M.D.C. Holdings' (MDC) CEO Larry Mizel on Q2 2018 Results - Earnings Call Transcript

M.D.C. Holdings, Inc. (NYSE:MDC) Q2 2018 Earnings Conference Call August 1, 2018 12:30 PM ET

Executives

Kevin McCarty – Vice President-Finance and Corporate Controller

Larry Mizel – Chairman and Chief Executive Officer

Bob Martin – Chief Financial Officer

Analysts

Neal Basumullick – J.P. Morgan

Stephen Kim – Evercore ISI

Peter Galbo – Bank of America

Alan Ratner – Zelman & Associates

Alex Barron – Housing Research Center

Buck Horne – Raymond James

Kenneth Zener – KeyBanc

Stephen Kim – Evercore ISI

Operator

Good afternoon. We are ready to begin the M.D.C. Holdings Inc Second Quarter Earnings Conference Call. I will now turn it over to Kevin McCarty, Vice President of Finance and Corporate Controller. Sir, you may begin your call.

Kevin McCarty

Thank you, Chantelle. Good morning, ladies and gentlemen, and welcome to the M.D.C. Holdings 2018 second quarter earnings conference call. On the call with me today, I have Larry Mizel, Chairman and Chief Executive Officer; and Bob Martin, Chief Financial Officer.

At this time, all participants are in a listen-only mode. After finishing our prepared remarks, we will conduct a question-and-answer session at which time we request that participants limit themselves to one question and one follow-up question. 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 conditions, results of operations, cash flows, strategies and prospects and responses to any 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 second quarter 2018 Form 10-Q, which is scheduled to be 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 Mizel

Thank you, Kevin and good morning to everyone joining us in the call today. I'm pleased to announce that M.D.C. Holdings turned in another strong quarterly performance in the second quarter of 2018. Highlighted by year-over-year home sales revenue growth of 16%, and home sales gross margin expansion of 230 basis points, and a pretax income growth of 48%.

We saw solid demand in the markets in which we build as evidenced by our Company wide sales pace of 3.7 homes per community, per month in the quarter. This sales pace was 8% greater than a year-ago period and marked the sixth consecutive quarter we've posted a year-over-year improvement in this metric.

Part of this pick up, in order activity can be attributed to the generally improving housing fundamentals in our markets. But an equally important factor has been our ongoing strategy to focus more heavily on affordable homes. We believe this is one of the fastest growing and deepest segments of the market.

Our Seasons Collection and other more affordable product lines have been very well received in the markets where we've introduced them with a combination of desirable community locations, quality home designs and lower price points. The strong demand we’ve experienced for our more affordable homes has allowed us to increase prices in these communities, which has in turn resulted in better margins than our overall company average.

We believe that the strength we’ve seen in this market segment, as well in the broader new home market will continue into the future and we have increased our land investment activity accordingly. To that end total lots under control at the end of the quarter increased 37% year-over-year. We now have a controlled lot supply that we believe will give us a clear path to potential market share gains in the future.

We continue to place an emphasis on tying up land with as little upfront capital as possible, as evidenced by the fact that 38% of our lots at the end of the quarter were controlled by option agreements. This strategy helps us maintain one of the strongest balance sheets in the industry. It also provides us with additional financial and operational flexibility and enhances our return profile.

Based on our result this quarter, the strategic initiatives we have undertaken are growing lot count and healthy balance sheet. We're optimistic about the future of our Company. With that I'd like to turn the call over to Bob Martin for more details about our results this quarter. Bob?

Bob Martin

Thank you, Larry. As Larry mentioned, our pre-tax income increased by 48% year-over-year to $76.6 million. On an after-tax basis, net income improved by 89% to $63.9 million for the quarter.

Our tax rate dropped from 34.7% to 16.6% for the 2018 second quarter, which was a big factor in our net income increase. The decrease in rate was in large part due to the Tax Cuts and Jobs Act.

In addition, we booked a sizable discrete tax benefit of $6.8 million or 890 basis points for the 2018 second quarter. This discrete benefit was related to the identification of additional homes that are eligible for the Section 45L energy-efficient home credit, which was retroactively extended earlier this year to include qualifying homes that closed in 2017.

For the final six months of 2018, we are estimating an effective tax rate between 25% and 27%. This estimated range assumes no additional discrete items during 2018. Our home sale revenues for the 2018 second quarter were up 16% year-over-year to $749.6 million due to a 7% increase in the number of homes delivered and an 8% increase in the average selling price of those homes.

Our backlog conversion rate was 40%, which was at the top end of the expected range for Q2 that we discussed on our previous call. Looking forward to the third quarter, we estimate that our backlog conversion rate will be in the 40% to 41% range higher than the 38% backlog conversion rate that we achieved in the third quarter of 2017.

The average selling price of almost $496,000 for closed homes was the highest in our Company's history. The increase from prior year was driven both by price increases across our market and a shift in mix to some of our highest price communities in Southern California.

Our average price would have been even higher without the expansion of our more affordable Seasons Collection, which grew to 13% of closings for the second quarter versus only 6% a year ago. We had Seasons closings in our Colorado, Arizona, Florida Nevada, and Mid-Atlantic market.

Furthermore, two additional product lines that we have recently developed with affordability in mind are Cityscapes and Landmark Collections contributed an additional 10% of Q2 closings.

Our gross margin from home sales was up 230 basis points year-over-year to 19.1%. This represents our highest level since 2010. It was also 90 basis points higher than the gross margin from home sales that we realized in the first quarter of 2018.

All of our homebuilding segments realized an improvement in their gross margin from homes sales with the West segment showing the largest improvement and the Mountain segment showing the highest absolute level overall.

With the higher gross margin and the increase in our average selling price the amount of gross profit dollars that we generated per closing rose by 23% to $94,600 in the 2018 second quarter, nearly reaching its highest level in Company history.

Our gross margin in backlog to end the quarter remained healthy, at a level that was roughly even with 19.1% we achieved for closings during the quarter. Additionally, our gross margins continued to be positively impacted by a higher percentage of our closings coming from our more affordable Seasons product, which has a higher average gross margin than our traditional new home plans.

Therefore, we're optimistic about our prospects for maintaining gross margin in the last half of 2018 at a level similar to the second quarter closings. However, it should be noted that the gross margin level we actually realized in future periods could be impacted by cost increases, cancellations, impairments, reserve adjustments and other factors.

Our total dollar SG&A expense for the 2018 second quarter was up $10.9 million from the 2017 second quarter. This was driven mostly by increased compensation cost due to the hiring that we did last year to plan for the growth we are now experiencing. As well as $3.6 million in additional stock-based compensation expense associated with the accounting for performance based stock option awards that were granted in 2016.

Because home sale revenue increased 16% year-over-year, our SG&A rate was unchanged at 10.9%. With many key positions filled in 2017, our rate of hiring slowed during the first half of 2018, as we added only 4% to our general and administrative headcount, compared to an 8% increase in the first half of 2017. Nevertheless, we believe there could be continued upward pressure on wages given the tight labor market overall.

Our last 12 months' core pretax return on equity was up 120 basis points year-over-year to 15.3% at the end of the second quarter of 2018, after excluding a one-time $52 million gain that’s recorded in the third quarter of 2017 related to the sales investments. Because of the expansion of our gross margin, our homebuilding operating margin defined as our gross margin for home sales minus our SG&A rate grew by 240 basis points year-over-year.

With our backlog value up 16% year-over-year and backlog gross margin showing continued strength, we're optimistic about further improvement for both our core homebuilding operating margin and return on equity for the remainder of 2018.

The dollar value of our net orders increased 9% year-over-year to $776.2 million, driven by an 8% increase in our monthly absorption rate as we continue to see solid demand in most of our markets across the country. Both our West and East segments experienced double-digit growth in absorption rates.

Our Mountain segment experienced a year-over-year absorption rate decline due to slower activity in Colorado where we increased prices in prior quarters in response to market demand, which allowed us to offset cost increases and improve gross margins. We continue to review pricing at a community level on a routine basis with the objective of making adjustments as necessary to maintain an appropriate balance between margin and pace.

The average price of our net orders was $451,000 for the quarter, up only 1% from the same quarter a year ago. During the quarter, we raised prices in about 70% of the communities that were active to start the quarter. However, our price increases were offset by a higher percentage of net orders coming from Arizona where average prices are among the lowest in the company.

Additionally, our more affordable Seasons Collection accounted for 19% of overall net new orders, up from 11% a year ago. Our Landmark and Cityscapes collection contributed an additional 10% of all net orders for the quarter, although that was only slightly higher than 9% for the same quarter last year.

We ended the quarter with an estimated sales value for our homes in backlog at $1.9 billion, which was up 16% year-over-year, driven primarily by an increase in the number of homes in backlog. The average selling price of homes in backlog was up 2% year-over-year to $487,000. However, this level was 4% lower than our peak of $507,000 at the end of 2017.

The decrease gives us an indication that we might see a decrease in the average price of closed homes during the second half of 2018, relative to a record high $496,000 in the second quarter of 2018. Overall our cancellations as a percentage of beginning backlog were up year-over-year from 10% to 12%, this was primarily due to cancellations coming from our Florida and Colorado operations where our mix has shifted to include more first-time home buyers who have a higher likelihood of cancellation.

Active subdivision count was at 164 at the end of the 2018 second quarter, up 7% from 153 a year ago and 6% from 155 at the end of the 2018 first quarter. Similar to recent quarters, our largest year-over-year decrease was in the East segment, driven by a lower subdivision count in our mid-Atlantic market where I previously disclosed a lower level of investment due to returns that did not meet our expectations.

I should point out however that our results in the mid-Atlantic have improved significantly in recent quarters, so we are accelerating our rate of investment in that market. Our Mountain segment had a 22% increase in active community count as a result of a significant investment in both the Colorado and Utah markets over the past two years. The West segment grew by 11%, mostly due to an increase in our California market. We continue to target at least 10% year-over-year increase in active subdivision count from 155 active subdivisions at the end of 2017 to the end of 2018.

For the 2018 second quarter, we acquired 2,088 lots, up 32% from a year ago. We acquired lots in every state in which we operate, with the heaviest concentration in our West segment, which accounted for 60% of the acquired lots. Approximately 67% of these lots acquired in the second quarter were finished lots.

Lots we acquired in the second quarter covered 53 communities, including 33 new communities. From a product mix standpoint, 32% of the lots we acquired during the 2018 second quarter are intended for our Seasons Collection. Also during the second quarter, we were excited to see our first lot acquisitions in the Portland market.

Acquisition spend for the lots was $188 million, after accounting for an additional $78 million of development costs, our total land spend for the quarter was $266 million. We approved 3,678 lots for acquisition during the quarter with two-thirds of the total coming from our West segment.

Our Seasons Collection represented 48% of these lot approvals and our other new affordable products accounted for about 14% of the total lots approved. At the end of the quarter, we owned or controlled 23,626 lots, up 38% year-over-year. With the significant amount of lot approvals during the quarter, the percentage of our lots controlled via option increased 38% at the end of the 2018 second quarter from 30% at the same point a year ago.

Our financial position remains strong at the end of the quarter as shown by quarter end liquidity, up 18% year-over-year to $1.1 billion. By design, our net debt-to-capital rose 300 basis points year-over-year to 26.3% reflecting our investments in the new communities that will drive our future growth.

And I will now turn the call back over to Larry for some final comments before we start the Q&A. Larry?

Larry Mizel

Thanks Bob. In conclusion, I'm extremely proud of our execution this quarter. We posted year-over-year pretax income growth of 48%, driven by healthy increases to both revenues and gross margins. We increased our lot count by 38%, laying the foundation for future community growth count. We also improved our trailing 12 month core pretax return on equity by 120 basis points.

We achieved these results while maintaining one of the best balance sheets in the industry. In addition, we paid out a quarterly dividend of $0.30 per share, which is up 30% over the prior year. Our dividend program is unique providing not only the highest yield in our industry but also consistent payments that date back to 1994.

Over the last several quarters, we have steadily improved our operating results and established a level of consistency that we believe is underappreciated by the investment community. To better highlight our accomplishments and provide additional color about our organization in future prospects. We have decided to host an investor event in Denver on November 7th and 8th. We feel we have a roadmap in place for continued success and we look forward to sharing more details about our efforts for this event.

That concludes our prepared remarks and Bob will now or we will now take any questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from Michael Rehaut with J.P. Morgan. Your line is open.

Neal Basumullick

Hi, this is Neal Basumullick in for Mike. I guess my first question's around demand in the quarter. I just want to get a sense of how kind of both demand and orders trended through the quarter, if you could, maybe, by month. And if there's any sort of pick up or slow down.

Bob Martin

It was mixed. I had indicated on the last call in April, it was actually a little faster than it was in Q1. So April was up about 20% year-over-year. May was down a little bit. It was down about 5% year-over-year. And then June was up 6% year-over-year.

Neal Basumullick

Okay, that helps. And then, I guess, kind of looking at community count, the anticipated growth for the year kind of implies some acceleration in the back half. What's, I guess, your level of confidence in that target?

Bob Martin

Well, it's a 10% increase from where we started the year. So if you do the math starting at 151 that would get you to 166. At the end of the second quarter, we were at 164, so almost to that 166 target. We do think there could be a little bit of a decrease between the end of Q2 and the end of Q3, but then some acceleration to that target from there. So that's really the logic.

Neal Basumullick

Okay, makes sense. Appreciate it.

Bob Martin

Sure, thanks.

Operator

Your next question comes from Stephen Kim with Evercore ISI. Your line is open.

Stephen Kim

Yes, thanks very much guys. Congratulations on the good results. I guess my first question was maybe, Bob, if you could give us a sense for the dollar land spend. You talked about the lots, I think, that you had allocated towards Seasons, and I think you had mentioned Landmark as well. Just curious if you could give us a sense for what the dollars kind of looked like in terms of allocation for those product lines. And then also, if you can give us a sense for regionally, which regions may be accounted for the bulk of the land spend this quarter.

Bob Martin

Sure, sure. So for the dollar spent, really talking about that $188 million that we talked about. Since Seasons is at a lower price point, it's 25% of the overall spend that was allocated to Seasons and then the remainder was to the remaining product types. Then looking regionally, you're looking for regional dollars spend, is that right?

Stephen Kim

Yes. Just some way to think about it, yes. But ideally, the numbers, yes.

Bob Martin

Yes. I think, as I said for the lot count, we were about two-thirds weighted towards the West for this quarter. Then actual dollars, we're pulling that up here right now. Yes, so dollars is about the same. It was about two-thirds as well in the West. And then you had Mountain coming in second and then East trailing behind that.

Stephen Kim

Right, great. And as we think about that West in dollars, you've also sort of been expanding your territory or footprint a little bit there. Is there any way to sort of give a sense for, excluding that sort of footprint increase just in your core markets, would it – would you think that the share of dollar spend in land was about similar? Or do you think, to other regions in terms of the increase year-over-year, was it kind of similar? Or do you think you actually now actually grew, not just geographically within the West, but also just in terms of your dollar allocation, year-over-year growth, to the West?

Bob Martin

Well, let me put it this way. I mean, really, the one place that's new for us in the West is Portland. All others would have annualized. We had about $120 million of total spend in the West acquisition-wise for the quarter. And I think about $20 million of that was Portland.

Operator

Your next question comes from John Lovallo with Bank of America. Your line is open.

Peter Galbo

Hey, guys. It's actually Pete on for John. Thanks for taking the question. Bob, I just wanted to dig a little bit deeper into the orders being down in Mountain, just given some of the permit activity that we saw there. I know you had mentioned kind of raising price in Colorado and that leading to a little bit of a planned slowdown. But I'm just wondering if the absorption being down as much as it was, was also a function of the communities you open kind of being back-end weighted in the quarter, and so you didn't really get the full benefit of those being open in the quarter and there would be some kind of rebound going into 3Q. Just any color there would be helpful.

Larry Mizel

Yes, I mean, it's hard to prognosticate on what happens in Q3. I will say we certainly had some communities in the comparable quarter a year ago that really were a pretty significant driver to the year-ago results. And those communities this year really had more limited amounts of inventory. So in some ways, we are adjusting to new communities coming online. I guess the other thing I would put out there is, if you look at the cancellation rate a year ago in the same quarter, it really was abnormally low.

It's the lowest in the company, about 7% of beginning backlog. This quarter, as I mentioned, it increased, but it really increased to something that was more normal, kind of more in line with the overall company. So I would throw those two items out to you in addition to giving you a little bit of information on the specifics of how the communities lay out.

Peter Galbo

Got it, okay. And I know you're doing this on the last call, but are you guys willing to share July order trends?

Bob Martin

Yes, for July, we were up about 6%. I mentioned June was up 6%. So it's about the same as the year-over-year increase as what we saw in June.

Operator

Your next question comes from Alan Ratner with Zelman & Associates. Your line is open.

Alan Ratner

Hey, guys. Good afternoon. Nice quarter. So I guess, just piggybacking on the order monthly data here. So I think we've heard from a lot of other builders as well as some of the national housing data, which shows some choppiness, I would say, over the last several months in some of the sales activity. And I guess you've seen something similar, but on one hand, you sound very positive and bullish about the market, and certainly, your growth prospects.

But it is a fairly meaningful deceleration, I guess, versus the growth you've been seeing over the prior six months, at least here in May, June and July. So I guess, my question is, when you think about the – I think you said 70% or so of communities where you've raised prices in the quarter, have you changed that approach at all, perhaps taking a pause from price increases, just to get that growth rate back up to the levels you were seeing previously? Have you started to incentivize at all in any markets more so than you have been in the past? Or overall, do you feel pretty comfortable with the current sales pace you're putting up?

Bob Martin

Well, as you know, it's a community-by-community decision on pricing, and we continue to look at every community, really, every week and make that decision as we go. I think it's normal, price increases, after you experience a significant period of price increases, for the market to adapt and adjust to that. And we're seeing a little bit of that here. But we'll continue with that discipline of reviewing our communities every week and adjust as appropriate. So I think still, what we saw in Q2 was a very healthy level of demand. 3.7 orders per community per month, we think, is a very healthy pace. And we're pleased with that.

Alan Ratner

Got it, thanks Bob. Yes, certainly would agree. It's a strong absolute level. I guess, just second on the margins. So I think you guys have done a great job building up the Seasons product and the affordable brands very quickly. And as I looked at the lot purchases you've made, clearly, it's a much higher percentage of recent lot acquisition versus what's currently coming from a sales standpoint, I guess, roughly 30%, you said from Seasons and the other affordable brands.

So should we just think about that 30% gravitating closer to the 40%, 50% level, that recent lot acquisitions had been at over the next year or so? And if so, does that imply a positive mix shift towards margin, given that these communities are generating better margins than the move-up?

Bob Martin

Yes, I think we would love to see the mix shift on more of that affordable product, whether it be Seasons or Landmark, Cityscapes, back to something that looks more like, say, 40% to 50% of our business. And that's not because the other ones are slowing down. It's because the more affordable product is growing more quickly. So I think that certainly could be a reality. It's a matter of time and continued focus on our acquisition efforts.

As far as what that does to margins, again, it's hard to predict where margins go with all the ins and outs and cost increases and everything that we worry about on a day-to-day basis. But as of right now, as I mentioned, the Seasons product from a margin standpoint does have higher margins than the traditional product. So there should, at least short term, be some positive benefits from that as we increase the percentage of Seasons in our mix.

Operator

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

Nishu Sood

Thanks. On the gross margins, last quarter, you had anticipated – or I'm sorry, the backlog gross margin was similar to what you delivered last quarter. And obviously, a nice surprise here to the upside. You folks have been deemphasizing spec, so that probably wasn't a big contributor to the upside surprise. Just wanted to understand the drivers of what drove the margins to come in higher than what you – what were in backlog when you reported last quarter?

Bob Martin

Yes, I think the verbiage we used last quarter was it was marginally higher than where we closed the houses. So we started with backlog that was a little bit higher than Q1 margins. And then from there, I think, really, what we see coming through is, generally speaking, the reason for the margin increases is price increases that we've been able to implement in most of our markets. Over the course, really, of the last year, we've shown those increases in communities across the board.

And then also, I think we're certainly seeing cost increases. There is no doubt about that. But those price increases are just offsetting what's happening from a cost increase standpoint and then some. So I think that dynamic has just been a little bit more favorable than we previously expected.

Nishu Sood

Got it, got it. And second question for Larry. Larry, in 2005, you were a contrarian in terms of curtailing land spend ahead of the slowdown in housing. And at this point, with the strong land investment and the kind of anticipation of gaining market share, and I think you have amongst the highest targeted community count growth amongst the builders. You're standing out as a contrarian the other way. So I just wanted to get a sense of your thoughts, what you're seeing that is encouraging you to take this position.

Larry Mizel

I'd say, really in almost all segments of the economy strengths. I see that the builders have been balanced in their growth. In fact, most of them are working very hard to maintain their growth. And I don't sense that, at this point, that we are fulfilling the demand that's out there. We are very focused in which markets we're in. As you know, in the last less than two years, we rotated to affordable products for what looks like now almost 50% of our land spend is in that market. I believe that we've built a superior home in the affordable market that competes very, very well with other builders that are in this price point.

A couple of unique things. We allow, in the affordable price point, people to personalize their homes. We have selections that people are able to achieve something special and unique. And I believe that there's a lot of capacity that we have the chance to fulfill in demand, capacity of demand by staying focused on personalization. We have been very careful with our growth. As you know our backlog and actually our work in process, almost 90% of our work in process that includes the lots under those homes is all pre-sold.

So as you comment that we are accelerating the land spend. Nevertheless, we are being very, very careful as we deploy our capital in not only the land but also the WIP. This has been a very deliberate strategy, and I believe the results that we are showing demonstrates that.

I invite you to come to our event in November 7 and 8. We're going to lay it out more clearly, so the market really understands the uniqueness and the strength that we are currently now demonstrating.

Operator

Your next question comes from Alex Barron with Housing Research Center. Your line is open.

Alex Barron

Yes, thanks guys and good job. I was hoping you could elaborate a little bit on how much better the absorption rate or sales pace is for the Seasons and other entry level communities relative to the more mobile communities.

Bob Martin

Yeah, I think generally, speaking we have seen the absorption rate be higher. But, I think as we've started to increase prices on the Seasons product as well we've seen that differential collapse to some degree.

Alex Barron

Okay, and are you currently, in all markets already introducing these new seasons product or are there is some markets where you haven't introduced it but are in the process of doing so.

Bob Martin

It's different levels in different places. We are actively trying to introduce it in all of our markets. I'll say it's harder in some markets versus others. Within each state, I think just about in every state, we've got a Seasons community at least going. But the extent to which we can expand it in a place like Seattle for example, with really severe topography in a lot of locations. It's harder.

Clearly, you're not going to put a Seasons community in Irvine, at coastal California. So some of those factors do limit where we can put it. But we're trying to get it into each one of our markets.

Alex Barron

Okay, And then I think you mentioned that in the Washington, D.C. area, you guys were seeing some new opportunities to invest. Whereas in previous quarters, I think you had said those markets have not shown, I guess, the type of returns you were looking for. So I'm kind of curious, what's changed either in your strategy or what you're seeing in the market there.

Bob Martin

Yeah, well to start with, you're right. A year or two ago, we've made the decision to actively reallocate the capital from the Mid-Atlantic to some of our other markets, like Florida, Portland, simply because the returns weren't great in the Mid-Atlantic. But the tables have turned for the Mid-Atlantic, I would say, to a large degree. If you look at absorption rate, margins, we've got much better performance year-over-year.

And we tweaked our operating strategy in the Mid-Atlantic. Familiar themes. We've shifted to really Seasons and Landmark product in that market. Instead of operating two distinct offices in the Mid-Atlantic, we used to have it at Virginia and at Maryland, now we just operate all of it as the Mid-Atlantic. But what we've seen recently after making all those changes has really given us confidence that it's a market that we want to continue to be in.

Operator

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

Buck Horne

Hey, thanks. Good afternoon. I wanted to go maybe a little bit deeper into understanding the margin differential between the Seasons product line and your company average, or just the traditional product. And curious to the extent you can either quantify for us what that split is right now or your understanding of, do you think it's sustainable going forward? And maybe it's not so much that Seasons is, well, Seasons is performing at or better than your expectations.

But would that mean that there is room for improvement on the traditional product line as well?

Bob Martin

Yeah, I think there is room for improvement on traditional as well. I think we're seeing improvement in margin across product lines. So it's not just limited to Seasons. We don't give out the specifics on the margins, specific percentages, but it is notably higher. It's not just 10 basis points. It's notably higher than the traditional product.

I guess, over time, whether or not that's sustainable, these things have a tendency to go back towards the mean, meaning if there's more demand for Seasons and other affordable products, the price of the land goes up and maybe that offsets some of the margin differential that we've seen to this point.

So it's tough to really tell how that plays out in the future. But for now, it is having a meaningfully positive impact.

Buck Horne

Okay, that's some helpful color. Can you at least maybe help us quantify or give us a range for what kind of hard cost inflation, or sticks and bricks inflation rate, you're seeing at the moment? And I think you mentioned it, but have land sellers adjusted at all to the rising cost you guys are having to absorb and maybe the moderating absorption pace?

Bob Martin

Yeah, Roughly speaking, I would say about 10% year-over-year increase in our direct costs year-over-year, and that's on a per square foot basis. As far as land sellers, I don't, I don't think they're really capitulating at all. I don't think we're seeing land prices go down at this point. It's flat to maybe a little bit up if you look at what went through our cost of sales year-over-year.

Operator

Your next question comes from Kenneth Zener with KeyBanc. Your line is open.

Kenneth Zener

Gentlemen good morning. And I look forward to the Analyst Day. My first question is your order pace, it dropped. We look at the world sequentially in terms of pace. So in 2Q, it dropped, pleased to have 13% sequentially. Normally, it’s 2%. Yet in 4Q, you guys did very well, dramatically increased the normal sequentiality of the orders.

So the reason I set the question up that way is I want to see if you think it's the market weakening in 2Q, given how much you outperformed in 4Q? Or did you guys really just kind of – I realize you're up year-over-year in terms of order pace, but sequentially, it was a little bit difficult to read. So was it community mix? Was it just kind of coming off what had been an exceptional fourth quarter pickup in pace? Or is there something else that you could comment on for that sequential change in pace?

Bob Martin

Yeah, I don’t think we look at it sequentially. I mean, you hit it on the head talking about year-over-year, it's up, I mean, that's a great fact for us, and we're focused on growing the company. But you're right, it could be lumpy because 4Q didn't have any seasonality relative to Q3.

And then it's hard to have a hard and fast rule, even though you can throw out generalities over time. So I think what we have in the press release and Larry's comments and my comments kind of stands for itself, is that we really think there's healthy demand out in our numbers for all the reasons that Larry talked about.

Kenneth Zener

If I could have us take a step back. Larry, obviously, you guys – Denver is a market you guys are very familiar with. So what I've been struggling with the last few months is if you look – we see rising existing inventory for the first time. And it's select markets, but it's starting to happen, or at least, not be contracting like it did. So along with that rising existing inventory, we're seeing actually kind of declines in new sales space. So, is there a way that you guys kind of think about how rising existing inventory interacts with the new home sales market that you're experiencing, rather than just national? I mean, can you talk about how it's happened to you guys in Denver? Thank you very much.

Bob Martin

I think, I guess our observation is even though we might see some increases in some markets, it's still at a pretty low level, really, in just about every one of our markets. So that supply/demand dynamic that we like to see is really still there in the market. So again, you're going to have some volatility with where inventories go or what the seasonality is on our orders on a quarter-to-quarter basis. But there's nothing out there right now that gives us a big concern.

Operator

[Operator Instructions] Your next question comes from Stephen Kim with Evercore ISI. Your line is open.

Stephen Kim

Yeah, thanks very much guys. Just wanted to have a follow-up here. Sort of talking on the Seasons having a higher gross margin. And I know Buck just sort of delved into that a little bit. I wanted to ask you sort of at a higher level. Do you think it makes sense for Seasons to have a higher gross margin than move-up over the long term? And if not, what kind of time period do you think the transition might take place?

Bob Martin

Well, I know on the second part, the answer is I have no idea. On the first part, just conceptually, it kind of goes back to my reversion to the mean. It seems like it would converge at some point. And I think part of the reason you're seeing better margin on the Seasons product is because the market segment that we're serving has really been underserved for a long period of time. And we've been able to increase prices for that product a little bit more than we have for the traditional product. So I think there's that dynamic to it.

Stephen Kim

Certainly. Yes, I guess, that makes sense. So I was just reflecting on the fact that when builders started to go after the entry level a while back ago, the initial underwriting and all the sort of thinking about it was that it was going to have a lower gross margin. And obviously, because of the forces you just mentioned, they've been higher. And so I just wanted to make sure that from a theoretical perspective, once things normalize, that we shouldn't continue to – I mean, there's nothing inherent about Seasons that naturally makes it higher gross margin, I would assume.

Bob Martin

And to that point, Steve, the only thing I would say that really distinguishes the Seasons product, and Larry mentioned it, is that it is built-to-order still. You can customize it at our Home Galleries. We think the products relative to our competition is just a little bit nicer. So I think that does appeal not only to a first-time buyer, but also to a move-down buyer. And so I think you get a little bit of extra play from the Seasons because of that dynamic. So I just wanted to add that part.

Operator

There are no further questions at this time. I will now turn the call back over to the presenters.

Bob Martin

Thank you, we appreciate everyone being on the call today and we look forward to speaking with you again following the reporting of our third quarter results.

Operator

This concludes today's conference call. You may now disconnect.