Meritage Homes Corporation

Greetings and welcome to the Meritage Homes second quarter 2020 analyst call. At this time, all participants are in 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. Please note that this conference is being recorded. I will now turn the conference over to our host, Brent Anderson, Vice President of Investor Relations. Thank you. You may begin.

Thank you, David. Good morning and welcome to our analyst call to discuss our second quarter and first half 2020 results. We issued the press release yesterday after the market closed, and you can find it along with the slides we'll be referring to during this call on our website at investors.lamarriagehomes.com or by selecting the investor relations link at the bottom of the homepage. Turning to slide two, We'll caution you that any statements made during this call as well as the press release and the accompanying slides contain forward-looking statements, including but not limited to our views regarding the health of the housing market, potential adverse impacts related to the COVID-19 pandemic and the second wave of infections, community count, absorptions, Projected third quarter and full year home closings and revenue, gross margins, SG&A expenses, tax rates, and diluted earnings per share, as well as economic conditions and others. Those and any other projections represent the current opinions of management, which are subject to change at any time, and we assume no obligation to update them. Any forward-looking statements are inherently uncertain. Our actual results may be materially different than our expectations due to a wide variety of risk factors which we've identified and listed on this slide, as well as in our press release and our most recent filings with the Securities and Exchange Commission. Specifically, our 2019 annual report on Form 10-K and quarterly reports on Forms 10-Q, which contain a more detailed discussion of those risks. We've also provided a reconciliation of certain non-GAAP financial measures referred to in our press release as compared to their closest related gap measures. Our speakers today are Steve Hilton, Chairman and CEO of Meritage Homes, Hilla Sferruzza, Executive Vice President and CFO, and Phillippe Lord, Executive Vice President and Chief Operating Officer. We expect the call to last about an hour and a replay will be available on our website within approximately an hour after we conclude and will remain active through August 6. I'll now turn it over to Mr. Hilton to review our second quarter. Steve?

Thank you, Brent. I'd like to welcome everyone participating on our call today and hope that you're safe and well. It's hard to believe that just three months ago we were discussing the sharp drop in March orders due to the nationwide shutdowns intended to slow the spread of the COVID-19. And today we're discussing record orders for the second quarter in demand for our homes that even surprised us. It's been anything but a normal spring selling season. I can't remember another time like this in all my 35 years leading Meritage. We'll review some of the highlights of the quarter and explain what we believe is driving our success and how we're positioned for continued earnings growth. I'll preface it by saying that while the market is broadly benefiting all builders, we believe our strategy and execution will continue to place Meritage among the best performing home builders to own. I'll start with slide four. We reported in mid-May that our orders for the month of April were down just 15%, which was less than we had projected just a few weeks earlier, and looked like May orders could meet or beat May of 19. We ended up setting an all-time record in May for a single month's orders, selling a total of 1,320 homes, which we then surpassed in June with a new record of over 1,500 orders. May orders were up 44% higher than last year and June was up 66% over last year. We finished the quarter with 3,597 total orders, another all-time record for Meridish and 32% higher than the second quarter of 2019. What's most surprising is that all those records came in the midst of a pandemic that is still dominating the news and affecting nearly every aspect of our daily lives. We firmly believe that it's important to remain diligent in fighting the spread of the virus and just last week we issued more stringent protocols for our sales office and construction operations to safeguard our customers, employees, and trade partners. We are also continuing to invest in our virtual capabilities for selling, building, and delivering homes as we believe that's an important tool for us in today's environment and will likely permanently change certain aspects of our industry. Homebuyers use of our virtual capabilities to assist them efficiently and safely research, tour, purchase, and close on their new homes. I'll now turn to slide five. As illogical as it may seem to be selling homes at record levels during a pandemic and record unemployment, we believe it's a combination of market forces and our strategy. While there are many theories as to what's behind this unexpected trend, I'll explain what we believe is driving demand based upon feedback from our customers and why we believe marriages are so well positioned for this market as listed on slide five. With interest rates at historically low levels, historic lows, home ownership is affordable for millions of more Americans who can qualify to purchase a home. Many are finding that they're not spending as much of their days on things like eating out, going to sporting events or other entertainment, So they have more money to afford a new home. For example, we sell a five-bedroom, three-bath, three-car garage home in Fort Worth for about $336,000, which is about $1,950 a month, PITI. Rental for a comparable home is over $2,700 a month. Inventories of existing homes for sale are very low, and homeowners as well as buyers are uncomfortable about touring currently occupied homes. New spec homes available for quick movement offer advantages typically associated with existing homes without those disadvantages. As a nation, we have never appreciated the safety and security of our homes more than we do today, including a healthy living environment. We don't want small cramped homes in crowded urban centers. Most of us prefer a single family home in the suburbs where we have our own space by sharing amenities like elevators, laundry, facilities, gyms, or pools. We also need more interior space to work at home while our kids are also at home, not knowing when the schools will reopen or what that will look like. The combination of those conditions is driving demand for new homes, and Meriden is one of the best positions to deliver. On slide 6, we made the decision several years ago to concentrate exclusively on entry-level and first move-up homes where we saw the greatest opportunities going forward. It was the right move at the right time. 70% of our total second quarter 2020 orders were entry-level and 26% were first move-up. That's a dramatic shift from where we were just a few years ago as entry-level is outpacing everything else. We offered a differentiated and compelling value proposition combining Meredith's quality construction and high-end finishes with our M-connected home automation suite and signature energy efficiency standards that make our homes safe and healthy for our homeowners. And we have streamlined our operations to deliver homes at competitive affordable prices while striving to offer our customers surprisingly more than they expect. Our trade partners, suppliers, and customers share the benefits It's a win-win-win proposition that's not only driving sales but gross margins that are exceeding our underlying standards, all while continually raising the bar for the industry best customer satisfaction rating. Moving to slide seven. We believe that we have a solid strategy and are executing at a high level. We have the strongest balance sheet we've ever had with plenty of liquidity and low debt leverage providing tremendous flexibility for growth as well as a safety net in the event of another downturn. We purchased just under 6,000 new lots in the second quarter as demand has rebounded, including some great positions that other builders dropped during the peak of the pandemic. And we have a robust pipeline with opportunities to acquire almost 50 new communities in July alone. Our strategy for land acquisition development makes our teams more efficient at finding and assessing new positions quickly and improves our confidence that finished lot costs will allow us to achieve our target margins. We're very close to being on plan that we announced at our investor day in November 2019 to have 300 communities open by the end of 2021, though it may be delayed into early 2022 due to the COVID-related shutdowns that we're experiencing. That along with solid execution positions us well for future growth. I'll now turn it over to Phillippe to discuss more of the recent trends and opportunities that we see ahead of us. Phillippe?

Thank you, Steve. This was an unexpected but remarkable quarter in many ways. We never imagined we'd be facing the conditions we found ourselves in at the beginning of the quarter. and I'm proud of the way our entire organization stepped up to the challenge to deliver the results we did. We demonstrated empathy and compassion for our customers and for one another, a never give up attitude, creativity, teamwork and perseverance to rise to the occasion time and time again. I want to thank each member of our team for living up to our core values and delivering the best for our customers every day. I'll now provide some highlights and recent trends on slide 8 before turning it over to Hilla to review our financial results for the quarter. The market faced a grim outlook at the start of the quarter, but we had already taken steps recommended by development and health organizations that would enable us to continue to sell, build, and deliver homes in a safe and healthy manner. When demand surged in May as shelter-in-place orders began listing, we were prepared to meet it. Our virtual selling capabilities and safety measures allowed us to continue to operate and ultimately lean in and exceed expectations for the second quarter. We sold about five homes per month on average in our communities during the second quarter, 42% more than we did in the same quarter last year. In fact, 48 of our communities sold more than 10 homes last month. Much of that was due to our entry-level position, which represented 57% of our total active community count at June 30, 2020, compared to 41% a year ago. An entry-level made up 70% of total orders for the second quarter, up from 51% in the second quarter last year. Absorption in our entry-level communities were over 19 homes per community on average for the quarter. 37% higher than the second quarter of 2019 and nearly double the pace of non-entry-level communities. Our first-year communities also performed very well, with per-store absorptions 25% higher than a year ago. We've been investing aggressively for the last couple of years in building our pipeline for additional entry-level communities where demand is the strongest. Executing on that strategy, 80% of the new lots put under control in the second quarter of this year were for entry-level homes and communities. We pulled back on starts in March when demand fell off, but were able to ramp up quickly when demand picked up strongly in late April, thanks to our streamlined process that makes us more nimble. We ended the quarter with an average of a little over 9 specs per community, approximately the same as last year, as strong demand for spec homes offset an accelerated construction pace over the last couple months of the quarter. Approximately 21% of total specs were completed, less than the last couple quarters, understandably due to strong demand. Slide 9. Moving to the regional level trends on slide 9. Our orders in the West region were up 27% over the second quarter of 2019, driven by a 31% increase in absorption, with 3% fewer communities on average. The West region had the highest percent of entry-level communities at 61% as of June 30th. Arizona is still producing the highest absorptions of all nine states we operate in, selling an average of just under seven per month per community during the second quarter, 32% higher than last year, as the entry-level market in Phoenix is red hot. But California produced the largest year-over-year growth in orders at 87% for the quarter, with average community count increasing 39% and absorptions up 35%. Our new Live Now affordable entry-level communities have been very successful. We said last quarter that we believe Texas would be resilient as we came out of this downturn, and that turned out to be correct. Our central region led in terms of order growth this quarter, with a 47% increase in orders over the second quarter of 2019, despite a 7% decline in average community count. Absorptions there were at 58% over last year, with 59% edge-level communities now in Texas. Demand in Dallas and Houston has been very strong despite the weak energy market, and Austin and San Antonio continue to outperform with our live now communities. We had strong growth in our east region as well, with 23% order growth on a 36% increase in absorption, offsetting a 10% decline in average community count. 51% of our communities in the east region were energy level at quarter end. Georgia and the Carolinas put up the strongest games, while Tennessee lagged near the aftermath of the tornado in Nashville in the first quarter. Florida also performed better than we may have expected, with order growth of 18% driven by a 14% increase in adsorptions. I will now turn it over to Hilla to provide some additional analysis of our financial results. Hilla?

Thanks, Philippe. Let's turn to slide 10. We generated 78% earnings growth in the second quarter of 2020 over 2019 as we outperformed across all key metrics with 20% home closing revenue growth, a 300 BIP increase in home closing gross margin, and 70 BIP improvement in SG&A leverage. Closings were up 23% over the second quarter of 2019 with 74% of closings coming from previously started spec inventory and a backdoor conversion of 78% compared to 70% last year. We generated over $1 billion of revenue in Q2 2020 as our increases in home closing volume more than offset the declines in community counts and ASPs consistent with our strategy. Clearly, our margin improvements demonstrated the savings achieved from our streamlined operations through product and process simplification, as well as efficiencies of scale. Margins also benefited from pricing power over the last several quarters, though we carefully managed price increases to keep volumes up and recognize that leverage comes from each additional sale. In the second quarter this year, we also had some temporary cost concessions running through our cost of sales that accounted for approximately 20 to 40 bits of the improvement, although we expect most of those to expire in the next couple of quarters. The 21.4% gross margin included contract termination walk-away charges of 3.3 million, or approximately 30 bps, in the second quarter of 2020. By comparison, we had about half a million dollars of similar charges in the second quarter of 2019, or an impact of about 10 bps. Our 70 BIP improvement in SG&A was primarily due to additional closing revenue in Q2 that improved our leverage of fixed expenses. While we took immediate action to reduce discretionary expenses in late March, we thankfully did not have any reductions in force. As demand began to improve in a matter of weeks rather than months, we were grateful to have full staffing to manage the increase in activity that ensured stability in our operations in May and June. Earnings from financial services were $2 million lower in the second quarter of 2020 compared to the prior year. As we have previously explained, we changed our mortgage joint venture structure related to customer incentives offered for using our mortgage JV last year, such that the profit from those incentives is now included as part of our home closing revenue rather than being reported as part of our financial services revenue. Interest expense decreased by $1 million net, with savings from our early repayment of debt in December 2019 partially offset by interest on the $500 million that we borrowed on our revolving credit facility in March of this year to provide liquidity, should we have needed it in a protracted recessionary environment caused by the COVID-related economic disruption. We also benefited from a lower tax rate with the extension of the energy tax credits into 2020. Our tax rate was approximately 22% for Q2 of this year versus 25% last year. Our second quarter diluted EPS of $2.38 further benefited from the repurchase of 1 million shares we completed in the first quarter of this year. Highlighting just a few items from the first half of this year beyond what we already covered in the second quarter, we generated a 113% increase in net earnings with orders and closings of 27% each year over year, a 320-bit increase in our home closing gross margin, and a 110-bit improvement in SG&A. The strong start to the year and the rapid recovery that started in mid-April more than offset the pullback experience from COVID uncertainties in late Q1 and very early Q2. Moving on to slide 11. Our balance sheet is in the best condition it's ever been with plenty of liquidity including $485 million of cash and the lowest net debt-to-cap leverage in the company's history at 20.4%. We repaid the full $500 million that we had borrowed against our $780 million credit facility by the end of May, so we had nothing drawn on the credit line as of June 30, 2020. Referring to slide 12. We spent approximately $214 million on land and development in this year's second quarter, almost $40 million higher than last year's Q2, despite a near shutdown on spending for most of April. We have accelerated our land acquisition and development spending as sales activity rebounded as Steve and Phillippe both covered. We still expect over $1 billion total spend for 2020 as we push forward to achieve our goal of 300 actively selling communities by early 2022. We added about 1,800 net new lots in the second quarter of 2020 to end June with approximately 42,900 lots of which 40% are options. That represented a 4.2 year lot supply based on trailing 12 months closings slightly higher than a year ago. Finally, I'll direct you to slide 13. After a one-quarter suspension of guidance, we're resurrecting and updating our guidance for the year. Barring any unforeseen repercussions from the second COVID wave, we see continued strength with a return to a more normal seasonality in the back half of the year. For the full year, we are projecting total home closings to be between 10,850 and 11,350 units, Home closing revenue of $4 to $4.3 billion, gross margin of about 21%, an effective tax rate of about 22%, and diluted EPS of $8.75 to $9.25. For the third quarter, we're projecting closings between 2,700 and 2,950 units, home closing revenue of $1 to $1.1 billion, Gross margin of approximately 21% and diluted EPS of $2.15 to $2.35. With that, I'll turn it back over to Steve.

Thank you, Neela. We're in unprecedented times. National unemployment levels are very high and there's still a global pandemic that has yet to be brought under control. We're doing our part to protect our employees, trade partners, and customers, and we encourage everyone to be respectful and at least do the basics, wear a mask, social distance, and wash your hands. At the same time, we're enjoying a very strong housing market and helping thousands of families move into their first new home. We're hitting all cylinders with a solid strategy, strong balance sheet, and a great team that is executing at a high level. We're setting new records while preparing to celebrate our 35th anniversary and are very well positioned for continued growth. While there's still a great deal of uncertainty on many levels, we're confident that we're up to the challenges of whatever lies ahead. I'm proud of our entire Meritage team for putting customers first and bringing their best efforts to deliver great results every day. 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. At this time, we'll be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. That's a star key followed by the number 1 key on your telephone keypad. A confirmation tone will indicate that your line is in the question queue. Please limit yourself to one question and to one follow-up each time you queue. You may press star followed by the number 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, to ask a question, press star 1 on your telephone keypad. Our first question comes from Alan Ratner with Zellman and Associates. Please state your question.

Hey, guys. Good morning. Congrats on truly a remarkable quarter and obviously great execution during this very difficult timeframe. My first question, just looking at the guidance for the back half of the year, seems very strong and obviously a continuation of the good trends you've seen through the quarter. When I look at your supply of specs, it's roughly flat year over year, yet you're expecting continued growth, at least in closings in the back half. I guess my first question is do you see any supply side constraints to ramping that spec supply over the next few months either as far as labor is concerned, municipalities dealing with permitting or are you kind of gradually maybe shifting the sale strategy a little bit willing to sell a little bit more pre-sale given some of the constraints on the labor side?

So I'll give you kind of a complex answer. Of course Early in the pandemic, we pulled back on spec starts, but we quickly reengaged in that area. Late April, coming into May, I think we started about 1,000 specs last month. In addition, we started build orders on top of that. We're going to be trying to start even more specs this month. We do have two feet on the gas to get our spec inventory back up. At the same time, there are some COVID-related supply chain issues out there with different vendors who've had factories closed that have slowed down the delivery of certain items, but it hasn't impacted our business yet. We're being very mindful. We have had isolated COVID-related issues with trades, but we've been able to work around it, and we don't see any reasons why we can't continue to stay on our plan for the rest of the year due to COVID.

One other data point to add is on the spec count per store, even though it dropped to nine on the entry level side, we were at 14 last quarter per store and now we're at 12. So a fairly limited drop. It's actually just kind of a shift of the communities and the mix and what we're doing in a non-core aspect and the spec levels there. So overall, the drop on the entry level, which obviously is 70% of our business right now, is fairly limited.

Got it. That's very helpful. Second question, obviously you're expecting a lot of growth on community count over the next year and a half, over 20%, and presumably that's probably what you're targeting, just overall growth in the business as well. I guess my question is, what would you need to see that would cause you to maybe change the current path you're on as far as both feet on the gas here, Steve? Unemployment remains very high, yet you're seeing strong demand on the ground, so would it Thank you for joining us.

Our land strategy is to be able to provide our product in the right locations at compelling value-based price points. And we think that's the sweet spot of the market going forward, the entry level and first move up. And we've been able to find quite a bit of land that we're pretty happy with. We're going to be bringing on next year to build and grow our community count going forward. I don't see anything on the horizon right now that dampens our enthusiasm for growth.

To add to that, Alan, we demonstrated that we can pull back very, very quickly. In March and early April, when it was very uncertain and visibility was near zero, we were able to pull back on spend very quickly. So while we're two feet on the gas, should there be another pickup in the economy or in the sector, we certainly can pull back quickly.

Great.

Thanks a lot, guys. Good luck.

Thanks, Alan.

Our next question comes from John Lovallo with Bank of America. Please state your question.

Hey guys, thank you for taking my questions. The first one, Texas and Arizona have been two of your hotter markets, obviously now being a little bit more impacted by COVID. Over the past couple of weeks, have you seen any changes in consumer behavior given the heightened concern around the virus?

No, pretty much the opposite. The Arizona market in particular has shown no signs of retreat, and we continue to have strong demand in our sales office here, even in the midst of the increasing pandemic and very warm weather that we have down here in July. So, no, not at all.

And highly qualified buyers. We're not seeing buyers that don't have jobs or are worried about their jobs, don't have strong balance sheets to buy a home, not seeing a bunch of investors show up to the party. It's just true household formation and household demand for affordable housing.

We gave guidance on the call that our cancellation rate dropped to 15% blended, but that dropped from 20% in April down to 13% in June. So we're seeing a fairly rapid decline in cancellation rates to Phillippe's point. The buyers that are coming in are well qualified.

That's really encouraging. Okay, great. And then in terms of the community town outlet that you guys laid out, How should we sort of think about the cadence of that, you know, through early 2022? And should we expect, you know, a similar sort of ramp in SG&A as those communities get, you know, come to fruition?

Well, community count is going to be, you know, down this year. Flatest to down, particularly considering we're selling through a lot of communities even faster than we expected. Many communities got delayed due to COVID. We are experiencing challenges in many cities, you know, getting our plans approved and getting through the entitlement process. But we have a huge, you know, for lack of another description, you know, rat moving through a snake here, you know, for next year where we got a big pipeline of communities coming online throughout 2021. And we should be at or pretty close to our goal You know, 300 communities open by the end of 21. And, you know, you can certainly do the math on that, what that means for, you know, our orders and deliveries.

Our guidance, obviously, for the remainder of the year builds in the declining to fly-ish community count for 2020. What quarter it's going to pop in 2021, I don't think we're prepared to give that guidance yet.

By the end of the year. Absolutely. I can't tell you quarter to quarter what it's going to look like. Okay, guys. Thank you. Thank you.

Our next question comes from Truman Patterson with Wells Fargo. Please say your question.

Hi, good morning, everyone, and thanks for taking my question. Great quarter. So first, you know, about the balance sheet and capital allocation, 20% net debt to total capital, almost $500 million of cash on hand. Just thinking about what you're going to do going forward, you know, is this purely to reinvest in the business and land and really grow the company? Are you looking to reduce debt further or possibly start a share repurchase program, M&A? Just trying to get your thoughts because you're in a pretty strong situation right now.

Strategy number one is to grow the business organically. Invest in more land, grow community accounts. and I see us deploying not all of our capital in that strategy. We don't have any plans to reduce our debt. We don't have any plans at the moment to buy our stock back. We've been pretty opportunistic about that. We did buy back a million shares early in the quarter. What's the average price on that?

It was around $60. About $60?

but we're not buying shares right now and I don't expect that we will be buying shares in the next quarter but you know as I said earlier we have 50 almost 50 potential community land deals for almost 50 potential communities that we've either approved or potentially going to improve this month that's not to even talk about what's on our plate for the next month and the months ahead for the remainder of the year so we have a really robust land pipeline and we're going to be directing our capital towards that.

Okay, thank you for that. And then also, I hopped on a few minutes late, so I apologize if you addressed this, but could you give an update on July order trends? I would imagine we're coming up on tougher comps year over year, so maybe there's some settling on the growth rate, but are the absolute units kind of in line with the June levels? And then any disparity recently among regions really in kind of June and July that we should know about, or have they been pretty much trending in line with what they did in 2Q?

You know, I wanted to give you a specific number on what I think June is going to be. We had quite a debate here before the call, but I got outvoted on that. I can tell you July is going to be very strong, very strong, and maybe not as much as June, but certainly in line with May.

Okay, on kind of an absolute basis?

on a percentage basis increase.

Okay. Okay. Gotcha. Fair enough. All right. Thank you all. Appreciate it. Okay. Thanks.

Our next question comes from Stephen King with Evercore ISI. Please do your question.

Yeah. Thanks very much, guys. Yeah. Exciting times. I wanted to see if I could ask a little bit about what you're seeing in terms of the ability to push price. I imagine This is something that you're managing on a community-by-community basis, and you've been obviously seeing the mortgage rates coming down. I'm curious about the ability to push price across both the entry level as well as some of your move-up product. Are you finding that the drop in rates is creating an opportunity for More on the pricing side than on the rampant sales. In other words, it's affecting price more than pace. Because I think some people have felt like maybe the lower rates is pulling forward demand or something like that. Whereas my view is that it would probably just allow you to price higher and that probably actually operates on a bit of a lag. Curious what your thoughts are with respect to that and if there's any difference between entry level and move up in that regard.

Our business model, like a few other large entry-level focus builders, is really driven by pace more than price. Leveraging our overhead is absolutely critical to our strategy. With that said, certainly in May we weren't pushing price in May because people were just coming back and we didn't really know how strong demand was going to be. We did start to push price more in June, but we probably left some dollars on the table. We could have done more on price, but then as we've gone into July, We've hit the price button a little harder, and our pushing price harder in July. But that said, we're still going to have robust order growth. We're probably not going to be as aggressive on price as other builders are, because we want to keep up that strong absorption level, that strong pace. But, you know, in Phoenix and many other markets that we're in, yeah, there's a lot of opportunity to probably get even more price. because it's a very, very strong demand market right now. Phillippe, I don't know if you want to add to that.

Yeah, I mean, we are getting price and pace right now because the market is so strong. As Steve said, we certainly focus on pace coming out of the shelter-in-place environment. We had a big deficit and we weren't sure what the market was doing. Thank you for joining us. I think the pandemic is increasing demand. I think all the things that we mentioned in our call is actually increasing the demand pull. Pull the buyers versus pulling it forward. We are seeing buyers that we hadn't seen before because they are currently looking for a new home and they were not looking for a new home. In fact, they were not planning on moving. Thank you for joining us.

and many more. Thank you for joining us.

compete with other entry-level builders that were not the lowest price. So these buyers are going to pay a little bit of a premium for a Meritage home because of the energy efficiency, because of the home automation, because of the extra design that you get. You get great values. You're going to pay a little bit more for our home than brand X or brand Y. But we have to be mindful of what that spread is. and to the extent that Brand X and Y are raising their prices, we'll be raising ours in line with theirs to maintain that appropriate premium. They'll get theirs and we'll get ours.

You had another question about 1MU, and we've seen pricing power in 1MU as well. There's been just as much pricing power. That 1MU buyer versus the entry-level buyer, sometimes they overlap, frankly, but there's been strong pricing power, everything under $400,000, really, if you look at kind of our global footprint.

Got it. And then just last one for me is, am I right in thinking that For your affordably minded buyer, the ability to come up with a down payment and having elevated levels of student debt have historically been two of the bigger impediments that your buyers had to get over. And if so, I'm curious as to whether or not you've seen those ease in part by virtue of the forbearance on student loans that got put in place with the CARES Act. that goes through September.

There's not necessarily a direct correlation that we've tracked in a survey, although we do see the ability to come up with a down payment for whatever the reason may be. Student loan forbearance being one of those. It's been easier to come up with a down payment, ironically, during this time. So that could certainly be one of the drivers.

A lot of them are coming from mom and dad. Great.

All right. Thanks a lot, guys. Thanks. Our next question comes from Michael Rehart with J.P. Morgan. Please state your question.

Thanks. Good morning, everyone, and congrats on the results again. First question, I wanted to hit on some of the comments around virtual and how it relates to the SG&A. We recently put out a survey, and one of the interesting Thank you for joining us. and all the investments you've put in. I'm curious how that might translate over time to your SG&A cost structure. If you kind of thought about this from a leveraging standpoint, the investments that you've put in place, if it could even impact your broker fees and such. Just any thoughts around there over the next couple of years in terms of how this might impact the SG&A side of the business would be interesting.

That's something we're thinking about every day, along with our competitors are thinking about that as well, how we reduce that cost. Only 44% of our customers came to our community with a realtor, even though our realtor co-broke is above 70%. but they were registered with realtors prior to their visit. Many of our customers are getting some real estate commissions back through the realtors, which I think is keeping that co-broke rate really high. But really, it starts with our website. The whole virtual selling process starts there. Our website traffic was up 82%. We're in the early innings of figuring out how we can squeeze that cost out of the SG&A. We have now for a couple of years been building less models. Most of our communities only have one model versus we used to have two or three or four in the old days. So we've been reducing that cost. We've been reducing the cost of how we furnish those models. We've been reducing the cost of our sales offices. So a lot of the hard costs that go into the marketing have changed, but we are having to spend more money on digital with the Googles and the Zillows of the world positioning us on the internet. It's an important part of our marketing plan. I hope that over an extended period of time, As some of the things we learned from the pandemic become part of the new normal that our marketing costs come down, but I don't think it's going to happen overnight.

Yeah, we're definitely early innings, Mike. I think that we're learning a lot of great lessons right now. For sure, we'll be able to harness some efficiencies in what we're seeing being accomplished virtually. Steve's right, there's an offset in higher technology spend, but it's A much smaller increase on the technology side versus the manual components or some of the processes and incremental marketing collateral that we were providing previously. So there's certainly a lot of opportunity for us, but like Steve said, this isn't a Q3, Q4 kind of an event. We're learning what works. We don't want to turn off the spigot to the sales machine, so we're treading cautiously, but you can expect some declines over the next year or so in that area.

that's helpful and obviously I think it's an area of opportunity over the next couple of years without a doubt I guess secondly maybe another kind of bigger picture question you guys have obviously had a tremendous amount of success with the Live Now and how you've kind of turned the company over in the last two, three years you're reiterating your community count outlook effectively or maybe slightly delayed but with the big plans for next year and obviously near term you're focused on managing through this current highly volatile backdrop but curious around taking a step back there are some parts of your geographic exposure that you could add to potentially over time Obviously, Las Vegas is very close, and I know you've had a lot of reservations, Steve, about that market in the past. But with Live Now, you would think that that could be very well-suited for that market. Also, even in the Pacific Northwest, where Seattle and Portland have hit affordability issues over time, you could argue that that's another market maybe that there could be some good traction. So how do you think of those markets, you know, bigger picture from a portfolio standpoint? And is this something that if you are thinking about it, you would be thinking about more from an organic standpoint or a acquisition, you know, bolt-on standpoint?

Good question, Mike. There are some new markets that we're working on entering on an organic basis. There's some in the West and there's some in the East. and maybe we can give you some more color on that on our next call in November, but we are working behind the scenes to formulate a strategy for us to organically enter some new markets in 2021. It's not part of our plan to get to 300 communities, but as we continue to grow our market share and all the markets that we're in, we realize that We'll have to add some new markets at some point, and we're going to do that primarily organically. If there's an M&A opportunity that comes about that is interesting, we certainly pursue it, but we can't wait for that, and we're going to be coming up with a plan to enter some new markets organically. So we'll tell you more about that next quarter. Great. Looking forward. Thanks again. Thanks.

Our next question comes from Adam Baumgarten with Credit Suisse. Please state your question.

Hey, good morning. Do you guys expect any labor savings over the balance of the years? You may have been able to renegotiate some contracts earlier in 2Q, and if so, would you expect that to revert given such strong demand in the industry right now? So, this is Fleet.

When the pandemic occurred, We were able to re-contract and get some meaningful savings that have played itself out in Q2 and potentially into Q3. Those contracts generally were set up to sunset after nine days because none of the trades wanted to commit to a long-term deal because no one knew really what was going on. We're seeing those sunset for the most part because demand is now up across the board. We got some cost and labor savings that should play itself out. It did play itself in Q2. It should play itself out in Q3. As we move into Q4 and Q5, we're probably back to our previous cost structure. I don't expect to see We're not seeing a lot of pressure on labor. Labor seems to be in a good place across most of our categories. Capacity seems good. I do expect to see cost pressure. I think you guys know lumber has reset at a pretty good high here. So we do expect to see some cost pressure in the back half of this year and we'll see how that kind of shakes out over the next six months. But I don't expect to see any savings going forward.

Adam, we quantified that the impact from those 90-day resets that Phillippe addressed were about 20 to 40 bits. And as he said, we don't really expect to see those continuing much beyond where we are right now.

Got it. Thanks. And then just second, are you seeing any meaningful land price appreciation just as competition may be increasing for these entry-level lots?

Yeah, I mean... The land market is always competitive when it's not a bad situation. I think we saw in April that a lot of builders stepped away from deals and took a pause on deals. Land prices didn't come down. Land prices are sticky. So as the market recovered in May and June, there wasn't a lot of people willing to negotiate off the original price, even with the pandemic backdrop. And as we're moving forward, especially in some of our hotter markets, Phoenix is one that you're seeing land prices go up. But again, we're really tight on our strategy. We're really tight on what works. We know what the right price of the land is, and we're staying disciplined on that. But certainly there is land pressure in some of these hot markets, and we're seeing builders compete for finished lots, even in the secondary markets and tertiary markets. So certainly seeing land prices increase in the hotter markets.

Got it. Thank you.

Our next question comes from Jade Romani with KBW. Please state your question.

Yes, thank you very much. Do you have any statistics you might be able to share regarding the percentage of demand currently being driven by move-outs from multifamily?

No, we don't track that. I mean, we do track that... People moving for rentals, but we don't distinguish if it's from a single-family rental or a multi-family rental. What is that number? Do we have that?

It's about 50%? We have it. I'm sorry, we don't have that number in front of us. We can get that back to you. But we do track, like Steve said, whether you're moving from an owner-occupied versus a for-rent situation. So we can get you that number, but we don't break out whether it's a multi-family rental versus a single-family rental.

Okay, thank you very much. Even within the rental market, just given the distribution of units, I would expect the majority is from multifamily of move-outs from those rentals. Also, if you could quantify what the average household size of Meritage's typical homebuyer is, are these families with children or are they in the first-time homebuyer bucket, perhaps in relationships but not yet at the children stage?

Yeah, we tracked that as well. It's pretty granular, but I think it was like 3.2.

Yeah. You know, so, you know, I think half our buyers are traditional families and the other half are either young adults planning to have a family or working at a family or mature couples, you know, that have already had their families and the kids have moved on.

Thanks for taking the questions.

Thank you.

Our next question comes from Carl Reichart with BTIG. Please say your question.

Thanks, everybody. I wanted to ask about lot supply, year-in-year supply. Obviously, it's a backward-looking number at 4.2. Is that kind of where you guys are comfortable, and is the 60-40 split-owned option, is that sort of the target where you want to be, or over the next couple of three years, do you think you could move that year supply up? Are you interested in that or that option-owned mix? Would that change in any way?

We've historically operated in that four- to five-year band. I think it's our intention to probably stay in there. We are focused on IRRs and continuing to improve our return on equity. So although we want to get larger communities Thank you for joining us today. and it's not as easy as it may sound to convert from an own strategy to an option strategy. It's not like it was in the last cycle. Cost is pretty high in this cycle. And so I don't expect it to change very much from really where it is today.

Yeah, just to say, I think Steve hit the nail on the head. The availability of liquidity that we have, we're not really willing to pay up to have option B or land B optioned off balance sheet. Having said that, the 40% is the highest it's been in quite a while. If you look at the last eight to 10 quarters, we're very slowly inching up as we're finding deal structures that aren't necessarily land banked off book, but deal structures that work with existing sellers to allow us to leverage cash a little better.

If you're self-developing out in the excerpts, I'm guessing you can turn those lots faster anyway, so that makes sense. I also just wanted to ask a little about Studio M and the first-time move-up side, which had some good absorptions. Can you just give me an update on how Studio M has rolled out and maybe talk a little bit about the margin profile of that business relative to entry level? Thanks, guys.

Yeah, I'll take the rollout and then Hilla will talk about the margins. But it's effectively rolled out everywhere. That was kind of a last year initiative. So we had a couple stragglers that came into this year. But we are now effectively rolled out across our entire footprint. We have pretty much our entire backlog is moving. We don't have any sort of tail backlog that's on the old process, even in the markets that were the last ones to convert. So we're effectively rolled out across the company, and it's a highly successful program, and Hilla can comment on the margins.

Yeah, I think we've said previously that the margins on entry level are our strongest margins in the company. First time move up is strengthened. The margin there has strengthened with the rollout of studio items. Obviously, we're able to leverage cost. and Efficiency a little bit better. So we're actually seeing those improve as well. There's still a little bit of a differential with entry level just a little bit ahead, but they're pretty much in line with one another.

Thanks, Hilla. Thanks, everybody.

Thanks.

Mr. Hilton, we're just about at the bottom of the hour. Do we have time to take another question or two or would you like to conclude?

Let's do one more question.

Okay. Our final question comes from Alex Barron with Housing Research Center. Please state your question.

Hey guys, thanks for squeezing me in and great job on the quarter. I wanted to ask, is there any physical constraints or any reason why if there are the buyers there ready to buy, why you couldn't do another 1,500 days? In other words, is there a labor constraint? Is there a land, you know, finished lot constraint? Anything like that that would prevent you from continuing at that pace assuming the buyers were there?

I'm going to repeat your question because you were cutting out just a little bit. I think your question was, is there any constraint where we couldn't deliver another 1,500 lots of sales and clothing, any labor or material constraints that would block us from that level of performance? The quick answer is no, but I'll let Philippe or Steve expand on it.

I mean, the only constraint... We have right now is our community count. We have a declining community count. We're selling out of things faster than we previously thought. And so we continue to drive higher absorptions on a sort of declining community count over the next couple of quarters. As far as having the homes, being able to start the homes, the capacity in the labor market to build those homes, there's nothing preventing us from doing that. It's really about can we get the volume out of the community, the community count that we have as we sort of go through the next couple quarters.

Okay, great. And when you said that you're starting 1,000 specs, I'm assuming that that wasn't including, that was only the specs.

In other words, if you're doing 1,500 sales and you're starting 1,000 specs, that kind of implies you would be starting 500 built-to-order homes. Is that correct?

Yeah, not quite that many, but close. Our starts have been a little behind our sales the last couple months because the sales were more than we expected. But as we get into July and August, we're going to get back on track to match up those numbers more closely. But that has been a bit of a challenge.

But you're correct. This album is fat stars. Not all sales.

Some of them are dirt, obviously. Thanks, Alex. I'm sorry we didn't get you on sooner. Operator, I think we're going to take one more question. We have one more out there. Operator? Yes.

Our next question comes from Susan McLaurie. Please go ahead with your question.

Thank you. Thanks for squeezing me in. I guess, you know, first question is just, you touched a little bit on the M&A environment earlier, but can you talk a little more about what you're seeing out there in terms of opportunities to, you know, maybe pick up some land deals or some smaller privates? Has anything changed over the last couple of months?

Only if you promise to write something nice about us.

I will. We wrote something nice about you last night.

Okay. No, you know, there hasn't been a lot changed on the M&A front. We just haven't seen anything that's that compelling. I don't think COVID scared a bunch of builders into selling their companies. Actually, one of the titans of M&A just passed away a few weeks ago, Mike Kahn, who did many deals with the company in the early stages in the 1990s and 2000s. He was an icon. You know, in that segment of the industry, we mourn his passing. But yeah, there hasn't been a lot of M&A activity that we've seen. And certainly, we're going to be more picky with how it fits with our business strategy.

but we were able to be opportunistic on some dropped land deals from other builders in the COVID environment. We actually picked up enough land deals from other builders and resurrected our own land deal that we initially dropped to end up net positive on land deals that we dropped and then picked up from COVID in addition to our regular pipeline of community activity.

Yeah, in the early stages of the pandemic, we parted ways with the land deals that we had approved that we liked the least, that we felt like had the biggest risk. And then we went out and saw a lot of deals that others had that we liked that we grabbed. Yeah.

Okay, all right, that's helpful. And then, you know, on the mortgage market side, obviously, you know, it seems like things there remain accommodative to buyers. Is there anything that you've seen that's really changed over the quarter or anything that could change your ability to qualify people looking out?

No, I think we're going to be sharing the analyst slides right here after the call. You'll see the historical trends are DPI, the company, still at low 38. And, you know, no real changes for us. Everything's still humming along.

It's like surprisingly, like, just no change. I mean, you would expect to see some type of change. There's just zero change.

Yeah. All right. All right. That sounds good. Thanks. Good luck with everything.

Thanks, Susan. That wraps up our presentation today and our Q&A. We thank you for participating in Meredith's Home Second Quarter Call, and we'll look forward to talking to you again in late October. Thank you.

Thank you. Home Parties May Disconnect. Have a great day.