Q2 2021 Meritage Homes Corp Earnings Call
Greetings and welcome to Meritage homes second quarter, 2021 analyst call.
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I would now like to turn the conference over to your.
Your host Emily Sudano, Vice President Investor Relations for Meritage homes. Please go ahead.
Thank you Brad good morning, and welcome to our call to discuss our second quarter 2021 results.
We issued a press release yesterday after the market closed.
You can find it along with the slides we'll refer to during this call.
On our website at investors that meritage homes dot com or by selecting the Investor Relations link at the bottom of our homepage.
Please refer to slide to caution you that our statements during this call as well as the press release and accompanying slides contain forward looking statements, including but not limited to our views.
<unk> on the health of the housing market economic conditions and changes in interest rate community count and absorption trends in construction cost supply chain constraints and cycle time projected third quarter and full year 2021 home closings on revenue gross margin tax rate and diluted earnings.
Regarding share potential disruptions to our business from COVID-19, as well as others, though than any other projections represent the current opinions of management, which are subject to change at any time, and we assume no obligation to update them.
Any forward looking statements are inherently uncertain and our actual results may be.
Earnings per really different than our expectations due to a wide variety of risk factors, which we have 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 2020 annual report on form 10-K, and quarterly reports on form 10-Q, which contain.
On 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 as compared to their closest related GAAP measures.
With us today to discuss our results are detailed to an executive chairman Phillipe, Lord CEO and he left from <unk> Executive Vice President.
<unk> and CFO of Meritage homes, we expect this call to last about an hour a replay will be available on our website within approximately 2 hours. After we conclude the call and will remain active through August 12th I'll now turn it over to Mr. Hilton Steve.
Thank you good morning, welcome to everyone just payroll.
On our I'll call.
Well first off we're discussing the market trends, we're experiencing today provide an overview of the first half of the year.
Blake will cover our strategy and quarterly performance you know o'bryan.
Our view of the quarter and 2021 guidance.
The housing market continues to be very healthy.
Combined activity in the second quarter of 2021 remained strong and steady in all our geographies.
Even as we manage our orders pace to align with production constraints or second quarter of 2021 average absorption pace was 5.5 per month.
Up from $5 per month from.
Fear.
This quarter, we also forgot successfully navigated supply chain challenges.
These are long term partnerships with our trades allowed us to minimize the impact to our job site.
Possible.
We delivered 3273 homes.
Which was both above.
Above what we forecast considering our anticipated cycle time expansion and also greater than the prior year.
We achieved our best second quarter.
Closings, we generated the highest quarterly home closing gross margin in company history of 27, 3%.
With pricing power more than offsetting.
Commodity cost increases.
We grew our community count from 203 at March 31, 2 at March 31 to 226 at <unk>.
June 30th.
As our focus remains.
On our 300 community goal.
We believe this is we believe this 11% sequential quarterly increase in start of meaningful.
So.
To address the macro backdrop and what we're seeing here in our communities.
Housing supply remains constrained lower interest rates continue to influence purchase decision and demographic trends in home buying from millennials and baby boomers are driving consistent demand in the housing industry today.
Mortgage interest rates remain at at or near historical low levels.
Buyers in the entry level space are mostly buying a payment so as long as rates remain low and the average monthly payment makes sense. The demand continues to be strong.
Secondly, the tight supply of new and resale homes remains an issue on the market.
For greatest state builder pipelines of new and new resale home listings will adjusted eventually adjust.
We believe the current supply and demand gets rates will persist for the foreseeable future.
Lastly, demand based on demographics and continuing to drive home Boeing for the next several years.
What else on baby Boomers.
Orders are still on the early stages of life events that align with home ownership.
With our growing community count and focus on entry level on first move up markets. We believe meritage is well positioned to deliver a greater volume and drive profitability over the next several years at 300 communities, we can generate 15000 orders.
The normalized run rate of 50 orders per store.
Which is just a bit over.
4 net orders per month.
I'll now turn it over to Felipe.
Felipe.
Thank you Steve.
While we continue to meet and exceed our absorption pace objectives in 2021, we're also able.
The prioritized price in today's favorable market environment.
We increased prices on a same store basis by about 9% to 10% year over year this quarter.
This led to order ASP, increasing 18% year over year, even as product mix shift towards entry level, despite managing our orders to align with production.
We still achieved 5.5 net orders per month this quarter.
The elevated absorption pace is partially a function of the current market conditions, although as we continue to focus on entry level homes are long term absorption pace should increase from its historical levels.
While we are certainly being operated optimistic in today's environment our business model.
Model is designed to operate at normalized pricing and pace, we recognize the current demand and pricing dynamics are not sustainable indefinitely, and we anticipate the market will revert to historical sales pace over the next couple of quarters as supply becomes more available.
We believe stable markets are necessary for sustainable growth long term however today.
We're still able to sell our home soon after they are released.
We acknowledged that there are early indicators that affordability is being stretched in some markets.
Our entry level and first move strategy is based on affordability, which influences all areas of decision, making pricing plan library land strategy and target customers.
Our strategy has been and will continue to be to offer quality, yet affordable homes as.
As we continue to shift to more entry level on our portfolio, we are moving down the price debt.
That being said the ongoing surge in housing demand has enabled us to raise prices again this quarter, leading to year over year increases in order backlog.
We include the HP and masking some of the shift to more affordable product in communities.
Spy higher Asp's, continuing low interest rates have kept average monthly payment of quarter, we've experienced minimal pushback on our pricing from the market and we continue to sell on inventory with limited or no incentives.
There are constant.
Constantly monitoring all our geographies and we will adjust incentives accordingly to align with local conditions as necessary.
Even as market demand remains strong we evaluate the overall affordability of our homes and credit metrics of our buyers to ensure customer kpis remained stable and consistent we also conduct conduct interest rate sensitivity.
The stress test on our backlog determined buyers ability to qualify if rates go up to date, we have not seen any pervasive indicators that concern us.
We have also continued our commitment to a 100% spec building strategy and entry level product.
And our focus on streamline operations in order to keep cost as low as possible and to pass.
Along those savings to our customers.
When it comes to our land acquisitions, which he will talk about in greater detail our strategy of buying in bulk and further our submarkets allows us to buy less expensive lots for entry level communities.
Every aspect of our business is focused on affordability to ensure we are keeping our customers needs in mind.
Before we get into the detailed numbers I would like to share some of the exciting milestones we achieved this quarter on slide 4.
In our series of ongoing education at Meritage, we held diversity equity inclusion or day, AI training and a company and a company wide conversation posted by a third party expert to discuss.
Cash inclusive leadership.
In addition to conducting a company culture survey. We also formed our DDI Council comprised of Meritage employees from various backgrounds to help management communicate and execute our day initiatives.
This quarter, we renewed our relationship with operation home front for an 8 year to build and deliver a brand new.
Mortgage free and energy efficient and Meritage homes near Tampa, Florida for deserving military family.
We think veterans for their service and want to show our support as they transition back to civilian life.
From a technology perspective, we rolled out the interactive chatbot feature to our consumer web page and we'll be talking about some further enhancements to.
New customer experience in the coming months.
I am proud of volume achieved in the first half of 'twenty 'twenty..1 a continued focus on new energy efficient features digital offerings technological innovations as well as additional DDI efforts all positively impact our financial performance and helped to create long term value.
New slide 5.
Our second quarter closings totaling totaling 3270 homes were up 18% over the prior year.
Additionally, closing asps increased 4% year over year due to sustain an elevated housing demand, which has allowed us to push to cigarettes.
Turning 2% in the prior year.
Together these increases drove home closing revenue, 23% higher year over year to $1.2 billion in the current quarter.
We sold 3542 homes this quarter orders.
Orders were slightly down 2% lower than last year's challenging comps driven entirely by a lower.
Key accounts.
<unk> 20 on an average community count of $2.39, compared to this quarter's average count of $2.15.
Steve mentioned average absorption pace was up 9% year over year from 5 point of sales per month to 5.5 per month, despite a tightly meters. Despite HIV needed order pace.
Sure.
With orders and average absorption pace actually improved between April and June when we released more homes to the market towards the end of the quarter.
The low housing supply conditions combined with strong home buying demand created considerable pricing power in the market.
<unk> net ASP on orders in the second quarter 2021 exceeded 400.
$20000 and was up 18% year over year.
During the second quarter strong demand existed in both entry level and first move up products.
Andrew outlook comprised over 80% of total orders for the quarter up from 70% in the second quarter last year and she level also represented 75% of our.
Average active communities compared to 54% a year ago.
Our absorption pace per first new homes increased 21% year over year.
Moving to the regional level trends on slide 6.
Our east region order volume increased 17% over prior year as a result of 25% growth in average.
Average absorption pace, partially offset by a 6% decline in average community count.
Performance in this region can be largely attributed to our strong entry level pivot.
The region continues to demonstrate the largest shift to entry level with 77% on this average active community selling entry level homes during the quarter compared to 45%.
In the same quarter last year.
Georgia has the highest average fridge absorption pace in east at 5.8 per month, which partially offset by a 31% decrease in average community count led to a 2% growth in orders.
Our average absorption pace in the central region comprised of our all of our Texas markets.
<unk> grew 8% over prior year to $6 per month, which was the highest absorption pace from the company, while average community count decreased 16%.
This led to a 9% decline in order volume and.
Entry level communities represent <unk>, 78% of Central's average active communities during the quarter the highest among all 3 regions.
Our second quarter 2000 tonne average absorption pace in the West region was relatively flat year over year at 5.5 per month order.
Order volume decreased 10% over prior year due to the 10% decline in average active communities.
The west strong demand and pricing power resulted in a 22% increase in order ASP.
California experienced an increase from 4.5 to $5.9 net orders per month largely to the shift due to the shift in average entry level community makeup increasing from 68% to 97 per cent.
Arizona demonstrated the strongest pricing power with order asps, increasing 31% year over year, Arizona.
The average community count remained flat.
If the supply chain was working more efficiently. The demand we are seeing in the marketplace. A day would allow us to sell homes EBIT faster.
Turning to slide 7.
Of the 3273 home closings this quarter, 74% came from previously started spec inventory the safer.
Arizona vintages, a year ago, we ended the quarter with nearly 2600 spec homes in inventory or an average of $11.3 per community as we pushed to get homes on the ground. Despite production delays this.
This is an improvement from about 22 interest back on average or.
For an average of $9.3 in the second quarter of 2020.
At June 32021, less than 5% of total specs were completed versus our typical runway of 1 third maintaining our goal of a 4 to 6 month supply of entry level specs has been challenging even as we started over 3800 homes. This quarter at an annualized rate of 15200 Homestar.
On starts validates our ability to maintain a necessary level of import inventory to support our community count objectives. We.
We ended the quarter with backlog of over 5500 units as our backlog conversion rate declined from 78% last year to 63% this year, although in line with the first quarter, 62%.
We expect slower conversions to persist in the coming months as we sell homes early in the production cycle, but believe our second entry level focus will drive the backlog conversion back up in 2022 and beyond.
Having available spect is crucial to our business model, although supply side headwinds have resulted in construction cycle times are extending.
Approximately 4 weeks, we were able to navigate through the challenges this quarter and we have not yet seen any further expansion.
We believe our spec building strategy gives us a competitive advantage by enabling us to pre plan on starts and contract per building materials in advance by.
By locking cost before pricing the home, we avoid cost risk.
Sending up can better manage our margins, especially in a rising cost environment.
Additionally, since our spec strategy is built on months of supply of sales and not an absolute number of specs, we're able to adjust that construction volume according to market demand.
We believe that our spec strategy has enabled us to increase our market share and we'll continue to do so.
So as you grow to 300 communities.
Now I'll turn it over to Sheila to provide additional analysis of our financial results.
Thank you Felipe, let's turn to slide 8 and cover on our Q2 financial results in more detail.
We've noted that 23% year over year home closing revenue growth in the second quarter as a result.
Results in the 18% increase in home closing and 4% increase in closing asps, despite being comprised of a greater mix of entry level homes.
The 590 bps improvement in second quarter 2021 home closing gross margin to 27, 3% from 'twenty, 1 'twenty Corp percent a year ago.
Reflects higher Asps.
And leveraging of our fixed cost on per year home closing volume day, DSP more than offset higher lumber pricing and increases in other commodity costs.
Lumber futures peaked in May and have begun a notable decline in June and July the anticipated positive margin impact will start to.
Way through our financials in the coming quarters that may be partially offset by other cost that continue to rise.
As we scale up community count towards 300, our gross margin will eventually benefit from even greater leveraging fixed overhead in the future.
Well documented that menu homebuilding materials, both Rob and.
Finished are constrained in todays environment due to ongoing supply disruption in 5 consecutive quarters of elevated demand the entire industries impacted to some degree and while we're certainly not immune to this phenomenon. We believe our reduced planned library limited SKU count strong vendor partnerships and constant predictable.
Work at construction Kanan allowed us some advantages to navigating these delayed.
While labor shortages are commonly associated with the homebuilding industry during periods of high growth. Fortunately lever is still relatively stable. We believe our strategy strategy makes us a preferred builder of choice since our transparency and scheduling.
What can Jody are attractive to local trade. However, we have had to absorb higher transportation cost affiliated with some of our inputs due to indirect labor challenges, we continue to monitor for indications of a tightening labor market.
Our SG&A leverage benefited from both greater closing volume and higher.
Asps in the quarter, bringing our SG&A down to below our 10 per cent goal to 9.2% 1 of our more permanent changes as the increased technology use in sales and marketing where possible, which is an effective lower cost solution. We rolled out in 2020, we continue to employ and refine the.
The second quarter.
The ZIP anyone's effective income tax rate was 22.4 per cent compared to 21, 7% in the prior year both years reflect reduced rate they primarily stem from eligible tax credits on qualifying energy efficient homes closed under the 2019 taxpayer certainty and disaster tax relief Act.
The price increases and higher clothing volume expanded gross margin and improved overhead leverage that we achieved this quarter led to an 83% year over year increase in second quarter diluted EPS of $4.36 times.
To highlight just a few items from the first half of 2021 results on.
On a year over year basis, we generated an 85% increase in net earnings orders were up 4% closings were up 21%. We added 530 bps increase in home closing gross margin to $26.1 per cent and SG&A as a percentage of home closing revenue improved 100 debt to 9.
On slide 5%.
Moving on to slide 9.
Our balance sheet remained strong even as we invested a record amount on land acquisition and development. We achieved several objectives. This quarter on April 15, we closed our offering of $450 million 378 senior notes due 2029 and.
We received approximately $444 million in net proceeds on.
On March 31st we issued a notice of redemption for all of our $300 million, 7% senior notes due 2022. This redemption that occurred in April resulted in $18.2 million from early debt extinguishment charges this quarter.
At least 37% impact to our EPS.
In the first half of 2021, we repurchased 300000 shares of stock for a total of $27.5 million of which 200000 shares totaling 19, $19.1 million were repurchased during the second quarter at June.
32021, our cash balance was $684 million compared to $746 million at December 31, 2020.
Our net debt to capital ratio was still low at 15, 4% compared to 10, 5% at December 31, 2020, our current maximum net debt to cap.
Approximate remains in the high Twenty's, which is in line with the quick asset turns from entry level and first move up offering and our solid commitment to maintaining sufficient liquidity to weather any unforeseen event.
We have not wavered from our capital usage priority, we will continue using the bulk of our cash on land spend for organic.
And to get specs in the ground.
Routine share repurchases are intended to offset new grants and keep our dilution neutral.
But we will opportunistically repurchase incremental shares our main focus remains on land acquisition and development to achieve long term gross drive profitability and gain market share.
Target on to Slide 10 on June 32021, with over 63000 total lots under control we had 4.9 year supply of lots based on trailing 12 month closings in line with our target of 4 to 5 year supply of lots under control, but closer to the middle of that range. When we look at our expected closing volume at 3.
300 community, we increased our land book by 47% from approximately 43000 lots at June 32020.
As we get closer to attaining our mid 2022 goal of 300 communities, we exceeded our own expectations on community count growth this quarter.
We made tremendous progress in.
Development and overcame supply chain issues to aggressively grow our community count by 11% sequentially from 203 at the start of the quarter to 226 active communities at the end of the quarter on a year over year basis, we were down 5% from 237 communities due to an accelerated orders pace in both 2020.
And land beyond 2021, like Steve said, we believe this quarter was the start of significant growth. We opened 45, new communities, our strong pipeline of upcoming community openings over the next 4 quarters should position us well both to address market demand with greater volume and to drive continued profitability.
We already own or control all of the land necessary for our 300 goal. We are focused on working through development of land over the next 12 months.
I am confident that we will have 300 active communities by mid 2022.
We spent $551 million on land acquisition and development this quarter.
Which was bad debt.
And free to 57% higher than last year's Q2s, you did spend of $214 million and 49% higher sequentially from Q1 spend of $370 million to demonstrate our commitment to sustain and replenish our 300 communities, we expect to spend about $1.75 billion to $2 billion on land acquisition.
100 on what men in 2021.
And maintain an annual pace of about 2 billion in the future.
Despite the additional demand for land from all builders today, we are able to find enough land to meet our internal goals, while remaining disciplined in our underwriting standards in the second quarter of 2021, we secured approximately 9.
Net new lot about 114% more volume and about 4200 net new loss in the same quarter of 2020. These new laws will translate to 64, new communities of which approximately 80% of our entry level or.
Our comfort with acquisitions of larger lot sizes and in secondary secondary and further out.
<unk> into bucket that best align with the entry level product has limited some of the competition for the land. We are interested in and also allowed us to contract for less expensive lots. These positions allow us to leverage community level overhead costs reduce the per lot impact of development and infrastructure allocations as well as mitigate community.
I'll start my churn.
In the second quarter of 2021, the average community size contracted for a 153 lots to preserve liquidity cleanest option or staggered purchasing terms, where financially feasible about 63% of our total lot inventory at June 32021 was owned and 30.
On any counter sent with options similar to last year.
Finally, I'll direct you to slide 11, we have more than 5500 units in backlog and another almost 2600 specs on the ground today, which provide us good visibility into our go forward margin trends for the rest of the year. Additionally, with today's strong pricing environment.
7 to paid at a lower lumber costs, we are lifting our guidance with allowances for either commodity cost increases and cycle time delay. It for full year 2021, we are now projecting total closings to be between 12500.13000 units.
Home closing revenue of 5 billion to $5.2 5 billion.
Home closing gross margin of approximately 27, 5% an effective tax rate of about $22, 5% to 23% and diluted EPS in the range of $18.55 to $19.45.
Given our strong pipeline of community openings.
And anticipate communities at December 31, 2021 will be about 10% greater than today's level as for Q3.2021, we.
We are projecting total closings to be between 2800.3100 unit home closing revenue of 1.15 to 1.5 billion.
We have the gross margin of approximately 27, 5% to 28% and diluted EPS in the range of $4.35 to $4.77.
That I will turn it back over to Felipe.
Thank you.
To summarize on slide 12.
Healthy land spend has led towards significant community count growth.
Growth demonstrating our commitment to sustaining strong land position.
We're confident that we will achieve our 300 community goal by mid 2022.
Our robust backlog and increased spec accounts combined with the SP on backlog exceeding 420000 will allow us to drive greater volume in home closing revenue in the second half of 2.
Home clear 1.
In the current environment, we will continue to push pricing based on what the market will bear while managing our orders pace to account for supply chain challenges in order to deliver greater margins and profitability.
We believe we can capture increased demand and greater market share over the next few years by continuing to execute on our entry level and first move strategy.
20 of elevated demand for at normalized levels.
Additionally, we believe our successful spec building strategy in the entry level communities and our stream on streamline operations will continue to service relative to future.
With that I'll now turn the call over to the operator for instructions on the Q&A operator.
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1 moment, please while we poll for questions.
Our first question today is from Alan Ratner of Zelman <unk> Associates. Please proceed with your question.
Hey, guys. Good morning, Congrats on a really fantastic quarter and results.
That's fair.
So Felipe I think you opened up the call with some pretty.
Realistic comments just about eventually you would expect to see some normalization on absorptions and you actually kind of put a timeframe around that over the next couple of quarters on a few quarters.
I'm guessing at this point that that's being driven.
By you guys in terms of kind of limiting the sales since it seems like demand is clearly outpacing supply, but I'm curious what impact if any you would expect that over the long run debt normalization to have on the very strong gross margin trends youre seeing today.
Hilla, you mentioned the benefit of leveraging the fixed.
<unk> expenses as you ramp community count, but the flip side of that I would imagine as you're probably benefiting today from the very very strong absorption pace that you are at in kind of leveraging some fixed expenses. So could you kind of just talk through the moving pieces. There on the margin side is that absorption normalization occurs.
Yeah.
Yeah. Thanks Alan.
You know obviously in the near term, we've kind of guided to what we think our margins are going to be in the back half of the year and so we feel like the margin profile in the near term is still really strong with lumber sort of moving down.
Even if the pricing power on.
The market isn't as strong as it used to be who feel like theres offsets there.
And.
Today, we are still able to push prices in some of our communities, even though we're being more mindful of it than we were in the prior 2 quarters.
As we sort of look out into the future and revert back to a more normal normal absorption pace Theres a couple of things that we see first of all.
All.
All of the communities were opening to get to our 300 is land that we bought prior to the pandemic on early 2000 late 2019.2020. So we think the margin profile on that land looks really good.
Do think costs will stabilize we're seeing what's going on with Lotte with lumber. So we think that's going to go into right direction.
The Big question is out there is just kind of what our incentives are going to do.
We're not thinking that we pushed prices beyond a place that on a sustainable long term without some without some sort of incentives to kind of still achieved a pace.
Sort of a normalized pace out there in the market.
As of right now we're.
Of IV anything really anywhere to sell the houses that we're releasing today, but we fully expect over the next several quarters that incentives will come back into the market is supplied us to what extent that is it's hard to say at this point I don't know if you have anything else to add to that yeah. I think just to answer your question on the margin side of.
We're not in fashion.
I agree with Felipe I don't think that we're going to be able to continue to increase pricing at the current pace indefinitely.
Even just for argument sake, if we hold it steady with lumber coming down and just from Meritage specific having additional volume from this community is it's kind of a more than offset.
The day screen normalization in the market on per store sales. So I do think our overall volume will be higher. So if we look at that number coming down and just some savings that we're going to start to harvest from our lower interest rate.
We think that even if absorbed absorption cases come back to normal in the.
That 234 quarters, the margin probably have a slightly longer runway until it normalizes.
Got it okay, that's really helpful.
Second question Felipe.
Felipe you also made a comment that you are seeing some early indicators that affordability is being stretched in some markets I'd love.
Any additional color you might have.
Next to that that kind of supports that statement, whether it's data you're seeing from your mortgage company or.
Perhaps just general less enthusiasm from the consumer given the price increases any commentary you can give there would be great.
Yeah, it's more of the later.
We do obviously look at our backlog.
Look at our pipeline of prospects find out where their app from FICA store by disorders, DTI ratios, all that looks pretty stable at this point even at the current prices.
Given the way interest rates have trended the payments are still very much affordable and achievable.
But it's more about the consumer.
Zoom or feedback rate when we when we go out and release homes.
2 our priority list you know, there's a larger percent of that priority list that just prefer not to buy today, just because of where the pricing is and how it stretching sort of their total sort of what they were thinking was going to be their payment for a new house.
So it's much more qualitative at this point.
Then it is quantitative we seem to.
Still have plenty of buyers who are willing to pay the price and are comfortable with the payment, but we definitely have seen more pushback.
From our priority list over the last say 30.40.
Okay. Yeah, just 1 more day to plenty of addition to FICO and DTI I think we mentioned on our call last quarter that there's a couple of additional data points that we're continuing to monitor which is broken appraisal and the ability to make up that that money on.
From from the buyer's perspective.
While on the stress test.
On our backlog if interest rates were to increase and whether it's interest rates or increases in price of its really kind of the net payment calculation that we're doing there. So even if interest rates hold steady on how comfortable is the buyer population with price increases and posted highest on.
Also de Minimis. The fact, the appraisal was almost a non event.
And if there are broken appraisals buyers are coming up with the extra funds and on the.
Trust has continued to be very low percentage of our backlog.
That would have an issue qualifying for the exact same house that they were looking for other they could certainly still qualify for a slightly less expensive.
Okay.
Gotcha. Thanks, a lot guys I appreciate it.
The next question is from Steven Kim of Evercore ISI. Please proceed with your question.
Yeah, Thanks, a lot guys.
Lots of good things to talk about but I want to address this question.
<unk> of peak lumber I think you mentioned that you thought that you would have a positive margin impact from falling lumber in the coming quarters, just wanted to get a little bit more granularity and 3 Q.
And <unk> can you give us a sense of what you foresee with the shape of lumber costs.
Running through your.
Our P&L.
Relative to what you saw in <unk>.
For the back half of this year, we're not going to see a significant impact.
From the lumber rely on <unk>.
Go into it starting with all stars.
August.
And on so most of the homes that are going to close. This year has been started already at prior lumber lumber rate. So we don't see a very positive impact in the back half of the year. This will start to be felt more in 2022.
It take lumber what the way builders experience.
<unk> lumber savings.
Is very inefficient as many has written about.
We'll re walk here, there's still quite a bit of supply in the lumber yards that they bought at the prior rate and they're trying to still push those prices through to us so to achieve all of those savings will take some time.
But.
It has dropped significantly staying there which is exactly what we needed for there to be some real significant savings here. So I think we'll get.
On some meaningful re lost here in <unk>.
<unk>.
But the big savings will come at.
Net loss after that and really start to impact Q1, Q2 of next year, if everything else stays equal.
Okay.
I guess I'd just to clarify on my question, a little bit I would think that actually the shape of lumber means a <unk> you might actually have higher lumber costs than <unk> just wanted to clarify.
If I that obviously on the back end of that there would be a benefit which is what you addressed but I was talking specifically about <unk>, maybe absorbing even higher lumber and that being incorporated in your margin guidance.
And then also with respect to the amount of the lumber.
Hit if you will year over year the headwind 1 of your peers mentioned.
And that they thought that it could be about 300 basis points year over year in terms of.
On the kind of hit that you absorbed in <unk>, and maybe well absorbed and <unk> wanted to see if you could comment on that range.
I don't think I have that exact math, but certainly.
We are not unique index, what we've experienced.
P&C lumber costs versus our peers. So if they had an accurate number there I would probably agree with debt, but to your earlier question yes.
Lumber Pete It appears in Q2 all of the starts that went out in Q2, which will close in Q4, it's probably going to be the peak.
The lumber impact to our P&L now as.
I said that he would have said the pricing power in the market more than offset that which is why we're comfortable with with our margin guidance.
Yes, Your home center right the biggest impact of the increase in lumber costs, when we close houses.
<unk> balance here in Q3 and Q4.
Yeah, No that's encouraging and then with respect to the comment about incentives you mentioned, you're not really doing any incentives at all I mean, obviously incentives are a normal part of the business in a in most times and so I wanted to talk about that a little bit.
First.
First of all.
What is the normal rate of incentives when you just think about what a normal market is like low single digits kind of a thing.
And is it consistent do you typically have prices increase even as you have incentives normal level of.
So in other words I'm asking if you have an increase in your incentives over the course of the next year would it also be consistent that you would also be having some asking price increases at the same time.
Yeah, I'll take that 1 so you're right typically let me just clarify incentives come in in Q.
Forum's here at Meritage I know every dollar or is it a little bit differently. We have just traditional incentives and then we have incentives are affiliated with using our mortgage company to the mortgage company incentives are still there.
Those are an incentive to use on SEDAR affiliated and breast have additional visibility into the backlog.
The incentives affiliate just for coming into our community and buying a home. Those are those are the ones that are.
Right around the day low single digit is the right number in a regular environment and you're right typically they go lockstep with ASP increases. So if you think in a normal environment ASP increase.
Or maybe 234 per cent per year.
That should still continue despite the fact that youre, having and incentives.
In future years, as we normalize now again, it's difficult to predict what a normal will look like or how normal will come to be is it going to be abrupt is it going to be steady and flow it's difficult to know.
These are you know chicken on the AG, which is going to come first continuing increases in asp's or halted asps the proliferation.
Information of incentives and then kind of a normalization. So it's hard to try to pinpoint any specific quarter, what the actions going to be but we do think that over the next 234 quarters, we will see what would be.
Every builder that's reported so far I've mentioned that they are increasing start then and spectrum looking to get more inventory on the ground there feels to be a little bit of loosening on inventory and the existing home market as well. So we think that there will be some stabilization there and whether that manifest itself in slower on.
Increases on ASP.
<unk> or the return of the incentives that's really from time to market by market decision.
Sure makes sense.
I appreciate it 1 last 1 if I could just sneak it in here is the loan limits on 1 of the things that you raised I think earlier. This year was the fact that loan limits, you're bumping up against loan limits I think in <unk> and in some.
And yet we know that the loan land that's formulaic, we will increase perhaps as much as 20% something.
Jumping to what degree we've never seen before on January 1 and given the abruptness of that I was curious as to how you are strategizing.
With your sales force in.
Cumulative how you will manage customers who come in who may be a little challenged because of the loan limit and for Q, but can look forward to the significant breathing room are being provided on January 1.
No.
And I think is.
Really important data point for.
1 data point, maybe more important is affordability because aluminum is really just driving the availability and FHA loan right. So we're looking at GAAP in tandem with overall affordability for our buyers. We do have quite a few of our upcoming communities that are going to be opening lower ASP. So we think that will deviate.
Terms he issues, but the way that we're looking at is really the broken appraisal.
The customers have the ability if there's if that mortgages coming in slightly above FHA and they really want or need the FHA loan do they have the ability to put a little bit more cash down to get the loan.
Non total below FHA, even if the house price doesn't get them there and for the most part.
Where our customers are looking for that we see that opt.
Opportunity, that's still available to them with their on the cash that they have on hand from stimulus checks. There are on economic success that they've had over the last 18 months.
Some of them were certainly monitoring the FHA limit and our company objective for our entry level product is to be below the FHA limits.
We're in today is kind of unique environment, we're monitoring FHA limits intend with just general affordability since the FHA take rate is a little bit lower today.
And we typically see I just wanted to drive that last point home.
You know we're out there sourcing land that allows us to position our product below FHA today's FHA.
Today's lumber cost.
At today's pricing so we continue to.
Look for land to move down move our asps down in our future business.
And I think that's really important for folks to understand because I know, we're going to get a lot of questions about what land prices are doing and they're certainly going up but our focus is to buy land positions all of our product below FHA and again.
Today, the FHA thresholds.
Thresholds not what they might be in the future.
Yeah, Great I appreciate it guys. Thanks.
Here.
The next question is from Michael Rehaut of Jpmorgan. Please proceed with your question.
Alright, Thanks, good morning, everyone.
Colonel.
And limit myself to 2 questions here.
First.
I'd love to get your thoughts.
You talked about sales pace.
Going forward and obviously, there's different pushes and pulls.
Well I think you've kind of talked about at some point sales pace normalizing.
Everyone at the same time, you're having more communities come online as we progressed through the year.
And <unk>.
Supply.
Right.
Supply constraints, you're still putting out starts at a decent pace.
Relative to a quarter or 2 ago. So just wanted to.
<unk> as we think about sales pace in <unk> and <unk> relative to <unk>.
<unk> pace sustainable for the rest of the year and how should we think about.
No.
2022 at this point Steven.
Yes.
And so we don't really guide to sales, so I'm going to stay true to that.
The sales pace in the market today is being 100% tied to production.
So we're just managing orders based on our ability to get spec started.
Get into stage, that's interesting to consumers to transact.
And what what what we can sustain and deliver a great customer experience around may.
Making sure we can deliver on the house on time and fully complete to those consumers so the supply chain.
I don't know if I can say, it's getting worse, it's not getting any better and it continues to be the biggest challenge to the market.
So.
The 5.5 sales pace in Q2 was a strong sales pace.
It's unclear if we will maintain that but through.
Through the back half of this year, it'll just I'll be.
Tie back to our ability to kind of get those starts on the ground get them through the production cycle and sort of manage our backlog conversion and keep our costs in line with what we're trying to achieve on our margins I know that's not the answer you're looking for and you look at from different but it really is just.
Connected to that 100% and then the laughing all day.
We think a normalized sales pace.
And we underwrite new land.
At 3 to 4 per month per <unk>.
4 to 5 per month on live now.
Our 3 year busy.
And that's.
That's what the absorptions are being underwritten app, so as as the new head opens up if we get more on that we get more than that but that's the assumptions that go into how we underwrite land and when we achieve 300 communities, we think that generates a 15000.
And unit business.
At 4 months.
It will be there middle of next year.
Okay.
I appreciate that belief.
Maybe just to clarify then.
Maybe you could just maybe talk to the fact.
On this point to finish off this thought here.
To the extent that you're saying production isn't getting worse.
Would you expect your starts rate to be sustained in the back half and then.
My second question is just on owned and optioned.
You know kind of staying in.
40 range, a little bit above 60% this quarter you obviously have.
Other builders that are trying to push or have pushed the option portion of their lot position higher is that a goal of yours over the next 1 or 2 years, how do you see that playing.
Playing out thanks very much.
Yes.
We're absolutely trying to do as much as we can on option.
No.
GAAP, we offered optimistic into land margin day, it's very very competitive.
On getting both payable per deal.
Yield sometimes gives you a better deal.
And what other it depends on what markets or what other builders are willing to do.
We're so focused on our affordability metrics and again getting our asps down that if we can do the bulk transaction and successfully position our future product at a much more attractive price point, we're going to do that over the option.
That being said, we continue to do well on the options, we will continue to push harder and tried to do more but.
But I think the market's just really hot right now on the land side and a lot of other builders are out there willing to.
Do bulk and we just have to compete with them. So I think we're kind of where we are but we're continuing to push.
As far as the start cadence.
I'd say you should fully expect it to continue as we ramp into the 300 communities, we're going to be getting to a page where we can do 15000 units and we've said this other times on the calls but starts and sales are almost the same for US. These days right we've changed the way our business model works.
We're selling almost 100% back so as we as we try to ramp up to the 300 communities. We believe that we need to be at 15000 starts for the year and it starts now rate as our community count growth continues. So that's the trajectory on that's why we started a bunch of homes last year last quarter, we're trying to replenish the stack.
Also getting community count growth and I fully expect our starts cadence to continue to escalate as the community count growth comes behind it.
Great. Thanks very much.
The next question is from Carl Reichardt of <unk>. Please proceed.
But we're on restaurant thanks, good morning, everybody.
Philip I wanted to ask about the cycle time extension I think I got at rate that you set a 4 week extension can you talk a little bit about sort of where in the build process that that's occurring and is it is it more product or labor pool related and then just sort of on on that point.
The thesis here being low and spec.
With you in a hurry as great per subs and they love. It now we've got a lot of other builders looking to Jack starts. So how are you feeling about retaining that labor pool as you move forward, maybe the next sort of couple of 3 quarters.
Yes.
I'm feeling really good about it right now considering we started 3100 houses last.
<unk> quarter, it was a big focus and effort of ours.
The team did a great job on driving that so I'm feeling pretty good about it but things are things are shifting around all over the place.
You asked is where it's happening it's kind of happening everywhere and it's happening.
Last from places.
Depending on geographies, depending on trade relationships et cetera, So I'm not sure I can tell you that it's back on trade versus front end trades.
Which stage of the house, we're slowing down it's just kind of it's kind of like a debt to buy 1 billion cuts theyre all over the place and Thats whats generating.
Turning into before week.
Elongated cycle times.
Which will obviously impact inventory turns and et cetera, but but I'm feeling I'm bill on that our operating model allows us to plan stuff in a different way, we already know what we need to start.
In Q3, we've been planning for for 60 days. So we've told the trades, what we're doing where we're doing it how we're doing it and we got them lined up and I think that that's what the spec strategy gives you as far as on the other builders getting into this I think they're seeing the same thing we're seeing and then in turn consumers want to.
Generally as lead a day, so the ability to move them and quicker it's something that's really important so so theyre diving in.
The key the key though is as the repeatability of your business to really drive that spec cadence. If you are still building a lot of different plans out there you have a lot of different skus, you're managing you are relying.
Hang on your sales folks to pick out design packages and things like that it just slows down the process. So with these other builders jumping into it I'm confident that they are figuring that out but we've been working 5 years on that and that's why I feel like we can ramp up our starts to 3800 like we did in Q2.
Again.
I'm optimistic that based on our performance and what I'm seeing in Q3, we're going to be able to ramp this thing up pretty pretty fast.
So that we have the best in these 300 communities that were getting to by next year and putting ourselves in a position to deliver on.
Our long term goals.
Thank you very much for leap and then and then Gila.
Looking at the this particular quarter as gross margin guidance, 25% as a guide at the end of last quarter on your 230 basis points above that this quarter can you walk through the 230 basis points differential from the guidance and specifically sort of by basis point what.
What drove that that change.
Yes.
It's kind of.
In every category honestly, so because our backlog conversion was a little bit off from what we expected we had a higher volume.
So in the period than what we entered into and those are at higher Asps.
So that obviously helps every category depending on the timing of the stacks there were some savings on.
On the expected lumber impact so there were some savings on the cost side, and then again the volume as closings as well as the ASP increase helped us leverage the fixed component.
On Pony and Thats, a fairly material component.
That leverages.
Pretty well with when the volume increases so it was kind of across the board obviously, the land scaly fix that sometimes impacted by your mix, but for the most part those land costs have been locked in for a very long time, so as your ASP increases you on.
Leveraging a piece of that land in dollars don't change of course, but the percentage increase it. So it's really all just a function on the volume flow.
Lightly lower lumber based on the timing on when that is homes started and the increased pricing power on that.
Homes that closed kind of all led to that improvement okay.
Watch for that detail I appreciate it.
Yes.
The next question is from Deepa Raghavan of Wells Fargo. Please proceed with your question.
Hi, good morning, everyone great quarter, Great Guide.
My first question is more generic.
As.
Thanks will reopen and resume to at some nominal say post COVID-19.
And seasonality coming back are there any trends that positively surprised you or underpaid your expectation so far.
No because.
So.
So, we're really metering and governing sales.
Every community.
And.
It's really hard for us to tell you tell everyone exactly if we took the governor off of averaging on community. What we would see in the market and did anything change from last year when.
We werent governing sales so as of right now.
Everything feels like we can sell what we have and we don't have to incentivize. It. It's still a very strong healthy demand market people are still seeking out housing there's lot of supply constraints.
And we.
We really haven't seen much change in buyer behavior.
For the most part.
But it's hard to hard to exactly say just because of the governors we have out there in our communities given the production constraints that are in the market. So no. We haven't nothing has really surprised us.
We're not even.
<unk> there was seasonality over the last 90 day, certainly people have gotten back into value vacations and doing other things, but we're still seeing plenty of buyers come to our communities way more than a typical summer would look like.
And so it's just hard to say at this point if anything's.
Share of aged.
As it relates to seasonality.
Alright Thats fair.
You're tracking better than you.
Your expectation for this 300 community count to mid 2022.
Does it mean you can achieve this target a little earlier.
It really should have thought or are there other constraints like you know you talked about supply chain et cetera, that's still the big hurdle and right now just getting to 300 by mid 2002, what would be a victory by itself.
Yeah, I mean, net we are going to grow our community count by 80 communities essentially over the next.
The new orders, that's net right because we closed out of communities as well so opening up a 100 plus communities over the next 4 quarters will take everything and the organization has to execute on it.
As we sit here in July we're in great great shape, but we still have a lot.
We have 12 more months of work to do here is to execute on this and so I don't think that debt.
There's going to be a meaningful pull forward of that community Council.
Alright, great. Thanks ill pass it on.
The next question is from Truman Patterson of Wolfe Research. Please proceed with your question.
Alright.
Good morning, everyone and thanks for taking my questions.
First question is on the discussion on kind of 22 gross margins in the outlook. If I heard you correctly. It seems like theres lower lumber flowing through that's largely going to be offsetting some of the inflationary pressures.
Going forward at least through early 2022. It seems like you have some fairly low cost land coming online through 2022 and your commentary.
Regarding consumers is that you might be seeing a little bit of anecdotal pushback on pricing, but when you look at their financials.
It doesn't seem like affordability that stretch so I guess when I'm thinking through this really.
The only item or the main item of concern for you all.
As most likely what happens when additional capacity comes online and whether or not incentives out.
Kind of home price appreciation in 2022.
Is that correct.
Hi, Julien.
1 data point, there are well on.
We're all excited as an industry as seen on lumber costs come down.
Every other category.
Strip, so first of all the impact from the lumber savings will be somewhat muted on Westwood.
Every other commodity increasing so it's a little bit of a guessing game right now on what it's going to look like over the next 123 quarters on the rest of the commodity side, the labor is still comfortable but.
Unclear as this new capacity comes on at that point, we start to be a trigger and then of course, it's fully bharti adjust incentive.
A couple of balls in the air.
I think the Crystal ball is clear enough guidance quite yet into 'twenty, 2 we absolutely agree that the expectation unless something unusual happens.
Again over the next couple of months the expectation is that that industry will harvest significant savings from lumber costs, but theres certainly.
Some are concerned about items going in the other direction on whether they're going to perfectly offset on.
In more than the lumber saving kind of unclear right now so I don't think we're prepared.
To provide guidance into 2022 back, but the thesis that the lumber that hold steady should be decreasing into 'twenty..2 is a craft line.
Even though we're we're excited that the land that we're opening up here to get to the 300 is all land we bought.
From a pandemic, but the land that's showing through our income.
Income statement right now is land that we bought before that.
So.
That land land is not getting cheaper, but but we're excited about the land that we have come flowing through.
Okay. Okay. Thanks for that and then on.
On the debt.
Indeed, count I don't I did not hear any guidance on 2020, 1 you know nice traction sequentially.
You know the past couple of quarters I believe you guided to about 25% gross by the end of the year in 'twenty 1.
Can you are you all reiterating this and should we.
Just see kind of a normal sequential improvement through the year.
Yes, I would think.
As we said in the opening comments, we believe we'll be up another 10% from here by the end of this year approximately 10%.
Okay.
Okay. Okay. Thanks for that and 1 final 1 on on our SG&A.
Nice leverage you know going forward, how should we think about you know.
The amount of new communities that you're opening just balanced against our leverage for solid growth while at the same time, we've we've.
Encountered builders, just kind of lowering outside third party realtor fees pretty aggressively as well as.
Some some tick down internal commissions, just hoping you can help walk us through those moving parts.
Do you think that you'll see from some commission changes.
Theres a recently.
Implemented here, so can I take a couple of quarters for those sales to come through it hopefully.
The timing will be as we ramp up on cost with the community count.
We're not providing any guidance specifically, although we do expect to see some as average commission cost savings coming through in the next couple of quarters.
Okay. Thank you and good luck in the upcoming quarter.
So operator, I think we'll take 2 more questions and then and then on we'll close it up.
Yes, Sir we'll take from the following question from Susan Mcclary of Goldman Sachs. Please proceed with your question.
Hi, This is jake titled <unk> on for Susan Congrats on a.
Okay.
Just a question as you expand your footprint, both geographically as well as just grow community count on your existing markets. How do you think about securing the necessary labor given the challenges there as you continue to scale the business.
Well I think guidance scaled the business is value security labor.
I mean the larger.
Largest builders have access to the best labor pools in those markets. So.
We always talked about being a top 5 market builder on each market and that gives you access to better land.
On better trade capacity et cetera.
So that's our focus right and as.
Great.
Hi builder in many of our markets I think we're seeing which.
Which is why we.
We feel really comfortable about our ability to grow on capacity in our new markets that we're in like we entered Charleston, it's going to be a little more challenging and we're on the bottom on the pecking order I got to earn our way up that's why we try to go as fast as we can.
But it's all about market share.
Is the reason the big guys got got the access to the best Labor pool.
That makes sense, thanks, and just from my follow up I'm curious if you guys are exploring the possibility of becoming more active in the single family rental market as other.
There is India and the industry get involved here and given your focus on.
Grocery level, just curious to gauge your appetite.
It's an exciting.
Exciting new energy filled space right now.
So much stuff being written about written about it it's highly successful right now we're really focused on organic growth, we have a great gross strategy focusing and investing.
On the <unk> market with our existing people with our existing products on our existing strategy. So that's the focus right now, but we're always entertaining everything that might give us some other scalable opportunity.
Thank you and good luck.
Do you.
The next question is from Alex Barron of housing research.
<unk> Center. Please proceed with your question.
Hey, Thanks for squeezing me in.
We've seen home prices go up quite a bit this year and some places up 80000 per 100000.
And I think you guys said you are planning on introducing new communities at lower price points.
So I'm curious what's different about these new communities are they.
Smaller in size.
How do you prevent from some type of cannibalization.
Yeah.
So the new the newer communities first of all it's just a pivot right.
Ben.
<unk> really focused on this for a while so we've been buying cheaper loss in secondary tertiary markets that we feel good about in the past the growth that allows us to position our product in the 300 versus 400, 500, which is where we typically play.
The second thing.
I think we said there's quite a bit but we've just been very successful. Our teams has been very successful sourcing larger deals.
And in buying the larger deals were getting better basis land residuals and also able to spread out the horizontal cost over.
More land, which is helping.
Bring launched to the market at lower prices, which allows us to price our homes at lower prices. So a lie on that land, we started buying them 2 years ago, and it's going to start flowing through and it's really the larger deals that are allowing us to position our product in a more affordable.
Expense.
Okay. Thanks, and then my second question is obviously you guys shifted.
The business model to building.
Mostly specs I'm just curious if you guys have also shifted the timing of when you release at home for sale or has it not changed.
<unk> totally on the last 3 to 6 months.
Well when we release.
Boy It has changed because of the elevated demand and the production constraints. So.
The normal market before the pandemic, we were always sort of had a third.
Meaningful specs were completed on <unk>.
Barbara facts were you know middle stage, and then our third of our stacks where early stage now we have less than 5% of specs that are finished just because there's so much demand out there and we're able to sell it earlier in the release, we'd like to get back.
To where we were where we have a third a third a third and we add sort of something for everybody and can meet their timing of when they want to move a need to move.
So things have changed where we're releasing houses earlier on and people are buying them earlier on in today's environment.
Okay.
Thanks, so much.
Thank you.
Well. Thank you operator, thank you everybody.
I'd like to thank our entire meritage team for their great effort and continue high level of execution.
And everyone who joined this call Tonight. Thank you for your continued interest in <unk> homes, we OPI on a great rest of your day and again, thank you very much.
Yeah.
This concludes today's conference you may disconnect your lines at this time. Thank you for your participation.
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