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Edited Transcript of TPH earnings conference call or presentation 25-Jul-19 4:00pm GMT

Q2 2019 TRI Pointe Group Inc Earnings Call

Irvine Jul 30, 2019 (Thomson StreetEvents) -- Edited Transcript of TRI Pointe Group Inc earnings conference call or presentation Thursday, July 25, 2019 at 4:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Christopher J. Martin

TRI Pointe Group, Inc. - Head of IR & VP of Finance

* Douglas F. Bauer

TRI Pointe Group, Inc. - CEO & Director

* Michael D. Grubbs

TRI Pointe Group, Inc. - Co-Founder, CFO & Treasurer

* Thomas J. Mitchell

TRI Pointe Group, Inc. - President & COO

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Conference Call Participants

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* Alan S. Ratner

Zelman & Associates LLC - MD

* Alex Barrón

Housing Research Center, LLC - Founder and Senior Research Analyst

* Alexander John Rygiel

B. Riley FBR, Inc., Research Division - Analyst

* Carl Edwin Reichardt

BTIG, LLC, Research Division - MD & Homebuilding Analyst

* James C McCanless

Wedbush Securities Inc., Research Division - SVP of Equity Research

* Michael Glaser Dahl

RBC Capital Markets, LLC, Research Division - Analyst

* Scott Evan Schrier

Citigroup Inc, Research Division - Senior Associate

* Soham Jairaj Bhonsle

Susquehanna Financial Group, LLLP, Research Division - Associate

* Stephen Kim

Evercore ISI Institutional Equities, Research Division - Senior MD & Head of Housing Research Team

* Truman Andrew Patterson

Wells Fargo Securities, LLC, Research Division - Associate Analyst

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Presentation

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Operator [1]

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Greetings, and welcome to TRI Pointe Group's Second Quarter 2019 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Chris Martin, Investor Relations Officer. Please go ahead.

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Christopher J. Martin, TRI Pointe Group, Inc. - Head of IR & VP of Finance [2]

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Good morning and welcome to TRI Pointe Group's Earnings Conference Call. Earlier today, the company released its financial results for the second quarter of 2019. Documents detailing these results, including a slide deck under the presentations tab, are available on the company's Investor Relations website at www.TRIPointeGroup.com.

Before the call begins, I would like to remind everyone that certain statements made in the course of this call which are not historical facts, including statements concerning future financial and operating performance, are forward-looking statements that involve risks and uncertainties. A discussion of such risks and uncertainties and other important factors that could cause actual financial and operating results to differ materially from those described 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. Except as required by law, 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 will be discussed on this conference call. Reconciliations of these non-GAAP financial measures to the most comparable measures prepared in accordance with GAAP can be assessed through TRI Pointe's website and in its filings with the SEC. Hosting the call today is Doug Bauer, the company's Chief Executive Officer; Mike Grubbs, the company's Chief Financial Officer; and Tom Mitchell, the company's Chief Operating Officer and President.

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

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Douglas F. Bauer, TRI Pointe Group, Inc. - CEO & Director [3]

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Thanks, Chris. Good morning and thank you for joining us today as we go over our results for the second quarter 2019 to update you on our long-term strategy and discuss current market trends.

TRI Pointe Group delivered strong results for the second quarter 2019, generating net income of $26.3 million or $0.18 per diluted share. We met or exceeded all of our guidance metrics for the quarter. Our orders for the quarter were up 11% year-over-year with a strong monthly sales pace of 3.4 homes per community, which was comparable to second quarter of 2018. In addition, we paid off $382 million of senior notes that matured in June of this year, and we ended the period with a net debt -- the net capital ratio of 37.7%. These results leave us well positioned to achieve our full-year guidance at the beginning of the year and pursue our long-term strategic initiatives. These initiatives include unlocking the value embedded in our long-term California asset, growing our market share within our existing operations and achieving better scale in our early-stage market. Contrary to the current narrative, we believe California continues to be a great place to be a homebuilder, thanks to the strength of the state's economy, the undersupplied nature of the housing market, and continued job growth.

While demand has softened in certain high-cost markets, we continue to have great success in other parts of the state such as San Diego and the Inland Empire. Thanks in part to the lowland bases associated with our long-term California assets, we are able to have great success in these markets by providing a compelling value proposition for our buyers while delivering strong margins at entry level, move up, and luxury price point. Another way we are seizing on the opportunities that exist in California is to capitalize on 2 of the fastest-growing buyer segments in the market, millennial and baby boomers. It should be noted that our initiatives to design and produce more product at affordable price points has been very effective.

In Los Angeles, our new Skyline community in the Santa Clarita market has had great success, and we are now planning on an active adult community in Phase 2 of Skyline. Additionally, in the Inland Empire, Altis, our active adult community in Beaumont, continues to gain momentum, and is currently selling homes between $300,000 to $500,000. Also the success of our market rate offering in Sundance has accelerated the development of a 4,000 unit community called Atwell, which will be a new affordable master-planned community in Banning scheduled to open late next year at estimated price points in the range of $300,000 to $500,000.

In San Diego, our affordable product offering at Weston in Santee and Playa del Sol and Chula Vista continue to be strong performers. With that success, we have planned and will be starting development on Meadowood, an 845 unit community in Fallbrook. Meadowood is anticipated to open in early 2021 with selling prices between $400,000 to $700,000.

While we believe California will continue to produce great results for our company for years to come, we see an equally bright future for our operations outside of the state. We have an established presence in some of the best homebuilding markets in the country. Markets with great housing fundamentals, job growth, and a lack of available supply. Each of our brands has an opportunity to take advantage of these favorable market trends over the next several years and increase their annual deliveries, thereby enhancing their local economies of scale. This is especially true for relatively new operations in Dallas, Austin and the Carolinas where the upfront investments have been made with the expectation of solid returns down the road. Thanks to our strong balance sheet and experienced management teams, we have the capital and know-how necessary to make these initiatives a reality either organically or through acquisitions.

With that, I would like to give some color on our existing markets. Overall, demand was strong throughout the quarter, and we experienced a very consistent sales pace in April, May and June. The decline in interest rates no doubt had a positive impact on buyer activity, and likely helped extend the selling season into the summer. We were also able to scale back on some of the incentives implemented earlier in the year and raise prices in several of our markets.

In California, we experienced a strong monthly absorption pace of 3.8 homes per community at an average sales price of $667,000 for the quarter. We had very healthy demand in our communities in San Diego and the Inland markets of the state, but experienced continued softness at higher price points in the coastal market. Buyers in both Northern and Southern California have migrated east in search of more affordable housing alternatives. Fortunately, we have a significant presence in the Inland Empire in Southern California. And a growing presence in places like Green Valley, Fairfield and Mountain House in Northern California, which allows us to capitalize on this trend.

Our operations in Seattle performed well during the quarter with a monthly absorption pace of 3.4 homes per community, which is a strong sales rate considering our average backlog sales price of $857,000. After a period of softness at the end of last year, we believe the market has found stability and is starting to regain some of its momentum. We recently shifted our focus to more affordable, attached and detached products in the core areas of the market, and these new offerings have been well received.

In Arizona, Maracay delivered the best monthly sales pace out of all of our brands, averaging 5.6 orders per community in the quarter, driven by healthy market dynamics and the successful opening of several new communities. The order strength was evident across a number of buyer segments, which allowed us to push prices higher in several of our releases. The Las Vegas market is stable, however, it is still fueled by incentives in select products and submarkets. Our positioning and product offerings enabled us to achieve a monthly absorption pace above the company average at 3.8 homes per community. We are also encouraged by our future project land pipeline.

Our Colorado operation continues to improve as profits doubled in the quarter as compared to last year, thanks to a combination of higher closing volumes and better margins. Our shift to more affordable product has been well received, and we now have a land pipeline to allow for significant growth in this market.

Turning to our Texas operations, Houston and Austin experienced a nice lift in monthly absorption pace during the quarter, with Austin leading the way at 3.6 homes per community. Our recent acquisition in Dallas is performing to plan, and we look forward to expanding our presence in this robust market. Now with operations in the top 3 markets in the states, we are poised for Texas to be a larger contributor to our overall business.

Finally, our Winchester brand continues to find its stride with Virginia faring relatively better than Maryland. Our recently opened West Oaks community in Tysons Corner garnered 16 orders in its first few weeks of being open, and we are optimistic this is a positive sign for future community openings in the D.C. market.

With that, I would like to turn it over to Mike for more details on our financial performance in the quarter. Mike?

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Michael D. Grubbs, TRI Pointe Group, Inc. - Co-Founder, CFO & Treasurer [4]

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Thanks, Doug. I would also like to welcome everyone to today's call. I'm going to highlight some of our results and key financial metrics in the second quarter, and then finish my remarks with an update on our expectations and outlook for the third quarter and full year 2019. At times, I'll also be referring to certain information from our slide deck posted on our website that Chris mentioned earlier.

Slide 6 of the earnings call slide deck provides some of the financial and operational highlights from our second quarter. Home sales revenue was $692 million for the quarter on 1,125 homes delivered at an average sales price of 16 -- $615,000. Our homebuilding gross margin percentage for the quarter was 17%, and our SG&A expense as a percentage of home sales revenue was 12.1%. Net income came in at $26.3 million or $0.18 per diluted share. For the quarter, net new homeowners increased 11% on a 12% increase in average selling community. Our overall monthly absorption rate of 3.4 homes per community was consistent with the same quarter in the prior year.

You can see the historical monthly cadence of orders on Slide 28. So far, in July, orders are up 10% year-over-year. As per our overall selling communities, during the second quarter we opened 13 new communities, 5 in Arizona, 3 in California, 2 in Texas, 2 in Washington, and 1 in Nevada. Those 13 communities resulted in an ending active selling community count of 146. Our active selling communities at the end of the quarter is shown by state on Slide 7. We ended the second quarter with 2,208 homes in backlog at an average sales price of $652,000 for total dollar value of $1.4 billion.

During the second quarter, we converted 61% of our first quarter ending backlog delivering 1,215 homes with an average sales price of $615,000 resulting in homes sales revenue for the quarter of $692 million. Our homebuilding gross margin percentage for the second quarter was consistent with our guidance of 17%.

It's worth noting that our current quarter gross margin was impacted by 190 basis point increase in incentives compared to the same quarter last year due to the softness we experienced in the back half of 2018, and earlier 2019 as we were moving through our inventory homes. However, as Doug previously mentioned, we have seen incentives decrease in certain markets and as a result, our overall incentives and backlog have trended down.

As mentioned on the last earnings call, we expect our margins to increase in the second half of the year as we deliver a higher percentage of our revenues from California, and more specifically our long-term California assets. For some additional color as of June 30, 2019, we had 1,942 homes in backlog that are scheduled to close in the second half of this year, building a homebuilding gross margin of over 24%. I will give some additional guidance on homebuilding gross margins for the third quarter and full year later in the call.

For the second quarter, SG&A expense as a percentage of home sales revenue was 12.1%, which was 140 basis point increase compared to 10.7% for the same quarter last year. The year-over-year increase in our SG&A percentage was due to the decreased leverage as a result of 10% decrease in home sales revenue, and higher overhead costs as a result of our expansion initiatives into the Carolinas, Sacramento, Austin and the Dallas-Fort Worth market.

At quarter end, we owned or controlled approximately 28,000 lots, which represents a 5.8 year of supply based on our last 12 months deliveries. Detailed breakdown of a lot zone will be reflected in our quarterly report on Form 10-Q, which will be filed this week. In addition, there is a summary of lots owned or controlled by state on Page 27 of the slide deck.

Turning to balance sheet. At quarter end, we had approximately $3.3 billion of real estate inventory. Our total outstanding debt was $1.4 billion resulting in a ratio of debt to capital of 40.7% and net debt to net capital of 37.7%. During the quarter, we drew on our $250 million term loan facility and paid off the $382 million in senior notes that were due in June. We ended the quarter with $590 million of liquidity consisting of $171 million of cash on hand and $419 million available under our unsecured revolving credit facility.

Now I would like to summarize our outlook for the third quarter and full-year 2019. For the third quarter of 2019, the company expects to open 14 new communities and close out 12 communities, resulting in 148 active selling communities as of September 30, 2019. In addition, the company anticipates delivering 45% to 50% of its 2,208 homes in backlog as of June 30, 2019, at an average sales price of $620,000. Company expects its homebuilding gross margin percentage to be in the range of 21% to 22% for the third quarter, and SG&A expense as a percentage of home sales revenue to be in the range of 12%, 12.5%.

Lastly, the company's expects it effective tax rate to be in the range of 25% to 26%. For the full year, the company reiterates its previous guidance of delivering between 4,600 and 5,000 homes at an average sales price of $610,000 to $620,000. In addition, the company expects homebuilding gross margin percentage to be in the range of 19% to 20% for the full year. The company expects a full year SG&A expense as a percentage of home sales revenue will be in the range of 11% to 12%. And then finally, the company expects its effective tax rate for the full year to be in the range of 25% to 26%.

I'll now turn the call back over to Doug for some closing remarks.

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Douglas F. Bauer, TRI Pointe Group, Inc. - CEO & Director [5]

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Thanks, Mike. In summary, I'm very pleased with our performance this quarter. We met or exceeded all of our previously stated guidance from last quarter's call, generated a strong order performance throughout the quarter, paid off a near-term debt maturity, and improved our leverage ratios. We also furthered our strategic initiatives by growing our operations within our expanding national footprint. While it will take some time for us to realize the full benefit of these investments, we are confident that TRI Pointe is on a path to becoming a more diversified, well-rounded homebuilder with the same premium brand focus that has differentiated us from our competitors.

Finally, I would like to thank all of our employees for their contributions in making TRI Pointe what it is today. In particular, I'd like to thank my good friend and partner, Mike Grubbs, who announced his retirement earlier this month, effective at the end of this year. As you know, Mike was a founding mentor of TRI Pointe Group and has played as an integral role in every phase of the company's evolution. He will certainly be missed by everyone in the organization, but we will continue his legacy of prudent financial discipline and trust within the financial community when Glen Keeler, our current Chief Accounting Officer, assumes the role at the end of the year.

That concludes my prepared remarks and we'll be happy to take on your questions. Thank you.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question today comes from Alan Ratner of Zelman & Associates.

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Alan S. Ratner, Zelman & Associates LLC - MD [2]

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First off, congrats to both Mike and Glenn on the upcoming changes in their lives. Mike, it's been great working with you over the years. So I guess the first question -- I just wanted a quick housekeeping question. That 10% July increase I just want to confirm, is that an apples-to-apples number I guess through July 24 or whatever? Or is that over all of July for last year?

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Michael D. Grubbs, TRI Pointe Group, Inc. - Co-Founder, CFO & Treasurer [3]

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Yes, it's apples to apples.

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Alan S. Ratner, Zelman & Associates LLC - MD [4]

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Okay. Cool. Thanks. And then the second question, Doug, I appreciate all the comments on the pricing environment, it sounds like you've been able to pull back on some incentives through the spring, and I think that's generally been the trend we've heard from other builders, but to be perfectly honest, I'm a little bit surprised, I guess, that the pullback hasn't been even greater, or I guess you have been seeing more pricing power in general just given how strong it seems like the acceleration has been on the order side. I mean you put up over 20% growth in June and a lot of other builders did as well, and when we've seen that in the past several years, I think, when order growth has accelerated like that, it's generally come alongside some pretty aggressive price increases. And it seems like this time might be different in terms of how builders are really approaching the price versus pace dynamic. So can you just talk a little bit about what you're seeing and your expectation if pricing power, you expect that to accelerate as the year goes on or if you think this is, kind of, what we should expect for the next several years, just kind of this fairly flattish pricing environment?

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Douglas F. Bauer, TRI Pointe Group, Inc. - CEO & Director [5]

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Yes, and I'll let Tom dive into the question too, but I mean generally speaking the pricing environment incentives have been very project and market specific, but if you take a kind of -- take a couple of steps back, and remember, there is a pretty big adjustment in the second half of 2018, and then you look at our premium brand space that we build in probably, and I am not going to speak for the other builders, but we're always pulling the levers of pace versus price, and I'm very proud of the fact that our company at an ASP well north of $600,000 is able to keep pace with frankly the entry-level price points at some of the other buyers and that's really due to our premium brand positioning that differentiates ourselves. So I continue to think going into the second half of the year that in certain markets, and certain projects will have pricing power and certain markets will be flat, and maybe a couple projects will have a little bit more incentives. So I call it a very normal market. We're pretty excited about where we stand right now. We're very excited about the second half of the year and going into next year too. We've got -- our positioning in both the entry level, move up and luxury price points is resonating with many consumers. Tom?

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Thomas J. Mitchell, TRI Pointe Group, Inc. - President & COO [6]

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Yes. Alan, the only other thing I would add to that is, basically we also had a lot of built-up inventory in the industry, and that was probably leading to less price elasticity on that type of product, but overall as Doug mentioned, we're encouraged as we go forward on a month-over-month basis to see more price elasticity in most of our markets.

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Alan S. Ratner, Zelman & Associates LLC - MD [7]

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And on that inventory comment, Tom, how would you characterize the situation today? Do you feel like builders have mostly worked through a lot of those excess specs that were built late last year?

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Thomas J. Mitchell, TRI Pointe Group, Inc. - President & COO [8]

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Yes, definitely, we had a lot of success in the first couple of quarters. We're back down to about 2 per community.

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Operator [9]

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The next question is from Stephen Kim of Evercore ISI.

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Stephen Kim, Evercore ISI Institutional Equities, Research Division - Senior MD & Head of Housing Research Team [10]

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Congratulation on the quarter, and also Mike congratulations as well, you'll be missed. Well, I hope this isn't a sign of any changes to the negative in terms of financial disclosure, but I don't think you gave a land spend this quarter. I was wondering if I could get that to start off with.

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Michael D. Grubbs, TRI Pointe Group, Inc. - Co-Founder, CFO & Treasurer [11]

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Actually, I'll get back to you here in a minute Stephen, I'll have to look that up, but that is no sign. We just didn't put it in the prepared remarks this time. Figures. Okay.

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Stephen Kim, Evercore ISI Institutional Equities, Research Division - Senior MD & Head of Housing Research Team [12]

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Well, your ASP in backlog, it came down about $20,000, I think, sequentially. Your closing ASP actually rose $10,000 sequentially. I assume that's probably just due to the longer cycle time with higher-priced units and all that. But I was wondering, you didn't lower your ASP guide for the year for closing, but it would seem that the drop in ASP backlog price should eventually flow through in closing. So I want to make sure that I am thinking about that properly, why you didn't change your full year ASP guide, what does that say about the back half ASP?

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Michael D. Grubbs, TRI Pointe Group, Inc. - Co-Founder, CFO & Treasurer [13]

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Yes. I mean it's kind of one of those things, our backlog ASP just never seems to flow through on our delivery ASP just because most of the time the majority -- a lot of our backlog is California units, and probably Washington units with the higher ASPs and they take a little bit longer to build. So they sit in backlog a little bit longer, and some of the other markets we're able to sell and close it in the existing quarter. So we still have confidence in our full-year ASP guide. I would say, I think, our orders for the quarter were around $600,000 though, and so ASPs in backlog will be coming down after we deliver some of those long-term California assets in the third quarter.

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Stephen Kim, Evercore ISI Institutional Equities, Research Division - Senior MD & Head of Housing Research Team [14]

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Got it. But it sounds like more like the backlog is going to come down to kind of where the closing price is -- the closing price will continue to, sort of, live where it is for the foreseeable future.

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Michael D. Grubbs, TRI Pointe Group, Inc. - Co-Founder, CFO & Treasurer [15]

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That's correct.

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Stephen Kim, Evercore ISI Institutional Equities, Research Division - Senior MD & Head of Housing Research Team [16]

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Okay. Great. That's what I wanted to understand a little bit better. Also from a -- just a housekeeping perspective, the Dunhill orders, can you give us a sense for how much that was? And then lastly, gross margins, would we be wrong in thinking the gross margin could peak, or likely to peak in the third quarter? Or is there -- is that due to lumber -- timing of lumber and things like that? Or is it conceivable that you could see gross margins continue to improve sequentially and so forth...

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Michael D. Grubbs, TRI Pointe Group, Inc. - Co-Founder, CFO & Treasurer [17]

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I think margins will be relatively flat between 3Q and 4Q. Originally we said that we thought our margins would be a little bit higher in 3Q. With the delivery of some of the longer-term assets, those are flowing into 4Q. So it's relatively flat for 3Q and 4Q.

And I will get back to you on that land number.

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Stephen Kim, Evercore ISI Institutional Equities, Research Division - Senior MD & Head of Housing Research Team [18]

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Yes. Okay.

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Operator [19]

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The next question is from Truman Patterson of Wells Fargo.

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Truman Andrew Patterson, Wells Fargo Securities, LLC, Research Division - Associate Analyst [20]

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Nice results. I wanted to follow-up on Alan's questions for a little bit of clarity. Could you guys give the magnitude of the incentive decline and order incentive decline in the quarter? And possibly break out between -- some commentary between California and your markets? And then the inventory levels that you guys said are normalized today, could you guys just elaborate on whether you think industry inventory levels are normalized as we enter this seasonally slower period?

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Michael D. Grubbs, TRI Pointe Group, Inc. - Co-Founder, CFO & Treasurer [21]

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Okay. I'll ramble up some numbers real quick, Truman, it's Mike. So order incentives as a percentage of our orders for 4Q '18 was 6.9%, 1Q was 5.7% and then 2Q was 4.7%; and then delivery incentives for 1Q was 5.8% and it was 5.4% for Q2; and then our backlog incentives were 3.6% in Q1 and it's 3.4% in Q4. So when you look at it monthly, the cadence, I think, we've dropped from about 5.9% to 5.1% on a monthly basis, so we're seeing progressive, incremental improvements in incentives as we move throughout each of the months within the quarter.

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Truman Andrew Patterson, Wells Fargo Securities, LLC, Research Division - Associate Analyst [22]

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Okay, that's really helpful. Okay.

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Michael D. Grubbs, TRI Pointe Group, Inc. - Co-Founder, CFO & Treasurer [23]

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And maybe just from an inventory perspective, I mean for us it somewhat normalized. It's usually 2 to 3 homes per community is what we have. We're not a huge spec builder across all the markets because we're a private one.

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Truman Andrew Patterson, Wells Fargo Securities, LLC, Research Division - Associate Analyst [24]

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Okay. Okay. Thanks. Looking at Phoenix, or Arizona, orders were up 90%. Could you guys elaborate a little bit on what was driving this? Is it purely market? Did you guys have some flagship community openings? Maybe discuss the repeatability of this going forward to some pretty tremendous growth?

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Douglas F. Bauer, TRI Pointe Group, Inc. - CEO & Director [25]

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We opened 5 new communities in the first part of the year and it definitely, Truman, had a significant impact. I mean market is very good in Phoenix, we're very well positioned in some of the major employment quarters in the southeast valley, but we also opened a project just outside of Phoenix called Avance, if you go to our website, right along the south mountains with 4 communities I believe there. So just -- it was just timing of a lot of communities opening, some of which wish we would open a little bit earlier, but we had some rain during the winter as you probably remember, but needless to say, it's a very positive sign for Phoenix. We're very excited about our Maracay division in Phoenix, and we see continued growth going into 2020 and 2021 with that division. So it's all very strong results from the marketplace.

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Thomas J. Mitchell, TRI Pointe Group, Inc. - President & COO [26]

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Yes. I would just add, Truman, that all of our teams do a great job in preview, marketing and generating interest for our new communities. Our new communities continue to perform very well and that many times we're opening with significant amount of presales and strong demand, and we're off to a great start and have the momentum moving forward, which is our goal.

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Michael D. Grubbs, TRI Pointe Group, Inc. - Co-Founder, CFO & Treasurer [27]

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In follow-up to Stephen's question, we had 66 orders in DFW for Trendmaker for the quarter.

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Operator [28]

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The next question is from Mike Dahl of RBC Capital Markets.

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Michael Glaser Dahl, RBC Capital Markets, LLC, Research Division - Analyst [29]

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I wanted to get a little more color on the sequential step up in the second half, and clearly you guys have been mastering that just given the mix of longer-term California, but based on those comments you just made around the incentives in both orders and backlogs, can you help break down kind of the -- call it 450 basis point step up sequentially second half versus 2Q. How much is land mix versus better pricing dynamics?

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Michael D. Grubbs, TRI Pointe Group, Inc. - Co-Founder, CFO & Treasurer [30]

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Well, I mean it's a little bit of both, right. Land mix is some of it, but the geographies of what we're closing, we're closing more California units within the long-term California assets, and a significant amount of those are coming from our Pacific Highlands Ranch projects, which you know the margins there are relatively high, and that's on the heels of us opening those 5 new commodities there at the end of last year and the beginning of this year that had a tremendous sale. But we've also had pretty good pricing power in San Diego, specifically, at PHR on the higher end. Our ASP there is close to $1 million for that whole division because we're building between 300,000 and 3 million. So it's a little bit of both, but the significant increase in margins are coming from just a lot more California deliveries in the back half of the year, and then a lot within the long-term California assets versus the first half of the year we sold a lot of inventory units, and we're moving through those, and not many California deliveries in the first half from the long-term California assets.

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Michael Glaser Dahl, RBC Capital Markets, LLC, Research Division - Analyst [31]

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And then some of the better incentive activity and selective pricing power would be more of an impact for first half of '20 closings at this point?

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Michael D. Grubbs, TRI Pointe Group, Inc. - Co-Founder, CFO & Treasurer [32]

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Correct.

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Michael Glaser Dahl, RBC Capital Markets, LLC, Research Division - Analyst [33]

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Okay. And then back to the conversation around ASPs and mix, and as you noted, kind of order ASP dipped a little below $600,000 and that's first time in a while that we have seen that. I think some of the commentary you've made so far around the new community openings, and some of the positioning, it seems like the mix is a little down the price spectrum. How should we be thinking about the -- is $600,000 a good run rate going forward? Do you think it'll moderate further? Just how should we be thinking about the order ASPs going forward?

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Michael D. Grubbs, TRI Pointe Group, Inc. - Co-Founder, CFO & Treasurer [34]

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Yes, it's Mike again. We are focused on coming down price point. I mean I think $600,000 is a pretty good number for probably 2020, but just what is sitting in backlog. Again, a lot of the sales of the long-term California assets happened in the first half of the year primarily lot of it in 1Q and even a little bit of it in 4Q. At the higher price points, at the $1 million to $3 million range in San Diego and so those are already, kind of, locked into backlog and impacting the orders, overall ASP, but I mean $600,000 is roughly what the -- just below the company averages, I guess, for the full year.

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Douglas F. Bauer, TRI Pointe Group, Inc. - CEO & Director [35]

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And we are definitely encouraged by our offerings going forward. We are well positioned and we think overall around that $600,000 is a good place to be.

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Operator [36]

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The next question is from Soham Bhonsle of SIG.

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Soham Jairaj Bhonsle, Susquehanna Financial Group, LLLP, Research Division - Associate [37]

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So first question was on community count. So this year is obviously a growth year there. But as we look beyond 2019, is this sort of double-digit growth. The target, or is it sustainable? Or do we sort of step up this year and then you work through that next year and reaccelerate after that?

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Michael D. Grubbs, TRI Pointe Group, Inc. - Co-Founder, CFO & Treasurer [38]

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Soham, it's Mike, it's a good question. The step-up this year is primarily the acquisition at Dallas, right. We added communities there. So when you just look at the pure averages at the end of the year, we're up roughly 12% year-over-year. Going into 2020, it's more mid-single digits on the community count and then it probably steps up a little bit more from that into 2021. As we start delivering more projects from those greenfield operations that we have in several divisions.

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Soham Jairaj Bhonsle, Susquehanna Financial Group, LLLP, Research Division - Associate [39]

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And then Doug, longer-term obviously sounds like you're still bullish on California, that's 50% of the business, but as you look a year or 2 out, where do you sort of want to get that down to and we sort of know the geographies, but if you could just talk about other geographies you want to get bigger in?

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Douglas F. Bauer, TRI Pointe Group, Inc. - CEO & Director [40]

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I don't think it happens in year time frame, I mean it takes anywhere from 2 to 4, 5 years to bring assets into the market place and turn it, but we see tremendous growth in -- outside of California, in the Texas, the Southeast markets, but we continue to see growth in California, Sacramento, the LA division with some more affordable price points that we're targeting. So the narrative on California has been, we think, significantly overblown. It's a state that really has a housing crisis, and we have the ability to not only deliver more affordable price points and luxury price points in Southern California, but we also have, more importantly, the teams to find the land and be able to deliver that here in a very entitlement constrained state. So it's going to be continued growth outside of California, with measured growth inside California is the best way to put it.

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Soham Jairaj Bhonsle, Susquehanna Financial Group, LLLP, Research Division - Associate [41]

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Got it. And if I could just sneak 1 in on active adults, one of your peers this week highlighted some -- just being slower to pick up there, have you guys seen the same or are your price points, I guess, just more favorable there?

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Douglas F. Bauer, TRI Pointe Group, Inc. - CEO & Director [42]

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I mean the active adult buyer is definitely a little bit more measured in the second half of last year with interest rates tipping up and now it's tipped back down, but they are definitely out as a percentage of our business, it's actually growing. Mike, what's the...

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Michael D. Grubbs, TRI Pointe Group, Inc. - Co-Founder, CFO & Treasurer [43]

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Just to follow on to that, I mean the absorption rate we saw for active adult was really strong this quarter, it is actually 4.1%, which is one of the higher absorption rates, but it's only 2% of our business right now of our orders. So that -- just a couple of products can swing that pretty quickly. Just to give you the overall absorption rates, as I'm sure it'll be one of the questions, entry level we're 4.7%, move up we're 3.2%, luxury 2.9%, and then 4.1% for active adult. And the average was 3.4%. And I wanted to answer the question that Stephen again asked about land and land development, we apologize not putting that in our prepared remarks, but land acquisition was $87 million, land development was $86 million for the quarter for a total of $173 million. So that puts us year-to-date at $308 million for acquisition and land development, $308 million.

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Operator [44]

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The next question is from Carl Reichardt of BTIG.

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Carl Edwin Reichardt, BTIG, LLC, Research Division - MD & Homebuilding Analyst [45]

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Mike, you're too young to retire. I wanted to ask about California outside the legacy assets, just to try to get a little more granularity there. So given the Sacramento expansion and some looks at some other markets outside of legacy. How are margins trending there, Doug? And sort of what's your expectation for what your mix of product outside the legacy will look like? Will it be over time sort of a similar split between entry level and move up or could you expect more of an aggressive move towards first-time buyers in those markets outside legacy?

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Thomas J. Mitchell, TRI Pointe Group, Inc. - President & COO [46]

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Carl, this is Tom. Good questions, and as you know, we're certainly very encouraged by our operations outside of our legacy assets as well. I would say that as we look at the different markets where we see the biggest potential for growth and that being our Sacramento market obviously that's more of a opportunity to reduce our ASP overall. But in general, we will have a diversified portfolio approach to that market like we have in all of our markets. Similarly, I would say that the Inland Empire continues to show strength and we are encouraged by our ability to have strong demand and generate significant margins, and we are actively in the acquisition phase for several new acquisitions that we're really encouraged by.

So our positioning going forward, again, has been to capitalize on lower ASP with a buyer segment that's probably shifted a little bit towards that entry-level buyer. Overall, as you look to the coastal market, we see those markets being a little more challenged currently because of the higher price point, and so we are looking -- continuing for infill opportunities to offer product at a little higher density again to bring down our average selling price. So there's a lot of diversity in California and that diversity holds true in each one of our operations as well.

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Carl Edwin Reichardt, BTIG, LLC, Research Division - MD & Homebuilding Analyst [47]

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Thank you, Tom. And then you sort of answered my next question which is right. So given California has been softer than other markets given that your perspective is that there is still a lot of long-term value in the state, which makes sense. Have you started to see any movement from some of the privates that are still around and sizable in the state towards looking to sell their businesses. Would you be interested in something like that given that you've also got a mandate to try to diversify out of the state?

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Douglas F. Bauer, TRI Pointe Group, Inc. - CEO & Director [48]

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This is Doug, Carl. Now we haven't seen any of that from any of the privates. So we would love to take a look at that opportunity. Obviously, we look at it as more of a land acquisition because we've got strong teams in most of the market places, but we haven't seen anybody in any form or fashion.

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Carl Edwin Reichardt, BTIG, LLC, Research Division - MD & Homebuilding Analyst [49]

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Is that true outside of California as well, Doug? I think I ask you this every quarter.

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Douglas F. Bauer, TRI Pointe Group, Inc. - CEO & Director [50]

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We continue to see some activity on the M&A front. Our focus is really the -- growing our early start division. In Carolinas we're having really strong success in tying up land there and getting going there in 2020 with our first communities. Austin, Dallas, Sacramento, LA, but on the heels of that with our strong balance sheet we continue to look at M&A opportunities primarily in the Southeast and the Northwest.

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Operator [51]

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The next question is from Scott Schrier of Citi.

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Scott Evan Schrier, Citigroup Inc, Research Division - Senior Associate [52]

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Earlier you talked about price elasticity in some of your markets and looking at your monthly absorption pace through the quarter, it looks like it trended a little bit more evenly than the past few years. I'm curious if there is anything to read into there, whether there was incentive used to moderate it? If interest rates were a factor or if it's indicative of better demand for your price point of a product? Perhaps some folks are a little more confident in the economy of the stock market. I know typically concerns are for the downside. We saw the new homes sales print show more activity in the $500,000 to $750,000 range than what we've seen so I'm just curious on that, the absorption pace how it trended through the quarter?

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Douglas F. Bauer, TRI Pointe Group, Inc. - CEO & Director [53]

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Well, I think, you are hitting at a key differentiating point for TRI Pointe, and we focus in both entry level, which is about 30% of our orders, roughly 50% is move up first and second, 17% luxury and 3% active adult year-to-date. When you look at our strategy, it's more of a premium brand strategy with our customers. That doesn't mean higher price, as I said, we're 30% entry level, but clearly at our absorption pace in our ASP, the consumer is locking in on our product offering in many market areas and it starts with the land planning all the way through the product offering and that premium brand strategy is a big differentiator as -- and I applaud the results of some of the builders going to the entry level. I think that's great, they're doing really well, and we love entry-level buyers that come into the market because then they may become move-up buyers, first time and second time. So the food chain and the housing business is great, and we're well positioned and very differentiated ourselves from the competition, that's for sure.

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Thomas J. Mitchell, TRI Pointe Group, Inc. - President & COO [54]

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Scott, this is Tom. I'd basically add to that relative to your question. I think there is a little bit of everything you suggested happening that has led to an extended selling season for us. So as we look at the market going forward, interest rates certainly have helped, there is stronger demand overall. As Doug just went through our product offerings, our focus on being a premium brand, and design and innovation certainly differentiates and makes a difference, but when you look at us year-over-year relative to demand and absorption on a monthly basis, we've had the least decline in absorption over this last quarter than any of the prior seasonality in other years. So we're definitely optimistic and encouraged by that.

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Scott Evan Schrier, Citigroup Inc, Research Division - Senior Associate [55]

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Thanks for that and then my next question really hits to the point that you both were talking about in your differentiated product offering, and in the land market it seems like there's a lot more capital that's chasing after the entry level type land. Does that create opportunity? Are you seeing potentially any easing in some of the more that move up type land that's more where you focus on?

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Douglas F. Bauer, TRI Pointe Group, Inc. - CEO & Director [56]

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It's a great question and certainly the land business, for 30 years I've been in this business, is always super competitive at all levels, but clearly with majority of the competition looking for the lower entry-level price points and where we offer our premium brand strategy at entry level move up and so forth, it does give us a strong bargaining position at the table. So we continue to focus on very well-located land, close to employment quarters, we're not going to chase price points out to the hinterland, so to speak. So great question and it does help us, but it's still very competitive out there.

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Operator [57]

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The next question is from Jay McCanless of Wedbush.

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James C McCanless, Wedbush Securities Inc., Research Division - SVP of Equity Research [58]

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The first question I had is on specs and what percentage of your closing this quarter started out as a spec, and how does that compare to last year?

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Michael D. Grubbs, TRI Pointe Group, Inc. - Co-Founder, CFO & Treasurer [59]

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I don't have that number off the paper that we have in front of us, Jay, we'll get back to you on that. But I mean we obviously closed more specs during the quarter than we did in the previous year. I'll just have to get back to you on that. And that really why we hit the upside and outside the range on the delivery guidance, as we were able to sell more within the quarter and close them, and that had a little compression on our margin for the quarter as well.

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James C McCanless, Wedbush Securities Inc., Research Division - SVP of Equity Research [60]

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But despite that you are -- and I believe you said earlier, you guys do expect the gross margin to be flat from 3Q '19 to 4Q '19, correct?

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Michael D. Grubbs, TRI Pointe Group, Inc. - Co-Founder, CFO & Treasurer [61]

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That's correct. So effectively the same guidance range for both quarters.

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James C McCanless, Wedbush Securities Inc., Research Division - SVP of Equity Research [62]

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Got it. And then the other question I had, well I got 2 more actually. Share buybacks, could you update us on that and have you all been active on that front?

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Michael D. Grubbs, TRI Pointe Group, Inc. - Co-Founder, CFO & Treasurer [63]

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Well, as we talked about at, I think, on our first quarter earnings call, we had the authority of $100 million, but we wanted to focus on paying down our debt for the first couple of quarters, which we just did in June, where we paid off the $382 million of our 2019 bonds that were maturing, and so now we're probably a little bit more focused on an opportunistic basis going forward on fulfilling that authorization.

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James C McCanless, Wedbush Securities Inc., Research Division - SVP of Equity Research [64]

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And then and I apologize, I got knocked off the call for few minutes. Can you guys talk about your stick and brick cost, how that's running this year versus last year? And are you, besides the lumbar benefit, are you seeing any other cost inputs that may be trending in TRI Pointe's favor?

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Douglas F. Bauer, TRI Pointe Group, Inc. - CEO & Director [65]

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Yes, it's good question. Jay, this is Doug. But I would tell you that currently through year-to-date, our stick and brick costs are down in every one of our markets except for Austin. Tiny, tiny increase in Phoenix and then flat in Houston. When I say down, it's down 1% to 4%. Our teams, we had a very -- we focused quite a bit at the end of last year going into this year on a number of initiatives. We talked about our 12 point sales and marketing initiatives, but we also had our cost initiatives, not just direct, but all cost segments through the P&L of anywhere from 4% to 10% depending on the division. That's not just direct by the way as I mentioned. So we continue to focus on our cost side of the equation. I always believe that you have more control over your costs and there may be less price elasticity. So you always want to be a very good operator on the cost side.

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Operator [66]

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The next question is from Alex Rygiel of B. Riley FBR.

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Alexander John Rygiel, B. Riley FBR, Inc., Research Division - Analyst [67]

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Can you comment a little bit more on the cancellation rate? It obviously appears to have stabilized. But are there any regional discrepancies there?

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Thomas J. Mitchell, TRI Pointe Group, Inc. - President & COO [68]

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No. Alex, this is Tom. We're holding pretty steady at a low cancellation rate of about 15% overall for the entire operation. We have seen a little bit higher can rate than that in Vegas. So that's something that's again, it's not atypical for that market, but it is a little bit higher relative to that, and then the Dallas-Fort Worth market, again has a little higher can rate overall, but again, that seems normal for what our experience in the past has been.

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Alexander John Rygiel, B. Riley FBR, Inc., Research Division - Analyst [69]

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And then what was your option rate as a percentage of sales in the quarter? And has that changed much at all recently?

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Douglas F. Bauer, TRI Pointe Group, Inc. - CEO & Director [70]

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It was about 10%, and we'll get you the exact numbers here.

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Michael D. Grubbs, TRI Pointe Group, Inc. - Co-Founder, CFO & Treasurer [71]

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11.8% in the quarter compared to 10.5% the prior year. So it's something about 130...

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Thomas J. Mitchell, TRI Pointe Group, Inc. - President & COO [72]

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A big focus of ours moving forward.

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Operator [73]

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The next question is from Alex Barron of Housing Research Center.

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Alex Barrón, Housing Research Center, LLC - Founder and Senior Research Analyst [74]

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And congrats, Mike, on the retirement and Glenn on the new position. I wanted to just ask on order size, the 10% number you gave us, was that including Dunhill or excluding Dunhill?

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Michael D. Grubbs, TRI Pointe Group, Inc. - Co-Founder, CFO & Treasurer [75]

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That was including Dunhill. So Dunhill had 66 orders for the quarter. The orders were up 11%.

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Alex Barrón, Housing Research Center, LLC - Founder and Senior Research Analyst [76]

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Okay. No, I meant for the July...

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Thomas J. Mitchell, TRI Pointe Group, Inc. - President & COO [77]

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It was inclusive as well.

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Michael D. Grubbs, TRI Pointe Group, Inc. - Co-Founder, CFO & Treasurer [78]

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Yes, that was consolidated number -- sorry.

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Alex Barrón, Housing Research Center, LLC - Founder and Senior Research Analyst [79]

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Got it. Okay. Then my other question was, what is generally your policy on taking contingencies given that you guys obviously work with a lot of move-up buyers and has that changed at all?

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Thomas J. Mitchell, TRI Pointe Group, Inc. - President & COO [80]

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Alex, this is Tom. We have had a big focus on contingency management. We think we do that extremely well. Basically, in order for us to take our home off the market we have to be very confident in the contingent sale that we're looking to, and we've done a great job with that. Most of our contingencies tend to come to fruition in a timely manner. So we're very cognizant of the time frames of what will take a contingent home to sell for, and we have been very successful with that.

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Alex Barrón, Housing Research Center, LLC - Founder and Senior Research Analyst [81]

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Got it. So if I could ask one last one, in the Inland Empire, do you feel the current FHA loan limit is still an issue as far as what you are able to sell? Or not really?

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Thomas J. Mitchell, TRI Pointe Group, Inc. - President & COO [82]

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We think that's a competitive advantage for us. Most of our offerings are able to accommodate a lot of FHA buyers. So at our price points, we think we're currently aligned where the FHA limits are positive for us.

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Operator [83]

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There are no additional questions at this time. I'd like to turn the call back to Doug Bauer for closing remarks.

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Douglas F. Bauer, TRI Pointe Group, Inc. - CEO & Director [84]

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Thank you, and thanks to everyone for joining us on today's call. We look forward to sharing our results with you on our next quarter's call and have a great weekend. Thank you.

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Operator [85]

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This concludes today's conference. You may now disconnect your lines. Thank you for your participation.