Earnings Call Transcript - MTH Q2 2025

Operator, Operator

Greetings, and welcome to the Meritage Homes Second Quarter 2025 Analyst Call. Please note, this conference is being recorded. I will now turn the conference over to our host, Emily Tadano, Vice President of Investor Relations and External Communications. Thank you. You may begin.

Emily Tadano, Vice President of Investor Relations and External Communications

Thank you, operator. Good morning, and welcome to our analyst call to discuss our second quarter 2025 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 homepage. 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 from 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 2024 annual report on Form 10-K and Form 10-Q for subsequent quarters. 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. Share and per share amounts have been retroactively restated to reflect our January 2, 2025, stock split for all prior periods. 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?

Steven J. Hilton, Executive Chairman

Thank you, Emily. Welcome to everyone listening in on our call. Today, I'll start by touching on our second quarter results and current market trends. Phillippe will cover our strategy, how our strategy helps us navigate the changing market conditions and the highlights of our quarterly performance. Hilla will provide a financial overview of the quarter and forward-looking guidance. We are proud of our team's efforts to navigate the tougher selling conditions, and we secured orders of 3,914 homes in the second quarter of 2025. Our strategy's focus on move-in ready inventory and the continued use of financing incentives allowed us to better compete in a challenging market because we provide our customers with certainty to help overcome strained consumer confidence. This performance generated a strong absorption pace of 4.3 net sales per month this quarter. In the second quarter of 2025, we delivered 4,170 homes. Our improved cycle times and move-in ready spec strategy drove another quarter of backlog conversion above 200%. We generated home closing revenue of $1.6 billion this quarter and achieved adjusted home closing gross margin of 21.4%, excluding terminated land deal charges, which contributed to diluted EPS of $2.04. We also increased our book value per share by 10% year-over-year. It is well documented that home buying demand has softened over the last several quarters and even more so this past quarter. Mortgage rates increased and remained volatile, while consumer hesitancy went up, causing potential buyers to take an extended time frame to commit to a home purchase. And at the entry-level segment, affordability remains the primary barrier to homeownership. We believe our strategy was designed to provide certainty and weather these challenges head-on, and we remain positive on the long-term outlook of our industry given favorable demographic trends. And with that, I'll now turn it over to Phillippe.

Phillippe Lord, CEO

Thank you, Steve. As Steve noted, we believe that Meritage is well positioned. Despite today's macro headwinds, we remain competitive and gain market share because we are choosing to focus on what we can control by having an agile business model with a go-to-market strategy, which delivers certainty for customers during challenging times. First, we want to commend everyone at Meritage for their dedication and hard work to focus on these controllables. We're happy to share that our second quarter 2025 ending community count was 312 active stores, the highest community count in company history with more planned growth to come in the second half of the year. Further, our teams once again challenged themselves, and we were able to reduce our construction time from approximately 120 calendar days in the first quarter of 2025 to about 110 this quarter, which allows us to reduce our starts per community. These two achievements are laying the groundwork for continued growth even during a time when there are macro factors that are challenging the entire industry. Next, I want to underscore the agility of our affordable spec building strategy. We can pull various levers at the local level to ensure we optimize every asset. Our operations and cost structure are more efficient when we are building, selling, and closing at a consistent pace of 4 net sales per month. We know that these savings and efficiencies can be used to offset the impact of increased incentives that are currently being offered to achieve the target. However, homebuilding is a local business, and we look to balance pace and price on a community-by-community basis to ensure we are maximizing our financial performance. As you have seen us do in the past, as the sales pace starts to slow, we moderate our starts in order to maintain our targeted level of specs, which is a 4 to 6 months supply on the ground. We also change the pace of our starts based on our cycle times to ensure we have an optimal amount of ready inventory. As part of our agile business model, we exercise a disciplined yet flexible approach around our land strategy that helps us optimize our land position on a market-by-market basis. We routinely review all of our land under control and determine if it still aligns with the changing market conditions. As a result of this analysis, we regularly terminate land deals that no longer fit our criteria, which in Q2 was approximately 1,800 lots. Lastly, our go-to-market strategy provides the certainty that buyers are looking for today. Our 60-day closing commitment and move-in-ready offerings compete directly with resale inventory, but with all the benefits of a new home. And our focus on including our customers' brokers in the buying process makes us a partner of choice for both future homeowners and the broker community. We believe our strategy and agility have allowed us to maximize our earnings while continuing to have a strong balance sheet with a focus on liquidity. We are making all of these decisions with the bigger framework of our capital allocation decisions. To align with prevailing macro dynamics, we have intentionally toggled between our spend on land and a focus on shareholder returns, which Hilla will cover later. Now turning to Slide 4. Demand remained healthy during the spring selling season as we work through affordability concerns on a customer-by-customer basis. Second quarter 2025 orders were 3% higher year-over-year due to a 7% increase in average community count that was partially offset by a 4% decrease in average absorption pace. The cancellation rate of 10% this quarter remained lower than the historical average given the limited time between sale to close with our 60-day closing rate commitment. Average absorption pace decreased to 4.3 in the second quarter of 2025 from 4.5 per month in the prior year, but was in line with our target of spring selling sales pace greater than 4 per month. Under normal market conditions, we expect a sales pace that is higher in the first half of the year and a little lower in the second half of the year, balancing to around 4 net sales per store annually. ASP on orders this quarter of $395,000 was down 5% from the prior year due to a greater utilization of rate buydown financing incentives. We offer a wide range of incentives to our customers, and rate buydowns continue to be the most attractive offering in the majority of our markets as they drive affordability and help our customers solve for a monthly payment. Our second quarter 2025 ending community count was 312. This was up 9% year-over-year compared to 287 at June 30, 2024, and also up 8% compared to 290 at March 31, 2025. During the quarter, we brought over 50 new communities online with additional community count growth in the second half of the year. We reiterate our outlook of double-digit year-over-year growth for our 2025 year-end community count. As for early July indications, the first few weeks exhibited normal seasonality at a slower pace. July is traditionally one of the slowest sales months, and the timing of the 4th of July holiday caused the month to start slower than anticipated, but demand has improved to normal seasonality since then. We believe we can continue to solve affordability concerns and achieve our internal sales targets through our incentive offerings and broker relationships. Moving to the regional trend levels on Slide 5. The Central region had our highest average absorption pace of 5.2 in the second quarter, followed by the East with 4.1 net sales per month. The West region had an average absorption pace of 3.9. During the quarter, we continued to see diversity in performance across the country, with some of our markets experiencing healthy demand, while others were more impacted by the elevated mortgage rates and growing retail supply. Although no market is immune to the current economic conditions, we saw relatively strong demand and sales performance in Arizona, Dallas, Houston, and Southern California. Florida, Colorado, Austin, and San Antonio continue to face more challenging conditions with increasing existing inventory and stretched affordability, while the balance of our markets were performing as expected. Now turning to Slide 6. We started approximately 4,000 homes in the second quarter of 2025, 5% less than last year's Q2, given our faster cycle times while aligning with the current sales volume. We will continue to review seasonal sales patterns and our improved cycle times when planning for our starts pace per community in Q3 and beyond. With over 200% backlog conversion, our ending backlog declined from 2,700 units as of June 30, 2024, to 1,700 homes as of June 30, 2025. The lower ending backlog balance is an intentional output of our strategy as we were able to convert sales to closings quicker. The higher backlog conversion and shorter cycle times are also generating improved WIP asset turns, helping us to achieve home inventory turns of around 3x per year. As we gain additional experience and consistency under our new strategy, we will be reevaluating our target for backlog conversion rate this year. Since about half of our deliveries have been generated from inter-quarter sales for several quarters now, we consider the aggregate of total specs and backlog to determine the right inventory levels of each of our communities. We have had approximately 8,700 specs and backlog units as of June 30, 2025, as compared to over 9,200 units at June 30, 2024. We had approximately 6,900 spec homes in inventory as of June 30, 2025, up 400 units from over 6,500 specs as of June 30, 2024, and up 2% sequentially from Q1. While the total number of specs slightly increased, our specs per store held steady at approximately 22 specs per community this quarter, which corresponds to about 5 months of supply in the middle of our 4 to 6-month target. As a reminder, to have the appropriate amount of inventory to meet our 60-day closing ready commitment, we intentionally release our homes for sale when they're nearly move-in ready. So similar to Q1, we maintained our percentage of complete specs at 38% as of June 30, 2025. We continue to balance our inventory levels to ensure success in our go-to-market strategy and offer customers peace of mind. Our strategic focus and community count growth create an opportunity for near-term growth during a time of economic transition. With that, I will now turn it over to Hilla to walk through our financial results.

Hilla Sferruzza, Executive Vice President and CFO

Thank you, Phillippe. Let's turn to Slide 7 and cover our Q2 results in more detail. Second quarter 2025 home closing revenue of $1.6 billion was 5% lower compared to prior year despite a 1% increase in closing volume, primarily as a result of increased utilization of financing incentives, which drove our ASP on closings lower to $387,000 per home. Home closing gross margin of 21.1% in the second quarter of 2025 was down 480 bps from 25.9% in the second quarter of 2024, reflecting the increased use of financing incentives and higher lot costs, partially offset by improved direct costs and cycle times. Our Q2 2025 margins also included terminated land deal walkaway charges of $4.2 million compared to $1.4 million in the prior year. Excluding these charges, adjusted margins were 21.4% and 26% in the second quarters of 2025 and 2024, respectively. As we look at the components of margin, we note that despite some green shoots in the current pricing of land, the land basis that is reflected in our closings was acquired and developed several years ago and remains elevated due to the higher-than-normal land development costs experienced since 2022. While we've not yet seen these costs start to notably decline, we have seen them stabilize, and we are in the midst of ongoing efforts to actively rebid land development spend. During the quarter, we were successful in reducing our direct costs by more than 1% per square foot year-over-year. We also achieved direct cost savings sequentially from Q1 to Q2. In addition to lumber prices trending down, our higher volume, combined with stronger national vendor partnerships and our purchasing teams negotiations led to the incremental savings. Labor also seems to be more available in our markets, potentially stemming from slower multifamily construction and reduced starts in the industry. Our Q3 margin guidance reflects the current incentive environment, our actual land costs, the savings in the direct from lower prices and improved cycle times. On a sequential basis, Q3 margins incorporate some loss leverage from Q2 since we have already closed most of the high volume of the spring selling season orders in Q2 and July, which now generates about one-third of our closing volume for Q3 under our new strategy, is one of our slowest months of sales, as Phillippe already mentioned. Our pace typically picks up in August and September, but most of those closings won't occur until Q4. Our longer-term gross margin target remains at 22.5% to 23.5% under normal market conditions, which is about 300 bps higher than where we were pre-COVID due to our structural differences since that time. We are a larger scale company with a different operating model today, which we believe permanently improves our gross margin trajectory from our historical averages. We believe this target is achievable with even just a small pullback from the current above-normal levels of incentives being utilized by a large percentage of our customers. SG&A as a percentage of home closing revenue in the second quarter of 2025 was 10.2% compared to 9.3% in the second quarter of 2024, primarily as a result of higher commissions, start-up costs for our newer divisions, carry costs related to increased spec inventory as well as some loss leverage. Given the tougher selling conditions, commission rates were higher year-over-year, and our marketing spend also increased, respectively. Our co-broke percentage is in the low 90s and remains similar to Q1 this year. Under our new strategy, the higher volume of specs resulted in an increase in utilities, cleaning, and landscaping costs, all of which are included as a component of our selling expenses. We are assessing all SG&A components to ensure we have the appropriate overhead to align with the current operating environment. There are also some AI opportunities we are pursuing that can help us further streamline operations in the future. We are maintaining our long-term SG&A target of 9.5% once we achieve higher closing volumes. The second quarter's effective income tax rate was 23.9% this year compared to 22.1% for the second quarter of 2024. The higher tax rate in 2025 reflects fewer homes qualifying for energy tax credits under the Inflation Reduction Act, given the new higher construction threshold required to earn the tax credit this year. Overall, lower gross margins as well as higher SG&A and tax rate led to a 35% year-over-year decrease in second quarter 2025 diluted EPS to $2.04 from $3.15 in 2024. We also generated a return of equity of 12.5% for the 12 months ended June 30, 2025. To highlight just a few results from the first half of 2025. On a year-over-year basis, orders were flat, closings were down 1%, and our home closing revenue decreased 6% to $3 billion. Adjusted home closing gross margin of 21.7%, excluding terminated deal charges, was 420 bps lower than 2024. SG&A as a percentage of home closing revenue was 10.7%, and net earnings decreased 35% to $270 million with $3.73 in diluted EPS. Before we move on to the balance sheet, I want to discuss our customers' second quarter credit metrics. As expected, our buyer profile remained relatively consistent with our historical averages with FICO scores in the 730s and DTIs around 41 to 42. LTVs were in the high 80s. This strong credit profile validates our belief that there is still a deep buyer pool that can purchase our homes and that as of today, student loans are not a material headwind. The current market slowing isn't just a qualification or affordability issue, but also a function of weakened consumer sentiment. On to Slide 8. Our balance sheet remained healthy at June 30, 2025, with cash of $930 million, nothing drawn on our credit facility, and net debt to cap of 14.6%. Additionally, earlier this month, we refinanced our revolving credit facility to extend the maturity from 2029 to 2030. We are committed to our long-term growth trajectory while managing to a strong balance sheet and maintaining our investment-grade credit rating. As such, our net debt-to-cap ceiling remains in the mid-20% range. We aligned our capital spend with current market conditions. We reduced land acquisition and development spend net of land development reimbursements to $509 million for the second quarter of 2025. This was a 12% decrease from $576 million in the prior year. Accordingly, we are lowering our full year land spend target from $2.5 billion to $2 billion, given today's economic uncertainties. We also shifted our capital dollars to return more cash to shareholders this quarter, exceeding our programmatic threshold. We again tripled our $15 million quarterly commitment in the second quarter of 2025, demonstrating that we can and will repurchase shares opportunistically based on market conditions. We spent $45 million to buy back over 674,000 shares in Q2, recognizing the current undervaluation of our stock. To date, in 2025, we have spent $90 million on share buybacks, reducing our December 31, 2024, outstanding share count by almost 2%. As of June 30, 2025, $219 million remain available to repurchase under our share authorization program. We increased our quarterly cash dividend 15% year-over-year to $0.43 per share in 2025 from $0.375 per share in 2024. Our cash dividends totaled $31 million in the second quarter of 2025 and $61 million year-to-date. We returned a total of $76 million of cash to shareholders in the second quarter of 2025 and $151 million for the first half of this year as we intentionally slowed our land spend and recalibrated our capital allocation to maximize returns in the prevailing market environment. Slide 9. In the second quarter of 2025, we put approximately 1,800 net new lots under control. This balance is net of the 1,800 lots that we terminated as part of our routine quarterly review of land deals that no longer met our underwriting standards. In the second quarter of 2024, we put nearly 8,700 net new lots under control. As of June 30, 2025, we owned or controlled a total of about 81,900 lots, equating to 5.3 years supply of the last 12 months closings. We also had nearly 26,200 lots that were still undergoing diligence as of the end of the second quarter. Given our strong land portfolio as of June 30, we owned or controlled all of the land we need for the next several quarters. About 66% of our total lot inventory at June 30, 2025, and 2024 was owned and 34% optioned. Our maximum ceiling for option land remains in the 40% range. Finally, I'll direct you to Slide 10 for our guidance. Due to volatility in the market at this time and our high backlog conversion, we have little visibility beyond the next quarter. Therefore, we are only providing Q3 guidance. For Q3 2025, we are projecting total home closings between 3,600 and 3,900 units, home closing revenue of $1.4 billion to $1.56 billion, home closing gross margin of around 20%, an effective tax rate of about 24.5%, and diluted EPS in the range of $1.51 to $1.86. With that, I'll turn it back over to Phillippe.

Phillippe Lord, CEO

Thank you, Hilla. In closing, I want to highlight on Slide 11 that we have worked hard to create a business model that maximizes return and is flexible enough to allow us to navigate successfully through periods of economic transition. Our spec strategy provides us flexibility and an efficient cost structure to maintain the right level of WIP and lot inventories. We are offering consumers affordability and certainty in their homeownership journey, and believe our go-to-market strategies make us resilient as we compete with resale and grow our market share. In Q2, we achieved community count expansion and shorter cycle times to prepare us for future growth opportunities and also demonstrated our commitment to disciplined land spend and growth in the business while increasing our return of cash to shareholders. Through our operations and capital allocation strategy, we are focused on maximizing returns. With that, I will now turn the call over to the operator for instructions on the Q&A.

Operator, Operator

Our first question comes from Trevor Allinson with Wolfe Research.

Trevor Allinson, Analyst

I appreciate your high backlog conversion rate and the volatile environment really limits your visibility into full year volume. So I guess a question on what you're seeing regarding absorption rates on new communities. I think previously, you expected that as you bring on a significant number of new communities, you would expect to see pretty good absorption rates relative to fleet average on those. Can you just comment on how that has trended versus what you expected?

Phillippe Lord, CEO

Yes. Thank you for the question. It's trended pretty well. As you can see from the Q2 results, we opened up 50 stores and achieved 4.3 net sales per month in that quarter. So they opened up and met our expectations as it relates to what we were thinking we were going to get from those communities.

Trevor Allinson, Analyst

Okay. Definitely encouraging to hear. And then the second question is somewhat related on community count specifically. You've had a really nice growth there, expecting more in the second half. Can you talk about the cadence that you're expecting in the second half? You talked about up double digits by the fourth quarter by any community count. Any additional color on what exactly you're thinking with double digits? And then with what you have in the pipeline, any early reads on where 2026 community count could grow?

Phillippe Lord, CEO

Yes. Thank you again. I think from this was a really big quarter for us, Q2. We knew we were going to get a big pop here. I think from here, the rest of it is pretty even-flowed between Q3 and Q4 to achieve the double-digit community count growth. We still feel that we're going to end the year there. As it relates to 2026, still doing a lot of planning around that, but we expect another solid year of double-digit growth between the beginning of that year and the end of 2026.

Hilla Sferruzza, Executive Vice President and CFO

Yes. Trevor, I think we touched on this a little bit in various conversations, but the double-digit growth is not going to be 10.0%, but it's also not going to be 20%. So it's somewhere in between, but it's going to be north of 10%.

Alan Ratner, Analyst

So first question on the volume outlook, understanding not updating the full year guidance. I'm just trying to think through how you're positioned from a volume standpoint for the remainder of the year. If I look at your homes under construction, the specs and backlog of about 8,700 and I look at the closings year-to-date, it would still seem like if the market cooperates, you're positioned to deliver 16,000-plus homes, like not too far off from where you were before. I just want to make sure I'm thinking about that correctly. And I guess, in general, are you scaling back spec starts at all here in the third quarter? And will that have any impact on your ability to deliver homes this year? Or is that more of a '26 story?

Phillippe Lord, CEO

Yes. Thanks, Alan. I think you are thinking about it the right way. Q3, based on our high backlog conversion rate is now going to be one of our lowest volume quarters because we basically close out all the spring demand, and then we obviously have July to start the quarter out. So that's really what's driving the lack of visibility and some of the macro conditions that we're experiencing. But we certainly have the community count and the inventory to achieve the numbers that you're mentioning. It's just a matter of whether the market will cooperate. To your second question, we are slowing down starts because of our cycle times. And so we can reduce the number of starts we have based on just the timing that's taking to build homes. And then we're ramping up starts because of our community count growth. But between those two things, I still think you'll see a slower Q3 to kind of match the seasonality of demand, but we're still starting quite a few specs in all these new communities that we're opening up between now and the end of the year.

Alan Ratner, Analyst

Got it. That's helpful. And then just thinking through kind of cash capital allocation, you've been buying back stock at a slightly greater rate than kind of the quarterly commitment you've set forth. I'm just curious with you pulling back the land spend by $500 million, is there an opportunity? Or are you thinking about accelerating that buyback number even further? Because it would seem like that should free up a pretty meaningful amount of cash in the back half of the year, if I'm thinking about that correctly.

Hilla Sferruzza, Executive Vice President and CFO

Yes. We're definitely looking at rebalancing those two, a good catch on the fact that we're pulling back on the expected spend by $0.5 billion. So we're definitely going to be pressing on the gas on the repurchases while kind of just keeping an eye on the store. We do have quite a few communities opening, and all those need new specs as well, which is also a cash utilization for us. So we're balancing all those pieces, but definitely an intentional rebalancing from the volume of land spend that maybe we projected coming into the year based on current economic conditions and redeploying that cash back into return of capital to shareholders.

Phillippe Lord, CEO

Yes. And I would just say that with our stock trading where it is, you can expect us to continue to buy more than our programmatic commitment because of the value that we see in our stock.

Stephen Kim, Analyst

I appreciate the clarification. Following up on Trevor's comment about your new communities opening up being beneficial for sales, is it correct that when these communities first open, they generally have a lower margin profile compared to when they mature? Is this a true dynamic for your company, and should we consider this in relation to how these communities impact your margins?

Phillippe Lord, CEO

So yes, I think traditionally, when you open up a new community, you set it up to make sure you garner momentum because momentum is really important; it gives the consumers confidence. And so we certainly evaluate and make sure we price our new community openings to achieve that momentum. I don't think it's fair to say that we open up new communities at lower margins just as a standard course of business. It's really sort of market by market. In today's environment, I think the theory of being more conservative when you open to make sure you get those first sales is probably a reality just because of the amount of incentives out there in the market and whatnot. But I'd have to go back and look. A lot of the new communities we opened up this last quarter are really good locations and really good spots. So I feel pretty good that the margin profile was pretty good. But yes, to your point, we always traditionally try to open up a community and gain momentum. And usually the number one lever to do that is pricing.

Stephen Kim, Analyst

Yes, I appreciate that. Another question relates to some of the changes you made in addition to guaranteeing move-in in 60 days, you've also changed the way in which your sales folks can cross-sell, sell homes in communities that are not the one they're sitting in. And I was curious, first of all, that seemed like it might be a really good thing for your strategy in terms of developing the relationships, not just with the realtors, but with also consumers who may be looking at more than one community. But I was wondering if you could give us some statistics on that, like roughly what percent of your sales are done in a cross-sell manner? And secondarily, are you seeing any of your peers copying this or not? And if not, why do you think that is?

Phillippe Lord, CEO

Yes. The reason we are pursuing cross-selling is exactly as you mentioned. When we engage with our customers and realtors, they often form a relationship with a specific salesperson. Even if they are not interested in buying or selling in a particular community, they prefer to work with that same salesperson. Cross-selling enables us to maintain and strengthen those relationships across different communities. I believe the percentage of cross-selling is quite high because it's occurring company-wide. Many salespeople in our organization are active in communities where they are not officially assigned. We no longer restrict them to a single community; instead, they are meeting with realtors and customers, showing homes, without being tied to any one location. I think we could reach a point where this becomes nearly universal. Regarding your question about competitors, I would say that some of them are indeed adopting similar practices. Lennar was among the first to implement cross-selling in a few markets, although they still tend to keep their salespeople connected to specific communities. In contrast, our approach is not to tether them to any community, solely focusing on cross-selling. I hope this information helps.

John Lovallo, Analyst

I wanted to talk about the gross margin. So the third quarter gross margin seems like it's expected to decline about 140 basis points sequentially. And I know you guys pointed to lower closings given the new strategy, higher land cost, and higher incentives. So as a starting point, I was hoping maybe you could bucket those three categories as it pertains to that 140 basis points decline. And then importantly, it seems like the fourth quarter gross margin is expected to step up from sequentially from the third quarter. I wonder if you could just help us kind of put some context around the magnitude of that potential step up.

Hilla Sferruzza, Executive Vice President and CFO

Yes. So we actually didn't give any guidance on Q4. So I don't think we're going to have any discussion about that. However, the commentary probably still stands. We did note that there's going to be a lost leverage in Q3 in our prepared remarks and that you can see that from the volume projections that we provided in the guidance, and that's really a function of July being a little bit of a tougher month. And that pickup that you're seeing subsequent to that is really not going to materialize in closings until Q4. So I think that you're seeing that lost leverage is the primary driver of the pullback in margins. If you recall from discussions in prior years, it can be 75 to 100 bps in lost leverage in gross margin alone from volume. So as we're looking at our expectations for Q3, and we know that the volume is going to be less, the majority of the pullback that you're seeing is loss leverage. As I said, we didn't give any guidance into Q4, and we didn't reiterate our full year guidance. But putting logic together, if we're expecting a different volume for the last quarter of the year, any lost leverage could potentially be recovered if the units increase at that point in time. So I think that that's the majority. I don't know that the other categories make up meaningful buckets. It's primarily the loss leverage.

Phillippe Lord, CEO

And just to amplify a few things that you highlighted, I mean, most build-to-order builders, their lowest leverage quarter is going to be Q1 because they close out all their backlog in Q4. For us, based on our new strategy, it's going to be Q3. And traditionally, July is the slowest month of sales across the whole year. Sometimes December can be slow, too, but July is traditionally the slowest. And then we start to see volume pick back up between September, October, and November. So that's kind of what we're currently expecting. But right now, it's tough to see with everything that's going on.

Hilla Sferruzza, Executive Vice President and CFO

Yes. When you think about the fact that we closed out such a material portion of our backlog, and we're coming in with a lower backlog, there's not that cushion to go into it. So some of those closings were accelerated into Q2. The strong volume that we're going to have in the back half in sales in Q3 isn't going to close until Q4. So it kind of creates this dip in Q3, which, as Phillippe said, is a different quarter for other builders.

Michael Rehaut, Analyst

I wanted to start off with some of the comments around how to think about closings for the full year. I think Alan brought that up. And obviously, you have a decent amount perhaps of a thought around volume, I would assume already. Gross margins obviously taking a little bit of a downward move in the third quarter and sensibly assuming a relatively stable backdrop. I know that might be a big assumption, but I would assume that there's some way to think about Q4 even at this point. I'm wondering about the pulling of the full year guidance at this point in the year. And if there's other variables outside of just what you're seeing today in terms of maybe being a little less certain that maybe we're not fully appreciating in terms of pulling the guidance rather than perhaps just adding a little bit of a wider range or maybe lowering the high end of the range versus what you had 3 months ago?

Phillippe Lord, CEO

Yes, it's a great question. Our uncertainty stems from the lack of visibility regarding our current backlog. By analyzing our community count and guidance for Q3, we can estimate the absorption per store, which reflects our market expectations. We remain optimistic that demand will follow the typical seasonal trend, as historically, August, September, and October show a significant increase compared to July. However, considering the broader economic context, we hesitate to make any firm commitments until we observe the actual performance. As we wrap up July and move into August, we’ll have a clearer picture. If September proves strong and October maintains that momentum, as well as our community count increasing in the latter half of the year, we expect to reach an encouraging full-year figure. However, given our currently low backlog rate, it's challenging to provide comprehensive full-year guidance at this time. This was the consensus we reached with our Board and other company stakeholders, and we believe it's the most prudent course of action.

Hilla Sferruzza, Executive Vice President and CFO

Yes. I'll just mention that it's quite obvious, but it needs to be stated. Looking at our backlog as we head into the quarter, which is 1,700 units, we've estimated 3,600 to 3,900 closings. We haven’t identified all our closings for Q3 yet, and we have no closings determined for Q4. Given the current market situation, we felt it was unwise to issue a number that could be inaccurate, whether too high or too low. We consider it irresponsible to provide a figure at this time since market conditions are changing rapidly, making it hard to predict. We have a solid level of confidence regarding Q3, even with fewer than half of the anticipated closings. Once market conditions and community count trends stabilize, we will be in a position to give better guidance moving forward. Unlike many of our competitors, we currently don't have units sold beyond the current quarter, so it’s essentially an educated guess from us, which didn't seem appropriate.

Rafe Jadrosich, Analyst

Just following up on some of the prior questions on the fixed cost side. Can you give some color on the fixed costs that are in cost of goods? It would be really helpful if we could get a dollar amount, so we sort of break out what the deleverage could be in the third quarter and what the leverage was in the second quarter?

Hilla Sferruzza, Executive Vice President and CFO

Yes, that's too detailed. We don't go into components of gross margin, but you guys can probably back into it if we're giving you the lost leverage pieces. We can tell you that it's mostly people, people costs, right? So there's superintendents and land acquisition and land evaluation team members that no matter how many homes we sell, they're still working. So it's really the leveraging of the human capital that's the primary driver.

Rafe Jadrosich, Analyst

Got it. So the 140 basis point decline from the second quarter to the third quarter is entirely due to deleveraging? It's not because of higher incentives compared to the previous quarter?

Hilla Sferruzza, Executive Vice President and CFO

No. So it's not all deleverage. I think we've gone on record many times in the past, the deleveraging from your highest quarter to your lowest quarter is typically 75 to 100 bps. So it's not the 140. It's just the large portion of that pullback. The rest is a million other factors going forward and backwards, product mix, geographic mix. It's a lot of other little things here and there.

Phillippe Lord, CEO

Yes. I mean we're not currently thinking that incentives are going to rise between Q2 and Q3. They were already pretty high. But certainly, July is a tough month, and we see some pretty aggressive stuff out there in July to get through the summer slowdown.

Charles Perron-Piché, Analyst

This is Charles Perron from Susan's team. Given the increasing for-sale inventory in the markets, are you adjusting your approach to broker commissions to boost traffic and volume, particularly in your new communities?

Phillippe Lord, CEO

I believe our overall strategy is to closely align with and compete against the existing home market. As inventory returns, we aim to be an attractive option for purchasing a new home instead of a used one. A critical element of this approach is providing a consistent and dependable commission structure for our realtors to rely on. We set our external commissions according to the going market rate in each area. Currently, the competitive landscape features many businesses employing various incentives, including realtor bonuses, which is more of an industry trend than specific to Meritage. In some regions where realtors significantly influence the customer base, we might adopt similar practices. However, generally, our realtor strategy is consistent and based on market rates at the metropolitan statistical area level, regardless of whether we are entering a new community or operating in an existing one.

Hilla Sferruzza, Executive Vice President and CFO

Yes. To clarify, several of our peers have already pointed this out. It's clear that resale inventory is rising across the U.S., but it doesn't necessarily pose a direct competition in every market we operate in. Much of the new inventory isn't aimed at entry-level buyers; a significant portion is older. Additionally, as we noted, buyers typically can't access financing incentives when purchasing from individual homeowners. Therefore, it hasn't created the negative impact we anticipated in markets experiencing a resurgence in resale inventory. While it is a factor and does present competition, it is not direct competition.

Phillippe Lord, CEO

Yes, I think that's a really important point. The incentives we're seeing out there are in the existing home space. The incentives we're competing with right now are more in the new home space.

Hilla Sferruzza, Executive Vice President and CFO

That's super helpful. And then in terms of the community count growth outlook, the double-digit this year and then also targeting that for next year. Can you talk about how many of those communities are in newer markets or expanding into additional markets versus places where are like in existing markets that you have today?

Phillippe Lord, CEO

Yes. So we went into Jacksonville and Utah recently, a couple of years ago. And then, of course, we bought Elliott Homes recently, which got us into the Gulf Coast. So other than those three, all the new community count growth we're talking about for this year and next year is in our existing footprint. But I would say we are overinvesting, obviously, in Jacksonville, Utah, and the Gulf Coast because we want to gain scale there, although the Elliott Homes transaction came with almost 5,000 lots. So we have quite a few lots through that acquisition. But there is no new community growth between now and next year in markets that we're currently not in. I appreciate everyone joining our call today. Thank you so much for your interest in our organization, and we look forward to seeing everyone next quarter. Appreciate it very much.

Operator, Operator

Thank you. And that concludes today's call. All parties may now disconnect. Have a good day.