William Lyon Homes' (WLH) CEO Matt Zaist on Q4 2016 Results - Earnings Call Transcript

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William Lyon Homes (NYSE:WLH) Q4 2016 Earnings Conference Call February 22, 2017 12:00 PM ET

Executives

Larry Clark - IR

Bill Lyon - Executive Chairman and Chairman of the Board

Matt Zaist - President & CEO

Colin Severn - SVP & CFO

Analysts

Michael Rehaut - JPMorgan

Alan Ratner - Zelman & Associates

Will Randow - Citi

Jay McCanless - Wedbush Securities

Alex Barron - Housing Research Center

Operator

Welcome to the Fourth Quarter and Year-End 2016 William Lyon Homes earnings conference call. My name is Shannon and I will be operator today. [Operator Instructions]. Now I would like to turn the call over to Mr. Larry Clark, Investor Relations for the Company. Please go ahead, Mr. Clark.

Larry Clark

Thank you, Shannon. Good morning and thank you for joining us today to discuss William Lyon Homes financial results for the three months and full year ended December 31, 2016. By now you should have received a copy of today's press release. If not, it is available on the Company's website at www.lyonhomes.com.

The press release also includes a reconciliation of non-GAAP financial measures used therein. In addition, we're including an accompanying slide presentation that you can refer to during the call. You can access these slides in the investor relations section of the website. Before we continue, please take a moment to read the Company's notice regarding forward-looking statements which is shown as slide 1 in the presentation and included in the press release. As explained in the notice 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 and the Company does not undertake any obligation to update them.

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. With us today from management are Bill H Lyon, Executive Chairman and Chairman of the Board; Matt Zaist, President and Chief Executive Officer; and Colin Severn, Senior Vice President and Chief Financial Officer. Now I'd like to turn the call over to Bill Lyon.

Bill Lyon

Thank you, Larry. Welcome ladies and gentlemen and thank you for taking the time to join us today. 2016 was another year of consistent growth as we increased the number of active selling communities across our existing geographic footprint and achieved meaningful year-over-year increases in closings, revenues orders and pretax income. Home building revenue for the full year 2016 was $1.4 billion, representing a 30% increase over 2015. Deliveries were up 20% year over year to 2781 and pretax income increased by 18% to $102.8 million. These figures represent the highest number of new home deliveries and home sales revenue achieved by the company in 10 years. During 2016, we also generated the highest annual number of net new home orders in 11 years.

We continued to benefit from the ongoing housing recovery this past year. Implementing same-store price increases across a number of our markets which helps to offset some of the increased costs on the land and labor sides of the business. We also experienced an annualized sales pace that was consistent with the prior-year and which followed its typical seasonal patterns as the year progressed. We closed the year with strong operating and financial momentum in the fourth quarter, delivering 902 homes up 11% from the fourth quarter of 2015 and at the highest level in 10 years. We generated $473 million in home sales revenue in the quarter, up 19% from last year's fourth quarter and representing our 18th consecutive quarter of year-over-year growth.

As we enter 2017, our Western markets continue to exhibit favorable economic conditions including high population and job growth and strong demand for housing. We believe that we have attractive, strategically located land positions that will generate continued revenue and profit growth. We remain focused on delivering strong results and attractive returns to our shareholders in a 2017 and beyond. 2016 represent a significant milestone for the company, as its 60th year of homebuilding operations. Before turning the call over to Matt, I would like to say a few words regarding our recent transition for our company's namesake, my father general William Lyon. As the Company previously announced, my father has decided to retire as an active member of the company's Board of Directors.

On behalf of myself, Matt and all of our fellow Board members, I would like to thank my father for his decades of service and stewardship on the Board and for his visionary leadership and the strong foundation he has established for William Lyon Homes. This decision comes as he approaches his 94th birthday in the coming weeks. We look forward to celebrating with him and continuing to benefit from him as a resource to myself, Matt and the Board in his continuing role as chairman emeritus of the Company. With that, I will now turn the call over to Matt for additional details on fourth quarter and full-year operations. Matt?

Matt Zaist

Thanks, Bill. 2016 was another year of significant growth for William Lyon Homes. As we continued to mature and make improvements across our operating platform. Through our strategic acquisitions and organic growth over the past several years, we're more geographically diverse than any time in the Company's history, while keeping our focus on core Western markets. We maintain a balanced approach in terms of product and buyer segments, with the ability to continue to drive focus on the entry-level buyer and adapt to changing market conditions. Over the last five years, a number of new home closings has increased nearly threefold and total revenue has increased nearly fourfold. In each of the last nine quarters, we've achieved an increase in gross profit dollars on a trailing 12-month basis and for the full year 2016 our consolidated pretax income was $102.8 million, up 18%.

At the beginning of a 2016, we laid out certain strategic initiatives with the goal of achieving a year of growth in orders, deliveries, revenue, profitability and community count while also improving the Company's balance sheet and leverage position. I am proud to say that we achieved these goals, improved our balance sheet and paid off a significant amount of debt by year end, while remaining in overall operational growth mode. We do not consider these objectives to be mutually exclusive and we would expect 2017 to be another year of growth in incremental deleveraging. Before diving into some additional details regarding our quarterly results, I would like to highlight some of the significant year-over-year achievements in certain of our divisions. Oregon delivered another year of impressive results with new home order growth of 27%, closings up 34% and homebuilding revenue up 46% than the prior year. We believe that we're the number one builder in the Portland MSA and hope to continue to capitalize on the compelling supply and demand dynamics in that market.

Our Colorado division continued to demonstrate a positive turnaround due in part to the new divisional management team and shift in product focused to more predictable portfolio of product, with absorption rates up 47% orders up 11%, homebuilding revenue up 20% and closings up 9%. In addition, Southern California we increased community count by 46% year over year, increased orders by 73%, closings by 54% and homebuilding revenue by 55%. Our new home orders for the quarter ended December 31, 2016 were 564 units, up 9% from the fourth quarter of 2015, marking the 23rd consecutive quarter of year-over-year increases in net new home orders. Our monthly absorption pace averaged 2.4 sales per community, up slightly from last year's fourth quarter pace at 2.3 sales per community. We finished the year strong from a net orders perspective with 181 orders in December 2016, up 19% from the orders achieved in December 2015. We're encouraged by our sales results thus far in 2017 which is off to a solid start, with net new home orders in January up approximately 12% year over year and up 25% sequentially from December. Year to date, 2017 is relatively consistent with January's performance, up approximately 14% year over year. Our sales teams have been able to achieve this strong year-to-date orders performance in the face of some challenging weather in certain of our regions, especially the heavy rains experienced in the Pacific Northwest and California. This gives us increased optimism heading into the balance of the Spring selling season as hopefully those weather conditions will moderate.

The dollar value of orders was $284 million during the fourth quarter, up 17% over the prior year. On a full-year basis, dollar value of orders was $1.4 billion, up 17% over 2015 and up 72% over a two-year period. Our backlog conversion rate for the quarter was 84%, a significant improvement from the 62% conversion rate that we experienced in the third quarter and a 600 basis point improvement from last year's fourth quarter of 78%. Enabling us to generate home sales revenue of $473 million in new home deliveries of 900 units, the highest quarterly levels of these metrics in over 9 years. As discussed on previous calls, we're implementing strategies to lessen the impact of labor constraints and increase cycle times in our business, such as a targeted spec start strategy in an effort to manage cycle times and deliveries on a more consistent basis. We made meaningful progress on this front in 2016, the number of homes sold and closed in the same quarter increased 15% year over year in the fourth quarter to 231 which represents approximately 25% of the total closings for the quarter. Complimentary to the spec start strategy across all of our markets, we continue to see increased demand from the entry-level buyer. Which made up approximately 48% of our homes closed during the fourth quarter and 47% of our homes delivered for the full year. We continue to believe that focusing on the best core geographic locations, where we have an opportunity to target the entry-level buyer through higher density new homes represents the most compelling growth opportunity for our Company.

We intend to maintain our focus on this buyer segment through the opening of some of our new key strategic assets that offer the lowest price points in some of the most compelling markets in the country to capitalize on this needs-based buyer in a low supply environment with rising rental costs. Our average sales price for homes closed during the quarter was $524,600, up 3% sequentially and 7% compared to the fourth quarter of 2015. ASP of homes in backlog at the end of the fourth quarter was $560,300 which is 7% higher than the ASP of homes closed in the fourth quarter. We ended the year was backlog of $411 million, up 5% over December 31, 2015. Units in backlog were 733, relatively flat from last year as a result of our strong backlog conversion rate during the quarter which I previously touched upon. We had an average community count of 79 communities for the quarter, up 7% year over year and up slightly from the 78 average communities during Q3 2016. We opened 36 new home communities during the year and ended with 81 active selling locations. Before I turn the call over to Colin to discuss further details regarding our financial results, I would like to spend some time discussing certain factors that impacted our bottom-line results for the quarter.

I am pleased with the results we achieved within our guidance ranges for home building revenue and deliveries for the full-year 2016. While our pretax and income results for the full year was within our guidance range, there was several factors that impacted our results and caused us to be in the lower half of the range on that metric. First, we experienced a higher than expected level of outside broker co-op for houses sold and closed within the same fourth quarter. Our G&A expenses were also higher than anticipated due in part to certain severance costs associated with divisional personnel changes and earlier than expected investment in CRM and construction management systems which had previously been scheduled for Q1 of 2017 and lastly, an increase in outside professional services. Those factors contributed to approximately $2.5 million of additional SG&A expense which accounts for a majority of the difference between our actual results and the midpoint of our pretax net income guidance range. For a discussion on our financial results, I will turn the call over to Colin before wrapping up with some commentary on our outlook for 2017.

Colin Severn

Thank you, Matt. Total homebuilding revenue for the fourth quarter of 2016 was $473 million, up 19% year over year from $397 million in the year ago period. The increase in home sales revenue was primarily due to an 11% increase in the number of homes delivered, combined with a 7% increase in ASP to $524,600 per home. During the fourth quarter of 2016, our homebuilding gross profit increased 11% to $81 million versus the fourth quarter of 2015 and adjusted home building gross profit grew 6% to $102 million. Our homebuilding gross margin percentage on a GAAP basis for the fourth quarter was 17%, compared to 16.6% in the third quarter and 18.3% in the year ago period. Our adjusted home building gross margin percentage was 21.6% during the fourth quarter, as compared to 24.2% in the year ago period and 22.2% in the third quarter. Turning to SG&A expense for the quarter, our sales and marketing expense was 4.5% of homebuilding revenue, compared to 4.8% in the year ago quarter. The improvement was primarily driven by higher homebuilding revenue and leverage on our advertising and marketing costs as compared to the prior year period, offset by an increase in outside broker costs.

General and administrative expenses were 4.5% of homebuilding revenue consistent with the fourth quarter of 2015 and up in dollars due to increases in expenses as Matt discussed previously. These combined for a total SG&A expense of 9% for the quarter compared to 9.3% in the fourth quarter of 2015. For the full year, the total SG&A expense was 10.4% of homebuilding revenues compared to 11.2% for 2015, an improvement of 80 basis points as we benefited from our top line growth. Ultimately, as articulated on prior calls, our target for SG&A leverage for 2016 was a 100 basis point improvement year over year. Our actual results were an 80 basis point improvement over the prior year, so still positive and trending in the right direction but below our goal. Income from our unconsolidated mortgage joint ventures increased by 23% during the quarter to $1.8 million, from $1.5 million in the previous year driven by an increase in volume as well as scalability on the fixed costs of debentures. Pretax income for the quarter was $40.4 million, up 6% over the prior-year period. For the full year, pretax income was $102.8 million an 18% increase year over year. Adjusted EBITDA was $63.2 million for the quarter and $188.1 million for the year, up 2% and 19% respectively. Our provision for income taxes was $14 million during the quarter for effective tax rate of approximately 34.6%, as compared to 29% in the fourth quarter of 2015. For the year, our effective tax rate was approximately 34%, up from 31% in 2015.

For the full year 2017, we expect our effective tax rate to be approximately 35% under the current tax code. Income attributable to noncontrolling interest was $3.4 million during the quarter and $8.3 million for the full year. Both up significantly from their respective prior-year periods due to an increase in deliveries from our consolidated homebuilding joint ventures and timing of those deliveries in the context of the overall lifecycle of debentures. All of these factors resulted in net income available to common stockholders during the quarter of $23.1 million or $0.60 per diluted share based on 38.7 million fully diluted shares. Our full-year net income available to common stockholders which was $59.7 million or $1.55 per diluted share. Our fully diluted share count for the year was 38.5 million shares. For the 2016 year, our land acquisition spending net of seller financing was $235 million and horizontal spend was $103 million for a total land spend of $338 million. For 2017 we expect approximately $210 million to $220 million of land acquisition spend and horizontal spend of approximately $140 million to $150 million. Turning to our balance sheet.

We ended the year with $1.8 billion in real estate inventories, $2 billion in total assets, total equity of $763 million and cash of $43 million. Our fourth quarter closings led to strong cash flow generation which allowed us to pay down debt of approximately $105.3 million during the quarter. Of the outstanding principal on our consolidated debt that was repaid, approximately $67 million was paid against our revolving credit facility and $36.6 million was related to our construction notes payable and seller notes payable. As of December 31, our outstanding borrowings under our revolver were $29 million and total liquidity was approximately $149 million. As of December 31, 2016, our total debt to book capitalization was 58.6%. Down by proximally 360 basis points from last year. Our net debt to net book capitalization was 57.6% at year end, down from 61.1% at the end of 2015. On January 31, 2017, we successfully completed a new $450 million senior notes offering at a very attractive coupon of 5.875%. We used the proceeds to pay off in full our existing 8.5% senior notes that were due in 2020 and originally issued in 2012. The lower coupon rate will save the Company approximately $10 million per year in interest costs. In addition to this significant reduction in the interest rate, the new notes will mature in 2025, approximately five years beyond the maturity date of the old notes.

We anticipate the net tax effected cost of the bond refinance to be approximately $13.9 million which will be a one-time charge in our Q1 2017 results. The return of cost on the charge giving effective at the interest savings, is expected to be approximately 17 months. Finally, as we disclosed in this morning's press release, our Board of Directors has authorized the repurchase of up to $50 million of the Company's class a common stock. Now I will turn it back over to Matt.

Matt Zaist

Thank you Colin. Before we open up the call to your questions, I would like to provide some additional information regarding our outlook for the year ahead. We believe that 2017 will represent another year of significant growth for William Lyon Homes. For the full year 2017, we currently expect results to include deliveries of approximately 3000 to 3250 new homes, home sales revenue of approximately $1.65 billion to $1.75 billion and pretax net income before minority interest of approximately $135 million to $150 million. Consistent with prior guidance, we expect community count by midyear to be in the mid-80 to 90 range. With respect to our full-year gross margin and SG&A percentages, we would expect each to incrementally improve year over year. And then the aggregate to improve by approximately 100 basis points between the two combined metrics. Overall, our 2017 forecast is a story of two halves as we expect to see meaningful deliveries in the back half of the year from our key strategic assets that we previewed on our prior conference calls. Such as our Bayshores committee and Northern California, Affinity in Nevada, Oaktree Preserve, Crossroads, Westridge in Washington and River Terrace in Oregon. We believe that these large-scale communities will produce significantly higher gross margins than our full-year 2016 results and provide an opportunity to really move the needle for us rounding out the year.

We expect these assets to represent approximately one-third of our second half 2017 deliveries and more than 40% of our homebuilding revenue, with an average GAAP gross margin in the low to mid 20s. Not included in this group is our Denver connection master plan community in Colorado which opens for sale late in the second quarter and is expected to deliver mid-20s gross margins as well. While not currently contemplated in our plans for 2017 from a closing perspective, we will have a meaningful impact on our 2018 results, we'll update you on the opportunity to enhance our 2017 plan as we move through the development on this asset over the coming quarters. In the near term for the first quarter of 2017, though, we expect gross margins to begin the year below the full-year rate we achieved in 2016 due to a low point in product mix within all of our divisions, such as the monetization of our previously underperforming assets in the Inland Empire in Colorado.

In the Inland Empire, sales activity has significantly increased across all price points, albeit at lower margins than the Company average. Our strategy is to continue push through these assets which should be helpful to our long term goals but will result in near term margin pressure. In addition, the rainy weather conditions experienced in Northern California and the Pacific Northwest late last year and year to date 2017, caused us to push a number of closings in those divisions out of the first quarter. Results of these factors in that the mix of our expected deliveries on the front end of this year is heavily weighted in our projects with margins that are lower than full-year 2016 and lower than what is currently in backlog for the whole company. All occurring at the same time without any corresponding positive offset. We expect backlog conversion rate in the first quarter to be in the percentage range of high 60%s to low 70%s. We also expect ASPs in the first quarter to be relatively flat to Q4.

We expect to see modest sequential improvement in gross margins from Q1 into Q2, with a meaningful pickup through Q3 and Q4 driven by the assets I highlighted. We need to execute and capitalize on the opportunity in front of us with our progress to date as well as consumer feedback gives us confidence in our anticipated timing and expected results. We believe the second half of the year will be more indicative of the value of our more recent land acquisition strategy and that the early results from these attractive assets will be a good indication of gross margin improvement in the back half of the year and heading into 2018.

Thank you for joining us today. I would now like to open the call to your questions. Operator, we're ready for the first question.

Question-and-Answer Session

Operator

[Operator Instructions]. Our first question is from Michael Rehaut with JPMorgan. You may begin.

Michael Rehaut

I appreciate all the comments and the forward guidance and details around that. I just wanted to clarify a couple of things and make sure I'm thinking about it right. When you referenced the positive mix going into the back half of the year with roughly 40% of revenue at low to mid 20s obviously, I assume that is pre-interest and just want to make sure that I have that right. Also, that I believe you alluded to but I wasn't fully clear that for 2018, are you thinking that the mix from those higher margin communities would increase past the 40% or would the 40% kind of be a baseline for 2018 that you would have the full-year benefit versus only a half a year in 2017? So any clarification there would be helpful.

Matt Zaist

Yes. Mike, it is Matt. Maybe I will paint a little bit of a more specific picture for you. In actuality, we're talking about relative to those specific assets where GAAP margin is inclusive of interest. We've talked about those being real needle movers for us. I have said before, I think we stepped back a couple of years ago looking at some of the land acquisitions that we made in 2013 and 2014 that probably were not underwritten as well as they should have. And also, it had a fair amount of exposure to the Inland Empire and we saw what happened when that got pulled back.

I think we have done a really good job of targeting very selective assets, larger assets that will have positive impacts on committee count as well as consistency in community count. Just to give maybe you an expectation of what we see, relative to Q1 margins being lower than last year and lower than overall margins in backlog, we're going to expect mix is going to impact Q1 margins and likely push them down into the high 15 to low 16 GAAP range. And in the back half of the year with that positive mix coming from those larger assets, you'll see that grow into the high 17 to low 18 range. I think based on where we see the year ending, I think that is a good indication of how we would see things plan out into next year.

Michael Rehaut

That is great. That is very helpful. I guess secondly, just looking at the size of the business, different builders at this point in the cycle have taken little bit different approach to growth. Some of the larger caps for example are more -- and these are obviously companies that have broad 40 to 50 to 60 market, very broad national footprints in aren't in the same position as yourselves, are looking more in the high single-digit to maybe 10% type of unit volume growth, you guys are clearly still more in a different camp of building out your footprint. Where are we in that stage? I know over the years; we've hit on different types of numbers in terms of the size of the Company over a two to three-year period. It seems to me that you guys are still to a degree still in somewhat of a build-out phase. Again, not trying to press your hand on 2018 too much, but at minimum, it would seem that you will be able to serve a low double-digit growth in 2018 and maybe into 2019 although, I am not putting numbers out there. Is that the right way to think about it, just given how you want to get perhaps deeper into some of your existing markets and not talking necessarily about acquisitions, but obviously you have a lot of stuff coming online and I would expect we'll continue to have things coming online over the next 12 to 18 months?

Matt Zaist

Yes. Little bit of a mouthful there, Mike. I will try to parse it a little bit. Certainly, I think we see a big to figure of growth for 2017 over 2016. We do see 2018 being a growth year above 2017, based on the land that we own and control today. I think that is one of the points that we have tried to make is, I think we've got a good deep supply of lot and land. We do think that our existing footprint without adding incremental markets should allow us to push to a size that, I am not going to definitively say the timeframe that we're going to get there, but we should be able to do it with 4000 units within our existing markets without having to go into tertiary sub-markets within our greater MSA. I think the rate of growth between 2018 and 2017, you will probably moderate a bit from constant growth that we're expecting to see 2016 to 2017 but still meaningful. I think still indicative of a company in growth mode. I think that is probably what we're comfortable giving you at this point in time relative to how we view 2018.

Operator

Our next question comes from Alan Ratner with Zelman & Associates. You may begin.

Alan Ratner

Hello. Good afternoon and congratulations on the debt deal. I am sure that was nice to get out of the books there. I guess my question relates to the balance sheet and the announcement on the buyback, just curious how you are thinking about the capital structure today? You still have an above leverage average ratio although it is certainly moving in the right direction. How high are you willing to take that in the near term if there is an opportunity that presents itself on the share buyback? You just revisiting some of the assets you have highlighted in the past, I guess specifically the Nevada asset where you had the 2011 change of control. Is there any expectation of monetization of that asset which could potentially free up some cash to buyback stock over the course of 2017?

Bill Lyon

First thank you for your comments on the debt deal. Very happy and I think excited about making real progress on our capital structure. Which is something that we're committed to. I think relative to the stock repurchase, as a small cap Company, we have experienced volatility in our stock price in the past. Our board decided to put this in place so we could be in a position to opportunistically repurchase the stock if we feel that the market is not appreciating the value that the Company is creating for our shareholders.

Of course, we still need to balance our capital allocation strategy between reducing our leverage and replenishing our land. We're really always thinking about what the highest and best use of capital is. We feel we've got a compelling story, we're focused on maximizing our financial and operational performance and communicating that effectively with our investor base. I think it is really meant to be opportunistic. I think relative to leverage is, we want to keep overall leverage trending down over the course of the year. I don't think we would view at as a tool that is in our toolkit and something that as we're looking at how we allocate cash that is going to be part of the analysis going forward.

Relative to our two previously held land assets for tax purposes, unrestricted starting in 2017 is one in Nevada and one in Arizona. I think we're right now on the Nevada asset, we're currently taking a portion of that and developing it as an active adult community which will open up in the back half of this year. I think there is opportunities for some select lot sales in that community. Relative to our Arizona asset, Rancho Mercado which we're starting horizontal development on, that is probably the asset that we would potentially look at a monetization event if we felt like it was compelling both from a recognition of land value perspective as well as potential to free up some deferred cash asset dollars. That said, very hard to predict land sales, timing and things of that nature.

Net-net exclusive of those things, though and inclusive of the lands spend that Colin mentioned, we expect this year to be cash flow positive year. And so we want to make sure that we've got opportunities to invest that cash in opportunities that's going to produce returns for our shareholders.

Alan Ratner

Very comprehensive, thank you, Matt. Second question on the margin, you gave some great color on the communities and why you think margins should move higher in the back half of the year. I didn't catch the entire list of the projects you highlighted there. I think it was Bayshores and River Terrace were the two that you have been talking about for a few quarters now. I'm not sure how many of those other communities are actually active selling homes today and where you have had some deliveries. So for the ones that you have actually delivered some homes on so far, just curious if you can give some us anecdotal evidence on what the sales pace and the absorption -- excuse me the sales pace in the margins have been there, just to give us a little bit more clarity and comfort on the expected ramp in the back half of the year. Versus those where maybe you're selling homes but you haven't actually yet deliver products so it is little bit more of a question mark. Thank you.

Bill Lyon

Good fair comment, Alan. If we take Bayshores and River Terrace as an example, those two projects will be two of the biggest delivery projects in the second half of the year on a combined basis, margins and backlog between those two are in the low 20s on a GAAP basis. So we feel like as those continue to ramp up in the second half of the year, those two projects on a combined basis are going to represent 350, plus, maybe closer to even 400 deliveries in the second half. So you'll certainly feel like we've got a handle on that from a visibility standpoint, horizontals 100% done, houses being built and we've got a real good handle there. Relative to a couple of the other larger ones that I mentioned, Affinity which is our Summerlin master planning community that will open up this spring, we've got horizontals 100% contracted, verticals contracted. Got 1100 people on an interest list with pricing out there, so I think we feel like we've got a real indicative sense from our home buying community as to the level of demand and expectation on revenues. Look, obviously, Alan, we've got to execute and get those things up open and turning. I think that we've laid out for you how we see the year progressing and try to give you as much color as we possibly can.

Operator

Our next question comes from Will Randow with Citi. You may begin.

Will Randow

As you think about the next year, when do you expect to see capitalized interest come down by 100 bps or more? Would that be a tailwind or just an offset to lower unlevered margins? Any sense on timing and impact there?

Colin Severn

It is Colin. I would say late this year into early next year was when we start to see that taper off. We're turning things at our previous cost to capital rates, but we will start to see that trend down in 2018.

Will Randow

By like 100 bps? Can you quantify that?

Colin Severn

I do not know if I really want to quantify it at this point because of the mix and some of the other things, but maybe can give you some more color as we move through the year.

Will Randow

Got it. I don't know why I definitely didn't fully catch the land spend and vertical spend numbers. I think from what I heard, it sounds like reinvestment is kind of neutral which would imply as you look into the out years probably flatter community kind of growth which could be a good thing for the balance sheet from a leverage perspective. I guess could you review those numbers, is my thought process kind of pointing in the right direction?

Colin Severn

Yes, Will. Total land spend probably up a little bit this year, but we were approximately inclusive of both acquisition as well as horizontal in 2016, we were at approximately $340 million total. In 2017, really looking at that number being somewhere in the neighborhood of $350 million to $370 million. A little bit up, not meaningfully up. I think part of the reason that we still believe we've got some incremental community count growth into next year would be really the opportunities around our two previously held master plans, one in Nevada and one in Arizona. To the extent we monetize them through sales process that might change, but without having to acquire that land, horizontal spend will help bring online some pretty healthy community count in those as we move into 2018 and really the end of this year. That said, I think as we mentioned, we've got room to continue to do growth the company from a revenue and delivery perspective, even with a relatively modest increase on land spend.

Will Randow

If you go a couple years back when you acquired Polygon and there was a lot of deal activity. Obviously, that is tapered off. Do you feel like that is picking up at all?

Bill Lyon

I feel like maybe I didn't quite understand the question.

Will Randow

Do feel like M&A activity overall in the homebuilding sector is picking up or has it been a steady state would last year or so, meaning what you are seeing today?

Bill Lyon

I think there is always opportunities in the M&A space on both the buy and the sell side. I think everybody's motivations are a little bit different. I think if you step back and say high-quality private homebuilding targets like Polygon, I think those are harder to find. So I think as people look at M&A as a way to grow, I think the quality of who is out there and who is in sell mode is maybe not as many players as there were in years past. At the end of the day, people's motivations are going to be driven by a need to continue to grow and provide good returns for their shareholders. So I think we will see how the year continues to progress. I think that is probably all I would say at this point.

Operator

Our next question comes from Jay McCanless with Wedbush. You may begin.

Jay McCanless

The first thing I want to ask about and make sure I have this right. The weather is going to push some of the higher margin closings into the back half of 2017 but at the same time, I don't believe you guys made a change in the community count guidance. Could you reconcile those two because I would think if the weather is going to push some closings it might also push your community openings back.

Bill Lyon

I think one of the things that we did, Jay, some conservatism in our expectations relative to community count at the end of last year as we were kind of setting expectations for this year. Certainly, the weather is pushing the openings of some of the new communities. The weather is having more of an impact right now on deliveries on stuff that were open last year that includes homes that are in backlog today. Relative to new committee openings, that said, the weather has been pretty good in Las Vegas. We moved up our timing on affinity, whether in Colorado continues to be really pretty good all things considered. So Denver connection from a timing standpoint, we're seeing some improvement on that. Offsetting that is community openings in Washington which have pushed back due to rain so there is a lot of ins and outs in that, but also, I think a little bit conservative from us relative to the timing of hitting those numbers but still feel good about that prior guidance.

Jay McCanless

Got you. In terms of the pace of ASP on a quarterly basis, should we expect low point for the year probably to be 1 to 17 and then just works up to the year like a normal progression or are these weather issues going to make -- ASP progression?

Bill Lyon

That is exactly right. We would expect Q1 to be low point consistent with Q4 like Matt mentioned and then trending up the back half of the year -- map on our guidance and you'll get there.

Jay McCanless

Okay. The last question I have, I believe it is on slide 13 were you guys talk about one-time or net effective cost effective with refinance of approximately $13.9 million to I understand break of that is going to hit in 1Q 17 and should we assume that the tax rate you guys used to tax affected is 45% -- 35%? Was at the rate you gave earlier?

Bill Lyon

That is correct.

Operator

Our next question comes from Alex Barron with Housing Research Center. You may begin.

Alex Barron

So I think I heard you say this margins were going to come down in the next couple of quarters because of Inland Empire. Is that enough what do you think you'll get the most of those issues in the next couple of quarters and they won't be significant problems in the back half?

Matt Zaist

Alex, I think what it is we have seen a meaningful pickup in the Inland Empire relative to all price points including products that were affected by the FHA rollback a few years ago. So in the low to mid-500,000 range, we have seen absorption rates over the last three months that have really exceeded absorption rates for previous 12 months before that. I think that is a good thing relative to the monetization of our asset there. The margin profile obviously been affected by a lot of different factors including having to lower prices to move to that product. We have also got the balance of our old product in Colorado that is absorbing well but flushing through with not having the offset of Northern California to a few of those other better margin projects in the Pacific Northwest to help offset that, yes, we're going to see margin -- margins come down in Q1. Will see progression a positive manner from Q2 over Q1? As we mentioned, margins and backlog our higher than what we're going to see in Q1 and even Q2. We feel like that progression is working its way through. It is not that we're bring for everything in the Inland Empire. Writing Q1 and Q2, it is just going to be a higher percentage of our closings than we have seen in the past. Net, I would say positive to save the Inland Empire continue to improve from absorption standpoint.

Alex Barron

Yes. Okay. Call. How about Bayshores? I know you guys a started to close some of those homes in a project or not yet?

Matt Zaist

A small handful. I think as we mentioned, we have a margins in backlog. We sold houses. We got them contracted. I think Bayshores will be a big project for us this year. I think that is a project we think we can deliver between 275 and 300 units. It is just going to be call it 70% of those deliveries are going to be in the back half of the year. On a positive note, though, Alex, we have about 200+ units already under construction at Bayshore. So I think we feel like we got a good handle on the production flow associated with that as we move into what should be a better weather period of there.

Operator

I am showing no further questions over at this time. I would like to turn the call over for closing remarks.

Matt Zaist

I would like to thank you all for joining us on our call today. We look forward to speaking with you next quarter. So have a great day everybody.

Operator

Ladies and gentlemen, this concludes today's conference. Thank you for your participation and have a wonderful day.

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