CalAtlantic Group's (CAA) CEO Larry Nicholson on Q4 2016 Results - Earnings Call Transcript

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CalAtlantic Group, Inc. (NYSE:CAA) Q4 2016 Earnings Conference Call February 9, 2017 11:00 AM ET

Executives

Larry Nicholson - President & CEO

Jeff McCall - EVP & CFO

Analysts

Stephen Kim - Evercore ISI.

Alan Ratner - Zelman & Associates

Michael Rehaut - JPMorgan

Bob Wetenhall - RBC Capital Markets

Paul Przybylski - Wells Fargo

Nishu Sood - Deutsche Bank

Carl Reichardt - BTIG

Jay McCanless - Wedbush

John Lovallo - Bank of America

Ken Zener - KeyBanc

Alex Barron - Housing Research

Mike Dahl - Barlcays

Operator

Good morning and welcome to the CalAtlantic Group's 2016 Full Year and Fourth Quarter Results Conference Call. Today's conference is being recorded.

Before we begin, I would like to direct your attention to the Company's notice regarding forward-looking statements 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 and a recording of today's presentation will be made 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 Larry Nicholson CalAtlantic's President and Chief Executive Officer. Please go ahead, sir.

Larry Nicholson

Thank you, Jessica and good morning everyone. Joining me on the call today is Jeff McCall, our Chief Financial Officer. We completed the merger of Standard Pacific and Ryland on October 1, 2015. We are pleased for the first time to be able to provide with you actual year-over-year comparisons over the performance of the combined business for the fourth quarter. For the full year we are providing pro forma comparisons for the entire merged business as if it had been operating as one business beginning on January 1, 2015.

We caution you that we were not actually operating as one business for the first three quarters of 2015 and that if we had been operating as one business results would have been different from those presented here.

2016 was a transformational year for CalAtlantic. Over the past 15 months we merged two great companies, integrated two tremendous cultures and defined the CalAtlantic way. Over that time, we’ve inventoried virtually every process in the company and deployed talented team members throughout the organization to develop a set of best practises.

Sometimes that entailed choosing the best practice from one of the predecessor companies, sometimes it was a combination of both companies practises and sometimes it was learning from the past to develop a new way of doing things. These best practises have been rolled out and implemented throughout the majority of the business and we are excited about the positive changes we are already starting to see.

At the time of the merger, we outlined our targeted product mix of 30% entry level, 50% move up, l0% luxury and 10% active adult. Our land acquisition efforts have been targeted at our [desire] product mix and we are starting to see progress from those efforts.

Over the past year we have grown our entry level from 20% to 24% of our deliveries, reduced our move up concentration from 69% to 66%, reduced our luxury from 10% to 7% and increased our active adult offerings from 1% to 3%.

As we look out over the headlights based on the land that we own today and have under contract, we expect to see a material increase in our active adult presence which should be approaching 10% by the end of next year.

With much of the heavy lifting behind us, we are well positioned for a solid 2017 where our focus will be on execution and continuing the profitable growth of our company. All the while ensuring we have polled the CalAtlantic brand promise of delivering superior communities and homes through innovative design and architecture while providing exceptional customer service.

Turning to the fourth quarter. 2016 fourth quarter net orders were up 6% to 2,848 homes with the value of those orders up 7% as compared to 2015 fourth quarter. During the quarter we averaged 580 active selling communities essentially flat from the prior year period.

New home deliveries were up 14% compared to the 2015 fourth quarter to 4,338 homes with an average selling price of 450,000 up 3% from Q4, 2015. Gross margins from home sales was 21.8% compared to 19.8% for the 2015fourth quarter.

Net income for the Q4, 2016 was $167 million or $1.25 per diluted share as compared to net income of $77.5 million or $0.56 per diluted share for the 2015 fourth quarter. Our land purchase and development cost for the quarter were $436 million as compared to $398 million for Q4, 2015.

In addition, we repurchased 3 million shares during the quarter at an average price of $32.10 in the total expenditure of $95.1 million.

Turning now to the full year. 2016 net new orders were up 4% to 14,435 homes with the value of those orders up 7% as compared to pro forma 2015. As of December 31, 2016 our backlog stood at 5,817 homes up 4% in number and 4% in value compared to December 31, 2015.

New home deliveries were up 13% year-over-year to 14,229 homes with the average selling price of 447,000 up 6% from pro forma 2015. Home sale revenue were $6.4 billion, up 20% of pro forma 2015. Pre-tax income for 2016 was $753,000 million versus $516 million for pro forma 2015.

Our land purchase and development cost were flat year-over-year at approximately $1.6 billion. Turning now to community count. We opened 202 new communities during 2016 including 43 in the fourth quarter.

We ended fourth quarter with 583 active selling communities. For the full year 2016, we averaged 570 active selling communities up 2% when compared to pro forma 2015. While the timing of the new community openings and closing can often vary from projections, we anticipate delivery of low to mid-single digit community count growth in 2017, weighted more heavily on the second half of the year.

On the land front, we spent approximately $436 million on land and land development in the fourth quarter bringing our 2016 total to [$1.6 billion]. As we enter 2017, we have approximately $500 million committed to land acquisition and estimate an additional $800 million to be spent on land development.

Land continues to be a top priority from a capital allocation perspective, as our land pipeline remains strong and we continue to find opportunities to meet our disciplined underwriting criteria.

Given our current land position, our operating teams are focused on identifying and acquiring land will result in new community openings in the first half of 2018 and beyond. As of the end of the quarter, we owned or controlled all of our expected average selling committees for 2017 and approximately 85% of our expected 2018 average selling communities.

On slide five, we break down our Q4 order activity across our four regions. As noted earlier, our net new orders for the fourth quarter increased 6% companywide, but then as you can see in the upper left hand graph, vary by region from up 23% in the north to down 3% in the southwest.

To get a better picture of the order performance across the regions, it is important to factor in the change in community count and focus on the order absorption rate. Across the company, order absorption rate was up 5% over the prior year, but vary significantly by region, from 21% in the West where every division other than Phoenix are double-digit increases in absorption rates to down 6% in the southeast.

In the Southeast, Florida was flat year-over-year, and the Carolinas were down 14% led by Charleston, which was down from 1.9 to 1.3. We saw a solid absorption increase in the Southwest where strong gains in Colorado, Austin, and San Antonio were partially offset by a decline in Houston.

Our order value was up 7% across the Company ranging from up 25% in the North, where every division was up double-digit to up 1% in the southeast. The average selling price of new net orders was up 1% across the company and ranges from up 5% in the Southwest to down 4% in the West.

ASP was up in every region with the exception of the West, largely attributable to community mix in San Diego, where our ASP dropped from about 1 million to about 800,000. Before turning the call over to Jeff to share some details on the quarter, I’d like to spend a few moments updating you on the start of 2017.

While we caution you that it is difficult to draw any meaningful conclusion from one month’s worth or orders, we recorded 1,138 net sales in January up 3% from the 1,105 in January last year. Incentives and orders in January ticked down from 6% in the fourth quarter to approximately 5% in January.

I’d now like to turn the call over to Jeff, who will provide some more detailed information regarding the fourth quarter.

Jeff McCall

Thank you, Larry. On slide 6, we dive a little deeper into our backlog. Our backlog value as we ended the quarter was $2.6 billion. The dollar value in backlog was up 12% year-over-year driven entirely by the focus on increasing units as our ASP and backlog was flat versus the prior year.

Of the 5,817 units in backlog, 2,757 unites are currently scheduled to close in the first quarter. The units scheduled to close in the first quarter have an estimated ASP of $445,000, down $5,000 from the $450,000 ASP of our fourth quarter deliveries.

The homes sold and closed in the first quarter will impact reported results up or down from those backlog figures. Typically, the homes sold and closed in the quarter are more concentrated in our communities with lower ASPs than the homes in backlog. The homes sold and closed in the fourth quarter had an average ASP of $446,000.

On slide seven, we break out our deliveries in a little more detail. As we mentioned earlier, deliveries in the fourth quarter were up 14% versus the prior year period to 4,338 homes. The key drivers to deliveries are your beginning backlog and the amount of homes sold and closed in the quarter. The 2,757 homes currently scheduled to close in the first quarter will get adjusted down due to cancellations and changes to targeted closing dates of homes currently in backlog.

We currently expect a 97% to 103% backlog conversion on homes expected to close in the first quarter which is roughly a 45% to 50% conversion rate on the entire year and backlog. The anticipated gross margin of homes and backlog expected to close in the quarter is approximately 19.5%. This is down from the fourth quarter gross margin of 21.8% which benefitted from a positive mix impact related to more closings coming from higher gross margin communities.

When we dissect the decrease in gross margin from the fourth quarter reported results to the first quarter backlog expected to close, the impact is almost entirely attributable to our west region. The three key drivers to the decline are first, we polled high margin closings into the fourth quarter that were previously expected to close in the first quarter of 2017, second, the percentage of closings coming from the west which is our highest margin region is lower than in the fourth quarter due to the timing of closings and the growth in community that – outside of the west as Larry highlighted earlier.

And third, several of our high margin communities particularly in Southern California are approaching close out and contributing less closings. I would highlight that our total backlog gross margins stood at 20.4% at year end. With 47% of the backlog scheduled to deliver in the first quarter at 19.5% gross margin, the remaining 53% of backlog stood at 21.2%.

On slide 8, we provide the SG&A trend over the past five quarters, including a breakout across four main expense categories. In the fourth quarter of 2016, our SG&A was 9.8% of revenue down 50 basis points from the third quarter and down 50 basis points from the prior year.

The 9.8% represented the lowest quarterly SG&A rates since the merger. By expense category, G&A was down 60 basis points year-over-year and 40 basis points versus the third quarter due to the leverage associated with higher revenue.

Insurance, which [weighs] directly with revenue was flat at 60 basis points year-over-year and quarter-over-quarter. Incentives have remained consistent throughout the year, incentive cost have remained consistent throughout the year at approximately 1% of revenue which was down 30 basis points year-over-year. Selling expenses ticked up 30 basis points year-over-year, but remained constant quarter-over-quarter at 5.1%.

On slide 9, we provide key balances from our year-end balance sheet. We ended the year with available liquidity of approximately $829 million including access to approximately $638 million of our unsecured revolving credit facility. Inventories of approximately $6.4 billion and goodwill associated with the merger of $970 million. We have senior notes payable of approximately $3.4 billion. Of the $3.4 billion in those payables our next maturity is $230 million in May. We ended the year with approximately $4.2 billion of book equity or a book value per share of $36.77, which was up 15% versus prior year and a tangible book value per share of $28.29.

Our net homebuilding debt to cap was 43.2% at the end of the fourth quarter, a 290 basis point improvement over the prior year. And with that, I will turn the presentation back to Larry for his final remarks before opening the call up for questions.

Larry Nicholson

Thanks, Jeff. Before we turn to your questions, I’d like to share with you our outlook. We maintain our positive view on the housing recovery, the fundamentals for housing are good despite the somewhat volatile political climate and the recent increase in interest rates. Consumer confidence, household formation, job and income growth, solid resale activity amid tight resale supply, and a tight supply of home sites in the prime locations we target continue to fuel our expectations of topline and bottom line growth.

Finally, I’d like to express my appreciation to all the members of the CalAtlantic homes team who worked extremely hard to make our successful 2016. I am grateful to each of you for your embracing our new company and look forward to seeing you in our upcoming Town hall meetings.

With that, I’d now like to open it up for questions.

Question-and-Answer Session

Operator

[Operator Instructions]. And we will take our first question from Stephen Kim with Evercore ISI. Please go ahead.

Stephen Kim

Hi, thanks very much guys, strong quarter. Wanted to talk about the -- one of the reasons you gave for the gross margin and backlog being around 19.5, I guess first of all the you had mentioned that there were a couple of communities, I think [Indiscernible] legacy sort of creating a little bit of having an effect on that. I was wondering if you could maybe quantify that relative to the other two factors you had mentioned in terms of the impact on the margin.

And also if you could give us a sense for how as things progress in those two communities as well as maybe the one you have coming up in Dublin, how that’s going to affect ASP and potentially margin as we look through the course of the four, upcoming four quarters of 2017?

Larry Nicholson

Yes, I’ll take a shot at that one, thanks for your question. We don’t comment on a specific community margins, but you are correct that there are a few large master plant communities that have less deliveries coming out of Southern California as you noted. When some activity convenes there as well as master plan coming online in Northern California, close to the middle part of the year we would expect to get a positive margin impact from that, but we don’t want to comment specifically on specific margins.

Stephen Kim

Got it, okay. And then, I guess tied into that, you had I think mentioned about community account being positive but maybe more backend weighted, was curious as to whether we are talking about flat to maybe down community account in the first quarter. I think could you just give us sense for sort of what the trajectory was like, is expected to be like for community account. And then also if you could comment on any -- how the orders going to float in 4Q month by month, were there any kind of trump bump or something like that post November?

Larry Nicholson

As far as community accounts, we expect to be slightly positive basically each quarter, but growing a little bit more on the second half of year. So no material quarter-by-quarter slings, but yes of course that’s also due to timing of close outs which can vary dramatically.

As it relates to monthly trends. On the order side, in the fourth quarter, 966 in October which was up 6%, 939 in November which was up 2%, 943 in December which will was up 8% and as Larry mentioned 1138 in January which was up roughly 3%.

Operator

And we will take our next question from Alan Ratner with Zelman & Associates. Please go ahead.

Alan Ratner

Hey guys good morning, nice quarter. So Jeff, I appreciate that the color on the margin and backlog though the West impact there definitely makes a lot of sense. I guess thinking about that from the other side though, if you look at the region that has posted the strongest order growth, it’s the north by far, also the strongest community count growth in your backlog there is up about 30% year-over-year. That region is entirely on Ryland, so presumably the margins on those are going to be several hundred basis points below like I see [Indiscernible] I think you mentioned and 18 to 20 you might be aware that, that Ryland piece normalizes out. So as we think about the community count growth going forward and the regional breakouts this year at your fixed swings from region to region, how should we think about where you expect the growth to come from? Is it going to be more evenly distributed across your regions and as that maybe the north comes closer to the company average, does that provide a tailwind gross margin going forward? Thank you.

Jeff McCall

Yes, great question Alan and yes you are correct I think on virtually every point. So the north region did entirely come from legacy round, and the side of the business which meant that every lot there was subject to purchase accounting, which does compress the margins a bit. So as we move further away from that acquisition day, we bring it on more communities that weren’t as impacted by purchase accounting and we are seeing in the north a positive trajectory in the margin which we are pretty excited about.

As it relates to geographic splits amongst the growth in the market. We are not projecting too much change from where we are right now. So a lot of the growth coming out of – in the north is now in our book. So right now from a community count perspective north represents basically 24%, Southeast 33%, Southwest 28% and West 15%. As we look out through 2017, full year we are expecting north to be around 25%. Southeast to 33% and Southwest to 27% so and west remaining at 15%.

So you won’t see much change in the geographic makeup from what we currently have in the fourth quarter with the exception of the southwest going down a little bit.

Alan Ratner

Perfect. That’s very helpful Jeff. And second question along the lines and the margins. So if you look back the last several quarters, you’ve consistently exceeded the gross margin on deliveries one quarter out versus what you highlighted was in backlog and during that quarter release on delivery is expected to deliver that quarter.

And I know there is a lot of moving pieces, you have to inspect sales, there is also issues and when you close out the communities and there are some shoot up on costs there. Maybe just help us think a little bit about how we should project that out going forward. I think the average has been about 80 basis points where you’ve actually come in ahead of what’s in backlog, so should we be cautioned now to assume a similar trend going forward and if so why not? Thank you.

Larry Nicholson

Great question, Alan. I’ll take that one so. There is a number of reasons why the reported gross margin in a given quarter can vary, some of the backlog expected to close both up and down, but we feel that the backlog is expected to close numbers is a solid baseline for setting expectations. And then so first is the population in the fourth quarter for example 17% of the deliveries in the fourth quarter were not in the beginning backlog population. This can have a positive or negative impact on the gross margin.

Second is additional option revenue. Some of the home and backlog have not completed their design center appointments and therefore there maybe additional option revenue which typically has very solid margins. Third, the backlog margin is at [the lot] level. The reported margin factor and other puts and takes. For example, the warranty staff is a period expense that reduces our gross margin, less impactful on the fourth quarter given the large revenue base and more impactful say in the first quarter revenue was lower.

And fourth is the greater of logic using calculating our backlog margins. For the calculation of the backlog margins we used the greater of our current cost by category where the cost actually booked on the lot. In a rising cost environment this adds a bit of conservatism. So there are a number of puts and takes, but that’s really the main ones that have affect on your question.

Jeff McCall

And just the only thing I would add is you’re right. I think in three of the last four quarters the actual reported results were higher than the indicative backlog and margin.

Operator

And we will take our next question from Michael Rehaut with JPMorgan. Please go ahead.

Michael Rehaut

Thanks, good morning everyone. Just kind of following on some of the questions around margins and I contracted being a little duplicative here my questioning, but just trying to get a sense of how to think about 2017. It’s very helpful. I think in your prepared comments talking about if you strip out what you expect to close in the first quarter that the remaining margin backlog is a little over 21%. Obviously that kind of leads the back half of the year subject to the spring selling season, but given how your current community and incentive trends are right now, if we were just assume kind of similar trends to what we’ve seen in other words not a spike in labor costs, perhaps a steady-ish type of pricing environment in the first half. Is that 21% kind of a good way to think of the back half of the year, because obviously there’s been a little bit of moving mark here with the gross margins, first we were thinking more around 22, then obviously you had some pricing adjustments with some underperforming communities in the third quarter of this past year, so just trying to gauge what’s the right way to think about it?

Jeff McCall

Yes. Great question, Mike. Mike, I’ll jump in and then Larry can add. Again, I might miss on here. But we don’t give specific gross margin guidance. I think the best indicator that we do give is our full backlog gross margin which is mid-20s right now, but we did try to highlight for you that our gross margin. We expect to increase as we go throughout the year, it could be a little bit bumpy, but we are expecting to get that backup in that or hopefully above that 21 as we progress through the year.

Michael Rehaut

Okay.

Larry Nicholson

Yes. And I’d just add to that Mike, I mean, obviously we’re focused on improving margin, right, where we can get price we’re going to push to get price and see where we can pick up on the revenue side whether its option revenue, lot premiums, controlling incentives and then looking at cost on the production side. Our costs material increases have been modest lately, so we hope that trend continue, so we got lot of different levers we’re looking at and pulling on,

Michael Rehaut

Right. That’s fair. Second question going to some your comments earlier Larry on the demographic shift that they started to see you across entry level, move up luxury active adult, and you mentioned particular active adult you hope to get that contribution to ramp 10% of our your business by 2017 end. I was curious if you could also share thoughts around the entry-level and if that mix shift would have all else equal any type of impact on margins or grows for that matter if your – for example the entry-level which is typically a little bit of a higher observing type of dynamic, what those ships might do margin and pace of growth?

Larry Nicholson

Great question. So, we underwrite everything to the same metrics, right, so 20% gross margin and the 20% IRR, whether it’s an entry-level product or active adult. That being said obviously you have better pricing power at the active adult level than you do at the entry-level. So, I think as we look out over the headlights we would expect to see a little bit better margin in that active adult component. What we have opened today would give us that comfort level based on what we’ve seen in both from absorption pace and from a pricing pace, so we feel real good about that.

At the entry-levels we continue to grow that. You're right, when you look across the four segments obviously the absorptions are at the highest space and we think that will continue, and we continue to retool in markets and in open more and more entry-level communities and hopefully we can continue to push that that number and get it back up to around that 30%, but we see the runway in front of us, we’re going the right way and we’re comfortable that with disciplined underwriting we can continue to put up good margins and good absorptions.

Jeff McCall

Mike, just to add one thing in Larry’s prepared remarks getting to a 10% at the end of next year, so its end of 2018 not end of 2017. And then a couple of data points that that we’ve got. If we compare our margins from entry-level to a first move up, in the last three quarters the margin differential was 10 basis points in the second quarter, 20 basis points in the third quarter and 30 basis points in the fourth quarter. So does margins are coming in really close and as Larry said, we’ve got similar expectations.

Operator

And we will go next to Bob Wetenhall with RBC Capital Markets. Please go ahead.

Bob Wetenhall

Hey, good morning. You guys mentioned you’re looking for mid-single digit -- sorry, low single-digit community count growth in 2017, and if I remember correctly, you guys had previously said kind of like mid single-digit and I just wanted a clarification. Are you slowing down community count growth? And your prepared remarks sounded kind of optimistic about demand, so that would lead me to think you would be accelerating openings. Can you just help me understand directionally what you are thinking?

Jeff McCall

Yes. So, I think we’re still on a low to mid single-digit kind of plan, Bob and looking at that. And obviously as communities are rolling off and new communities are rolling on we do expect to see some pickup in that actual absorption pace based on price points. As I said, the entry-level product which will be open more of the paces higher and will be open in more active adult and actually the base is higher there.

So, we do expect to see through the year a little pickup in absorption pace. I think when we look at the whole space and think about community count growth we think that there's a lot of markets out there today that have reached maximum community count growth and are going to start to recede based on what's coming through the pipeline which would lead us to believe that absorptions would go up.

Bob Wetenhall

Got it. And so, just thinking about quarter growth and your backlog and everybody -- homebuilders challenging a balancing price versus pace, you had a very good margin, a very strong gross margin which looks like it's shifted lower based on the backlog guidance and just in the current environment as you try to accelerate volume and order growth, do you see gross margins moving in 2017 down to the 20% range, so when people are thinking about long-term growth of the business you are saying we’re going to get more order growth but margin will be closer to a 20% range. Is that the right framework for thinking about profitability as you move through the cycle?

Larry Nicholson

Well, as Jeff said earlier, we don’t give full guidance. I think what we would tell you is that what we see that will be open it up, we’re confident in our margin, continuing to be at the higher end of the spectrum and being strong again this quarter and in the first quarter rather just really a mix issue. So, again we’re focused on taking price where we can take it. We got a lot of new communities that will open up through the year that we think are stellar communities that will contribute to that.

You heard that in the -- I think in the first conversation we got some larger communities in Northern California that we expect to have the impact on the company. So, we’re optimistic that we can continue to put up good margins.

Operator

And we will go next to Stephen East with Wells Fargo. Please go ahead.

Paul Przybylski

Thanks. Thanks. This is actually Paul Przybylski on for Stephen. My first question revolves around absorption rates quarter over quarter. They slowed meaningfully from the third quarter on and it's an easier comp and I was wondering if you had reduced your effort to bring those lower quartile communities up to more acceptable sales paces?

Larry Nicholson

There’s a normal seasonality that we see in the business and what we saw with our orders overall, its up 6% with absorptions gains driving the majority that increase which was pretty close to our expectations. We always want more, but clearly we want more at the right price. When you breakdown our order performance over the last couple of quarters as you mentioned, in the third quarter we had 9% increase in year-over-year absorption rates, and that beat seasonality by about 10% in the third -- from second to third quarter typical seasonality is down 19% and we were down 10%. And then in fourth quarter we believe our orders were solid where absorptions were up year-over-year in three or four regions, but that was slightly below the normal seasonality which is I think in the fourth quarter we were down 21% versus the three-year average of down 18%.

So we may pull a little bit of the Q4 demand into Q3 potentially, but overall I think we’re not taken the foot off the gas. We want orders. We want lots of them. We want good margins and I also note that in the fourth quarter our incentives and our orders tick down 30 basis points, which is not that typical for the fourth quarter. So I think we are in a good position starting off the year and it’s all about spring selling season.

Paul Przybylski

And then, you've had some difficulty in San Antonio the past year. I was wondering where you stood on repositioning that product towards the entry-level market and also with respect to that market, have you seen any hesitation on the entry-level buyer given that they probably have one of the lower relative incomes across the country?

Larry Nicholson

Yes. To your point, yes, we are repositioning the division, Paul and we’re moving towards the entry-level to under $300,000 price point, today we’re about 315. We did see you orders tick up in San Antonio. They were up 7% year-over-year. So we’re starting to see some of that come through on the execution side. The market still seems healthy at the rice right price point. But I do think when you get above that 300 we do see softness, so our focus will be reposition and trying to pick up absorption and increase margin.

Operator

And we will go next to Nishu Sood with Deutsche Bank. Please go ahead.

Nishu Sood

Thanks. You mentioned pricing relative to costs that's coming a little bit more into alignment. I was wondering if you could dig into that a little bit more. I think the comments out there about labor in particular still sound pretty bad, so I was wondering if you could dig into that a little bit, that just on the materials and products side? What is the overall basket doing and if there is any regional color that is interesting there, if you could provide that as well, please?

Larry Nicholson

Yes. So we’ve seen and as I said relatively modest labor and material increases through the year in 2% to 3% range across the country and that does vary a little bit. The labor markets that are still the probably the most difficult are Dallas, Denver and Phoenix. They continue to be extremely stressed but we’re happy to report that we've seen some improvement there with some vendors we been able to sign up particularly Colorado.

We signed up a new large framing company that's having a great impact on the business. I would tell you that land cost is impacting margins the most still because obviously land cost is continue to escalate, so we’re just trying to make sure we’re discipline in our underwriting and making sure we’ll negotiate to get the right terms so we can get margin in return. But I think right now at the beginning of the year we feel little bit better about labor materials than we probably did at the beginning of the fourth quarter.

Nishu Sood

Got it. No, that's helpful. And at the risk of killing this issue dead, on the gross margins, I think that -- obviously that's going to be the main focus or one of the main focuses coming out of this call. If I could summarize, I think that a lot of folks are going to hear the comments about the West region and communities selling out, a shift out of the West which have typically driven higher margins, and I think investors are going to hear that is a headwind, which really cannot be directly addressed or reversed.

But later on, obviously in your discussion about gross margins, you’re expressing confidence in the ability to be able to drive them back -- to be able to drive them back up to the 20s or maybe even 21 and above. So, how do we reconcile that? I mean the confidence level, it does seem like the mix shift and the California issue is pretty much set and whereas the ability to counteract that is more contingent on what market conditions are going to be. So how should we reconcile that those two different facets of that?

Larry Nicholson

Well, I think the California comments and we said earlier that we have some things that are opening up in the second half of the year in California that will have an impact, a positive impact on margins. So, a lot it just timing in California. Obviously the business in the North has grown dramatically over the last year and as Jeff said we see continued improvement in those margins, we’re happy with what we see there.

So I think we look across the global space. I think we feel pretty comfortable that we’re in a good spot. We need to get our communities open and we need to continue – and we need to have a strong selling season and raise price where we can, but we feel were extremely well-positioned.

Operator

And we will go next to Carl Reichardt with BTIG. Please go ahead.

Carl Reichardt

Hi, guys. How are you? I wanted to ask a little bit about land spend, I think you’ve got a declining 15%, 20% for next year. and I wondered if that was just a function of the mix of lots that seem to shift -- to finish into raw and out of the developed based on the stuff you put in your release, or if that's something else going on, a conscious desire to shrink lot count going forward?

Jeff McCall

Well, first Carl, welcome back.

Carl Reichardt

Thanks.

Jeff McCall

Just to clarify on the comment. So, we talked about on land spend is what we currently are committed to acquire as of the end of the year in 2017 obviously throughout the rest we will be adding to that number. And so, we would expect land spend to be most likely above 2016 in 2017.

Carl Reichardt

That makes a lot more sense; sorry if I missed that. Thanks. And on that line, as much changed in the last couple of quarters regarding the availability of lot options, third-party developers or your expectation that is going to continue to be really hard to find those guys?

Larry Nicholson

Yes. Market by market, but I do think it still difficult to increase your option inventory and when you look at risk reward and price in the margin and all that, you got weigh both side, so we think we can do sometimes just outright buying it, then we can get a better margin, a better return because of a discount. So, you got to look at every deal, every deal it's not easy to underwrite. As we've said and so as anybody else in the industry, but there are still opportunities out there. We continue to buy lots in every market and are able to get things to underwrite, so we think that will continue and hopefully we’ll see some more developers come in through the recovery as the banks loosen up a little bit, hopefully will see some more developers come back in.

Operator

And we will go next to Jay McCanless with Wedbush. Please go ahead.

Jay McCanless

Hi, good morning. First question I had, and I apologize if I missed this. Have you guys talked about how far along you are with the community revitalization efforts for the 25% of your community count that was underperforming? And if you're still working on that, when do you think that's going to be completed?

Larry Nicholson

Well, I would say ongoing going obviously Jay, but we focused on it. It’s kind of a core of any homebuilding business. We made progress absorbing at a half a ton better in seasonally slow fourth quarter versus the second quarter. It has come a little bit of cost. Some of those margins are in the mid-teens, but you once we find pace as we go into selling season we feel like we can start to raise prices well, and I think we feel on lot of those communities we’ve reach that point. But you we continue to watch those on a regular basis and its part of everyday business.

Jeff McCall

But just to clarify we always going to consider a bottom quartile, so there’s always bottom quartile, on that there is specifically 25% that were under performing, it is a bottom quartile.

Jay McCanless

Got it. Okay. Second question I had, can you talk about sale…

Operator

I do apologize his line has cut off. We’ll go next to John Lovallo with Bank of America.

John Lovallo

Hey, guys. Thank you for taking my call. First question would be, how are you guys thinking about your ability to drive SG&A leverage in 2017?

Jeff McCall

John, I’ll take a step at that. We had pretty progress. We reduced our SG&A by 100 basis points in 2016 versus 2015, so we’re proud of that. And as you look I think in the stack rankings, we’ve got one of the leanest overheads, but we do look to continue to leverage that. Our ultimate goal is to get down ideally into the [9s] that’s not good happens in 2017 will be tough sledding for 2018, but would like to make some progress towards that. So we’re looking for probably in the 20 to 30 basis points this year, but it did remains a key focus and part of the cost conscious culture.

John Lovallo

Okay. That's helpful. And then in terms of share repurchases, how you guys thinking about that relative to maybe a quarter or two ago? Is there any increased appetite here for potentially share repos?

Jeff McCall

As you saw in the quarter we spend about 95 million, also share repurchase bought back almost 3 million shares. We’ll continue to look at share repurchases opportunistically and really from a value perspective, when we look out over the longer term and what we see ahead of our business, we think the stock prices in those low 30s are very attractive. So we have push some capital allocation in that direction and we’ll continue to do it opportunistically.

John Lovallo

Okay. Thanks guys.

Operator

And we will take our next question from Ken Zener with KeyBanc. Please go ahead.

Ken Zener

Good morning, gentlemen.

Larry Nicholson

Hi, Ken.

Ken Zener

It just kind of broad question, but the West is obviously a big market and it’s not specific to the gross margin necessarily, but how do you balance the structural elements of the West? When the 10-K comes out, we will have a clearer view, but it looks to be about half of your EBIT comes from the West, led by California, and how did the difficulty of growing volume cyclically here because it's so constrained and – et cetera, et cetera., and it leads to these type of gaps of EBIT contribution. That's my first question.

And the second one and then I'll pullback is, what is the impact on overall SG&A leverage when you have a region like this that's so high-priced? What impact could that slowly have on your overall SG&A leverage? Thank you.

Larry Nicholson

So, to your point it is somewhat choppy in the land buying process sometimes in California and timing and entitlements are extremely difficult. And so I think as we said previously as we look out over the headlights is what we have on board to come open later in the year in California, we’re very excited about and because it is always constrained historically it’s been a higher-margin environment in the West than in the rest of the country.

From an SG&A standpoint it’s a division by division drill based on their revenue and they need to make sure that they are making their adjustments and we’re looking at it at the local level or the lot level and making sure that everybody run their business efficiently not saying hey we got somebody that provides a lot of revenue so we can hide things, but it’s a division by division and our groups pretty good about making sure we don't hire people early, we monitor our marketing efforts to make sure we’re getting results for them. So I think we have a pretty good process in place. And I think will continue as Jeff said earlier we’ll be disciplined and we watch this every month and every quarter.

Ken Zener

Thank you.

Operator

And we will take our next question from Alex Barron with Housing Research. Please go ahead.

Alex Barron

Yes, thanks. So you’ve mentioned that the orders in January were up 3%. I was wondering if you could give any color whether some -- that's pretty much across the board or is there some regions that are doing better, some doing less than that?

Larry Nicholson

Yes. I would say we feel pretty good across the board, Alex, we’re really excited that the super bowl past us and we’re officially into the selling season and hopefully we see escalation in the near term, but January was solid, traffic was solid, quality traffic was solid, interest rates really seem to be playing, no negative effect on the buyer psyche. So I think we’re optimistic and looking forward to the beginning of the selling season.

Alex Barron

Okay. And as far as interest rates are concerned, I know it’s only about 50 basis points and you just said it hasn't had much of an impact, so how are people actually dealing with that in your experience? Are they trading down to a slightly smaller home? Are they putting in less options or are they just paying up more for the home they wanted?

Larry Nicholson

Yes. I think if we look at our mortgage business and we look at the leverage that people have, most people can afford more, I think that’s a one good thing we’ve seen over the recovery is people are overspending, their balance sheet still pretty healthy. So that's point one. Point two is if somebody is at that point it probably put less options in the bigger house to start with because they can add hardwood floor later granite countertop, whatever.

And then some people will just opt for smaller square footage, couple hundred feet same room count at a little less price, so they can put the amenities in, but so far our operators in the field have not seen anything negative in their opinion on the traffic.

Operator

And we will take our last question from Mike Dahl with Barlcays. Please go ahead.

Mike Dahl

Hi, thanks for taking my questions.

Larry Nicholson

Hi, Mike.

Mike Dahl

Wanted to get a sense going back to some of the comments around land spend or also the escalation in costs. So a lot of builders are talking about exercising more discipline right now. You're seeing kind of a mix and what we're seeing out of land budgets, but I'm curious just to hear your comments on what you're seeing competitively from the -- in the land market just given costs continue to escalate. Are you seeing non-traditional competitors come into the market or is it still primarily the public's -- other publics that you are competing against?

Larry Nicholson

Great question. We have seen the same publics I would says competitively showing up. The one thing I will say which is great is the discipline has been good when prices have got to the point that everybody’s pushing back. We haven’t seen anybody do things anything which I would say is unique. There are more third party off balance sheet guys around today, they have resurfaced. We don’t have any of our communities in those, we feel like, we don’t want to pay a higher price on the for those deals, but there are we are seeing more and more builders put some things to the off-balance-sheet side of the business, but we are going to stay the course as we always have. We have capital, we’ll buy t he deals ourselves and develop them because we like to control and we like the margins and the returns.

Mike Dahl

Thanks. And just following on, on that from a second. The acquisitions spend this year or what’s already been committed and what you expect to substantially add to that, what year is that geared towards as far as when those communities would come online?

Larry Nicholson

It will be 2018 and beyond. We have about 85 % of what we need for 2018. So it’s going to be 18 and the large inventory product will be 19 late 18...

Operator

And we have no further questions. I would like to turn the call back over to the presenters.

Larry Nicholson

Thanks, Jessica and thank you everyone for joining us today. We look forward to sharing our results with you again in a few months. Thank you.

Operator

This does conclude today's program. Thank you for your participation. You may disconnect at any time.

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