Q2 2019 Earnings Call
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I would now like to turn the conference over to Brent Anderson, Vice President of Investor Relations. Please go ahead.
Thank you Chad.
Good morning, welcome to our call to discuss our second quarter 2019 results.
We issued a press release yesterday after the market closed and you can find it along with the slides, we'll be referring to during this call on our website <unk> investors dot meritage homes Dot com.
Or select the Investor Relations link at the bottom of our homepage.
I'll refer you to slide two and remind you that our statements during this call as well as the press release and slides contain forward looking statements, including our projections for 2019 operating metrics such as home closings closing revenue margins as well as overhead and diluted earnings per share. In addition to our expectations of all market trends.
Those and other projections represent the current opinions of management, which are subject to change at any time, we assume no obligation to update any forward looking statements are inherently uncertain.
Our actual results may be materially different than our expectations due to a wide variety of risk factors, which we've identified and listed on this slide as well as in our press release and most recent filings with the Securities and Exchange Commission, specifically, our 2018 annual report on Form 10-K , and subsequent 10, Qs, which contain a more detailed discussion of those risks.
We have also provided a reconciliation of certain non-GAAP financial measures referred to in our press release or presentation as compared to their closest related GAAP measures.
With me today to discuss our results are Steve Hilton Chairman and CEO of Meritage homes peeling through the executive Vice President and CFO and sleep, Lord Executive Vice President Chief operating officer of Meritage homes, we expect to conclude the call within an hour and a replay will be available on our web site.
In approximately one hour after we conclude the call it will remain active through maybe.
I'll now turn it over to Mr. Jones, who will review our second quarter results Steve.
Thank you Brenda and welcome to everyone participating on our call today I'll begin on slide four.
We had another solid quarter and are pleased with the results we delivered through the first half of 2019.
We delivered strong year over year order growth driven mainly by an increase in orders per community from our strategic pivot to lower priced homes.
Our total orders for the second quarter were 22% higher than last year, our year to date orders are up 14% over 2018.
Our average community count was up just 2% for the second quarter of 2018.
Over the second quarter of 2018, and most impressively our absorption rate of 10.6 orders per average community was up 19%.
Higher than last years, 8.9 sequentially better than our first quarter's absorption of 9.5.
It was the highest quarterly absorption rate Weve achieved 13 years going all the way back to the second quarter of 2006.
Turning to slide five.
Clearly those results demonstrate the marriage is in the sweet spot of the market with our live now homes designed for entry level buyers as well as our first move up homes.
We've made more affordable.
We had a 42% year over year growth and our entry level orders.
41% of our communities at quarter end and 52% of our orders in the second quarter of 2019 were entry level compared to 34% of the communities at 44% of the orders a year ago.
Our orders page Brinci low it was about one and a half times our average for all non entry level communities, mostly offsetting the corresponding declines in ASP.
We believe our absorptions the order growth demonstrates the commit we major reengineered our operations to enable us to deliver homes at lower cost with faster cycle times.
More than just decide to build smaller all drilling small loss the strategic changes we made in the way we designed to build sell and deliver homes are impacting our results significantly.
Turning to slide six.
Our second quarter home closings were 5% higher than last year. After we ended the quarter with 9% fewer orders and backlog than we had a year ago.
And our home closing revenue for the second quarter was down only 1% a significant accomplishment considering the total value of our beginning backlog was 13% lower.
Then the second quarter of 2018.
The 5% increase in closing volume offset most of the 6% reduction or average sales price.
Resulting from our mix shift towards entry level homes.
As our mix stabilizes and the SPV level off we expect our sales volume growth to drive revenue growth until then.
Offsetting ASV declines with volume growth helps maintain our total revenue, while we improve our margins.
We've said before we're not sacrificing margin with entry level homes. In fact, our entry level homes are producing higher average margins that our move up homes.
Home closing gross margin rose again, this quarter to 18.4%.
From 16.7% for the first quarter and 18.3% a year ago.
As a result, we maintained our home closing gross profit despite the small decrease in home closing revenue.
Pretax earnings for the quarter were 5% lower than the second quarter of 2018, primarily due to higher interest expense this year, which he'll will explain later, but we expect to reduce our debt early we expect we expect to reduce our debt early next year.
Which will eliminate our non capitalized interest expense for most of 2020.
Despite lower pre tax earnings in higher tax rate in 2019, we generated the same diluted earnings per share for the second quarter. This year as we did in the second quarter last year since we have reduced our outstanding share count by repurchasing shares in the second half of last year and the first quarter of this year.
I'll now turn it over to fully to discuss some highlights of our sales trends.
Felipe Thank you Steve.
Demand was strong across our markets all markets outside of California, especially in the entry level space, where we expect demand continued to be strong and we're well positioned with that in mind.
Our orders for the second quarter of 2019 were up over the second quarter 2018 for all three regions and hated the nine states, where we operate with the sole exception of South Carolina I'll provide additional color beginning with the west region on slide Sad.
Our orders in the West region were up 31% over the second quarter of 2018, driven by an 18% increase in absorption coupled with an 11% increase in average active community. We added nine more live now communities in the west during the second quarter.
Arizona put up the strongest performance across the company our averages options. There were 15.7 for the second quarter up 45% year over year, which drove 40% order growth and 39% growth in total order value.
Arizona is furthest along and making street best strategic shift to entry level and first move up so our mix things closing to our target and our ASP was down just 1% year over year that is a good example of the revenue growth potential Steve described as we stabilize our mix to the company as a whole.
While California remains the highest price and most.
While California remains the highest price and most unaffordable and challenged market. Our absorption of 10.1. This quarter, we're not too much lower than the company average of 10 point Sachs absorptions were down 20% from last year with our average community count in California increased by 37% year over year. The net 9% order growth was partially offset by a 6% decline in ASP, resulting in 3% growth in total order value for California, we have rebuilt our community count in Colorado over the past year after years of selling out communities faster than we could replace that.
Average community count was up 22% year over year, and our absorption pace increased 9% on top of that to drive a 33% increase in units and a 23% increase in total order value for the state.
Overall, the last was our best performing region this quarter. Despite the decline in California demand slide eight.
Moving to the Central region, Texas produced 8% order growth with a 20% increase in absorption that was partially offset by a 16% decline in average communities. We closed out a 14 communities in Texas during the second quarter, including several good producers in San Antonio and opened a few live now communities in Houston and Austin that are off to a very good start we expect to grow our net community count in Texas over the next several quarters and expect that is Archie should also improve as we continue to open up many more live now communities to replace move up communities that are closing out.
The 8% increase in orders offset an 8% reduction in ASV as we continued our shift towards and towards more entry level.
Austin and San Antonio outpaced Dallas, and Houston is option since they are further ahead in transitioning to entry level and first leave that to you.
Slide nine East region.
We are very pleased to see that continue to improve in our east region. We opened six new live now and to first move up communities. There in the second quarter. This year, though we also closed out of a couple of high producers. However, our opportunity count was up 13% and we also increased our absorption to east by 12% year over year, which drove a 26% growth in total orders for the region and an 18% increase in total order value.
We more than doubled hours in Tennessee, with a 57% increase in average communities and a 35% increase in absorptions over the last year's second quarter demand there was strong and our new communities and improved throughout the quarter orders were also up 68% in North Carolina due to 20% expansion in average community count and a 39% increase in absorptions over last year, primarily primarily associated with our entry level communities.
On the other hand, we close out a strong communities in South Carolina, reducing our average community count and intelligence there.
Demand also improved in Georgia during the second quarter with a 37% increase in orders, mainly driven by a 42% increase in absorptions. We opened a couple of new communities. There last quarter that are selling very well.
Florida increased orders just 3% over last year's second quarter, which was a difficult comp total orders in the second quarter of 2018 was an all time record for Florida until we need it this year in the second quarter, the timing of the openings and package absorptions and the year over year comparison since the opening a handful of live now communities late in the second quarter. This year. So they contribute a few orders to the quarter.
Slide had these results validate our strategy as the markets where were furthest along and our shift towards entry level and first move up our top performers.
As we continue to roll out our strategy, we are streamlining our products and processes to enable us to start more homes convert those sales and to close more quickly and reduce our costs in the process to drive greater profitability. For example, we are we are reducing our cycle times with additional spec inventory in a live now communities as well as taking we are the contract to start cycle time with our new studio and designs that is for move up homes, which are allowing buyers to complete their often selection process much quicker with lower stress and greater customer satisfaction.
Slide 11, we started the second quarter 2019, with 9% few orders in backlog than a year earlier, yeah. We closed 5% more home, we were able to do that by having more spec inventory started that can be sold and closed quickly working with our trade partners. We have taking days and weeks out of our cycle times through value engineering and simplifying our construction process. Our backlog conversion rate was 71% in the second quarter. This year compared to 61% last year and 66% of our first quarter 2019 closing her back inventory up from 55% a year ago in order to capture those sales and closings we had to have import inventory to sell that is all part of our strategy.
Ill now hand, it over to he like to provide some more additional information he loves you Felipe.
Ill provide some more detail on our key unresolved land and operating metrics beginning with lifestyle.
Even so we've already covered how we conclude our operations to drive efficiency and deliver more home at lower cost.
Hi, My estimate the impact of those improvements on our financial results. So far this year.
For the first half of the year, our home closing gross margin with tenant that's lower in 2018 and 2018 due to a onetime charge, we had the benefit of a $1.4 million, while keeping coverage increase our gross margin in the first half of 2018, excluding that item our year to date 2019 gross margin would have been essentially flat with the prior year.
As a teenager benefit were consistent for the second quarter of 2019 compared to 2018, the increased slightly as a percentage of home closing revenue due to the reduction in 18 year over year.
Year to date 2019 as he makes banks is we're just slightly higher than 2018, mostly due to higher brokerage Commission and incentives offered in late 2018 in early 2019, we also incurred severance cost of approximately 1.7 million and another 1.4 million for accelerated equity compensation here. It was pulled forward into Q1 from future period. The combined effect of these items accounted for the entire increase year to date and EXINI percentage.
Interest expense increased $3.2 million for the second quarter, and 7.1 million year to date compared to last year, primarily due to less interest capitalized to assets under development, which is the result of faster construction times and turnover if inventory as part of our entry level strategy. We expect higher interest expense to continue throughout 2019, but it should be eliminated early next year. After the anticipated retirement of our notes due in 2020.
The negative year over year earnings comparison was also due to first quarter 2018, net earning benefiting from a favorable legal settlement of approximately $4.8 million, which accounted for the comparative decline in net other income.
Finally, our effective tax rate was 1% higher in 2019 for the second quarter and 5% higher for the first six months compared to 2018, our tax rate in 2018 benefited from a one year extension of energy tax credit for all qualifying homes closed in 2017, which totaled 6.3 million. While these credits have not been renewed for 2018 or 2019. They are still in the extenders Bill. So we're not ruling out the possibility that we could capture that tax benefit in the future.
75% of the new lots that we put under control in the second quarter or for entry level communities and we're exiting non strategic position as expeditiously as we can in the second quarter, we exited one such community and the Dallas market, taking an impairment of 1.7 million I didn't anticipate itself, which accounted for our land closing gross loss in the second quarter of 2019.
Turning to balance sheet and cash flow items on slide 13, we spend approximately 175 million on land development in this year's second quarter 46 million less than last year's second quarter, but up from 141 million in the first quarter of 2019 as I explained on our last earnings call. This is primarily due to the lower lot cost for entry level phone and we ended the second quarter of 2019 with total lot supply of approximately 34700 compared to 33700 at June 32018.
That translates to total lot supply of about four years this year compared to 4.2 years last year based on trailing 12 month closing.
About 66% of total inventory with the owned and 34% was option at June 32019.
Reduce land bank stock that act faster asset turn contributed to the $113 million of cash flow generated from operations year to date in 2019, our net debt to cap ratio was 33.4% at the end of the second quarter of 2019 down from 36.7 at December 31st 2018 that is historically in the low range for married edge, we expect that it will be even lower next year, if we reduced our debt as anticipated by paying off our notes coming due as well as the stockholders equity continuing to increase.
Do you have reduced cycle time, and higher inventory turnover, we are comfortable at a lower net debt to cap ratio than our historical guidance range in the low fortys percent as we believe we are generating sufficient liquidity to continue to grow our operation.
Consistent with our strategy to increase our focus on the entry level market. We are building more spec homes in that community. We ended the second quarter of 2019 with about 2400 spec homes or an average of 9.5 specs per community compared to an average of 9.2 per community a year ago, approximately 23% of total specs were completed as of June 32019, compared to 31% in 2018.
Turning to Fyfourteen, we are encouraged by the outlook for interest rates and optimistic the demand for our home and community will remain strong based on our results in the first half of this year. We are currently projecting 2019 home closing and total home closing revenue of approximately 8700, 9100 unit with $3.4 billion to $3.6 billion, respectively for the full year, we are anticipating home closing gross margin to be in the mid 18% for the full year.
We expect a slightly higher SDMA as a percentage of home closing revenue for full year 2019, compared to 2018 due to the increased commission expense early this year that we've discussed and about 10 best of cost to operate our studio and showrooms, which are reducing our cycle times and improving our gross margin.
Interest expense is expected to trend down a bit sequentially in the last half of 2019 from the first half, but we'll continue to be higher than 2018 due to our fast faster asset turn.
With that tax rate holding steady at 25%, we expect to generate approximately $5.20 to $5.50 of diluted earnings per share for the full year.
For the third quarter of 2019, we're projecting 22 to 2400 clothing for total home closing revenue approximately 860 to 935 million and home closing gross margin percentage in the high 18, 18% for the quarter, we expect as Jenny and interest expense to be higher than 2018 for the reasons I stated earlier for the full year, which translates to about $1.40 to $1.50 of diluted earnings per share for the quarter with that I'll turn it back over to Steve. Thank you in summary, we were pleased with our second quarter year to date 2019 results and believe were further improving our business and differentiate our products in accordance with our strategy.
In addition to changing our product mix, we're streamlining and simplifying to drive greater efficiencies and profitability, which is valued by our customers employees and trade partners.
Demand for new homes remains healthy and we believe the demand we've seen so far this year reflects sustained positive macroeconomic factors for the housing industry I'm proud of our entire Americas team for putting our customers first and working hard every day to make the company successful we're confident in our ability to make the most of the opportunities ahead of us and we expect to continue to grow and deliver increased shareholder value. Thank you for your support of Meritage and we'll now open it up for questions.
Operator.
Thank you.
We will now begin the question and answer session to ask a question you May Press Star then one on your telephone keypad. If you are using a speakerphone. Please pick up your handset before pressing the keys if at any time. Your question has been addressed and he'd like to withdraw. Your question. Please press Star then too.
We please ask that you limit yourself to one question and one follow up if you have additional questions you may reenter the question queue.
At this time, we will pause momentarily to assemble our roster.
The first question comes from Alan Ratner with Zelman and Associates. Please go ahead.
Hey, guys good morning, and congrats on the great quarter and all the success with the strategy shift its its really great to see.
Yeah.
Steve I guess my the question I was hoping to drill in on a bit is I'm just kind of thinking about this the supply demand dynamic right now clearly the order growth very strong it's apparent that the demand is there at the segment, you're you're pushing the entry level.
If I look at some of the supply side of things I mean, your community count to his drifted a bit lower here, which is certainly expected given how strong sales have been and your spec count is only up slightly year over year and that had been up quite a bit more over the last couple of quarters. So.
Where are you where you sit today I'm just curious how do you see the the price versus pace dynamic playing out over the next few quarters, because I think it's clear the the sales environment. This spring has been very solid is there any risk that you and maybe some other builders might start to feel the pinch on the supply side, a little bit like the ads. They experienced a couple of years ago. When when we saw a similar dynamic.
Well thanks for the complement first thanks for the question.
We still we still have opportunities.
As we continue to change our mix.
For growth without community count growth, because we're opening more entry level communities than we are then we are.
Move up communities, but I would say, we haven't had a challenge.
Wine industry level, when we bought.
If we talk we talked about the number of lawsuits 75, or so last we bought last quarter I think we bought over 20 foot boat on 2500 loss.
In the quarter.
More for entry level and are actually more than that with us and we bought 2500 last month was 4004.
Yes, we were 4000 lots lots for 2500 entry level. So we're still fine.
The challenge is just bringing them to market, giving him through the entitlement and development process and getting them open.
But long term, we really feel like there's a long runway for for our lives now product and.
We're going to continue to push that and.
As time goes on it will.
Will drive revenue growth.
You know and and produce better margins just one quick follow up Alan on that said as we start to.
Lap prior year that where we start to see the community count growth in live now we're not going to continue to have the SEC.
A quite explicitly that wasn't 18 17 that we just started to build up our live now communities, we still have more sex per store than we have.
Ever held at 9.5 specs per community, but as the shift in me to be more live now year over year, you're not going to see the same absolute value growth.
Got it Thats helpful guys I appreciate that and then.
Second question just on on the.
The entry level, we are hearing.
From from some others that the single family rental operators are very interested in either purchasing.
Bulk sale of homes closed out communities or even entire phases of projects and just curious if you've gone down that road at all in some of your live now projects or or entertained the prospect of building for any of the single family rental operators.
We've looked at it and we have entertained but we feel like.
We can do better building them for our own account at higher margins.
Well to deliver better value to our shareholders. So if we had a lot of excess entry level positions.
Core positions that we Didnt want maybe we would sell them to them, but thats not the case, we're really really happy with all of our entry level stores and.
And.
We don't see a desire to need to discount those onto those rental offering theres nothing theres no no contribution or no no orders this quarter were to any of those operators.
None.
Got it okay. Thanks, guys. Good luck. Thanks.
The next question is from Stephen Kim of Evercore ISI.
Yes, thanks, very much guys good job on the quarter.
Wanted to ask you a few questions regarding absorptions and indicate whether or not.
One and a half times higher than the move up.
Did move up absorption rates increase too and if so can you give us a sense for what the drivers to that might be.
And then with respect to the expected life span of live now communities given the strong absorption.
How has this changed relative to your initial expectation how long you think it's going to take to sell out of these communities for example.
And basically are you seeing absorptions faster than what you had initially envisioned.
And therefore the.
The life span of these companies being shorter or not.
Well I'll, let healer fleets.
Some of the number on the average size of our entry level communities, but I can tell you they are much bigger.
Yes, we were buying the main much bigger physicians for entry level than we were for move up.
150 book loss and a lot of cases.
But he might have a number but I can tell you in absorptions are entry level was up 19% year over year first move up was up 7%.
And our second move up in our small active adult presence was up 19% because we're really incentivizing those stores to move out of those move out of those segments.
So the opportunities for the buyers were pretty.
Pretty compelling but.
Certainly the absorption increases better.
For entry level and it was removed.
You know the average loan count it was over 100.
Yes, 212, actually average side, which is which and for both.
Combined.
Let me start that and Mark 75 ish.
Okay increase yes.
Well I'm not I'm not concerned that we're working on.
You know a move through these run out of entry level lots or have a supply issue because we anticipate that the absorption will be will be stronger and thats, what we bought bigger positions. Our goal is to purchase.
Land positions that have three to four year life and not based on the anticipated absorptions have obviously, we're going to pick up or down based on that on the product offering in acne.
Great Yeah that makes sense now so you anticipated the stronger absorptions. When you originally moved into or bought these communities you know a couple of years ago and and that's great.
You talked about your land spend and some of the dynamics there one of the interesting I heard you say with that you're not really having trouble finding land to buy for entry level that meets your your underwriting threshold.
And I'm I'm curious about that because entry level in general and obviously live now for you specifically has been tremendously successful.
And this is something which would be kind of hard to Miss I would imagine for your competitors. So I'm curious if that you're not seeing more competition, let's say for the land parcels that would be suitable for an entry level product. So I'm wondering why that is.
That you're able to find land to buy so readily is it that your let's say moving into larger communities further out in your prospecting or our land sellers, putting a lot more entry level land onto the market or is there. Some other reasons that you are just simply not seeing other builders bidding on these kinds of parcels.
Well, there's a lot of competition is number one.
We're competing with a lot of dollars for these these parcels.
No thats a given.
But there is a lot of reasons why we're winning now in many cases.
You know, it's our local operators.
You know relationships with land sellers as our lean team is it's our it's our you know our reputation in the market.
There's a whole variety of reasons, why we're getting that particularly in a market like Phoenix or were a real big player on we've been here for sure.
35 years.
But another markets, we've carved out a really strong position in the entry level space like in Austin and in other places in.
You know we're just.
We're.
Were I think a little ahead of how we really know our costs, we've driven our costs down.
It allows us to underwrite deals quicker and.
Maybe we're just more comfortable in the segment then.
Some of the other mid cap builders, who are just maybe defer their tone right now starting to get going clearly we have competition from a couple of the bigger larger.
Large cap builders.
You know on every corner, but.
We're still able to get the land that we need and.
And grow the business.
Got it and then lastly for me on community Count I, just want to make sure I got this right.
Are you what are you looking for for your ending sub count at the end of the year generally speaking and what do you think the mix of entry level versus move up and second time move up.
We'll be at that time in terms of selling communities at the end of the year.
So our community count will dip in Q3.
It will be a little lower than where it is today.
But it should rebound in Q4, and we should end the year right about where we are right now Unfortunately, that's a little bit less than we would we expected starting the year.
Thats because of the faster sell out of communities. Its also because when we ended last year sales were pretty slow in the fourth quarter, we ended with more communities than we expected.
And then we hope as we get into next year, we can start to resume some community count growth.
And we're working hard for that.
So as we move into the year, we'll probably end with one with less.
Two m. you.
Communities as were working feverously to to finish those up and get out of those and we'll have more force entry level communities.
But I don't from a friend to give specific numbers right now for those segments, but I can tell you.
As I said will be will be less than three in Q3 and.
At the end of the year will be about flat with where we are now.
Great. Thanks, a lot guys. Thank you.
The next question will be from John Lovallo with Bank of America. Please go ahead.
Hey, guys. Thank you for taking my question. The first one Steve you mentioned the entry level, having higher average margins than than your move up homes. I'm. Just curious is that a function of just the more efficient build process, maybe less materials or is it more of a function of just having to put more incentives on the move up homes at this point.
It's really both.
I would say the incentives are a big part of it I mean that just demand is stronger for entry level. It is for move up so we're not we're not incentivizing as much.
And by building a 100% spec.
And for our live no internal communities were able to get better costs.
And.
And bill more efficiently leverage our overhead better course, and all that leads to higher margins.
Okay Thats helpful. And then he'll I think you talked about taking debt down in the in the early part of 2020 should we expect non capitalized interest expense to largely disappear by the second quarter is that the right way to think about that.
Yes, we should really not have insurance basin to the piano after higher maturity of our 2020.
Perfect. Thank you very much guys.
Thank you.
The next question will be from Macquarie Hart with JP Morgan. Please go ahead.
Hi, guys. Congrats on the quarter is actually a lot on for Mike.
I wanted to just ask a little bit more about the incentive levels and the overall pricing environment, you mentioned that incentive levels on entry level are still lower than on your move up but just compared to last quarter have you been able to roll back on incentives to the quarter and then maybe just some more commentary on the overall pricing environment.
Oh, I mean, we had fewer incentives in the second quarter than we did in the first quarter or certainly in the fourth quarter last year, especially entry level homes.
We elevator incentives in order to have you.
To close those out in California, the incentives of have been sort of somewhat level with demand has been.
Softer.
Yes, there's actually some locations across the country, where we've been able to start to increase.
On pricing a little bit definitely not in every market in some geography and as Steve already mentioned incentives on essentially models are already lower.
We also had some mix shift to more entry level, we're going to see the total intend to decrease at a company.
Okay. Thank you.
The next question comes from Truman Patterson with Wells Fargo. Please go ahead.
Hi.
Good morning, guys.
Nice quarter.
First just wanted to dig into the rollout of studio and if you guys could just give some some metrics around that the timeline to completion some of the costs on the back half the year.
And also could you just give an update and how it's been accepted by the customer in the market.
So for those who don't know studio and reserve.
New design center strategy that we are executing for our one interview buyers Oliver live now entry level buyers are buying spec homes.
They are already pre previous pre plotter and free Colorize.
With a variety of colorization schemes are one in new buyers come to our new design centers are called studio.
And within those centers there you go through a process of picking their selections.
And it's a much more streamlined version.
Of.
What we were doing before.
Less choices, but still a lot of choices.
If you come to our analyst day that we're going to have in New York in November you can see a lot more color one more about it but this new studio M will.
Allow us to offer less skus, which will allow us to negotiate better pricing with our vendors and at the same time.
Take away a lot of the stress and anxiety that goes with going to a design center pricing will be more transparent.
It will be easier and quicker, it's easier and quicker for buyers to get through the design center process and get through two or three hours with one visit versus two or three business before and we'll know when they leave exactly what things cost and what their what they spend so we're really excited about it Weve opened 88 studios out out of 16 that we plan.
Reopening the balance sum up this quarter I made a couple of more flow into the fourth quarter.
But.
Their acceptance has been fantastic.
We're getting a lot of positive.
Feedback from our customers very little negative.
And our customers are actually spending more in these design centers and our margin in these.
From our customers for the upgrades is stronger than it was limited than it was previously.
When we.
Use the traditional design center.
Method. So we're very very excited about studio in them and we think it's going to.
The one one more arrow in our quiver to improve our margins streamline and simplify our business and make a better experience for our customers and make it easier to operate for our employees.
Okay. Thanks for that.
Jumping over to your gross margin guide you know you bumped it up by about 50, Bips I am just hoping you guys can help us bridge the gap.
What led to the increase it seems like incentives are taken down for you, but you mentioned that land competition remains.
You know pretty high if you will.
So if you can just bridge that gap for us I would appreciate it and then also could you.
Just give us what the gross margin Delta is between your live now.
And your first move up and kind of legacy to move up plus segments.
Sure. So the majority of the lift in the full year guidance on margin.
Really a function of seating as we accelerate the shift into entry level high those higher margins are improving the overall margins for the company and the second piece is leverage obviously, we sold and closed more homes than we initially projected for the second quarter and you can see that projection thats going through for the balance of the year. It wasn't a pull through from Q3 into Q2, so as as we've talked about in other calls they are they fixed component overhead in gross margin that just gets leveraged at a much faster pace on higher volumes actually the combination of mix continuing to find value engineering opportunities and our product Rollouts have additional studio lens as Steve had mentioned with higher margin and the leveraging from the higher volume so kind of a combination of all of that is driving the higher guidance for the full year on gross margin and then on the entry level I don't know that we want to get into specifics the kinect shift quarter to quarter to quarter based on the net even within the energy.
Level and the person that well stay at the entry level has notably higher margins than our non first time.
The second time luxury stuff that we're exiting out of a highly discounting entry level, the hair better and our first time move up right now, though station because the studio and roll out, they're probably going to come pretty close to minus line other.
All right. Thank you.
The next question will be from Jade Rahmani with KBW.
Hi, everyone. This is actually Ryan on for Jade.
Just regarding M&A do you think that the industry is really ripe for significant consolidation at this point to drive things like scale economics and also the ability for.
The industry to stick more significantly invest in technology and infrastructure and.
Why do you think we haven't seen more consolidation at this point.
For the same reasons to go back.
No.
Decades.
There's a lot of social issues with.
Founders that are still in control of some of the public companies in the large.
Regional operators that.
Are holding on to control these companies and.
Family planning to stay flat.
So we're in a very fragmented business and.
Absolutely looks like on paper that we should have more consolidation.
But realistically.
It's probably not going to be a lot different than the past.
We're sir our eyes are certainly open to M&A opportunities.
No. We're we're constantly looking at different things.
But our first and foremost priority right now is to grow organically, new particularly in those markets, where we're not a top three four or five builder and.
You know that's the.
Thats the strategy that we're employing.
And just.
Second question in Arizona and in particular Phoenix.
Are you seeing any impact in the market there from the growing share.
Hi buyers.
No I mean.
The i. buyer.
Presences is gotten larger here we're using.
We are using these the some of the I acquire companies too.
Do trade ins for some of our move up communities.
But it's still a relatively small.
A piece of the overall resale market here no in Phoenix.
Can you put any context around any figures on the trade ins that have occurred with you and I buyers today.
I mean, if we did.
Very very limited.
Great and then take we're rolling it out across the country are partnering with.
A couple of the big names that you now.
We've probably done a couple of few hundred transactions with these companies.
Over the last year plus year to 18 months.
So you know.
Kind of more than 10000.
Orders that we've taken we've only done a couple of few hundred and of course, we haven't had a nationwide.
But we had it in several markets and.
You know, it's a nice it's a nice tool I think it's a nice thing for us to have when buyers come in them how to sell.
But it hasn't moved the needle yet.
Great Thanks for that color.
The next question comes from Carl Reichardt with BTG. Please go ahead.
Thanks, Hi, guys.
Hello.
To go back to Truman's question.
So the guide for this quarter was I think mid Seventeens gross margin and you did 18 four so is that component of differential really all related to leverage of fixed or there's some other things in there in terms of.
What you ended up with relative to where you guided three weeks into the quarter.
Yeah. So same story for our actual results in Q2 versus our guidance. The company is next obviously higher live now composition of the total.
We were able to lift the margin actually have had some non recurring annual someone always asked on the call heightened marketing breakout by region. So.
Thanks, all relatively steady year over here, it's like the east where we had.
Problems getting our margins up in the top the margins in the East actually grew a 100 day Q2 of last year to Q Q2 of this year.
Value engineering ability at close.
Bigger portion of our backlog and value engineering that we have not caught up in backlog in that that product really helps push our margins up of course lumber aisle. We top I think all of those components with the higher closing volumes and we had anticipated that helped us gain leverage on the fixed component gross margin all of those together key to deliver a higher higher margin than we had anticipated.
Okay, great. Thank you for that and then just on on your lot options I think 34% of your your base now do you know roughly off hand, what percentage of those are our on paper lots or finished lots and is that is that percentage within the option count changing.
I don't know that percentage on the actual.
Oxy piece of paper versus not but I believe we were right around 30%. When we purchased it takes about 37 split between cash and maybe some level of development.
Yes.
We don't option pay for lots, we buy finished lots to the option. So I guess, you're asking is which ones haven't been developed yet which when they're ready to go right. Now I would guess that time here, primarily most need to be developed and are not ready to go right now okay. Thanks, and then one last one just thinking that Alan asked about.
Institutional purchases of single family rentals.
I'm interested in the sort of more of the mine Paul buyers do you know off hand, what percentage of your of your orders have been tracking to that's just probably call them non owner occupants.
I can tell you is pretty small I go out in the field quite a bit to go to our new communities and to talk to our salespeople and ask him.
How many of these are real investors and how many.
People are actually living here.
I could tell you the investor community. Unlike what we saw in the last cycle.
There's really really small I'd say, it's less than 5%.
Okay. Thanks, Steve Thanks, all.
Again, if you have a question. Please press Star then one.
The next question will be from Alex Barron with housing Research Center. Please go ahead.
Hey, guys great job.
John I wanted to ask two questions one was on the.
Let me now.
I guess.
What what percentage of your communities are.
Live live now and where do you see that trending over the next year or two.
And the second question is on the.
On the balance sheet, so you've got the 2020 debt coming due.
Is there any plan longer term too.
And to renew.
Issue, some debt to replace that or to maintain a lower level of leverage and therefore, a lower level of interest.
If you're just generating enough cash.
The sustain the business at current growth rates.
So 41% of our communities at quarter end were entry level, 52% of our orders were entry level.
That 41% could go as high as 60%.
I think thats, our upward target to be 60% entry level.
I don't have a timeframe for that but thats sort of where we're heading.
As far as.
As far as the data our plan right now at the moment.
As to pay that debt off in March with the cash that we are building up on our balance sheet.
And not not to go out and replace that with additional debt. Those plants early can change you know for.
A variety of different things potentially have opportunities potentially coming our way but.
That's the plan at the moment.
We just feel like.
As we get longer into the cycle, even though we believe there's tremendous opportunity long term for entry level housing.
It's prudent to de leverage the company a bit and.
And not to refinance that debt issue that we're paying off and reduce our interest expense and less one other point on that but I think some of it.
Asked earlier, if the interest expense that you are seeing breaking into financial payment is going to go away anyway, but the total burden on that is closer to $22 million not seen break through for the balance of that will over time help margins as well because that interest will be capitalized that we'll see some margin improvement from now on upcoming years.
Right, Yes, that's why I was asking okay, well, thanks, a lot and best of luck.
Thank you. Thank you.
Ladies and gentlemen, this concludes our question and answer session I would like to turn the conference back over to Steve Hilton for any closing remarks.
Thank you very much for your participation in our second quarter earnings call and we look forward to.
Talking to you again next quarter now great day.
The conference has now concluded. Thank you for attending today's presentation you may now disconnect.