Taylor Morrison Home Corp Q1 FY2021 Earnings Call

Good morning, and welcome to Taylor Morrison's First Quarter 2021 Earnings Conference Call. As a reminder, this conference call is being recorded. I would now like to introduce Mackenzie Aron, Vice President of Investor Relations.

Thank you, and good morning. I am joined today by Sheryl Palmer, Chairman and Chief Executive Officer; and Dave Cone, Executive Vice President and Chief Financial Officer. Sheryl will provide an overview of our performance and strategic priorities, while Dave will share the highlights of our financial results, after which we will be happy to take your questions. In the interest of time, we ask that you please limit yourself to one question and one follow-up. 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 earnings release, which is available on the Investor Relations portion of our website. These statements are subject to risks and uncertainties that could cause actual results to differ materially from our expectations and projections. These risks and uncertainties include, but are not limited to, those factors identified in the release and in our filings with the SEC, and we do not undertake any obligation to update our forward-looking statements. In addition, we will refer to certain non-GAAP financial measures on the call, which are reconciled to GAAP figures in the release. Now let me turn the call over to Sheryl.

Thank you, Mackenzie, and good morning, everyone. I appreciate you joining us today and sincerely hope each of you and your loved ones remain healthy and safe. I am pleased to share with you our first quarter results, which reflect the initial benefits of our enhanced scale and local market depth as we continue to execute our strategic plan. We achieved a 42% increase in our monthly absorption pace to an all-time high of 4.3 net sales per community and a 320 basis point improvement in our home closings gross margin. In addition, we ended the quarter with a company record backlog of over 10,000 homes and more than 73,000 total homebuilding lots under control, positioning us to capitalize on the strong demand momentum we are experiencing across each of our price points and markets. And most importantly, we made progress towards our operational priorities aimed at increasing our profitability and return metrics over the next several quarters. After years of strategic growth and multiple acquisitions aimed at improving our long-term return potential, we are committed to delivering financial performance reflective of the size and operational advantages we have achieved in becoming a top side homebuilder. To that end, across the organization, our priorities are aligned to improve gross margins, increase asset efficiency, leverage our overhead and optimize our balance sheet. On the operational front, this work encompasses everything from streamlining our floor plans and design options, optimizing our strategic selling process, reducing our cost through procurement initiatives and leveraging our virtual sales tools. These efforts have always been key to our strategy, but there is still room to apply our best practices consistently across our newer markets to partially offset the higher land residuals and construction costs in our newly acquired communities. We are following the proven roadmap we have used in other acquisition markets such as Phoenix, Atlanta, Orlando and Charlotte, where we have successfully realized significant accretion to deliver margins at or above the company average. I am pleased that these efforts are beginning to translate into strong results as reflected in the composition of our homes and backlog that we expect will drive accelerated margin accretion in the second half of the year and into 2022. For example, to streamline and optimize our business, we eliminated over 5,000 option SKUs from our inventory in the first quarter alone and have reduced our floor plan library by over one-third since we began our rationalization effort. We have also introduced our standardized option pallets to well over 50% of our markets, further simplifying our design and construction processes. These initiatives are driving increased option penetration, higher option margins and greater production efficiencies. In addition, our strategic selling practices have doubled lot premiums year-over-year on sold homes and backlog. We are also continuing to find creative ways to optimize our sales structure to drive additional bottom line accretion. The most exciting and impactful of which is our innovative suite of new virtual selling tools, which we recently expanded with the launch of a new, first-of-its-kind online home configuration and reservation system for to-be-built homes. This new tool allows our buyers to pick a home site and design a floor plan entirely online on their own terms. With lower broker representation and higher conversion rates in the company average, our virtual sales tools are enabling us to reduce realtor commission expenses, leverage our overhead and enhance our customer experience. In total, this focus on operational excellence and balance sheet optimization is expected to drive our return on equity to the mid-teens range in 2021, followed by further expansion in 2022 and beyond before considering the anticipated benefit from more programmatic land financing vehicles. As I shared last quarter, we're exploring several opportunities that would allow us to grow our business with enhanced capital efficiency. I am pleased we've advanced those discussions during the quarter and expect to share more detail in the months ahead. From a macro perspective, all indicators are pointing to continued strength in consumer demand for housing. Interest rates remain at historically low levels at approximately 3%, enhancing borrowers' purchasing power and affordability remains favorable even when considering strong home price appreciation. In looking at the buying power of our consumers, we remain encouraged by the overall financial health and affordability metrics. In addition, we intentionally seek to serve a diverse mix of homebuyers and carefully manage our balance of pace versus price, especially within our entry-level communities, to mitigate affordability risk. As you've heard me share before, we monitor the difference between the actual interest rate of our borrowers served by Taylor Morrison Home Funding versus the maximum interest rate they could have qualified for as the gauge of affordability. In the first quarter, this spread averaged over 700 basis points for our conventional borrowers and over 500 basis points for our FHA borrowers, giving us confidence in our customers' financial flexibility if and when interest rates move higher. This strong interest rate cushion is a reflection of our consumer quality. Specifically in the first quarter, our Taylor Morrison Home Funding borrowers provided an average down payment of 20% at an average debt-to-income ratio of 36% and an average credit score of 750. Notably, these strong credit metrics slightly improved from a year ago level despite our mortgage first-time homebuyer share growing by over 1,000 basis points to a company high of 40%, and our cash rate also expanding by 1,000 basis points to 85% over the same period last year. In other words, while we have increased and broadened our customer base to serve more homebuyers, particularly at the entry level, we have maintained the high credit quality and consumer strength we have long enjoyed. I attribute this to our mortgage team's diligent prequalification of nearly all our homebuyers prior to entering into a purchase agreement and the embedded value of our financial services to our customers and homebuilding operations. Turning now to our sales success. In the first quarter, our strong activity was driven by gains across all geographies and consumer groups. There are a couple of highlights we're sharing. Among our markets, we experienced the strongest year-over-year increase in our monthly absorption pace in our central region, which includes Texas and Colorado. This strength has been partially driven by an influx of homebuyers from California whose share of our Texas sales orders in the first quarter doubled pre-COVID levels, with acceleration throughout the quarter in California home shoppers, suggesting further gains in the months ahead. Among our consumer groups, our active adult segment drove the highest year-over-year gains in net sales orders and absorption pace as this cohort increasingly reengaged as the vaccine rollout accelerates and strong home equity gains appeal mobility among existing homeowners. These active adult buyers are also relatively less impacted by changes in interest rates due to an above-average share of all cash transactions. Given the demographic tailwind in this segment of the market, I'm excited to share that we are expanding our signature active adult lifestyle brand, Esplanade, nationally from its home base in Florida, where we have established a reputation for distinctive, resort-style living and concierge services that command a strong premium among active adult home buyers. We recently introduced the Esplanade brand to the West Coast with two new communities in California and have planned to open another in North Carolina later this year. The expansion has been well received as our Southern California community has been selling with limited releases amid strong demand since its successful grand opening in March, while our Sacramento community slated to open in May already has a wait list of over 2,000 interested shoppers. The nationalization of our Esplanade brand will bring greater consistency to our active adult communities, leverage our brand awareness and meet the needs of active lifestyle residents in our markets. With above-average gross margins, partially driven by higher option take rates and lot premiums that are more than twice the company average, we expect this growth will be a long-term benefit to our overall profitability. However, today's remarkably strong housing market is not without its challenges. The supply side of our industry remains constrained by the severe deficit of trade labor, ongoing COVID-19 and weather-related disruptions affecting product manufacturers and distributors, and municipality-level delays. Our teams are navigating this environment by holding new sales to align to our starts pace, managing construction cycles and leveraging trade relationships to ensure our business continues to run effectively. In the first quarter, our production pace of 4.1 starts per community was up more than 70% year-over-year to another company record high. And our cycle times were roughly flat year-over-year as our teams have accelerated our construction capacity despite the supply side challenges. In addition, we are raising prices in nearly all our communities, and as mentioned, limiting releases to align with production. This disciplined approach ensures we are realizing appropriate price increases in excess of cost inflation, managing the length of our backlog and maximizing the return potential of each asset. In closing, we're committed to taking full advantage of our competitive strengths and executing on our long-term strategic vision, which has been years in the making after six acquisitions that have equipped us with the size and team capable of generating attractive long-term returns for our shareholders. As I have said before, we believe 2021 marks an important inflection point in our multiyear journey to realize the operational and financial advantages of our significant growth, and I look forward to continuing to update you on our progress as we move forward. Now let me turn the call over to Dave for his financial review.

Thanks, Sheryl, and good morning, everyone. Turning to the details of our first quarter results, we generated net income of $98 million or $0.75 per diluted share compared to a net loss of $31 million or $0.26 per diluted share in the first quarter of 2020, which had been impacted by our acquisition of William Lyon Homes a year ago. During the quarter, our net sales orders increased 30% year-over-year to 4,492, the highest quarterly level in our company history. Our monthly absorption pace increased 42% year-over-year to 4.3 net sales orders per community, also an all-time company high. This benefited from an all-time company low cancellation rate of just 6%. As Sheryl noted, we achieved this record sales success, even while the strategy is designed to meet our sales activity to align with production capacity, underscoring the resiliency of the current demand environment and the competitive strength of our product offerings. This strength continued into April as we have managed absorption into the high 3 range. This order growth, combined with our large median backlog drove a 54% year-over-year increase in our ending backlog to 10,074 homes at quarter end, representing a sales value of $5.3 billion. The stronger-than-anticipated sales activity drove our average community count to 345 as accelerated community closeouts once again outpaced new community openings. This was below our prior guidance range due to a number of factors, including stronger-than-anticipated sales paces and ongoing extensions in municipality approvals. In addition, given the size of our backlog and commitment to our best-in-class customer experience, we opted to delay presales in a handful of communities and wait until models are fully complete to grand open, a strategy we believe ensures optimal margin performance on new openings. As a result, in the second quarter, our average community count is anticipated to be approximately 330, and for the full year, we now expect our average community count to moderate to approximately 330 before rebounding in late 2022 and inflecting higher in 2023. We continue to expect to open nearly 150 new communities this year. In the first quarter, we delivered 2,821 closed homes. This was also slightly below our prior guidance range due primarily to the impact of disruptions related to the February winter storm in Texas. We are pleased that thus far in the second quarter, nearly all first quarter effective closings have now been delivered. However, there are still lingering disruptions from the storm to the supply chain, particularly in petrochemical manufacturing, which is causing delays in plastic building components such as plumbing, landscaping and electrical products. Including the impact of these delays on our Texas production, we expect to deliver between 3,200 and 3,400 closed homes in the second quarter. However, Texas cycle times are expected to normalize by the third quarter. As a result, we continue to anticipate a significant ramp in deliveries in the second half of the year to drive our 2021 full year deliveries to the range of 14,500 to 15,000. This implies an 18% year-over-year increase at the midpoint and is consistent with our prior guidance range. Turning now to gross margins. Our home closings gross margin was 18.6%, up 320 basis points from the first quarter of 2020, which was impacted by our acquisition of William Lyon Homes. We anticipate our second quarter home closings gross margin to be generally flat sequentially in the mid-18% range. Based on the timing of cost increases and home price gains, we expect our first half gross margin to reflect the greatest impact from lumber and other cost inflation. Based on an acceleration in margin accretion in the second half of the year, driven by pricing power and operational synergies as we pass the critical 18-month mark post our acquisition of William Lyon, we now anticipate our full year 2021 home closings gross margin to improve to the low 19% range. Looking ahead, we expect further margin improvement in 2022 based on the favorable mix of our backlog and operational efficiencies that Sheryl discussed earlier. Our SG&A as a percentage of home closings revenue was flat year-over-year at 10.8%. But for the full year 2021, we continue to expect our SG&A to decline to the mid-9% range, reflecting cost leverage from the anticipated increase in our total revenue and cost synergies from our enhanced scale. In the first quarter, we invested approximately $552 million in land acquisition and development, up from $317 million in the first quarter of 2020, given the increased size of our business following our acquisition of William Lyon Homes. In 2021, we continue to expect our total land investment to be approximately $2 billion. We remained disciplined in our underwriting to acquire land where we see opportunities to drive profitable growth over the full cycle, with the land acquisitions we are approving largely expected to impact deliveries in 2023 and beyond. Our lot supply increased by approximately 3,000 lots since year-end to 73,000 total lots owned and controlled. This represented 5.8 years of total supply, of which 4 years was owned. As of quarter end, we control 32% of our lots through options and other arrangements, up from 28% in the first quarter of 2020 and marking the highest level since the third quarter of 2018. To minimize risk and maximize return terms, we are targeting an increase in our controlled share to approximately 40% within the next 2 years, which we expect to achieve through evolving land financing vehicles, as Sheryl noted, and other off-balance sheet structures such as joint ventures and project financing that we utilize when appropriate. Turning now to our balance sheet. We ended the quarter with $1.1 billion of total liquidity, including $393 million of cash on hand and $748 million of available capacity on our $800 million revolving credit facility, which was undrawn outside of normal corporate letters of credit. Additionally, at quarter end, our total spec inventory equaled 3 homes per community, nearly all of which were under construction. This was well below our normal run rate due to faster than normal sales conversions of our spec starts. Overall, our capital and liquidity position are in solid shape, and we will continue to manage the business within the context of our disciplined capital allocation framework. Our net debt-to-capital ratio equaled 40.1%. Based on our outlook for strong cash flow generation, we continue to expect our net debt-to-capital ratio to reach the low 30% range by year-end, followed by further improvement in 2022. Lastly, in the first quarter, we spent $38 million to repurchase 1.4 million shares. This brings our cumulative share repurchase to approximately $690 million or 30% of our shares outstanding since 2015. At quarter end, we had $48 million remaining on our current repurchase authorization, and we will continue to utilize share buybacks opportunistically to return excess capital to our shareholders and enhance their overall returns. Now I'll turn the call back over to Sheryl.

Thank you, Dave. Two weeks ago, we published our third annual environmental, social and governance report, which highlighted the ESG-related achievements we made in 2020 and the initiatives and priorities we are focused on for the future. At Taylor Morrison, we strongly believe that our people-centric approach to home building is foundational to our ability to generate long-term attractive returns for our shareholders. To that end, we incorporate sustainable, forward-thinking decision-making across all layers of our organization, from our land development, construction processes, people management, community engagement and governance. Among some of the highlights I am proud to share is the progress in our exclusive relationship with the National Wildlife Federation, with whom we collaborate to preserve and protect the natural environment in our communities. To date, we have certified nearly 4,000 acres of wild habitats and developed plans for over 170 more protected spaces, Monarch butterfly gardens and eco-friendly playscapes across each of our divisions to foster responsible stewardship of the land we build on for generations to come. We also deepened our partnership with HomeAid America to renovate shelters in our local communities and provide housing options for our neighbors most in need. This is just one way in which we empower our team members to use our resources and talent to uplift our communities. A responsibility, which became even more important in 2020 as the pandemic laid bare the housing and security space by so many Americans, which is a crisis we feel uniquely charged to help address. This commitment to philanthropy recently earned us the 2021 Hearthstone BUILDER Humanitarian Award, which is presented annually in recognition of a lifetime commitment to bettering communities. And lastly, but certainly not least, I'm proud that we have helped pave a way for greater gender equality, and we feel similarly compelled to be a leader in representation for all races and ethnicities, starting with my own commitment to the CEO Action pledge, a promise to advance diversity and inclusion in our organization. In closing, I'd like to offer my deepest appreciation to our team members and trade partners for their tremendous efforts and commitment to our customers and our organization. Now I'd like to open the call to your questions. Operator, please provide our participants with instructions.

Our first question comes from Matthew Bouley from Barclays.

This is Ashley Kim on for Matt today. So just given supply chain tightness, labor inflation, lumber inflation that you mentioned in the prepared remarks, can you just talk about your estimates around cost inflation and how it hasn't changed since given the full year outlook in 4Q? And then just maybe what assumptions on pricing and costs you're embedding in the gross margin guide?

Yes. Ashley, I'll start on the cost side. Clearly, the focus continues to be on lumber. We're hoping to see that normalize as we move through the year. With mills coming online, hopefully, some potential relief that the trade agreement has reached. There are other pockets impacted by costs as we've all heard, resin being one of those that's impacted cost and put some pressure on the supply chain. As we look out, I think from a cost increase standpoint for the rest of the year, it's probably around 400 basis points. But we're working with our trade partners on labor, getting materials and supplies onto the job sites, but I do believe we're going to see prices stay ahead of cost as we move through the rest of the year as well.

I might add to that, Ashley, because Dave's right, the biggest one that everyone's talking about is lumber. And I would tell you that the industry continues to raise the issues of lumber prices with the administration and probably members of Congress because it feels like we've been pretty slow to engage on the Canada negotiation. And I think even more concerning than that because I do understand we're getting close in the next many weeks. But I think even more concerning or maybe better said, the greater opportunity is if we could really respond with better domestic capacity. I mean, if you look across the border in Canada, we've seen that their mills have been kind of open at full speed since August. And we just haven't come back to full capacity yet. So I think we're all very excited about that opportunity in the months ahead.

That's helpful color. And then just my next one. As we get closer to the back half of '21 and start to think about normal sales pace, given communities are running low. Do you think sales pace kind of stays elevated on an absolute basis while just sequentially moving lower, taking in normal seasonality? Or how are you thinking that will progress, just given your start pace?

Yes. No, it's a good question. I think you have to look at a couple of things. One, when you say "stays elevated" right now, there's a few things that are at play, right? We are, as we reported, kind of a record pace in the first quarter. We are really managing that pace as we look forward, as we said, to align production. So, I think if you want to talk about the demand side, the paces could remain quite elevated. And if you want to do a compare for us year-over-year, they're still tremendously elevated. But I'm going to share that we likely won't repeat this over four paces as we look through the balance of the year, partly because of our alignment to production, partly because of some seasonality. I think in April, we're probably somewhere in the 3.7 range. I think somewhere in those high 3s would be something that we would plan on compared to just anything over two as we look to the balance of the year.

Our next question comes from Carl Reichardt with BTIG.

Sheryl, I'm curious about our current community count, which appears to be somewhat stable until the end of 2022. How do you anticipate the mix will shift, if at all, between different product types and geographies, considering that you'll be both opening and closing some locations?

Carl, that's a great question. At a broad level, regarding consumer groups, I don't anticipate any significant changes. There has been a shift, as I've mentioned in my prepared remarks, where our mortgage consumers include about 40% first-time buyers. Looking specifically at first-time buyers, we are up roughly 40% year-over-year. The structure you can see in our investment deck reflects the overall percentage. In terms of geographic presence, there has definitely been some movement. As noted in the press release, we have seen a reduction in our central area, partly due to our transition away from a finished lot business, which Texas has traditionally been. We are focused on controlling our own destiny and avoiding any potential gaps caused by development delays. By operating larger, more efficient communities, we hope to achieve that. Texas is where we've seen the most significant change, but overall, when I consider consumers as a whole, things remain relatively stable.

And then maybe can you talk a little bit about what the land market looks like now? We've had a couple of builders say, "Well, we're seeing a bit of erratic pricing in some markets." And then others say that the business remains largely rational. I'm just curious as to your perspective on that.

Thanks, Carl. You're always going to be able to point to those one or two crazy deals. I could probably do the same, but it's probably not where I would focus my effort. I think it's about how you approach the land market. I mean, everybody is out there, given the paces that have been recorded through the quarter. Everyone's running into the same challenges and opportunities to bring more land on board. But I would say, as we continue to stay focused on our strategy around key locations, actually, that's quite helpful because there's been a lot of movement out to the fringe. We're going to retain our strong processes and approval cadence and the way we look at deals. In fact, when I look at our land residual over the last 12 months, I would tell you that it's actually in line, and in some markets a little bit lower. Obviously, that's aided by price appreciation. The biggest shift we're seeing in our land kind of acquisition efforts is we're seeing a much higher penetration of raw deals if you don't see the same finished lots available. But even with the activity that's out there, our return margin expectations remain higher than we've seen for a number of years.

The next question comes from Alan Ratner with Zelman & Associates.

First question. I'd love to drill in a little bit on the average order price, a huge increase this quarter, up 18% year-over-year. And I'm just curious, obviously, there's a lot of pricing power, but can you talk a little bit about whether any of that was impacted by mix? Or is a price in the mid-5s now kind of the right way to think about your business going forward? And assuming that's the case, I'm a little bit surprised, maybe there's not more of that upside flowing through to gross margin in the back half of the year. Just given, Dave, your commentary on cost inflation kind of in that 400 basis point range. So any conversation there would be great.

Yes, Alan, I'll start maybe with where we think ASP is going to trend to help you guys from a modeling perspective, given the ramp-up that we have seen in ASP. We're likely going to see the 2021 ASP in the 515 to 520 range, assuming pricing holds to where it is. Obviously, there's some additional pricing that we believe that's out there in the back half as we do believe it's going to stay ahead of cost. And then I can jump into the...

The margin, I guess, just perhaps maybe why that's not flowing through the margin a little bit stronger, just given how much pricing is up.

Yes, there are a few points to consider. We are noticing our pricing power. As you may remember, the acquisition of William Lyon has resulted in lower legacy margins compared to our traditional Taylor Morrison operations due to a different cost structure. It typically takes around 18 months to enhance these margins by leveraging synergies. We have established those synergies, but it took most of 2020 to reach this point. Many of the deliveries we are reporting this quarter, and somewhat in the second quarter, originated from the legacy William Lyon Communities completed before these synergies were effective. As we approach Q3, the deliveries will increasingly reflect these synergies, which will be more visible in the margins. We expect to fully realize these synergies by Q4. Additionally, our level of spec inventory is relatively low compared to our usual amount. We had a substantial amount at the time of the William Lyon acquisition, which we quickly sold off, partly due to COVID as we aimed to push through those sales. Many of those specs were not optimal, so we acted in a hurry to generate cash. We are now in the process of rebuilding our spec inventory, which is taking some time, resulting in a reduced number of specs available for sale and closure within the year.

Yes. I think Alan's point is quite relevant. Dave's comments regarding the specs and the to-be-builts are important for understanding our 2021 margins. To give you a bit of history, when we closed the deal, we had around 2,000 to 2,200 Lyon specs. When COVID impacted us, we paused our spec production. Some of those specs were challenging, and we made it a priority to ensure they were sold. As the year progressed, COVID actually aided that process. We maintained our focus on the to-be-built segment of our portfolio and worked hard to ensure that buyers were able to close, especially during the first half of last year. Entering the year, we had a high level of to-be-built backlog, and with lumber prices already contracted, that added some pressure. As we transitioned to the end of the year and into the first quarter, we began to build new spec inventory. We implemented strategies similar to many others, which included releasing specs later in the construction process to maximize market pricing. However, at the end of the year, we faced challenges due to the significant backlog we carried into 2021.

Got it. I appreciate all of that color there, it's very helpful. And if I can just squeeze a second one in, Sheryl, thank you for the comments on the absorption pace and kind of helping us think through where that might normalize out at. The improvement you've had on your start pace over four months is very positive, especially given all the labor constraints out there today. And I know there's seasonality in that. But I guess I'm a little bit curious why, if you're starting over four a month right now per community and you just sold over four in the quarter, why that sales pace can't be sustained at over four a month, at least in the near term? And I'm curious, maybe land is the reason why, you just don't want to burn through more communities faster. But can you comment on that?

Yes. We want to continue to align pace and starts, sales pace and starts. So we've hit this pace of the 401. I think you have a couple of factors in there, Alan. One is some seasonality of where our starts can happen. I think, too, I wouldn't say land is really the governor at this point because I think where we're starting the homes, we actually have the land in inventory. But we're going to make sure that the trades can retain the pace. It is a fairly significant ramp up. And there was one more thing I was just going to mention. So when you think about the start pace, we're trying to put specs in there as well. I'm sorry.

And then obviously, we're continuing to push price.

Yes. We do want to continue... That might meter pace a little bit as well.

Got you. Our next question comes from Michael Rehaut with JPMorgan.

This is Maggie on for Mike. First question. First question on the active adult expansion beyond Florida that you talked about. As you look into the longer-term and you presumably continue that expansion into more markets, do you see any meaningful shifts in your mix of buyer types? Or will this more allow your active adult segment to grow in line with the rest of the business?

Yes. I think saying that it would stay generally the course, Maggie, is right. We really do like that part of the business. In the quarter, our active adult sales were up about 46%, our pace was up about 62%. That's a little bit guided by what happened at the end of the first quarter last year with COVID, and that was the buyer that really shut down. But I would tell you that they've come back with a vengeance and in fact, they've comes back with a slightly different attitude as well. And really, we see some urgency in their buying decision. But I would say somewhere in that 15% to 20% range of buyer mix as the business continues to grow. It's probably, for the next couple of years, about right.

Got it. And then second, I was wondering if we could get some more color just around the supply chain. I know you talked a little bit about how the Texas storms impacted the business in Texas. But as you look across the entire business, are there any other particular pressure points worth calling out?

There are challenges that come and go. What might be an issue today tends to get resolved, and then a new issue emerges. The labor situation is present, which has always been a struggle. We are experiencing some moderate labor pressure. However, the main challenges we face are related to supply allocations. We are dealing with issues concerning drywall, doors, and windows, which have longer lead times, but nothing is overwhelmingly disruptive. Problems arise periodically, and we have a strategy in place to manage these situations. When issues come up, we develop solutions and implement them. I anticipate this will be an ongoing process throughout the year. It is challenging, but I believe we can navigate through it.

What stands out in today's comments is that the market conditions vary significantly from one region to another. For instance, a couple of quarters ago, we had issues with appliance availability, as we were heavily backordered on washers, dryers, and refrigerators. Now, that's no longer a concern, whereas it was a major focus for our team back then. In Texas, which predominantly uses brick for construction, some brick colors are hard to find, but the situation may improve in the next quarter. While some areas are experiencing drywall shortages, many others are not facing this issue at all. Overall, it's a mixed bag, but our teams are effectively managing these challenges.

Our next question comes from Jay McCanless with Wedbush.

So my first question on G&A expense this quarter, up pretty meaningfully year-over-year and sequentially. Can you talk about that increase and what we should expect for a quarterly run rate going forward?

Did you say G&A?

Yes. The G&A dollars.

Yes, there is a bit of timing involved. I see it more as an overall SG&A leverage. We did manage to leverage the selling expense. However, we didn’t achieve the same leverage on G&A due to lower closings, which we mentioned were impacted by the weather in Texas. If we had experienced that, we would have likely seen an additional 30 to 40 basis points of leverage on G&A. Nonetheless, we remain confident in our guidance that we will end up in the mid-9% range. Depending on where the ASP lands, it could be slightly better. This is an area we are concentrating on, and I want to emphasize that we typically maintain a strong performance in relation to SG&A as a percentage of homebuilding revenue.

At the end of 2019, on a pro forma basis, you and William Lyon had nearly 450 communities. Now, it's projected to decrease to 330 by the end of this year, indicating a slow growth rate to reach 23%. From an operational or strategic viewpoint, why do you prefer to maintain such a low number of communities? Is it due to a lack of opportunities for growth, or are you hesitant to explore some of these secondary markets to increase your community count and overall volume?

A lot is wrapped up in there, Jay. Let me give it my best shot. So no, I don't think there's a strategic effort or initiative to keep it low. I would tell you, there's some places where we're going to trade-off doing 30-, 40-, 50-unit communities for larger communities. And I mentioned that in Texas, that was certainly one market where we were reliant on a lot of developers, and we've absolutely changed that. But that's not a company initiative to keep it low. I think when you look at the total number of communities back in, like you said, '19, and then we look at what actually came on board when we acquired William Lyon. There's a number of different ways that we count communities. So I would tell you, the 450 combined was probably never quite right because when we aligned it to our community, every product line as a community, we had a slight shift there. You'll probably recall from a couple of quarters ago, we also took some of the underperforming assets with William Lyon, and we made the decisions to dispose of those. And so what you're seeing now, Jay, is really more of a timing as we continue to regrow the business. One, because we've sold PRU at a 4.2 pace, which is a 50% higher than our historical pace. So that burned through relatively quick. It doesn't bring any of the future ones forward. But the teams are quite focused on year-over growth. And you'll see, as we move into next year, you'll see that continue to tick up with strong growth for the following year.

Yes. Jay, we still plan to open nearly 150 communities this year. I mean, some of it is, as Sheryl said, selling through more quickly. Some of it is just delays in getting some new communities open. And we're focused on that. Some of that is from just municipalities and working through. But for me, the big takeaway, as Sheryl said, we're going to see growth in '22 over '21, but really towards the end of '22. And into '23, you're going to see that inflection point where you'll see the community count grow more meaningful. So it is really timing.

And then lastly, on active adult. Is the older product down in Florida that you acquired from AV, just wondering, is it selling at or better than the same pace that you're seeing for maybe some of the newer properties that you talked about in California and North Carolina?

Yes. If we're talking about the Solivita project in Florida, I'd say it aligns with our other active adult communities. What we've focused on, Jay, is streamlining our product offerings across the state. It's not so much about the specific product in a place like Solivita. When active adults make their choices, they first consider the lifestyle aspects before selecting a home. Our customers travel throughout the state to see what they prefer—whether it’s a country club environment in Naples, a waterside experience in Sarasota, something more urban like in Orlando, or a quieter community like Solivita. The truth is, the demand is fairly consistent across these options, and it's mainly about consumers choosing the lifestyle that fits them best. Plus, there are various home sizes to choose from. Also, I think it's worth noting that we're observing some changes in buyer preferences since COVID. Specifically regarding product desire, which is interesting since this is not often a major focus for consumers. We might be noticing an influx of buyers from the Midwest and Northeast who are seeking more outdoor experiences. There's a strong interest in larger outdoor spaces—this includes extensive screened-in patios and outdoor kitchens, which seems to be the most significant shift among buyers.

Our next question comes from Truman Patterson with Wolfe Research.

First, just wanted to touch on the community count guidance again, just really trying to understand what shifted over the prior quarter for you all to update your guidance, maybe rank order? Was it primarily the elevated absorption pace that you're now baking in? You also mentioned some local municipality constraints. Could you touch on that a little bit? Maybe how much the approval process is extending. And then finally, on the land development side, everybody is really trying to ramp up community count today as quickly as possible. Are you seeing any internal development delays as well?

On the community count, I would say that approximately 60% was due to an accelerated sales pace, while about 40% was a delay in opening the communities. This is mainly a timing issue, and those openings are being pushed to the second quarter, with a slight impact extending into the third. However, when we evaluate our current communities and what we have left to sell, we anticipate that some of the new community openings will be balanced out with additional closeouts, bringing us to that 330 figure. We are optimistic about maintaining that run rate as we progress through the next couple of quarters and into year-end.

When you consider that 40%, delays is a significant term because it can mean different things. It's not really about land delays since we were aware of those when we provided our guidance. It's more about our approach to bringing the product to market. For instance, there are several communities where we chose not to enter presale and instead focused on completing the model complex to ensure everything is fully ready. Looking at our production schedule and the timeline for starting those houses, there was no need to rush to market. So, there are many factors contributing to that 40%. The smallest portion would be land delays, but it primarily relates to our strategy for introducing the homes to the market, which can shift timelines and subsequently impact our community count.

Okay. Okay. And then, Sheryl, in your prepared remarks, I didn't quite catch this, and I'm hoping if you could elaborate on it a little bit further, a question on affordability. And you were discussing your backlog and how much, I'll just say, kind of wiggle room your backlog has relative to rates before being, we'll say, unable to qualify.

Yes, I absolutely did, Truman. This is a statistic that I’ve been sharing every quarter for at least the last two to four years, and it’s truly interesting. With all the discussions we're hearing in the market, particularly on the calls this quarter, we’re seeing a cushion that’s nearly at an all-time high. This reflects a shift in consumer behavior. Specifically, I mentioned that the average cushion for our conventional buyers is around 700 basis points, while FHA buyers have about 500 basis points. Overall, the credit profile is improving despite rising prices and an increase in first-time buyers. What’s particularly intriguing is that I expected an offset in square footage, suggesting buyers might be opting for smaller homes. However, that’s not the case. Our square footage is either flat or slightly increasing. While our inventory of homes is down, which aligns with where we would place more affordable options for first-time buyers, those selecting lots and home sites are opting for larger square footages. It's essential to consider all this in context. While buyers may have a cushion of 500 to 700 basis points, my concern is that if interest rates rose to 7% or 8%, it could significantly impact the market. To gauge the consumer’s situation compared to a year ago, we’re likely seeing a 30 to 40 basis point improvement in interest rates from the first quarter last year, which translates to around $17,000 to $20,000 more buying power for consumers. Currently, rates are about 3% or lower for both conventional and FHA loans, but they are around 70 to 80 basis points higher than the peak in the last 12 months. Looking long-term at affordability, according to the NAR's affordability index, we are significantly more affordable than our long-term 20-year average. There are many factors at play, and while we've seen price fluctuations, it's encouraging that consumers are still making decisions, making this a relatively affordable time to buy.

Our next question comes from Alex Rygiel with B. Riley.

Can you give us an update on your build-to-rent strategy?

You bet. Thanks for asking the question. So we have two projects in Phoenix that have begun production. And we actually just closed on our first deal in Phoenix, which is going to be a combo deal with our traditional homebuilding side as well as our build to rent. We've got our vertical construction amenities, obviously, going forward in our first projects in Phoenix. But probably most importantly, as we look at the growth of the business, we have about 20 deals at some stage from accepted LOI through contract that you'll see coming to market over the next couple of years. I think what's probably most important from a modeling standpoint is we have no real impact on the financials until we begin to sell the assets, which will likely be in late next year. You'll start to see some immaterial rental income come in to the business next year. And when we give next year's guidance, we'll include that. But excited about kind of the trajectory. And as we said last quarter, by the end of this year, we'll have nine markets with BTR in the portfolio at one stage or another.

Our next question comes from Tyler Batory with Janney.

I appreciate all the commentary thus far here. Just had one multi-part question on my end here. Just interested in your views on leverage and capital allocation in this environment. I mean, I think you've laid out an outlook with the community count ramp and the margin improvements, and there should be a substantial amount of earnings power coming through the business. And you also have a very strong backdrop right now, strong demand, strong fundamentals. How much of a priority is lower leverage right now? Where would you like to see leverage move in the long term? And given the environment and your outlook over the next couple of years, how would you rank leverage against some of the other uses for your capital, cash, whether it be repurchases or really ramping up the land acquisition side of things even more from here?

Yes, Tyler, thanks for the question. First and foremost, we're return focused. The actions that we take are designed to improve our returns, and we strive to be top quartile there over time. Leverage is important. It gets balanced with all the other opportunities that are out there. We've talked about, by the end of this year, we'll be in the low 30% range from a net debt-to-cap standpoint. I expect that to drop further next year as well. What we can do around leverage is somewhat constrained just based on that we have due. We're in a great position that we don't have any debt due till 2023. When I look at where current rates are right now, it's a little bit expensive to take those out. It gets more appealing as we move through the year. So we balance that with other investments that we make, just in general, whether that be back in the business through organic growth, buying back stock or paying down debt. So we'll continue to look at all those. We're focused on buying back stock right now, just given the limited opportunities when we look at debt, at least here in the short term. We continue to believe strongly our stock is undervalued. We have about $48 million of share repurchase authorization left. I think you will probably see us go through that maybe a bit sooner than later. And then once we're through that, we'll reassess our investment opportunities. But again, this is about driving returns for the business first and foremost.

Our next question comes from Mike Dahl with RBC Capital Markets.

Appreciate the color so far. My first question is in some ways a follow-up on capital allocation. But first, in terms of the community count, your previous expectation with respect to '22 was kind of modest growth later in '22 relative to a base of kind of 360, 365 communities. So now when you're referencing the modest growth expectations still in late '22, is that now off the 330 base or would you still expect that you could get something kind of closer into the 360s by year-end next year? The second part of this is, I know you talked about kind of harvesting and the returns focus. But given the sales pace, community count has shifted relative to how you would have viewed things over the past year or 18 months. Has your attitude towards the M&A changed at all? Is there a willingness to look at opportunities going forward?

So we'll start with community count. So yes, Mike, we end the year with, call it, the 330. We do expect to grow that in 2022. Obviously, as the year goes on, and we'll refine where we think that expectation is, but it's probably somewhere in the mid-300s. And then we'll see that inflection point as we get to the end of 2022. We expect to start, call it, an additional wave of growth on the community count and we'll see that move higher in 2023.

And then to your M&A question, Mike. I think as we had said last quarter, right now, we are a year into a fairly significant transformative M&A, and we're just anxious to get everyone back to work full time, working on-site, so that we can finish the cultural integration, make sure that we're seeing all the synergies pull-through. So it's head down for us on getting this one done. And too early to talk about anything in the future.

Okay, I understand. My follow-up question is about the comments regarding costs. Dave, I'm trying to make sense of your remarks about cost impacts reaching a peak, which seems to be expected soon in the second quarter. I'm curious if that peak is measured in absolute terms or in relation to your margins, especially with your pricing power becoming more effective. Additionally, the 400 basis points figure seems a bit low considering the current prices of lumber and panels, along with ongoing inflation affecting labor, land, and building materials. While I recognize that some other categories may not contribute significantly, they're all experiencing inflation. It just seems a bit too quick and understated in terms of the peak and extent of cost inflation. Could you provide more clarity on this?

Yes, I threw out 400 basis points. What I'm talking about is we see what's coming down the pipe from a cost perspective between now and the end of the year. It's not necessarily going to be tied to what's in our backlog. For example, in Q2 those costs are generally known.

Yes. I believe the difference lies in the exposure we had in the backlog. As we look ahead, our focus has been on how to adjust pricing to manage it. The most significant pressure was indeed in the first half when we tackled the large backlog. Considering the impact for the remainder of the year, we are actually in fairly good shape.

And we are seeing advantages of our new sites as well. That is helping us when we go to the table to negotiate costs. It's much around cost avoidance as anything else and getting folks and materials onto our site.

Our next question comes from Deepa Raghavan with Wells Fargo Securities.

Can you share your thoughts on pricing strength and how we should approach 2022 and beyond, especially as inflation begins to ease? Is there a case for continued moderate price increases, perhaps between 1% and 2%, next year, even if we experience some price reductions due to easing inflation?

Yes. It's a great question, Deepa. I think we're all trying to understand exactly the longevity of the strength that we're seeing out in the market today. What I would tell you today is we have a supply issue in this country. And as a result of it, it's giving a great deal of pricing opportunity. As we sit here today, we continue to see those advantages and opportunities really across the board. It's very hard to say when you look 6 months or 12 months out and new supply comes to the marketplace, will they continue at the pace we've seen? My crystal ball would say we're going to continue in a very strong market for some time, given the undersupply that we have today. But the first that will begin to moderate will be price, right? So when I look at the pricing power we've had, if I just take a quarter, Deepa, and say, on average, maybe we're seeing 2% on the quarter. Do I think that's long-term sustainable? Probably not. Do I think that we'll continue to see pricing above cost? Probably so, but hard for me to estimate what exactly that will look like in 2022.

I would like to ask about any additional concerns from buyers. I appreciate the insights you've shared regarding rate sensitivity; it's quite compelling. I also recognize that the immigrant population may be contributing to price increases in certain markets. However, are you hearing any new concerns from local buyers, particularly as prices have been rising sharply? I'm curious about the potential impact on demand since the flow of immigrants cannot continue indefinitely. So, are there any additional concerns from local buyers that you've come across? That's the main point of my question.

Yes. It's a good question, Deepa. And I guess I'd respond in a couple of ways. First, I would say if there's noise in the system. And of course, there's always going to be some noise, right? I would tell you that, that's probably at the more affordable first-time buyer. And I'm quite delighted as we look at the kind of dynamic of our first-time buyer, it's a very well balance sheet, first-time buyer/consumer. And so we're not feeling it tremendously. But if I look at our most affordable communities, I would say that's where we are very careful in our pricing strategy. The other thing, to your point, and it's why I highlighted in my prepared comments the California migration, is in most of our markets as we bring Californians in, and if I were to point to a market, I think like Vegas, I think we're seeing 20%, the buyers came out of California in the quarter. Their perspective of affordable is very different. So to your point, you might see that local consumer that wants to sell their house. And even though it's a really good time to sell and they've got appreciation in their home. Having been in the market for so long, they're going to look at that price movement a little different, but then they're going to rely on what is it going to cost me on a monthly basis. And now go back to the statistics I shared with you from a year ago, it's still more affordable. So I hope that helps.

Next question comes from Ken Zener with KeyBanc.

Thank you for your time. I have two straightforward questions. First, can you discuss the trends you are observing with options and whether they are contributing positively to your margins? The second question is broader; given this significant year of integrating William Lyon and all the other integrations you've undertaken, when you assess your overall returns, which are roughly about four years of land today, what do you believe will be the primary focus to enhance your asset turns?

So I'll start with on the option side. I would say that's holding in very nicely. The margin for options overall are accretive to the homebuilding margin. So obviously, we try to push that where we can. But I'm actually very pleased with where it's holding in, especially given the pricing environment that we're seeing right now.

Yes. To be more specific without diving into too much detail, year-over-year we are experiencing slight increases on a per unit and percentage basis, as our average selling price continues to rise. Much of this growth is coming from our active adult buyers, who are showing significant strength. This relates back to the mindset I mentioned earlier regarding these buyers; they know what they want, can afford it, and want it on their own timeline. We are definitely observing this behavior in the design center today. Regarding your question about the timing of the acquisition, that was one of your inquiries towards the end.

Just like you guys have done an amazing job. You were given lots of operational challenges in even normal times. And you guys have done very well during these very difficult times. But as you kind of look out in the next year or two or three with your asset turns, inventory turns kind of being at that one, give or take level. How do you think you might be improving those? Is it lowering the land? Is it somehow making homes faster, which is difficult. Just try to think about the capital somehow put in net turns.

It's a great question. And yes, we're always focused on asset turns. Again, our priority is driving returns, and that's key. We've talked a lot about optioning our land more so, controlling it versus owning it. We moved that up to 32%. We're targeting to get to 40% over the next, call it, two years. And with that, lightening that balance sheet will enhance the returns. We're always aspiring to reduce cycle times in production. We're looking for ways to improve that constantly. But obviously, in the market that we're in right now where demand is so high and labor and materials are so constrained. Just even holding serve is a win, I would say. That will start to ease at some point. It always does. That will just help turns later on.

The key point in what Dave is saying, Ken, is that there is no simple solution. When we discuss operational excellence, we need to focus on every aspect. I appreciate your positive remarks on integration, as over the past two and a half to three years, we have acquired two large companies. Achieving alignment within these companies is crucial. I could explain how our more affordable offering will slightly improve our margins, or discuss the Canvas initiatives aimed at simplifying processes to reduce the time from contract to start. Architectural alignment and managing land off-balance sheet, as Dave mentioned, will also play a significant role. The impacts of these factors will become apparent, and that’s why we always request about 18 months before we provide a full assessment. Initially, you’re just working through previous projects, meaning you don’t have a chance to influence those. What we’re currently developing is now benefiting from the improvements we’ve implemented. Until we cycle through the land, we won’t fully realize those benefits. Achieving prosperity isn't about just cutting costs; it’s about effectively managing land and efficiently bringing it to market.

Next question comes from Alex Barrón with Housing Research Center.

Yes, I wanted to focus on a couple of things. One was your land strategy. It seems like your options have been increasing recently. I'm trying to understand how far you think that could go this year. The second question is regarding the migration from other states, which you mentioned last quarter. Can you provide an update on what you're observing there?

Sure. From a controlled land aspect, like I said, we're at 32%. We expect to move that a little bit. Each quarter, hopefully, sequentially, we might see a couple where it stalls maybe for a quarter, but then picks back up. But that's a little bit harder to predict quarter-to-quarter, Alex. So we're looking more at the end of call it, 2022, where we're aspiring to be at that 40% controlled level.

Yes. And I think it's important. It's not like this is a new aspiration, Alex. Remember that when we did some of these acquisitions, I'll go back to AV. That really changed our mix and we were happy to do that because of the age and when that land had been acquired. But now we had to start working that back down. So we're just kind of back on track. As far as the migration question, probably the best data I can share is in 2020, about 13% of our sales or closings came from out of state. In our backlog right now, that number is almost 20%. So a significant shift in migration patterns, and we're seeing the probably most noticeable increases in Arizona, Nevada, Florida and our Texas markets.

And I'm not showing any further questions at this time.

Well, thank you all for joining us today to share our Q1 results. I'm excited to talk to you again next quarter. Stay safe.

Ladies and gentlemen, this does conclude today's presentation. You may now disconnect, and have a wonderful day.