Q2 2024 Meritage Homes Corp Earnings Call
Greetings and welcome to the Meritage homes second quarter 2024 analyst call. At this time, all participants are in a listen only mode.
A brief question and answer session will follow the formal presentation.
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 to Donal Vice President of Investor Investor Relations and ESG. Thank you you may begin.
Thank you operator, good morning, and welcome to our analyst call to discuss our second quarter 'twenty 'twenty four it results we issued a press release yesterday. After the market close you can find it along with the slides we'll refer to during this call on our website at investors that meritage homes, dotcom or if I select.
The Investor Relations link at the bottom of our homepage. Please.
Please refer to slide two questions you better statements during this call as well as in the earnings release and accompanying slides.
Forward looking statements.
There wasn't 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.
Any forward looking statements are inherently uncertain.
Our actual results may be materially different than our expectations due to a wide variety of risk factors, which we have identified it listed on this slide as well as in our earnings release and most recent filings with the Securities and Exchange Commission.
Typically our 2023 annual report on Form 10-K, and subsequent 10-Qs.
We've also provided a reconciliation of certain non-GAAP financial measures referred to in our earnings 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 worked through that executive Vice President and CFO of Meritage homes. We expect today's call to last about an hour a replay will be available on our website later today I'll now turn it over to Mr. Steve.
Thank you Emily welcome to everyone listening on the call I'll start with the brief discussion. He tells me kind of market conditions and signed a leasing company milestones. He will highlight how our strategy is progressing.
From a quarterly performance and he will provide a financial overview of the second quarter and forward looking guidance.
Q2 was another strong quarter for Meritage product and price points, you're talking at the mortgage segments of homebuyer demand, which drove a solid spring selling season for us leading to an average absorption pace of four.
One five sales per month, this quarter and your higher second quarter sales of 3799 homes.
The second quarter of 2024, our backlog conversion of 136% generated 1118 home deliveries and home closing revenue of $1 7 billion.
Home closing gross margin for the quarter was 25, 9%, which combined with SG&A leverage of 19, 3%, resulting in EPS of $6.31.
At June 30th 24, we increased our book value per share a 16% year over year to 134, 41 and generate a return on equity of eight.
18, 3%.
Now on to slide four for a recent milestones.
Truly our juicy, but a wide range of recognition in the second quarter reflects a corporate steward stewardship.
And if we see just avid count for the third consecutive year has excellent again into a builder for exceptional customer satisfaction scores.
Again celebrate our long standing partnership with the EPA accepting the market leader award for certified homes for the 11th time.
We will also wanted three builders named America's climate leaders by USA today, and lastly, U S News and we'll report added US the list of the 2024.
That's companies to work for you are proud to be recognized externally for our social sustainability initiatives.
I'll now turn it over to Felipe thank.
Thank you Steve.
During the second quarter, we hosted two Investor day calls to introduce the evolution of our business model.
For the past seven eight years, we have migrated to a lower ASP spec strategy.
Streamlining operations to yield efficiencies now we are once again continuing to refine our strategy and taking the home to a near completion stage before releasing it for sale.
[noise] approximating the just in time home inventory structure that exists in the retail market.
This strategy evolution is built on three new core tennis.
60 day closing guarantee the concept of move in ready homes, and a focus on deepening our realtor relationships.
These changes allow us to target the biggest piece of the potential homebuyer pool by effectively competing against retail inventory not just in today's environment that favors builders, but also in the retail market returns to historical averages.
Our strong second quarter 'twenty four financial performance.
Our financial performance validated the shifting focus on quick turn move in ready homes is the right one for us and attractive offerings for our customers. We will continue to build affordable entry level and first move up product, but now we will be focused on buyers who want to move into the home and 60 day and typically have already gave you the breakdown.
Our new strategy enabled us to exceed expectations quarter by achieving a higher absorption pace than our target and year over year increase in home closings and gross margin.
Now turning to slide six.
<unk> solid throughout the spring selling season, our sort of sales orders of 3799 homes in the second quarter of 2024 were up 14% year over year.
Cancellation rate of 10% remains below our historical average in the mid teens.
Two level homes comprised 92% of total orders volume.
S T. A S. P. On orders this quarter of 414000 was down 6% from prior year due to a larger mix of our orders coming from both our eastern markets and entry level homes.
Sequentially, we increased ASP on orders and we were able to take price increases and some of the strongest submarkets.
The strength in demand for a move in ready product and our continued use of financing finance incentives generated second quarter 2024 average absorption pace of $4 five net sales per month above our target average annual sales pace of four net sales month aligning the seasonal patterns do you expect the second part of the year to experience a slower sales pace in summer months.
The holiday season.
Although we are seeing a return to more typical sales seasonality, we do believe that the demand environment will remain constructive for the rest of the year. This resiliency scans from favorable demographics below average resale listings and many of our markets and our fundamental annabel supply of homes, all of which create an opportunity for us to increase our market share despite ongoing mortgage rate vol.
Jody <unk>.
Our second quarter 2024, and you continue to have a 287 was up 4% sequentially from the first quarter, placing four and down 1% compared to prior year.
35, new communities came online this quarter similar to what we opened up in Q1 for.
For the second half of this year, we anticipate additional neck unique umbrella any more meaningful double digit increase in 2025.
Our own and control all walks, we need for plankton me openings in 2024, and 2005 and most of 2026.
Moving to the regional level trends on slide six all of our regions achieved an average absorption pace exceeding our target of 4.0 net sales a month and year over year growth, whereas volume this quarter.
The central region comprised of our Texas markets had the highest regional average absorption pace of $4 seven net sales per month, and an average quarterly backlog conversion rate that has exceeded our targeted 125% for the last few quarters.
You can access a resale home supply has increased and some taxes submarkets a move in ready homes effectively completed against its inventory with nearly 30% completed tax inventory in the region. We believe we have the right available product to continue to increase our market share.
The west region experienced the largest year over year growth in average absorption pace to four four net wells per month in Q2 from three four net sales were down from last year, we are seeing strength in Arizona, where we achieved five plus net sales per month.
This quarter with strong year over year growth and back out in the west we expect to be able to continue meeting the high demand in this region.
East region had an average absorption pace of $4 four net sales per month, and the largest regional year over year increase in sales leaders, making the east our largest region based on sales order volume, even as retail inventory more noticeably return in some submarkets in South Florida.
We are poised to continue completing competing aggressively for market share here at each as our east region exhibited the strongest regional growth year over year, and ending community count and spec inventory in the second quarter of 2024.
Now turning to slide seven.
As we align our starts pace with our sales pace. We started about 4300 homes. This quarter we were.
About 5%, both sequentially and year over year replenishing, our pipeline with our anticipated community count growth in the next six months, we expect to start more homes to maintain our targeted four to six months supply per community across our growing footprint.
As discussed in the past our strategy is agile. So if we do see any pullback in the market in the coming quarters, we will adjust our spec starts accordingly.
We had approximately 6500 spec homes in inventory as of June 32024 up 46% from about 4500 stacks as of June 32023.
This represented 26 packs for comedians quarter between four to five months supply stocks based on absorptions over time under the new strategy our percentage of complete with should increase slightly to ensure we have the right inventory to meet our 60 day closing guarantee.
All of our home closings this quarter, 96% came from previously started inventory up from 87% in the prior year, 26% and pulls back some completed as of June 32024 closer to our goal of carrying one third move in ready homes with a focus on quick turning inventory intra quarter sales to closing percentage was just about 40% this quarter.
Our ending backlog continues to clock can do decline intentionally from about 3800 as of June 32023 to Fox in the 2700 homes as of June 32024.
We expect this trend to stabilize once we are delivering 60 day move in ready homes in all of our communities with.
With our backlog and facts on the ground together totaling over 9200 homes. We believe we have the optimal level of inventory for the current demand environment.
I'll now turn it over to he like to walk through our financial results. Eva. Thank you Phillipe before we get started I'd like to share that earlier. This week moodys upgraded us to investment grade. We're excited to now be holding <unk> ratings from all three of our readers. It's been humbling to see third parties recognize our efforts over the last several years to strengthen our balance sheet.
We are producing exceptional results and we believe the benefit of these upgrades will continue to positively impact our financial performance now lets turn to slide eight and cover our Q2 results in more detail.
Quarter 2020 for home closing revenues were $1 7 billion, reflecting 18% higher home closing volume year over year and was partially offset by 7% lower asps.
<unk> and geographic mix and addition to select price increases the costs related to rate locks decreased slightly year over year and sequentially from the first quarter, even as the utilization of these financing incentives increased with recent volatility in interest rates as we look to the second half of the year, we anticipate a slower month yet.
Portion pace due to seasonality and a corresponding lower closing volume compared to the first half of the year, reflecting the seasonality in our higher backlog conversion, resulting in the delivery of the majority of our spring selling season orders during the first half of the year.
<unk> gross margin increased 150 bps to 25, 9% in the second quarter of 2024 compared to 24, 4% in the prior year. This improvement was a combination of lower direct cost greater leverage of fixed expenses on higher revenues and shorter construction cycle times, which were partially.
Offset by higher lot costs, lower direct costs benefiting from both market dynamics and our purchasing teams ongoing pursuit of cost reductions since direct costs peaked in Q1 of last year.
We're also securing volume discounts from trade partners based on our increased deliveries.
We expect to see continued savings in lumber and lumber related products in the coming quarter and labor capacity continued to hold steady.
Further our construction cycle times improved about 10 days from Q1 to Q2 to around 130 calendar days, which helps us turn our home inventory faster.
Putting in on our historical average at about 120 calendar days cycle time, which would allow us to turn our web inventory three times a year.
As a reminder, all of our land costs are more elevated as compared to 2023, we have already turned over the majority of our community from pre Covid land sort of higher cost slots are not expected to have a material pullback on our margins beyond the current levels.
Turning to SG&A.
G&A as a percentage of second quarter 2020 for home closing revenue of nine 3% improved 30 bps from nine 6% in the second quarter of 2023, primarily due to the better leverage achieved on higher home closing revenue. It's important to note that this quarter total commissions as a percentage of.
Home closing revenue were flat year over year, specifically external commission rates were essentially the same in Q2 2023, despite our higher Cobra participation as our strategic relationships reduce the need for AD hoc bonuses and incentives we continue to see the proof in our results that our new strategy.
Of aligning with Realtors is working and proving profitable.
We expect commission as a percentage of home closing revenue to remain relatively steady for the rest of the year.
As we've mentioned several times today, given our strategic evolution. The first two quarters of ear will likely be the strongest revenue quarters, leading to the most leverage in our SG&A in the first half with that in mind, we are still maintaining our full year SG&A guidance of 10% or better.
Longer term, we're targeting nine 5% SG&A as a percentage of home closing revenue as we grow our existing markets and leverage our overhead platform to reach our goal of 20000 units in the next three to four years and.
In the second quarter of 2020 for the financial services profit of $48 million included 2 million of write offs related to relax unwind costs. This compares to a financial services loss of $2 6 million in the second quarter of 2023 and had $7 9 million in similar write offs the.
Quarters effective income tax rate was 22, 1% this year essentially flat to prior year with both periods benefited from energy tax credits and qualifying homes under the inflation reduction Act.
Higher home closing revenue and gross profit coupled with greater SG&A leverage led to 26% year over year increase in second quarter 2024 diluted EPS to $6.31 from $5 in Tucson in 2023.
To highlight just a few results from the first half of 2024 on a year over year basis orders were up 14% closings were up 19% and our home closing revenue increased 13% to $3 2 billion. We had a 240 that improvement in home closing gross margin to <unk>.
Five 9% SG&A as a percentage of home closing revenue was nine 8% and net earnings increased 31% to $418 million with $11 37 in diluted EPS.
Before we move on to the balance sheet I wanted to cover our key Q2 thousand 24 customers credit metrics as expected our buyer profile remain relatively consistent with our historical averages with FICO scores in the mid 730 and DTI is around 41 42.
T V's, we're still in the mid eighties and about 80% of our buyers in Q2, we see some sort of financing incentives consistent with our mortgage company capture rate now turning to slide nine.
This quarter.
We successfully enhanced our capital structure, we issued $575 million in new 175% convertible debt due 2028 part of the proceeds from the convert went to pay down the remaining 250 million of senior notes due 2025, the incremental cash from the convertible notes increased our available sources for land.
Spence dividends and share repurchases, we also refinanced our revolving credit facility to increase the facility size to $910 million extending its maturity date from 2028 to 2029 and reducing its pricing grid to align with our investment grade rating, we had nothing drawn on our credit facility cash of 900 and.
$93 million and net debt to cap is fixed up six 2% as of June 32024, our net debt to cap maximum ceiling continued to be in the mid twenties range, leveraging our improved backlog conversion and quicker cash generation, we utilized 118 million operating cash flow during the second quarter of 2024.
Primarily related to land acquisition and development onto.
Speaker Change: Onto slide 10, our capital allocation and focus on organic growth and cash dividends this quarter to enhance shareholder value. This quarter. We spent about 631 million on land acquisition and development, which was up 54% from prior year on a year to date basis. Our land spend has totaled $1 1 billion as of.
Speaker Change: June 32024, with the exception of a small pullback in late 2022, we have been accelerating our investment in organic growth for the past several years, we expect our go forward trend in 2024 and beyond to be two to $2 5 billion of land spend annually.
Speaker Change: We nearly tripled our quarterly cash dividend on a year over year basis to 75 per share in 2024 from 27 per share in 2023, our cash dividend totaled $27 $2 million in the second quarter of the year and $54 $5 million on a year to date basis.
Speaker Change: The convertible notes issuance, we were unable to repurchase any shares in the second quarter as we were bound by the customary lockup provision that will lift at the end of the day today share buybacks are integral to our capital allocation policy. So we plan to double up on her systematic quarterly commitment and QQ to catch up.
For the first half of 2024, the company repurchased over 362000 shares of stock totaling $55 $9 million $129 1 million remain available under our authorization program as of June 32024, turning to slide 11, we secured and put over 8700.
Speaker Change: Net new lots under control this quarter, representing an estimated 63 future communities. We put around 2800 net new lots under control in the second quarter of 2023 as of June 32024, we owned or controlled a total of about 71000 Max <unk>.
Speaker Change: Leading to a four seven year supply in line with our target of four to five years, we continue to utilize more option financing for land deals ranging from ranging from traditional landbanking to seller tranche deals where the underlying salaries about 66% of our total lot inventory at June 32024 was owned and 34.
Speaker Change: That was the option compared to prior year, we had a 76% owned inventory and a 24% option lot position, we own 69% and auction 31% of our loss at March 31, 2024, we are comfortable with our off balance sheet land ratio up to 40% since the off balance sheet transactions comment.
Speaker Change: Financing costs were going to use them as needed while balancing our other capital commitments. Finally, I'll direct you to slide 12 for our guidance given current market conditions, we have revised our full year projections higher to the following total clothing between 14000, and 750, <unk> and 15500 unit home closing revenue.
Speaker Change: And six one to $6 3 billion home closing gross margin around 24, 5%, 25% an effective tax rate of about 22, 5% and diluted EPS in the range of $19.80 to $21 flat.
Speaker Change: As of Q3, 'twenty 'twenty four as for Q3 2024, we are projecting total closings between 3000 and 650 to 3850 units.
Speaker Change: Closing revenue of one five to $1 6 billion home closing gross margin of $23, 5% to 24% and effective tax rate of about 22, 5% and diluted EPS in the range of $4 60 and.
$5 five.
Speaker Change: Q3, and full year guidance, assuming current market conditions and interest rate with that I'll turn it over to Felipe.
Felipe: To summarize on slide 13, our second quarter 2024 results demonstrate that our new focus on quick turning move in ready inventory immediately strengthen our absorption pace home closing volume in home closing gross margin with a strong balance sheet. We can continue to execute our strategic evolution and create long term value by investing in our growth on the <unk>.
20000 units, while also returning cash to shareholders with that I'll now turn the call over to the operator for instructions on the Q&A.
Speaker Change: Operator.
Thank you.
And at this time, well conduct a question and answer session. If you would like to ask a question. Please press star one on your telephone keypad, a confirmation tone will indicate that your line is in the question queue. You May Press Star two if you would like to remove your question from the queue for participants do think speaker equipment it may be necessary.
Speaker Change: Sorry to pick up your handset before pressing the star keys, one one moment, while we poll for questions.
Yeah.
Our first question comes from Alan Ratner with Zelman and Associates. Please state your question.
Hey, guys. Good morning, Congrats on the great performance in what seems like a lot of success, so far and the strategy pivot our evolution here.
Alan S. Ratner: I was hoping to drill in a little bit though to the gross margin guide I know you walked through a lot of detail back and Youre right Youre investor meetings, a month or two ago kind of your outlook there longer term and I think.
Speaker Change: Your expectation for some normalization makes a lot of sense and generally is in line with our expectations, but.
Speaker Change: I'm a bit curious if you could drill in a little bit what's driving the sequential pressure specifically in the back half of this year I think we've heard from some other builders would expect more of a flattish margin environment and it seems like Youre incentives right now are fairly stable. So why this significant leg lower in in the second half.
Following are much stronger than expected second quarter.
Thanks, Alan This is Joe I'll take it and until he can jump in with any additional commentary. So I think that that sequential decline I know theres been a lot of questions and thoughts about it kind of pre pre earnings this morning.
It's mostly a function of two things media function of three things. The first is geographic mix, we have some diversity in margin performance across our markets. So it's a little bit of geographic mix.
Speaker Change: Second part of it is volume right. There's some leveraging in the fixed components of overhead with the heavy closing volume now shifting into Q1 and Q2 for US from Q3, and Q4 are going to see some slightly reduce leveraging in the fixed component of <unk>.
First margin and then incentives continue to be utilized there's been a lot of volatility in the market over the last six weeks. Those closings are the ones that were really going to see in Q3, and we're continuing to see.
As we sell homes in July so, it's really a function of those three things theres nothing different structurally or fundamentally in the market and market strength.
It's holding in there it's pretty much the same it's really just mix and leveraging the overhead couponing.
This is felipe I'll just add.
From the beginning when we budget our business, we expected seasonality returned to the market. This year. So we still expect that we are here in July and so we think that we will probably have to use more incentives in the back half of the year to acquired ourselves those are on our original budget, we've had to use less in the first.
Half of this year, but we're still expecting to use more in the back half of the year.
Got it okay.
It was very helpful and I guess circling that back to the upside in <unk> that I think you kind of touched on that just now in your your answer fully but the upside that you saw this quarter was that that was just a function of you kind of came into the quarter expecting to have to maybe incentivize a bit more heavily than you actually did on some of those homes that you sold and delivered in the <unk>.
Intra quarter.
Yes exactly.
And after he was answer on how we're guiding to the back half. We also picked up volume and leverage which was significant.
So along with the leverage and volume picked up because now we're closing selling and closing more homes just in time.
Lower incentive utilization because the market was stronger in Q2 allowed us to produce the beat in Q2.
Got it okay, that's really helpful.
Second question on community Count growth, you know really impressive acceleration there in the quarter and I know that was an area that you are maybe a little bit more cautious on in the near term just given the pace of absorption in kind of a flow through of some of your more recent land buys whats contributing I guess to the I don't want to call. It a pull forward, but the better than expected.
Speaker Change: Growth here in the near term, which it sounds like you expect to continue in the back half of the year.
Yeah, I don't know if its better than expected and I feel like it's been kind of coming sort of within one or two of what had been expected. That's why we sort of suggested growth was going to be somewhat choppy over the next over this year and then next year, we are expecting meaningful growth and thats essentially what it's been.
Speaker Change: We opened up a few more extra few extra communities. This year and may be closed out a few few less not more than expected, but just look what we were expecting.
Speaker Change: And that will continue I think the next three quarters will continue to be choppy and then we will see meaningful growth, but as we said from the very beginning we expect community count growth this year, which we will be achieving.
We share every quarter when.
The new lots that we put under control on how many new communities is going to generate for the last several quarters. The number of communities that the land that we put under control regenerate is more than the number of communities that we're closing so as we start to lapse in those communities.
Become active you're going to see that our pipeline of the lots that we have on booking under control are going to come on at a faster pace in the communities that are closing out which again, we had a pretty material. This quarter to 71000 lots under control. So I think that that youre going to see that acceleration really kick off in 2020 fives, but we fully expect.
To go into next year spring selling season with <unk>.
More communities than we went into this spring selling season.
So that's the expectation.
Great. Thanks, a lot guys appreciate it.
Our next question comes from Michael Rehaut with Jpmorgan. Please state your question.
Hi, good morning, everyone. Thanks for taking my questions.
Wanted to start off with.
Speaker Change: You know.
Focusing on the sales pace and you know, particularly I think you kind of referenced the obviously that the strategy that you have broadly speaking in terms of more effectively or more aggressively competing with the broader retail market as inventories normalized.
And obviously theres been a lot of talk around the increase in inventory levels in Florida, and Texas I was wondering if you could kind of share as you know those.
Tori levels have increased.
Speaker Change: Year to date.
You know how the your various communities and those markets have performed you know if.
If you've seen the broader market, maybe softened slightly or require slightly higher incentives.
And you know how your communities have kind of.
And navigated if any.
Speaker Change: Challenges or modest softening lets say in either demand or price as a result of the change in inventory in those markets.
Speaker Change: Sure I mean at this point, we're pretty optimistic about how we're doing there because as you can look at.
Our Q2 numbers, we produced really strong order growth.
Across all of our markets, including some of the markets that have been highlighted as softening.
I don't think we're going to be immune.
To the market as resale market starts to return and becomes more competitive and therefore it brings the market into balance we will have to navigate that just like every other builder, but we believe having move in ready inventory will allow us to compete directly with that resale inventory.
No longer will buyers have to make the compromise of new versus used is the idea.
There are markets in Texas, there are markets in Florida that people have highlighted where existing home inventory is starting to return to something a little bit more normal I think when you look at it collectively right now across new homes and existing home, it's still it's still far far from being normal and therefore, we're still <unk>.
<unk> achieved the market share we get.
But because we can meet people on their move in time with our inventory we saw strength all the way through Q2.
April was good may was good and June was good so and we saw that across all of the markets.
Certainly we had communities that were utilizing more incentives to acquire sales they're not all in those locations. There's other reason why we are using incentives maybe its qualification issues et cetera, et cetera, but as we sit here today, Michael I can't tell you that the existing inventory is becoming a problem.
For us just yet.
This is part of the reason why Felipe mentioned on the gross margin components in the back half of the year, we're anticipating having to potentially offer some incremental incentives in some markets. As we've mentioned, we're a pace company, we're very very focused on maintaining our foreign net sales per store.
Annual basis, if we need to do more we're prepared to do more currently we're not seeing the need to do something materially greater than where we have been for the first half of the year, but if we need to in markets with higher inventory, we're prepared to do so and I think our margin guide has an element of conservatism in it.
We're expecting seasonality going into the quarter with less backlog and going into an election cycle. So we're being a little conservative right now.
And then we'll see how it goes.
Great and I appreciate those comments and actually kind of blood in your comments right at the end kind of segue into my second question.
Just around.
Just trying to clarify and make sure we're crystal on in.
Incentive trends currently and what you're baking into the back half and you kind of just said we are being conservative to some extent. So just wanted to make sure it's kind of clear that.
Number one the incentive trends during two Q I believe you just said hilla, but again wanted to make sure we're fully on top of this that.
Speaker Change: Incentive trends I believe you just said have remained.
Have been consistent throughout <unk> and not in other words, you haven't seen an increase in incentives.
As you kind of exited the quarter, let's say and.
If that's the case and Youre kind of just building in an extra cushion in the back half and that's why he said, there's an element of conservatism there.
Any way to kind of ring.
Speaker Change: Ring fence, you know what that.
Uh huh.
If you're talking about a 200 basis point decline back half versus first half how much of that might be related to being a little more conservative from the incentive front.
So I think we've been on record many times in the past Theres about 100 at the leverage component on volume typically from our best quarter to our R. R.
The strong quarter. So I think a piece of that is just that right. When we're talking about the margin guidance the pizza and shift in volume base leveraging components. That's the second part is exactly what you alluded to so during the quarter. Our actual cost per home was less we're able to you on a teen rate locks were slightly different stuff.
And the last couple of last couple of mines that have really helped our cost per room to come down, but we are seeing folks ask for them more frequently so our utilization is up a little bit while our cost per loan or cost per phone is actually coming down so back half of the year again, we're in a really wacky election cycle.
Very unclear whats going to happen I think some of our peer companies previously previously on this earnings cycle has said, it's not so much that the buyer doesn't qualify they're just real nervous right now it's a nervous time device. So we're committed and ready we have the firepower to offer incremental incentives into a wider group of.
As awesome buyers if they need that we don't know if they will or if they want but we're ready to offer if they do to maintain our sales pace.
Okay, and just to be clear again, you haven't seen that level of incentives increased throughout the second quarter and then if you're talking about 100 bips from volume deleveraging.
You also mentioned geographic mix or maybe the incentives as a $50 to 75 type of cushion is that fair to say.
Yes, we're not going to give specific numbers, but I don't think Youre mountains too for us.
Great.
Thank you.
Okay.
Our next question comes from Stephen Kim with Evercore ISI. Please state your question.
Yeah. Thanks, very much guys I appreciate all the color so far and the heavy lifting on the gross margins are there Mike just did I.
I think my question I wanted to shift here to the backlog turnover ratio and overall just your rate of velocity from your backlog into your actual revenues.
Speaker Change: Moving to a 60 day.
Kind of between sale and delivery kind of.
Speaker Change: Structure across the board that that that would imply about 150% backlog turnover ratio.
Speaker Change: You know, you're you've sort of been running in the high 100, <unk>. So I just want to make sure that we understand if you fully implement your strategy and it's humming along at some point, let's say next year.
Is that is it right to think that we should be incorporating in our modeling you know our backlog turnover ratio of about 150 or are there going to be markets, which are deliberately kind of permanently going to be not doing that 60 day kind of strategy.
Speaker Change: Yeah, no you're spot on I think over time as we get all of our communities and markets and operations pivoted into a 60 day move in ready.
Inventory model and cycle times remain.
Where they are 150% is within reach on a quarter by quarter basis. That's how the math works I don't know if I would model that for January one 2025, but thats 5 million evolution, we expect Arlington export five six quarters cash to have more clarity on how quickly we can get to that number but that is the target.
Yeah I appreciate that that's that's really helpful and I also appreciated your comment about the normalization of the resell inventory.
We're not there yet I mean nationally we're still at 3.8 months a normal it seems to be you know like five to six so yeah is it fair to say that if you look across your markets that there are one or two markets, maybe where you're you're at or above that normal level. You know, it's like six months, but by and large the vast majority of your markets are still nowhere near.
That is that a fair is that a fair assessment.
Yes, that's fair and again, we don't really operate at the MSA level.
We operate at sub market levels, we buy land in Submarkets, where housing dynamics are stable. So when you look at it across an MSA I think it can be misleading there are certain tertiary sub markets that are more impacted in infill submarkets different price points. So on a submarket by submarket level.
Speaker Change: It's a very small percentage of Submarkets, where we're seeing existing home inventory become become relevant in any way.
Yeah, that's what I would have thought.
Speaker Change: Last one for me I, just forgot to ask about build to rent.
That this is something that we're starting to hear.
People talk a little bit more of that can you just share again your thoughts regarding the build to rent market and any interest what their level of interest is in getting involved there.
Yeah, no. It's a choppy market, although I agree with you there has been some more interest we're seeing are.
Engagement with the VFR operators shift to more community level versus one off here and there to kind of close out subdivision. So we are seeing them re engaged a couple of folks that we hadn't heard from an Ohio jumping back in and so there is you know kind of that mid single digits total.
Volume that we're targeting and we're pretty much dead on right now.
Okay perfect. Thanks, so much guys.
Thank you.
Speaker Change: Our next question comes from John Lovallo with UBS. Please state your question.
Good morning, guys. Thanks for taking my questions.
John Lovallo: It sounds like everything is pretty good out there and fairly positive.
But your implied second half EPS is actually coming down by about a dollar from call. It 10 Bucks to nine Bucks. So I'm curious, what's driving that I mean, it seems like theres nothing that is worst today than it was in may So maybe you could help us understand that.
It's just the timing of closings, we haven't made any assumption changes in the back half of the year.
Speaker Change: All we've done is the timing of closings have been pulled into Q1 and Q2.
I mean I'm in a deep dive that just a tiny bit John so basically when we came into Q4, we guided to at 14000 to 15000 units. Then we brought up our guidance 14, five to 15, five and you brought up our guidance again this quarter. So we actually see the year developing better than we expected every time, we talk to you, which is which is really great news.
The kind of benefit that we're seeing some heart and stroke.
Strategic evolution is that we're just able to close more of those sales faster. So we've just moved the timing of some of those clothing, there's no degradation in what we're expecting for sales volumes, we actually increased our expectation for total full year sales. So it's really just the fact that we were able to execute on exactly what Steven talked to.
Our backlog conversion those benefits came in a little bit earlier than we had initially expected. So we're able to close our backlog in earlier quarters, but the total sales volume for the year is actually improving in the last two quarters not not not deteriorating. So we were able to harvest some of those prospects earlier in the year.
Okay understood and then you know you guys have talked about starting the number of homes in a particular quarter that you believe you can sell in the following quarter.
Starts in the second quarter ramp to I think 4319 from 4142 in the first quarter. So I mean is it fair to assume that you're expecting a sequential improvement in orders in the third quarter.
No I think we're there's a couple of things right. We have community count growth. So we're ramping up starts to marry our community count growth and usually.
In new communities, we tend to ramp ups. That's more so we can get started and then we're carrying more stacks to finish because we want to have move in ready inventory. So that's really driving the increase in the starts versus our expectation that Q3, and Q4 are going to be stronger than Q1, and Q2 that would be.
That would be unusual.
It's a combination of community count growth and it's the combination of trying to get all of our key is to a point, where we have move in ready inventory also.
This gain 4300, a little over 4100 feel like kind of the same to be honest.
Unique starts decision.
Months in advance so we actually thought that was a pretty good notch over time will tell as we get closer but that didn't see all that far apart.
Okay. That's helpful guys. Thank you.
Okay.
Our next question comes from Carl Reichardt with <unk>. Please state your question.
Good morning, everybody.
Want to ask about operating cash flow Hela do you have some expectations you could share with us about 2024 and then in addition.
Given the model you're operating your Oc F has been much more consistent quarter to quarter less seasonal than a lot of the folks that we cover.
I'm curious if you've got a target in mind in terms of converting conversion of net income to cash flow or vice versa either way.
More as you as you continue to run your inventory faster more of your net income converts to operating cash flow or free cash flow.
Yeah, I think that's a good way to look at it I think we try to introduce this concept that on our last call. We kind of look at our inventory in two different category, our wet bar sticks and bricks is turning much much faster.
Speaker Change: Improved cycle time, and the way that we're in.
We're shifting our strategy theater seeing that cash conversion happened very very quickly. The same time. We're also growing so our land investment is increasing which obviously as you know it takes about two years to come to market for that piece of our balance sheet is growing we're improving that with the off balance sheet piece, we haven't really talked about it yet on Q&A.
Any material growth in off balance sheet utilization this quarter. So we're getting that cash benefit on our balance sheet. So overall I think we're comfortable clothing, and but want to continue to hold a very large cash balance consistent with the other builders and equally are all a little gun shy during rough times in the cycle over the last 15 years.
We're going to have a big war chest of cash same as everybody else I said youre not going to materially pulling that back on the cash balance that we have today, which pretty much means youre redeploying what what we're.
Speaker Change: Generating back into the business and Q dividends and share repurchases, but probably not going to materially beyond that which means that we're gonna have to utilize off balance sheet financing to get to the numbers that we need to on our land spend.
Okay.
Just wanted to see if you could.
Could you give us a sense as to what ocs might be for 24, so I'll leave that but I did want to add one other element here.
So that the land that you are looking at now my sense is you want to continue to invest in the markets, where you've already got a deep presence because he want to build your share there, but as you're starting to look out a couple of years on the on the acquisitions you are making in the land market now do we think about the potential that you begin to expand into some new areas or should we expect that youre going to continue to focus on.
On the key markets that you're operating in now thanks.
Speaker Change: Yeah I appreciate it.
As we think about going from where we are at 20000 units. It really works. This way I think we can grow first and foremost market share in the markets. We're already in our goal is now to be a top three builder in every market that we're in.
We also have entered four new markets in the last I guess four years or so Charleston, Myrtle Beach Jacksonville in Salt Lake City. So we're getting those up to scale. So that that's a big big focus of ours and then there are a handful of secondary markets in the South, Texas and Florida that were looking at.
That are also part of that plan. So that's kind of the highest priority of our priorities.
Speaker Change: We've looked at 20000 units.
Great. Thanks, Felipe Thanks Sheila.
Our next question comes from Susan Mcclary with Goldman Sachs. Please state your question.
Thank you good morning, everyone.
Your cancellation rate has been running in that high single low double digit range, which as you mentioned is really below that mid teens historical norm as you think about the new strategy that youre putting in place.
Speaker Change: Should we expect that that can continue to come down does this feel like a more normalized level going forward just any commentary on how that's coming together and how we should think about the trajectory there as the full implementation of the strategy comes through.
Yes. Thanks for the question, it's definitely something that we're studying very carefully. We obviously believe hypothetically that if were selling 60 days moving homes buyers are pretty committed at that point, they're picking out their furniture at that point. So we feel like our cancellation rates should run lower.
And then folks that arent selling 60 day move in ready homes. So long term structurally we believe our cancellation rate could could move down meaningfully from where it has historically, but we still need to study that carefully certainly.
In Q2, we saw a really strong metric and believe that that could be sustainable.
Okay.
And then you saw.
Have some nice leverage on the SG&A line. This quarter as you think about the back half and the seasonality in the business just any thoughts on where that can go over the next couple of quarters.
Should we think about some of the investments that will be required around the strategy relative to the leverage that you can achieve.
Yeah, Great question. Thank you Susanne so most of our.
Capital to execute on the strategies already in place. So you shouldn't see a daily increase in SG&A commitments related to the strategy rollout. We've been we've been rolling it out behind the scenes here backs off 18 months as far as the leveraging as we said if we're going to have a lower revenue and lower units in the back half of the year there'll be some pull back.
And.
In leveraging although we continue to refine our cost structure and we expect can be able to be under for the full year. This year versus last year, and we have a target of nine 5% SG&A leverage longer term, so maybe a little bit of an increase in the back half of the year, but we're still going to come in under our prior guidance, which is 10% of that.
Sure.
Okay. Thanks for the color and good luck with everything.
Our next question comes from Alex Barron with housing Research Center. Please state your question.
Thank you good morning.
Speaker Change: I wanted to ask.
Assuming the fed starts to cut rates later this year.
How are you guys assuming rates start to move towards 6% or lower over the course of next year.
How do you guys envision.
Your approach to incentives do you feel like you would reduce the incentives to boost margins or you would maintain high incentives to boost the sales pace you know by offering even lower interest rates.
I think lower rates can only be good for our business and.
And for the housing sector in general.
I know people are concerned about lower rates.
As the impact they'll have on existing home inventory.
I think it's only a good thing it will help inventory turnover and those folks need to find home et cetera, et cetera, and I also think it should help with incentives clearly right now we're utilizing incentives to basic.
Basically the payment for our buyers.
Are being used for and I think as rates go lower will use less of those and because we are a move in ready.
Builder Theres not a lot of other incentives we need to offer.
Do options our design centers are lot premiums the types of the home is the price of the home and so I think lower rates will have nothing but a positive impact on our incentives for meritage homes, Alex if we wanted to pull that trigger we can use it in any way that we can actually extend its only going to be a benefit.
We choose to continue to press on the gas and increase the sales pace the cost of the incentives will be less right buying someone down into something with a four in front of that sun almost seven is much more expensive than buying them down funding with a foreign net from effects, it's still a material improvement over what they can get.
And in retail market or from their local bank, but the cost to us would be a lot less obviously for that 100 that strategy. So I think that there's opportunities every homebuyer has it has their own story and we have an arsenal of tools that we can use to make sure that we're getting them into the homes, but optimizing our margins at the same time.
Yes, because it would seem.
You want to offer lower rates to stay in their floors or even in the threes as as time goes by.
But you could get a big edge over over others, who.
You would probably not do that.
My My other question has to do with you mentioned maybe.
Maybe your next target is to go to 20000 units.
Over what timeframe would that happen or do you guys have like an annual growth rate that you were trying to hit over you know over the next few years.
Yeah.
Some of that will just be dictated by sort of reading the market.
Speaker Change: Our kids and our ability to secure land at the right price that underwrites.
Speaker Change: Even with those factors in mind, we believe we can grow 10% year over year. So that's the that's the minimum right. If we can do more than that we will.
And so when you think about that I think youre looking at a three to four year time.
Online.
Got it alright, well best of luck. Thank you.
Speaker Change: Thank you.
Speaker Change: Our next question comes from Ken Zenner with Seaport Research partners. Please state your question.
Good morning, everybody.
Good morning.
Just a two part question first when do you think given your planning youre going to see starts.
Match, the order pace given year rollout.
While they are they are pretty close.
We have a little room to go but we're pretty close.
But we're also going to see meaningful community count growth over the next six quarters.
So.
For new for new communities it wont match.
Exactly quarter by quarter until we get those right.
But other than that should be the only delta.
So like he was that I don't know if January one is the cutoff date, you still have some communities and divisions that were getting situated here as you roll out the strategy, but as we move into next year.
That should be what they should they be should match other than community count growth.
Okay.
And.
So.
Just so we can understand the <unk>.
Regression of your.
Increased land banking given your growth can you talk to the mix.
Finished acquired lots.
This quarter. So if you bought 100 lots or 30% of them.
Yes.
Given the owned lot could be either raw or finish.
And then as well what's happening kind of as a percent of sales. So closings for March you acquired finished just try to understand that dynamic is changing.
Change your laser approach it.
Yes, we can follow up with you on this.
Later I don't think we have those metrics in front of us, but I think what youre asking us is as we start to.
Land Bank.
More.
Are we going to be buying just in time finished lots from that land bank is that the spirit of your question.
It is a piece of it.
And I think that's actually maybe you could clarify when youre doing the land banking are you having the bank.
The are you buying Raleigh in front of them and why I assume you're implying you'd be buying finished lots maybe just a clarification.
Yes, so theres lots of different land banking structures out there.
We've been running closer to 30% for a while because most of the land that we've done with land sellers.
And that type of land banking is you take phased takedowns from a farmer or somebody else.
Overtime and bylaws when you are ready to put a shovel in the ground and start developing and it helps us keep some of the land off balance sheet and land bank.
There are also traditional land banking structures out there that are through land bankers, who come in and buy the land pay for the development and then roll you finished lots we haven't done a lot of those but are starting to ramp that up.
Over time that piece of it will provide finished slots as it relates to the market.
There arent a lot of finished lots out there. So we're not finding a lot of finished lot deals over 98% of our land is self developed.
Thank you very much I appreciate it.
Okay.
Thank you and our next question comes from Jay Mccanless with Wedbush Securities. Please state your question.
Hey, Thanks for taking my questions first question I had with this new strategy and trying to sell within that 60 day window is there going to be a lag as you are opening these new communities and he can actually start selling homes. Just based on that 120 day cycle time, you were talking about it seems like youre going to have.
To get some of these homes built before you can actually open the communities is that the right way to think about it.
The right way to think about it if we were pivoting.
Every.
Land and community growth schedule, we have now built that into our plan already and we've been layering that in for over a year, we've been 100% stat builder for a while so all we're doing now is carrying those specs 30 more days or so so we're building those into our community schedules, we're building those into our.
Forecasting and we're building those into our underwriting when we actually buy land that we know when we open up our communities need to open up with with Union ready inventory that to say it another way.
Most people don't open up communities without any inventory kind of ready to go because it's a new Canadian people want to see it right. So typically when you open up a new can we at least if you affect though that one of your 60 day moving or not you have <unk>.
So actually you mentioned you're already in the construction cycle. So you mean, you here just a little bit further along and our 60 day commitment, but it's not too different than how we've been operating.
Okay and then.
Then in terms of the gross margin impact from some of the extra as you guys talked about in the analyst day, the blinds garage code et cetera.
Do you have an average so far of what gross margin impact of those extras are are going to put on the house.
We were we were conservative and we thought that they would be breakeven and we didn't know that we had the opportunity to increase prices. We thought we were going to put that stuff in house, because we and aligned with our strategy and we were going to kind of charge.
<unk> forehead.
Actually been able to earn a nice margin on it so I would say worse case, it's neutral best-case medians, adding like five depth, but.
But we are actually seeing a profit component on that move in ready package at package, we probably underestimated the desirability of that package in the marketplace.
Speaker Change: Okay.
Speaker Change: And then the last one for me any could you benchmark, where you are in terms of rolling This out is it 60% of the count 70% account any type of framework of reference for where you are in the rollout.
Yes.
Speaker Change: Yes.
Ken insight, where when it comes to a move in ready.
Speaker Change: Good.
<unk> per se when it comes to.
Having turnkey homes, it's a little bit further and then when the real true relationship piece, we're still figuring out. So we expected to have this fully implemented implemented next year.
The timeline we're on.
Good day.
Okay, great. Thanks for taking my questions.
Thank you.
Speaker Change: Thank you there are no further questions at this time I'll hand, the floor back to Phillipe Lord for closing remarks.
Thank you operator, I'd like to thank everyone, who joined this call today for your continued interest in <unk> homes. We hope you have a great rest of the day and great weekend. Thank you.
This concludes today's call all parties may disconnect have a great day.