M.D.C. Holdings, Inc. (NYSE:MDC) Q3 2022 Results Conference Call October 27, 2022 12:30 PM ET
Company Participants
Derek Kimmerle – Vice President and Corporate Controller
Larry Mizel – Executive Chairman
David Mandarich – Chief Executive Officer
Bob Martin – Chief Financial Officer
Conference Call Participants
Stephen Kim – Evercore ISI
Truman Patterson – Wolfe Research
Alan Ratner – Zelman and Associates
Alex Barron – Housing Research Center
Jay McCanless – Wedbush Securities
David Stuehr – Longfellow Investment
Operator
Good day, and welcome to M.D.C. Holdings Third Quarter 2022 Earnings Conference Call. All participants will be in listen-only mode [Operator Instructions]. Please note this event is being recorded. I now would like to turn the conference over to Derek Kimmerle, Vice President and Corporate Controller. Please go ahead.
Derek Kimmerle
Thank you. Good morning, ladies and gentlemen, and welcome to M.D.C. Holdings 2022 third quarter earnings conference call. On the call with me today, I have Larry Mizel, our Executive Chairman; David Mandarich, Chief Executive Officer; and Bob Martin, Chief Financial Officer. At this time, all participants are in a listen-only mode. After finishing our prepared remarks, we will conduct a question-and-answer session, at which time we request that participants limit themselves to one question and one follow-up question. Please note that this conference is being recorded and will be available for replay. For information on how to access the replay, please visit our Web site at mdcholdings.com.
Before turning the call over to Larry and David, it should be noted that certain statements made during this conference call, including those related to MDC’s business, financial condition, results of operations, cash flows, strategies and prospects and responses to questions may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements involve known and unknown risks, uncertainties and other factors that may cause the company’s actual results, performance or achievements to be materially different from the results, performance or achievements expressed or implied by the forward-looking statements. These and other factors that could impact the company’s actual performance are set forth in the company’s third quarter 2022 Form 10-Q, which is expected to be filed with the SEC today. It should also be noted that SEC Regulation G requires that certain information accompany the use of non-GAAP financial measures. Any information required by Regulation G is posted on our Web site with our webcast slides.
And now, I will turn the call over to Mr. Mizel for his opening remarks.
Larry Mizel
Good morning, and thank you for joining us today as we go over our results for the third quarter of 2022 and provide an update on current market conditions. MDC generated net income of $144 million or $1.98 per diluted share in the third quarter of 2022. Home sales revenues increased 12% year-over-year to $1.4 billion and the home sales gross margins for the quarter were 22.7%. Excluding home impairments, home sales gross margins expanded 120 basis points year-over-year to 24.7, as our team did an excellent job of delivering homes in backlog and maintaining price integrity in what continues to be a difficult market environment. Since our last quarterly update, mortgage rates have risen another 100 basis points, putting additional strain on new home affordability and demand in our markets. Gross orders for the third quarter came in at 1,569 which equated to an absorption pace of 2.4 homes for community per month. However, due to a spike in cancellations, our net order total for the quarter came in significantly below our expectations.
We believe the combination of rising interest rates and the steady stream of negative news surrounding the future of housing and the overall economy eroded the confidence of perspective homebuyers and led them to reconsider their purchase. Another factor that contributed to the order shortfall was our strategic decision to focus on delivering homes in backlog rather than aggressively chasing sales during a typically lower seasonal period for industry. We continue to believe that the long term fundamentals driving new home construction remain positive and that there is a strong desire to own a home in this country. However, we expect the near term sales environment will remain challenging until there is more clarity around the future interest rates. In light of these industry headwinds, we have refocused our efforts on generating cash [orderfying] the balance sheet and taking cost out of the business. We ended the third quarter with $744 million in cash and cash equivalents and marketable securities, a debt to capital ratio of 33.2% and a net debt to capital ratio of 19.9%. Our control lot count declined 20% year-over-year as we approved virtually no new land deals during the quarter, and walked away from over $11 million in option deposits and preacquisition costs. For the option agreements we still have in place we have renegotiated or we’re in the process of renegotiating the terms of many of those agreements.
These actions, coupled with our focus on delivering homes at backlog and rightsizing our cost structure can put us in a very strong financial position at year end. Our leadership team has been through several housing downturns over the course of our careers, giving us a broad perspective on how to navigate difficult operating environments. Market corrections are a natural and often times healthy occurrence in our industry and usually lead to market share gains for the well capitalized builders when things do improve. We plan on being one of those builders in our positioning our company accordingly. We have no single note maturities coming due the remainder of this decade, and enough lots in the pipeline to fulfill our delivery projections through 2024, allowing us to operate from a position of strength during this period of uncertainty. Our financial strength should also give investors confidence in our ability to pay our industry leading dividend, which currently stands at $2 per share on an annualized basis. As a result, I continue to be optimistic about long term outlook for our company.
With that I’d like to turn the call over to David who will provide more detail on our operating performance this quarter.
David Mandarich
Thank you, Larry, and good morning to everyone. MDC was once able to deliver on its stated guidance for the third quarter by closing 2,387 homes at an average sales price of 590 and generating a homebuilding gross margin before impairments of 24.7. This was no small feat considering the supply chain issues, labor shortages and municipal delays that continue to act as headwinds for our industry. Phoenix, Utah and Sacramento post the highest year-over-year delivery growth for our company, while Phoenix, Northern California and Jacksonville generated the best homebuilding gross margins. Similar to last quarter, we saw improving conditions on the front end of the construction process, but continued to experience long lead times and delays on the back end. We are working diligently with our trade vendors and suppliers to find solutions to these issues and expect to see some improvement over time as the slowdown in order activity translates into better trade availability.
As Larry mentioned, we experienced softer demand and increased cancellations in the third quarter, resulting in a disappointing net order total for the period. Our monthly net order results mirrored the movement in mortgage rates, with September being our most difficult month. Cancellation activity in the second quarter was largely driven by affordability issues due to sudden increase in mortgage rates. Cancellation activity in the third quarters seem to be driven more by psychological factors than financial ones, as a percentage of buyers who could still afford to move forward with their purchase at higher rates felt compelled to cancel. We are currently offering incentives to spur demand at our community, including financing incentives aimed at lowering a prospective monthly house payment. In the third quarter incentives as a percentage of the dollar value earned gross new orders increased approximately 400 basis points year-over-year and 280 basis point versus the second quarter of 2022. Protecting the backlog and delivering as many homes in the fourth quarter as possible remains our primary goal for the remainder of the year. However, as we close more of our legacy backlog and open new communities ahead of the spring selling season, our focus will be the sales side of the business with an emphasis on sales pace along with rebuilding the backlog.
Now I’d like to turn the call over to Bob, who will provide more detail on our quarterly results and forward-looking guidance on some key metrics for our business.
Bob Martin
Thanks David, and good morning everyone. During the third quarter, we generated net income of $144.4 million or $1.98 per diluted share, representing a 1% decrease from the third quarter of 2021. Pretax income from our homebuilding operations rose by $3.1 million or 2% from the third quarter of 2021 to $168.2 million. This increase was driven by home sale revenues, which rose 12% year-over-year to $1.41 billion. However, the increase was largely offset by an 80 basis point decrease in our gross margin from home sales to 22.7%. The gross margin decline was primarily due to inventory impairments of $28.4 million, impacting seven communities within our West segment and two communities within our East segment. The impairments mostly related to communities already open for sale as well as a couple communities scheduled for opening during the fourth quarter.
Our financial services pretax income decreased during the third quarter of 2022 to $17.6 million. This decrease was primarily due to our mortgage operations, as we have seen profitability per loan locked, sold and closed return to more historical levels, with a significantly increased level of competition in the primary mortgage market. Further, within our mortgage business, we saw a decrease in the number of loans locked during the third quarter due to the higher volume of long term interest rate locks utilized in the second quarter of 2022. The decrease in mortgage operations was partially offset by our insurance operations, which benefited from increased premium revenue within our captive insurance companies. Our tax rate decreased from 24.3% to 22.3% for the 2022 third quarter. The decrease in rate was driven by the extension of the federal energy efficient home tax credits during the quarter, which was partially offset by an increase in nondeductible executive compensation.
We delivered 2,387 homes during the quarter, which represented a 1% decrease year-over-year but exceeded the midpoint of our previously estimated range for the quarter of 2,200 to 2,500 closings. The average selling price of homes delivered during the quarter increased 13% to $590,000. This was primarily the result of price increases implemented over the past two years. Our sale to close cycle times foreclosed homes remain extended and are unlikely to materially improve in the fourth quarter. With that said, we believe cycle times have the potential to improve in 2023 and be a positive catalyst for closing volume longer term. We currently anticipate home deliveries for the 2022 fourth quarter of between 2,200 and 2,500 units and we expect the average selling price of these units to be between $570,000 and $580,000. There continues to be a heightened risk of underperformance relative to our forecasts this quarter due to the increased volatility of economic and industry conditions.
Gross margin from home sales decreased by 80 basis points year-over-year to 22.7%. As previously mentioned, the decrease was primarily due to inventory impairments recognized during the quarter. However, increased building costs as well as an increase in incentives also contributed to the decline. Incentives on closed homes increased 130 basis points year-over-year, of which 40 basis points related to financing incentives offered through our mortgage company. The level of financing incentives will likely increase in the near term as we continue to use these incentives as a tool to address affordability concerns brought about by higher mortgage rates. Excluding inventory impairments, our gross margin from home sales improved across each of our segments with our West segment having the highest absolute level in our East segment having the largest year-over-year increase. These improvements were driven by price increases implemented across nearly all of our committees over the past two years. We are currently expecting gross margin from home sales for the 2022, fourth quarter of between 20% and 22% assuming no impairments or warranty adjustments. Our total dollar SG&A expense for the 2022 third quarter increased $21.3 million from the 2021 third quarter driven by increased general and administrative expenses. This resulted in a 40 basis point increase in our SG&A expense as a percentage of home sale revenues.
General and administrative expenses increased $20.9 million from the prior year quarter to $80.9 million. This increase primarily resulted from an increase in stock based compensation expense, as we recognized $15 million of expense related to equity awards granted during the quarter. As Larry noted, we have taken steps to reduce our general and administrative expenses moving forward. We have seen our quarter end headcount decrease 11% from its peak earlier this year and continue to evaluate other opportunities for additional cost savings. We currently estimate that our general and administrative expense for the fourth quarter of 2022 will be approximately $70 million. The dollar value of our net orders decreased 88% year-over-year to $252.8 million due to an 88% decrease in net unit orders. Net unit orders were negatively impacted by the number of cancellations during the quarter, which more than doubled from the prior year to 1,270 cancellations. Given our build to order business model, we believe it is best to analyze cancellations as a percentage of beginning backlog. In the third quarter of 2022, cancellations as a percentage of that beginning backlog were 17.1% compared to the prior quarter of 7.4%, and our longer term quarterly average over the past 10 years of 13.9%.
In large part the cancellations during the quarter were from orders that occurred prior to the run up and mortgage rates with 59% of our third quarter cancellations coming from orders that occurred prior to March 31, 2022. As David mentioned, we also saw a higher percentage of cancellations during the third quarter from buyers who could still afford to move forward with their purchase at higher rates. This type of buyer equated to approximately 43% of cancellations during the third quarter compared to 36% of cancellations during the quarter that were strictly due to the buyer no longer qualifying for a mortgage. In contrast, during the second quarter, the greatest percentage of cancellations was attributable to those who no longer qualified for a mortgage. Before cancellations, our gross order activity for the third quarter was down 47% year-over-year and 30% from the second quarter of 2022. About 50% of our third quarter gross order activity was spec inventory.
Looking at the monthly cadence of activity, each month of the third quarter saw fewer gross orders and more cancellations than the month before, with September having the lowest number of gross orders and the highest number of cancellations for the quarter. With a few days to go, the number of gross orders and cancellations for October seem like they will be similar to the numbers we recorded in September. Looking at our average sales price of new orders, we analyze this metric on a gross basis given the magnitude and mix of cancellation activity during the quarter. On a gross order basis, our average sales price of new orders increased approximately 4% as compared to the prior year and decreased approximately 5% as compared to the second quarter of this year. The decrease in our average selling price from the second quarter of 2022 was due to an increase in incentives, as well as a decrease in base pricing for certain communities. Our active subdivision count was at 220 to end the quarter up 8% from 203 a year ago. This increase was driven entirely by our West segment with our East and Mountain segments both experiencing year-over-year decreases. Our Arizona and California markets saw the largest year-over-year increase in community count, adding a total of 22 net new active communities. We expect our active community count to continue to increase through the remainder of the year and into the 2023 spring selling season.
We acquired 447 lots during the quarter, resulting in total land acquisition spend of $74 million down 73% from $273 million in the 2021 third quarter. We also had $169 million of planned development spend during the 2022 third quarter, up modestly from $147 million in the same quarter last year. We incurred $11.8 million of project abandonment charges largely resulting from non refundable deposits on land transactions that were no longer viable in the current market. This charge is in addition to the $15.5 million of project abandonment charges recognized in the second quarter. As of quarter end, we had $24.1 million in cash deposits and $5.9 million in letters of credit at risk associated with the 5,364 lots currently under option. During the third quarter, we approved just one new land deal with 12 lots for acquisition. This minimal activity coupled with a number of projects abandoned over the last six months resulted in a 20% year-over-year decrease in our controlled lot supply to 29,256 lots. However, we believe the supply is sufficient to meet our operating needs for several years consistent with our philosophy of maintaining a two to three year supply of land. With lower land acquisition activities so far this year, operating cash flow has increased to $344 million for the first nine months of 2022 compared with $86.5 million of cash used to fund operating activities for the first nine months of 2021. With cash balances increasing during the quarter, we purchased approximately $292 million of US treasury securities during the third quarter. These marketable securities have enhanced our yield, but are of a short duration with initial maturities upon purchase of six months or less.
Our work in process inventory has decreased $152 million from its peak at the end of the second quarter this year despite the increase in our overall speculative inventory. As of September 30th, we had 1,082 spec units, of which only 187 units were complete. We ended the quarter with total liquidity of $1.89 billion with no senior note maturities until 2030 and a book value per share of $42.23. In summary, while we remain confident in the long term growth prospects for the industry given the under production of new homes over the past decade, the demand for new homes is likely to continue to experience headwinds in the near term. As I mentioned last quarter, our financial position and cash flow will remain a key focus for us, especially as the economic picture remains unclear. Delivering homes in backlog during the fourth quarter will be key to the continued improvement to balance sheet and cash flow metrics. Furthermore, as uncertainty in the market persists, we believe that our strong balance sheet and liquidity will put us in a position to pursue new land transactions with better terms and/or better pricing than has been recently available, which could be a great opportunity for our company. Our strong financial position also supports the continued payment of our quarterly dividend, which was again approved by our Board at the $0.50 per share level this week, continuing our long established record of consistent or increasing dividend payments dating back to 1994.
That concludes our prepared remarks. We will now open up the line for questions.
Question-and-Answer Session
Operator
Today’s first question comes from Stephen Kim with Evercore ISI.
Stephen Kim
Bob, just a housekeeping item. Do you have the inventory breakout, the housing completed and under construction versus the land and land inventory — land and land under development, if you have those that would be helpful. But I wanted to — if you’re looking that up, I also wanted to ask you about what percent of your backlog is rate locked at this point and what was that at the end of 2Q?
Bob Martin
I think rate locked for Q4 specifically, we’re probably right around 50% and I guess overall, we are probably somewhere in the neighborhood of 40%. The prior quarter, I’ll have to check on this, Steve but I think it was closer to 30% overall.
Stephen Kim
And why wouldn’t those numbers — why wouldn’t you proactively seek to get those numbers higher? Because it just seems like with all the volatility and with the uncertainty in the market, that might be an effective way to sort of mitigate the effects of cancellations. And then also, you mentioned a lot of the cancellations were sort of psychological and you back that up with some of your commentary. Are you — in those situations, are you keeping the deposit and that the earnest money these folks have had put down? And we’ve noticed that your earnest money percentage is kind of on the low side, and we’re wondering whether you’re actually looking to take more earnest money? These are things that could theoretically mitigate your cancellation experience, and just wondering if you’re pulling some of these levers.
Bob Martin
So a couple things, I’ll try to answer as much as I can remember. So first of all, just speaking to the interest rate lock situation. I was speaking as of September 30th. And I would say, certainly, on the interest rate lock side of things, we’re focused on the ones that are closing the quickest, the ones that have the quickest cash flows, so locking those in at least a quarter ahead. We do also have longer term lock programs available for consumers if they are interested in that. But the main priority is try to lock folks in that are going to close within the coming quarter. That’s one. Two, your housekeeping item, I think you were just asking about the split between WIP and land. And that is in our release, it’s 2.2 billion on WIP and 1.8 billion on both the land account for a total of 4 billion of inventory. In terms of the other items, the other thing I heard of was the deposit policy. We feel pretty comfortable about our deposit policy. But much like everything else in a changing market, we have reviewed that we have made changes to that policy and we continue to make some changes to that policy. So it’s a bit of a balance, because we want to make sure our backlog is secure. Then again, we want to make sure that buyers feel comfortable entering into new contracts as well. And of course, we’re looking at what the rest of the market is doing. So certainly, we’re very focused on reviewing a lot of our practices as we continue to operate through very volatile market.
Stephen Kim
And then lastly for me, how many of your net sales would you say were dirt sales versus spec sales in the quarter?
Bob Martin
I’m not sure if we split out the net, the gross is about 50%. I guess 50% gross. Derek can add, maybe 60, it’s a little bit less meaningful on the net basis. But on a gross basis, it’s about 50%, which is up from where it was in Q2 and of course a year ago in the third quarter.
Stephen Kim
So the gross sales, you’re saying 50% of your gross sales were dirt sales, and that that share of gross sales being dirt sales is higher than it was before?
Bob Martin
No, the percentage of spec sales.
Operator
And our next question today comes from Truman Patterson, Wolfe Research.
Truman Patterson
First, I was just hoping on the $28 million inventory impairment charge, hoping you could give some color there. Was it concentrated to single land deal or multiple communities? I’m also hoping you can give color, was it related to a specific metro or region as well as kind of the vintage of when that land was bought?
Bob Martin
Yes, it’s a bit of a mixed bag on all fronts. I think overall it was nine different communities. As we said on the call, two in the East, seven in the West. The two in the East were in Pennsylvania, it was actually a newer area that we were operating in. So in that case, it was an area where we encountered some unexpected costs. So that one’s a different animal out there. But those two were in Pennsylvania. If you look out west, the biggest areas for the impairments was Phoenix and Southern California. Then we kind of had a little smattering elsewhere. We had one in Vegas, for example. So naturally, in this environment, we’re still at pretty high levels of cost overall. And of course, we’re dealing with higher levels of incentives. So that tripped a couple of triggers in a few areas. So we did the analysis and that’s the number that we came up with. So we made sure we were very thorough in that analysis. And we really used today’s assumptions with what’s going on. So that’s the scoop vintage again, it was different vintages. I don’t have kind of one specific kind to point to, but different periods of time that those were originally contracted.
Truman Patterson
And then Bob, I heard you give commentary earlier about the level of incentives in your closings. I’m hoping you could just give where third quarter order incentives or base price cuts kind of combined might have been for the third quarter, and what kind of the exit rate was in September, October time period?
Bob Martin
So as far as incentives go, I think for sales for the quarter overall, we were about 7%, but I think they were trending up towards 8% as we got to the end. Of the quarter as we looked at base price decreases, hang with me for one second, so I can get you a more exact number. Derek, what page was that?
Derek Kimmerle
Base price decreases are pretty small relative range…
Bob Martin
It was, I think 1% or 2% overall kind of a relatively de minimis number relative to the incentives, but I can get that exact…
Truman Patterson
And then just one final for me whenever we’re thinking through the level of incentives. Are there any markets, metros, regions to call out where you know you’re seeing a relatively elevated level and any way you could put some numbers behind that?
Bob Martin
In terms of price decreases?
Truman Patterson
Yes, just the level of order incentives…
Bob Martin
Probably, you’re getting some in most markets. Some of the outer line areas of Phoenix might be a little bit more elevated relative to those numbers. I don’t have an exact percentage for you, but that’s one that I would call out.
Operator
And our next question today comes from Michael Rehaut with JPMorgan.
Unidentified Analyst
This is Dan [indiscernible] on for Mike. I just wanted to ask, was there — could you kind of give any more color around build cycle times. any relief that you see in the future? I know you spoke to Q4 not really materially improving. Anymore detail there?
David Mandarich
We’re at, I think, 303 days on the houses that closed during the third quarter and that’s sale to close, including the time in the front end before we start the house. And we expect, it’s going to be at that level or maybe even a little bit more than that in Q4. So in terms of the actual period of construction from the time we start the house to the time we finish, I don’t know that we have seen a ton of relief there yet, but we expect there could be some opportunity for that in 2023 simply because there is going to be less houses started, less working through the pipeline. I think the finished trades are still plenty busy. So we haven’t really seen any relief there yet. So I’m hesitant to put any quantification on it at this point, other than to say before we went through this period of time, we were just under 200, as our sale to close cycle times. And this is on dirt sale houses, I should say. So that’s been the recent low. Certainly, not saying we can necessarily get there in 2023 but we have that in the past at much lower levels in terms of cycle time.
Unidentified Analyst
And then I think in the prepared remarks, I heard you guys saying something about cost cutting initiatives. I wanted to see if you could expand on that at all.
David Mandarich
Yes, I think from our peak in terms of headcount, we are down about 11%. And that includes — that does as of the end of the quarter, that includes some attrition where folks left and we didn’t replace position. And then a couple situations where we reduced our staff more proactively.
Unidentified Analyst
And then one more from me. Is there any change in the go-to-market strategy, are you any less focused on entry level or any color there?
David Mandarich
We have got a pretty good spectrum of products. I would say we’re still a bit more focused on the affordable realm, much as we have been over the course of the past few years.
Operator
And our next question today comes from Alan Ratner with Zelman and Associates.
Alan Ratner
First, revisiting the impairments for a second. Bob, do you happen to know, I guess, probably more relevant to the active communities, what type of net price adjustment triggered those impairments? You mentioned the incentives company wide, but I’m guessing those communities might have been a bit larger. And do you have an updated figure in terms of a watch list in terms of communities that might not have been impaired this quarter, but might have shown some potential indicators of impairments. I believe that’s a figure that you and others used to disclose back in the day, and I’m guessing my might be disclosed going forward here.
David Mandarich
I don’t have a watch list for you. I will say, clearly in this market, if we see more deterioration, we’re going to be doing the same impairment analysis at the end of the quarter. So impairments are always possible in the wake of changing industry conditions. So we’ll continue to do the impairment analysis every quarter and report back. In terms of the magnitude, each asset, I think, is different in terms of what drove it. In some cases, I mentioned there was a couple of communities where the community wasn’t even open yet. And we see the direct comps, maybe those selling spec inventory, showing decreases of pretty big significance. Whether or not that is just clear the spec inventory for their current fiscal year or if it’s a longer term trend, it’s hard to say whether or not the prices are going to stick at that point. But we can only kind of deal with the facts and circumstances that we have at the time when we’re looking at those impairments. So we took the information that was available and made the calculation.
Alan Ratner
Second question on cancellations, obviously, have been increasing across the industry. You mentioned that your priority is kind of closing the backlog that you have in place and making sure that as many of those homes get to the finish line as possible. Your [can] rate was a bit higher than the group average, at least what we’ve seen so far as a percentage of backlog. So I’m curious, when you think about the equation of whether you offer incentives to the buyers and backlog or discount the price further in order to keep those buyers in place versus kind of letting them walk, because you did mention a good chunk of them could still afford to move forward. It sounds like it was more of a confidence/pricing decision there. Where do you draw the line and what type of results have you had where you can point to reselling some of those canceled units? What is the margin and price difference look like compared to what it was originally in backlog for?
Bob Martin
I mean, I think the most important thing is that we’re communicating with those buyers that are cancelling and at least get — taking a shot at seeing if we can keep them in backlog. So I think we’ve even gotten to the point where we want our division presidents to have conversations with every one of those consumers, whereas in the past, we may have just had the sales manager or someone else have that conversation. So it’s a really skilled group we have of division managers out there. They’re having those conversations and they’re making a business decision, and we’ve got a lot of tools out there for them to use. We’ve got the interest rate locks at below current market prices, which are great. In some cases, it’s an increased incentive or something else. But in a lot of cases, it just comes down to payment.
And so the point on those who still can afford it, in a lot of cases, they’re just a little bit concerned in this market. And there’s really not much we can do to bring them back. But we certainly keep that relationship fresh and try again when maybe things settle down a little bit. In terms of resale of specs, I would say we’ve had a pretty good record on that. You heard the 50% number in terms of our overall gross orders that related to specs, that’s a recent high for us. And we can certainly see that there’s some demand out there, when somebody gets that certainty of I can get the house relatively quickly and I know what my payment is. So I think our management teams have done a great job of getting those results.
Alan Ratner
And just on that point, Bob, so in the event where you are reselling it and you look at the price you’ve achieved, does that inform any decisions going forward perhaps in terms of maybe, are you coming in lower than you would have if you would have, maybe met the bidder or the buyers price that was in backlog? Or is it a situation where you feel like you’re getting a better price than you would have if you had to kind of discount to keep that original buyer in place?
Bob Martin
I think our division mangers are well aware of what the current trade is, what the current house pricing is and how that relates to the buyer that’s already in backlog. So I would say they’re doing a good job of kind of managing against what they think they could get post cancellation versus what they can get before it cancels. So they’re taking all that into account.
Operator
And our next question comes from Alex Barron from Housing Research Center.
Alex Barron
Bob, I wanted to ask, I think I heard the markets involved into the impairments. But how many communities got impaired this quarter? And what’s roughly the thing that triggers the impairment, is it the gross margin or the operating margin, what is it that triggers them?
Bob Martin
It was nine communities and it’s really the operating margin that you have to look at. And once you go negative, so if you go $1 negative on expected cash flow and on undiscounted basis then you trigger an impairment and you did discounting the cash flows, and that’s what determines what it is. But really it’s on the operating level within that one community, I should say.
Alex Barron
And also, I’m not sure if I missed it or if you didn’t give. Do you happen to have the number of starts in the quarter? And philosophically speaking, how are you guys thinking about spec starts going forward? I know in the past few years, you guys have been inclined to go towards build to order model. But some other builders are saying that there’s more demand for homes that can close within 30 to 90 days? So I’m wondering is that changing your perspective on that?
Bob Martin
I think those are good questions. With regard to the spec start philosophy, we haven’t changed anything at this point. I will say we have generated a lot of great cash flow. And when you’re in a good balance sheet position, it gives you the optionality to start specs, for example, if you really need to, if conditions warrant. So that’s something that we’ll continue to evaluate. But we still want to be a place where a buyer can come for a bill to order a house to. So it’s a balance and we’ll continue to kind of assess that as we go. As we look at just what happened in terms of starts during the quarter, I think we’re at right around 910 was the number for the quarter.
Alex Barron
And in terms of, again, what’s triggering this impairments? Is it just mainly like you said with newer communities and you’re looking at comps, or are you actually cutting prices on existing homes that’s getting some of these communities there?
Bob Martin
So there are communities but some of it’s older communities that just had higher costs. I mentioned the example of a couple in Pennsylvania in the area we hadn’t operated much in before, where we have some unexpected costs that we were hit with. So it’s different things for different communities. Certainly, in some cases, it was directly related to the fact that there is some discounting going on out there, whether that’s us or a competitor. We take that into account and run it through the cash flows.
Operator
[Operator Instructions] Our next question comes from Jay McCanless with Wedbush Securities.
Jay McCanless
I guess the first one, were the majority of the cancellations in the quarter customer driven or did you guys decide proactively cancel out some people that you thought might not get to the finish line?
Bob Martin
Yes, I guess it’s a combination because we are coming to our backlog constantly. And if we find a buyer who we just don’t think is going to make it, we will have that conversation proactively. But as I mentioned earlier and David hit on it as well, we saw more that were in that remorse category. So that’s more where the buyer proactively comes back to us. And so they really just didn’t want to proceed at this point. So a mixed bag, number one being that remorse category, number two being financing.
Jay McCanless
And so if the vintage of the cancellation for people who had signed, I think you said Bob before March 31st and you’re on a 300 day cycle. Does that suggest that closings from 4Q ’22 to 1Q ’23 are going to take a steeper drop than normal just because of that gap you have?
Bob Martin
4Q, did you say 4Q 2022?
Jay McCanless
’22 into 1Q ’23. Just trying to think about the volume ramifications look like from that?
Bob Martin
I mean we put out our 2,200 to 2,500 range on closings for Q4, so that’s your best information for there. We haven’t put out any guidance for Q1. But I will say when you do get a cancellation and it dates back to Q1 or Q4 of last year, of course, that means you have got us back that you can potentially sell and close within the quarter or maybe even into Q1. So a lot of those units will be additive to future periods even if we had to cancel them in the current period.
Jay McCanless
And then last question I had, not to pick apart strategy. But when you said that the majority of openings this quarter were in Arizona and California, are those more entry level lower affordably priced or is this land that you had to go ahead and open, because it seems like you’re opening more communities in some of the tougher areas?
Bob Martin
I think, we continue to open communities. In a lot of our markets, those two just stuck out as the ones that had the greatest increase in community count. In some cases, community counts going up a little bit more than expected, because the sales rate is a little bit lower, so you have fewer closeouts. So from a strategic standpoint, we’ve got a fairly limited supply of land. So I don’t think we’re of the mindset that we’re just going to sit on communities, we’re going to open them as they’re ready and become available. And with the short land supply, we have the ability to convert to cash readily easily and then reinvest in the market later on when it makes sense. So that’s really the strategy and we’ll continue to open communities as they’re ready to come online.
Operator
And our next question comes from David Stuehr with Longfellow.
David Stuehr
A few months back, you filed this a rather substantial shelf registration and you’ve emphasized, certainly, on this call and on prior conference calls, definitely you have solid liquidity here. There’s no pressing bond maturities. But I’ve always been kind of curious in terms of what the thought was behind that shelf filing. Were you taking a look at doing a potential acquisition at the time? And if my conspiracy theory is wrong, just kind of curious in terms of once this down cycle ends and they typically do, what your firm’s viewpoint is on industry consolidation in this space? So overall just more color on that would be great.
Bob Martin
I don’t think there was any particular transactional activity anticipated when we did that shelf. There’s really no kind of incremental work or that much cost involved with doing five versus two versus one. So it was kind of one of those things where you might as well. But in terms of industry consolidation, that’s not what I’m smart enough to figure out. I think there’s been a lot of others out there who have been a lot more acquisitive than us. And there’s nothing out there right now that I’m aware of that’s cooking.
David Stuehr
But I mean, clearly, that’s something that you would entertain, I mean, at some point, from a strategic perspective to take a look, I would figure?
Bob Martin
Well, I think any company, public company has to look at things as they come along and do what’s in the best interest of the shareholders.
Operator
And ladies and gentlemen, this concludes our question and answer session. I’d like to turn the conference back over to the management team for any final remarks.
Bob Martin
We appreciate you being on the call today. And we look forward to speaking with you again after our year closes and we jump on our Q4 earnings call.
Operator
Thank you, everyone. This concludes today’s conference call. We thank you all for attending today’s presentation. You may now disconnect your lines, and have a wonderful day.
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