Q2 2019 Earnings Call
<unk> income comforting the next available operator will be with you momentarily.
Thank you for calling income conferencing. The next available operator will be with you.
Conference Center can I have your first and last name please.
Jason Hormann HR and man.
<unk> company do you work for Sir.
Era.
Okay.
On her for KBR.
Yeah.
And you're right to standby.
Sure results and the company does not undertake any obligation to update them.
Due to factors outside of the company's control, including those detailed in today's press release and filings with the Securities and Exchange Commission actual results could be materially different from those stated or implied in the forward looking statements.
In addition, a reconciliation of the non-GAAP measures referenced during today's discussion to their most directly comparable GAAP measures can be found in today's press release and or on the Investor Relations page of our website at Kb home dotcom and with that I will turn the call over to Jeff Mesker.
Thank you Jill and good afternoon.
We continued to deliver solid performance in the second quarter.
Under our returns focused growth plan, which prioritizes the profitable growth of our business.
And greater productivity and efficiency of our assets.
Our execution on this plan has been consistent and strong since we launched it in 2016.
And has produced measurable results.
We have realized significant growth in our community count this year, which fueled a 15% year over year increase in our second quarter net orders.
In addition by substantially reducing our debt while growing our active inventory.
We expect to lower our annual interest incurred in 2019.
By more than $40 million since the plan was introduced.
In the second quarter, we accelerated our community count growth by successfully opening 43, new communities, bringing our total openings over the last 12 months to 123.
Which had us well positioned for the spring selling season.
Our second quarter average community count was up 17% from a year ago.
Reflecting increases in all four regions.
With three of our regions producing greater than 20% growth.
We expect to continue growing our average community count year over year over the next two quarters and remain committed to realizing a 10% to 15% increase for the year.
Which sets us up well as we look ahead to 2020.
We generated just over $1 billion in total revenues in the second quarter.
Diluted earnings per share of 51 cents.
Our housing gross profit margin, excluding inventory related charges held even with our 2019 first quarter at 17.6%.
While this result was lower year over year, we are encouraged by the composition.
Of our $2.2 billion backlog.
Which we expect to drive gross margin improvement over the balance of the year as Jeff will share with you shortly.
From a macro perspective, the combination of a decline in mortgage interest rates, along with steady economic growth.
Hi, consumer confidence.
And favorable demographics in particular household formation.
Continues to provide a healthy backdrop for our industry.
In addition, the buyer pause at the industry experienced in the latter part of 2018.
As generally moderate at home prices, which is positive for the market given the significant levels of price appreciation over the past few years.
On the other side of the equation supply remains insufficient to meet demand.
Stemming from the underproduction of new homes over multiple years, and a shortage of existing home inventory, particularly at the price points, where we operate.
These factors contributed to the solid market conditions that we saw in the early weeks of March.
Which we spoke about on our last earnings conference call.
On a per community basis.
Net orders were a healthy 5.4 per month.
Which closely track the prior year quarter's robust absorption pace.
Our business gained momentum as the second quarter progressed fueled in large part by the significant number of new community openings that I discussed earlier.
Resulting in a 15% year over year increase in net orders.
Each of our four regions produced a double digit increase in the second quarter.
Net order value expanded by 13% in the second quarter to $1.5 billion.
This result helped bolster our backlog value to $2.2 billion as I mentioned earlier.
In terms of units our backlog in the second quarter was up about 2% year over year.
Moving on to the regional commentary, our net orders were up 18% in our West Coast region, driven by an increase in average community count.
And a healthy pace of 5.7 net orders per community per month compared to 6.2 net orders in the year earlier quarter.
In northern and Central California, we experienced generally solid market conditions.
In the Bay area, we expanded our average community count contributing to net order growth of more than 20%.
While achieving an absorption pace slightly ahead of our company average.
As we are now successfully rebuilding our bay area community Count. The division's order result supports our expectation for a sequentially higher company, a ASP and gross margin in the second half of this year.
In Southern California, our net order trends improved.
In both our Los Angeles and inland Empire divisions.
Net orders increased by roughly 25%.
Driven by community count growth in areas with healthy market conditions.
We view these results positively.
As we have been monitoring our inland Empire business for any ripple effect from conditions along the coast.
Within our coastal business the smallest of our California divisions in terms of units.
While market conditions are softer than the inland areas.
The net order decline that we experienced was primarily due to the sell out of one community in San Diego that alone produced nearly 30% of this division's net orders in our 2018 second quarter.
Finally in April .
We were pleased to successfully opened our first community in Seattle.
In Pierce County.
A commuter market southeast of the city.
When we started up our Seattle business.
We identified an opportunity to offer affordable products in the high 300000 to 400000 price range.
Starting first time and first move up buyers.
Our first community falling water is aligned with this market approach with an ASP starting at $385000 as compared to a median new home price of 620000, and a median existing home price of 465000 across the three county Metro Seattle area.
We expect deliveries from this community by the end of the year and look forward to our second community in Seattle opening later this year as well.
In our central region, our largest in terms of units.
Net orders increased 11% driven by our Houston and Colorado divisions.
In Houston.
The combination of a strong economy population growth and our positioning at affordable price points in desirable areas.
Resulted in the highest quarterly net sales for this division in over a decade.
The most active sales volume price band in Houston.
Is between 200 and 300000.
And with our ASP of roughly 245000, we are operating in the sweet spot of this market.
Elsewhere in the region, our Colorado Division opened five new communities in the second quarter.
The openings were well received in a supply constrained market.
Contributing to a 45% increase in net orders.
Demand in the Denver housing market is strong driven by positive in migration and job growth.
We are well positioned to meet this demand with our ASP of approximately 485000.
In between the median new home price of 525000.
The median resale price of 425000.
On point with our pricing strategy, providing affordable product and attractive areas.
In addition to these specific market updates I would also like to comment on KVH as our mortgage joint venture with Stearns lending.
In the two years since becoming fully operational KVH US has provided high quality level of service to our homebuyers.
Helping to drive our customer satisfaction scores higher.
In addition, the Jvs consistent performance has supported our divisions as well.
Enabling more predictability in deliveries and contributing to our ability to successfully deliver homes to our buyers on time.
With the capture rate of nearly 70% in the second quarter.
Growing significantly from 52% in the year ago quarter.
And our expectation for continued enhanced execution from Kb Hs.
We anticipate a meaningful increase in the income contribution from our JV in the second half of this year.
In closing with the backlog value of $2.2 billion and a considerable number of new communities still to open this year.
We are well positioned to deliver year over year growth in revenue and profitability by the fourth quarter of this year.
And for momentum entering 2020.
With strong execution on our core business strategy to increase our scale.
We have achieved the top five market share ranking and just over 70% of our divisions.
As compared to roughly 30% when we launched our plan.
We have a business model with our built to order approach that allows us the flexibility to move with demand.
And react quickly to market changes.
This differentiates us and contributes to our growing share of first time buyers, which increased to 55% of our business in the second quarter.
We are poised for a strong finish to 2019.
And look forward to updating you on our progress moving forward.
With that I'll now turn the call over to Jeff for the financial review Jeff.
Thank you, Jeff and good afternoon, everyone.
I will now provide highlights of our financial results for the second quarter as well as our outlook for the third quarter and full year 2019.
We are very pleased with our second quarter performance, particularly our strong backlog conversion, which helped drive housing revenues and a solid absorption pace in community count growth that led to a 15% year over year increase in net orders.
We believe we are well positioned for a strong second half of the year and expect to generate improvements in virtually all our key financial metrics.
In the second quarter housing revenues were just over $1 billion is compared to $1.1 billion in the prior year period.
Reflecting an 8% decrease in our overall average selling price that was partially offset by a 2% increase in the number of homes delivered.
The primary drivers of the overall housing revenue decrease were a lower proportion of total deliveries from our West Coast region, and a decline in our West Coast region average selling price that stem from both a mix shift towards deliveries in lower price inland markets and the absence of certain communities with high average selling prices they closed out in prior quarters.
The 2768 homes, we delivered in the quarter represented a backlog conversion rate of 60%.
This strong performance reflected several factors, including a sequential and year over year reduction in construction cycle time, an increase in closings financed by our mortgage joint venture.
And a higher percentage of standing inventory that was both sold and closed within the quarter.
We ended the second quarter with over 5900 homes in backlog, an increase of 2% versus the prior year.
Our ending backlog value was $2.17 billion as compared to the year earlier level of $2.24 billion, which represented our highest second quarter backlog value in 11 years.
Considering the quarter end backlog and expected future net orders. We currently anticipate third quarter housing revenues in a range of $1.1 billion to $1.18 billion.
For the full year, we believe our housing revenues will range from $4.45 billion to $4.6 billion.
In the second quarter, our overall average selling price of homes delivered decreased 8% year over year to approximately $368000 due to the impact from our West Coast region that I previously mentioned and a mix shift in our central region with a lower proportion of deliveries from our Colorado operations.
We believe the expected increase mix of West Coast region deliveries driven by the successful rebuilding of our California community Count.
Will result in higher average selling prices in the second half of the year.
For the 2019 third quarter, we're projecting an overall average selling price in the range of 395 to $400000 and believe our ASP for the full year will be in a range of 385 to $390000.
Homebuilding operating income decreased from the year earlier quarter to $52 million or 5.1% of revenues.
Excluding inventory related charges of $4.3 million in the quarter and $6.5 million in the year earlier quarter. This metric was 5.5% compared to 7.3%.
For the third quarter, we expect our homebuilding operating income margin, excluding the impact of any inventory related charges will be in the range of 6.4% to 7.0%.
For the full year 2019, we expect this metric to be in the range of 6.7% to 7.3%.
Our housing gross profit margin for the second quarter was 17.2% compared to 17.1% from the prior year period.
Excluding inventory related charges, our gross margin for the quarter was 17.6% compared to 17.7% for the 2018 second quarter.
The current year metric reflected favorable impacts from lower amortization of capitalized interest.
As well as the change in the classification of certain model complex costs.
Due to our adoption of the new revenue accounting standard as C. Six six.
These favorable impacts were offset by pricing pressure on fourth quarter, and first quarter orders due to weaker market conditions during those periods.
The effect of certain high ASP in high margin West coast communities, having closed down in previous quarters.
And reduced operating leverage due to lower housing revenues and higher fixed community level expenses supporting community count growth.
Our adjusted housing gross profit margin, which excludes inventory related charges as well as the amortization of previously capitalized interest.
Was 21.3% for the second quarter compared to 22.2% for the same period in 2018.
Assuming no inventory related charges, we expect a sequential increase in our third quarter housing gross profit margin to a range of 17.9% to 18.5%.
And further improvement in the fourth quarter.
Considering this expected favorable trend.
We believe our full year housing gross profit margin, excluding inventory related charges will be within the same range of 17.9% to 18.5%.
Our selling general and administrative expense ratio of 12.1% for the quarter was up as compared to the 2018 second quarter record low ratio of 10.4%.
The increase mainly reflected the AMC six those six impact mentioned earlier.
Reduced operating leverage due to lower housing revenues.
Increased marketing expenses to support new community openings.
And the impact of legal recoveries and favorable legal settlements in the prior year period.
As we continue to prioritize containment of overhead costs and expect to realize favorable leverage impact from higher housing revenues in the second half of the year.
We are forecasting our third quarter SGN, a expense ratio to be in the range of 11.3% to 11.9%.
In our full year 2019 ratio to be in a range of 11.0% to 11.6%.
Income tax expense for the quarter was $9.3 million, which reflected $5.2 million of favorable impacts from federal energy tax credits and benefits from stock based compensation.
Without these impacts the effective tax rate for the quarter would have approximated 26%.
We expect our effective tax rate for the remaining quarters in 2019 to be approximately 26% excluding potential impacts from stock based compensation.
Overall, we reported net income for the second quarter of $47.5 million or 51 cents per diluted share.
For modeling purposes diluted earnings per share for the remaining quarters of 2019 should be calculated using approximately 92.5 million shares which reflects the 8.4 million reduction in our diluted share count due to the first quarter repayment of our convertible senior notes.
Approximately 93.5 million shares should we use for the full year calculation, representing a year over year decrease of 7%.
Turning now to community count.
Our second quarter average of 252 was up 17% from 215 in the same quarter of 2018.
We ended the quarter with 255 communities, including 27 communities or 11% Denver previously classified as land held for future development.
As we continue to successfully implement our strategy of monetizing these inactive assets and with less than $200 million in this inventory category at quarter end.
We expect to see further declines in the number of reactivated communities in the future.
We invested $399 million in land land development and fees during the second quarter with $132 million of the total representing new land acquisitions.
Over the past 12 months in addition to the capital allocated to pay down debt, we deployed over $1.8 billion into land related investments and opened 123, new communities as Jeff mentioned earlier.
On a year over year basis, we anticipate our third quarter average community count will increase in the range of 15% to 18% as compared to the 2018 third quarter.
We still expect our average community count for the 2019 full year to be up approximately 10% to 15% year over year.
We ended the second quarter with total liquidity of approximately $600 million, including $179 million of cash and $419 million available under our unsecured revolving credit facility.
Earlier in the year, we entered into a new $50 million unsecured letter of credit facility separate from our existing $500 million unsecured revolving credit facility.
Over time, we anticipate that most of our letters of credit will be transferred to or issued under this new line, which will free up capacity on the revolver and enhance liquidity.
At quarter end, our debt to capital ratio of 45.8% improved by 930 basis points as compared to the second quarter of last year, reflecting a $280 million increase in stockholders equity combined with $500 million of debt reduction.
As we continue to drive improvements in our credit metrics, we have tightened once again, our leverage objective from a 35% to 45% net debt to capital target.
To a debt to capital ratio within that same range.
While our quarter end ratio was just above the upper limit of our revised target range, we expected debt to capital ratio to be within this range by year end.
Along with our return of capital to shareholders in the form of our quarterly dividend.
Our capital allocation priorities remain consistent with a focus on investment in land assets to grow the business and improve returns and continued deleveraging of the balance sheet through retained earnings growth enhanced by future debt reduction.
In summary, our second quarter highlights included a strong backlog conversion rate driving over $1 billion in housing revenues.
A measurable increase in community count and a healthy sales pace per community contributing to a 15% year over year increase in net orders.
On a sequential expansion of operating margin and a significant improvement in our debt to capital ratio to 45.8%.
We believe that our expanded community count and solid quarter end backlog value position us to achieve growth in housing revenues and improvement in both our gross and operating margins during the second half of this year.
We will now take your questions Devin Please open the lines.
Thank you at this time, we will conduct a question and answer session.
So that we may address as many questions as possible.
We ask our participants to limit themselves to one main question and one follow up.
If you would like to ask a question. Please press star one on your telephone keypad a confirmation until indicate your line is in the question queue.
Let me first start to feel like to remove yourself from the queue for participants using speaker equipment. It may be necessary to pick up your handset before pressing the star key.
Our first question comes from the line of Alan Ratner with Zelman and Associates. Please proceed with your questions.
Hey, guys. Good afternoon, congrats on really a really great results. So first question I was hoping you might be able to talk a little bit about what you're seeing on the the incentive environment. I think there is a lot of confusion out there right now exactly what's going on I mean that you have a few builders talking about incentives coming down, but it sounds like they're still at fairly elevated levels across the industry at the same time I look at your absorption numbers and they are extremely strong and it would seem like you should have some pricing power at that type of sales pace. So.
Do you have an ability to push price now are you kind of a big being a little bit conservative there just given how many communities you're opening up and just any any general commentary you could have on on that front would be great.
But Atlanta and thanks for the recognition on the quarter as you know our business model doesn't really focus much on incentives we believe in.
For the consumer the best value in price.
And then the personalization in our studios. So we don't we don't have a heavy incentive business model. We did there is some closing costs, we pay in certain communities, where the buyers may not have the cash to close without it I think in the quarter our.
Our sales and sales were up 30, Bips was the jet boat up 30 Bips sequentially. So it's it's not a big mover for us.
I think the markets are pretty rational I do think overall.
The industry's backing off of their incentives or pushing pricing as we look at our communities. We did raise price during the quarter in the majority of our communities. So we were able to take some price while holding the the fairly strong absorption rate.
Great and I assume that would deal with that kind of continued through the quarter and you have to remain into June new year to you see kind of progressively to the pricing power improving through that that period.
Well I don't want to talk to June because we're just closed in the second quarter, but within our second quarter I would say it was pretty consistent through the quarter. We manage each asset every week based on our sales are going and if we have an opportunity to take price, we'll take prices to community where sales are little softer we won't.
Won't take price I would say it was fairly consistent.
Through the quarter as we shared in our prepared remarks, we did see our sales strengthening.
Sequentially from March to April to May.
Got it no that's that's very helpful.
Second question, if I could just for Jeff K. and we thank you for the updated targets on the the leverage and the goals there.
You guys have been incredibly opportunistic through this cycle with buybacks, especially when your stock is seemingly disconnected with reality and it would seem like were kind of entering one of those periods right now stocks back below book value and in the face of.
What I perceive to be extremely strong results. So can you talk about a little bit just the willingness or the opportunity there to maybe deviate a little bit from that target. If the stock remains at these low levels for an extended period of time would you be willing to to a similar buyback like you've done in the past.
Right well, let's let's first talk about the target level I mean, it's a pretty wide range right. Its 35% to 45% were just above the range right now at the end of the second quarter and would just retained earnings growth alone.
By the end of the year, we can clearly see a path to be well within that it is a it is a wide range for a reason, it's there to allow us flexibility on.
On capital allocation is decisions as we go forward due to market conditions, but.
As you know I think you used the right words with our stock buybacks in the past they have been opportunistic buybacks or not is not a scheduled program. At this point, we're still focused on our two main capital priorities capital allocation priorities of growing the business and improving our returns as well as getting the leverage in place but.
We've been opportunistic in the past in with fairly modest buybacks at certain points in time and.
I'd say, we'd still be open to that but no one no prediction, where we're going with it at this point.
Great and if I could just go back real quickly just to clarify something that the Jeff Im said on the incentives I just want to clarify it I think you mentioned incentives were up I assume that's on closings not on orders so little bit of a backward looking data point there.
Correct.
Okay got it thanks, guys. Good luck.
Our next question comes from the line of Stephen East with Wells Fargo. Please proceed with your question.
Hi, Good afternoon, guys. This is actually a truman Patterson on for Steven Nice quarter.
So thanks for thanks for clearing up the incentive commentary you know I realize you guys don't use a lot of incentives but.
He said that pricing was up in the majority of communities is there any way you guys might be able to quantify the magnitude of that improvement from first quarter to second or maybe the percentage of the communities that you actually saw some base pricing power.
That's a determinants, it's very hard to quantify that because every assets unique and.
It could be a 1000 bucks on a 500000, our house or $5000 on a 300000 miles. It just depends on how the community is pacing Tonight I think apart. We're we're sharing we expect.
Margin improvement going forward and part of that is the price that we have been able to take.
Okay. Okay. Thanks for that actually segways nice into into my follow up.
Yeah, just a little bit more more clarity on the gross margin ramp in the back half of 2019.
It seems like a little bit of that is just a little bit better pricing. If you will but could you maybe walk us through the moving parts because it seems like there's a pretty nice ramp in the back half of the year.
To hit your guys is guidance.
Any way you can just walk us through the moving parts to get investors comfortable.
Sure Yeah, there's there's several things that are coming into play there I mean, the one we should never lose sight of the mix impact.
That you see in all this we have.
A fairly large change in our portfolio as I mentioned during the prepared remarks, I think Jeff mention as well.
We opened 123, new communities since the end of the second quarter of last year that was on a base of 210. So we ended the second quarter last year 120 to 210 communities opened 123, new and closed out of 78.
So there's been a pretty large churn in communities that were selling out of right now that will provide third and fourth quarter deliveries.
On top of that when you look at some of the Tailwinds that we have we should continue to enjoy some year over year.
Positives from the improvements that we've implemented in our capital structure.
So the lower.
Interest incurred is now coming through and and lower amortized interest and we expect to see more of that.
As we go through that rest of the year and the new community openings and salad.
Should be providing a higher and an uptick in gross margins on load a lot of those communities and a lot of those communities are actually replacing reactivated communities at lower margin levels. So we'll see some impact from that as well. So when you roll. It all up we do expect to see two quarters of sequential improvement and our full fiscal year that will be in at 17.9% to 18.5% range.
Our next question comes from the line of mission soon with Deutsche Bank. Please proceed with your question.
Thank you.
Yeah absorption pace was really strong in the second quarter.
And at the end of March you had anticipated that it would be similar to 17 at the second quarter, and 2017, which would've implied.
Kind of continued down double digit pace as you saw in housing market was weaker what changed so dramatically I mean, it apply it implies a really serious ramp.
You know in a in April and May just wanted to understand the drivers of that where there are you know successful Grand openings. Jeff K. You were just mentioning you know how many communities you have opened that boost the absorptions what changed so dramatically from a from the end of March.
What may strike make couple of comments and then turn to Jeff at the time, we guided on the absorption pace. We were early in the spring. So it is still unclear to us how strong the spring would be and we also had the variable of so many communities.
Yet to open and you wonder if theres communities are going to hit.
As expected and as planned and for the most part of the community openings.
Good.
And.
But I wouldn't just attributed to that our overall sales rate around the system was pretty good we target strategically to optimize our assets we target about four a month on average you have to do better than four in your strongest selling part of the year, which is right. Now so that 5.4 is right on track for us to optimize the assets.
And Thats, one and not just just as we move through the quarter, we saw pretty nice ramp I mean, when we were doing the call at the time of the call.
We were actually only up single digits.
Over the prior year, so that was tracking about 2017 as a person pace and it just started picking up and getting progressively better as we went through the quarter as Jeff mentioned, the new communities performed very well and importantly.
You know a large proportion of them opened when they were supposed to open and we had a lot of openings in the quarter I think we said.
Last last call that we were expecting opened over 35.
And we ended up opening 43, new communities, so that helped as well, but I think just general market conditions. The way, we had our product position I think some of the changes we've made in night and positioning in model at a product of health and we're right price point at the right place is the right time, and we we did really well in sales or print as a result.
Got it no that's that's really encouraging and I. Thank God I think I know you're not commenting on.
On June in particular, but as we think about some of the factors that you described how should we think about the sustainability of some of those factors. You know is there going to be continued you know in terms is there going to be continued rate of new community openings, which might impact that.
When you say sequential trends you would you be able to expect them to continue the third quarter of last year had a pretty nice absorption pace as well. So I guess, what it's what it boils down to is would you expect to be able to sustain our meet that rate in the third quarter.
Tom nature.
Yes, you're correct, we don't want to talk about the third quarter.
But my expectation is that we'll see the normal seasonal trends.
That you typically see from Q2 to Q3, we don't see any storm clouds on the horizon in the housing markets because there's there's no inventory rates are low and people are out there looking and buying so I think you'll see the normal seasonal trends, we do have a lot of openings Phil.
Coming at US here in the third quarter and.
We're we're hopeful that we produce.
Nice sales number as the quarter rolls through.
Our next question comes on line of Matthew Bouley with Barclays. Please proceed with your question.
Hi, This is actually Kristina Q on for Matt. Thanks for taking the question.
And just looking at California.
You had an 18% order growth and I was wondering if you could elaborate and provide more color on what caused the strength, there and what you're expecting regionally in the back half of the year.
Okay, Christine I'd make few comments again, Jeff can.
Offer some more.
As we shared in the prepared comments, nor northern Cal overall did very well and.
If you look at the inland areas I touched on our Ela business inland Empire Central Valley Sacramento, They're all very good right now in the Bay area. We're bridging through this we had a slowdown in community count.
As we successfully sold through a lot of high priced high margin communities last year, and it's taken some time to reload and get the new communities open and Thats, what we started to see.
In our order results here in Q2, the expected openings hit.
And wallets, it's higher priced.
On average than anywhere else, we operate in the state it's still at a low price relative to the Bay area.
And I think Thats why you saw some strong sales as we shared in the Bay area were on the affordable side and Theres such a shortage of housing up there the price points are compelling.
When you move down down to southern Cal.
Coastal's, a small business for us we want to grow it but it's still a little soft and it's the the higher priced goods the.
Our view on that market is it held steady.
That.
Sales rates are similar were not seeing pricing pressure. So price is holding its just not as robust as the inland areas are.
Because prices are holding as continuing to fuel a lot of demand out in the more affordable.
Inland areas of southern Cal. So overall, we're pleased with what we're seeing in California right now.
Got it thanks, and then given your lot position at this stage of the year. Nearly 55000 lots are you comfortable highlighting at least directionally what community count growth could look like beyond 2019.
No not at this point, we really try not to get too far out ahead and things like that as far as guidance goes we're seeing obviously a really nice.
Cadence this year, we've been very successful in opening communities and I'll say relatively on time at least within the same quarter is when we planned.
And we're looking forward to the next couple of quarters of year over year growth and will will bubble up again later in the year and give you guys more guidance on on what 2020 is going to look like.
Our next question comes from the line of Stephen Kim with Evercore ISI. Please proceed with your question.
Yes, thanks, very much guys and thanks for all the color and good job in the quarter. Your guidance is really interesting obviously because it. It suggests a nice margin ramp and I want to talk about that for a SEC.
One of the things we get a lot is people wondering whether there is a lag effect from rates and.
As we think about that your build to order business model would seem to be well teed up to capture.
A drop in rates that happens maybe better than guys that do more spec building.
Because the fellows, who decide to sign on the dotted line by one of your homes.
It does a little time goes by and all of sudden they can afford more and they can cut back and maybe buy some more goodies a stick in the house and so I was curious as to just generally have you seen that and is there any way that you can quantify the delta between the price that you initially sell the house at and what you ultimately our closing the house that is that is that a delta that you can monitor is that had widened.
In the last few months and you projected to widen in the next several months.
Well, David I guess, a few things just on the business model itself, we try to lock in all the option choices before starting the house and in fact, we don't try to Thats, what we do do so we've actually require the customers lock in under options before start so you don't really see accrete.
And the price of the house once were under construction. That's the one way were able to really still build efficiently and not to stay away from the customization in more towards the personalization part of our strategy. So that's that's that's one point.
The second I think when you look at what happens with the lower rate environment, you certainly would see less cancellations if rates are moving up.
You could potentially see some cans coming out of the inability to still qualify for loan at the new rate, our cancellations tick down three points or so this quarter, which I think was an indication partially of that anyway.
So that's a good thing, but I think overall the strength of the market and the build to order approach I think.
Definitely has a lot to do with our.
Strong sales pace and you see it almost every quarter with with our pace versus the rest of the industry, where we're always one of the highest sales paces in the quarter.
And I think a lot of that is a result of customers like the ability to personalize their homes and they like the business model. So I think that.
I'm not sure it gets right to the answer your question or right to your question, but that's kind of what we're seeing right now in the market.
Yes, I guess, the only that difference would be if there is.
Maybe a couple of weeks or maybe a three week lag between when you take the owner and when you actually start the house I imagine, it's not too great a period of time.
So that probably isn't a huge huge factor.
Could you talk a little bit then about what you're seeing in your margins as we look.
Drilling into this a very nice ramp euros seem to be forecasting for your gross margin into the fourth quarter.
Implied through your your year and in the Threeq Guide you have given.
Can you talk a little bit about what you're seeing in terms of input costs that are informing your view on that.
Your margin for the year relative to the Threeq margin that you've talked about particularly I'm thinking lumber.
Are you are you anticipating that you're going to see a benefit in all the way through your Four Q4 th quarter.
Before the spike in lumber futures that we've just seen maybe.
Weighs on your one Q of next year, just trying to try to get a sense for input cost inflation movements.
Sure Yeah. The input cost side is pretty good news for US. We just had our second consecutive quarter decreases in input costs in <unk>, we talked about on a lot of conference calls in the past we use an index approach to it we think it's probably the cleanest way to show it where you're taking out factors like square footage differences and things like that so we'll index a house.
And we'll calculate what that index house will build four at a point in time and now we will compare that indexed to the same house index at a later point in time. So if you compare ended the second quarter to ended the year were actually down 1.1% in our budgets for that index House, and I think where that's coming from it's a couple of factors. One certainly the lumber cost decreases have been there and have helped that and they've also helped to offset what we view is somewhat moderate.
The increases in other input costs, and we think theres been some moderation due to the market pause in the fourth quarter in the first quarter. So you know the one good part of the market pauses, we felt that we've experienced some moderation in increases.
On a year over year basis, our largest decreases are advantages favorables to margin came in obviously to lumber category in the drywall category net offset increases in a few of the other commodity categories like cement roofing and calming.
On a year over year basis were actually also down less than a percent down but still down on a year over year basis. So the inputs story the input cost story for US has been pretty favorable. Obviously you know there is few watch outs you have there is a whole tariff issue, that's a watch out for us and.
As you pointed out the increase in the lumber futures is also watch out, but because we are on look back pricing.
And we obviously the cost out the house at the point in time, when we frame. It we do think there's still more favorability coming from lumber before any potential downside that we put experienced by the end of year, depending what the market does.
Our next question comes from the line of Mike Dahl with RBC capital markets. Please proceed with your question.
Hi, Thanks for taking my questions and nice results.
I wanted to start on the order side and one of the things that you guys have been pretty vocal about and proactive.
About as kind of the shift to smaller floor plans and at least introducing.
A smaller plan options into.
The newer communities, so that and wanted to ask if.
Even anecdotally you can give us any update or color on.
How those smaller floor plans are.
Our performing or perform through the quarter, presumably to get this type of order number it had to be fairly broad based but just wondering if you could give us anything specific on on the newer plan options.
Mike as I shared in my comments, our sales were up double digit in every region. So it definitely was broad based and the strength of the sales.
We've introduced smaller plans, we've modeled them in many locations coincident with that shift we had a drop in interest rates. So I think its tempered the need a little bit. If you will we are seeing with the lower advertised price that were drawn in a bigger pool of buyers, where they're coming in and may not have thought they could afford it and then they get in and once they understand what they qualify for they'll move to a little bit larger home.
So it is helping to expand our our marketing and create a bigger pool, our sales in the quarter on the.
The and started homes, so our presales square footage ticked down just incrementally it could be.
Just a function of mix by market, So I wouldn't call. It a trend yet and we're certainly monitoring it. So it's helped us from a marketing standpoint, but would be the rate decline people will move up to the biggest home they can afford.
Okay, Yeah that assets have us well positioned for one whenever rates do go back up we're already there.
Right. Okay helpful. And then that makes sense and then second question just around margins and Jeff K. I think you kind of alluded to a couple of different things, helping you do.
Kind of bridge to to.
You know the year end and implied for Q margin with which makes sense, but I wanted to follow up and try to get a little more quantification of two of the issues. One youve continued to benefit from the lower interest amortization, so any update on how to think about that.
That delta as we move through the year and then the second part, though you mentioned reactivated communities that mix starting to.
Kind of.
Be reduced and help your margins by year end I thought of that as more of a 2020 occurrence can you just help us how much is that starting to help by the end of this year and how to think about.
Potential support asset mix continues to decline if the reactivated communities.
Right, Okay, let's let's we'll take the interest amortization first because that's probably the simpler more straight forward, we talked about during last quarter's call that we expected.
Year over year benefit in interest amortization of between 80, and 100 basis points per quarter for the full year in the first quarter were up a 100. This quarter. We were 80 and we still expect to be within that same range. The next two quarters. So 80 to 100 basis points per quarter year over year is still good number on the reactivated communities. What you see there is you definitely see a lag from the point in time, when they enter community count or when the community count starts declining to one it's actually running through the the revenues and impacting the overall gross margins.
In the quarter in the second quarter, we really didn't see any any benefit from the prior year, because we had a fairly high revenue.
Number coming from reactive reactivated communities, partially because of the strong sales that we saw.
Relative to last year in those communities so.
You know that was pretty pretty well even with the prior year, we do expect to see some incremental improvement by the fourth quarter as account continues to decline, but I would say you are correct in saying that most of that improvement will see yet in 2020, which would be nice because there'll be another tailwind or continued tailwind for us as we get into the next fiscal year.
Our next question comes from the line of John Lovallo with Bank of America Merrill Lynch. Please proceed with your question.
Hey, guys. Thank you for fitting me in here.
The first question, Jeff K., you brought up tariffs so just curious.
It seems like to me that that would be a pretty small impact amazing when your competitors laid out shipping only 500 bucks per home.
If I was wondering if you guys maybe had an estimate for you know through list 123, and then maybe if.
As for as well.
We I would say you know at this point, we're really not seeing any impact any material impact at all on our cost it may be being absorbed through the supply chain or we may be seeing certain increases here and there that are getting offset by others, but it's it hasn't been significant for us Stephen.
We are all that focused on at this point.
Okay, Yes, that's encouraging and then.
Clearly demand is getting a little bit better year, and it's been I think it's been largely focused at lower price points have you guys seen any improvement, though add as we move up the price point spectrum, you certainly see increasing demand.
Kind of the first to maybe even second time move up.
John I think it's a fair comment that there is strong demand.
The price points that we operate at our for our first move up communities are hitting their pro Formas just like our entry level. We don't have as many first move up and very little if any second move up even.
Come to mind for me right now so we're watchful of what happens to pricing in the markets.
My My General sense is the higher priced goods Earl softer demand.
Then the price points that we operate at.
But.
Our first move up programs are selling well to.
Our next question comes from the line of Mike Rehaut with JP Morgan. Please proceed with your question.
Hi, good afternoon. Thanks for taking my question and congrats on the results.
The first question I, just wanted to circle back if I could to the sales pace I think that was really one of the big upside surprises relative to your prior expectation again that.
You know to Q sales pace you had originally expected would.
You know matched 2017 and instead it roughly matched 2018. So you know in your prior answer you talked about.
You know a few different factors, but it just seemed the answer itself that you gave was just more kind of generic in terms of.
Yeah things just overall performs a little bit better.
I I guess I just wanted to to make sure.
From my perspective, or maybe from investors perspective, I think the initial reaction would be wow, those new communities really did perform a lot better or and perhaps it was just to come.
Between that and a combination of some conservatism you know that that was really the ultimate driver there and you know oftentimes when you have new community openings, you really want those new communities to start off strong.
And they can be an outsized contribution to results. So I'm just trying to if it you know I just wanted to ask if I'm thinking about that correctly or you know by contrast was there some region or regions that really just kind of.
The the switch you know you know flips back on and you really just had some.
Disproportionate strength from from some regions are recovering a lot better than you might have expected.
A few months ago.
Mike I can say a couple of things.
You're not totally correct on the it's just coming from the new communities in there. It's a it's a frustrating statistic for me to share our average community count because it could be open for one month two months three months or one day in the quarter and it's really a 90 day lag before the.
Communities blend in and really start to.
The gained strong momentum so up it opened in March it may have served a full full quarter, but the communities. We opened in mid May Didnt drive that the absorption up and if you think of it.
From a math perspective, if you got 255 communities.
And you have 43 openings and you'd still average the same as the year before that tells you that the.
The existing communities that were already opened perform well hit that that kind of an average, but if you look at it regionally. The one I would highlight is California, where we typically have a higher sales pace per community on average because you have to turn a bigger asset base.
With the community count growth there in the sales rate that we saw in California, I think it lifted our company average.
Yes, Mike the other thing that I think you know Jeff was saying we did see across the board improvement and doesn't mean every single community in every market, but it was pretty broad based for the quarter.
I think a lot of it is just the business model and where we're competing I mean, you've read it all over the place with the industry news about the.
Return the first time buyer on the entry level picking up and being at the right price point is very important and the company's stayed very disciplined over the last several years, especially as we were rebuilding community count.
To make sure we were putting communities underground at metals parameters.
And it's very natural for our company to operate in that space. It's it's been the strategy. The company for long time. So for for me. It was gratifying I guess to see.
The results at the end of the quarter coming off some of the.
Based communities that we've had new ground for long time as well as from the new communities, but Jeff said it right. I mean, we opened 43 communities and there were not many of them that were open for 13 weeks.
They would have average into the count at 21, and a half because we.
Zero at the beginning of 43 at the end and two point average.
So they they certainly didnt drag us down, but I don't think that you could point to that as saying that was a single point of focus but that said we are pleased with how they are performing and how the rest of communities. We opened this year perform equally as well.
That's great I appreciate that I I guess secondly.
Shifting to the to the gross margins and obviously you know reiterate you reiterated your outlook for improvement there.
Yeah, as we think about three queue in for Q.
I think the math would work more or less you know that that you'd have.
Perhaps even a little bit of soup.
A greater sequential improvement it seems like.
If I'm kind of getting to the mid points of your your guidance ranges.
Well, let's see yeah, maybe perhaps equal to a little bit better of a sequential improvement.
And for Q versus three Q, a at least let's say similar amount of improvement. So I'm just trying to get a sense yeah.
So I'm just trying to get a sense.
Okay. Good good.
So I'm just trying to get a sense for you know as you look for the drivers of those improvements would you say its.
Equal parts, you know revenue leverage and mix or you know how I guess, how would you rank order the drivers of that improvement as it relates to you know across lets say you know operating leverage.
If mix is a contributor and you know obviously input costs with lumber and such.
Sure, let's start right up top right and let you guys know, how we come up with our guidance ranges in how we actually estimate and forecast the rest of the year.
And you can start with our backlog value I mean, we had about $2.2 billion in backlog.
At the end of the second quarter, which is a pretty high percentage of our expected third and fourth quarter revenues. So we've already price that product we already have budgets on the costs, we know the land costs.
We know about what the studio add will be some of those some of that backlog hasn't been through the studio process, yet, but we know on average about what that takes and we basically just forecast out our deliveries on a on a community by community Division by Division region by region in total company basis and roll up the margins coming off of that it's we're we're getting obviously more.
I'm confident in the ability to forecast is the first time, we've gone out to the full year because of the backlog and because of the quarter. We just had and because of what we saw during the spring selling season, we definitely have a higher level of confidence in the in the guidance ranges that we have out there and what we're seeing.
As far as the gross margin specifically I'm, certainly we always see better leverage in the back half of the year in the third and fourth quarters and this year is no exception, we do expect to see some pickup from higher topline revenues leveraging the fixed costs that we have in cost of sales and the remainder that exactly as you as you kind of outlined.
Does come from mix and not not the least of which is we expect to see a higher west coast mix later in the year, where we typically do carry higher margins and we have some pretty high margin communities come into to market that will be delivering out in the fourth quarter. So all that's helpful.
You know and we're pretty encouraged by the year and we like the progression.
Certainly after.
Some pretty tough market conditions in the fourth quarter and early first quarter. It was welcomed to see them to market come back to us and in the second quarter and.
To be able to build that level backlog and have the visibility out for the rest of year is.
It is important for our for our business model.
Our next question comes from the line of Scott Schrier with Citi. Please proceed with your question.
Hi, Good afternoon, I wanted to ask a little bit more on the conversions to the smaller floor plans understanding about the lower rates or does the lower lumber and the other not costs.
Does that make it may be a little more efficient to try to push more of the larger plans. How flexible are you in your communities to kind of shift around the number of smaller plans that you've had to.
As you alluded to earlier as more of a marketing tool to bring people in and how do you think about.
Keeping this smaller plans in the community versus potentially.
Hi, going back to the larger plans versus the smaller plan, but possibly get more out of the design studio.
From both lower rates and then from your perspective that the trends that you've seen in input costs and the efficiencies associated with that.
You bring up an interesting topic and what what we try to toggle will use the term bracket. The median income we try to make our product attainable by the median income in that Zip code.
And we will look at the median income and then how can we position the product to make the most money per lot.
That can be attainable for the median income so over here in a higher income area. The smallest model, maybe 1800 square feet and over here it may be 1200 square feet.
And the the beauty of this for us is that.
It's the buyer picking it not us building it and then selling so we constantly are tracking.
Which end of the footage spectrum. The buyers are tilting too in a community of their tilting up big will push the price we may introduce an even bigger home if there.
Moving to the smaller products you push the price the best you can.
And everything in between so it's it's pretty fluid each week.
In every community that's out there, but we go to optimize how much money can we make on everyone.
Got it and then on a year to date basis. It looks like your southwest your southeast Asps are up quite a bit year on year can you talk about some of the drivers whether there's any glaring granularity into the different mix or regional considerations or potentially on a like for like basis, how much pricing you were able to get in some of those regions.
Right, So you're thinking he said southeast and southwest right Yeah, there there both on the.
There's there's a little bit of division mix, particularly in the south west.
Where our asps in the Vegas market are higher than our asps in the Arizona market, a nave accelerated by a higher pace as well for the year. So most of that came out of the Vegas market.
In the southwest in the southeast.
You see it pretty much across Florida, and even into the Carolinas and our business. There were a lot of that is this replacement communities probably at higher price points I don't think.
When you look at it.
We couldn't say, we got 6.4% price increase.
In the southeast on a year over year basis, but theres definitely some price in there along with community mix.
Outside of that I don't know if I could get any more granular detail Dan.
And that high level for you.
Ladies and gentlemen, we see end of our question and answer session as well as today's teleconference. I would like to thank you for your participation. You may now disconnect. Your lines at this time and have a wonderful day.