Taylor Morrison Home (NYSE:TMHC) Q2 2020 Earnings Call

0:00 Good morning and welcome to the Taylor Morrison Second Quarter 2020 Earnings Conference Call. Currently, all participants are on a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will be given at that time. As a reminder, this conference is being recorded. I would now like to introduce Mr. Jason Linderman, Vice President, Investor Relations, and Treasurer.

0:29 Thank you and welcome everyone to Taylor Morrison's second quarter 2020 earnings conference call. With me today are Sheryl Palmer, Chairman and Chief Executive Officer, and Dave Cohen, Executive Vice President and Chief Financial Officer. Sheryl will begin the call with an overview of our business performance and our strategic priorities. Dave will take you through a financial review of our results. Then Sheryl will conclude with the outlook for the business, after which we'll be happy to take your questions. Before I turn the call over to Sheryl, Let me remind you that today's call, including the question and answer session, includes forward looking statements that are subject to the safe harbor statement for forward looking information that you will find in today's news release. These statements are subject to risks and uncertainties that could cause actual results to differ materially from our expectations and projections.

1:20 These risks and uncertainties include, but are not limited to, those factors identified in the release and in our filings with the Securities and Exchange Commission and we do not undertake any obligation to update our forward-looking statements. Now, let me turn the call over to Sheryl Palmer.

1:36 Thank you, Jason, and good morning, everyone. We appreciate you joining us today. We continue to find ourselves navigating these uncertain times and I sincerely hope that you have all been healthy and safe and will continue to be. Earlier this month, we provided an update on our second quarter results as a part of our debt refinancing project, which Dave will discuss in more detail soon. And at that time, we expressed how pleased we were with how the business has performed the last few months after the initial impact of COVID-19. I'm happy to report that those trends have continued through July, and with two more days left in the month, we're on track to deliver year-over-year growth in net sales of approximately 80%.

2:25 That sales success translates to a projected pace of nearly four sales per outlet per month, about 60% growth year over year. The resiliency of the business has been remarkable and something that has produced great pride within the organization. We pivoted quickly, established new norms, and aggressively pursued strategies to ensure the safety of our team members and customers conforming to the necessary social distancing practices. It's because of this flexibility that we were able to deliver our impressive second quarter results, so let me share some key highlights. We finished the quarter with 3,453 net sales, representing year-over-year growth of 23%. April represented our lowest sales point during the pandemic, where we were down year-over-year by 36%.

3:24 May was up 17%, and then June was an extraordinary up 94% on a year-over-year basis. The consumer data driving these numbers is worth sharing. Three of our largest consumer groups saw overly quarterly growth, entry-level, first and second move-up, and active adult, and they each have their own story. The first two groups delivered solid growth, both in timing and magnitude. and for those customers the rebound was swift and steep. Our first time buyer group was up 16% year over year and I was delighted to see our move up buyers up more than 20%. The active adult group is where the most interesting narrative has emerged as their recovery has been slower and slightly better than flat on a year over year basis for the second quarter.

4:18 Thank you for watching. Although I find most interesting that our in-state Florida sales on an absolute basis for this buyer was up more than 50% in the second quarter year over year. Our out-of-state buyers remained highly engaged in planning for their winter travels. In fact, 40% of our website shoppers in the quarter were 55 plus, more than two times any other age cohort.

5:07 During the pandemic, we have seen the greatest success in our luxury lifestyle, golf, water, and country club communities, as they have all continued to perform well. The luxury active adult buyer has remained the most engaged, and it is actually the more affordable subset of this demographic that has taken a little longer to reengage. The overall strength in sales drove a quarterly pace of 2.8%. which ties to the highest level for a second quarter that we've seen in years. In April, our pace was down 43%. In May, it was flat. And in June, it was up over 70% year over year at 4.3, which was the highest pace in our company's history.

5:52 This is the most critical metric providing an apples-to-apples blend for sales activity levels. This strong performance was driven by both the Taylor Morrison and William Lyon legacy businesses. Closings for the quarter came in at 3,212, an increase of about 24% compared to the same quarter last year. In April, we were basically flat last year. In May, we were up almost 20%, and in June, we were up just over 55%. The second thing to note with our quick ramp-up We were able to further enhance our strong cash position, which Dave will speak to during his remarks.

7:03 Looking forward, I'm hopeful that the trades will be able to shake the constraints felt during the pandemic and the most recent spike in positive cases that we have seen amongst some trade partners and manufacturers. I'm often asked, what's at the heart of our sales success or what is driving demand during such uncertain times? and do we think the drivers are sustainable? Although a complicated question, I'd like to share some of my thoughts, some macro related and one very specific to Taylor Morrison. First, the interest rate environment is the most accommodative I've seen in my career. With rates at all-time lows, it in and of itself provides an extremely strong stimulative impact. It's compelling for the consumer, drives real action, and more importantly, create multiple ripples throughout the larger economy that benefit home building.

8:03 Second, the resale inventory is extremely low and coupled with the rate environment, it effectively pushes more demand to new homes. Third, there was a thesis at the beginning of the pandemic involving a flight from urban areas where personal space is limited to more suburban or rural areas where space is more abundant. I can tell you this is a real phenomenon and we are seeing it come to life in our data. We now have about 20 consecutive weeks of targeted research on COVID impacts driving motivations with our buyers and shoppers. And what we've seen in both our sales offices and virtually through our website is that what began as casual discussion has evolved into real action.

8:51 It has become clear in our buyer data that these initial discussions have converted into sales. Some are highly motivated to get out of the urban core in addition to their motivations for bigger and more spaces, enhanced technology, and a strong bias to new for the differences in health and wellness features. We've seen a steady appeal to new product as a reflection of customers' desires for safer and cleaner living. As a result of this feedback from our home buyers and customers, I am delighted to announce that effective August 1st, all homes sold for new construction starts will include a number of Taylor Morrison Live Well product enhancements.

9:39 These products will be standard features in every home including an upgraded air filtration system, a new whole house water filtration system, and a micro bisidial interior paint with a chemical free formula which absorbs bacteria and prevents mold, all contributing to cleaner indoor air quality. With our customers spending much of their time at home these days, we want to positively contribute to their quality of life by providing standard features that will help keep them healthy. Our Live Well Suite will also soon include several selections available in our design studios with both healthy and convenient options for our buyers.

10:25 And lastly, I continue to be encouraged by another significant driver of our strong sales performance, and that's our unmatched focus on the virtual experience with new innovative tools and digital capabilities. Our digital journey began long before the pandemic and will live on long after it. The home shopping experience has an equal role to play in the overall customer experience, so we stood up more self-service features for consumers to do as much of their research at home and on their own time than ever before. We aggregated our virtual tours from across the country into a single point of entry, making it easier than ever for shoppers to experience visiting a Taylor Morrison model or community without having to leave the comfort of their home.

11:16 The engagement of our virtual tools online continues to be more than twice as high as other webpages and with much higher conversion rates. The website offers more than just a digital retail experience, but really serves as a true extension of our sales teams. Recently, we introduced two innovative additions to our online suite of self-service and virtual options, self-guided tours and online home reservations. Our self-guided touring technology is live in completed inventory homes across the country. Thank you for joining us today. Thank you for joining us today.

12:53 Thank you so much for joining us. 100% virtually. We know consumers have long craved technological advancement, self-service, and convenience when it comes to our industry. This transition has been long overdue and is one of the few silver linings to an otherwise extremely tough period.

13:43 So how sustainable is the current environment? I'm not sure how good my crystal ball is, but thought I'd share a few thoughts. When it comes to the mortgage rates, The Fed has made it clear they will work to protect the economy, and in their estimation, a low-rate environment is one meaningful way to do that. As for low inventory levels, they were relatively low before the pandemic, and that has only been exasperated in both total number of units and quality of inventory. Thank you so much for joining us. We believe that a more structural impact of COVID is consumers' focus on their personal health and environment. We believe giving our homebuyers peace of mind around the quality of their home will eventually become table stakes in building and are so delighted to introduce TM Live Well. And finally, the transition in our approach to the sales experience is absolutely here to stay, and I

15:13 am pleased with how our virtual shopping experience is the first to have advanced to being truly an online buying experience. As I said earlier, it's long overdue, and as an organization, we're committed to continue to be out in front with these changes. Now, let me turn the call over to Dave for the financial review.

15:37 Thanks, Sheryl, and hello, everyone. Before I get into our second quarter financial review, I'm going to take a minute to discuss our recent debt offerings because it showcases our consistent commitment to the stewardship of our balance sheet. At the time of the William Lyon acquisition, we discussed our desire to eventually refinance a portion of the debt assumed as part of that transaction. Earlier this month began that effort when we raised $500 million, upsized from $400 million due to healthy demand, to partially refinance our acquired 2023 and 2025 bonds. In addition, we used $125 million of our cash on hand to partially pay down the same sets of notes while also covering the standard fees and call premiums associated with the refinance.

16:29 In total, this effort will save the company about $10 million in annualized interest while also helping our focus to de-lever over time. This is a first step in the overall vision of managing our existing debt and will continue to be opportunistic as the market dictates. Assuming current trends continue, we hope to address the roughly $185 million remaining balances on the 2023 and 2025 bonds through a partial or complete pay down in the coming months. We were able to incorporate a significant pay down piece to this refinancing project because of our strong liquidity. At the end of the second quarter and before the debt refinancing, we had over $900 million in total available liquidity.

17:14 About $675 million of that was cash on hand, with the remaining difference being capacity in our $800 million corporate revolver. We did have $485 million in borrowings on the revolver at quarter end, but similar to the end of the first quarter, much of that has been held in cash on our balance sheet, as we've taken a cautious approach to preserve liquidity during even certain times. We anticipate paying off some or all of the revolver balance by year end, Subject to other considerations around balance sheet management as I previously discussed. Our net debt to capital ratio at the end of the second quarter was 46% and we expect it to be in the low to mid 40% range at year end.

18:01 Our leverage continues to track well ahead of where we expect it to be at this point in 2020 and we now believe we will reduce our leverage to the low 40% range by the end of 2021. as compared to our previous expectation of mid 40%. Turning back to results for the quarter, net income was 104 million and diluted earnings per share was 80 cents when adjusted for expenses and purchase price accounting related to the William Lyon Homes acquisition. Including these acquisition expenses, we reported net income of 66 million and diluted earnings per share of 50 cents on a GAAP basis. Total revenues for the quarter were $1.53 billion, including home building revenues of more than $1.47 billion. Home building revenues were up roughly 20% from the prior year.

18:54 For the quarter, adjusted home closings gross margin, excluding 220 basis points and purchase accounting adjustments, was 17.6%, which is consistent with the second quarter expectations we shared in our first quarter call. Gap Home Closings gross margin was 15.4%, inclusive of capitalized interest and purchase accounting. The strong order success in the second quarter led to better than anticipated sales of finished spec inventory from William Lyon that sold and closed within the quarter. While this did put a bit of pressure on margins, we are excited to be working through this aged finished spec inventory more quickly than we planned and is a big reason in how we drove the number of finished specs per community from 1.7 in the first quarter to 1.3 in the second quarter.

19:43 I'm also pleased to report that even with our effort to reduce this aged inventory, our second quarter total incentive levels were sequentially lower than Q1 as well as lower on a year-over-year basis. We are two quarters into the integration of William Lyon and have worked through some of the more significant headwinds impacting margins. Reducing this aged inventory earlier than expected bodes well for margins in the second half of 2020. And while purchase accounting will continue to be a headwind for us over the next two quarters, it will be at lower levels relative to the first half of the year. This should lead to sequential margin improvement as we move through the year despite some continuing integration impacts as well as our efforts to increase Legacy William Lyon margins to be in line with that of Legacy Taylor Morrison, a process that takes about 12 to 18 months to fully complete.

20:40 Moving to financial services, we generated approximately $40 million in revenue for the second quarter and more than $17.5 million in gross profit. Our mortgage company capture rate for the quarter came in at 81% compared to 72% during the second quarter of 2019. We continue to be pleased with the capture rate as we've integrated our legacy Taylor Morrison and William Lyon financial services team. It's worth adding that as we look at the consumer data in our lending operation for the second quarter, our millennial buyers were up more than 38% year over year, and our single buyers were up more than 20%. Our backlog capture looking forward for the new combined business is 87%.

21:27 SG&A as a percentage of home closings revenue was 9.9%, representing 20 basis points of leverage over the same quarter last year. The leverage was driven by increased scale, strong market conditions as we rebounded through the quarter, and cost control measures we implemented in response to the pandemic. Adjusted EVT margin was 8.9%. In addition to purchase accounting impact in Q2, we had approximately $18.7 million in expenses, related to the William Lyon Homes acquisition. We're through the vast majority of the expenses related to the acquisition, but you will see additional expenses over the next couple of quarters as we continue to integrate the business. I'm encouraged to report that we continue to be in good shape with integration, which Sheryl will expand on later, and we can once again reaffirm our previous guidance of $80 million in annualized synergies.

22:25 Lastly, income tax was $17.6 million, representing an effective tax rate of 20.8%, as we benefited from energy credits as well as favorable tax true-ups. During the quarter, we spent over $370 million in land purchases and development. As demand has returned and we see sustainable trends, we began to slowly transition back to more normal course land acquisition and development activity. We had approximately 67,000 home building lots owned and controlled. The percentage of home building lots owned was about 72.5% with the remainder under control. On average, our home building land bank had approximately 4.9 years of supply of which 3.5 years were owned at quarter end based on a trailing 12 months of closings including a full year impact of the William Lyon acquisition.

23:23 I'll wrap up by sharing our Q3 guidance. For the quarter, we anticipate average community count to be about 410, consistent with the second quarter. Closings for the quarter are planned to be between 3,000 and 3,200. Gap home closings gross margin, inclusive of capitalized interest and purchase accounting, is expected to be in the mid to high 16% range. In addition, we will have a charge of about $8 million related to the debt refinancing we completed earlier this month. Effective tax rate is expected to be about 22%, and the diluted share count is expected to be about $131 million. For the full year, we anticipate closings to be approximately $12,000.

24:11 GAAP home closings gross margin inclusive of capitalized interest and purchase accounting is expected to be in the low to mid 16% range. SG&A as a percentage of home building revenue is expected to be in the low 10% range. We anticipate an effective tax rate of about 25%. Land and development spend is expected to be approximately $1.4 to $1.5 billion for the year, and we expect our diluted share count for the year to be around $129 million. Thanks, and I'll now turn the call back over to Sheryl.

24:46 Thank you, Dave. Before we move to Q&A, I'd like to share some local market updates. First, I'll focus on a few states that have been in the news lately with higher infection rates of COVID-19, including Arizona, Texas, and Florida. Out of the 11 states in which we operate, those three are in the top five for quarterly net sales growth on a year-over-year basis. When I look at pace, Arizona and Texas are in the top three, for quarterly year-over-year growth. So the recent surge in cases doesn't appear to be dampening consumer demand. As for the balance of our portfolio, each of those markets are in different stages of reopening with a few notable call-outs.

25:31 In California, we saw nice sales recovery in each of the markets, including the Bay, which is still our only market that is not 100% open for business due to regulatory constraints. Colorado Business has added a needed affordable segment to the portfolio with overall ASP down nearly 10% for the quarter. The Pacific Northwest has seen meaningful improvement in sales over the last few weeks even with Seattle on an appointment only basis while experiencing municipality restrictions similar to what we're seeing in the Bay. The good news is our Seattle production was in the ground early in the year and it is a high inventory turn market.

26:17 The last topic I'll address is the progress we're making with the integration of William Lyon Homes. Let's break up the different integration categories. Beginning with people and brand management, we're 100% complete and have been for some time. Our other categories of processes, systems, product and synergies, continue to advance making good progress through the oversight of our integration management office. And I would describe each of them somewhere between 50% and 75% complete, just less than six months from the acquisition closing. To say I'm pleased with our progress given all that we've had to manage through would be an understatement. It's because of this great integration work and what Dave alluded to in his comments, that we remain in a position to reaffirm our $80 million synergy estimate on an annualized basis.

27:12 I want to close with a heartfelt thank you to our teams for exhibiting the type of resiliency we've always talked about but now have the opportunity to demonstrate. It's an honor to watch it and I hope you know that you inspire me on a daily basis. To our trade partners, thank you for being wonderful partners through such difficult times and for working with us to deliver the best experience we can to our customers. And to those customers, thank you for your business and for your loyalty to Taylor Morrison. With that, I'd like to open the call to questions. Operator, please provide our participants with instructions. Thank you. Ladies and gentlemen, if you wish to ask a question at this time, please press star then 1 on your touchtone telephone. We do ask that you limit yourself to two questions.

28:00 If your question has been answered or you wish to remove yourself from the queue, please press the pound key. To prevent any background noise, we ask that you please place your line on mute once your question has been stated. Our first question comes from the line of Carl Rincart with BTIT. Your line is open. Please go ahead.

28:16 Thanks. Morning, everybody. Morning, Carl. Hi. I had just a clarification question on the guidance to start with, just on the margins, David. And I guess it's a broader question, too. What's the purchase accounting and integration impact likely to be in basis points or dollars on Q3 and for the year? And then when do you expect it to really bleed off and we're looking at sort of a core normalized margin?

28:40 Sure, Carl. So first, from a purchase accounting impact for Q3, it's likely going to be around 100 basis points. And then we're estimating right now for Q4 about 50 basis points and That obviously will be determined based on mix, but it should be somewhere in that neighborhood. From a core margin perspective, and I think you know we've talked about this in the past, it takes us about 12 to 18 months to bring, in this case, the legacy William Lyon margins up to a level that's equal to legacy Taylor Morrison. And we've seen that with our past acquisitions, more recently with A.V., When we were able to do it, it took us a little bit more than a year, and I anticipate this to play out the same way. We've done a lot of work around our national contracts as well as regional contracts, and a lot of the heavy lifting that's going on right now is down at the local level from a cost perspective.

29:42 And the way things are trending, we're confident we're going to fall back in between that 12 to 18-month window to get the margins where we want them to be.

29:52 Okay, that's very helpful. Thank you, Dave. And then, just again, a bigger picture question here. So, post-Lyon, obviously the mix has shifted significantly to the West. It's gone downstream to a certain degree. So, Sheryl, as you look at the markets that you have now and the mix that you have now, over the course of maybe three to five years, are you kind of happy with where this is, or how would you like that to change, or where might you shift that over time? Thanks very much.

30:20 Thank you, Carl. Good questions. So let me break that into two pieces, I think. One would be geographic, and one would be consumer. When I look at our footprint today, with the addition of Lion and getting into the PAC Northwest and into Nevada, we really like our footprint. There's always possibilities, but we're quite content with where the business is today and being in the key markets across the U.S. When I look at consumers, Carl, you know, Part of the strategy with both AV and Lion was that we had a stronger bias to that more entry-level buyer. When I look at the business today, you know, William Lion was just over 80% entry-level and first move-up. Today, the combined business is about 72%.

31:13 So when you take that and you add the active adult, we're really pleased with the consumer mix I would say that as part of that, you know, it was really about a change in average sales price. When I look at markets like Austin, for example, you know, the Taylor Morrison ASP was about 50% higher. And I look at places like Phoenix and Denver where, you know, it probably brought those ASPs down 10 plus percent as well. So I like the entry level. I like the more professional entry level that we have. We like the active adult. We're starting to see real movement there. So a long way of saying, I think the mix could move a few basis points, but it feels pretty good.

31:59 Thank you, Sheryl. Appreciate it. Thanks a lot.

32:00 Thank you. Thank you. And our next question comes from the line of Jack Messinko with CSIC. Your line is open. Please go ahead.

32:11 Good morning. Close enough. I guess first question, Dave, on the balance sheet, when I'm looking at Bloomberg here, I think you had said you were thinking about paying off the balance of the 23s and 25s. I get about $150 million there. Am I thinking that right? And I'm assuming that $10 million interest guide does not include the payoff of the sub on those. Am I thinking about that correctly in total?

32:36 Yeah, let me just clarify one thing. The payoff's about $185 million, or that's what we have left. remaining on the two tranches. So, but to your point, yeah, the $10 million that we talked about in the prepared remarks, that's just for the refinancing part that we took care of plus the small pay down a few weeks ago. If we were to, just as an example, pay off that entire $185, the savings annualized on the combined between the previous transaction and what could be the second transaction is probably more around 18, 19 million savings and interest.

33:15 Okay, great. Perfect. And then, Sheryl, I'll just bring a picture. You know, you highlighted virtual, I think, maybe more than your peers. And two sales a day completely virtual is pretty surprising. You know, I'm thinking about what this means longer term on the SG&A side. And you think about You know, maybe less agent co-op, maybe more sales, you know, less sales people per community, maybe more of a multi-community. How are you thinking about, you know, you kind of had this, you know, real estate marketing has made like five to ten years of advancements in about six weeks. How are you thinking about that at a higher level on those points?

34:03 Yeah, it's a really good question, and Jack, one we're spending a lot of time on. So there's so much there. Let me try to attack it a couple different ways. I mean, I think first and foremost, this was really about allowing the customer to interact with us, meeting them where they want to be, giving them a direct line to our sales associates even when they can't come in, and we did that through the original technology, and that was setting up appointments. When we started to see the success there, and to date we've had over 9,000 appointments set, there's still a desire for personal contact. If I look at those 9,000 appointments in the last three months, 80% of them set up an appointment directly with the salesperson to come in and still meet with them and still have a private tour.

34:54 And the rest kind of divide their way between the other vehicles that they took advantage of. I'm surprised but I'm not surprised because when I look at the way they're interacting with the site, Jack, it's really been interesting. So if I look at the new trends with the self-guided tours or the reservations, those are just literally a couple weeks in. But we're already seeing pretty significant trends in the way they're going deep into the site. They're spending their time. If they're booking a tour, they're spending about 11 minutes on our site. if they're making a reservation, it's closer to 14, 15 minutes. That's five times historical averages. So what we're learning from the consumer is they really crave data and giving them the ability to self-select I think is part of our new normal. So when you look at our reservations today on inventory homes, I expect that will evolve sometime hopefully later this year to reservations on to be built, pick a lot, pick a house.

36:06 And then I think the impacts of that, to your point, will really start showing up in the way we look at model centers, the number of plans that we have to put into our model centers, our co-broke opportunities. We're already seeing a trend. Now, it's small numbers so far, so we'll continue to watch it, and I can update you next quarter. but we are already seeing a trend that those reservations are coming at a lower percentage of co-broke than you would normally see in the business. So early days but I think it becomes very promising. Probably the last thing that I should mention is the real impact SG&A is we spent about 50% in advertising in the second quarter that we did in the first quarter and generated significantly higher traffic Thank you. Have a great day.

37:09 Thank you. And our next question comes from the line of Alan Ratner with Zellman & Associates. Your line is open. Please go ahead.

37:19 Hey, guys. Good morning. Congrats on all the progress and nice job in the quarter here. So, First question, maybe this is for Dave, just looking at the closing guidance. So if I look at your full year, it implies that 4Q closings are actually going to be less than 3Q, which obviously is counter seasonal, and especially given the strong order activity. And I'm imagining a lot of that has to do with all the disruption during the pandemic. But I'm curious if you could just kind of talk a little bit about what you're seeing as far as cycle times, labor availability, what's really driving that conservatism in the 4Q closing guide and Kind of building on that a little bit, what's your current strategy related to specs? Because I know Lion obviously was more spec-heavy than legacy Taylor Morrison, and I think you had indicated that you were kind of willing to keep an elevated spec count on those projects going forward, but the closing guide doesn't seem to suggest that.

38:14 Thank you.

38:16 Hey, Alan. Yeah, thanks for the question. It's a good one. So, yeah, if you take the midpoint, it does imply that Q4 will not be the highest year. Thank you for joining us. to close in Q4. And just from a cycle time perspective, April, May, June is probably going to close in the fourth quarter.

39:01 So that is the main driver of Q4 and the closing guidance. From a cycle time perspective, that one's actually pretty interesting. You know, I would tell you with the pandemic and what's gone out in the industry, you We've actually seen cycle times either be flat to slightly better than they were, call it, you know, this point last year. I think with the reduced level of starts, there was a little bit of a catch-up out there in the industry, which obviously favored cycle times. The one probably push on that is maybe around the municipalities, but I would say by and large they've been great in working with us as well, trying to get, you know, either home started or over the finish line.

39:52 We'll see how that plays out for the rest of the year. I think we're putting starts back in the ground obviously with strong demand to your point. We're targeting call it six to seven specs per community that's both in process and finished. We're obviously lower than that right now because of the shortfall in starts in April and May. But we expect to build that back up, you know, over the course of the year.

40:19 And maybe I just add, Alan, I'll take the opposite, the unusual role for Dave and I to be more of the pessimist of the group. You know, we saw that improvement in cycle time and we saw that lag in total work. You know, some of this is just we don't know. You know, day to day you see COVID crew impacts, you see manufacturer impacts. If we can retain those cycle times, But you have everyone. That lag doesn't exist anymore. Everyone put in a lot of starts. So if you can retain those cycle times, which I wouldn't expect we could. You know, I think if you lose a week or two, you do lose your fourth quarter, some impact on the fourth quarter closings. Then, you know, hopefully we're a little conservative. It's hard to be sure. If that's what we deliver for the year, we're going to have a wonderful first quarter.

41:09 That makes a lot of sense. I appreciate the explanation there. Sheryl, I guess just thinking about the portfolio now, obviously through all the acquisitions, you guys are as diverse as you've ever been from a geographic and product standpoint. As you start to step back on the gas on land acquisition, I'm curious, based on what you're seeing in the market and your views on what this post-pandemic world could look like from a housing perspective, Should we think about any notable mixed shifts in the business going forward in terms of where you're allocating your spend today? Is there a price point you are more bullish on or more conservative on? Is there a geography you're more positive on going forward compared to where your current portfolio is?

41:51 Yeah, I think like I said before, Alan, I actually feel pretty good about the portfolio. I look at our overall inventory of three and a half years owned. That's a number we haven't seen before, you know, almost five years controlled, total closing controlled. I like that. We're pretty much done for 21, 22, honestly. We're actually in pretty good place. So there will be some opportunistic. When I look well beyond that, you know, it's really going to be on the kinds of deals we put on the books, you know, really to drive the returns. But as far as the geographic and the consumer mix, I'm very happy with where we are. I think the other opportunity that you'll see us spending some dollars on is BTR. Now we haven't really updated the street because we are now just have gone horizontal on our first two projects.

42:48 We're under contract on a number of other projects in Arizona and starting in Texas and Florida. So I think you'll see some dollars spent there and I think that also bodes well when I look out over the next few years on the demand characteristics as potentially interest rates move that this whole need, everything we're talking about for single family living will be very much alive and if not on steroids. And I think we'll be prepared on both sides of that.

43:19 Sounds great. Good luck with everything.

43:21 Thank you. Thank you. And our next question comes from the line of Michael Routt with J.P. Morgan. Your line is open. Please go ahead.

43:31 Hi, this is Maggie on for Mike. First question on incentives. You mentioned that 2Q was down both sequentially and year on year. I was wondering if you could give us kind of a month by month breakdown of how those trended as demand strengthened and then looking into 3Q and into July, what you were seeing in terms of incentives and any opportunity to take price in your markets.

44:01 Sure, Maggie. You know, go back to, you know, kind of the March-April when the pandemic first began. Our bias was forward space, obviously moving the inventory because we weren't sure what was going to happen. So incentives did creep up during the April timeframe and into May. You know, call it, you know, early to mid-May, we started to see the strength. We started to pull back on incentives, and they've fallen from there. Sheryl gave you an update on July. market continues to be very strong and we're taking back incentives where we can and obviously pushing price where we can.

44:39 Yeah and I think that's the interesting pattern Maggie as you know still every month was lower than last year but sequentially to Dave's point they came down so first incentives came down and then prices started to move up.

44:55 Okay thank you and second just on SGA and some of the cost control measures that you took early in the quarter. In terms of those measures, as you're looking forward over the kind of the medium to longer term, how many of those cost control measures would you say are temporary and those costs will come back as demand has returned? And how many would you say are kind of more permanent in nature?

45:27 Maggie, I'd say the vast majority were more temporary. They were around headcount, primarily deferring some projects, things like that. We not only are seeing demand that has returned, it's actually, as you know, in excess of what we saw in the first half of the year. As we think about our business going forward, we're in the process of ramping back up to meet the The demand and the deliveries that we're going to have over the next six to nine months. That said, our SG&A runs relatively low, especially relative to the rest of the peer group. And we continue to expect that will happen as we get the efficiencies of scale from William Lyon.

46:15 We're starting to see that come through a little bit, but that's going to happen more so, call it over the next three to four quarters.

46:21 Yeah, and I would hope the more permanent buckets because from a headcount standpoint, it's right. I mean, look at the run rate of the business today based on our sales and the size of this business. But if you think about advertising and the efficiencies we're going to get through this virtual environment, if you think about co-broke, it won't change overnight, but even modest trends on the kinds of co-broke dollars are significant. So you'll see some of those offsets. Great. Thanks, guys. Thank you. And our next question comes from the line of Jay McCandless with Woodbush. Your line is open. Please go ahead.

47:01 Good morning. Thanks for taking my questions. Thanks, Jay. Good morning. The first one I had, if we look at the orders in 2Q, could you break out what percentage of those were 2B built homes versus spec? And then in terms of the 2B built, when those should approximately deliver?

47:24 Close to half and half, right? It's close to half and half, Jay. So your 2B bills, if you sold them in Q2, you know, you have some markets that will deliver some. And then you have some that just won't. Because if you think about, you know, from sell date to start, I would say depending on the municipality, could be anywhere from 3 to 10 weeks. It's quite a range. But I think that... To your point, the real important data point here is just that we continue to see success in both the to-be-built market as well as the inventory. People are, you know, the consumer today knows what they want and are willing to wait for it and pay for it.

48:09 Absolutely. Definitely a good sign of confidence that people are waiting on a 2B built home.

48:14 Yeah, agreed.

48:16 The other question I had is around your split between your orders or closings, however you want to express it. First-time buyers versus the move-up versus active adult, where are those percentage splits hitting now?

48:31 Yeah, so, you know, like I said, Jay, really there's been a fair amount of movement year over year. with the combined business. So right now, we are about 72% for the quarter. You know, depending on closing, if I'm talking closings or sales, you know, one, they're two points apart. So 70, 72% entry-level first move-up. There's a lot of blurriness. between those two segments because a lot of folks from a price point are buying their first house but they're waiting longer. So I kind of put those two together. We've seen a reduction in our second move up and in the quarter a very slight reduction in active adult.

49:24 I expect that when I look at the active adult business we'll see that ramp back up in the shoulder season given all the buying signals were seeing from the active adult today. They're spending a lot of time on the phone with our sales teams, hours on the website. They've become our largest web user, which was a surprising step for me.

49:49 If I could sneak one more in. You talked about how the luxury active adult buyer seems to be hanging in there. What have you seen from more blue-collar, entry-level white-collar type of active adult buyers?

50:02 Yeah, so another, you know, like I said, another area of interesting kind of trend is we really dissected this active adult and what their behaviors were. I mean, all along we've seen the lowest CAN activity. But when we look community by community and product line by product line, there's two real interesting trends, and that's why we mentioned them. One is the amount of in-state business. I mean, our in-state numbers have gone, especially in Florida, have moved meaningfully. And it's not because the total's down, so it's not a percentage gain. It's the absolute numbers have really moved. The out-of-state, we've seen another interesting trend, and then I'll get to the subset, is things like Connecticut has become a really important feeder for Florida. Those folks are all of a sudden...

50:59 are able to sell their homes because there's a lot of movement out of New York and then relocate to Florida. So that's where a lot of the Internet business is coming from. But so far, we've seen our most success in what I would say are our highest price points, luxury living. I think these folks look at the environment and see it as a staycation and moving to Florida and within these country club environments. Having said all of that, probably in early June we've started to see the more affordable active adult come back in larger numbers. It just took a little bit longer.

51:42 That's great. Thank you for taking my questions.

51:44 Thank you so much. Thank you. And our next question comes from the line of Ryan Frank with RBC Capital Markets. Your line is open. Please go ahead.

51:54 Hi. Thanks for squeezing me in here. So some of your peers, there's been some difference in how everyone is approaching pace versus price. And with kind of absorptions running hot across the industry, I just want to see where you fall on that spectrum, if you're willing to run pace a little more, maybe run out some community accounts, or if you're thinking about pushing price to kind of slow that for the balance of the year.

52:20 Yeah, so you're not going to love the answer, but it's just being honest, you know? It really does depend, but let me walk you through the journey. If I think back to early in the year, it was really about moving our pace to a better place. We felt that we had greater opportunity and we generate more efficiencies with something much closer to three than two. As we got to COVID, it was probably that on steroids. Not knowing, not having a crystal ball, You have to plan for the worst. We knew we had some very challenged inventory. It was about moving that inventory.

53:00 That's the William Lyon.

53:02 And that was the William Lyon inventory. Thank you. And we had, you know, it wasn't just the quality. It was the amount of inventory in specific positions. Yeah, some of their specs were just a little dated, and we had too many in the wrong places. So it was about moving those. So it was absolutely a pace. As you got to mid-May, I would tell you that has changed. And as we said earlier, we started really pulling back discounts. And then by early June, I would tell you we were really starting to move price. Having said all of that, I'm going to say there's this overall cover of you really have to look at each individual community, the competitive factors, the supply, what's behind it, our ability to replace it, the gaps you're creating.

53:50 But if I were to say, if I were to generalize over the portfolio today, I would tell you my bias is price. But 90 days ago, I would have told you it was pace.

54:03 All right. Thank you. Yeah, that's very helpful. And then just one last quick one for me. How are you thinking about kind of the mix of owned versus optioned on a go-forward basis over the next couple of years?

54:16 Yeah, Ryan, you know, kind of going back in time a little bit, you know, we were a few years ago kind of in that low to mid 30% range with acquisition of AV that was largely owned that dropped us down to call it the 20 range. And then William Lyon actually kind of boosted that back up to the mid 20% range. I would tell you longer term, we would like to see the control number go up. That's probably somewhere, you know, ideally back to the The low to mid, you see that we're working on our total years of supply. We're now down below five. But, you know, we're always going to be a little bit longer maybe on the owned, just given that we're a developer as well. But we do see opportunity over the next, call it two years, to continue to increase that ratio of controlled versus owned.

55:12 Got it. Thank you. Thank you very much for squeezing me in. Best of luck going forward. You have a great one. All right. Thank you. And our next question comes from the line of Truman Patterson with Wells Fargo. Your line is open. Please go ahead.

55:26 Thanks. This is Paul Cibulski. Dave, I guess looking at your 3Q gross margin guidance, it looks like, you know, the lion's share of that improvement is going to be from, you know, reduced purchase accounting impacts. and then if I were to add in some hits from the William Lyon inventory sales this quarter, that kind of implies that your core gross margins might be down slightly quarter over a quarter. Am I thinking about that correctly?

55:59 No, I wouldn't say they're gonna be down. I mean, I guess keep in mind the largest driver, the largest two drivers are going to be purchase accounting like you mentioned but it's also the mix. So going back to the earlier discussion around the William Lyon margins right now are running lower than what they are on the TM side. We're gonna see that kind of persist, hopefully get a little bit of an increase but the greater mix in there is gonna have an impact. I can tell you on the data that we have on the legacy TM side, we're definitely seeing margin accretion A lot of this is going to come down to what we're able to do from a spec standpoint on homes that we can both sell and close in the quarter and what we can do from a pricing standpoint.

56:51 So no, I would argue that we're going to be probably worst case flattish, but I actually think slightly up on a core basis in Q3, and I feel more strongly about that as we go into Q4 and into next year.

57:05 Okay, thank you. And then, Sheryl, thanks for the walk around the MSAs for demand. But as we look out into the fourth quarter, obviously June, July is strong for everybody. There's going to be a tremendous push for the industry to close. Any particular areas you're more concerned about from a labor perspective and getting those closings across the finish line? And on top of that, you mentioned some material issues. Are you seeing any shortages in any product categories?

57:36 Yeah, you know, there's a flavor of the week each week, Paul. I would tell you the more systemic ones have been appliances. That one has been the most difficult. I think that started with a lot of COVID cases. And I think, you know, management was in, you know, in the manufacturer plant trying to get appliances out. So I think that one has probably been the most systemic. From there, it gets very local. I mean... I've seen landscape crews go down. We've seen some cabinets. When you combine that with the volume of starts, I think the places where I've heard the most pressure are Phoenix. I mean, the market is just tremendously hot.

58:22 I mean, we are holding back releases and taking very healthy price increases with every release out to market in just about every community we have. I would tell you we're seeing that through Texas. and parts of Florida. So, you know, this is what we do and we'll work our way through it. But I think that's why, you know, it's hard to project. You get a letter one day that says the cabinet plant's shutting down or the window plant's shutting down. If it stays down for three days, you know, we'll make it up. If it stays down for two weeks, we probably won't because everybody else is going to be in the same vines. So I wish I could be more specific, but it's really hard to know. In many places we have the inventory, and I'm not concerned at all about the deliveries. Where we have a lot of May, June, July starts, you know, those are – if the labor gets tighter or there's this just race across the industry or hopefully not a bidding up of labor, we'll get there.

59:26 It's just going to be a little lumpy.

59:30 Okay, thank you. Appreciate it.

59:31 Thank you. Thank you, and our next question comes from the line of Matthew Bowley with Barclays. Your line is open. Please go ahead.

59:39 Hi, good morning. This is Ashley Kim on for Matt. The first question I wanted to ask was on the, you know, the QQ order saw a strong exit rate pro forma around 30% in June and kind of continuing to similar levels in July. You know, when you think about the top comp in 3Q and the assumption that this probably in part reflects and some pent-up demand from the shutdowns. How much of this do you view as kind of sustainable going into the back half of the year?

1:00:10 So I just want to make sure I answer the question you're asking. I don't know if you're on a speakerphone, but it's not coming from a real estate. Can you mind giving me that one more

1:00:23 time? Yeah, sure. So when you think about the strong exit rates, in June and July. And you think about the 3Q comps and the assumption that this probably in part reflects some pent-up demand from the shutdowns. You know, how much of that do you view as sustainable into the back half of the year?

1:00:49 Great question. You know, I don't think we're going to continue on a four-pace like we saw in June and July. We won't have the inventory. Given the sales pace, we are absolutely selling out of communities. I expect that positive trends will continue. We will have some seasonality come into the back half of the year, and I think we'll continue to see great year-over-year success, but I wouldn't expect them to be at the 80% to 100% that we've seen in the last couple of months.

1:01:27 Thank you. That's helpful. And then when you, you know, on community count, when you think about your positioning, especially into 2021, as these orders kind of sell through and go through your land supply, you know, how are you thinking about community count into 2021? And, you know, are you comfortable with the amount of land you have in the pipeline to support growth next year?

1:01:50 Yeah, you know, we're not quite ready to get into 21 from a guidance perspective, but from a land perspective, you know, I can tell you for the closings that we're planning, we have about 99% of the land either owned or controlled. And in fact, you get out to 22, we're over 90%. But, you know, give us a little bit more time to come back from a Thank you so much. Thank you. Thank you. And our next question comes from the line of Alex Barron with Housing Research.

1:02:49 Your line is open. Please go ahead.

1:02:51 Yeah. Thanks, guys. Yeah, great job here in the quarter. I wanted to ask, I think last quarter you had guided to about $10 million of transaction expenses, and it was a little bit higher. So should we expect that there's going to be no more in third quarter, or are you still expecting a little bit more in third quarter?

1:03:12 We're probably going to see a little bit leak into, call it the next two quarters. I don't think it's going to be much. The vast majority of it was in Q1 and Q2. I think if we do see any kind of excess, it's probably going to come from maybe some leases or if we extend folks on retention. Obviously, it's a different work environment. with folks working at home. So if we're doing the integration, as we talked about, we're well on track for that, but we might have to extend some folks as well just because things are a little bit more challenging in a stay-at-home environment.

1:03:55 There are some things we just can't get done until we put people together, yeah.

1:04:01 Okay, that's fair.

1:04:03 The last thing I'd add on that, Alex, is the chunk of that would probably be non-cash as well. So some of that could come through.

1:04:15 Okay, great.

1:04:16 Okay, and then as it pertains to your mix of homes, now that you've integrated William Lyon and AV Homes, what percentage, I guess, of your orders that came in this quarter would you say are entry-level or first-time How does that relate to your land purchases for that same type of product at this point or going forward?

1:04:49 I would say there's not real differences between what we're seeing in the orders and our investment strategy in replacing the communities that we have. Alex, and as I said, I mean, when I look at our orders and our closings, I think that's really what says it best. There's not really a difference between, if I look at entry-level first move up on the closings, it's about 70%. When I look at it on the sales, it's 71%. So pretty darn consistent, and I think our land strategy generally follows suit.

1:05:27 Okay, great. Well, best of luck for the rest of the year.

1:05:30 Thanks. Thank you so much. Thank you. And our next question comes from the line of Alex Reigel with B. Reilly. Your line is open. Please go ahead.

1:05:40 Thank you. You touched upon it a little bit, but can you go into a little more detail on your Built to Rent program? I believe you have two projects now. You have looked at three new markets. Has COVID changed your views at all on the Built to Rent market?

1:05:54 COVID has, I mean, it might have put us four to six weeks Thank you for joining us today. This has actually helped us right in the sweet spot. People want to get out of multifamily. People want their backyards. They want high technology. And they still want a lifestyle.

1:06:40 And if they can achieve that in a single-family home and be part of a community without having the burden, or maybe they don't have the financial resources to buy, I think it's I think that this is an asset class you need to watch very carefully in the next five years because I think it's going to be a very different thing than it is today. Thank you. Thank you, and I'm not showing any further questions, and I'd like to hand the conference back over to Ms. Sheryl Palmer for any further remarks.

1:07:11 Well, thank you very much. I appreciate you joining us today. I hope you all take care of yourselves. Stay safe. Stay healthy. Thank you for participating. You may all disconnect. Everyone, have a great day.