Meritage Homes Corporation

Greetings and welcome to the Meritage Homes first quarter 2020 analyst call. At this time, all participants are on a listen only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Brent Anderson, Vice President of Investor Relations. Thank you, sir. You may begin.

Thank you, Donna. Good morning and welcome to our analyst call to discuss our first quarter 2020 results. We issued the press release yesterday after the market closed. You can find that along with the slides that we'll be referring to during our call on our website at investors.meritagehomes.com or by selecting the investor relations link at the bottom of our homepage. I'll refer you to slide two and remind you that our statements during this call as well as the press release and accompanying slides contain forward-looking statements. including but not limited to our views regarding current business conditions and the potential adverse impacts related to the COVID-19 pandemic. Our expectations or projections regarding the demand for our homes, home prices, costs, mortgage financing, margins, overhead expenses, cash flow and liquidity. Those and other projections represent the current opinions of management which are subject to change at any time and we assume no obligation to update them. Any forward-looking statements are inherently uncertain. Our actual results may be materially different than our expectations due to a wide variety of risk factors, which we've identified and listed on this slide as well as in our press release and our most recent filings with the SEC, specifically our 2019 annual report on Form 10-K, which contains a more detailed discussion of these risks. We'll also be filing our 10-Q shortly. We have also provided a reconciliation of certain non-GAAP financial measures referred to in our press release as compared to their closest related GAAP measures. With me today, or at least distant, are Steve Hilton, Chairman and CEO, Hilla Sferruzza, our Executive Vice President and CFO, and Phillippe Lord, Executive Vice President, Chief Operating Officer of American Homes. We expect the call to conclude in about an hour and a replay will be available on our website within approximately an hour after we conclude the call. It will remain active through May 13th. I'll now turn the call over to Mr. Hilton to review the first quarter. Steve?

Thank you, Brett. I'd like to welcome everyone participating in our call today and sincerely hope that all of you and your families have been able to stay safe and healthy through this global health crisis. Our hearts go out to those who are sick or caring for loved ones stricken by the virus. And our heartfelt thanks to all the healthcare workers, first responders, and those who rely on to provide us with necessities like groceries and gas during this time when most of us are staying in our homes. We are grateful for your service. Our number one concern since the coronavirus began to spread has been the health, safety, and well-being of our people, including each of our Meritage team members and their families, as well as our customers and business partners. And I commend our entire Meritage team for their commitment to overcoming challenges we've never experienced before over the last six weeks. We'll cover what we're seeing on the ground in April shortly, as well as the change we've made but we think it's important to also review a few of the financial highlights of our first quarter performance, though we realize it's not a current indicator of the remainder of the year. We believe the financial strength of our balance sheet and our strategic market position exiting Q1 will allow us to successfully weather the uncertainty of the upcoming quarters and be prepared for the near to mid-term volatility while keeping our long-term focus aligned with our strategy. Turning to slide four. Through most of the first quarter, we enjoyed strong demand for new residential construction amongst the highest demand I've seen in my 35-year career. As you're well aware, economic conditions have deteriorated across the U.S. since mid-March, which coupled with declining consumer confidence and a tightening of mortgage markets have negatively impacted our traffic and our sales. Demand was especially strong in the entry level and first move up. Our strategic markets that make up 90% of our communities, while we're able to capture that strong demand to generate 23% order growth with almost 70% of that coming from spec inventory that we were able to close quickly. That in turn drove 27% revenue growth and 180% earnings growth over last year's first quarter. In addition, the simplifying streamline of our product and operations that we have completed as part of our strategy has driven our costs down and resulted in the first quarter home closing gross margin expanding 330 bps with 160 bps improvement in our SG&A leverage. In other words, while strong demand for most of the quarter provided the opportunity, Execution of our strategy allowed us to capitalize on the opportunity and to deliver 180% earnings growth. It also provided cash flow for our early retirement of debt in December last year while maintaining the liquidity we need for the flexibility through this period. I'll now turn it over to Phillippe to discuss more specifics regarding recent trends and changes we've made in the way we operate.

Thank you, Steve. Slide five. As we reported earlier this month, the spread of the coronavirus began to have a noticeable impact on our operations in the later half of March, as evidenced by an 8% drop in orders compared to March 2019, following year-over-year increases of 38% and 51% in January and February. Based on our sales through the past weekend, we expect April orders to be down approximately 25-30% from April 2019, above 650 sales compared to 916 last year. Our order cancellation rates increased from 13% in the first quarter to the high teens in late March and are currently around 20% month to date in April. Shelter and place orders are still in effect across most of our markets, but residential construction is currently deemed as an essential service in almost all of our locations with the exception of a handful of communities in California. We are continuing to build and deliver homes following the protocols recommended by the CDC, OSHA, and other government and health agencies to stay safe and minimize our risk. Slide six. While the world we are living in today is very different than it was just a couple of months ago, I'm proud of the way in which our teams have quickly adapted to the new temporary model. And we are leveraging our technology for solutions to continue to operate remotely. For example, We are seeing customers either virtually or by appointment only in our sales offices and studio and design centers, allowing our customers to practice social distancing during their home buying process. Our online traffic has held pace since earlier in the year and is up almost 50% since last year's April. Additionally, approximately 15% of our net orders came from virtual tours, a validation of the creativity and determination of our sales team during these new times and the acceptance from buyers of this home purchasing format. Our sales counselors also take photos or videos of sold homes under construction to update home buyers on the progress of their home when they can't physically visit the construction site. We are getting accustomed to working remotely and are accelerating adoption of new technologies throughout the organization, which will continue to benefit us even after the market is fully functioning again. With mobility restrictions in place, the customers we are seeing today tend to be highly motivated buyers who are ready and able to purchase a home. We assist them in their research with their robust website, customer contact center, and agents available to answer their questions by phone, text, or email without the need to actually visit a community until they are comfortable. Consequently, our conversion rates of traffic to sales have increased monthly from earlier this year. Customers are using our 24-7 online mortgage pre-approval tools to help them move through the process of qualifying to purchase a home more quickly. NCH Mortgage consultants work with them to complete the process without ever needing to come to the office in most cases. We are also doing drive-through closings and are now equipped to process earnest money deposits on customers' debit or credit cards remotely through a secure, emailable link. These tools and procedures make it more convenient and safer for our homebuyers to work with us. Since many of the changes we've made are also more efficient and are in sync with today's more digital lifestyle, we intend to keep and expand upon them to help reduce the cost of selling and closing homes even after the current pandemic recedes. We're working effectively with most of the municipalities and utilities we do business with to enable us to get permits and complete inspection, as well as billing and payment for services. Our crews are typically able to maintain our construction schedules, and we have not experienced any significant supply chain disruption so far. For the safety of our employees and customers, we have temporarily suspended all non-emergency warranty work involving the interior of occupied homes. We will begin warranty work as soon as allowable in our markets. Moving on, rather than covering our operating results in as much detail as I typically do, I'll point out just the highlights of the first quarter before turning it over to Hilla to review our financial results. Slide seven. The first 10 weeks of the quarter were exceptional by any measure. Absorptions were up 35% year over year, so despite having 9% fewer communities open on average than a year ago, we still achieved 23% order growth. Our ongoing pivot to entry-level continues to benefit our results. Entry-level orders were up 69% year-over-year and represented 51% of our total ending community count at March 31, 2020, and 61% of our total orders for the first quarter. Those are up significantly from Q1 2019, when 36% of our community and 45% of our orders were entry-level. Orders from our non-core assets, which is anything outside of entry level or first move up, dropped to under 6% of our order volume for the quarter. Slide 8. Our spec inventory at quarter end was up 23% year over year to a total of just over 2,700 homes started, of which only 28% were completed. The number of completed specs at quarter end was down 7% from a year ago. were selling more spec homes before completion and have been able to resell homes that canceled, typically without any additional concessions. We ended the quarter with an average of a little over 11 specs per community, compared to 8.5 a year ago, mainly due to having more entry-level communities, which are 100% spec. Although we have certainly reduced the volume of specs we were starting over the last month, we do not plan to change our strategy of selling spec builds in the entry-level space. We are managing spec inventory to keep a four-to-month supply to meet the demand for quick move-ins. That four-to-five-month supply is based on order volume, so it will be a smaller number as demand softens and larger when demand increases. Slide 9. Our orders in the West Region were up 35% over the first quarter of 2019, driven by a 41% increase in absorption with 5% fewer communities on average. Entry level now makes up almost 70% of our total California communities with very limited exposure to the jumbo market. Total orders and order value in California more than doubled over last year's first quarter. Despite a 14% drop in average communities, Arizona again produced the strongest absorption across the company at an average of 17.8 per average community for the quarter, up 44% year over year, resulting in 25% order growth for the quarter. Our Texas region had a 41% increase in absorptions, and despite a 13% decline in community talent, orders were up 22%. Austin had exceptional growth of 85% year-over-year for the first quarter due to our strong entry-level presence with our live-in-out communities. Overall, we believe Texas will be resilient as we continue to come out of this downturn and as we experienced in the last cycle. We continue to see improvement in our east region during the first quarter. Year-over-year order growth was 11% due to a 20% increase in absorption, which offset an 8% decline in average community count. Closings and orders were reduced due to the devastating tornado in Nashville during March. Within the region, North Carolina produced the largest year-over-year growth with a 25% increase in orders, primarily driven by product mix, which contributed significantly to the 39% increase in absorption there. Our backlog is solid. We don't count continued contracts for buyers with the homes to sell unless the sale is just waiting to close. We are seeing limited cancellations on our near-term backlog, and we expect most of it to close quickly, which is an advantage in today's market due to the employment uncertainties and higher standards to qualify for mortgage financing. Our JV partner is honoring all pre-qualified mortgage approvals for customers in our backlog without re-qualifying them using the tighter qualification standards that exist with many lenders today. I will now hand it over to Hilla to provide some additional analysis of our financial results. Hilla?

Thank you, Phillippe. Considering the fluid conditions and lack of clarity regarding the timing and path back to a more stable economy, before I begin, I'd like to note that we're withdrawing our previous guidance until an appropriate time in the future. Starting on slide 10, we produced strong earnings growth of 180% in the first quarter of 2020 over 2019 and achieved that result with margin expansion and SG&A leverage in addition to the 27% home closing revenue growth. Closings were up 31% over the first quarter of 2019, with 69% coming from spec inventory and a backlog conversion rate of 83%, compared to 73% last year. Our home closing gross margins increased 330 bps over last year's Q1 to 20% for the first quarter of 2020, traditionally our lowest margin quarter. Our margins benefited from pricing power over the last couple of quarters as well as construction efficiencies due to simplification of our product and processes, cost efficiencies from better negotiating power on a lower number of SKUs, and incremental efficiencies in construction overhead from the additional closing revenue. Thank you for watching. We anticipate volume will be lower in the current environment, but we are still continuing to sell and close homes every day. While profit is always front of mind, in the current environment we believe it is important to continue to maintain cash flow from home closings to cover our fixed costs. It's also important to maintain a production cadence that delivers cost savings with our streamlined construction processes. As we continue to operate over the next couple of quarters, we will monitor our markets and will adjust the conditions with pricing decisions locally as necessary in order to maintain our minimum volume thresholds. The additional closing revenue in Q1 also resulted in increased leveraging of our SG&A, which declined to 10.7% from 12.3% a year ago. We were on pace to hit our 10% long-term target for the full year, although we aren't expecting that trajectory to continue in the current economic environment. Earnings from our financial services segment were $2 million lower in the first quarter of 2020 compared to 2019. We changed our mortgage joint venture structure relating to customer incentives offered for using our mortgage JV last year such that the profit from those incentives is now included as part of home closing revenue rather than being reported as part of our financial services results. Our early repayment of debt in December of 2019 resulted in a $4 million net decrease in interest expense that aided our first quarter 2020. We also benefited from a lower tax rate with the extension of the energy tax credits into 2020. Our tax rate was approximately 18% for Q1 this year versus 22% last year. Our full year tax rate this year is expected to be between 20 and 21%. Our board had previously authorized $100 million for share repurchases, and we repurchased 1 million shares at an average price of around $61 per share this quarter. We have 23 million remaining authorized, but we have suspended repurchases indefinitely in light of the current economic conditions. The benefit of the share repurchases was fairly limited in the first quarter of 2020, as the majority of the activity occurred in March, but it will more meaningfully benefit diluted EPS on a go-forward basis. Slide 11. Our balance sheet is in the best condition it's ever been, with net leverage at one of the lowest points in our company's history. We have ample liquidity, and our banking partners are willing to extend additional credit if needed. We borrowed $500 million against our credit facility in March to provide additional flexibility during this period of extreme economic uncertainty, and we expect to hold that cash reserve at least for the short term. The net cost of that debt is very low at under 2%. We ended the quarter with almost $800 million of cash, additional liquidity of almost 220 under the credit facility, and net debt to cap of about 26.6%. We have no debt maturities until 2022 and have been deferring most of our land acquisition and development over the last six weeks while eliminating non-essential discretionary expenses and metering the production of spec homes to preserve ample liquidity for future uncertainties. We don't feel any pressure to liquidate assets to generate cash, and our recent operating results are trending better than our internal downside projections with lower cancellations and higher sales than we anticipated short term. Slide 12. We spent approximately $246 million on land and development in this year's first quarter. That was about $110 million less than what we expected to spend when we entered 2020 due to deliberately curtailed spending in March. We added about 2,900 net new lots during the first quarter of 2020 to end March with approximately 41,500 lots, which is about where we ended 2019. That represents a 4.2-year lot supply based on trailing 12-month closings. We were on target for our goal of 300 communities by the end of 2021 prior to our decision mid-March to pull back and curb cash spend to preserve liquidity. Since mid-March, We deferred approval of approximately 1,800 additional lots in the quarter. We terminated several deals prior to the end of the quarter and a couple more since in April prior to the expiration of their feasibility period resulted in very limited charges of just under a million dollars. We continue to work with our land sellers to extend purchase and feasibility deadlines. Although most sellers have been willing to work with us and are offering acceptable terms, we're closely monitoring additional deals for termination if the economic recovery is more protracted than currently anticipated. We expect such actions to only result in a limited amount of walk-away charges for the rest of the year. In addition, we have daily reviews of our upcoming land acquisition and development spend with all land cash expenditures requiring corporate level approvals for the current time. Unlike the last significant downturn in the market, we have far less risk in our land book now. No speculative luxury projects, no deals with significant development or entitlement risk, and a well-defined land playbook with consistent expected margins that provides us with much more confidence in our land position. We also want to provide some additional information regarding our buyer profile in relation to mortgage financing on slide 13. Our buyers have solid FICO scores, typically around 730, with more than 70% of that above the 700 mark. Even for our entry-level buyers, the average FICO is 720 and well over 60% of those buyers are over the 700 mark. Our back-end DTI for the average buyer is below 40%. That's true across all of our buyer groups, including entry-level, and has been for many years. Nearly two-thirds of our buyers finance with conventional mortgages, with down payments averaging in the mid-teens. All of those are indicators of more stable credit than the credit profile for traditional entry-level buyers. Our long-time JV partner has been able to continue to deliver mortgages for our buyers where other banks and non-bank lenders can't or won't in this environment. While there is a risk that the market could tighten further and impact buyers' ability to qualify for a mortgage, there is no cash or put-back risk to Meritage for mortgage servicing as our JV is a broker only, not a mortgage banker, and doesn't own any loans or servicing assets. We have been successful thus far in working through mortgage solutions with our lender and navigating the financing environment, which seems to be shifting daily. To date, we have had limited impact from the inability to qualify buyers that would have qualified pre COVID-19. With that, I'll turn it back over to Steve.

Thank you, Hilla. As our first quarter results demonstrated, our strategy was hitting on all cylinders until late March when closures of large sectors of the U.S. economy began to severely impact the market. Since then, our focus has changed as we are leading and managing the company through a much different landscape now. However, we've reminded our employees, partners, homeowners, and investors that this is not 2008. Home inventories are still in short supply and the industry has been underproducing relative to demand for many years. Demand for homes is from buyers who are taking possession and moving into them. The attraction of single-family homes is even more compelling in today's shelter-in-place world. Prices are not being arbitrarily inflated by investors looking to flip homes for a quick profit. Mortgage standards are tighter, yet interest rates are still very, very low. And builders are focused on bringing costs down to make homes more affordable rather than offering aggressive discounts to harvest cash. We believe Meredith is well positioned in that regard with our strategy to simplify and streamline our operations, which has been very successful to date, and we believe will continue to serve us well through this crisis and in the future. Our entry-level Live Now Home offers surprisingly more value than some of our competitors at the bottom of the entry-level market, so we can attract a higher credit buyer. Our first move-up homes are appointed with the features and finishes that also attract some second move-up buyers, which expands our potential buyer pool. We are also in a much better condition today than we were before the last recession. Our balance sheet is the strongest it's ever been with ample liquidity and very manageable debt levels and maturities. We have curtailed discretionary spending and delayed development projects where possible to reduce our cash outlays in 2020 and beyond as necessary. We are carefully managing our spec starts and inventory while maintaining the cost advantages of that model to maintain a competitive edge for our entry-level communities and help protect our margins. We are well positioned in the market with our entry-level and first-level communities, which we believe will continue to serve us well. We have an experienced management team who is in sync with our current strategy. Employee morale is good and we are supporting each other, our families, our business partners, and the communities that we serve. This is not the end of the world. It's the most remarkable act of global solidarity the world has ever seen. And to that end, we rolled out a new charitable program last week. where Meritage Care Foundation and our employees are contributing $250,000 to Feed America. I'm proud of our entire Meritage team for putting our customers first and working hard every day to make a positive contribution. That concludes our prepared remarks. I'd like to thank you for your support of Meritage Homes and we'll now take questions. Operator?

Thank you. We will now be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad at this time. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Once again, that's star 1 to register questions at this time. Our first question is coming from John Lovallo of Bank of America. Please go ahead.

Hey, guys. Thank you for taking my questions, and I hope you all are well. First question, Hilla, I think you mentioned more recently some of the activity has improved a bit. Maybe in the context of that 25% to 30% decline you're expecting in April, can you maybe frame the past two weeks maybe versus the first two weeks in April in terms of year-over-year declines just so we can kind of gauge how things are progressing?

I'm going to let Philippe take that one. Yeah, I'll take that, John. It's Philippe. So certainly when the shelter-in-places started to occur and stay-at-home orders were instituted, we saw a dramatic slowdown that occurred, you know, the back half of really the last week of March. and really the first two weeks of April were pretty slow. They were off, you know, 50, 60% ish from last year's April. But then as we move through the month of April, things have gotten much better. So that's where you start to see us being off, you know, 20% that really gets you to that 25 to 30% that we're talking about. So what I would tell you is, and April's not over yet, we still have a few more days here, but we have seen a meaningful difference in the back half of April versus the first half of April and sort of that last week of March.

Just one other point I'll add to that, John. I know some other folks have mentioned a detailed scrubbing of backlog and a higher cancellation rate during the last week, and that's not typical for us. We scrub backlog every day, so we're not expecting an unusually high spike in cancellations to occur in the last day or two of the month.

We don't report any contingent sales in our sales numbers or in our backlog numbers. Got it. That's all really helpful, guys.

And then I think there was a mention that I think 15% of orders came from virtual tours or something in that neighborhood. I'm just curious. The percentage of those folks that will typically need to come in physically to see the house before purchasing.

Well, I think they will all come into the house, come to the house at some point in the process. The point of that stat is they're buying the house, basically sight unseen virtually, and then before they close, they'll come see it. But... It's a pretty remarkable stat. It's a stat that I didn't even want to believe. I couldn't believe. I struggled to believe that people would actually buy a home without physically going out and walking in, touching it. But in this new reality, we're happy that 50% of our buyers are doing that, and we think that that number could potentially increase. That said, let me just add one more thing. and many of our markets, the shelter in place orders are expiring and being replaced with the phase one of America reopening. So many of our communities this weekend and then into the following weekend will be are back open for business under more of a normal situation. And we will begin to bring some of our offices back online next week in those states where while the shelter-in-place orders have been relaxed.

I would just add that obviously having finished specs, It's really how you're able to sell a home virtually. It's much more difficult to do that in a built-to-order environment. Our Live Now models, our Live Now specs, we have to carry more specs. We carry a variety of specs, so we're able to demonstrate that home in a virtual tour. What you see is what you get when you get out there, and I would tell you that all of those sales, for the most part, are on finished specs.

It's a good proxy for folks that are nervous about existing inventory. If the inventory that's being listed declines and people are nervous about doing tours in someone else's home, we're a good proxy for that.

Makes sense. Thanks, guys. Thank you.

Thank you. Our next question is coming from Alan Ratner of Zellman & Associates. Please proceed with your questions.

Hey guys, good morning. Glad to hear everyone's doing well and congrats on the strong performance both in the quarter and since then as well. So, you know, my first question, I guess just touching a little bit on that last comment about the advantage of having finished specs, you know, one of the things that we've been seeing on the resale side in this current environment is there's been a huge decline in inventories as people are sheltered in their homes and presumably can't sell it if they're looking to move. And I would imagine you guys have benefited to some extent from that trend there. I guess the question is, as you look forward and eventually perhaps listings do start to increase and you have to think about that four to five month ideal supply of specs that you have on the ground, how quickly are you kind of adjusting that start pace? Because obviously the trends are changing so dramatically by the week. So should we think about your current start activity, you know, kind of down in that 25, 30% range that you're forecasting April to be in, or are you taking some differing view based on what's going to happen with resale inventory once eventually it does come back online?

First of all, thank you for the question, and I hope you guys are doing well also. I'll tell you that I think our spec strategy... is going to be the defining elements of our overall strategy and it's going to be what allows us to gain market share in this downturn because many builders don't do it and we believe very strongly that buyers in this environment and the environment going forward don't want to wait for a home and they They want to move quickly and we have that inventory for them. That said, obviously our April starts are going to be down significantly. We don't report starts, but I can tell you our April starts will be down significantly from previous months and from what's normal for us because we're fine tuning where we want specs and where we have too many and where we don't have enough. and where we're selling houses at a fast rate and there are many places, we're building specs. So how do we manage that? We manage it daily. Every day we figure out what we've sold and where we need to replace it. And Phillippe and I together, Phillippe leads the effort on that. I support him. I can tell you this is hand-to-hand combat. We're managing that part of the business very aggressively as we're managing our land acquisitions, our land development, not just about conserving cash but about putting the right product on the ground in the right place at the right price.

That's very helpful. I appreciate the insights there. Thank you for having me. When you look across your footprint, are you seeing any discernible differences in trends of late? Maybe ones where the demand hasn't seemed to bounce back as sharply, perhaps due to that job uncertainty, or is this strength over the last week or two? Is that pretty widespread across your footprint?

I would say that, you know, I think about it kind of just the way you just laid it out. Going into this pandemic and through it, I was the most concerned about Orlando and Houston, right? There's 75,000 people in Orlando that work for Disney. They furloughed 43,000 people a couple few weeks ago. You know, it's a resort market, a travel leisure market. Very worried about Orlando. Also very worried about Houston with, you know, almost zero dollars for a barrel of oil. But surprisingly, our sales in Houston have been very robust for April. I'm floored how well we're selling homes in Houston this month. Orlando sales have been off, but not as much as I would have expected. Really where we're having the most challenges at this moment would be California. California, I think is the one state that we could be most challenged by. Fortunately, our footprint in California is not that large. We only have 29 communities in California. But that's what I'm concerned about. I'm also a bit concerned about Colorado. Our community count has fallen dramatically in Colorado from from 23 a year ago to 13 because we've been selling out of communities and replacing them with new lower-priced entry-level communities. But the price of housing is pretty high in Colorado, and I think buyers there are being a little bit more cautious. But demand in Arizona is stellar even through the last six weeks. and a demand in most of our Texas markets continues to be very good as well. So hopefully that answers your question.

Yeah, that's great. Thank you for the color and good luck and stay healthy. Thank you.

Thank you. Our next question is coming from Truman Patterson of Wells Fargo. Please go ahead.

Thanks. Actually, it's Paul Schabelsky. I guess Steve, as we look for an inflection in demand, what would you need to see to give you comfort to re-engage the land market and develop? How long would you remain conservative?

Well, we're not unengaged. We're going through our land pipeline. You know, maybe we had a couple hundred deals in escrow, maybe a hundred of them we had gone hard on. We're reviewing those. We may have some of those, you know, a modest amount of those that we decided to part ways with. And so we're not just going to completely blow up the land pipeline. We're going to, you know, reanalyze every one of them. Every market is different. I think some land prices are going to be somewhat sticky. in certain places, but I think in other places they may go down and, you know, we don't want to be in a position where we overpaid for land. But we also think, you know, other builders, private builders are going to be stressed in this environment and they're going to have to let go of some land that we maybe wanted to buy that we couldn't buy that maybe now we'll be able to buy. And we're going to be very strategic and we're going to use this This is an opportunity to increase our market share. So I don't know that we're going to be running out and buying land tomorrow, but we're going to be ready this summer for sure. Particularly if our city sales rates that we're experiencing, particularly when some markets hold up, we're going to be ready to buy land where it makes sense. So as I said earlier, this is not 2008 where we're just Thank you for joining us.

And Hila, earlier in the call, you mentioned you had significant headroom on the incentive front before triggering impairments. Do you have any color on the magnitude? Is it probably in the 10% range?

Yeah, I mean, you guys saw the margins this quarter were 20%. So there's quite a long runway between that and break even. There's some additional costs for, you know, not to get too geeky in the accounting part, but the auditors make you throw in a little bit more money. But you probably have between 10% and 15% decline in ASPs before we would even need to start having conversations. And that's assuming that there's no price concessions at all to be gotten in the market today, which obviously there are. So I think that kind of the culmination of all of those items gives us a lot of breathing room.

We had 30 to 40% price declines in the last great recession, which certainly caused all those impairments. Our margins were really strong then. They were even stronger at that time. But, you know, we're not seeing any real price declines yet. Certainly, you know, incentives are picked up a little bit, but not meaningfully. Okay, thank you.

Thank you. Our next question is coming from Stephen Kim of Evercore ISI. Please go ahead.

Yeah, thanks a lot, guys. Encouraging stuff. Good to hear. It certainly does seem like things are holding up a lot better than they were looking like they were going to be a few weeks ago. I guess I'm curious as to whether you could comment on what you're expecting or what you're versus the markets, I mean, where the states are kind of reopening versus the states where it'll be more delayed. And what specifically are you looking for in these markets that are opening up earlier to gauge how you're going to perhaps pivot your strategy in the other markets that may follow?

Well, I mean, it's traffic. You know, it's sales activity. You know, it's buyer engagement. and it's pricing. What incentives are necessary or not necessary to get people to transact? I mean, it's no different than in a good time than in a bad time. And the activity that we're seeing in the field and in the communities is really gonna drive our decisions around building specs and buying land. It's a pretty simple, It's a pretty simple formula.

I mean, in the markets, Georgia opened up a little bit, South Carolina. We're now seeing Texas open up here. In the markets that are sort of painting the way for opening, we're seeing incremental traffic right away. We're seeing buyer engagement as Steve articulated. So we're seeing all that. I mean, you know, it'll just be key to watch the sort of economic landscape for each one of these markets. You know, I think someone mentioned where the job loss is going to occur. Keep an eye on that, but we've already seen buyer engagement improve just with the idea of opening back up. So we're certainly expecting incremental activity and traffic when we actually can be open up in a non-virtual appointment-only environment.

Yeah, absolutely. Particularly seeing things improve over the last couple of weeks is important. Do you attribute or how are you anticipating that you're going to utilize incentives during this, what you might call a diagnostic phase? You've indicated you've seen some nice pickup in traffic and buyer engagement. I'm assuming that that is in the absence of a material increase in incentives on your part or any special programs. Can you talk about the degree to which you are planning to maybe pull back on incentives in the near term or conversely to increase incentives as these markets open up?

Well, the question really should be more what were our incentives in April. And I would say we used a variety of tools in April, but they all add up to about 150 BIFs. Some of them was commissions. Some of it was more closing costs, a variety of different things that we did. That said, we were raising prices in March. So I don't believe that our April incentives, that $150,000 that we spent, is going to have a meaningful impact on our margin because I think our prices were on the upswing of our inventory going into April. So I think it kind of washes. But, you know, I'm going to refrain from telling you what we're going to do in May. I know a lot of our competitors are listening to these calls as well and reading transcripts, so I don't want to telegraph to the market what we're going to do. But I can tell you this, you know, we're not going to sit on our hands and, you know, watch the movie go by. We're going to be aggressive. and active in making sure that we maintain our volume to a reasonable level and move our product and compete. And that's what the really good entry-level builders do. And I just ask what the good builders do, period. They did it in the lockdown term. They're going to do it now. And we're going to be right up there with them. So I don't know what else I can tell you on that, but I I'm not going to tell you precisely what incentives we're going to be offering.

I would just add, this is not a peanut butter approach. Every community has a different story. We believe we're going to sell over 650 houses in April in a largely sheltering in place environment. We have a lot of communities, especially in the entry level that performed at or above our original underwriting expectations. We're not looking to over incentivize those, especially as we think they'll do better coming out of this. So every community we look at and we evaluate what our competition is doing and what's the story on that community, what's our spec story. So it's a community by community thing, a market by market thing. And then I would also tell you, again, I believe this is the advantage of having specs. You know, when you look at incentivizing specs, it's very different than incentivizing dirt. You can control the margin erosion much better.

Yeah, no, it's all very encouraging. Appreciate it. And you also didn't mention the fact that lending standards tightened a little bit, too, in the recent weeks, and so the strength is really encouraging. Thanks a lot, guys. Appreciate it. Thank you.

Thank you. Our next question is coming from Carl Reichardt of BTIG. Please go ahead.

Thanks, morning folks. Glad to hear you're well. I was curious, Phillippe, if you could talk about April in terms of entry-level live now spec versus the move-up side of the business and maybe how absorptions on a net or gross basis had trended between those two segments.

You know, I don't have those stats right in front of me for April yet on how much of that was entry level versus 1MU versus sort of our non-strategic assets. But I can look at the data just in front of me and I can tell you the Live Now is continuing to perform very strongly. There's been modest pullback in the 1MU. It's definitely stronger there than in Live Now. And then the 2MU stuff is definitely more slower, much more slower than the first quarter. So I would just tell you in general, entry level, you know, entry level plus, you know, lower end first MU is all performing much better than the higher end stuff. And I think you'll see that trend in April and as we come into May as well.

Higher end stuff for us was only 6% of total volume for Q1. It's not really even a footnote for us anymore. And the pace is holding relatively steady. We've been watching some of our competitors and we do have a few communities that are closer to what I would deem as ultra entry level.

and I see that some of those are more challenged because they're impacted, the buyers are less credit worthy and they're tending to have a lower credit score. We cater to a little bit more of a premium entry level buyer who has a better credit score. Our entry level buyers credit is generally over 700. We do have some in the 600s, but we don't have any of those low 600, even high 500 entry-level buyers that some other people might have. So our entry-level communities have not really seen a drop-off in activity.

Okay. I appreciate that answer. Thanks, guys. And then, Hilla, you talked before at the Analyst Day and previously about Community Count, What 20 Would Have Been, which was a transition year before 21 Community Count grew. Let's operate under the assumption that you're sort of down 25%, 30%, and that's sort of where we are for a few months before there's some type of a rebound. Is your sense then that effectively you'll just run your Community Count down or replace communities that do sell out at a slow rate? I guess the question to me is what does the market need to look like Before you start to think about a more aggressive expansion of your community count.

Carl, that's just too hard to answer at this moment in time. You know, because we got so many moving parts. We have some communities that we've frozen development for a short period of time to see what's going on. So those will be, some of those will be delayed. That we're, you know, have planned an opening later this year. we have some communities that are selling out a little bit slower that may continue to be open through the year we have some that are going faster you know it's just we're just in the eye of the storm right now and i i don't want we don't want to give any guidance on community count until we get a little farther down the road with this i think next quarter it's more reasonable question to ask we definitely still have our Our mindset and our target on getting to that 300 communities. You know, we wanted to be there by the end of 21. We're still going to get there. It's just going to take us a little bit longer. You know, we've been dealt the curveball here. And I think, you know, with these low interest rates and the tight supply of housing. that we're going to get through this in a pretty good way. But I don't want to give any kind of guidance like that yet.

I think that Steve had in his prepared remarks, we're just trying to navigate the short and midterm, but nothing's changed for us long term. That's still the strategy is to hit the 300 community mark. Not sure it's going to happen on the quarter that we thought it was going to happen in, but that's still the eye on the prize.

Great. I appreciate it all. Thanks.

Thank you. Our next question is coming from Michael Rehart of JP Morgan. Please proceed with your question.

Thanks, and good morning, everyone. I hope everyone's healthy and safe. First question, I was just hoping to get maybe in some ways more of a clarification on some of the numbers provided earlier, specifically just around the down 25 to 30% in April that appears to be more of a gross decline.

And, you know, if you kind of extrapolate, you know, the... Mike, I think there's a slide in our presentation. We had 916 sales last year's April net sales. and we're projecting north of 650 net. So that's how we're getting to the 25 to 30. So that already has all of the cancellations in there.

Okay. Okay, that's helpful, I guess. Maybe we can follow up offline with some of those numbers. But also around the down 50 to 60 early in April and then down 20 in the last couple of weeks, is that also net or gross?

This is all net. So, you know, the first two weeks of April, we were and I'm trying to think about week to week trends year over year is what the question was. And I'm not sure if I'm spot on. I think the point is, is the last two weeks. And as we move through this week are meaningfully stronger than the first two weeks of April.

I maybe wouldn't get caught up on the weekly percentages. I think the takeaway is that was rougher in March. It's been improving steadily ever since. And we expect April to close out 25 to 30% net. And as Talib mentioned, likely April will be the toughest of the month considering almost the entire country's shelter in place right now. And we're exiting out of that rolling into May.

Yeah, I mean, Mike, I know you know this because you've been doing this a long time, but you know... Sales numbers always build as you get later in the month. Okay, because incentives expire. Sales people get more motivated. They work harder at the end of the month than they do at the beginning of the month. People clean up their backlog and take a can. So as you move through a month, numbers are always building. So that said, the last two weeks in March, as Hilla said, numbers were declining. and the first two weeks of April numbers were lower than you expect for the prime time of the selling season. But the last couple of weeks, particularly this last week, it's been pretty strong. We endeavor to deal with our cans on a daily basis and we're always reporting net numbers.

Okay, I think maybe I was also just confused on the bar chart that there was a 600 number in there for the month. Maybe that's again where we can follow up on, but I appreciate the clarity. I guess secondly, just on the gross margins in the first quarter, understanding a lot will change off of the current market conditions going forward, but There was a very impressive number around 20% gross margin for the first quarter and compares to the mid-18s that you were expecting. So I was just hoping to get a little bit in terms of what the drivers were of that upside on a relative basis. And if that's kind of the new starting point, all else equal. You know, if you're to kind of take out maybe what incentives and market demand is going to do, but if there's any type of, you know, kind of mix shift or timing that benefited that quarter or if structurally perhaps you're at a higher level than you realized.

Well, here's the thing with our strategy and our model. We're able to sell homes in a quarter and close them. Okay, because we have an 83% Conversion Ratio and Q1. So we had a robust January and a robust first half of February, and we were able to sell inventory and close it within the quarter, which allowed us to outperform the guidance that we gave you for closings, which drove a higher margin because we didn't have to create any additional overhead to produce that revenue. So that's why it's important to keep building and selling because the overhead leverage is significant. And it has a tremendous impact on the bottom line. So because January and February were so strong and we sold quite a few more homes than we expected to, we were able to close those and produce a better gross margin.

Mike, if you're looking year over year, Q1 to Q1, of that 330 BIP improvement, about 80 BIPs of that is increased leverage from the higher volume. The rest of that is a combination of what we talked about, which is our ability to increase pricing, the strength that Steve talked about coming into the quarter, but also those cost efficiencies. We've been improving our processes and our product, as we've been talking about for the last couple years, so the culmination of all that. really became evident in our closings in Q1. So again, that 330, it's mostly comprised from improved processes and cost reductions, although there is 80 bps in there from that overhead leveraging from the additional volume.

Okay. Thank you.

Excuse me. Thank you. Our next question is coming from Jade Romani of KBW. Please go ahead.

Good morning, this is actually Ryan Thomas for Jade. Thanks for taking the questions. I was wondering if you're seeing any early indications for a potential increase in acquisition opportunities across the landscape and, you know, including large scale M&A in the market?

No, no one's looking at acquisitions, you know, in the middle of a pandemic. And then, you know, I don't think any builders are inclined to be selling right now unless they're looking for a lifeline. So short answer is no.

Okay. And then, you know, are you seeing any preliminary signs in your market today of increasing demand as a result of specifically the pandemic from multifamily renters?

I think it's too early to tell. I mean, we believe long term that people are going to want to own a home. They're going to want to be in the suburbs. They're going to want to socially distance, you know, not live in tight quarters. We think we're going to get an influx of people from high density cities to move out to the Sunbelt where we build. But, you know, we're just only a few weeks into this thing and it's just, you can't really... You know, take any trends away from this based upon anecdotal evidence. Yeah, it's too early. Okay. Next question, operator.

Certainly, our next question is coming from Alex Barron of Housing Research Center. Please go ahead.

Yeah, thanks. Thanks. Hope you guys are well. I wanted to ask about How much is your bill time being affected by social distancing and all that stuff?

Yeah, thanks, Alison. Well, the first thing I would say is It's not getting any worse. In fact, I would tell you that we're seeing more effective construction activity. We think that's largely attributed to us being an essential service. It's being carved out. This is what the trade crews are performing at a very high level right now. They're getting to the job site faster. They have less other work to do. That's a distraction. Thank you so much for joining us. Thank you so much for joining us.

and those crews came over to our job site and said, can we double up? And we said, sure, come on over. Let's get some more stuff built. So those guys are reading the paper too and they're nervous and they're working hard to maintain their share as well. That's good to hear.

The other question is, Steve, you said you're not going to Are you going to be aggressive and not let others take your market share? My question is, how much flexibility does each individual salesperson have on getting a sale done? In other words, do they have some pool of money that they can work on incentives or do they need to check more all the way up to you guys? I guess I'm trying to understand how centrally controlled the Thank you very much.

You know, that's our job. That's Phillippe's job. He monitors that every day. He has his hands on the wheel. He's pulling the levers as needed. And we don't have any delay in reacting to what's happening on the ground.

Yeah, and I mean, we rarely go into an environment where salespeople are empowered to just get buyers on paper at whatever cost. We're certainly a long ways from that. Yeah, that's not how we operate.

Okay, and my last question is if you guys have any communities that maybe haven't had a sale for a few weeks or what's the trigger to kind of re-evaluate your incentive or your pricing? How many weeks would need to go by Thank you for joining us today.

Figure out what the problem is and make the adjustments accordingly. But I can't tell you a formula. After three weeks, we're going to slash the price. We don't function that way. Okay, thanks, and best of luck for this. Thanks, Alex. Stay well. Operator, I think we're getting close to the end. Do we have any more questions?

We're starting time for one last question, which will be from Charles Perrone of Goldman Sachs. Please go ahead.

Hey, good morning, gentlemen. I'm playing for Susan today. My first question is, can you discuss the different trends that you're seeing in the labor and material costs through April? And if you believe these could provide a tailwind to the margins in 2020, assuming a weaker demand environment?

I would say that we haven't had any price increases in April or cost increases from our trade base. Certainly we did experience some in March, but it's been more muted. I do think with the low price of oil, we will be able to get some price concessions going forward, cost concessions, I should say, from our trade base. and I also believe that lumber is, we have a lot of lumber contracts expiring tomorrow and we're going to be renewing those contracts. We believe at lower, at lower, at lower, lower, lower cost, maybe 10 to 20 percent lower. and certain geographies, of course, more than others and others less than others. But I think the cost environment has become more favorable for us and for builders moving forward.

Okay, thank you. That's very helpful. And second, I would like to go back a little bit more on the SGMA. And obviously, even if you don't hit your 10% target for the year, Do you give us a sense of where things could go on the agenda for this year, and what do you expect to trend overall for the year?

That would be guidance. We're not giving guidance, so I don't know how to really respond to that. I just...

We can't, we can't, that percentage is a function of revenue, and we're not giving out revenue numbers. The only thing we will say, and we said it a couple times during the prepared remarks, is we're pulling back dramatically on non-essential discretionary spend. So we're going to be controlling costs very tightly, but the revenue piece is still murky, so I don't think we're prepared to provide any guidance on SG&A right now.

Okay, that's all helpful. Have a good day. Okay, thank you. So that concludes our question and answer and prepared remarks for today. We appreciate everybody coming, joining in on our call. We hope you stay well and navigate through this crisis and come out on the other side. So we'll look forward to talking to you again next quarter. Thank you very much. Have a great day.

Ladies and gentlemen, thank you for your participation. This concludes today's event. You may disconnect your lines at this time and have a wonderful day.