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Edited Transcript of NWHM earnings conference call or presentation 31-Oct-19 4:00pm GMT

Q3 2019 New Home Company Inc Earnings Call

Aliso Viejo Nov 3, 2019 (Thomson StreetEvents) -- Edited Transcript of New Home Company Inc earnings conference call or presentation Thursday, October 31, 2019 at 4:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Drew P. Mackintosh

The New Home Company Inc. - Founder & Managing Partner, Mackintosh IR

* H. Lawrence Webb

The New Home Company Inc. - Executive Chairman

* John M. Stephens

The New Home Company Inc. - CFO & Executive VP

* Leonard S. Miller

The New Home Company Inc. - President & CEO

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Conference Call Participants

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* Alex Barrón

Housing Research Center, LLC - Founder and Senior Research Analyst

* Samuel Thomas McGovern

Crédit Suisse AG, Research Division - Research Analyst

* Thomas Patrick Maguire

Zelman & Associates LLC - Senior Research Associate

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Presentation

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Operator [1]

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Greetings, and welcome to The New Home Company Third Quarter 2019 Results Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Mr. Drew Mackintosh, Investor Relations. Thank you, sir. You may begin.

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Drew P. Mackintosh, The New Home Company Inc. - Founder & Managing Partner, Mackintosh IR [2]

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Good morning. Welcome to The New Home Company's earnings conference call. Earlier today, the company released its financial results for the third quarter of 2019. Documents detailing these results are available in the Investor Relations section of the company's website nwhm.com.

Before the call begins, I'd like to remind everyone that certain statements made in the course of this call, which are not historical facts, are forward-looking statements that involve risks and uncertainties. A discussion of such risks and uncertainties and other important factors that could cause actual operating results to differ materially from those in the forward-looking statements are detailed in the company's filings made with the SEC, including in its most recent annual report on Form 10-K and in its quarterly reports on Form 10-Q. The company undertakes no duty to update these forward-looking statements that are made during the course of this call.

Additionally, non-GAAP financial measures may be discussed in this conference call. Reconciliations of these non-GAAP financial measures to the most comparable measures prepared in accordance with GAAP can be accessed through The New Home Company's website and in its filings with the SEC.

Hosting the call today is Larry Webb, Executive Chairman; Leonard Miller, President and Chief Executive Officer; and John Stephens, Chief Financial Officer.

With that, I will now turn the call over to Larry.

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H. Lawrence Webb, The New Home Company Inc. - Executive Chairman [3]

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Thanks, Drew, and good morning to everyone joining us on the call today. I would like to start out by giving some high-level commentary about the company and the housing market. Leonard will then give some additional color about current trends in each of our markets, and John will provide more detail on the numbers.

The New Home Company did a solid job of executing on its core objectives in the third quarter by generating cash flow, reducing our net leverage and lowering our SG&A expense ratio. We completed 2 of the 3 large land sales scheduled for this year in the quarter, bringing in roughly $25 million in net proceeds. The third land sale closed earlier this week, giving us an additional $16 million, which will be booked in the fourth quarter. The execution of these land sales was an important part of our strategy that resulted in the repayment of $48 million in debt and a 280 basis point sequential reduction in our net debt-to-capital ratio to 54.9%.

Furthermore, we lowered our net leverage ratio by 520 basis points from the high of 60.1% at the end of 2019 first quarter. As we have stated previously, our goal is to end the year with our net leverage in the low 50% range and stay in that range moving forward.

With respect to costs, we were able to reduce our SG&A expense ratio by 170 basis points versus last year on a similar revenue base, thanks to cost-cutting initiatives we've undertaken since the beginning of the year. As our company has evolved, we have discovered ways to do more with less and stretch our existing resources to generate more operational leverage. This discipline will carry forward into the future.

In terms of current market dynamics, we continue to see a consistent trend playing out in our markets. Buyers are gravitating to the more affordable segments of the market, while the move up in luxury segments continue to be more challenging. We have been repositioning the company to address this ongoing trend, and we think our new communities will resonate well with buyers who are looking for a great place to live at an affordable price.

In summary, I think we have a great opportunity to capitalize on a housing market that continues to show signs of improvement. Consumer confidence continues to be high, while the unemployment rate and mortgage financing costs remain low.

In addition, new and existing home inventory is in short supply, creating a new need for more housing. This positive macroeconomic backdrop, coupled with our improved balance sheet and our product repositioning, have me excited about the future of The New Home Company.

With that, I'd like to turn the call over to Leonard, who will provide more color on our operations this quarter.

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Leonard S. Miller, The New Home Company Inc. - President & CEO [4]

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Thanks, Larry, and good morning to everyone on the call. As Larry mentioned, our focus this quarter was to generate cash flow, improve our leverage ratios and lower our SG&A expenses, and we've succeeded on all fronts. We have emphasized pace over price, leading to compressed margins, particularly at some of our higher price point legacy communities in order to generate cash flow, lower leverage and reinvest in more attainably priced communities.

Our more affordable projects continue to perform well relative to our move-up and luxury communities from both a sales pace and margin perspective. This was evident in the sales activity we experienced at our more affordable communities in the quarter, which came in at 3.3 orders per community per month versus 2.0 for the company average. We expect this trend to continue and have been focusing on our land acquisition efforts on more affordable projects over the last several quarters. In fact, 13 of our next 18 community openings over the next 24 months are expected to have base prices within FHA loan limits.

Similar to our existing communities, these new projects will be in well-located core areas of the market, but will feature smaller floor plans and higher densities. This is an encouraging development given that we have made significant investments to move our company down the price spectrum in the last few years.

Our monthly sales absorption rate was 2.0 for the 2019 third quarter as compared to 2.2 for the prior year period. Our California absorption rate was flat for the quarter as compared to the prior year, while our Arizona absorption rate was down largely due to a lack of inventory at our nearly sold-out move-up community in Gilbert.

Demand trends in the higher-priced coastal areas of both Northern and Southern California were a bit softer while the housing markets, Inland in both regions performed better characterized by healthy order paces and normalized incentive activity.

As part of our strategic shift to more affordable product, we have one remaining project in the Bay Area and have limited exposure in Coastal Southern California at this time.

On the cost front, the price of building materials in California appear to have stabilized, and most builders are staying disciplined in the underwriting of new land deals, which has put a cap on lot prices.

Phoenix continues to be one of the best housing markets in the country, and builders are taking advantage of the strong fundamentals with improving order rates and periodic price increases. We currently only have 2 wholly owned projects in the market, but our presence in Arizona will scale dramatically over the next 1.5 years, as we have 8 new communities scheduled to open, all priced between $275,000 and $425,000.

In summary, I share Larry's enthusiasm for The New Home Company's future given our solid execution this quarter, which improved our financial position and furthered our efforts to better position our company from a product standpoint.

Now I'd like to turn it over to John for more detail on our financial results this quarter.

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John M. Stephens, The New Home Company Inc. - CFO & Executive VP [5]

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Thank you, Leonard, and good morning. For the 2019 third quarter, we generated a $4.8 million pretax loss as compared to pretax income of $3.4 million in the year ago period. The current quarter pretax loss included a $1.5 million loss on land sales and $3.6 million in inventory impairments, $1.9 million of which related to a land sale in Northern California and $1.7 million related to one housing program in Southern California. Including these impairments and loss on land sales, we generated a net loss of $4.6 million or $0.23 per diluted share compared to net income of $2.5 million or $0.12 per diluted share in the prior year period.

Adjusted net income for the 2019 third quarter after excluding the inventory impairments and loss on land sales was $242,000 or $0.01 per diluted share. Our home sales revenue for the third quarter was towards the high end of our quarterly guidance and was essentially flat with the prior year at $119 million.

Deliveries were down 5% while our average selling price was up 4%, coming in at $958,000 per delivery for the quarter.

Based on the homes in backlog and the spec homes available for fourth quarter delivery, we are estimating fourth quarter home sales revenue of between $140 million and $160 million, which equates to between $500 million and $520 million of home sales revenue for the full year 2019. We estimate that our average selling price for the fourth quarter will be approximately $875,000.

Our backlog conversion rate for the quarter was 60% as compared to 42% in the prior year period as a result of our strategy to move down price point and our success in converting spec homes into deliveries more quickly. As a result of the higher third quarter backlog conversion rate and the lower beginning backlog to start the quarter, the number of homes in our backlog was down 33% from the prior year and represented a backlog dollar value of $186 million.

Net new orders for the 2019 third quarter were down 6% year-over-year. However, the 19% sequential decline from the second quarter was more in line with expected seasonality as compared to the 32% sequential decline experienced in the prior year period.

Our gross margin for the 2019 third quarter, including impairments, was 9.5% versus 14.8% in the prior year period. The 2019 third quarter included a $1.7 million inventory impairment charge related to one higher-priced community in Southern California that has required more incentives than originally anticipated. Excluding impairments and interest in cost of sales, our gross margin from home sales for the 2019 third quarter was 16.2% as compared to 18.4% in the year ago period. The 220 basis point reduction in gross margins before interest and cost of sales and impairments was primarily related to higher incentives and a product mix shift.

Moving forward, we are projecting home sales gross margins, including interest for the fourth quarter of between 12% and 12.3%. We are projecting our full year 2019 gross margins to be between 11.5% and 11.7%, including impairments taken to date.

Our SG&A rate as a percentage of home sales revenue for the third quarter was 11.1% versus 12.8% in the prior year. The 170 basis point improvement in our SG&A rate was primarily due to lower co-broker commissions, more efficient marketing and advertising spend and lower personnel expenses.

For the 2019 fourth quarter, we expect our SG&A rate to be in the high 10% to low 11% range, and for the full year 2019, we expect to be in the mid- to high 11% range, excluding Q1 severance charges.

Our share of joint venture activity for the 2019 third quarter resulted in a pretax loss of $63,000 as compared to $34,000 of income in the prior year period. For the 2019 fourth quarter, we expect to break even from our joint venture participation.

Our fee building revenue for the third quarter was $22 million as compared to $39 million in the year ago period. The lower fee revenue and margin for the quarter was due primarily to less construction activity at our Irvine fee building communities. For the fourth quarter, we are estimating fee building revenue of between $20 million and $30 million and between $85 million and $95 million for the full year.

Our effective tax rate for the third quarter was a 3.6% benefit as compared to a 27.8% provision in the year ago period.

The lower effective tax rate for the third quarter was primarily due to the impact of deduction limitations for certain severance payments and lower stock-based compensation expense actually realized upon investing. We estimate an effective income tax rate, including discrete items of between 3% and 6% for the fourth quarter.

Our ending community count was slightly above our prior quarter guidance due to the opening of 2 new communities in Northern California at the end of September that were previously scheduled to open in October. We expect our year-end community count to be flat on a sequential basis.

We ended the quarter with $41 million in cash, $506 million in real estate inventories and $327 million in debt. We generated approximately $40 million in operating cash flow during the quarter and approximately $59 million for the 9 months ended September 30. We are targeting strong operating cash flow for the fourth quarter and are estimating a full year operating cash flow figure of approximately $80 million to $90 million.

In addition, we rightsized our revolving credit facility during the quarter, which better aligns our commitment with our lower expected leverage and also extended the maturity date of the facility to March 2021. As of the end of the third quarter, we had $18 million in borrowings outstanding under our $130 million facility. We spent $26 million on land during the third quarter and $66 million year-to-date. We expect to spend approximately $100 million of land for the full year 2019 and expect to increase our land spend in 2020 to about $150 million.

I'll now turn the call back to Larry for his concluding remarks.

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H. Lawrence Webb, The New Home Company Inc. - Executive Chairman [6]

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Thanks, John. In conclusion, I'm pleased with the direction our company is heading. We've taken cost out of the business, reduced our debt levels and made further progress in repositioning our company to address the fastest-growing segment of the market.

We recognize that our current gross margins are at unsustainably low levels, but some of that can be attributed to our decision to emphasize pace over price this quarter and turn through our legacy communities more quickly.

Moving forward, I expect our margins will improve as our community profile better reflects our shift to more affordable product.

We've had to play defense for most of this year in an effort to shore up our balance sheet and rightsize our cost structure. Now that we've made progress on both fronts, I'm looking forward to reaping the benefits of the investments we've made over the last few years and improving our profitability. We have a clear plan in place for future success and a seasoned, experienced management team on hand to execute that plan. And as a result, I'm as excited as ever for the future of The New Home Company.

Finally, my transition from CEO to Executive Chairman has gone very smoothly, and I have full confidence in Leonard and the rest of the senior management team. I'd like to thank them and our team members for their efforts.

That concludes our prepared remarks, and now, we'll be happy to take your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Thomas Maguire with Zelman & Associates.

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Thomas Patrick Maguire, Zelman & Associates LLC - Senior Research Associate [2]

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Nice job on leverage and cash flow progress in the quarter. Just staying with that, part of what drove was working through some of the higher-priced product, getting cash back in the door and focusing on the better performing, lower-priced communities and appreciate you quantifying the pace side, but can you talk about the margin differential on the higher-priced product you're working through now in new communities more towards the lower end? And more broadly, once you get to a normalized product standpoint, how do you think about the longer-term margin profile?

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Leonard S. Miller, The New Home Company Inc. - President & CEO [3]

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Sure. This is Leonard. I'll take that one. We sold -- about 26% of our sales in the third quarter were specs that we sold and closed. And those margins again were older, higher-priced closeout communities that had margins that were half of what we reported in the third quarter. The encouraging thing as we move down in price point, which really will only represent approximately about 13% of our revenues for the year. Again, our absorption was higher. It was 3 plus per month, and our margins were 400 to 500 basis points higher than the company average. So I think that bodes really well for the future as 13 of the next 18 communities that we open will be priced over the next 24 months at or below FHA.

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Thomas Patrick Maguire, Zelman & Associates LLC - Senior Research Associate [4]

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Got it. That's really helpful. And then just back to the leverage side, can you just talk about more broadly the capital strategy? I understand that we have the goal to get to the low 50% range here. Is that something we view as sustainable and could grow into longer term? How do we think about the debt level and the necessary size of the revolver and then just the senior notes coming due, understanding its a few years out?

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H. Lawrence Webb, The New Home Company Inc. - Executive Chairman [5]

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Well, I'll let John take the heart of this, Thomas, but I think everyone is aware, we've been talking about it every quarter that this -- we understand the importance of getting our leverage down to the low 50s and really roughly around 50 moving forward after that. I would say John's primary focus this year is doing that. And I'll let him tell you kind of where it's going and how he feels about it.

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John M. Stephens, The New Home Company Inc. - CFO & Executive VP [6]

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Yes. I mean, we've made -- we continue to make progress as you saw by the results and that was despite having some impairments to move out some of the land that we thought made sense to liquidate some of those positions and continue to bring down the leverage. I think as we move into next year, we would like to sort of manage the company around a 50% on a net basis. Longer term, is there an opportunity for us to go lower? We'll see. But I'd like to see that in the future. But I think for the near term, 50% is a good goal for us. And you saw we did do an extension on our revolver, not an overly long term but it puts us out to March of '21 and then our bonds are March of '22, the following year. So those will be things that will be -- continue to be focused on as we continue to bring down our leverage, increase our cash flow and look at extending both of those in the future. I would say next year, that will continue to be a focus for us as well as opening a lot of these new more affordable products that have had better margins and absorption paces, Leonard, sort of outlined.

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Operator [7]

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Our next question comes from the line of Sam McGovern with Crédit Suisse.

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Samuel Thomas McGovern, Crédit Suisse AG, Research Division - Research Analyst [8]

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I was hoping you could discuss a little bit about the decision to pay down the revolver versus continuing with the bond buybacks. Was that driven by covenants or the lower dollar discount in the bonds? Or what sort of drove the decision to pay down revolver?

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John M. Stephens, The New Home Company Inc. - CFO & Executive VP [9]

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It was primarily due to the current limitations we had during last quarter in connection with the extension that we did. If our leverage is below 55% on a net debt-to-cap basis, we're authorized to purchase bonds. There's a limitation as to how much we can purchase per quarter, but that was a limiting factor during the quarter. I think moving forward, that has opened back up. And we will continue to focus on paying the line down and looking at opportunities for bonds if they're available and they make sense. But again, our goal is to continue to generate cash flow and pay down the leverage, whether it's revolver debt or senior notes.

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Samuel Thomas McGovern, Crédit Suisse AG, Research Division - Research Analyst [10]

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Got it. So with regard to any cash generated in the fourth quarter, we should expect it to be deployed for debt pay down one way or another?

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John M. Stephens, The New Home Company Inc. - CFO & Executive VP [11]

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It could be or could -- we could continue to just build cash reserves as well depending on just sort of what the circumstances are.

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Operator [12]

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

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Alex Barrón, Housing Research Center, LLC - Founder and Senior Research Analyst [13]

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I wanted to ask a little bit about the community that you mentioned you impaired. Is there anything else you can share about that, maybe, was it just a high-priced location? Was it just a kind of a close-out? Any other color around that?

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Leonard S. Miller, The New Home Company Inc. - President & CEO [14]

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Sure. Alex, this is Leonard. I'll take that one. And it was a community in Corona in the Inland Empire that was kind of the second time move-up price segment. And I'm sure you guys are really well aware of this. But anything above $500,000 and this was purely significantly above that, that's kind of the breaking -- the breakpoint, I would say, in the Inland Empire. Anything priced below that absorb -- is absorbing very well. You get above that, and the air gets a little bit thinner. So we own 40 lots there. We had to go to find the market. We were negotiating deals and basically got to a margin where we thought it was -- we needed to impair it. But to give you some perspective on that, in the same master plan community, we have one of these lower price point FHA-eligible projects and that is absorbed at 4 or better a month than we have some of the highest margins in the company. So I think it's just a reflection or it is a reflection of the difference of entry first time move-up versus some of those higher price points.

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Alex Barrón, Housing Research Center, LLC - Founder and Senior Research Analyst [15]

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Got it. And then can you elaborate a little bit on the rollout of these new communities in Phoenix as far as timing to get a sense of how to model the orders next year?

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Leonard S. Miller, The New Home Company Inc. - President & CEO [16]

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Sure. We have 8 new communities that are supposed to come on board in Arizona over the next 18 months. The first of which is scheduled to open early next year or in the first quarter of next year, and it will be really at the tail end of the first quarter. Going beyond that, let me just grab -- I want to make sure that I have this reflected correctly, but it's about 18 months between all of those communities to give you some perspective. So again, so really we start seeing it in -- I apologize, Q2, we have 3 communities that we're projecting to come on in Arizona. In Q3, we see an additional 3 communities, and we have a couple rolling in after that.

You're not really going to see significant -- any significant closings. You'll see some sales activity in 2020 on those 8 new communities in Arizona, but it's really 2021 before you really start seeing any closings of any substance rolling through.

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Alex Barrón, Housing Research Center, LLC - Founder and Senior Research Analyst [17]

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Yes, understood. But I mean, the order pickup is going to be more noticeable in that segment next year, for sure.

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H. Lawrence Webb, The New Home Company Inc. - Executive Chairman [18]

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Yes. Alex, this is Larry. We feel like we -- the groundwork is laid for Phoenix to really do well and hit the heart of the market, and you're going to see it, but it won't be until the second half of the year, okay? That's where you'll start seeing the sales.

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Alex Barrón, Housing Research Center, LLC - Founder and Senior Research Analyst [19]

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And as far as price points and locations of those 8 communities, can you give us any color on that?

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Leonard S. Miller, The New Home Company Inc. - President & CEO [20]

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Sure. The 8 communities are priced anywhere from $275,000 to $425,000. They're well located in places like Gilbert and Chandler, for the most part. They're higher-density projects. So what our strategy really is, is to stay in strong schools, close proximity to jobs. So with that, you have some attached townhome cluster type product, but its higher density and very competitively priced.

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Alex Barrón, Housing Research Center, LLC - Founder and Senior Research Analyst [21]

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Okay. Great. And could I ask one last one? Your tax rate, I guess, has moved around every quarter this year. Any sense of how we can model that for next year?

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John M. Stephens, The New Home Company Inc. - CFO & Executive VP [22]

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Yes, it's a little bit -- sorry about that. It's a little difficult with obviously these quarters fluctuating in profitability versus loss as well as just the lower sort of overall sort of pretax projected for the year. Couple that in with some of these discrete items, it's just a little bumpy this quarter, and I apologize for that, but I guess as we move into next year, it will be probably more like -- I'd say, in 2020, we're projecting probably in the 28% to 30% range next year. But this year is a little bit dicey on that front.

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Operator [23]

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(Operator Instructions) There are no further questions at this time. I'd like to turn the floor back over to Mr. Webb for any closing remarks.

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H. Lawrence Webb, The New Home Company Inc. - Executive Chairman [24]

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Thank you. As most of you know who've been listening to our calls, the company's set some pretty specific goals that we're on a path to meet, and we feel very positively about returning cash flow, lowering our leverage, reducing our net SG&A and for all intents and purposes, making our company stronger and positioning it better for the future. The transition from -- for my role has been seamless, and we are very optimistic about our future, about where we're going and about how we're going to achieve that.

And with that, I'd like to thank all of you.

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Operator [25]

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Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation, and have a wonderful day.