Q3 2021 Meritage Homes Corp Earnings Call
[music].
Greetings and welcome to Meritage homes third quarter 2021 analyst call. At this time, all participants are in a listen only mode.
You didn't answer session, while only follow the will follow the formal presentation. If anyone should require operator assistance. During the conference. Please press star zero on your telephone keypad.
As a reminder, this conference is being recorded it is now my pleasure to introduce your host Emily Good Auto Vice President of Investor Relations. Thank you you may begin.
Thank you Doug good morning, and welcome to our analyst call to discuss our third quarter 2021 and year to date results. We issued a press release yesterday. After the market close you can find it along with the slides we will refer to during this call on our website at investors that meritage homes dot com or by selecting the.
Mr Relations link at the bottom of our homepage.
On page two please refer 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 regarding the health of the housing market economic conditions and changes in interest rates community count and absorption trends in <unk>.
Structuring costs.
Ply chain constraints and cycle time projected full year 2021 home closings and revenue gross margins tax rate and diluted earnings per share potential disruptions to our business from an epidemic or pandemic, such as COVID-19, as well as others.
And 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. Our actual result may be materially different than our expectations due to a wide variety of risk factors, which we have identified and listed on this blog.
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 a more detailed discussion of those risks. We've also provided a reconciliation of certain non-GAAP financial measures referred to in our <unk>.
Press release as compared to their closest related GAAP measures.
With us today to discuss our results are Steve Hilton Executive Chairman Phillipe, Lord CEO and he left for today Executive Vice President and CFO of Meritage homes. We expect this call to last about an hour a replay will be available on our website within approximately two hours. After we conclude the call and will remain active through November <unk>.
11.
I'll now turn it over to Mr. Hilton Steve Thank.
Thank you Emily and welcome to everyone participating on our call.
I'll start with a brief discussion about current market trends and provide an overview of the year to date 2021.
Felipe will cover our strategy quarterly performance and he will provide a financial review of the third quarter and forward looking guidance.
Home buying activity remained solid during the third quarter, we continue to experience elevated demand and despite the return of some seasonality in the quarter monthly demand has improved sequentially from August to September and October.
The macro drivers for market demand continued to be what we've experienced all of 'twenty one.
Limited housing supply still extremely low interest rates and higher home buying activity for millennials and baby boomers were experiencing life events associated with changes in housing needs.
New and reach new and existing resale houses supply remained tight, especially for affordable entry level homes.
Mortgage interest rates are still very attractive.
Buyers are typically focused on a monthly payment the low interest rates continue to offset higher asp's and we're seeing elevated demand persists.
Lastly, we continue to see household formation for millennials and downsizing for baby boomers, both of which create demand for the type of housing that we build.
We believe these underlying demographic factors.
Fundamentally changed in the near future and although there may be bumpy as interest rates move materially within a short period of time.
This quarter, we lead.
We leaned on our deep vendor relations to navigate ongoing industry wide supply chain challenges Easter.
These strategic supply side partnerships and our operating model focus on spec homes and limited FCA us allowed us to deliver 3112 homes, which set a company record for the highest third quarter home closings.
We also said two additional quarterly company records, we generated the highest quarterly home closing gross margin of 29, 7% in.
In company history, as a result of pricing power more than offsetting the elevated number another commodity cost.
Our quarterly diluted EPS of $5 25.
It was the highest in our company's history.
We grew community count sequentially again, this quarter as well as year over year overcoming municipal delays in supply Jordan's and land development as well.
As of September 32021, we had 236 in the communities.
And we remain confident in our ability to achieve our goal of 300 communities by mid 2022.
On slide four I wanted to touch on the latest milestones we achieved this quarter.
The EPA recognize mariners as a recipient of the 2021 indoor Airbus Leader Award, our advanced Air filtration ventilation hvac's as well as spray foam installation help minimize indoor exposure to airborne pollutants and contaminants. So it's great to be recognized for these accomplish mint nationally.
In terms of innovation, we launched self guided tours in select locations to address customers' changing preferences when it comes to home buying the home buying process.
Tours allow buyers to sign up for a no contact tours of our model homes on our website and then toward the home after hours at their convenience.
We expect to have this program rollout throughout the country in the coming months.
Additionally, we expanded our offering of digital financial services. So meritage customers can now receive guaranteed on demand homeowners insurance quotes on their selected home on our website.
From an ESG perspective with memorial lives are new and rights policy, which can now be found on our Investor Relations website and stay tuned as we will have more to share on ESG on the ESG front before year end.
Overall, it was another successful quarter, where our teams the supplier relationships helped <unk> deliver 3112 homes I'll now turn it over to Felipe.
Thank you Steve.
Affordability was one of the cornerstones of our strategic shift in 2016, and we continue to be focused on today.
From land acquisition to operation, we look to maintain our NGL product at an affordable home offering in the new home marketplace that.
That being said the sustained favorable pricing environment stemming from the elevated demand for our products over the past few quarters.
Tight housing supply conditions led to AFP increase on orders backlog and closings that are masking, our ongoing product mix shift towards entry level.
Although order a order A&P grew 12% year over year, we experienced a deceleration in AFP growth sequentially this quarter and the new product, we'll be bringing on in 2022, and 2023 will allow us to continue repositioning our future communities down the ASP ban.
During the third quarter, we continued metering out workspace to align with the current production environment and supply chain challenges, even still our average absorption pace remained elevated at five per month.
We were still typically able to sell inventory shortly after releasing yet, but we are only releasing hall and once we have visibility into our cost structure and confidence about closing pilots, which is a good way in the process today due to supply constraints. It is unclear when the current supply challenges will work themselves out. We currently have no insight and suggest that it's on the near term.
And therefore, we are continuing to model elongated cycle times for the foreseeable future.
Now turning to slide five.
Our third quarter closings totaled 3112 homes, they were up 4% over the prior year entry level comprised 78% of closings up from 62% in the prior year for.
For US Q3 of last year was the quarterly peak of the surging housing demand since the start of COVID-19, resulting in an all time highest third quarter absorption pace of five eight sales per month.
In 2021, we have been new orders due to the well documented supply chain issues.
As a result, the total orders of 3441 for the quarter of 2021 reflected a decrease of 11% year over year, driven by a 15% decline in average absorption pace that was partially offset by a 5% increase in average fees.
Fight metering, our third quarter 2021 absorption pace.
Currently remained elevated at five sales per month.
Entry level comprises over 80% of quarterly orders up from nearly 70% in the third quarter of last year and two are also represented 77% of our average active communities compared to 60% a year ago.
Moving to the regional level trends on slide six.
Our central region, which is comprised of Texas led in terms of average absorption pace with five four sales per month, this quarter, which was 14% lower than prior year. This decline was partially offset with that offset by a 5% greater average active community, which together contributed to a 10% decline in order volume.
Third quarter orders increased 20% year over year, given solid market conditions in Texas.
Our east region with the highest entry level product mix with <unk>.
Representing 80% of the average community was the only region to generate year over year growth in order volume of 3%. Despite meter as a result of an 8% increase in average active communities in third quarter, which offset a 4% decrease in average absorption pace.
South Carolina opened several new several new communities late in the third quarter, which resulted in a $3 seven average absorption pace in the third quarter. This was our lowest absorption patient accompanies quarter, Despite south Carolina orders, increasing 11% over prior year given healthy demand in the state we anticipate the order pace will increase in the near future.
The West region third quarter, 2021 order volume had a largest decline of 24% year over year, mainly due to 25% lower average absorption pace to four nine per month Spitz.
Specifically, Arizona reduces absorption pace from $6 five per month in Q3 of 2020 to $4 eight per month this quarter as a result of supply chain challenges.
Colorado remain the lowest percentage of entry level mix of 48% of its average active communities. This quarter. However, given the quarter the greater representative representation of NGL products and its upcoming pipeline, we expected absorption pace will start to increase overtime.
During the third quarter, California has the highest average absorption pace of all our stake at five six per month.
Given 100% of the added opportunities our ESG level. There we continue to focus on affordability, particularly as it's our most expensive geography.
The third quarter or ASP increased 15% year over year in the West region, Arizona, Colorado, Colorado had the largest increase in order ASP.
Our state at 26%. So are we are monitoring these markets to ensure we align ASP to local local market condition and continue to introduce product that is more affordable.
Overall demand remained healthy in all of our markets.
Turning to slide seven.
Of our home closings this quarter, 74% came from previously started spec inventory, which increased from 71% a year ago.
We ended the quarter with nearly 200 spec homes in inventory or an average of 11 seven homes per community as we push to get homes on the ground.
This was an important improvement from you from approximately 23, <unk> or an average of $11 two in the third quarter of 2020.
At September 32021, less than 5% of the total specs were completed versus our typical runway of one third.
Available spect is crucial to our business model, but even as we started over 3400 homes. This quarter, maintaining our goal of a four to six months supply of eventual effects has been challenging.
As we have been ramping up our new communities. We are working very hard to get enough back started and all.
We didn't accomplish all that we wanted in Q3, but we expect to accelerate starts pace in Q4.
We ended the quarter with a backlog of over 500 unit our conversion rate declined from 68% last year to 57% this year due to supply delays.
Although we believe our spec strategy and entry level focus will drive the conversion up in the long term when the supply chain normalizes, we expect current supply issues and the resulting slower back.
Backlog conversions to persist at least for the next couple of quarters.
During the third quarter following that abound in various areas along the supply chain.
So I'm on the front end and others on the backend leading to an additional two weeks or so our construction cycle times sequentially from Q2 to Q3. This year in particular Windows and trust delight trusses delays impacted our operations throughout the country.
As Steve mentioned, our operating structure and strong vendor partnerships have afforded us some advantage as we navigate these disruptions.
We reengineered our product a few years ago, which limit our SKU count and plan library, allowing us to order material in bulk in advance. We are also heavily invested in relationships with our vendors, which we have strengthened during the last several quarters, we are maintaining constant communication and remain flexible to substitute for upgrader sku's or find more.
Turning to supplies as necessary.
We have been benefiting from our 100% spec building strategy for entry level homes priests.
Pre starting homes enabled us to maintain its dedicated of homebuilding construction and makes us a preferred a preferred partner to our trades.
This transparency and scheduling visibility as well as no structural changes, making our products simpler to build.
Times like these we appreciate that we can leverage our spec building strategy and our operating model to continue to deliver our backlog and get more homestar runner I will now turn it over to <unk> to provide additional analysis of our financial results.
Thank you Felipe, let's turn to slide eight and cover our Q3 financial results in more detail.
10% year over year home closing revenue growth to $1 3 billion in the third quarter of 2021, and as a result of the 4% increase in home closing and 7% higher quality AFP. Despite the mix shift to more entry level products.
The 820 that improvement in third quarter 2021 home closing gross margin to 29, 7% from 21, 5% a year ago was driven by the price increases over the past several quarters as well as the leveraging of our fixed costs and greater home closing revenue.
The pricing power more than offset the increased cost of lumber and other commodity.
Today's more normal lumber costs will start to be reflected in our gross margin in early 2020, but will be partially offset by other increased commodity costs as well as the additional overhead burden in gross margin from our community count ramp up once we're fully selling and closing.
300 community in 2022, you will be able to leverage the highest fixed overhead cost across a corresponding higher revenue. We are also continuing to monitor the recent increases in the number and the impact they may have on our 2022 gross margin.
Our SG&A leverage of 93% remained better than our 10% exit expectations and continued to benefit from both greater clinical volume and higher ASP.
The 80 bps year over year improvement in SG&A and buy rate from 10, 1% in the third quarter of 2020 also included lower brokerage Commission in 2021 and cost savings from technology innovation that particularly benefited our sales and marketing efforts, we will continue to find ways to incorporate technology into our operation.
And expect to be able to better leverage our total SG&A and higher closing volumes in 2022 as well.
The third quarter of 2021 effective income tax rate was 23, 3% compared to 19, 5% in the prior year both years reflect reduced rate primarily from eligible tax credits and power <unk> energy efficient homes closed under the 2019 taxpayer certainty and disaster tax Relief Act Inc.
<unk> profit in states with higher tax rate and reduced benefit of the energy tax credit due to greater overall profitability for the company both contributed to the higher tax rate in 2021.
Higher closing volume pricing power expanded gross margin and improved overhead leverage that we achieved this quarter all led to the 85% year over year increase in third quarter diluted EPS of $5 25.
To highlight a few year to date results through September 32021 on a year over year basis, we generated an 85% increase in net earnings orders decreased 1% closing were up 15%. We added 640 bed expansion of our home closing gross margin to 27, 4% and ASP.
G&A as a percentage of home closing revenue improved 90 bps to nine 4%.
As seen on slide nine our balance sheet ample liquidity and flexibility for further growth.
Timber 32021, our cash balance was 562 million compared to $746 million at December 30, <unk> 2020, and was down just 184 million, despite an $815 million increase in real estate assets over the same time.
Our net debt to cap ratio at 17, 5% at September 32021 remain low we still try to target a maximum ceiling of net debt to cap in the high 20, which is in line with a quick asset turn we expect from our entry level and first move up offering.
Our capital usage priority is still focused on credit the bulk of our cash will be spent on land acquisition and development and to get specs in the ground in our new community.
Keenly repurchase shares to offset new grants and keep our dilution neutral as demonstrated in the third quarter. We will also continue to opportunistically repurchase incremental shares we repurchased over 95000 shares during the quarter for $9 5 million since the end of the quarter, we repurchased an additional nearly 200.
Third 44000 shares for another $24 million today over 153 million remains on our share repurchase authorization program, we expect cash generation to accrete once our 300 communities are operating and delivering homes in the back half of 2022.
Onto slide 10.
Our land book increased 46% from September 32020, with nearly 70000 lots under control at the end of this quarter. We had five four year supply of lots based on trailing 12 months clothing, which is higher than our target range of four to five year supply of lots under control. However, looking forward to the clothing.
If he would generate onetime 300 communities are actively selling in the middle of next year the ratio drops back to our four to five year objective.
We secured about 9800 net new lots this quarter compared to approximately 9000 in the same quarter of 2020. These new laws will translate to an estimated 45 net new communities of which 87% of our entry level with an average community size of 196 dropped.
Despite the additional demand for land from all builders today, we were able to meet our internal made acquisition goals, while making sure our projects meet our underwriting hurdle modeling a normalized absorptions pace and a higher incentive environment, our understanding of who we are his sharp and <unk>.
Our confidence level and the type of projects, we bid on by knowing the cost of the phone and increasing our land development expertise, we feel comfortable bidding on the land parcel that others might not from acquisition of larger lot sizes to those in secondary submarkets that best align with our entry level products and projects with complexity and landed.
In fact, our year to date finished lot cost for newly controlled lots is right around $75000 a lot.
During the third quarter of 2021, we continue to make excellent progress in our land development, Despite municipal delays and supply chain constraints and we opened 40 new communities. We grew our community count by 10 net community from 226 at the start of the quarter to 236 accurately signed to me at the end of the quarter.
On a year over year basis, we were also up 16% or 32 net communities from two O four at September 32020.
We spent $526 million in land acquisition and development this quarter, which was 76% higher than last year's Q3 spending of nearly 300 million. We continue to expect our annual land acquisition and development to be about $2 billion in 2021 and thereafter.
To preserve liquidity, we use options are staggered purchasing terms, where financially feasible about 64% of our total lot inventory at September 32021 was owned and 36% with options compared to 68% owned and 42% option at September 32020.
Finally, I'll direct you to slide 11.
With limited visibility into when the supply chain and we think we continue to forecast supply chain delays and longer cycle times for the rest of 2021 and into 2022 with more than 5800 units in backlog and another almost 2800 specs in the ground today, we are projecting 12600 to 12900.
Home closings for the full year 2021, which we anticipate will generate 5.5 to $5, one $5 billion and home closing revenue.
We are looking at full year 2021 guidance and home closing gross margin, which we now anticipate will be between 27 five to 27, 75% with an increased to the projected effective tax rate to 23%, we expect diluted EPS to be in the range of $18 75 to 19.
<unk> 40 for 2021, a year over year increase of over 70%.
For year end 2021, we also anticipate around 250 active community. We are reiterating our commitment to 300 communities by June 2022 with around $2 billion of law.
Land acquisition and development spend projected for next year as well.
For 2022, we anticipate double digit growth in unit and home closing revenue as I. Previously noted we expect gross margins in 'twenty and future remains elevated although supply chain issues commodity costs and recent lumber cost increases may all cap further upside with a higher volume of communities operating next year we.
The paid full year 2022, SG&A rate will drop below our current SG&A rate of the low nines with that I'll turn it back over to Felipe. Thank you Hugh.
To summarize on slide 12, we have capitalized on the ongoing favorable market conditions by having available supply of entry level and first move up homes that are attractive to both millennials and baby boomers, the largest home buying demographic today.
The continued significant investment in land acquisition and development as well as the meaningful growth in community count over the past few quarters to 236 communities as of September 30th demonstrates our ability to attain our strategic goal of 300 communities by mid 2022.
Our operating model strong execution growing community count and focus on the entry level and pursue our markets have all led to the company hitting our closings achieving an absorption pace of Piper months, while meeting the order pace growing community count again and obtain industry, leading gross margins this quarter.
Additionally, these attributes position us well to continue expanding our market share leveraging our operating cost and driving profitability over the next several years.
With that I'll now turn the call over to the operator for instructions.
And in the Q&A operator.
Thank you ladies and gentlemen at this time, we will be conducting a question and answer session. If you'd like to ask a question you May press star one on your telephone keypad, a confirmation tone will indicate your line is in the question queue. You May press star two if he would like to remove your question from the Q.
For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star team.
Our first question comes from the line of Alan Ratner with Zelman and Associates. Please proceed with your question.
Hey, guys nice nice job in the quarter and thanks for taking my questions.
Felipe I think you made a comment early on that.
The goal going forward is to try to bring that average price back down a little bit from the current $4 30 ish range that you're at today.
Yeah on one hand that certainly would be great news from an affordability perspective, but I'm curious if you could talk a little bit about how you're going to make that happen I'm sure Youre lot costs are going up at a pretty pretty strong rate costs are going up across the board maybe aside from lumber so.
What levers are you pulling to bring that price back down a little bit and can you put any meat behind where you actually see that that ISP going over the next few years.
Yeah. Thanks Alan.
You know we continue to try to source land that allows us to position our product in the three hundreds mid three hundreds low three hundreds in certain markets, maybe higher close to 400 in other markets I think were being successful doing that.
The land that were passed we have source over the last 18 months allows.
Allows us to do that we.
We said multiple times that we're willing to go out to sort of secondary market I wouldn't say, we're going out to tertiary markets, but definitely further out secondary markets, where we're able to source low cost land, where we can position our products and much more affordable segments.
In her comments mentioned that our average lot prices $75000 on a go forward basis and you can do some math on that but for the most part that should allow us to position our product below 400000 across all of our markets and that's really the goal and that's really a target. So it just comes down to the land, we don't expect our vertical.
Costs are certainly not modeling our vertical cost to do anything from where they are today. It's just about sourcing less expensive land, we still see refining quality land in good secondary markets, where we can do that.
Got it that's helpful and I guess drilling in a little bit deeper on that so a how quickly does does the mix below 400, I mean is that just as you open up and ramp the community count to 300, so by Middle of next year into 'twenty. Three you are kind of operating at that level and second on that point, you know with that lot cost at 75.
Can you just kind of back of the envelope it would.
Seem to me you know as that flows through unless you do get price appreciation maintaining at call. It 20, 28% gross margin.
Thank you and the next several years might be a little bit difficult. So any comment on that would be great.
Yes.
Next year most of the land thats falling through his land we bought two years ago. So we still feel that our margins will stay elevated through next year, obviously land we bought over the last two quarters, we underwrite to more normal margins so that way it doesn't come on until late <unk>.
Three and 24, we have all the land we need for the next two years. So this is land we're buying for future years and that land is underwritten at a more normal margin as it relates to the next two years like I said, it's really about positioning our product below 400, and we think that barring further.
Depreciation and anything else out there the land is positioned to allow us to move our price point down into the three hundreds over the next few years.
Great. Thanks, a lot for that guys. Good luck.
Our next question comes from the line of Stephen Kim with Evercore. Please proceed with your question.
Okay. Thanks, a lot guys really impressive results so congratulations on that.
My first question relates to gross margin.
Which was obviously up tremendously and you had mentioned that I think 26% of your closings. This quarter were what we would call.
Dirt sales.
I was curious whether those dirt sales generated a lower gross margin than the units, which you had sold already.
Already in the construction process.
And if there is a differential between those dirt sales than spec margins has that differential widened.
Versus pre pandemic.
Yes, I'll take that one Steven so primarily our dirt sales as you know we are 100% spec builder in entry level set of dirt sales are coming from our one and you move a product. So there's not a tremendous variance between the two although in today's environment, there's slight benefit not repeating.
Similarly for the fact that it's back but the entry level process allows us some additional efficiency that I don't think that we're prepared to quantify the difference between the two but there is a slight benefit, particularly in today's supply chain constrained environment to selling specs, which for us is our entry level product.
Yeah got it and as a follow up here what would you say that that's because it's more entry level or because it's more spec. If you had to guess because it it's definitely because it's more specs typically you should earn a higher margin on the more expensive options in the home, but in today's environment.
<unk>.
Cadence and we're able to achieve on this that product helps us it helps it always kind of neutralize the benefit the normally we're yielding about the same margin between the two products the higher option costs that youre gaining on what inning, you are offset by the faster cadence and a more streamline operations on the stat Pak in todays environment. There is a slight.
In effect to the spec product, even overtaking the margins and the higher options on one India.
And even when one M U we've completely streamlined our operations I think you are familiar with our new studio and so although youre able to personalize the home, we still have a lot of visibility into those costs.
They're almost the stack, but theyre just we allow the buyer a personalized within that sort of stack process. So we're almost all stack for.
For the most part of the company.
Great Okay.
Okay second question relates to gross margin outlook I think you had talked about seeing the benefit of reduced lumber prices probably flowing through in early 'twenty two but you did caution that there is a fixed cost I guess in SG&A.
That will increase as your community count is increasing but youre not obviously can be delivering a lot of them. So theres a little bit of a mismatch I suppose could you help us quantify this give us maybe some sort of a framework a rubric to be thinking about how this could influence your results and I think you also indicated fixed cost leverage helped you this quarter. So just how much.
<unk> of the Cogs are we you know are.
Are we seeing that are kind of fixed and maybe give us a framework for thinking about how to model that going forward.
I think historically, we've said that between kind of normal seasonality I know the last couple of years time, we held to that standard back in using normal seasonality. There's almost a 100 bps improvement between Q1 and Q4 on a level Jamie just based on volume. So there's a fairly material portion that we can.
And minimize the impact of those fixed costs on higher volume and also higher <unk>. Obviously have also helped us this quarter. The next year is going to be a little bit.
I've been down because we're going to be growing our community count every quarter of 2022. However, the closings from those will come a couple of quarters later when crude cost upfront. Obviously, we have to have people on the ground getting the community right, but the closings won't come until a quarter or a quarter and a half later.
A little bit of uneven.
Until we kind of hit that 300 community count target in June and then all of this community will start to the variations in the back half of the year.
Okay, great well I appreciate it thanks, very much guys and congratulations on the good results.
Thank you.
Our next question comes from the line of Mike Rehaut with Jpmorgan. Please proceed with your question.
Hi, Doug Boardwalk for might be good morning, guys. I just wanted to know if you guys could give a little more insight into our cycle times, maybe now versus a quarter ago, and then there's just been any improvement or worsening and the process in that timeframe.
Yes, I think in our.
Comments, we said that our cycle times have gone up around six to seven weeks year over year, maybe another week or two from Q3 to Q2.
We kind of saw those coming frankly, when we put our guidance together for Q3 and I would say as we look into Q4 in the following year, we kind of things are about stable could they get worse, it's anybody's guess, but right now we feel like <unk>.
Q4 is going to be about the same.
Just to clarify we're not modeling any improvement at this point.
Awesome and just.
For a little bit of further insight are there any.
Stages are product categories that are currently the biggest challenges or is it just across the board right now.
Yes.
I think for US nationally, we see windows being the bigger problem.
There's a little bit and then when you go regionally it seems like it's a little bit of different stuff everywhere.
But mostly nationally it's really just trusses and windows are the stages, where were having the biggest challenge.
Awesome. Thank you guys.
Youre welcome.
Our next question comes from the line of Carl Reinhart Reinhart with <unk>. Please proceed with your question.
Hey, everybody.
Felipe I wanted to ask you made a comment about <unk>.
Third quarter orders per community per month, five being I mean, you call them elevated but down from last year I didn't know if he met elevated just seasonally.
Elevated generally and sort of tying to that tying that to your underwriting for new communities. If you said normal absorption pace or where he led it.
So what is that is that for a month is that how you look given the given the model transformation that meritage is that how you look at what a normal absorption pace should be with your product mix.
Yes, I think as we think about our business long term you know we look at one end you as something that can do three or four depending on kind of where we're positioned in the sub market and we think about live now as something that can do anywhere from four to six depending on kind of where we're positioned in the submarkets. So when you kind of.
Put that altogether, we think we're going to do somewhere between four and five.
Our month long term, probably more closer to four than five.
We've stated many many times that when we get to 300 communities. We think we can produce 15000 homes. When you do the math on that is 48 per store our store in that kind of four months. So as we look at new land, that's how we kind of underwrite land.
And then as it relates to my comment around five being elevated I would say all of the above right certainly havent seen any seasonality. So we're still still seeing really strong demand and then I would tell you that.
We could sell more than five months, we're selling five a month, because we're pacing and 80% of our stores were doing that because that maximizes the efficiencies of our business and the current supply constrained environment.
We produce really strong results and fiber one and doing any more than that today, just seems like it creates problems for the trades, but I do believe that if we just let a lot of these run we'd see something more closer to six or seven or even eight in submarkets that are really really strong and where we're really price low so in my my.
Demand remains very elevated out there and we're very happy with the five sales that we're getting per store in the metered environment.
That's great. Thank you for that comprehensive answer.
And then looking at.
Your own option split of lot you've been reasonably consistent for a fairly long period of time now you've had some peers out there who who shifted relatively aggressively to option lots.
Can you talk a little bit about how you view the option market today.
And maybe in terms of developed the availability of finished lots I know you want itself developed often but also the emergence of the land banking industry, which is which is an industry view.
<unk> pretty heavily in the early two thousands as I recall.
So you seem to be able to find land.
That you can put on balance sheet and turned into communities quickly.
What is the thought on utilizing.
Utilizing options on a go forward. Thanks.
Yes.
Take that I'm sure. He will have some comments as well I would kind of answer it three different ways.
I think first of all.
We like the land refining.
We find that certain projects provide a better residual for us theyre larger deals with development Big development jobs, and those don't profile well for land bankers, but they profile well for us because we keep our land prices down where.
We're constantly looking to put more land off balance sheet that being said, we have a really strong balance sheet and we have a lot of liquidity and we think the most effective use of that cash right now is to put it back into our business and so we're doing that we are.
We are talking to a lot of different land bankers the pricing model out there. We think is still too high for the risk that they're taking.
So we haven't done as much as I sneak some other builders have although I think you should expect us to start doing some more as we're sort of trying to manage our liquidity and manage our.
Net debt to cap ratios.
The other thing that I think that's exactly absolutely.
Are there other than put out targets that they're looking for a balance sheet percentages on a relative ratio versus the option for us. It's not so much a ratio. We're really just focused on the balance sheet strength. So if we're seeing our net debt to cap get closer to our target, which we set as Hy 'twenty, we closed out the quarter at seven and half is quite a bit of breathing room.
So using our own balance sheet and very very cheap interest rates seems like a better solution than taking the much higher carry that you would have a land bank deals not that there's not opportunity to do so we are doing so where it makes sense, but we don't feel like an arbitrary target percentage of owned versus option.
We should be striving for understanding that there's a fairly large trade offs on in my margin profitability and the deals that you land bank.
A lot of our lots that we do have an option or what we call seller options because we buy the larger projects and frankly those are just way more attractive than a traditional land banking institution.
So our carry costs on those type of deals is lower.
Okay I appreciate that thanks very much all.
Thank you.
Our next question comes from the line of Depot Raghavan with Wells Fargo. Please proceed with your question.
Hi, Good morning, everyone. Thanks for taking my question.
Pretty impressive you're still on track to 302 with all the supply chain headwinds that congratulations there.
Couple of questions from me.
Can you help us understand within your 2022 guide component what elevated gross margins I mean is that in life. So the 2021 or is it slightly below but still higher than 2020.
Any color would be helpful.
Actually we didn't provide specific guidance around and just to give directional guidance on 2022 thirds intentionally not providing a specific percentage I think that theres been enough commentary both from ourselves and from our peers, noting that the peak of the lumber is really happening in Q4. This year and then you're going to start to see some of it is.
Lower lumber costs, starting to flow through the financials of course, that's offset with increases in literally every other category, including labor.
It's difficult to sit here today as you guys know we are expect sellers to our cycle times are much quicker than some others that we will be through our inventory the visibility that we havent, maybe a quarter or two rather than nine months 10 months into the future. So we can give you a rough expectation, but we're not comfortable putting.
<unk> out there for the entire year EIC dynamics of what's happening on the cost side are literally shifting every day.
We see nothing short term that's going to result in a deterioration on the margin although the cost environment is still rapidly shifting.
Understood that's fair enough Mike.
My second one is.
On some pricing dynamics can you talk to some what's happening on the pricing front with their orders.
Some of them I feel check suggests some builders actually took a pause with price increases in the last couple of months.
What's been your cadence.
Yeah, I would I guess sort of echo what you've been hearing I mean, I think what we're seeing out there is a much more measured approach to pricing, it's not to say that prices, we don't see price increases happening, but there. They are more on a monthly basis versus every other week or on a per sales basis.
We're very very mindful of affordability, our whole business plan is built around that so well.
We're doing the same we're raising prices where demand is really strong and we have limited supply and in a lot of other places.
It will probably stay input we feel like as we look at our buyer profile in that community. This is what they can afford and we're not pushing any further so I think that's what we're seeing.
It's a much more sort of normal pricing environment again, I think theres still pricing upside, but it's something much more measured and much more normal.
Thanks, so much for the color I'll pass it on.
Our next question comes from the line of Truman Patterson with Wolfe Research. Please proceed with your question.
Hey, good morning, everyone. Thanks for taking my questions.
First just wanted to start off you know supply chain challenges are clearly impacting everyone, but it seems like your you all are navigating the environment, a little bit better than peers, but just trying to think through if there's anything unique to meritage that's driving.
Some outperformance you know Youre live now and studio M spec strategy and Felipe you made some comments about you know pre.
Preordering.
In bulk and reducing Skus, just hoping you could elaborate.
Yeah, Thanks, Julian and good morning.
We think theres a lot of things unique to meritage.
This is all the work that we did six years ago.
Streamlining our product removing complexity, reducing skus streamlining the journey for the customers the digital journey the studio M.
All of it is paying dividends today I do think we're performing better when we talk to our folks out there.
We're not telling us that theres. These weird things popping up that were completely unexpected.
Certainly seeing the pressure from the supply chain out there, but our business is more predictable its more repeatable and so we're planning it out well in advance and our trades are communicating with us and if theres issues, we're seeing them earlier, so I think when you simplify what youre doing.
You streamline it you got more visibility on what that visibility you can manage through uncertainty better and so I would say, we're doing a lot of things differently and I feel a lot better navigating the supply chain today than I would have six years ago.
Alright. Thank you for that and then your 40 community openings in the third quarter, just trying to understand how how did the timing of those really kind of compare to budget and what im trying to understand you know one of your competitors.
So that supply constraints are delaying horizontal development further just trying to understand what what you all are seeing.
Out there relative to earlier in the year.
Yeah, I mean, we're actually I think exceeding our budget when we put this the path to 300 together at the beginning of this year I think last quarter, we were a much higher than we thought we're going to be at that point and now we are trending from that point on so we're more landing our communities as expected.
We are seeing the same challenges out there, but I think we bought all this land a long time ago. As you remember we had a goal to get to 300 last year. So just kind of pushed out.
But this land was being planned and we've been able to process it through.
And.
We're landing we're landing the communities as expected I don't see any issues with Q4 and as we look out into Q1, and Q2 and our goal to get to 300 everything's on schedule and <unk>.
Moving forward as planned.
Curious just to clarify.
<unk> logic holds true here as in our forecast on the P&L side right. We're not unique we're seeing the same issues that everyone else is we were just.
Careful in how we projected our community count and how we projected in our clothing and our revenue can make sure that we had enough breathing room.
To adjust for anything that we're seeing in the marketplace today, which of course occurred but we have sufficient capacity with entire guidance to still hit the numbers that we lost seven factories increased our ending community count expectations for 2021, a bit from where we were last quarter and as the lease that we have not wavered from that.
300 community Count goal in June of 'twenty, two I think we've been saying that thing pretty much June of last year.
So we're very confident in that number.
Perfect. Thank you all for your time.
<unk>.
Our next question comes from the line of Ken Zenner with Keybanc. Please proceed with your question.
Good morning, everybody.
Good morning.
Dave you talked about pace, whether it starts or orders, obviously I think more to starts for you guys.
Long term being therefore, you don't want to get above five things hasnt been seasonal because demand has remained strong.
I reiterate that to ask you is there any reason or what would change your pace from that.
The kind of current rate you are as you open up more communities, meaning.
If seasonality occurs I E demand shifts a little bit I mean is there any reason for you to be moving right now from that five pace. That's optimal and then second related to that community count openings, you talked about that low nine SG&A.
Does that suggest as you open up these communities it'll be a little less efficient than the front half of the year versus the back half of the year. Thank you.
Yeah, you're welcome.
The five feels like the right number today, given the supply chain I think we'd love to do six.
And in entry level, we're built for speed, we have big Big land position, so even doing Devin as long as we can.
Build those homes with the right cost structure keep affordable and deliver a great customer experience, we'll do that much. So if the supply chain gets better going into next year and the market stays as strong as it is those are two big yes.
We will do more but right now that's really the right number and we basically we plan our specs. According to what the market is going to give us on what the supply chain will give us and we can pull that lever appropriately if we need to.
I think the second question was about how are our fixed costs will roll through next year as we ramp up the community count and you have answered. This question earlier, but certainly in the beginning first half of that year as we ramp up youre going to see less leverage and then as those 300 stores start producing closings in the back half of the year youre going to see more.
Leverage.
I do appreciate that.
<unk>.
Efficiency, the supply chain related to closings as a percent of.
Backlog of inventory.
What are you kind of looking forward to perhaps see that or under these conditions that generate high pace is it reasonable to think that the industry is just at a lower level of efficiency from that closing perspective. Thank you.
I think youre, describing backlog conversion and again right now our backlog conversion below 60% is not what we ideally model.
As a spec builder with 77% of our communities being entry level, we'd like to see that closer to 80% plus and that's where we were prior to the supply chain issues. So as the supply chain.
It works its way out I would hope our numbers would trend back up there, especially as we get these 300 communities ramped up if we can get back up to that 80% number that would be the goal. We have as a company are our cycle times are six to seven weeks longer than they were a year ago. We were building houses and three to four months prior.
To COVID-19, we'd like to see our cycle times get back down to that three or four a month, which means returning.
Two plus close to three a year.
Thank you.
Our next question comes from the line of Susan Macquarie with Goldman Sachs. Please proceed with your question.
Thank you good morning, everyone.
My first question is you mentioned in the comments when you're thinking about SG&A that you expect some more technology and some of those efficiencies to come in can you give us a little more color there and maybe how we should be thinking about those advantages starting to flow through your results.
Sure Susan so they're already in our results.
<unk> continued to refine on that on that possibility as Steve mentioned that we started soft guided tours by leveraging additional.
Is it really into our models at half hours, we certainly do virtual tours online now theres a lot of.
A lot of advantages to what we're doing online regime Prequalification is online we're doing online notary signing when we can in the states that allow it for home clothing, whereas using insurance products online, there's a tremendous volume of activity that we're doing.
The online, including marketing social media, leveraging our website, there's a lot of costs out of advertising cost that were using on digital channels, which are less expensive or actual processes that are being automated like they remain at the core earnings deposit.
Including process itself, there is opportunity to continue to leverage a.
A lot of that benefit youre seeing flow through right now as we mentioned in our CTO at $10. One last year, it's been great and we're at 93. This year's Q2, and you're already seeing some of that benefit, but we're going to continue to be an opportunity rich technology can save us money in the long term.
Okay. That's helpful. And then I have a follow up you know appreciating that a lot of the cash and the capital allocation is focused on growth, but you have purchased back your stock for the last I think its four quarters now or so can you talk about your interest in kind of doing that on a more consistent basis and how we should be thinking about.
Our approach to the share count and shareholder returns.
To date, we've just been opportunistic.
Purchased over 600000 shares this year already so it's about one 6% of our total our total outstanding. So we're definitely doing more than what we initially committed to which is just to make sure that we're not that we're taking out of the marketplace. All the shares that are issuing some equity.
Associated with compensation, so we're definitely getting more than what we committed to which has always been the goal, but forming opportunistically right now as we mentioned in our prepared remarks, we're hyper focused on getting that community count growth, making sure we have sufficient cash to get there and get all the specs in the ground and not overtax our balance sheet.
Yeah, we do believe that there is an opportunity in the future to maybe do something more programmatic and if that's the case, we're going to take a look at it at once we once we hit the targets that we want to hit in 2022, and we'll come back and provide more visibility at least in the next couple of quarters. Our focus is on.
Growth and making sure that we have the capital to do that.
Got you okay. Thank you.
Our next question comes from the line of Alex Barron with housing Research. Please proceed with your question.
Yes, Thank you and great great job, obviously, you guys have.
Massively improved in the last year.
I wanted to focus on the interest expense this.
This quarter, there was a more noticeable drop in the.
And the interest that went through the cost of goods sold and obviously you guys had been.
Delevering and refinancing your debt so is that a pretty decent run rate should we expect that the.
Interest that goes through cost of goods sold will continue to drop as a percentage of of Asps of revenues.
Yes.
Not to get very technical on the accounting side as our assets grow and our debt doesn't grow the relative ratio in the Q that we take through the P&L is going to be lower unapproved unit closing so that the benefit of the refinancing that we did earlier in the year and just as a reminder, last year also we had a $500 million.
And our credit facility for our short duration right at the onset of Covid and Covid pandemic can be onshore, while it's going to happen in the financial markets. So that also kind of.
You the numbers a little bit and obviously, you see that coming through the financials. A couple of quarters. Later, so Q3 of 'twenty is a little off from Q3 of 2021, but you should continue to expect to see that component of interest running through gross margin be smaller over time.
Okay got it.
And along the lines of capital allocation other.
Builders have been either initiating or increasing their dividend any thoughts along those either of those lines. Since you guys don't have one yet.
They're kind of saying answering <unk> question about additional share repurchases, it's something that we're looking in Q, along with our programmatic share repurchase program not something that we're committing to in the near term because we have to make sure that our balance sheet is secure for the growth that we want for 2022 and beyond that we will definitely start looking.
At different cash flow projections and provide additional commentary on one or both of those channels and the next thing is three or four quarters.
Got it thanks and best of luck.
Thank you.
That is all the time, we have for questions I'd like to hand, the call back to management for closing remarks.
Thank you operator, I'd like to thank our entire Meritage team for another solid quarter of dedication and strong execution. It's truly these folks out of work for us that are making the biggest impact to our results.
I would also like to thank everyone, who joined this call today. Thank you for your continued interest in Meritage homes. We hope you have a wonderful rest of the day. Thank you.
Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation you may disconnect. Your lines at this time and have a wonderful day.
Okay.