Meritage Homes Corporation (MTH) Q3 2016 Earnings Report, Transcript and Summary

Good day and welcome to the Meritage Homes’ Third Quarter 2016 Analyst Conference Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Brent Anderson, VP of Investor Relations. Please go ahead.

Thank you, Nicole. Good morning, welcome to our analyst call to discuss our third-quarter results which we issued in a press release before the market opened today. If need a copy of the release or the slides that accompany this call, you can find them on our website at investors.meritagehomes.com, or by selecting the Investor Relations link at the bottom of our homepage. Referring you to Slide 2 about the presentation for the customary cautionary language. Our statements during this call and the accompanying materials contain projections and forward-looking statements reflecting the current opinions of management. These projections are subject to change and that though we may update them from time to time we are not obligated to do so. As forward looking statements they are inherently uncertain and our actual results may be materially different than our expectations. We have identified the various risk factors that may result influence our actual results and they are listed and explained in our most recent filings with the Securities and Exchange Commission specifically our 2015 annual report on form 10-K, subsequent forms 10-Q. We have provided a reconciliation of certain non-GAAP financial measures in our press release presentation as compared to the closest related GAAP measures. Referring to Slide 3 with me today to discuss our results are Steve Hilton, Chairman and CEO of Meritage Homes, Hilla Sferruzza, Executive Vice President and CFO, and Phillipe Lord, our Executive Vice President and Chief Operating Officer. We expect the call to run about an hour and a replay will be available on our website a proximally an hour after we conclude the call. It will remain active for two weeks. I will now turn the call over to Mr. Hilton to review our third-quarter results. Steve?

Thank you Brent. And welcome to everyone participating in our call today. Turn to Slide 4. We delivered another quarter of strong earnings growth. We have produced significant top to bottom line growth in each of the first three quarters of this year with net earnings increasing by 22% in the third quarter and 29% year to date as compared to 2015. Those results were primarily due to the increases in home closing revenue of 11% in the third quarter and 20% year-to-date in 2016 over 2015. Our focus has been on long-term’s earnings growth which led to our geographic expansion and further diversified operations and product offerings. We’re seeing benefits from that expansion on our top-line and expect to see additional bottom-line benefits for both margin improvement and additional leverage in our overhead over time is our newer divisions reach critical mass and realize expected operating efficiencies. We’re now focusing on another growth opportunity for our company. Offering more homes and communities that target the growing market of first-time home buyers. That market represents potentially millions of additional household formations in the US over the next decade, and I’m confident in our ability to capitalize on that opportunity and translate into solid returns for our shareholders. Turning to Slide 5. Focusing our third-quarter results our 22% net earnings growth was driven by increased home closing revenue that more than offset the year-over-year decline in gross margin. We closed 1,800 homes during the quarter, a 5% increase over last year and our average home closing price rose 6% to $490,000, generating a 11% increase in total home closing revenue for the quarter. Our home closing margin rose sequentially to 17.8% in the third quarter from 17.3% in the second quarter of 2016. It was 19% in the third quarter of last year. Our third-quarter net earnings also benefited from a slight improvement in our SG&A percentage, lower interest expense, a positive swing in other income and a lower tax rate which Hilla will expand more detail later. Turning to Slide 6. Our total orders grew 11% over last year’s third quarter as a result of a 14% increase in our orders per average community in the third quarter of 2016. Our sales pace improved in most of our markets, most notably in Colorado where we more than doubled our orders per average community leading to a 25% increase in absorptions for the West region. Additionally, absorptions in our East region were 14% higher than our third-quarter of 2015. The increase in orders per average community more than offset a small decline in our average community count for the quarter. We expect to grow modestly in the fourth-quarter and increase meaningfully and 2017. We’re being somewhat cautious since potential delays in the aftermath of hurricane Matthew could push back the openings of some communities in North Carolina and Florida. Total order value was up 14% year over year as average sale prices also rose slightly in addition to our units ordered growth and our backlog value of $1.38 billion which was 9% higher than it was a year ago. The key drivers for housing growth remains positive this year including continued job growth, increasing household formation, low interest rates, and good affordability in most markets. We are also seeing the return of more first-time buyers. We believe we are positioned with a right product in the right markets to continue to grow in these conditions. I’ll now turn it over to Phillipe to provide some additional color on the trends in various markets. Phillipe?

Thank you Steve. I will provide some operational highlights beginning on Slide 7 with the West region which had the strongest order trends in the third quarter. Total orders were up 22% over the third quarter of 2015 in our West region. Led by a 44% increase in Colorado, followed by a 27% increase in Arizona and a 6% increase in California. The market is strong in Colorado, and we’re very well positioned there as evidenced by the fact that it has the highest sales pace in the company after increasing 104% year-over-year for the third quarter. Because of high demand, we sold out of several communities earlier than we anticipated and are working to maintain our community count of the next several quarters while searching for additional communities to grow our Colorado market share further. We are also in the process of reloading with new communities in California where our average active community count was up 17% from a year ago. Our sales pace has normalized in northern California compared to last year, when it was the highest in the company by a wide margin. And housing fundamentals remain strong there. Sales have improved in Southern California as we found a sweet spot in pricing. Those have compressed margins as some communities acquired prior to the reduction in the FHA loan limits. Sales have also picked up in Arizona and have price points that fall under the FHA loan limits. Our ASP there was 5% lower than the third quarter this year compared to last year but our sales pace was up 28% year over year as we’re successfully making the shift for more first-time home buyers. Slide 8. Moving to Texas our orders and total order value was up 8% primarily due to an increase in committee count compared to the third quarter last year. While our orders per average community and ASP were flat year-over-year, our operations in San Antonio continue to perform very well with the fourth-sales pace in the company as demand has been very strong there in 2016. We have moved toward more affordability priced communities in the Austin area, which have gained traction and produced good year-over-year growth in the third quarter. The Dallas-Fort Worth market saw some slowing in the third quarter, especially at higher price points, but it remains a strong market overall. We have opened several new communities there with more of a focus on lower-priced homes to deal with a significant rising prices of the last couple of years. And we expect this to be successful additions to our portfolio as the market continues to grow. Our sales in Houston were up in the third quarter of 2016 compared to 2015 and our third-quarter sales pace was higher than last year’s despite the prolonged relative weakness in the energy sector our year-to-date orders are comparable to 2015. Overall, Houston has been better than we expected this year in we are pleased with our results there. Slide 9. Our total orders for the third quarter were up 2% in East region despite an 11% decline in our average community count compared to a year ago. Our performance improved substantially in 2 of the 3 markets where we made acquisitions in the recent years. We produce 50% order growth in Tennessee with a 20% increase in orders per average community and a 27% order growth in Georgia with a 22% increase in our sales pace there. We attribute our progress to those markets to the changes we made in product condition of communities and personnel, and we expect these improvements to continue. Our orders in South Carolina declined primarily to 16% decline in average community count compared to last year as we consolidated several small communities there. Orders were down 8% in Florida as an 8% increase in sales pace partially offset a 15% decline in average communities opened in the third quarter of 2016, compared to the prior year. The demand trends were better at the low end than at the high end, thanks to the strengthening of the first-time buyer segment. We are adding more communities for first-time home buyers there, including several townhome communities. We have traditionally stuck to single-family detached homes, and are adding some attached products in certain markets that we expect to do well and they are priced for first-time home buyers and a very good locations. Overall our East region is improving the terms of production and we expect it to contribute to earnings expansion in the coming years. We have been asked about what impact hurricane Matthew had on our operations in the East when it hit earlier this month. So I will address that. Fortunately, most of our communities are far enough inland that they were not directly damaged by the storms or flooding. It did impact production and sales for 1-2 weeks in Charlotte, Raleigh, Orlando, and South Florida, as those areas made preparations for the hurricane and cleaned up afterwards. The unknown is what may happen to the labor base once the insurance settlements start flowing. So we’re staying on top of that and doing what we can to minimize disruptions to our delivery schedules. We’ve layered in some conservatism in our forecast due to potential delays related to the storm. I will now turn it over to Hilla for additional details on our financials. Hilla?

Thank you, Phillipe. I will review some additional details from our income statement, as well is our key land and balance sheet metrics. Starting on Slide 10. Home closing gross profit increased by 4% for the third quarter and 11% year to date as we grew home closing revenue. Our home closing gross profit of 17.8% in the third quarter of 2016 compared to 19.0% in the third quarter of 2015, reflecting a heavier mix of closings from newer communities that are earlier in the profitability cycle as well was broadly higher land and labor costs with moderate pricing power to offset them. For the first nine months of the year, our home closing gross profit margin was 17.5% in 2016 compared to 18.9% last year. We are pleased to see the slow but steady improvement in gross margin after adjusting for impairments this year. Excluding impairments, our first quarter of 2016 home closing gross margin was 17.5% which improved to 17.6% in the second quarter and 17.9% in the third quarter. Financial services profit increased by 6% in the third quarter, and 17% year to date driven by increased home closing volume. Total Selling, General and Administrative Expenses were slightly lower as a percentage of total home closing revenue in the third quarter, 11.4% in 2016 compared to 11.5% in 2015. The third quarter 2016 SG&A percentage was higher than the second-quarter’s percentage due to the leveraging of fixed overheads and higher home closing revenue in the second quarter. Year to date, our SG&A percentage has come down to 11.5% in 2016 from 12.4% in 2015. SG&A cost control will continue to be a focal point throughout 2017 for us. Interest expense for the third quarter declined 60 bps from 2015 to 2016 and is down 50 bps year to date as we can have capitalized more interest incurred to additional land and homes under development. Other income increased by a net $5.4 million for the third quarter and $6.7 million year-to-date in 2016 over 2015, primarily due to a $4.1 million adverse legal ruling, which we expensed in the third quarter of 2015. Our pretax earnings increased 15% year-over-year and the third quarter and our tax rate fell to 31.4% in 2016 compared to 35.1% in 2015 resulting in a 22% increase in net earnings. The tax rate was lower than last year’s third-quarter due to the timing of tax credits earned on our energy efficient homes this year. We weren’t able to take those credits last year until the fourth-quarter when legislation was passed extending the credits for both 2015 and 2016. In 2016, we’ve been able to take those credits each quarter in-line with our corresponding home closings. I’ll emphasize the point we made last quarter, that the lower tax rate for Meritage due to energy tax credits has become the new normal as long as the tax credit legislation continues to be enacted annually and reflects our product strategy of building energy efficient homes. Turning to Slide 11. Our ending cash position decreased approximately $154 million during the first nine months of 2016 to $108 million as of September 30 which includes $25 million drawn against our revolving credit facility which was repaid in early October. Cash was used primarily to fund the construction of homes under contract. Our net debt to capital ratio as of September 30, 2016 was 43.0% compared to 40.4% at year end 2015 and 42.6% at June 30, 2016, remaining within our target range of below 40%. Our total real estate inventory increased by approximately $331 million year-to-date ending the quarter at $2.43 billion. We invested approximately $232 million in land and development during the third quarter of 2015 compared to approximately $175 million in the third quarter of 2015. 40% of our closings in the third quarter of 2016 were from spec inventory, or homes started before the orders were taken compared to 33% a year ago. We ended the third quarter of 2016 with approximately 1,530 specs compared to 1,360 specs a year ago, an average of approximately 6.5 specs per community in 2016 versus 5.4 in 2015, in line with our greater focus on entry-level communities which require more specs. About 21% of total specs were completed at the end of the third quarter of 2016 compared to 32% for the third quarter of 2015 as we are selling specs at earlier stages to give customers the opportunity to select finish options that fit their individual preferences. Slide 12. Our total lot supply has been relatively constant over the last three quarters, ending the third quarter of 2016 at approximately 28,800 lots compared to 28,900 lots at the beginning of the quarter and 27,800 at the end of 2015. We have approximately a four-year lot supply based on our trailing 12 month closings. We sold out of some communities quicker than expected, and encountered some delays in opening new communities throughout most of 2016. We are sourcing new committees in a very competitive environment and have been disappointed that we haven’t been able to increase our community count this year, but we expect meaningful community count growth next year and will provide more specific guidance next quarter. With that I’ll turn a back over to Steve before we begin Q&A. Steve?

Thank you Hilla and Phillipe. In summary, we were pleased with the results for the third quarter and of the first nine months of 2016. As we continue to execute our strategy for growth and area expansion. We generated strong top line and bottom line growth so far this year successfully countering the impact of rising direct costs through approved overhead leverage and interest expense savings. We’ve grown orders closing the backlogs year-over-year, both in terms of units and dollar value. We continue to be focused on improving our home closing gross margins through a combination of better community positions, products, and people, and are increasing the production and operational efficiencies within our new markets. We recently introduced our LiVE NOW homes, they’re specifically designed to capture more of the growing segment of first-time buyers which we expect will help us achieve our goal of having 35% to 45% of our communities directed at entry-level and first-time home buyers by 2018. And we just delivered our 100,000th home earlier this month, celebrating a milestone in Phoenix on October 14. I appreciate all of our employees’ efforts and commend them for making the dream of homeownership a reality for all those families over the past 31 years. Turning to Slide 14. Based on our outlook and results for the first three quarters of 2016, we are refining our projections for full-year orders, closings, revenue, gross margins, and diluted earnings per share. Specifically we’re being slightly more conservative on our estimated orders in closings due to delays in community openings. We expect 7,300 to 7,500 orders and the same rates of closings for the full-year of 2016. We are maintaining our estimated home closing revenue of $2.9 billion to $3.1 billion for the full-year, though expecting slightly lower ASPs in the fourth-quarter based on the mix shift towards entry-level plus. We expect home closing margins for the year to be approximately 17.5% excluding impairments due to our early success in newer communities that are early in the profit cycle, as well as our success in selling through those committees in California and Phoenix, where we reduced prices to qualify under lower FHA loan limits. We believe those are temporary. Accordingly, we are projecting EPS of $3.40 to $3.60 for the year, which reflects our revised revenue and margin expectations. Thank you for your interest in Meritage Homes and for sporting our growth and success. We will now open up for questions. And the operator will remind you of the instructions. Nicole?

Thank you. We will now begin the question-and-answer session [Operator Instructions] Our first question comes from Alan Ratner of Zelman & Associates.

Hi guys, good afternoon. Thanks for taking my questions. Hilla, I thought your comments about the land market were interesting. You referenced being frustrated with an inability to source deals yet you’re still pretty confident in growing committee count next year. I’d be remiss if I did not ask about you being a mentioned in some articles recently, rumored on the M&A front. I’m curious if that’s what you specifically had in mind if you’re looking more closely at M&A given where some of the valuations on stocks are today as well as where the land market is and then I have a follow-up to that. Thanks a lot.

Thanks, Alan. We don’t comment on any rumors or speculation. Relative to M&A opportunities in general, we’ve consistently demonstrated that Meritage is strategically growth-oriented and we explore all kinds of opportunities for growth that is accretive to earnings. I’ll also mention that you guys know how much money we spent on land and development throughout 2015 and 2016, and though it’s fallen a little bit below our initial expectations as we been more cautious to only purchase land that meets our underwriting criteria, we do expect to see the fruits of that labor come through in 2017. We’ve had some delays in community openings but those communities are still in the pipeline.

Got it, that’s helpful. And my second question just on the guidance revision. You mentioned some more conservatism on the margin and closings and revenue. I guess what I’m hoping maybe just to get a finer point on is what specifically or what is the primary driver in terms of what has changed versus July? Is it entirely company specific in the sense that the communities just haven’t opened as quickly as you thought? Or is there more of an underlying demand story here or delays that you see across the entire industry that is causing you to lower those numbers for the full-year? Thank you.

Alan, I think there are several small reasons and I think they are all temporary in nature. Number one, we sold more homes in Southern California and in Arizona on the lower margin communities that are left over from the FHA price adjustment than we expected. That’s the good news. Where clearing that inventory out quicker than we thought. We are performing if you less sales in closings in the East region, Ford and North Carolina because of the hurricane. So we brought that number down a little bit. And our ASP is lower which is because of these newer, entry-level communities that have really taken off, to some degree better than we thought. And there’s a lot of overhead that’s loaded in the front of those communities as well. We did open a lot of communities this quarter we actually closed a lot of communities this quarter. More than previous quarters and there’s some overhead loaded into those communities, without revenue that comes through so that’s had an impact on margin as well that we’re going to see in the fourth quarter. I’m very bullish about our margin trajectory for next year. I think it’s stabilizing and I don’t really get too worried about some of these short-term challenges that we are going to see over the next quarter.

I appreciate that very detailed response, Steve. Thank you. And good luck.

Thanks.

Our next question comes from Stephen Kim of Evercore ISI. Please go ahead.

This is actually Trey on for Steve. Thanks for taking our questions. First, you mentioned that gross margins were partially had to buy average communities being early in their life cycle. Could you quantify how much you think that impact was? And similarly, on average, how much do you think gross margin rises in a typical community over a lifespan of say 2.5 years?

I don’t have exact impact on a bips perspective, but I can share you with you that even though our committee count declined with the net impact of 30 communities closing and 26 communities opening, this quarter, which is 10% of our basis, a very large percentage in an individual quarter, so you have quite a bit of initial startup costs in a community before you actually see any closings. We are seeing the impact of that running through our financials now and through Q4 until we see a more meaningful impact of closings from those community openings. That’s the rationale behind Steve’s comment as far as quantification I don’t think we have an exact number, but once the field overhead as trending in line with the closings volume, that’s when you see those normalized margins that we talked about, the underwriting margin.

But the second part of your question, certainly, the early homes that close in the lifecycle of a community are the lowest margin ones. In a lot of cases because you’ve loaded in the construction overhead for the period where you’re building your models and you’re getting your community started. You’ve got some upfront marketing expenses that you’re flowing through, and as the community gets more mature, you’re able to push prices generally speaking. It’s hard to quantify and certainly is going to vary also by geography. Those markets where prices are stronger it’s going to be better, but it certainly could be 1% to 2% difference. But it’s going to be different in different places.

Got it. Thanks for that. And then secondly your order guidance implies for the fourth quarter think of down 4% to up 9%, so at the midpoint of 2% which is definitely a deceleration from where you’re at now. And a broad range in general. I was wondering if you could talk about the push and pulls that you’re seeing that could get you to that up 9% or potentially see orders down year over year?

You know, it’s the hardest metric to guide to. Orders change on a weekly basis depending upon things are happening in the macro economy, what’s being printed in the newspaper, what the weather is, certainly the hurricane kind of shot some of our communities down in the south for a week or two. People were not really buying houses when they were putting hurricane shutters on their homes. I think we’ve got 15 inches of rain in one of the markets. It’s just a very hard metric to predict, but we look at the store count the we have, the locations we have, and we feel pretty positive that we can produce a positive comp over last year.

Our next question comes from Michael Rehaut of JPMorgan. Please go ahead.

Thanks. Good morning, or good afternoon. First question – Hilla – you mentioned community count for next year, and gave some guidance to 4Q, but in terms of next year said you expect meaningful growth but you’ll talk more on the call for next quarter. I guess maybe just at the risk of pushing my luck, meaningful, I think most people would think of that in terms of double digits or above 10%. I just wanted to get a sense of at least directionally order of magnitude we’re thinking about that correctly, and if so, given the lot count being steady, is it just more that you reduce your year supply and be able to finally turn the switch on as you had alluded to the land spend over the last couple of years, turn the switch on to a bunch more communities that maybe got delayed this year? Is that the right way to think about it at least?

Yes. I’m going to take that one Mike for Hilla. We haven’t done a very good job at forecasting community count this year. We’re very disappointed that we haven’t been able to produce better growth because we certainly have the land and lots in our pipeline. We just haven’t gotten them open fast enough. We’ve encountered some entitlement and development delays. I’m going to stick to the word meaningful for next year. I don’t want to get pinned down to a number. But, you know, I don’t think 4%, 5% is meaningful so it’s going to be higher than that. Whether it’s going to double digit or how far into double digits, I just don’t want to say, but I can promise you will give it to you next quarter and we’re going to try to give you a number next quarter that we know we can hit and do a better job in 2017 predicting what community count growth is. I know it’s a very important metric that everybody is focused on and we’re focused on it as well. So, just give me a little more time on that and will give it to you.

Thank you, Steve. I appreciate that, and appreciate some of the context around that. Thanks for that. Second question just on the East region. Obviously highlighting that the sales pace improving, and obviously from a gross margin standpoint this has been a little bit the area of relative weakness. I guess at this point you feel like you’re starting to get some traction here and perhaps some community count growth also. You referred to North Carolina reloading with new communities in the first half of next year. You’re currently, I don’t know if I saw the updated regional margins for 3Q but obviously you’re a good couple 100 to 200 bips below corporate average right now. Any thoughts around what the improvement might be for 2017 as you see it today with what’s in backlog and what’s in the pipeline?

If you could save that one for next quarter we could probably give you a little bit more color around that. But certainly as we open more newer communities on new land that we bought in the South region and those markets in Georgia, the Carolinas and Tennessee, we expect margins to rise but I don’t want to pin ourselves to a specific number. But I think throughout next year that area of the country is going to have a better impact on results of the unit did this year.

Without giving specific numbers I think Phillipe covered it in his prepared remarks. We have new communities opening up. We have a higher volume of communities active in the East, and we have our new product rollout. What you’re seeing is well liked by the market, you’re seeing our sales volumes pick up you just haven’t seen that come through the P&L yet. So the combination of those factors is giving us confidence that we’ll see improvement in the East.

Great. Thanks.

Our next question comes from Nishu Sood of Deutsche Bank.

This is Tim on for Nishu. My first question was regarding the entry-level offerings. You mentioned about the 35% to 45% target. I believe you mentioned by 2018. That’s a pretty sizable step up from the 15% that was mentioned the communities open in 1Q. Are you able to provide how many, what percentage of your communities in 3Q were entry-level and how do you expect that to trend into 2017 to hit that 35% to 45%?

We are a little over 20% right now of our communities, are primarily targeted to first-time home buyers. Again, I don’t want to give specific numbers as to what that’s going to be at the end of 2017 and through 2017, maybe that’s a number we can focus on and give you the next quarter, but I feel fairly confident that we can get to the 35% to 40% by the end of 2018.

That’s very helpful. And then as well – do you guys typically underwrite through a different absorption for these committees? I’m just curious. You’ve had strong growth and it seems that you’re understanding the difficulty that you stated in the community count, getting them open, are you as well retooling some maybe move up communities towards this entry-level product and will that have any sort of headwind to margins in the future?

Well, yes, we do underwrite to a higher absorption. We typically underwrite to a minimum of three sales per month for our typical move-up project products, sometimes luxury is little less, but entry-level needs to be more into four to five sales per month range. You can’t really retool a community. Once you’ve bought the land and designated the product to where you can’t really retooling to an entry-level if it’s not entry-level. But I can also just add to tag on to your question, we opened up two live now communities in Metropolitan and Phoenix area around Labor Day weekend. And we also opened up one in Houston around the same time. And the results blew us away. We had phenomenal sales success way above our pro forma. Deep demand. Sales continue to be strong. It’s a very small sample. Is only a few communities, but I really believe those communities that are under the FHA loan limit that are well located, we are also building a high number of specs. We’re almost exclusively spec in some of these LiVE NOW communities where people can move in, in a very short period of time. We will have tremendous success there, and I’m very bullish about our future as long as we continue to find locations and get that product series online. The next question, operator?

Our next question comes from Stephen East of Wells Fargo. Please go ahead.

Steve, can you hear me?

Sorry about that. Steve, a couple questions on the regions. If you look at just your acquired in Atlanta and Nashville, where would you say you all are right now on transitioning the product over from their old legacy product to the Meritage product? And then if you look at Phoenix you had some really strong growth. Can you give a little more color on how much of that was just because you are switching heavier to entry-level versus maybe just trying to drive some better absorption with pricing, margin, et cetera?

I will talk about Phoenix and let Phillipe talk about Georgia and South Carolina. In Phoenix we had our best month of the year last month. We sold more than 100 homes, and not only was that because we have these two entry-level communities open up that we had phenomenal sales success in, but across the board, the market, the volume in the market over the last three to four months has been notably better. There’s not a lot of pricing power in the market, but the good news is we are moving some low-margin inventory off our books and it is impacting our margins, as we already said. We will get those dollars back and we will redeploy them in our higher-margin communities throughout the country and into more entry-level plus first-time home buyer communities. I’m feeling really excited that Arizona is finally starting to wake up. It’s been a tepid market down here for a long time but it seems to be picking up steam. I will let Phillipe talk about the product revisions that we’re doing –

We are basically at the goal line. We built all the new product. It’s fully bid out. We’ve locked it. We go through a process, a value engineering process. We are right at the end of that, and basically all new communities going forward are opening up with our new product and in communities where we have longer land positions we’re phasing the new product into that as well.

To elaborate on what Phillipe just said when you have a community that has 100 lots and you’ve built 50 of them, you can’t really change the product. So we had changed in areas that we can but we can’t change it in every community and so it’s still a process over time. It still going to be while till we’re 100% new product in every community, but certainly every new committee will have new product and a good percentage of the old communities have new product as well.

Okay. So it sounds like 2017 is the big transition year in those new markets for you then. If I look at your philosophy right now given what you’re doing at entry-level plus, et cetera, tell me how you all are thinking about pace versus price? As you move through the new year in 2017? Is this – have you evolved it to where you would much prefer to drive a lot more volume through, how do you think about it right now?

We’re not sacrificing price for pace. I just really want to dispel that misnomer. Even though our order absorptions are up for the quarter, I laid out a whole variety of reasons for that. The FHA loan limit issues in Arizona and the entry-level communities coming online, et cetera. We’re really focused on stabilizing and improving our margins, particularly as we go on to 2017. So we are going to hold the line on price. I don’t see a lot of pricing power in a lot of markets, so we can’t raise the prices at will and be competitive. But I really think we have a floor in our margins and in our prices and we are something to build off of. We do have a tremendous opportunity, I think, to leverage our overhead. I think we can grow our business next year without adding hardly any incremental overhead and we’re going to be really focused on doing that and mission one here is to drive down our SG&A percentage to something subsequently lower than it is today.

All right. I really appreciate that. Thanks.

Thanks.

Our next question comes from John Lovallo of Bank of America Merrill Lynch. Please go ahead.

Thanks for taking my call as well. I’m just looking at Slide 14, I just want to make sure I’m understanding this. Your outlook slide. Home closing revenue looks like it remains unchanged. Your gross margin outlook is coming to the lower end of the previous range. It looks like you’ll get a little bit of benefit on the tax rate versus where you were thinking before, but the EPS forecast goes below the low end of the range, and to me that would seem to imply that you’re thinking there’s going to be a step up in SG&A? Am I thinking about this correctly or am I missing something?

I think you’re not focusing enough on the margin change and on the slight decline in the units. Although our revenue range hasn’t changed, we’ve certainly mentioned that with the acceleration of the entry-level plus business, we would maybe tend to be closer to the middle bottom of the revenue range versus the top where we were at last quarter. That combined with the margin refinement is pretty much going to get you to that EPS number. We’re certainly not – the middle of EPS number. Were not anticipating increases in SG&A. We are expecting improvements in SG&A leverage, not decline.

Traditionally you get more leverage in the fourth-quarter, and this year should be no different than any other year.

Exactly.

So it’s just more of a shift to the lower end of the revenue range then?

And the margin. The margin refinements.

I was going to say 17.5-ish.

Right, exactly, the combination of those two. No change on our SG&A expectation.

Okay. And I guess of the next question would be in the quarter, the $33 million of G&A expense relative to the second quarter of $29 million on the lower revenue base. Was there anything that was one-time in nature there? What was the step up attributable to?

Not too many unique items, although I will say that the accounting roles, we have some composition costs that is performance-based. The accounting rules don’t allow us to take any expense until it seems likely or reasonable that we will meet the hurdles. Our auditors and us have come to the understanding that Q3 is when you can appropriately have enough visibility into full-year numbers. There is some disproportionate catch ups for full year expenses in Q3, so there’s a little bit of an aberration every Q3 for us related to composition costs which then dissipates by Q4. It’s a little bit of an unusual quarter, however, as I mentioned we’re not expecting SG& A to increase. We’re expecting our leverage to go back to where it was in the first half of the year.

Okay. Thanks, guys.

Our next question comes from Jade Rahmani of KBW.

This is actually Ryan Tomasello on for Jade. Thanks for taking my questions. Regarding your appetite for land you mentioned Colorado for example as a strong market your hoping to grow community count. So I was hoping you could provide some color on what other markets you view as attractive, and perhaps driving that strong community count growth into 2017, as well as perhaps some color on your gross margin underwriting and if that’s changed at all.

Well, we think all of our markets are attractive. If we didn’t like them we would not be in them. Of course we see the biggest opportunity for growth for us to be in the South because those are markets where we’re the smallest in and we want to gain more market share. And market share has a lot of benefits, you get better cost from your contractors, gets you better land positions, you can attract better people. We like everywhere we are, certainly in markets like northern California, Colorado and Dallas are more fully priced. You need to be more carefully when you buy land in those markets. But, business is still robust in all of those. I can’t really point I can’t really point to one market where we’re going to see a lot of growth of next year. I think it’s going to be pretty balanced across the company, but certainly more oriented toward the south.

Great. Thanks. And then you mentioned to 30% of closings were spec this quarter given your mix shift goals towards more of the LiVE NOW product and entry-level and first-time. Can you say how you might expect that figure to trend into next year?

Just to clarify it was actually 40% not 30%.

My mistake.

Which was up from the before which was 33%. We don’t have an exact projection, although to Steve’s point, almost 100% of our volume in some of the entry-level plus, LiVE NOW committees will be sold as a spec. I would expect as a mix shift that we’ll see some upward movement in that metric

Thank you.

Steve, would you like to take one to two more questions?

Sure.

Okay, our next question comes from Alex Barron of Housing Research Center.

Thanks. Good job on the quarter, guys. I wanted to see if you could comment on incentives throughout the quarter and how they compared to a year ago and last quarter and whether there was any step up in incentives toward the end of the quarter?

I don’t think there’s been any meaningful change in incentives in this quarter and where they were a year ago. I think they’re probably pretty similar. I don’t have that specific information in front of me. Obviously it varies by market. That’s not a number that we specifically track. Maybe we should be doing a better job tracking that but I don’t know of any real difference in incentives.

Okay. Great. And I’m not sure if I missed it but have you commented on how orders have been trending so far in October?

We haven’t made any comments on that. Clearly, early October was a little softer with a hurricane in the East. But it’s consistent with our guidance and our internal forecasts. It would be premature for me to give you a number right now when we still have a weekend to get through.

Okay, great. Good luck.

A lot of orders in the homebuilding business come in the last few days, you know. Whatever incentives we put out there expire at the end of the month. You generally see a big bump in the numbers right at the month-end.

If I could ask one last one, Steve, when’s the last date roughly the someone bought a spec, you could still close it by the end of December?

About 45 days out depending on where the spec is. Were getting close to that date right now. We may have a couple, a few more weeks. If the house is completely done, all it needs is carpet or something, 30-35 days before the end of the year.

Got it. Okay. Good luck. Thanks.

Thanks. Last question, operator?

Yes. Our last question is going to be from Susan Maklari of UBS. Please go ahead.

Good afternoon. Thanks for taking the last question. As you think about opening the LiVE NOW communities and some of the entry-level plus product that you’ve been expanding, how do you think about positioning each of those in the different markets and perhaps avoiding any cannibalization that could happen between one and the other?

Well, they don’t really compete with each other. LiVE NOW is a subset of our ELP strategy. Live now communities is a community that’s predominantly specs where we don’t send our customers to design center where they have a few choices on colors and options, our predesigned packages that are probably already built into the spec inventory, so we make the process a lot simpler. Other entry-level communities, we may still be offering the opportunity to have the home built and to go to the design center but those are going to be a little longer cycle time. So we’re not putting them next to each other we can pick one or the other. These are just generally in different parts of town, in different locations. It just depends upon who we’re competing with, and if we’re competing with an LGI community, it might be more LiVE NOW. If were competing with L&R, where we concluded, it might be more of a traditional entry-level plus community. I don’t see that as a worry for us.

Okay. That’s all I had. Thank you.

I think that wraps up our call. Thank you very much for your participation and attention and we look forward to talking to you next quarter. Have a great day.

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