but I'm sure we've developed over 30,000 lots. And we certainly have the skills, the ability to develop. And as I speculate, in future years, we'll probably be doing more development than we did last year, each year sequentially that we can see at this time.

John M. Stephens

And Alan, just to tack on to your original question, we -- most of the lots we did purchase during the quarter, the vast majority were finished. Maybe 10% were lots we're developing. But going forward, like Larry said, that might shift a little bit, but we are still seeing finished lot deals in better locations, too.

Operator

Your next question comes from the line of Stephen East from ISI Group.

Stephen F. East - ISI Group Inc., Research Division

If you could talk just a little bit more, you had orders up 69%. You did push your gross margin up. But as you look at the ideal mix and, Larry, I don't know if you want to answer this or not, but how do you view the price that you're pushing versus the volumes that you're driving? It seems like you are churning through a lot of communities, and it's not cheap to open up communities and stay ahead on that path. So do you prefer to drive down your order growth from where you've been running and generate greater margins or how do you view it?

Larry A. Mizel

Well, I think the easy question is it's a balancing act. The -- I think it's good business to not see how many units you can sell in a particular subdivision versus what's the most amount of money you could make so we look at each subdivision separately. We look at the absorption pace and if it accelerates in a manner that we think will allow us to have a little bit of pricing power, then we will utilize pricing power to slow the absorption down. But the -- we're just coming into a healthy change from as recently as a year ago, so we're using good judgment and we will be conservative in what we do and we'll make sure that, that balance serves our profitability to the maximum that we can evaluate it. But we do look at sales and expect our people to look at sales virtually every week to adjust releases and pricing. I'd like to say every day, but that would be optimistic on my part.

Stephen F. East - ISI Group Inc., Research Division

Is there anything that you're running up against as far as appraisals or not being able to drop incentives faster, raise prices? That's the first thing. And then the only other question I had was what type of trends you all were seeing in October.

Larry A. Mizel

The appraisal issue seems to have gone away. The comps are much easier. You don't have the distress dragging it down. The new home prices are pretty broad. This is an extremely competitive business, so what I'm able to achieve for a particular size home is generally similar to one of my competitors. No one has a large share of any market either -- any market period. So this is extremely competitive, which keeps all the pricing in line. The answer to your question on what do we see in October, I'm going to let John answer it.

John M. Stephens

Yes, we just -- Stephen, as you know, we're just kind of finishing the month up, so we don't have numbers finalized yet. But it is tracking up over last year's number, and one thing to keep in mind is last year, we had our -- we had a sales promotion in October. That was really our last national sales promotion we had in place, so I'll just kind of leave it at that.

Operator

Your next question comes from the line of Adam Rudiger from Wells Fargo Securities.

Adam Rudiger - Wells Fargo Securities, LLC, Research Division

Sticking with the gross margins, I'm not sure if the one topic we haven't discussed yet today is labor, materials and what you're seeing there. Any kind of comments on pressures you may or may not be seeing?

Larry A. Mizel

I see pressures on labor and certain materials. When you look through the other lens, they have been under tremendous pricing pressure, pricing down as our market deteriorated. And as our market recovers and is recovering, I expect to see that for a period of time. At some point, there'll be more pushback versus less, and we -- and the other builders, it's something we have to work on day-to-day. But that is -- in some sense, that's a good sign because that means they have a little pricing power. We have a little pricing power. The consumer is getting a great value with fabulous financing and hopefully, it'll help the entire economy, which can only be good for our country.

Adam Rudiger - Wells Fargo Securities, LLC, Research Division

And second question is, going back to the land for a second. When you think about, say, the first half of 2013, what's your expectation for community count, what the trends will be there both for the company and then those specifically interested in Arizona and Nevada?

Larry A. Mizel

I'll talk about Arizona and Nevada, and the company. We'll try not to make forward-looking statements other than the fact we have commented we have several thousand lots in the process. Arizona and Nevada are doing very well. You can see by sales, and you'll see as the closings accelerate also. It's the unique world of the cycles of real estate. You don't have to go back too long ago to remember in the 80s, Phoenix hit the wall and in the middle of 2005, Phoenix was a spectacular market, and then, of course, whoever was there looked stupid for being there a year or 2 ago. So Phoenix is a great place to live. It's affordable. Land is still affordable, building cost, the ability to live there. So we expect Phoenix to be one of the great markets for growth in the United States on unit sales. Las Vegas, they've had a wonderful period of time, 2004, '05, was probably one of our most profitable divisions in the history of the company. And of course, you look foolish having been there over the prior few years when everything imploded in '08, '09 and '10 was beginning to bottom out and last year, things started to percolate. There are segments of the Las Vegas market that are probably not as robust as others, but we found Nevada, Las Vegas, specifically, where we are, to be increasing in the velocity of activity, and again, it's a great place to live. And they are squaring away their employment issues, but it's affordable, it's the West, and it's the western part of the United States. I used to say, "If you can't get a job in the East, you should move West." And they'd say, "Well, why move West if you don't have any employment?" I said, "Well, it's a nice place to live even if you don't have a job." So we've been marketing even while job creation was slow. But like in Colorado, job growth has accelerated pretty significantly, and the West, we believe, will be an attractive place to live and a good place to build.

John M. Stephens

Adam, I could just probably give you a little more color, too, on what we've kind of approved for acquisition during the quarter. The 1,478 lots, I think we've referenced earlier, about 50% of those were really in Arizona and Nevada, with, really, Phoenix leading the way with about 27% of those lots. So we're working for the communities, but we are replenishing too in those markets.

Operator

Your next question comes from the line of Dennis Huspeni from the Denver Business.

Dennis Huspeni

We'd heard a lot about the Western market leading the growth for the company. I was wondering if I could ask specifically about the Colorado division?

John M. Stephens

Yes, well, our orders were up pretty significantly in Colorado, and we have a very large presence here. And it is our largest division in the company and we continue to expect to be a large player here in this market. And just, in particular, our orders were up for the quarter in Colorado, 71%. So we were happy with the type of activity we had during the quarter in Colorado.

Dennis Huspeni

Do you ever expect it to return to the days -- I mean, Colorado, MDC used to pull -- or the whole industry, in general, used to pull 15,000 permits a year. Of course, that was in the heyday. Now it's turning more towards the 3,000 to 5,000 range. When do you ever expect it or will it ever get back to that level?

Larry A. Mizel

I expect it to be substantially greater than the level it's at today.

Operator

Your next question comes from the line of Joel Locker from FBN Securities.

Joel Locker - FBN Securities, Inc., Research Division

Just on the community, just maybe if you have a number that you're going to open in the fourth quarter targeted and for 2013 also.

John M. Stephens

Joel, we didn't really -- we haven't really given that information out on a forward-looking basis, but we do expect to kind of work through a few more communities in Q4. But with our land activity, what we've purchased and what we have kind of in feasibility or moving forward with, we do expect that to creep back up in the first quarter, maybe to back to where we are now and a little higher. But in terms of specific community count numbers, not really going to give that out today.

Joel Locker - FBN Securities, Inc., Research Division

Right. And then also the financial service profit margin on mortgages sold, I guess it's around 6%, a lot higher than historically. Where do you expect that to normalize, I mean, going forward?

John M. Stephens

Well, our profits are up in the financial services sector. Again, we referenced earlier a lot of it's volume-related, and the margins we're getting on those mortgages is better than it's been historically. As we kind of mentioned in our prepared remarks, we would expect it to moderate over time. So are we going to continue to generate these types of margins out of the financial services mortgage company going forward? That's a little bit hard to predict, but -- and keep in mind that last year, we did have about $3 million of reserves that we booked for some settlements that we entered into. So that drew -- drove the increase in profitability this year as well.

Operator

Your next question comes from the line of Ken Zener from KeyBanc Capital Markets.

Kenneth R. Zener - KeyBanc Capital Markets Inc., Research Division

Question on the absorption pace. Can you talk about the differences you see and what you expect from the communities that you're buying? So for example, the 3,000-plus that you bought, which is over 1/3 of your current owned land inventory, what would you expect out of those as you're opening it as opposed to your older communities? And what's your kind of thought process around that in terms of what's a regulator?

John M. Stephens

Well, I mean, when we buy land what we're underwriting to today is kind of what our -- what we're seeing in the marketplace. So we're not putting in a much higher absorption pace than what we're seeing in our current market place, and so I would say the absorption pace is a reasonable absorption pace relative to what we're seeing today.

Kenneth R. Zener - KeyBanc Capital Markets Inc., Research Division

Okay. I guess just -- because, to me, it seems over half the growth that's going to occur as the cycle normalizes over the next couple of years is actually going to come from absorptions, going from, let's say, a 2 to a more normalized 4 per month. What do you think will be the driver of that? I mean, if you all are underwriting at 2 per month, all these other builders are underwriting at 2 per month, so the kind of the absorption pace versus past trends or normalized trends, you will have twice as many communities as we need. So why wouldn't you guys necessarily target higher absorptions? Is it something related to you're able to get it cheaper because it's only 2 and you actually expected to go to 4?

John M. Stephens

Well, it really depends. Every market's different. So what we underwrite to in Colorado might be different than what we underwrite to in Phoenix versus what we underwrite to in Nevada, Las Vegas so -- and it depends on the submarket, the subdivision whether it's a master-planned community, what's the price point you're offering. So all those things go into -- I'm not saying every one of our deals is at 2. It does vary. A higher-end project may be absorbed at a little slower but -- and we would expect that, as Larry mentioned, our -- the industry is improving, and we would expect it to improve over time. As it heals, the absorption paces, we would hope and expect them to improve as well, as the market recovers.

Operator

Your next question comes from the line of Nishu Sood from Deutsche Bank.

Nishu Sood - Deutsche Bank AG, Research Division

Wanted to talk again about the price versus pace issue. Now, obviously, that is something that all the builders are managing in the stronger demand environment. However, if I think about for your folk's situation, late last year and earlier this year, you were really focused pretty intently on revamping the sales process. So that was -- it was -- it seemed more critical earlier this year to get the absorption pace up. So my question is, does that mean that you may have some more room in terms of pushing price because your priorities were more on the sales process earlier this year?

Larry A. Mizel

I would say we're in the mode of pushing price, pushing absorption and acquiring more land. We're very narrowly focused on those elements to increase profitability subject to market conditions.

Nishu Sood - Deutsche Bank AG, Research Division

Right. Well, I guess my question really relates to did you find you had more room to push pricing as to, say -- did you find your pricing was lagging a little bit this quarter and so you had a little bit more room to push it?

Larry A. Mizel

I think what the industry is saying is, as it is healing that one can segue that you have pricing power, which you really have, is a recovery of impaired values. Many of these homes, whether they're resales or new, on a square footage basis are still selling less than where they were 5 years ago. So I think the pent-up demand for housing and the fact that there's such compelling values that the price point versus affordability versus tied-in with the mortgages because of affordability creates an opportunity to increase prices, but really, it's trying to get the prices back aligned to where they were, and it is a -- it's just a process of the market now. One of the things that's happening is all markets aren't created equal. All builders are not having the same degree of success. I think the public builders, because of having the access to the capital markets, have gotten a real jump on the rest of the industry because the banking world may begin to start to finance the non-public builders, but it's going to be a few years before they're in a position to be aggressive, and that's the period of time that I see demand and price adjustments in front of us.

Operator

Your next question comes from the line of Michael Rehaut from JPMorgan.

Michael Jason Rehaut - JP Morgan Chase & Co, Research Division

First question on community count. John, you had mentioned that you expect a little bit of a, maybe, a similar rate of decline sequentially in 4Q, but then for it to begin to improve in the first half of next year. And just want to make sure that I understand that correctly that, that would be again more sequentially -- sequential improvement off of 4Q levels, as I think it would be a pretty huge hurdle to get above where you were in the first half of -- or at least in the first quarter of 2012.

John M. Stephens

Yes, you're right, Michael. That's probably the way to think about it.

Michael Jason Rehaut - JP Morgan Chase & Co, Research Division

Okay. Also, the gross margins on the lots that you're acquiring, I would assume that they are above your current margins that you're booking today in the third quarter, as you mentioned, that you expect further margin improvement in 4Q and into '13. The lots that you're acquiring today, the lots that you're underwriting, is that more at a 18% to 20% range? Or how are we to think about -- I know you had a question earlier about the rate of improvement, I'm not necessarily trying to get at that, but -- the rate of improvement that you might see over the next 4 quarters. But is that type of differential, again, underwriting at 18% to 20%, is that kind of in the ballpark in terms of what, ultimately, we could see in the next couple of years over time?

Larry A. Mizel

The underwriting as to gross profit margins and absorptions, really, we don't speak about it as specifically because you can appreciate since we're in a highly competitive market for acquiring assets, the underwriting criteria that we use is proprietary, and it all -- in a couple of quarters, it all comes out, but at this point, I would say we don't want to make a further comment on it.

Operator

There are no further questions in queue.

Larry A. Mizel

Thank you for being here today on our call, and we look forward to talking with you again following the fourth quarter.

Operator

And this concludes today's conference call. You may now disconnect.

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