MERITAGE-HOMES Earningcall Transcript Of Q2 of 2024
Phillippe Lord -- Chief Executive Officer Thank you, Steve. During the second quarter, we hosted two Investor Day calls to introduce the evolution of our business model. Over the past seven, eight years, we have migrated to a lower ASP spec strategy while streamlining operations to yield efficiencies. Now we are once again continuing to refine our strategy by taking the home to a near completion stage before releasing it for sale. Basically approximating the just-in-time home inventory structure that exists in the retail market. This strategy evolution is built on three new core tenants, a 60-day closing guarantee the concept of move-in ready homes and a focus on deepening our realtor relationships. These tenants allow us to target the biggest piece of the potential homebuyer pool by effectively competing its resale inventory, not just in today's environment that favors builders but also when the resale market Page 3 returns to historical averages. Our strong second-quarter 2024 financial performance validated that the shift to focus on quick turn move-in ready homes is the right one for us, an attractive offering for our customers. We will continue to build affordable entry-level and first move-up product, but now we will be focused on buyers who want to move into the home in 60 days and typically have already engaged with the broker. Our new strategy enabled us to exceed expectations this quarter by achieving a higher absorption pace than our target and a year-over-year increase in home closings and gross margin. Now turning to Slide 6. Demand remained solid throughout the spring selling season. Our sales orders of 3,799 homes for the second quarter of 2024 were up 14% year over year. The cancellation rate of 10% remains below our historical average in the mid-teens. Entry-level homes comprised 92% of total orders volume. ASP on orders this quarter of $414,000 was down 6% from prior year due to a larger mix of our orders coming from both our Eastern markets and entry-level homes. Sequentially, we increased ASP on orders as we were able to take price increases in some of the stronger submarkets. The strength in demand for our move-in-ready product and our continued use of finance incentives generated second-quarter 2024 average absorption pace of 4.5 net sales per month, above our target average annual sales pace of 4 net sales per month. Aligning with seasonal patterns, we would expect the second part of the year to experience a slower sales pace through the summer months and into the holiday season. Although we are seeing a return to more typical sales seasonality, we do believe that the demand environment will remain constructive for the rest of the year. This resiliency stems from favorable demographics, below-average resale listings in many of our Page 4 markets, and a fundamental underbuilt supply of homes, all of which create an opportunity for us to increase our market share despite ongoing mortgage rate volatility. The second-quarter 2024 ending community count of 287 was up 4% sequentially from the first quarter of 2024 and down 1% compared to prior year. 35 new communities came online this quarter, similar to what we opened up in Q1. For the second half of this year, we anticipate additional net community count growth and a more meaningful double-digit increase in 2025. We now own and control all the lots we need for client reopenings in 2024 and 2025 at most in 2026. Moving to the regional level trends on Slide 6. All of our regions achieved an average absorption pace exceeding our target of 4.0 net sales per month and year-over-year growth in orders volume this quarter. The Central region comprised of our Texas markets had the highest regional average absorption pace of 4.7 net sales per month and an average quarterly backlog conversion rate that has exceeded our targeted 125% for the last few quarters. Even as the resale home supply has increased in some Texas submarkets, our move-in ready homes effectively completed against its inventory. With nearly 30% completed spec inventory in the region, we believe we have the right available product to continue to increase our market share. The West region experienced the largest year-over-year growth in average absorption pace to 4.4 net sales per month in Q2 from 3.4 net sales per month from last year. We are seeing strength in Arizona where we achieved five-plus net sales per month this quarter, with strong year-over-year growth in spec count in the West we expect to be able to continue meeting the high demand in this region. The East region had an average absorption pace of 4.4 net sales per month and the largest regional year-over-year increase in sales orders, making the East our largest region based on sales order volume even as retail inventory more noticeably returned in some submarkets in South Florida. We Page 5 are poised to continue competing aggressively for market share here as our East region exhibited the strongest regional growth year over year in ending community count and spec inventory in the second quarter of 2024. Now turning to Slide 7. As we align our starts pace with our sales pace, we started about 4,300 homes this quarter. We were up about 5%, both sequentially and year over year, replenishing our pipeline. With our anticipated community count growth in the next six months, we expect to start more homes to maintain our targeted four to six-month supply per community across our growing footprint. As we have discussed in the past, our strategy is agile. So if we do see any pullback in the markets in the coming quarters, we will adjust our spec starts accordingly. We had approximately 6,500 specs homes in inventory as of June 30th, 2024, up 46% from about 4,500 specs as of June 30, 2023. This represented 23 specs per community this quarter between a four to five-month supply specs based on absorptions. Over time, under the new strategy, our percentage of completed WIP should increase slightly to ensure we have the right inventory to meet our 60-day closing guarantee. Of our homes closing this quarter, 96% came from previously started inventory, up from 87% in the prior year. 26% of total specs were completed as of June 30, 2024, closer to our goal of carrying one-third in move-in ready homes. With our focus on quick turning inventory, our intra-quarter sales to closing percentage was just above 40% this quarter. Our ending backlog continues to decline intentionally from about 3,800 as of June 30th, 2023 to approximately 2,700 homes as of June 30th, 2024. We expect this trend to stabilize once we are delivering 60-day move-in ready homes in all of our communities. With our backlog in specs on the ground, together totaling over 9,200 homes, we believe we have Page 6 the optimal level of inventory for the current demand environment. I will now turn it over to Hilla to walk through our financial results. Hilla? Hilla Sferruzza -- Executive Vice President, Chief Financial Officer Thank you, Phillippe. Before we get started, I'd like to share that earlier this week, Moody's upgraded us to investment grade. We're excited to now be holding IG ratings from all three of our readers. It's been humbling to see third parties recognize our efforts over the last several years to strengthen our balance sheet while producing exceptional results and we believe the benefit of these upgrades will continue to positively impact our financial performance. Now let's turn to Slide 8 and cover our Q2 results in more detail. Second-quarter 2024 home closing revenue was $1.7 billion, reflecting 18% higher home closing volume year over year that was partially offset by 7% lower ASP due to product and geographic mix. In addition to select price increases, the costs related to rate locks decreased slightly, both year over year and sequentially from the first quarter, even as the utilization of these financing incentives increased with recent volatility in interest rates. As we look to the second half of the year, we anticipate a slower monthly absorption pace due to seasonality and corresponding lower closing volume compared to the first half of the year, reflecting the seasonality and our higher backlog conversion resulting in the delivery of the majority of our spring selling season orders during the first half of the year. Home closing gross margin increased 150 bps to 25.9% in the second quarter of 2024, compared to 24.4% in the prior year. This improvement was the combination of lower direct cost, greater leverage of fixed expenses on higher revenue, and shorter construction cycle times, which were partially offset by higher lot costs. Lower direct costs benefited from both market dynamics and our purchasing teams ongoing pursuit of cost reductions since direct costs peaked in Q1 of last year. Page 7 We are also securing volume discounts from trade partners based on our increased deliveries. We expect to see continued savings on lumber and lumber-related products in the coming quarter and labor capacity continues to hold steady. Further, our construction cycle times improved about 10 days from Q1 to Q2 to around 130 calendar days, which helps us turn our home inventory faster. We're closing in on our historical average of about 120 calendar days cycle time, which would allow us to turn our WIP inventory three times a year. As a reminder, although our land costs are more elevated as compared to 2023, we have already turned over the majority of our communities from pre-COVID land so the higher-cost lots are not expected to have a material pullback on our margins beyond the current levels. Turning to SG&A. SG&A as a percentage of second-quarter 2024 home closing revenue of 9.3% improved 30 bps from 9.6% in the second quarter of 2023 primarily due to the better leverage achieved on higher home closing revenue. It's important to note that this quarter total commissions as a percentage of home closing revenue were flat year over year. Specifically, external commission rates were essentially the same in Q2 to 2023 despite our higher corporal participation as our strategic relationships reduce the need for ad hoc bonuses and incentives. We continue to see the proof in our results that our new strategy of aligning with realtors is working and proving profitable. We expect commissions as a percentage of home closing revenue to remain relatively steady for the rest of the year. As we've mentioned several times today, given our strategic evolution, the first two quarters of the year will likely be the strongest revenue quarters leading to the most leverage in our SG&A in the first half. With that in mind, we are still maintaining our full-year SG&A guidance of 10% or better. Longer term, we're targeting 9.5% SG&A as a percentage of home closing revenue as we grow our Page 8 existing markets and leverage our overhead platform to reach our goal of 20,000 units in the next three to four years. In the second quarter of 2024, the financial services profit of $4.8 million included $2 million of write-offs related to rate lock unwind costs. This compares to financial services loss of $2.6 million in the second quarter of 2023 that had $7.9 million in similar write-offs. The second quarter's effective income tax rate was 22.1% this year, essentially flat to prior year, with both periods benefiting from energy tax credits on qualifying homes under the Inflation Reduction Act. Overall, higher home closing revenue and gross profit, coupled with greater SG&A leverage, led to 26% year-over-year increase in second-quarter 2024 diluted EPS to $6.31 from $5.02 in 2023. To highlight just a few results from the first half of 2024, on a year-over-year basis, orders were up 14% closings were up 19%, and our home closing revenue increased 13% to $3.2 billion. We had a 240 bps improvement in home closing gross margin to 25.9%. SG&A as a percentage of home closing revenue was 9.8%. And net earnings increased 31% to $418 million with $11.37 in diluted EPS. Before we move on to the balance sheet, I wanted to cover our Q2 2024 customers' credit metrics. As expected, our buyer profile remained relatively consistent with our historical averages with FICO scores in the mid-730s and DTIs around 41, 42. LTVs were still in the mid-80s. And about 80% of our buyers in Q2 received some sort of financing incentives consistent with our mortgage company capture rate. Now turning to Slide 9, this quarter, we successfully enhanced our capital structure. We issued $575 million in new 1.75% convertible debt due 2028. Part of the proceeds from the convert went to pay down the remaining $250 million of senior notes due 2025. The incremental cash from the convertible notes increased our available sources for land spend, Page 9 dividends and share repurchases. We also refinanced our revolving credit facility to increase the facility size to $910 million, extending its maturity date from 2028 to 2029 and reducing its pricing grid to align with our investment grade rating. We had nothing drawn on our credit facility, cash of $993 million, and net debt-to-capital of 6.2% as of June 30, 2024. Our net debt-to-cap maximum ceiling continues to be in the mid-20s range, leveraging our improved backlog conversion and quicker cash generation. We utilized $118 million operating cash flows during the second quarter of 2024, primarily related to land acquisition and development. On to Slide 10, our capital allocation was focused on organic growth and cash dividends this quarter to enhance shareholder value. This quarter, we spent about $631 million on land acquisition and development, which was up 54% from prior year. On a year-to-date basis, our land spend has totaled $1.1 billion as of June 30, 2024. With the exception of a small pullback in late 2022, we have been accelerating our investment in organic growth for the past several years. We expect our go-forward trend in 2024 and beyond to be $2 billion to $2.5 billion of land spend annually. As we nearly tripled our quarterly cash dividend on a year-over-year basis to $0.75 per share in 2024 from $0.27 per share in 2023, our cash dividend totaled $27.2 million in the second quarter of the year and $54.5 million on a year-to-date basis. Due to the convertible notes issuance, we were unable to repurchase any shares in the second quarter as we were bound by the customary lockout provision that will lift at the end of the day today. Share buybacks are integral to our capital allocation policy, so we plan to double up on our systematic, quarterly commitment in Q2 to catch up. For the first half of the company repurchased over 362,000 shares of stock, totaling $55.9 million. $129.1 million remain available under our authorization program as of June 30th, 2024. Turning to Slide 11. Page 10 We secured and put over 8,700 net new lots under control this quarter, representing an estimated 63 future communities. We put around 2,800 net new lots under control in the second quarter of 2023. As of June 30th, 2024, we owned or controlled a total of about 71,000 lots equating to a 4.7-year supply, in line with our target of four to five years. We continue to utilize more option financing for land deals ranging from traditional land banking to seller tranche deals with the underlying sellers. About 66% of our total lot inventory at June 30, 2024, was owned and 34% was options compared to prior year. We had a 76% owned inventory and a 24% option lot position. We owned 69% and option 31% of our lots at March 31, 2024. We are comfortable with our off-balance sheet land ratio up to 40%. Since off-balance sheet transactions come with the financing cost, we are going to use them as needed, while balancing our other capital commitments. Finally, I will direct you to Slide 12 for our guidance. Given current market conditions, we have revised our full-year projections higher to the following: total closings between 14,750 and 15,500 units; home closing revenue of $6.1 billion to $6.3 billion; home closing gross margin around 24.5% to 25%; and effective tax rate of about 22.5%; and diluted EPS in the range of $19.80 to $21 flat. As for Q3 2024, we are projecting total closings between 3,650 to 3,850 units; home closing revenue of $1.5 billion to $1.6 billion; home closing gross margin of 23.5% to 24%; and an effective tax rate of about 22.5%; and diluted EPS in the range of $4.60 to $5.05. Both Q3 and full year guidance assume current market conditions and interest rates. With that, I will turn it over to Phillippe. Phillippe Lord -- Chief Executive Officer Page 11 Thank you, Hilla. To summarize on Slide 13, our second-quarter 2024 results demonstrate that our new focus on quick turning move-in ready inventory is leading to strengthen our absorption pace, home closing volume, and home closing gross margin. With our strong balance sheet, we can continue to execute our strategic evolution and create long-term value by investing in our growth on the path to 20,000 units, while also returning cash to shareholders. With that, I will now turn the call over to the operator for instructions on the Q&A. Operator? Questions & Answers: |
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