Meritage Homes CORP Q1 FY2024 Earnings Call

Hello, and welcome to the Meritage Homes First Quarter 2024 Analyst Call. As a reminder, this conference is being recorded. It's now my pleasure to introduce your host, Emily Tadano, Vice President, Investor Relations and ESG. Please go ahead.

Thank you, operator. Good morning, and welcome to our analyst call to discuss our first quarter 2024 results. We issued the press release yesterday after the market closed. You can find it along with the slides we'll refer to during this call on our website at investors.meritagehomes.com or by selecting the Investor Relations link at the bottom of our home page. Please refer to Slide 2, cautioning you that our statements during this call as well as in the earnings release and accompanying slides contain forward-looking statements. Those and any other projections represent the current opinions of management, which are subject to change at any time, and we assume no obligation to update them. Any forward-looking statements are inherently uncertain. Our actual results may be materially different than our expectations due to a wide variety of risk factors, which we have identified and listed on this slide as well as in our earnings release and most recent filings with the Securities and Exchange Commission, specifically our 2023 annual report on Form 10-K. We have 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; Phillippe Lord, CEO; and Hilla Sferruzza, 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. Hilton. Steve?

Thank you, Emily, and welcome to everyone listening in on our call. I will briefly discuss current market trends and our recent accomplishments. Philippe will cover highlights of our operational performance and how our strategy is driving our success. Hilla will provide a financial overview of the first quarter and our forward-looking guidance for Q2 and full year '24. Meritage had a remarkable start to the year. We achieved an average absorption pace of 4.9 sales per month in the first quarter of 2024, which resulted in our highest quarterly sales orders totaling 3,991 homes. During the spring selling season, with a healthy supply of move-in ready inventory, we were able to capitalize on strong market conditions generated by the increasing need for housing for millennials and Gen Zs, as well as the move down baby boomers who continue to find our limited inventory and the limited availability of resale housing supply. In the first quarter of this year, our record backlog conversion of 138% drove 3,507 home deliveries, which led to home closing revenue of $1.5 billion. Home closing gross margin for the quarter was 25.8%, which combined with SG&A of 10.4%, resulted in diluted EPS of $5.06. As of March 31, 2024, we increased our book value per share 17% year-over-year to $129.98 and generated a return on equity of 18%. Although visibility into what interest mortgage rates will do for the remainder of the year remains unclear, we believe that by satisfying homebuyers' desire for quick closing timelines, our available inventory should position us to continue increasing our market share. Now on to Slide 4 for our recent milestones. It's very timely that during the month that we celebrate Earth Day, we can announce Meritage's 11th Award as the EPA's Energy Star Partner of the Year for sustained excellence, recognizing our continued industry leadership in the production of energy-efficient homes. Additionally, Meritage was also named in Newsweek's 2024 America's Greenest Companies list as our commitment to sustainability is recognized even outside of our sector. I take pride in sharing that at the end of the first quarter of this year, Meritage received the President's Volunteer Service Award, a civil award bestowed by the U.S. President, the highest honor available for volunteerism, which refers to our partnership with No Child Hungry and the 1,100-plus hours our team members volunteered to package nearly 260,000 meals over the past two years to fight childhood hunger. Lastly, this quarter, we were recognized as one of Forbes' 2024 most successful mid-cap companies based on sales and earnings growth, return on equity, and total stock return for the last five years. At Meritage, we believe that financial achievements must be maintained while focusing on responsible corporate citizenship, and we are honored that these accolades continue to illustrate the breadth and depth of our commitment. With that, I'll now turn it over to Philippe.

Thank you, Steve. This quarter, we are excited to share our financial results, but I wanted to provide a bit more context behind the numbers. Nearly 50% of our quarterly deliveries were sold and closed intra-quarter, a trend that has been increasing for the last three to four quarters, resulting in a record backlog conversion of 138%. This conversion rate is materially above our previous long-term target of 80% or higher and notably higher than even our fourth-quarter 2020 backlog conversion of 110%, helping drive improved ROE over the last several quarters. This success was the intentional result of migrating to a move-in ready strategy across both our entry-level and first move-up products, allowing us to enter the year with a sufficient supply of homes available for quick closure, particularly in advance of the spring selling season. We were able to increase prices and offer less financing incentives than we anticipated on those quick move-in closings, meaningfully improving our first quarter 2024 gross margin. With our inter-quarter sales activity representing half of the quarter's closing volume, our gross margin reflects more current market conditions in real-time, and our outperformance validates that our move-in ready strategy is the right one for Meritage and for our customers. Now turning to Slide 5. Demand remained solid this quarter. Our sales orders of 3,991 homes were up 14% year-over-year. The nationwide sales event conducted in late January and February was highly successful. We achieved our highest quarterly sales order volume, which benefited from an 8% cancellation rate, significantly below our historical average in the mid-teens. Entry-level homes comprised more than 90% of the total order volume. The ASP on orders this quarter was $409,000, down 5% from the prior year, but fairly aligned sequentially from the fourth quarter of 2023. The ASP decrease from 2023 was due to both a larger mix of our closings coming from our Eastern markets and a product mix shift, even as we increased pricing in about half of our communities and used fewer rate locks this quarter. The first quarter 2024 average absorption pace of 4.9 per month improved from 4.2% in the prior year and was well above four net sales per month due to the strength of spring demand. The first quarter 2024 ending community count of 275 was up 2% sequentially from the fourth quarter of 2023 and down 1% compared to the prior year. 34 new communities came online this quarter. We are still on target for more material community growth later in the year, ending 2024 mid- to high single digits higher than where we started, with even greater projected growth in 2025. We control all the lots we need for planned key openings in 2024 as well as most of our 2025 communities. We are now focused on opportunities for quick openings in 2025 as well as longer-term growth into 2026 and beyond. Moving to the regional level trends on Slide 6. All of our regions generated a sales pace well above four net sales per month during the first quarter of 2024. Although we do expect Q1 to be one of our strongest absorption quarters due to the overlap with the spring selling season, the Central region, including our Texas market, had the highest regional average absorption pace of 5.2 sales per month and a backlog conversion rate of over 150%. The economic growth in Texas fuels the positive momentum in the housing market, and with over 90% of this region's communities being entry-level, a steady supply of affordable and move-in ready inventory has been in high demand. The West region had an average absorption pace of 4.8 net sales per month compared to 4.5% last year. Our previously challenged markets in this region regained sales momentum this quarter, primarily in Arizona and Colorado, which were among the toughest markets last year. Colorado's first quarter 2024 sales order volume increased by double digits on a year-over-year basis on a reduced community count. The East region experienced the largest year-over-year growth at an average absorption pace of 4.7 net sales per month, up from 3.8% from the prior year. As we have been focused on rebalancing our land portfolio over the last couple of years, our efforts in the East regions are now visible with a 10% year-over-year growth in average communities and double the prior year spec inventory, which positions us well to continue to gain market share in the high-growth parts of this country. Now turning to Slide 7. Our quarterly starts were approximately 4,000 homes in the first quarter of 2024, up from about 2,500 in the prior year, and consistent with our quarterly cadence for the last few quarters. In order to ensure we have sufficient inventory available for quick move-in, we align our start pace with our expected future sales pace. Further, as we grow community count in the latter half of this year, we will start more homes to meet our targeted per-community move-in ready supply across our growing footprint. We had approximately 6,000 spec homes in inventory as of March 31, 2024, up 54% from about 3,900 specs as of March 31, 2023, but only about 100 homes greater than where we started this quarter. This represents 22 specs per community this quarter, which equates to a 4.5-month supply of specs on the ground, well within our target level of four to six months of supply. As our home closings this quarter, 93% came from previously started inventory, up from 87% in the prior year. 22% of the total specs were completed as of March 31, 2024, as we continue to make progress toward our target run rate of carrying one-third move-in ready homes.

Thank you, Philippe. Before I cover our financial highlights, I wanted to first address the momentum we've gained with our land goals as this has been a key pillar in our growth plan. Our land teams have been successful at sourcing deals despite the competitive land market. Through their efforts, we put nearly 6,300 net new lots under control this quarter. This led to the growth in our total lot count by nearly 10% year-over-year and up sequentially by 3% to approximately 56,400 lots. With these new deals, we're starting to increase our use of off-balance sheet financing, growing our outlook percentage to 31% this quarter from 25% in the first quarter of 2023 and 28% from Q4 of last year. We continue to be focused on accelerating our land acquisitions and looking for off-book opportunities while maintaining a healthy balance sheet. Now let's turn to Slide 8 and cover our Q1 financial results in more detail. First quarter 2024 home closing revenue was $1.5 billion, reflecting a 21% higher home closing volume year-over-year, which was partially offset by a 4% lower ASP due to a shift in product mix. On a sequential basis, ASP closings increased in the first quarter of 2024 with reduced utilization of rate locks and targeted price increases reflected in our intra-quarter sales and closings as the market improved over the last 90 days. Assuming interest rates hold steady or improve, ASP for the rest of the year is expected to be fairly consistent, with some reductions from geographic mix and new entry-level communities opening with lower prices, which will be balanced by reduced financing incentive costs and price increases where the markets can absorb them. While the utilization of rate locks has slowed from '22 and 2023, our all-in discounts are still running at an elevated level, and we expect to continue to utilize rate locks and buy-downs to negate concerns around rate volatility. Home closing gross margin increased 340 bps to 25.8% in the first quarter of 2024 compared to 22.4% in the prior year. This improvement was a combination of several factors. First, the reduced utilization of rate lock financing incentives that we've discussed. Next, the greater leverage of fixed costs on higher revenue. Finally, improvements in our direct costs, as last year's first quarter marked the highest per square footage direct for us since the start of COVID. These savings were partially offset by higher lot costs. We want to take a minute and cover the trends we're seeing in our direct costs. Our team has been leveraging our spec strategy and increasing volume, allowing us to deepen our relationships with our vendors. We're proud of the reductions we achieved to date, and we expect that we'll be able to hold the line to keep cost steady and find offsets to the recent lumber increases. On the labor front, capacity has held fairly steady, perhaps as multifamily construction has pulled back a bit, creating a stable environment for residential construction at the moment. Our cycle times have settled in at around 140 calendar days over the last three quarters. We remain disciplined in our start cadence and are only selling homes later in the construction process to have the necessary inventory for quick move-in closings. Our goal is to turn our assets three times a year to get their additional capacity, which will likely be needed for both trade labor and local government staffing for permitting and inspections. When we review the composition of our gross margin, the only known variable is lot cost since the land acquisition and development dollars have already been spent. Elevated land development costs, the impact of the entire industry over the past three years are now fully flowing through our financials, as almost all of our land is now from post-COVID acquisitions. Our current guidance reflects the elevated lot cost, and we do not expect any additional pullback on margins beyond 2024, as go-forward lot costs have a similar land development composition component. Over the past four to six quarters, our long-term gross margin target has been at least 22%. Structurally, we believe our target has changed as we continue to dial in our relationships with national vendors and further streamline our operations. The goal of these efforts is to improve cycle times and reduce costs. We've been operating under extreme environments for the past several years, both highly favorable and then very challenging. As the markets stabilize, we are gaining a clear understanding of our capabilities in a normalized environment and expect to share our higher internal targets with you over the next several quarters. Turning to SG&A. SG&A was 10.4% of home closing revenue in the first quarter of 2024, which was fairly in line with 10.2% for the first quarter of 2023. Higher commissions this quarter offset the incremental leverage achieved on higher home closing revenue. We are still comfortable with our full year SG&A goal of 10% or under and expect quarterly SG&A to improve throughout the year. Given our anticipated volume growth over the next few years, our longer-term SG&A target is 9.5%. In the first quarter of 2024, the financial services loss of approximately $700,000 included $5.8 million in write-offs related to rate lock unwind costs. This compares to financial services profit of $2.9 million in the first quarter of 2023 that had $1.9 million in similar write-offs. We anticipate potentially incurring another $7 million of rate lock underlying costs in the second quarter, which is included in our guidance. Excluding these charges, the profitability of our financial services has held in line with our historical averages. The first quarter's effective income tax rate was 20.5% this year, essentially flat to the prior year, with both periods benefiting from energy tax credits on qualifying homes under the Inflation Reduction Act. Overall, higher home closing revenue and gross profit with flat SG&A leverage and tax rate led to a 43% year-over-year increase in first quarter 2024 diluted EPS to $5.06 from $3.54 in 2023.

Before we move to the balance sheet, I wanted to cover our Q1 2024 customer's credit metrics. As expected, our buyer profile remained relatively consistent with our historical averages, with FICO scores near 740 and DTIs around 41 or 42. LTVs were still in the mid-80s, and about 80% of our buyers in Q1 received some sort of financing incentives consistent with our mortgage company capture rate. Now turning to Slide 9. Our balance sheet, returns, and liquidity management are a core focus for us. We have nothing drawn under our credit facility, cash of $905 million, and net debt to cap of 2% at March 31, 2024. Our net debt to cap ceiling target is in the mid-20s, leveraging our improving backlog conversion. We also generated $82 million in operating cash flow for the first quarter of 2024. Our overarching capital spend philosophy looks to generate long-term shareholder value expansion through both growth in the business and returning capital to shareholders. Since early 2023, we have been accelerating our investment in organic growth. This quarter, we spent $430 million on land acquisition and development, which was up 39% from the prior year. We expect our go-forward trend for the full year 2024 and beyond to total $2 billion to $2.5 billion of land spend. Given confidence in our business model and our ability to deliver strong and stable financial performance during the first quarter of 2024, we meaningfully enhanced our shareholder returns directive as well. In February, we instituted a formal programmatic share repurchase plan with a minimum buyback commitment of $15 million in each quarter to provide consistency and predictability to our share repurchase activity. During the first quarter of 2024, we went beyond the systematic $15 million commitment and opportunistically bought back an additional $41 million. We repurchased over 360,000 shares or 1% of common stock outstanding at December 31, 2023, for $56 million this quarter. $129 million remains available under our authorization program. One year after initiating our dividend policy, we nearly tripled our quarterly cash dividend to $0.75 per share this quarter or $0.27 per share, providing another avenue for us to improve our ROE. This resulted in total spending of about $27 million in dividends in the first quarter this year. And rounding out our capital plan for the year, we're also evaluating near-term opportunities to address the senior debt that's coming due in early 2025.

On to Slide 10. In the first quarter of 2024, we were able to find and secure land deals that meet our underwriting standards in the majority of our markets, meaningfully putting more lots under control than home starts. The nearly 6,300 net new lots under control this quarter represent an estimated 43 future communities. We put about 200 net new lots under control in the first quarter of 2023 as we were only starting to ramp up from the pullback in late 2022 that quarter. As of March 31, 2024, we owned or controlled a total of about 56,400 lots, equating to a 4.6-year supply of lots in line with our target of a four to five-year supply. Our land financing strategy focuses on managing our capital while being mindful of balance sheet metrics and margin goals. We've been able to utilize our healthy balance sheet to replenish our land portfolio while minimizing the gross margin impact from option land yields for the past several years. As we mentioned earlier, we have recently been utilizing more option financing for our land purchases. About 69% of total lot inventory at March 31, 2024, was owned and 31% optioned compared to the prior year, where we had a 75% owned inventory and a 25% option lot position. We believe that off-balance sheet financing will allow us to control more land and increase our year supply of lots beyond what we like our balance sheet to absorb. Our intent is to accelerate our growth into 2025 and onward, and we're currently working on some land financing opportunities that we hope to be able to share with you in the next several quarters. Finally, I'll direct you to Slide 11 for our guidance. Given the robust market conditions and our supply of move-in ready homes, we revised our projections upward for the full year 2024 to the following: total closings between 14,500 and 15,000 units, home closing revenue of $6 billion to $6.2 billion, home closing gross margin of around 24.5% to 25%, an effective tax rate of about 22.5%, and diluted EPS in the range of $19.20 to $20.70. As for Q2 2024, we are projecting total closings between 3,600 and 3,800 units, home closing revenue of $1.5 billion to $1.6 billion, home closing gross margin of 24.5% to 25%, an effective tax rate of about 22.5%, and diluted EPS in the range of $4.70 to $5.30. Both Q2 and full year guidance assume current market conditions and interest rates. We will continue to refine our guidance as additional clarity around interest rates becomes available later in the year. With that, I'll turn it back over to Philippe.

Thank you, Hilla. To summarize on Slide 12, our first quarter 2024 results demonstrate that our ample spec home supply for quick closings and our focus on pace over price allowed us to exceed our volume targets, as well as our gross margin guidance. As we increase our community count in the second half of this year, we believe we're positioned to continue growing our market share. Further, our acceleration of both land spend as well as share repurchases and dividends demonstrates our confidence in our business model. We are committed to balancing growth in the business and returning cash to shareholders in order to continue creating long-term value. With that, I will now turn the call over to the operator for instructions on the Q&A.

Our first question is from Stephen Kim at Evercore ISI.

Really impressive results. Thanks for all the guidance and insight. I have a question about the backlog turnover ratio. We've discussed this quite a bit over the past year. It seems like you're now indicating that you've reached a level in your business model where you feel confident providing guidance for a turnover ratio in the triple digits. I'm curious if you believe that, based on your plans for this year, this level of backlog turnover ratio is something that can continue to move towards your long-term normalized level. Is this the new standard, or do you anticipate 2024 might be somewhat higher than usual?

I would say that it's pretty much going to be the new normal. As we think about the rest of this year, we're modeling a similar backlog conversion for the remaining quarters. Some of it is just predicated on cycle time stability, which currently we have. The production capacity is really, really good. So as long as that remains in the same state, this is going to be the new normal for us.

And I assume the same thing could probably be said for absorption rates perhaps per community, but maybe you can update us on that. I know historically, I think you've talked about 3 to 4. And then as a follow-on to that, you talked about your gross margin now pretty much for this year, incorporating a fully adjusted land cost. You don't have that pre-pandemic unusual land effect. So that would seem to suggest that your gross margins have potentially some upside from here. I know you're going to give us more on that later. But you had talked in the past about how a higher level of volume translates very directly for you into a higher level of profitability, not just on the SG&A, but the gross margin. So I was wondering if you could remind me again about the sensitivity of higher volume to your gross margin as well as updating us on your absorption rate longer term?

Yes. I'll take the absorption question, and then I'll hand it over to Hilla on the margin guidance. We believe we're going to sell more houses in the front half of the year than the back half due to seasonal trends. But we are reevaluating our overall absorption targets, specifically for our entry-level business. We've often said that our target is around 4 to 5 for entry-level and somewhere between 3 and 4 for the first move-up. The affordable part of the market is extremely strong, and we're finding really strong land positions to support that affordable price point. We are evaluating whether we can do better than that 4% to 5%. But stay tuned on that, and I'll let Hilla talk about the margin guide.

Sure. So historically, when we have longer cycle times and lower closing rates, they could see an up to 100 bps pickup in the fixed component of gross margin between Q1 and Q4 due to the incremental volume. Now that's a little bit different these days because we're selling the spring selling homes and closing some of the spring season houses in the same quarter. However, increased volume for us, even 400 or 500 incremental units in a quarter can lead to up to a 100 bps improvement in our gross margin, not just SG&A leverage.

Our next question today is coming from Alan Ratner from Zelman & Associates.

First question, gross margin. If I look at your full year guide, I think the biggest adjustment was to the margin range. And if I think back to 3 months ago when you gave that, I believe, if I'm remembering correctly, obviously, higher land costs flowing through was kind of the main headwind as far as your expectation for some pressure through the year. But I think you probably also had some assumption on incentives embedded within that as well. And clearly, the first quarter came in better than you guys were expecting. But when you think about the macro environment today versus back then, rates are higher and continuing to move higher. So what is actually embedded in that guide for the remainder of the year as far as incentives? Do you expect to continue the improvement you've seen in the first quarter? Or are you baking in any potential for having to increase incentives as you get to the back half, which is a softer seasonal time of the year?

We're still at elevated levels of incentives compared to where we were pre-2022. So we're maintaining that level. There was a decent amount, even with the pullback in improved market conditions in Q1, of incentives that were used. However, something that's important to consider is when you're selling and closing intra-quarter. Even though you’re offering an incentive, you can offer it much less expensively if you're offering a 45-day interest rate lock because it's much cheaper than trying to buy a forward commitment. We are still planning on using the tools that we have in our toolkit to lock rates, buy downs, and rate locks in general, but the cost to those is going to be less expensive because of our ability to sell and close so quickly. So we're modeling current market conditions, including what we're seeing in April, which includes the uptick in the guidance that we provided.

I'll just give you an extra question here because people are going to ask you about April. We don't need to increase our rate lock costs to acquire the customers for April. That's included in our guidance. Even in these elevated rate environments, we're able to move people into our move-in ready inventory at about similar costs than we were in Q1. So it's all baked into our guidance.

Second question, I guess, just pointing to your Slide 10, where you show the lot acquisition activity, which is very helpful to see. So I know this is not a smooth number by any means, but the first quarter looks like it was down a little bit from the last couple of quarters in terms of dollars spent on both development and acquisition. It looks like the community acquisition was relatively steady, but you're tracking below the $2 billion to $2.5 billion target for land spend year-to-date. Is that just a timing function? Or is it getting harder to find deals to pencil? How should we think about that? Because I know obviously, your 25 community count growth is somewhat dependent on hitting that target.

Yes. Everything is going as planned. It's really just a timing thing. I think you'll see that timing reverse out here in Q2 and Q3. But none of it indicates anything around our ability to acquire the lots we need for '26 and beyond. We're also finding deals for 2025. So it's really all just timing.

I'll add one more point, Alan. This is a disclosure that comes out in the 10-Q. So you'll see, but I will just give you guys a sneak peek. You know that we ended last year with about 28,000 lots that some level of due diligence was ongoing, but were not counted in our actual lot totals because we hadn't committed. That number has actually increased from 28,000 to 34,000 just in the quarter while we grew our community count. The ability to find land to pencil is definitely not the issue. It's just timing on when deals were closing.

Your next question is coming from Michael Rehaut from JPMorgan.

So first question, just around gross margins. I would love to just get a sense, and I apologize if I kind of missed some of this earlier in the call. But just what drove the actual upside in the first quarter versus prior guidance? I think part of the review that was earlier was more just focused on year-over-year, but was more interested in kind of zeroing in on the upside in the first quarter results versus your guidance and how that also flows through to the higher guidance for the full year? And then also, on the gross margins. I believe I heard correctly that you expect '25 gross margins to, at minimum, be similar to '24. I just wanted to make sure that I heard that correctly as well.

As we came into Q1 and guided to our Q1, we didn't have real visibility into the strength of the spring selling season. It was early in January. And obviously, the spring selling season has been very, very strong. As you can see from our backlog conversion rate, we were able to convert a lot more move-in ready inventory than we had initially assumed. The demand for that move-in ready inventory was really strong, so we were able to increase pricing, and we didn't need to use as much of the rate lock dollars we had in our assumptions to get people into those mortgages and homes. We had assumed that rate locks would still be heavily utilized coming into the year, and they were much less utilized. So between backlog conversion and more leverage, ASP improvement, and less incentive utilization, we had a beat on our margin guide. And then I'll let Hilla talk about the guidance for '25.

Yes. So we are not providing guidance yet for '25. We just wanted to clarify. We heard there was a lot of confusion about the composition of our lot cost flowing through the financials in 2024. If it was going to be a little bit of noise from the higher land development cost in '24 and some also coming in '25. We just wanted to clarify that pretty much everything that's running through our financials these days is fully baked in at the higher land development spend. We don't have any more pre-COVID land. So for us, the level of lot cost as a percentage of revenue that you're seeing in our numbers in '24, that’s the new run rate until land development costs come down. So there's not another shoe to drop with another reduction to gross margin from land. We've not given guidance on any other component of gross margin for 2025, just yet.

And I guess maybe just also looking forward, you talked consistently about an accelerated rate of growth in '25 and beyond. You're obviously looking for mid- to high single digits this year. Without getting into too many details, I mean, my impression of higher growth would be something more in the low double-digit range at minimum. I'm just curious if that's the right way to think about that? Or could it even be something in the teens? I'm just trying to get a degree of magnitude when you talk about accelerated growth.

Are you talking about for 2025?

Correct.

Yes. I mean, we're not prepared to give any guidance on 2025, but we're buying a lot of land. And anything less than 10% isn't what we're targeting either, but we're just not prepared to guide to that at this point.

Your next question is coming from John Lovallo from UBS.

The first one is not to get nitpicky, but if we look at the midpoint of the 2024 delivery outlook, it's 14,750 homes. And if we back out the first quarter deliveries of 3,507 and then the second quarter midpoint of 3,700, it would imply sort of average deliveries in the third quarter and the fourth quarter of around 3,771. So I guess the lack of sequential step-up in delivery is more a function of the business becoming a bit more even flow from a production standpoint? Is it sort of a lack of available homes in the pipeline? Or is there something else that may be kind of leveling that growth off?

Yes. That's a great point. I'm glad that you made it. So I think we alluded to it a little bit, but maybe we'll just put a fine point on it. When you're selling and closing homes in the same period, the spring selling season results get pulled up. So before Q4 was kind of our huge quarter where what we were selling through May got delivered 2.5 quarters later because we're now buying. But because we're selling and closing intra-quarter, you're seeing that same fantastic value just come up earlier into the year. It's still going to be a good Q4, but it's not really reflecting the spring selling season homes anymore.

Yes, that's right. I mean, we expect that we will now see Q2 and Q3 being our biggest volume quarters with Q4 being a little more modest and then Q1, just depending on the spring selling season. So that's going to be kind of the new cadence of our business, unlike what it was before, where usually Q3 and Q4 were our biggest quarters.

And then you guys returned $83 million back to shareholders in the first quarter and generated a similar level of cash from operations. I mean, as we move forward here, can we think of matching cash flow with repurchases and dividends over the next few quarters, particularly considering no real debt due until 2025?

The timing of land development acquisitions depends on when deals close, not necessarily on operating cash flow but rather on profitability from the previous year. We're aiming to achieve a return similar to last year's net income in the 20s and to return capital to shareholders, regardless of when land deals are finalized.

Your next question is coming from Susan Maklari from Goldman Sachs.

My first question is you've commented on the target of bringing the ASP down over time. The guidance does imply that sequentially we will see a bit of a slowdown in that. When you think about that relative to the pricing power and the level of demand that you talked to on the ground, how are you thinking about those two factors coming together? And any thoughts on how that ASP will come through over the longer term?

Yes. The ASP, our forward-looking ASP guidance is predicated on the land we're buying. If we're buying less expensive lots, it allows us to produce our product in a more affordable part of the market long term, which is our core strategy, and that's driving the ASP decline. But that doesn't mean we're not taking pricing when the markets are elastic in that affordable segment of the market, which it has been and was very strong in Q1.

That makes sense. And then I guess, can you just comment a bit on what you're seeing in terms of overall cycle times and input costs regarding some of the sticks and bricks and anything there as we think about the forward quarters?

Yes. As Hilla said in her opening comments, cycle times are the best they've been in a long time. We're hitting our timelines, and production capacity is really stable. We're not sure how much more can be done, but capacity is strong. If there's more to take out of our cycle times, we will. Direct costs are also quite stable. Given the size of our business at this point, we have really strong relationships that produce a great cost structure for us. Lumber has ticked up a little bit, but we've been able to offset that in other areas and the categories of the business. So as we look out into 2024, we're modeling stable cycle times and stable direct costs.

Next question today is coming from Alex Barron from Housing Research.

I was hoping you guys could elaborate a little bit on your average buyer. First of all, what percentage of the buyers are actually first-time buyers? What does that average buyer, entry-level buyer look like? What's their cycle? What's their down payment? What's their average income, that type of thing?

Hilla is pulling up some more details for you. Just give us one second, but I'll reiterate what Hilla said earlier. Our FICO scores, our DTIs, everything is pretty much the same as it was. We're obviously targeting a more qualified entry-level buyer. For the most part, these are their first homes. But they have really high income levels and they're looking for as nice a home as they can buy in a certain price point. But hang on. Hilla will tell you the exact metrics.

Yes. Our first-time buyer, they don't declare themselves as first-time buyers, but based on past data, we estimate our first-time buyer rate is about two-thirds of our business right now.

And I was kind of interested just to see what type of income level these people have.

I don’t know if we're sharing the income, but you can probably back into it because the DTIs are averaging 41, 42, and we're sharing that the LTV is in the mid-80s, so you can back into our ASP as it relates to what the loan amount is with an 85% LTV. You can probably back into their average monthly income.

We're not seeing our particular consumer struggle to qualify and afford our home. We don't have to do rate buydowns and rate locks to qualify them. It's more of a psychological incentive versus qualification.

Got it. And then if you can elaborate on a comment you made about the cost of incentives being lower than the forward commitment, if it was like a short close. If you can elaborate on that because my thought was that the forward commitment was supposed to be the lower form.

A forward commitment has several dynamics, and we can discuss that offline. However, if you're doing something spot rate for a short period, if you have good credit, that's going to be cheaper. We have the opportunity because our sales-to-close cycle time is so short. We have opportunities for certain customers to go out into the market if the rate is favorable that day and just buy a rate lock and/or buy down for them at the point of sale, which could be cheaper than a forward commitment.

Your next question today is coming from Jay McCanless from Wedbush Securities.

Just to clarify what you were saying earlier, Philippe, are you seeing a slowdown in April foot traffic and demand that some of your competitors have mentioned?

No.

Okay. And then in terms of pricing power, where do you think you're gaining better pricing power right now? Is it on the entry level, first move-up? How has that been trending? And how has that been trending thus far in April?

Jay, we're mostly entry-level at this point, although we're trying to source some more what we call first move-up land, which we're having some success. We're primarily in the entry-level market. So obviously, the pricing power we experienced in Q1 was entry-level pricing power. The strength of pricing power differs geographically and community by community. Certain communities have a lot of pricing strength, but other markets that are more price-sensitive don't have as much.

And then the last question I had. With the pretty large increase that the board instituted with the dividend, maybe walk me through that from a capital allocation standpoint because it seems like a significant burden to place on the company, especially with a cyclical industry. Can you walk me through the thought process and why such a big increase right now, especially with rates at this point, not having affected your business, but they might in the future?

We discussed this a lot through our organization as well as with our board. At the end of the day, we felt that there was a benefit to returning shareholder equity in two different ways: not just buying back shares where we have a limited float, but also providing a dividend. We believe the dividend signals to the Street that we have tremendous conviction in our cash flow. Our operating model has dramatically changed from where it was seven years ago. You can see our backlog conversion. We're generating a much stronger cash flow quarter-to-quarter. We felt strongly that that was the signal we needed to send to the Street that we believe our operating model, and our business is less cyclical than it was before. There's been a lot of conversations about the industry being rerated because our balance sheets are stronger, but we think paying a dividend tells you exactly how strong our balance sheet is.

I think it's important to note that while it's a sizable increase, we just reiterated our $2 billion to $2.5 billion annual land spend commitment. Our dividends are around $100 million a year, a pretty small portion of our total capital outflow.

Your next question is coming from Ken Zener from Seaport Research.

I would like to understand more about the backlog. The results were impressive in terms of both units and margins, and I assume that the backlog is converted at the margins you provided at the end of January. Is there a difference there? I believe half of your units came from backlog and half from closings. Can you discuss that implied difference?

You know what we guided to and then what we delivered. So if you came into the quarter with a backlog, that's generally what we guided to. However, we closed 148% of that backlog. We closed an extra 2,000 houses this quarter than we were expecting. That's the spread.

It seems like the spread on the implied margins for the specs actually improved quite a bit more than you expected, correct?

Absolutely. As we came into January, our ability and the demand for move-in ready inventory that we were able to close intra-quarter was really strong, allowing us to increase the pricing of that product while using fewer incentives.

The sheer fact that we closed many homes allowed us to leverage and gain incremental benefits in margin. So it's a combination of all of those coming together that drove margin.

When we guide, we guide to what we know. If there's a significant inter-quarter movement, like we experienced during the spring selling season, it’s either going to benefit us or not.

Yes. Did you have another question? Thank you. Operator, is that it?

We've reached the end of our question-and-answer session. I'd like to turn the floor back over to Philippe for any further or closing comments.

Thank you, operator. I'd like to thank everyone who joined this call today for your continued interest in Meritage Homes. We hope you have a great rest of your day and a great weekend. Thank you.

Thank you. That does conclude today's teleconference and webcast. You may disconnect your lines at this time and have a wonderful day. We thank you for your participation today.