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spk06: Greetings and welcome to the Meritage Homes fourth quarter 2022 analyst call. At this time, all participants are on a listen-only mode. A brief 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, Ms. Emily Tadano, Vice President of Investor Relations and ESG. Thank you. Please go ahead.
spk00: Thank you, operator. Good morning and welcome to our analyst call to discuss our fourth quarter and full year 2022 results. We issued the press release yesterday after the market closed. You can find it along with the slides we'll refer to during this call on our website at investors.meritagehomes.com or by selecting the investor relations link at the bottom of our homepage. Please refer to slide 2, cautioning you that our statements during this call, as well as in the earnings release and accompanying slides, contain forward-looking statements. Those and any other projections represent the current opinions of management, which are subject to change at any time and we assume no obligation to update them. Any forward-looking statements are inherently uncertain. Our actual results may be materially different than our expectations due to a wide variety of risk factors, which we have identified and listed on this slide, as well as in our earnings release and most recent filings with the Securities and Exchange Commission, specifically our 2021 annual report on Form 10-K and subsequent quarterly reports on Form 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 GAAP measures. With us today to discuss our results are Steve Hilton, Executive Chairman, Philippe Lord, CEO, and Gilles Ferruza, Executive Vice President and CFO of Meritage Homes. We expect today's call to last about an hour. A replay will be available on our website within approximately two hours after we conclude the call and will remain active until February 16th. I'll now turn it over to Mr. Hilton. Steve?
spk07: Thank you, Emily. Good morning. Welcome to everyone participating in our call this morning. I'll start with a brief discussion about what we are seeing in the market and provide an overview of our recent company milestones. Philippe will cover our strategy and quarterly performance. Hila will provide a financial overview of the fourth quarter and forward-looking guidance. Q4 marked a strong finish to a year of exceptional execution and dedication from the Meredith team. We delivered 29% more homes this quarter and generated $2 billion in home closing revenue in the fourth quarter, which was 32% higher than the fourth quarter of 21. Our home closing gross margin of 25.2% and quarterly SG&A leverage of 8.4% led to our quarterly diluted EPS of $7.09. Although favorable demographics and the low supply of housing inventory should drive long-term demand, We believe they were overshadowed in the back half of the year by ongoing economic uncertainty and buyer psychology, increasing mortgage interest rates and inflation. With home buyers on the fence about when to get back into the market, our fourth quarter sales orders declined 46% year over year, driven by a cancellation rate of 39%. Today's higher mortgage interest rates continue to pressure housing prices as monthly payments still remain above 2020 and 2021 levels, despite price cuts and rate locks. We believe that until rates stabilize, home sales activity will remain choppy. We see some potential buyers who could qualify but are waiting for further price declines as they anticipate additional builder incentives are coming. Other current buyers with rate locks in place Our below current market mortgage rates were canceling due to the buyer hesitancy, as they may have been nervous about the general economy or their own financial positions. However, given our available inventory, we are seeing some buyers read into the market and respond favorably to our quick movement selection, as well as our incentives and company-wide sales initiatives. Now on to slide four. As a team that embodies our start with heart core value, Meritage employees donated countless hours to deliver three mortgage-free homes to deserving military veterans and their families on Veterans Day in Houston, Nashville, and Tucson. This is one of the most impactful annual initiatives that the entire organization looks forward to, and we were excited and humbled to continue that tradition in 2022. We also expanded our long-term history of contributing to local nonprofit organizations to further our diversity, equity, and inclusion mission, as well as volunteered time and donated financial support to organizations combating food insecurity across the country and providing shelter to those in need. This quarter, Meritage was recognized by the Phoenix Business Journal both as one of the best places to work and one of the healthiest employers. And as a result of our overall commitment to ESG, Meredith was named one of the 2023 America's Most Responsible Companies by Newsweek Magazine. Overall, we are proud of what our team members accomplished this quarter on top of the quarter of solid operational execution. I'll now turn it over to Philippe.
spk05: Thank you, Steve.
spk09: During the quarter and looking into 2023, we are analyzing the business through the lens of market events and actions that are within our control. We could not influence the macroeconomic factors impacting Q4 sales that Steve described. However, we can control how we react to them and how agile our business can be by focusing on our core strategies that we have honed for many years now. To reiterate our strategies and the actions we have taken, we remain committed to pre-starting 100% of our entry-level homes. This readily available home inventory puts us in a favorable position since buyers in the current market want homes that are ready to close within 45 to 60 days. Eliminating uncertainty and reducing stress are a premium in today's murky economic environment. Further, line building allows us to complete homes on a shorter cycle time than a built-to-order model, despite supply chain issues. Pre-starting homes with a limited SKU library means we can also offer more affordable products as we pass on our savings to our customers. As an added benefit, when we have canceled inventory, the lack of customization in our homes stemming from our streamlined interior specifications results in limited discounting for the future resell of that home. Since we mainly build entry-level products, we expect a higher average absorption pace and prioritize pace over price. Like all home builders, we benefited from the run-up in home prices for the first two years of COVID, and despite higher costs, we experienced industry-leading gross margin levels. More importantly, we increased our market share. Consistent with our strategy, we continue to target three to four net sales per month. As we had a net orders absorption pace of 2.2 per month in Q4, we have taken additional actions to get back on our target, including lowering prices and utilizing a full range of incentives, such as mortgage rate loss, rate buy-downs, until we find the market clearing point to move our inventory and get back to our target sales pace. The timing of these actions aligned with the production timeline of our spec inventory, which is now completed or near completed and ready for quick move-in sale ahead of the spring selling season. Further, during Q4, our operations team worked hard to close a large portion of our backlog, despite supply chain issues impacting cycle times. We also aggressively validated every home that remained in our backlog as of year end. Most confirmed their commitment to their homes. Some needed incremental pricing or rate adjustments that we were able to offer. In other cases, though, we had to cancel the sale if it was clear the buyer was not going to purchase the home with a reasonable incentive structure. By proactively scrubbing our backlog, we likely identified some cancellations early in the cycle than normal, but this gave us more confidence in our backlog at the end of 2022 and added available inventory for sales by the end of January. While we certainly don't have a crystal ball regarding what cancellations rates will do in 2023, we are comfortable that the buyers who purchased homes in earlier March 2022 under a different market and economic environment represent a smaller portion of today's backlog compared to a greater portion coming from buyers that have a more fulsome understanding of the current market conditions, their monthly payment expectations, and the relative advantage of their rates and pricing incentives. In addition to our sales initiatives, our purchasing team is actively rebidding our vertical costs to capture cost savings as incremental capacity is growing within our supply chain. Hiva will touch on more details, but suffice to say, we are pursuing cost savings across all cost categories in all of our markets this year. These intentional actions enable us to adjust pricing and incentive structures community by community so that we can take advantage of our supply of available inventory as we kick off 2023. we believe we have the right level of completed and near-completed homes to sell, which combined with a different mix of pricing actions, financing solutions, and incentives allows us to offer a total package that is aligned with each local market environment. Now turning to slide five to share operational statistics. The 29% year-over-year increase in our Q4 closings to 4,540 homes was attributed to our team successfully managing the persistent labor and supply chain challenges. Entry-level homes made up 85% of closings, up from 81% in the prior year. Our fourth quarter 2022 sales orders of 1,808 homes were comprised of 89% entry-level homes, up from 82% in the fourth quarter last year. The 46% decline in sales orders year-over-year was primarily due to elevated cancellations and weaker overall demand, despite a 10% year-over-year increase in average commutes. A cancellation rate in Q4 of 39% increased from 12% in Q4 2021 and 30% in Q3 2022. Quarterly growth sale orders declined a more modest 22% year-over-year. Our fourth quarter 2022 average absorption pace was 2.2 per month, which was down from 4.5 per month in the fourth quarter of 2021. But growth sales pace was 3.6 per month, at our three to four monthly target, affirming that underlying consumer demand is indeed present. In finding the right pace to price relationship, we expect our average absorption pace will get back to our target of three to four net sales per month during 2023. Moving to the regional level trends on slide six. The highest regional absorption pace of 2.6 per month in the fourth quarter occurred in our central region, which is comprised of our Texas markets. Orders were down 46% year-over-year in Texas overall. With all four Texas markets holding a growth sales pace greater than 3.0 per month, we believe we are starting to find stability in Houston, Austin, and San Antonio, while in Dallas we are experiencing a steadier environment and are gaining market share. The fourth quarter regional absorption pace for the East region was 2.5 per month. We still have work to do here, but all of our eastern markets actually had a growth sales pace in line with our three to four per month per target, and we are confident that we are well positioned in this part of the country. The east had the lowest regional decline in orders at 41% year-over-year and the lowest cancellation rate in the fourth quarter. In Florida, ASPs on orders were up 11% due to product mix shifts even after our price adjustments, while orders were down to 25% reduction in average communities. Consumer pullback was most evident in the West region, where the absorption pace was 1.6 per month for the fourth quarter. California was the only state to have an increase in orders year-over-year, which was primarily the result of more communities. California also had a growth sales pace over three per month, given the quality of our locations and our entry-level positioning in the market. Colorado and Arizona continue to experience buyer hesitancy to transact as they adjust to the higher monthly payments in these markets that experience a higher run-up in ASPs over the past two years. Further, cycle times in these two markets are still some of the longest and least predictable, although the new incremental capacity showing up in the supply chain now is providing a runway for improvement here. We wanted to provide some color into January sales. As we know, that's top of mind for everybody on today's call. Compared to the average absorption pace of 2.2 per month in Q4, we saw a notable improvement in January, achieving a net absorption pace greater than 4.0 per month per community, as well as a more normalized cancellation rate in the mid-teens. We sold over 1,200 houses in January, up approximately 4% over last January. We have some initial confidence that we found the right combination of pricing incentives to sell at our targeted three to four net sales per month. Now turning to slide 7. To align starts with slower demand, we further moderated construction this quarter, starting approximately 2,100 homes in the fourth quarter compared to approximately 2,700 in Q3 2022 and more than 3,700 in the fourth quarter of 2021. We ended the period with nearly 4,900 spec homes in inventory or an average of 18 per community as compared to approximately 3,200 specs or an average of 12.3 in the fourth quarter of 2021. Market demand dictates our target amount of available inventory in each of our communities. Our goal is to keep four to six months supply of specs on the ground by managing our startups to match our sales pace and production capabilities. Although excess cancellations increased our specs slightly above our target rate this quarter. To align with the additional supply of inventory on hand, we will flex and slow down our starts until we reach our optimal equilibrium. But as noted, we have already worked through about 25% of these specs in January. Similar to last year, 79% of our homes closing this quarter came from previously started inventory. At December 31st, 2022, we had over 750 complete homes to sell. Our 15% completed homes is higher than the last couple quarters, and coupled with our homes that can close by the end of Q1, represent about one-third of our spec inventory. We ended the fourth quarter with a backlog of 3,300 units, as we closed out a significant portion of our backlog and improved our conversion rate from 60% last year to 75% this year. Q4 cycle times continue to be similar to the earliest record of 2022, which were still approximately six to eight weeks longer than our pre-COVID averages. However, we are targeting aggressive reductions in construction time for 2023 and are already starting to see some improvements from our front-end trades. We are hopeful that with the industry backlog clearing over the next few quarters and the capacity of back-end trades like appliances, flooring, countertops, and cabinets loosening, our cycle times and backlog conversion rates will improve in the back half of this year. I'm now going to turn it over to Hila to provide additional analysis on our financial results. Dila?
spk04: Thank you, Philippe. Like last quarter, we'll start by providing a bit of color on our BFR business before reviewing the financials in detail. Sales through our bill for rent partners in the fourth quarter only represented a low single-digit percentage of our net orders volume as the rental operators, much like the rest of the sector, are pausing to analyze their financial hurdles and adjust underwriting targets. We're encouraged to see some incremental interest in January and continue to believe in the viability of this channel due to the historical counter-cyclical strength of rental markets and higher interest rate environments. Now let's turn to slide 8 and cover our Q4 financial results in more detail. Home closing revenue grew 32% year-over-year to $2.0 billion in the fourth quarter of 2022, combining 29% greater home closing volume and 3% higher ASPs when compared to prior year as we overcame supply chain challenges to close a substantial portion of our backlog. Our fourth quarter 2022 home closing gross margin was 25.2%. The 380 BIP deterioration from 29.0% a year ago was the result of greater incentives and higher direct costs, as well as several non-recurring items, including $10.9 million in warranty adjustment related to two specific cases, and 4.2 million in write-offs for option deposits and due diligence costs for terminated land deals, which were partially offset by 5.4 million in retroactive vendor rebates. In the fourth quarter of 2021, we had 2.5 million in write-offs for terminated land deals and no warranty or rebate adjustments. Excluding these non-recurring items, adjusted fourth quarter 2022 home closing margin was 25.7% compared to 29.2% in Q4 of 2021. We expect that price concessions, elevated discounts, and a continuation of financing incentives for rate locks and buy-downs will negatively impact gross margins in 2023. However, with our sales ASP down 10% to $389,000 this quarter when compared to last year, we have already taken material pricing action, demonstrating our commitment to elevating our sales pace. And although we're not projecting broad-based cost savings to offset the challenging market conditions today, we are starting to make some headway to reduce direct costs and improve cycle time. There are full company initiatives to drive substantial cost reductions, with success stories of $15,000 per home in savings just since Q3 already emerging in some divisions. particularly in our slower markets where trades have excess capacity. However, we likely won't benefit from the full impact of these savings until the tail end of 2023 and into 2024, as they won't be captured in our home starts until mid to late this year. We still believe that long-term, our normalized gross margins will benefit from better operating leverage from our increased volume and our streamlined operation, and we'll end up at or above 200 bps from our historical average of 20%, although the next several quarters are likely to be bumpy. SG&A as a percentage of home closing revenue was 8.4% for the current quarter, which was a slight improvement over 8.5% in the prior year. Our higher revenue allowed us to better leverage our SG&A. This was partially offset by higher commissions and advertising costs that reflect our response to the current sales environment. We believe marketing costs and broker commissions will remain above historical averages in the near future, which combined with lower expected closing volume in 2023 will drive lower SG&A leverage. The fourth quarter 2022's effective income tax rate was 23.3% compared to 23.8% in the prior year. Tax credits were earned on qualifying energy efficient homes under both the 2022 Inflation Reduction Act for the current quarter and the 2019 Taxpayer Certainty and Disaster Tax Relief Act for the prior year. Overall, higher home closing volume combined with a lower outstanding share count in the current quarter led to a 13% year-over-year increase in fourth quarter 2022 diluted EPS to $7.09. To highlight a few full-year 2022 results, on a year-over-year basis, order units declined 15%, closings were up 10%, We had an 80 BIP expansion of our home closing gross margin to 28.6% in fiscal 2022, and SG&A as a percentage of home closing revenue improved 90 BIPs to 8.3%. We generated a 35% increase in net earnings, and diluted EPS was a record $26.74 for the year, a 39% increase from 2021. Turning to page nine. Given slower market conditions, we are also focused on exercising balance sheet discipline. We reduce spend on land, development, and home inventory, ending the year with over $860 million in cash and generating $562 million of free cash flow just this quarter. At December 31, 2022, nothing was drawn on our credit facility, and our net debt-to-cap was just 6.8%, which is well below our maximum internal threshold of high 20s. With no shares repurchased during the quarter, we ended 2022 with $244 million available under our authorized share repurchase program. Ahead of the spring selling season, we felt it was prudent to grow our cash position to maintain maximum flexibility in this uncertain environment. In the coming months, we will look to strike a balance between cash preservation for operations and returning dollars to shareholders, and we expect to provide additional updates on our next quarterly call. Shifting gears, I want to remind everyone about how impairments are calculated. When we estimate that the cash to be generated from the sale of homes in a community is not expected to cover the cost we will incur in that community, an impairment is present. We review all of our assets every quarter and determine that there were no impaired communities in Q4 despite the reduced ASPs and higher direct costs. Looking at our expected home prices in 2023, we do not expect broad-based impairments across our assets. On to slide 10. Even with the increased liquidity this year, we grew our community count 5% in 2022 to 271 communities at year end. In Q4, we opened 21 new communities compared to 11 in Q3 this year. The ongoing supply chain issues and lack of transformers continue to extend the timeline for our new community opening. Additionally, we have strategically slowed and at times halted some of our openings to take advantage of the opportunity to re-bid and lower our vertical costs so that these communities can open in a more competitive position when they come online. We expect to continue to open new stores throughout the year and return to our 300 community target over the next several quarters. This quarter, we continue to right-size our land portfolio, walking away from underperforming land deals or recently sourced deals where we could not secure closing extensions. Even with slightly more than 10,000 terminated lots this year, we still ended 2022 with 4.5 year supply of lots within our target of four to five years. So we're comfortable that we have all the land we need right now. In Q4, we did not add any new lots under control while we terminated roughly 3,700 lots with a corresponding write-off of $4.2 million. These terminated lots relate to approximately $280 million of future land and development spend that we will not be incurring. For full year 2022, after considering $15.8 million of walkaway charges from terminated land deals, we only have $92.5 million of incremental exposure related to deposits and due diligence for future lots under control, which includes next phases of our existing communities. All in, this makes up less than 2% of our total assets. During the fourth quarter, we spent only $351 million on land acquisition and development, bringing our full-year total spend to $1.5 billion. With reduced land acquisitions, about two-thirds of the spend was on land development costs. We expect our 2023 land acquisition and development spend to be at or below the $1.5 billion expended in 2022, despite the anticipated community count growth. At December 31, 2022, we had approximately 63,000 total loss under control compared to approximately 75,000 total loss at December 31, 2021. About 73% of our total lot inventory at December 31st, 2022 was owned, and 27% was optioned, as the terminations of option loss, understandably, drove the mix of controlled but not owned loss lower. In the prior year, we had a 65% owned inventory and a 35% option lot position. With just under 50% of our current portfolio, Sourced from land secured in 2022 or earlier, we are comfortable with the basis of the land control as well as the balance of owned and option lots. Finally, turning to slide 11, looking to Q1, we expect closings to be between 22 and 2,600 units with corresponding revenue of 940 million to 1.1 billion. We expect margins to trend down to 21 to 22% and our tax rates to be around 22 to 23%. With limited visibility and market conditions, we're holding off on providing full year guidance at this time. With that, I'll turn it back over to Philippe.
spk09: Thank you, Hila. To summarize on slide 12, January is off to a great start, but it's too early to quantify the strength of spring selling season. We are prepared to find the right combination of product, price, and incentives for all of our communities to achieve a pace of three to four net sales per month. Our commitment to pre-starting 100% of ranch-level homes, streamline operations, and prioritizing pace over price positions us to capture market share, gain leverage, and maximize profitability as market conditions evolve. In conclusion, I would like to thank all marriage employees for their hard work and a job well done in 2022. Their dedication drove our success. And with that, I will now turn the call over to the operator for instructions on the Q&A. Operator?
spk06: Thank you. Ladies and gentlemen, the floor is now open for questions. If you would like the opportunity 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 the handset before pressing the star keys. In the interest of time, we do ask that you please limit yourself to one question and one follow-up. Again, that is star 1 to register a question at this time. The first question today is coming from Truman Patterson of Wolf Research. Please go ahead.
spk13: Hey, good morning, everyone. Thanks for taking my questions. First, just making sure I heard this correctly. Did you all say previously that January net orders were about 1,200 and up 4% year over year?
spk09: Yeah, we have sold about approximately 1,200 houses annually. In January, a little bit over 1,200, which over last January was up about 4%. And then our absorption pace per store was right around 4.5 per sales per community.
spk13: Okay, okay, perfect. Thank you. And I realize not reading too much into, you know, January trends. But, you know, we have lower lumber costs beginning to flow through the P&L market. You all mentioned perhaps some other stick and brick costs maybe hitting later in the year. We also have some higher land costs and maybe an uncertain pricing or incentive environment that maybe you all have found the floor. But I'm hoping, can you help us think through 1Q gross margins if you all think that might be kind of the floor for the year? Or should we still expect it to be pretty choppy?
spk09: I'll let Gila dive into a more detailed description of what's going on in Q1. But, I mean, it's just really too murky right now to know what pricing is going to do. Obviously, we've been aggressive. We're an affordable spec builder, so we're going to price ourselves in the bottom two tiles of our competitive set, community by community, which is what we've done, which is why our prices... Our ASPs are down now into the 300s from 480 at the peak. So we feel like we've made some really significant adjustments to be affordable and to find the pace that we need to and feel like we're well positioned for the long term. But it's hard to tell what our competitors are going to do. Some builders still have quite a bit of backlog that they're going to close out and I don't think they've adjusted pricing yet. So we'll have to wait and see how that plays out and we certainly don't know what interest rates are going to do. We're happy to see them stabilize where they are and feel optimistic about that. But those two factors are really driving our inability to predict pricing at this point. And then I'll let Hila share kind of how we got to our Q1 margin guidance.
spk04: Yeah, so thank you for our Q1 is primarily what we saw inactivity over the last 4 or 5 months. It's the ASP that you're seeing in our sales. As we mentioned, we had fairly decent growth sales. It's really the scrubbing of the backlog and the cancellation that brought the net sales down in Q4. So we think we found the market. for three to four net sales per month, January definitely proves it. So right now, we're not comfortable giving guidance beyond Q1, but what we're seeing in Q1 reflects the current sales environment. It does not reflect anything yet in the direct cost However, as we said, we don't think that those margins are really going to materialize until the latter part of the year, and that's assuming that there's no other increases that are coming our way. So kind of looking at where we are, we're comfortable at our current pricing structure. We're down almost 20% from the peak, and we're able to sell at an acceptable pace, so we don't feel like we need to move any further at this time, although we're constantly adjusting with market conditions.
spk13: Perfect. Thank you for that. And you all clearly have streamlined business model, generally with fewer vendor SKUs and floor plans than competitors. I'm hoping we'll leave lumber alone. It's clearly down a lot year over year. It's jumped up here pretty quickly so far in January. But I'm hoping you can help us maybe quantify the magnitude of potential cost tailwinds that you're experiencing as of today's starts outside of lumber. Any chance you can help us think through those?
spk09: Well, we're going through an entire rebidding effort right now. As Hila mentioned, We're aggressively rebidding all of our communities for spring starts. We also have been holding off on opening some new communities to really rebid those to get our vertical costs as far as we can. So it's way too early to let you know exactly what that's going to look like. But as we said in our script, we're having success on the front end and less success on the back end as it relates to the build. So we've seen in some of the hardest hit markets that we've recovered over $15,000 per house, which on a $200,000 construction budget, you can do the math. In other markets like Florida, we haven't seen that because the market's still pretty stable. Starts are still going out pretty fast and we haven't seen that opportunity. But that's all we're prepared to say right now because we literally are going through this effort right now. But the early feedback from our vendors is that there's opportunity here, and we're going to capture everything we can, and we'll report back to you next quarter on how we did.
spk13: Perfect. Thank you all, and good luck in the upcoming quarter.
spk01: Thank you.
spk06: The next question is coming from Stephen Kim of Evercore ISI. Please go ahead.
spk11: Yeah. Thanks very much guys. Exciting times. Appreciate all the color and particularly the commentary on January really dovetails with what I've been hearing. You know, a lot of excitement out there, but everyone seems extremely cautious about predicting the sustainability of the rebound. So with regard to that, you know, obviously the sales that were extremely good, you were over your three to four order per month pace in January. And so the market clearly has done kind of an about face. And I'm wondering if you're beginning to ratchet down incentives at the community level or taking other actions which would effectively mean that you're raising your net price.
spk09: Yeah. So at the end of the day, you know, we're going to try to get four net sales per store. That's how we built our business, and we're going to try to get a 21% to 22% margin at that pace. And we built everything from that point of view. So we went out there, we had some additional inventory, and I'm optimistic that having that inventory really is why our sales rebounded in January. We're not sure the market, frankly, is any better other than the fact that it's the spring and not the winter, and interest rates have somewhat stabilized. From our perspective, it's about having move-in ready inventory, which we have. That's what consumers want. And that's why we feel like we saw the January result. In a number of communities where we've made adjustments, we did see very strong elasticity in demand when we lowered prices and we were able to achieve even above our four net sales. So in those communities, we're pulling back on incentives where we think that's sustainable and we'll back off on rate buy downs. We don't have to use rate buy downs nearly as much as we did now that we're selling all specs. People can move in relatively quickly, and we can drive those costs down. So it's community by community, but it's one month, and we're going to go take market share right now. We're going to be aggressive. If we can do more than four a month at today's margins, we'll probably take more than four a month at today's margin. It's a spring selling season, and we want to go get this market share while other builders don't have the spec homes to go get it. So we'll pull back a little bit where it makes sense, but for the most part, we're comfortable where our margins are, and we're going to go try to sell more houses.
spk11: Yeah, that makes a lot of sense. Your commentary, though, about community count and your rollout of those communities would seem to be a bit at odds, though, with running hotter than four a month. So correct me if I'm wrong. If this demand actually proves to be deeper and broader than anyone's really willing to bet on yet, do you have the ability to do an about face on your community count openings or community openings so that you can maintain a positive year-over-year community count over the course of the year?
spk09: We can always accelerate opening our community. The demand is really strong. I think we don't feel that that's prudent today. So it would have to be really strong for us to make the decision to do that right now. we're seeing some meaningful opportunity to lower our vertical costs on those new openings. And I think that's probably more critical for the long-term success of the community than opening it up early and getting positive community comps. Because we have these big investments we made and we don't want to compromise the integrity of those communities by opening them up at high vertical costs that don't underwrite. So that's number one. Number two is It's still not getting any easier to open these communities, get the municipality municipal approval, get transformers to the job site. And frankly, get finished inventory so that when we open up a community, we have ready to move, move in ready inventory and every single one of the community. So that that's driving the decision is the operational discipline there. And I don't think we're going to compromise that just to hit our to accelerate community count this year. It's more about opening up those communities with strong momentum, opening them up clean, well executed, opening up with standing inventory, ready to move in and opening up with the best vertical cost structure we can.
spk04: So just to clarify, Stephen, the 300 community count target that we said we're going to hit in a couple quarters, that already takes in the rebidding process. So as we said, it's going to take us a couple quarters to get through the full rebid. We said we're not going to have those home starts until the latter part of this year, which exactly aligns with our community count opening target that we just provided. Opening a community without inventory doesn't really work. As we said, the volume that we're seeing is because we have available specs and putting a whole bunch of specs in the ground at an inflated cost when you know it's coming down in just a couple quarters doesn't seem to be the right decision. So we're willing to be patient to make sure we drive at an accelerated pace while not sacrificing what sales price we can set the target at and just have those sales in the back half of the year instead of more anemic at a lower margin pace in the front end of the year. And just one last comment.
spk09: The cancellations in Q4 were all part of the issue with people opening up communities without production. And then you're hoping to hold on to your buyer for nine months. And that just doesn't make any sense when we don't know what interest rates are going to do. So we want to open up with move-in ready inventory. Customers are willing to... Engage with something that moves in 30, 60, 90 days, they can lock their rate. And I think it minimizes your cancellation exposure. So we've got our cancellations down to where we want them now. And we're going to run our business to make sure we keep those cancellation rates low. Assuming that interest rates will continue to remain volatile.
spk11: Yeah, so that's interesting, Philippe, because I think that you mentioned that you'd like to see rates stabilize. And what you just said is that we've seen a lot of volatility in the mortgage rate, which we certainly have. And so I'm curious, you sort of suggested that buyers need to see some rate stability, but I'm curious if that's really true. For instance, if we were to see the mortgage rate drop into the fives, which it certainly seems is possible here, in the relatively short term. Do you not think that that might represent an additional boost to homebuyer sentiment as that starts to make the headlines?
spk09: I mean, you're clearly not asking me a trick question. If rates are lower, there's more demand. It's an absolutely one-to-one relationship. So, yeah, if rates go to five, we're going to see stronger demand. But We're going to stay with our operational discipline of selling move-in ready specs. It's about our supply chain. It's about our cost structure. And it's about not knowing what the future holds. We could see a great, a strong spring selling season, but rates could go up in the back half of the year. The Fed, you know, made their speech yesterday. They certainly didn't say they were going to lower them. So, you know, we don't know yet. And we're going to focus on operating the way we think is in the best interest of our company.
spk06: Thank you. Once again, ladies and gentlemen, we ask that you two please limit yourself to one question and one follow-up to allow as many people the opportunity to ask a question today. The next question is coming from Alan Ratner of Zellman & Associates. Please go ahead.
spk10: Hey, guys. Good morning. Thanks, as always, for all the great info. First, on the pricing side, Hila, you brought up average order price down 20% over the last couple of quarters, which is obviously significant. way more than the market is down and, uh, certainly way, way more than your peers are. And it sounds like maybe some of that is you guys being more aggressive, but I would imagine there's a decent amount of mix in there as well. So I'm just curious if you're able to kind of parse that out for us, because I do recall a couple of quarters ago when you were kind of given the impairment, uh, sensitivity, I think you said, like, you know, home prices would need to drop 20% for there to be any, you know, meaningful impairment risk. And now you're saying there's obviously not a ton of risk out there, which makes a lot of sense given the current market. I'm just curious if you could kind of drill into that a little bit.
spk09: I'll let you unpack the impairment question. But I would just tell you, it's not a lot of mix. It's mostly just price. We absolutely our ASP was close to 480 middle of last year and we're now close to 390. And it's mostly store to store. Primarily, the biggest adjustments have been in the West and certain parts of Texas, although a little bit to the east. And, you know, our position is that we're an affordable builder. We have to get to a payment that makes sense for our customers. And we believe that payment exists when we're under 400 ASP. So we underwrote most of our land that's coming through our income statement two years ago, assuming our ASP was going to be in the threes to low fours. And that's where we position our product. And then so we're about competitively positioning ourselves at the bottom of the graph or slightly above the bottom of the graph and being the affordable new home builder in our competitive set. So all that is mostly prices. Yeah, we've opened up a few new communities and they're maybe at lower ASPs, but it's pretty much all price and then Gila can speak to the impairments. But you have geography with the East.
spk04: When we're looking at it, Alan, we mentioned just on a mixed perspective, 89% of our sales in the quarter were entry level. It's not that different from 82% last year's fourth quarter. So the mix is somewhere in the 80s category, so that's not causing material shift. There's always geographic shift that's difficult to quantify, but California was a fairly material portion this quarter, but Colorado went down. So it's always a little bit of that, but that's not driving. The majority of that shift, the majority is really from true reductions or incentives. So I think it's really notable that with this material of a price reduction that we're still north of 20% margin, that gives us the confidence to say as we sit here today, we don't see broad-based impairment with north of 20%. margins not just in the current quarter but in the quarter that we gave guidance for. So how did that math work? How can you drop 20% from 31.6 and still be above 20? There's some other pieces that go into the mix. Certainly some increased efficiency some simplification of the product, but then also the higher volume is helping us leverage some costs better, particularly as we saw in the fourth quarter. So there's a lot of other pieces that roll into those calculations, but overall, you're seeing the impact of lower prices already in our numbers, which is why we feel comfortable especially looking at our January numbers that without any large material shifts in the market that we have a good ASP to hit our three to four net sales per month.
spk09: And where we've made the most meaningful adjustments in Phoenix, Denver, we've also saw the most meaningful direct cost savings. which have softened what our margins have done. When we quoted earlier in our script that we got $15,000 per house, that's in Colorado and Phoenix. That's where we got those numbers, where the market has adjusted the most and also where prices ran up the most over the last three years.
spk10: That's all really helpful. And I think it's really impressive that, you know, you've been able to reduce prices as much as you have and bring the affordability equation, you know, at a more reasonable level for your consumers and still generate the margins you are. I think it obviously speaks to the execution of the operation there. So well positioned to kind of continue taking share from that regard. Second question, you know, we heard from another builder last night that kind of gave similar commentary on January activity, but they did kind of add in a comment that they might have seen a bit of a leveling off of the improvement over the last week or two, kind of implying that things really accelerated kind of back half of December into early January. Not to get too fine here on weekly activity here, but is that a statement you would agree with, or do you feel like the market is continuing to gain momentum at this point?
spk09: I mean, we just gave out monthly. Now you want weekly sales trends. I can just tell you we would not agree with that statement.
spk05: Okay, perfect. Thanks, guys. Best of luck.
spk01: Thank you. The next question is coming from Mike Rahat of JP Morgan. Please go ahead.
spk12: Thanks. Good morning, everyone. Appreciate you taking my questions. I just wanted to circle back and make sure I'm understanding some of the puts and takes on the gross margin side and obviously appreciating you're only giving first quarter guidance at this point. But if I heard right, you know, you said that you're thinking about your long-term gross margins being in a 21 to 22% range, I believe you said, which is where you are on the first quarter. How should we think about the puts and takes beyond first quarter, just directionally at least? Because Obviously, we're talking a lot about reduced construction costs, you know, either materials or labor or both, which everything else equal, you know, could be a tailwind, as you had said, might impact late 2023, early 2024. You know, I'm wondering if there's anything that would kind of perhaps even offset that if you're thinking about trying to hit a 21, 22 percent. It could even still be above that, given some of the lower construction costs. Or is there any lag in the impact of the incentive and pricing environment that you've seen over the last few months that might create a little bit of even a further dip in the second quarter relative to where you are in the first quarter?
spk04: So, thanks for the question, Mike, the 2020, the 21, 22% that we guided to for the 1st quarter. That's already homes that are under production. So we know what those costs are. Right? If they're closing in the quarter, we either came in to them with backlog or their specs that can close in the quarter. So we have a good visibility into Q1. Now, not to be too cute here, but when we spoke about our long-term trend, obviously we're not talking about 2023 as a whole. We're talking about long-term trends. We sat at or above 200 bits from the normal margin of 20%. So I think that what we were trying to communicate there is that the long-term margins are 22% or north of that. So to be honest, we kind of just really got our whole operational structure in place right as COVID hit, right? 2019 is the first year that we really kind of had all engines humming in a new strategy. And then we had COVID and it was impossible to look at what an environment would be in a normalized pace. So at the beginning, we thought it would be 21. Since then, we raised it to 22. And on today's call, we said normalized would be at or north of 22 as we continue to harvest the efficiencies that we're seeing in the business. So when we look at Q1, I can't predict. Sitting here today, if it's the trough, I know another builder took that position and said that's going to be the low point for the year. By not providing guidance for the whole year, we're not confident that we understand all the dynamics yet for the rest of 2023. Where we do feel confident in the long-term operational structure that we have, that long-term will be 22% or higher. As that clarifies over the coming quarters, we'll give additional insight there.
spk12: No, that's great. That's helpful. I appreciate that, Hila. And just to make sure also, one element of my question around the current pricing environment, would you say that in terms of where you are in the last couple of months in terms of incentives on orders, that that is more or less fully reflected in your first quarter gross margin guidance or Because I would assume that incentive levels in December were higher than October, let's say, but maybe I'm wrong on that. So just trying to get a sense of what the first quarter gross margins reflect and if current incentive levels are higher than that or in line with that.
spk04: So I'll just clarify. I know you said incentives, but just to clarify, we don't look at incentives because we're a spec builder primarily with 89% of our volume coming from entry level. So we use base price, incentives, and financial discounts interchangeably because we're solving for a payment for the buyer. So all in, what you're seeing in our Q1 guidance includes those January sales. This is our current volume and what we expect. It's those specs that we've mentioned, that we have a third of them entering the year, ready to close in the quarter. We sold some of those. We sold 1,200 of those in Q1 already. So what we're seeing in the margin guidance of 21 to 22 reflects the current environment.
spk12: Great. Thanks so much.
spk06: Thank you.
spk12: Thank you.
spk06: Thank you. The next question is coming from John Lovallo of UBS. Please go ahead.
spk03: Morning, guys. Thank you for taking my questions as well. You know, I know you mentioned about potentially being more open to returning capital to shareholders, but just thinking about your liquidity position, the stock's valuation, there's no debt coming due to 2025. I mean, is there an opportunity here to get aggressive on share buybacks?
spk04: Sure. There's an opportunity to get aggressive on share buybacks, to consider other methods of getting cash to shareholders, to look at a debt pay down. We're looking at everything and trying to make sure that what we do optimizes the return to the shareholders while keeping us in the strongest balance sheet position possible. So there's definitely some action that we'll be taking in 2023, but the magnitude and which action it is, we're still vetting through with our board. So stay tuned for next quarter's call for some more visibility into that.
spk03: Okay. That's good to hear. And then the 89% of orders for entry level, how high can this go and how high would you like it to go? And Just remind us, is there any margin differential on the entry level versus other parts of your portfolio?
spk09: Yeah, there's really no differential. We have three consumer segments that we focus on. Entry-level buyer, what we call the move-down value-conscious buyer. and then we move up value-conscious buyer. And it's kind of blurry. The lines get blurry. Some of them are the same people, same type of families, aspirational entry-level buyers are kind of move up value-conscious. So I think it can get all the way up to 90%, 95% based on your definition of our customers and our communities. But our target is, you know, 70%, 75% entry level and 25% to 30% value conscious move down and move up buyers. And so I think it's, you know, it can move around depending on what interest rates are doing and what the market's doing. But that's kind of the sweet spot.
spk03: Got it. Thanks very much, guys.
spk01: Thank you.
spk06: The next question is coming from Carl Reichart of BTIG. Please go ahead.
spk08: Thanks, Sial. Good morning. Fleet, you mentioned that cycle times in Arizona and Colorado were the longest in the company. I'm just curious, why is that?
spk09: That's a good question. I think it's a couple of different things. I think, and they're both different, actually. They're not the same reason. But in Arizona, there was just so much demand during COVID, and I just don't think the trade capacity could keep up with The amount of starts that were being pushed out both in both in multi family and. Single family, so tremendous ramp up in 2020, 21, just put a lot of constraints on them and they just weren't able to keep up and we saw some pretty meaningful expansion and cycle times across. A lot of categories, not just front end versus back end, but across the board. So just big market lots of demand Colorado has always had. A labor issue, it's always been difficult to attract. You know, skilled labor there, it's a lot of folks don't get into that business there. It's always been somewhat constrained. And then when you add a surge in demand that we saw again out of cobit. You just saw our cycle times get really, really long. So two different reasons. I think Phoenix recovers relatively quickly as demand has slowed significantly here. And so we're already seeing that. I think we'll be able to get our cycle times down here relatively quickly as demand slows. Denver is always going to be a challenge. We always have the longest cycle times there. We build basements. We do a lot of high density there because of affordability. So we'll continue to have challenges there, but hopefully we'll do better as the market slowed there as well.
spk08: Thank you for that. I appreciate it. And then second, in the past, you've talked a lot about the importance of keeping your pricing near to, below FHA-conforming loan limits. Obviously, we've had a big jack-up in those limits. Has that helped at all in January? Are you hearing that from consumers or seeing that in terms of apps? Thanks.
spk09: No, it's really not even a factor for us anymore because FHA – And conforming low limits have gotten so high. So now it's just all about where we're positioned against our competitive staff. We want to be. As I said earlier on the bottom to the middle of the bottom of the graph, depending on who we're competing with and really be the affordable offering in the market. So it's just driven by our pricing and our research department. That looks at every community every week and tells us where, where we need to price our inventory to find. The ideal page, but it's no longer really connected to that unless it is right. It clearly matters. We want to be below that.
spk04: Um, but we probably want to be well below that these days, given how high they are just visibility Carl for the year for us with 15% of our total mortgage pool. So certainly some people are using FHA, but it's so high that a lot of people are just getting conventional loans. They don't need the assistance that comes from FHA. The dollars kind of got a little bit disconnected. It was a maybe two-year lag to where they needed to be, and they came up right when ASP started to come down.
spk08: Thanks, Hila. Thanks, Philippe.
spk09: Hey, operator, we'll take one more question.
spk06: Certainly. Our final question today is coming from Alex Barron of Housing Research Center. Please go ahead.
spk02: Thank you. Yeah, I wanted to ask regarding your land position, you know, how you guys are thinking about, you know, what's transpired, I guess, in the last few weeks and your approach to land going forward. Do you feel there's going to be opportunities, you know, to replace land the stuff you guys canceled at Better Deals, or are you just going to hold off? How are you guys thinking about the current land environment?
spk09: We're definitely going to be cautious and patient here. We're going to get through certainly the spring and sort of reevaluate what the market looks like, what the long-term prospects look like. We're seeing some opportunity out there. I saw a survey recently. recently that land prices have started to decline modestly, I think around 5%. I don't think that's enough. We've got to get our land development costs down as well or things are hard to underwrite if today's industry environment is the new reality. So we have plenty of land. As Hila articulated, we have the ability to maintain our 300 community count trajectory for the next couple years without really buying anything. So it'll be about when it's time to grow from there. We're in some new markets. We clearly want to be active there, but we want to be patient as well. So I think you're just going to see us be really, really patient. We're definitely going to get through the next couple of quarters to read the tea leaves, kind of evaluate what 2024 and 2025 are going to feel like before we start ramping it up. That being said, we have 850Million dollars sitting in the bank and opportunities present themselves. We'll certainly go get them.
spk04: Alex, just to clarify, you're hearing from all of our peer builders. A lot of folks are dropping options that don't make sense. We're walking away from land deals. Those land deals still exist. They're just going to be repackaged and sold to the builders at a cheaper price. So at some point, there is going to be a jumping point that we're going to enter the market, maybe opportunistically, more than having a land committee every week and buying land aggressively. But there will be opportunities to buy land at more attractive prices.
spk02: Got it. And, you know, if you reflect back to the last two years, I mean, we had supply chain issues, then we had rising interest rates. What do you think are the, I guess, lessons for you guys, or how are you thinking about maybe if either of those two things, you know, let's say the market reaccelerates and we start to see supply chain issues again, what do you think you'd be doing differently this time to capitalize on, you know, on these opportunities if Or how would you approach things differently this time around, given your experience in the last two years?
spk09: Well, we're always learning. I think that we've demonstrated over the last five years that we're an extremely agile and proactive organization. We've been ahead of a lot of the trends. We came out of COVID. more aggressively than anybody, grab market share. We pivoted our strategy. I think we're playing with the right strategy in the right part of the market. We have specs. So we're going to continue to be agile. You know, we do this job 24-7. We're paying attention to everything. We have a very aligned, engaged team out there. We talk all the time. We listen to one another. And we're going to continue to collaborate as a team. and move quicker and faster than we have before so that we can take advantage of whatever opportunities that presents in this market but also uh properly manage the risks that are still evident as well so it's about being agile it's about being willing to change and innovate you know constantly and we have a real strong capability here and we'll continue to invest in that and um you know that's what we've learned right don't don't uh Don't continue to think that everything that was is going to be and just be willing to evolve and adapt.
spk02: All right. Sounds like a plan. Well, best of luck, guys. Thank you. Thanks.
spk09: Thank you. Thank you, operator. I'd like to thank everyone who joined this call today for your continued interest in marriage homes. We hope you have a great rest of the day and a great weekend. Thank you.
spk06: Ladies and gentlemen, thank you for your participation. This concludes today's event. You may disconnect your lines at this time or log off the webcast and enjoy the rest of your day.
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