Meritage Homes Corporation (NYSE:) has announced strong financial results for the second quarter of 2024, highlighting a total of 3,799 homes sold and a significant backlog conversion rate of 136%. The homebuilder reported home closing revenue of $1.7 billion and a notable increase in its home closing gross margin to 25.9%. The diluted earnings per share (EPS) stood at $6.31.
The company’s new strategy centers on providing move-in ready homes and strengthening relationships with realtors, which has been met with industry accolades for customer satisfaction and sustainability efforts. Looking ahead, Meritage Homes expects to see community count growth and is projecting a double-digit increase in 2025.
Key Takeaways
- Meritage Homes sold 3,799 homes in Q2 2024, with a 136% backlog conversion rate.
- Home closing revenue reached $1.7 billion, with a home closing gross margin of 25.9%.
- Diluted EPS was reported at $6.31.
- The company’s new focus on move-in ready homes and realtor relationships has been well-received.
- Future projections include community count growth and a double-digit increase for 2025.
Company Outlook
- Meritage Homes forecasts total closings between 14,750 and 15,500 units for the full year.
- Home closing revenue is projected to be between $6.1 billion and $6.3 billion.
- Diluted EPS is estimated to range from $19.80 to $21.
- The company aims to grow by 10% year-over-year and reach 20,000 units in the next three to four years.
Bearish Highlights
- A slower absorption pace and lower closing volume are expected in the second half of the year due to seasonality and backlog conversion.
- The company plans to use more incentives due to increased inventory levels in some markets.
Bullish Highlights
- Meritage Homes experienced an 18% increase in volume and a home closing gross margin increase from 24.4% to 25.9% year-over-year.
- SG&A expenses improved, dropping to 9.3% of home closing revenue.
- The company’s financial services profit was $4.8 million in Q2 2024.
- Meritage Homes is optimistic about its performance in Q3 and Q4, expecting stronger sales volume.
Misses
- There was a 7% decrease in average selling price (ASP) despite an increase in home sales volume.
Q&A Highlights
- The company discussed its land acquisition strategy and the positive impact of selling homes with extras like garage codes on gross margins.
- Meritage Homes is in the process of rolling out its new strategy and expects full implementation next year.
Meritage Homes has outlined a strategic plan to enhance its market presence by focusing on move-in ready inventory and expanding into new markets, including secondary markets in South Texas and Florida.
The company’s ability to lower the cost per home through rate locks and maintain a lower-than-historical cancellation rate has contributed to its optimistic outlook. Additionally, the company plans to reinvest its cash balance into the business, dividends, and share repurchases, while also utilizing off-balance sheet financing for land spending.
The company’s commitment to becoming a top three builder in its existing markets and its entry into four new markets underscore its growth ambitions. With a 60-day backlog turnover ratio target in sight, Meritage Homes is poised for a higher velocity of sales, aiming to compete effectively with the resale market.
The effective income tax rate for the quarter stood at 22.1%, and the company has seen improvements in sales volume, leveraging on the SG&A line, and expects to continue making investments aligned with its strategic direction.
InvestingPro Insights
Meritage Homes Corporation’s (MTH) second quarter of 2024 financial results reflect a company on the rise with robust home sales and revenue. To further understand the company’s financial health and market position, let’s delve into some key metrics provided by InvestingPro and consider a couple of InvestingPro Tips that shed light on the company’s performance and prospects.
InvestingPro Data reveals a solid foundation with a market capitalization of $7 billion and a Price/Earnings (P/E) ratio of 8.39, which adjusts slightly to 8.76 when looking at the last twelve months as of Q1 2024. These figures suggest a reasonable valuation relative to earnings, which is reassuring for investors considering the company’s growth strategy. Additionally, Meritage Homes’ revenue growth of 14.76% in Q1 2024 indicates a strong start to the year, complementing the positive results reported for the second quarter.
In terms of profitability and efficiency, the company has demonstrated a commendable Operating Income Margin of 15.34% over the last twelve months as of Q1 2024. This margin showcases the company’s ability to translate sales into profits effectively, which is crucial for sustaining growth and delivering shareholder value.
InvestingPro Tips highlight the company’s performance and future outlook. Notably, Meritage Homes has been profitable over the last twelve months, and analysts predict the company will remain profitable this year. This aligns with the company’s optimistic projections for community count growth and a double-digit increase in 2025. Additionally, the company’s stock has seen a strong return over the last month, with a price total return of 18.01%, which speaks to investor confidence and market momentum.
For those looking to dive deeper into Meritage Homes’ potential, there are more InvestingPro Tips available, which can be accessed through the dedicated page at https://www.investing.com/pro/MTH. Interested investors can use the coupon code PRONEWS24 to get up to 10% off a yearly Pro and a yearly or biyearly Pro+ subscription, unlocking further insights that could guide investment decisions.
With a comprehensive strategy to enhance market presence and a strong financial backbone, Meritage Homes Corporation is well-positioned to achieve its ambitious growth targets and continue delivering value to its shareholders.
Full transcript – Meritage Homes Corp (MTH) Q2 2024:
Operator: Greetings and welcome to the Meritage Homes Second Quarter 2024 Analyst Call. At this time all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Emily Tadano, Vice President of Investor Relations and ESG. Thank you. You may begin.
Emily Tadano: Thank you, operator. Good morning, and welcome to our analyst call to discuss our second quarter 2024 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 home page. Please refer to Slide 2, caution 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 2023 annual report on Form 10-K and subsequent 10-Qs. We have also provided a reconciliation of certain non-GAAP financial measures referred to in our earnings release as compared to their closest related GAAP measures. With us today to discuss our results are Steve Hilton, Executive Chairman; Phillippe Lord, CEO; and Hilla Sferruzza, 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 later today. I’ll now turn it over to Mr. Hilton. Steve?
Steve Hilton: Thank you, Emily. Welcome to everyone listening on our call. I’ll start with a brief discussion covering current market conditions and some of our recent company milestones. Phillippe will highlight how our strategy is progressing and its impact on our quarterly performance and Hilla will provide a financial overview of the second quarter and forward-looking guidance. Q2 was another strong quarter for Meritage. Our products and price points are targeted at the largest segments of homebuyer demand, which drove a solid spring selling season for us, leading to an average absorption pace of 4.5 sales per month this quarter and our highest second quarter sales orders of 3,799 homes. In the second quarter of 2024, our backlog conversion of 136% generated 4,118 home deliveries and home closing revenue of $1.7 billion. Home closing gross margin for the quarter was 25.9%, which combined with SG&A leverage of 9.3% resulting in diluted EPS of $6.31. As of June 30, 2024, we increased our book value per share 16% year-over-year to $134.41 and generated a return on equity of 18.3%. Now on to Slide 4 for our recent milestones. We are truly honored to receive a wide range of recognition in the second quarter that reflects our corporate stewardship. We are in the prestigious Avid Cup for the third consecutive year, the highest accolade presented to a builder for exceptional customer satisfaction scores. We once again celebrate our longstanding partnership with the EPA accepting the Market Leader award for certified homes for the 11th time. We were also one of three builders named America’s Climate Leaders by USA Today. And lastly, U.S. News and World Report added us to the list of the 2024-2025 Best Companies to work for. We are proud to be recognizing externally for our social sustainability initiatives. And with that, I’ll now turn it over to Phillippe.
Phillippe Lord: Thank you, Steve. During the second quarter, we hosted two Investor Day calls to introduce the evolution of our business model. Over the past seven, eight years, we have migrated to a lower ASP spec strategy while streamlining operations to yield efficiencies. Now we are once again continuing to refine our strategy by taking the home to a near completion stage before releasing it for sale. Basically approximating the just-in-time home inventory structure that exists in the retail market. This strategy evolution is built on three new core tenants, a 60-day closing guarantee the concept of move-in ready homes and a focus on deepening our realtor relationships. These tenants allow us to target the biggest piece of the potential homebuyer pool by effectively competing its resale inventory, not just in today’s environment that favors builders but also when the resale market returns to historical averages. Our strong second quarter 2024 financial performance validated that the shift to focus on quick turn move-in ready homes is the right one for us, an attractive offering for our customers. We will continue to build affordable entry-level and first move-up product, but now we will be focused on buyers who want to move into the home in 60 days and typically have already engaged with the broker. Our new strategy enabled us to exceed expectations this quarter by achieving a higher absorption pace than our target and year-over-year increase in home closings and gross margin. Now turning to Slide 6. Demand remained solid throughout the spring selling season. Our sales orders of 3,799 homes for the second quarter of 2024 were up 14% year-over-year. The cancellation rate of 10% remains below our historical average in the mid-teens. Entry-level homes comprised 92% of total orders volume. ASP on orders this quarter of $414,000 was down 6% from prior year due to a larger mix of our orders coming from both our Eastern markets and entry-level homes. Sequentially, we increased ASP on orders as we were able to take price increases in some of the stronger submarkets. The strength in demand for our move-in-ready product and our continued use of finance incentives generated second quarter 2024 average absorption pace of 4.5 net sales per month, above our target average annual sales pace of 4 net sales per month. Aligning with seasonal patterns, we would expect the second part of the year to experience a slower sales pace through the summer months and into the holiday season. Although we are seeing a return to more typical sales seasonality, we do believe that the demand environment will remain constructive for the rest of the year. This resiliency stems from favorable demographics, below average resale listings in many of our markets and a fundamental under built supply of homes, all of which create an opportunity for us to increase our market share despite ongoing mortgage rate volatility. The second quarter 2024 ending community count of 287 was up 4% sequentially from the first quarter of 2024 and down 1% compared to prior year. 35 new communities came online this quarter, similar to what we opened up in Q1. For the second half of this year, we anticipate additional net community count growth and a more meaningful double-digit increase in 2025. We now own and control all the lots we need for client re-openings in 2024 and 2025 at most in 2026. Moving to the regional level trends on Slide 6. All of our regions achieved an average absorption pace exceeding our target of 4.0 net sales per month and year-over-year growth in orders volume this quarter. The Central region comprised of our Texas markets had the highest regional average absorption pace of 4.7 net sales per month and an average quarterly backlog conversion rate that has exceeded our targeted 125% for the last few quarters. Even as the resale home supply has increased in some Texas submarkets, our move-in ready homes effectively completed against its inventory. With nearly 30% completed spec inventory in the region, we believe we have the right available product to continue to increase our market share. The West region experienced the largest year-over-year growth in average absorption pace to 4.4 net sales per month in Q2 from 3.4 net sales per month from last year. We are seeing strength in Arizona where we achieved 5-plus net sales per month this quarter, with strong year-over-year growth in spec count in the West we expect to be able to continue meeting the high demand in this region. The East region had an average absorption pace of 4.4 net sales per month and the largest regional year-over-year increase in sales orders, making the East our largest region based on sales order volume even as retail inventory more noticeably returned in some submarkets in South Florida. We are poised to continue competing aggressively for market share here as our East region exhibited the strongest regional growth year-over-year in ending community count and spec inventory in the second quarter of 2024. Now turning to Slide 7. As we align our starts pace with our sales pace, we started about 4,300 homes this quarter. We were up about 5%, both sequentially and year-over-year, replenishing our pipeline. With our anticipated community count growth in the next six months, we expect to start more homes to maintain our targeted four to six month supply per community across our growing footprint. As we have discussed in the past, our strategy is agile. So if we do see any pullback in the markets in the coming quarters, we will adjust our spec starts accordingly. We had approximately 6,500 specs homes in inventory as of June 30, 2024, up 46% from about 4,500 specs as of June 30, 2023. This represented 23 specs per community this quarter between a four to five month supply specs based on absorptions. Over time, under the new strategy, our percentage of completed WIP should increase slightly to ensure we have the right inventory to meet our 60-day closing guarantee. Of our homes closing this quarter, 96% came from previously started inventory, up from 87% in the prior year. 26% of total specs were completed as of June 30, 2024, closer to our goal of carrying one third in move-in ready homes. With our focus on quick turning inventory, our intra-quarter sales to closing percentage was just above 40% this quarter. Our ending backlog continues to decline intentionally from about 3,800 as of June 30, 2023 to approximately 2,700 homes as of June 30, 2024. We expect this trend to stabilize once we are delivering 60-day move-in ready homes in all of our communities. With our backlog in specs on the ground, together totaling over 9,200 homes, we believe we have the optimal level of inventory for the current demand environment. I will now turn it over to Hilla to walk through our financial results. Hilla?
Hilla Sferruzza: Thank you, Phillippe. Before we get started, I’d like to share that earlier this week, Moody’s (NYSE:) upgraded us to investment grade. We’re excited to now be holding IG ratings from all three of our readers. It’s been humbling to see third parties recognize our efforts over the last several years to strengthen our balance sheet while producing exceptional results and we believe the benefit of these upgrades will continue to positively impact our financial performance. Now let’s turn to Slide 8 and cover our Q2 results in more detail. Second quarter 2024 home closing revenue was $1.7 billion, reflecting 18% higher home closing volume year-over-year that was partially offset by 7% lower ASP due to product and geographic mix. In addition to select price increases, the costs related to rate locks decreased slightly, both year-over-year and sequentially from the first quarter, even as the utilization of these financing incentives increased with recent volatility in interest rates. As we look to the second half of the year, we anticipate a slower monthly absorption pace due to seasonality and corresponding lower closing volume compared to the first half of the year, reflecting the seasonality and our higher backlog conversion resulting in the delivery of the majority of our spring selling season orders during the first half of the year. Home closing gross margin increased 150 bps to 25.9% in the second quarter of 2024 compared to 24.4% in the prior year. This improvement was the combination of lower direct cost, greater leverage of fixed expenses on higher revenue and shorter construction cycle times, which were partially offset by higher lot costs. Lower direct costs benefited from both market dynamics and our purchasing teams ongoing pursuit of cost reductions since direct costs peaked in Q1 of last year. We are also securing volume discounts from trade partners based on our increased deliveries. We expect to see continued savings on lumber and lumber-related products in the coming quarter and labor capacity continues to hold steady. Further, our construction cycle times improved about 10 days from Q1 to Q2 to around 130 calendar days, which helps us turn our home inventory faster. We’re closing in on our historical average of about 120 calendar days cycle time, which would allow us to turn our WIP inventory three times a year. As a reminder, although our land costs are more elevated as compared to 2023, we have already turned over the majority of our communities from pre-COVID land so the higher cost lots are not expected to have a material pullback on our margins beyond the current levels. Turning to SG&A. SG&A as a percentage of second quarter 2024 home closing revenue of 9.3% improved 30 bps from 9.6% in the second quarter of 2023 primarily due to the better leverage achieved on higher home closing revenue. It’s important to note that this quarter total commissions as a percentage of home closing revenue were flat year-over-year. Specifically, external commission rates were essentially the same in Q2 to 2023 despite our higher corporal participation as our strategic relationships reduce the need for ad hoc bonuses and incentives. We continue to see the proof in our results that our new strategy of aligning with realtors is working and proving profitable. We expect commissions as a percentage of home closing revenue to remain relatively steady for the rest of the year. As we’ve mentioned several times today, given our strategic evolution, the first two quarters of the year will likely be the strongest revenue quarters leading to the most leverage in our SG&A in the first half. With that in mind, we are still maintaining our full year SG&A guidance of 10% or better. Longer term, we’re targeting 9.5% SG&A as a percentage of home closing revenue as we grow our existing markets and leverage our overhead platform to reach our goal of 20,000 units in the next three to four years. In the second quarter of 2024, the financial services profit of $4.8 million included $2 million of write-offs related to rate lock unwind costs. This compares to financial services loss of $2.6 million in the second quarter of 2023 that had $7.9 million in similar write-offs. The second quarter’s effective income tax rate was 22.1% this year, essentially flat to prior year, with both periods benefiting from energy tax credits on qualifying homes under the Inflation Reduction Act. Overall, higher home closing revenue and gross profit, coupled with greater SG&A leverage, led to 26% year-over-year increase in second quarter 2024 diluted EPS to $6.31 from $5.02 in 2023. To highlight just a few results from the first half of 2024, on a year-over-year basis, orders were up 14% closings were up 19%, and our home closing revenue increased 13% to $3.2 billion. We had a 240 bps improvement in home closing gross margin to 25.9%. SG&A as a percentage of home closing revenue was 9.8%. And net earnings increased 31% to $418 million with $11.37 in diluted EPS. Before we move on to the balance sheet, I wanted to cover our Q2 2024 customers’ credit metrics. As expected, our buyer profile remained relatively consistent with our historical averages with FICO scores in the mid 730s and DTIs around 41, 42. LTVs were still in the mid-80s. And about 80% of our buyers in Q2 received some sort of financing incentives consistent with our mortgage company capture rate. Now turning to Slide 9, this quarter, we successfully enhanced our capital structure. We issued $575 million in new 1.75% convertible debt due 2028. Part of the proceeds from the convert went to pay down the remaining $250 million of senior notes due 2025. The incremental cash from the convertible notes increased our available sources for land spend, dividends and share repurchases. We also refinanced our revolving credit facility to increase the facility size to $910 million, extending its maturity date from 2028 to 2029 and reducing its pricing grid to align with our investment grade rating. We had nothing drawn on our credit facility, cash of $993 million and net debt-to-capital of 6.2% as of June 30, 2024. Our net debt-to-cap maximum ceiling continues to be in the mid-20s range, leveraging our improved backlog conversion and quicker cash generation. We utilized $118 million operating cash flows during the second quarter of 2024, primarily related to land acquisition and development. On to Slide 10, our capital allocation was focused on organic growth and cash dividends this quarter to enhance shareholder value. This quarter, we spent about $631 million on land acquisition and development, which was up 54% from prior year. On a year-to-date basis, our land spend has totaled $1.1 billion as of June 30, 2024. With the exception of a small pullback in late 2022, we have been accelerating our investment in organic growth for the past several years. We expect our go-forward trend in 2024 and beyond to be $2 billion to $2.5 billion of land spend annually. As we nearly tripled our quarterly cash dividend on a year-over-year basis to $0.75 per share in 2024 from $0.27 per share in 2023, our cash dividend totaled $27.2 million in the second quarter of the year and $54.5 million on a year-to-date basis. Due to the convertible notes issuance, we were unable to repurchase any shares in the second quarter as we were bound by the customary lockout provision that will lift at the end of the day today. Share buybacks are integral to our capital allocation policy, so we plan to double up on our systematic, quarterly commitment in Q2 to catch up. For the first half of the company repurchased over 362,000 shares of stock, totaling $55.9 million. $129.1 million remain available under our authorization program as of June 30, 2024. Turning to Slide 11. We secured and put over 8,700 net new lots under control this quarter, representing an estimated 63 future communities. We put around 2,800 net new lots under control in the second quarter of 2023. As of June 30, 2024, we owned or controlled a total of about 71,000 lots equating to a 4.7-year supply, in line with our target of four to five years. We continue to utilize more option financing for land deals ranging from traditional land banking to seller tranche deals with the underlying sellers. About 66% of our total lot inventory at June 30, 2024, was owned and 34% was options compared to prior year. We had a 76% owned inventory and a 24% option lot position. We owned 69% and option 31% of our lots at March 31, 2024. We are comfortable with our off-balance sheet land ratio up to 40%. Since off-balance sheet transactions come with the financing cost, we are going to use them as needed, while balancing our other capital commitments. Finally, I will direct you to Slide 12 for our guidance. Given current market conditions, we have revised our full year projections higher to the following: total closings between 14,750 and 15,500 units; home closing revenue of $6.1 billion to $6.3 billion; home closing gross margin around 24.5% to 25%; and effective tax rate of about 22.5%; and diluted EPS in the range of $19.80 to $21 flat. As for Q3 2024, we are projecting total closings between 3,650 to 3,850 units; home closing revenue of $1.5 billion to $1.6 billion; home closing gross margin of 23.5% to 24%; and an effective tax rate of about 22.5%; and diluted EPS in the range of $4.60 to $5.05. Both Q3 and full year guidance assume current market conditions and interest rates. With that, I will turn it over to Phillippe.
Phillippe Lord: Thank you, Hilla. To summarize on Slide 13, our second quarter 2024 results demonstrate that our new focus on quick turning move-in ready inventory is leading to strengthen our absorption pace, home closing volume and home closing gross margin. With our strong balance sheet, we can continue to execute our strategic evolution and create long-term value by investing in our growth on the path to 20,000 units, while also returning cash to shareholders. With that, I will now turn the call over to the operator for instructions on the Q&A. Operator?
Operator: Thank you. And at this time we will conduct our question-and-answer session [Operator Instructions] Our first question comes from Alan Ratner with Zelman & Associates. Please state your question.
Alan Ratner: Hey guys, good morning. Congrats on the great performance and what seems like a lot of success so far in the strategy pivot or evolution here. I was hoping to drill in a little bit, though, to the gross margin guide. I know you walked through in a lot of detail back in your investor meetings a month or two ago, kind of your outlook there longer term. And I think your expectation for some normalization makes a lot of sense and generally is in line with our expectations. But I am a bit curious if you could drill in a little bit what’s driving the sequential pressure specifically in the back half of this year. I think we’ve heard from some other builders that expect more of a flattish margin environment. And it seems like your incentives right now are fairly stable. So, why the significant leg lower in the second half following a much stronger-than-expected second quarter?
Hilla Sferruzza: Hey Alan, this is Hilla. I’ll take it, and then Phillippe can jump in with any additional commentary. So I think that the sequential decline, I know there has been a lot of questions and thoughts about it kind of pre-earnings this morning. It’s mostly a function of two things, media a function of three things. The first is geographic mix, right? We have some diversity in margin performance across our markets. So it’s a little bit of geographic mix. A second part of it is volume, right? There’s some leveraging in the six components of overhead with the heavy closing volume now shifting to Q1 and Q2 for us from Q3 and Q4. We’re going to see some slightly reduced leveraging in six components of gross margin and then incentives continue to be utilized. There has been a lot of volatility in the market over the last six weeks. Those closings are the ones that we’re really going to see in Q3, and we are continuing to see as we sell homes in July. So it’s really the function of those three things. There is nothing different structurally or fundamentally in the market. The market strength is holding in there. It’s pretty much the same. It’s really just mix and leveraging in the overhead components.
Phillippe Lord: Yes. And this is Phillippe. I will just add from the beginning, when we budgeted our business, we expected seasonality return to the market this year. So, we still expect that. We are here in July. And so we think that we will probably have to use more incentives in the back half of the year to acquire those sales. Those are in our original budget. We had to use less in the first half of this year, but we’re still expecting to use more in the back half of the year.
Alan Ratner: Got it, okay. That is very helpful. And I guess circling that back to the upside in 2Q then I think you kind of touched on that just now in your answer fully. But the upside that you saw this quarter, that was just a function of you kind of came into the quarter expecting to have to maybe incentivize a bit more heavily than you actually did on some of those homes that you sold and delivered in intra-quarter?
Phillippe Lord: Yes, exactly. And back to Hilla’s answer on how we’re guiding to the back half we also picked up volume and leverage, which was significant. So along with the leverage and volume we picked up because now we’re closing – selling and closing more homes just in time and then lower incentive utilization because the market was stronger in Q2 allowed us to produce the beat in Q2.
Alan Ratner: Got it. Okay, that’s really helpful. The second question on community count growth, really impressive acceleration there in the quarter. And I know that was an area that you were maybe a little bit more cautious on in the near term just given the pace of absorptions and kind of the flow through of some of your more recent land buys. What’s contributing, I guess, to the – I don’t want to call it a pull forward, but the better-than-expected growth here in the near term, which sounds like you expect to continue in the back half of the year.
Phillippe Lord: Yes. I don’t know if it’s better than expected. I feel like it’s been kind of coming sort of within one or two of what had been expected, that’s why we sort of suggested growth was going to be somewhat choppy over the next – over this year and then next year, we’re expecting meaningful growth. And that’s essentially what it’s been. We opened up a few extra communities this year and maybe close out a few less, not more than expected, but just what we were expecting and that will continue. I think the next three quarters will continue to be choppy, and then we’ll see meaningful growth. But as we said from the very beginning, we expect community cap growth this year, which we will be achieving.
Hilla Sferruzza: I think we share every quarter the new lots that we put under control on how many new communities that’s going to generate. For the last several quarters, the number of communities that the land that we put under control will generate is more than the number of communities that we’re closing so we start to lapse and those communities become active you’re going to see that our pipeline of the lots that we have on book and under control are going to come on at a faster pace in communities that are closing out, which again, we had a pretty material growth this quarter to 71,000 lots under control. So, I think that you’re going to see that acceleration really kick off in 2025.
Phillippe Lord: Yes. But we fully expect to go into next year spring selling season with more communities than we went into the spring selling season. So, that’s the expectation.
Alan Ratner: Great. Thanks a lot guys. Appreciate it.
Operator: Our next question comes from Michael Rehaut with JPMorgan (NYSE:). Please state your question.
Michael Rehaut: Hi, good morning everyone. Thanks for taking my questions. Wanted to start off with focus on the sales pace and particularly, I think, you kind of referenced the – obviously, the strategy that you have, broadly speaking, in terms of more effectively or more aggressively competing with the broader resale market as inventories normalize. And obviously, there’s been a lot of talk around the increase in inventory levels in Florida and Texas. I was wondering if you could kind of share as those inventory levels have increased year-to-date, how the – your various communities in those markets have performed if you’ve seen the broader market maybe soften slightly or require slightly higher incentives and how your communities have kind of navigated, if any challenges or modest softening, let’s say, in either demand or price as a result of the change in inventory in those markets.
Phillippe Lord: Sure. I mean at this point, we’re pretty optimistic about how we’re doing there because as you can look at our Q2 numbers, we produced really strong order growth across all of our markets, including some of the markets that have been highlighted as softening. I don’t think we’re going to be new to the market as resale market starts to return and becomes more competitive and therefore, bring the market into balance, we’ll have to navigate that just like every other builder, but we believe having move-in ready inventory will allow us to compete directly with that resale inventory and no longer will buyers have to make the compromise of new versus used is the idea. There are markets in Texas, there are markets in Florida that people have highlighted where the existing home inventory is starting to return to something a little bit more normal. I think when you look at it collectively right now across new homes and existing home, it’s still far from being normal. And therefore, we’re still able to achieve the market share we did. But because we can meet people on their move in time with our move-in ready inventory, we saw strength all the way through Q2. April was good, May was good, and June was good. And we saw that across all of the markets. Certainly, we have communities that we’re utilizing more incentives to acquire sales. They’re not all in those locations. There’s other reasons why or using incentives, maybe it’s qualification issues, et cetera, et cetera. But as we sit here today, Michael, I can’t tell you that the existing inventory is becoming a problem for us just yet.
Hilla Sferruzza: I would add, this is part of the reason why when Phillippe mentioned on the gross margin components in the back half of the year, we’re anticipating having to potentially offer some incremental incentives in some markets. As we’ve mentioned, we’re a PACE [ph] company. We’re very, very focused on maintaining our four net sales per store on an annual basis. If we need to do more, we’re prepared to do more. Currently, we’re not seeing the need to do something materially greater than where we have been for the first half of the year. But if we need to in markets with higher inventory, we’re prepared to do so.
Phillippe Lord: Yes. And I think our margin guide has an element of conservatism in it, we’re expecting seasonality. We’re going into the quarter with less backlog and we’re going into an election cycle. So we’re being a little conservative right now, and we’ll see how it goes.
Michael Rehaut: Great. And I appreciate those comments and actually kind of bled in your comments right at the end kind of segue into my second question. Just trying to clarify and make sure we’re crystal on incentive trends currently and what you’re baking into the back half, and you kind of just said we are being conservative to some extent. So just want to make sure it’s kind of clear that – number one, the incentive trends during 2Q, I believe you just said Hilla, but again, I want to make sure we’re fully on top of this, that incentive trends, I believe you just said have remained – have been consistent throughout 2Q? In other words, you haven’t seen an increase in incentives as you kind of exited the quarter, let’s say, and if that’s the case and you’re kind of just building in an extra cushion in the back half, and that’s why you said there’s an element of conservatism there. Any way to kind of ring fence what that if you’re talking about a 200 basis point decline back half versus first half, how much of that might be related to being a little more conservative from the incentive front?
Hilla Sferruzza: So I think we’ve been on record many times in the past. There’s about 100 bps leverage component on volume typically from our best quarter to our least strong quarter. So I think that a piece of that is just that. right? When we’re talking about the margin guidance, the pieces just a volume-based leveraging component. The second part is exactly what you alluded to. So during the quarter, our actual cost per home was less. We’re able to obtain rate locks through a slightly different structure in the last couple of months that have really helped our cost per home to come down. But we are seeing folks ask for them more frequently. So our utilization is up a little bit while our cost per loan or cost per home is actually coming down. So back half of the year, again, we’re in a really wacky election cycle, very unclear what’s going to happen. I think some of our peer companies previously on its earnings cycle has said, it’s not so much that the buyer doesn’t qualify, they’re just real nervous right now. It’s a nervous time to buy. So we’re committed and ready. We have the firepower to offer incremental incentives into a wider group of home buyers if they need them. We don’t know if they will or if they won’t, but we’re ready to offer it if they do to maintain our sales pace.
Michael Rehaut: Okay. And just to be clear, again, you haven’t seen that the level of incentives increased throughout the second quarter. And then if you’re talking about 100 bps from volume deleveraging, you also mentioned geographic mix or maybe the incentives is a 50 bps to 75 bps type of cushion. Is that fair to say?
Hilla Sferruzza: Yes. We’re not going to give specific numbers, but I don’t think your amount is too far off.
Michael Rehaut: Great. Thank you.
Operator: Our next question comes from Stephen Kim with Evercore ISI. Please state your question.
Stephen Kim: Yes, thanks very much guys. Appreciate all the color so far. And the heavy lifting on the gross margins that Mike just did. I think my question, I wanted to shift here to the backlog turnover ratio and overall, just your rate of velocity from your backlog into your actual revenues. You’re moving to a 60-day kind of between sale and delivery kind of a structure across the board. That would imply about 150% backlog turnover ratio. You’ve sort of been running in the high 130s. I just want to make sure that we understand if you fully implement your strategy, and it’s humming along at some point, let’s say, next year, is that – is it right to think that we should be incorporating in our modeling, a backlog turnover ratio about 150%? Or are there going to be markets which are got – deliberately kind of permanently going to be not doing that 60-day kind of strategy?
Phillippe Lord: Yes. No, you’re spot on. I think over time, as we get all of our communities and markets and operations pivoted to a 60-day move-in ready inventory model and cycle times remain where they are, 150% is within reach on a quarter-by-quarter basis. That’s how the math works.
Hilla Sferruzza: Yes. I don’t know if I’d model that for January 1, 2025 but that definitely an evolution, we expect to in the next four, five, six quarters to have more clarity on how quickly we can get to that number, but that is the target.
Stephen Kim: Yes, I appreciate that’s really helpful. And I also appreciate your comment about the normalization of the resale inventory that – we’re not there yet. I mean nationally, we’re still at 3.8 months. Normal it seems to be like 5% to 6%. So is it fair to say as you look across your markets, that there are one or two markets maybe where you’re at or above that normal level, it’s like six months. But by and large, the vast majority of your markets are still nowhere near that. Is that a fair assessment?
Phillippe Lord: Yes. That’s fair. And again, we don’t really operate at the MSA level. We operate at submarket levels. We buy land in submarkets where housing dynamics are stable. So when you look at it across an MSA, I think you can be misleading. There are certain tertiary submarkets that are more impacted, maybe infill submarkets, different price points. So on a submarket by submarket level, it’s a very small percent of submarkets where we’re seeing existing home inventory become relevant in any way.
Stephen Kim: Yes. That’s what I would have thought. Last one for me, I just forgot to ask about build to rent. I know that this is something that we’re starting to hear people talk a little bit more about. Can you just share again your thoughts regarding the build-to-rent market and any interest – what the level of interest is in getting involved there?
Hilla Sferruzza: Yes. It’s a choppy market, although I agree with you, there has been some more interest. We’re seeing our engagement with the BFR operators shift to more community level versus one-off homes here and there to kind of close out a subdivision. So we are seeing them reengage a couple of folks that we hadn’t heard for a while are jumping back in. So there is kind of that mid-single-digit total volume that we’re targeting and we’re pretty much dead on right now.
Stephen Kim: Okay, perfect. Thanks so much guys.
Phillippe Lord: Thank you.
Operator: Our next question comes from John Lovallo with UBS. Please state your question.
John Lovallo: Good morning guys. Thanks for taking my questions. So it sounds like everything is pretty good out there and fairly positive. But your implied second half EPS is actually coming down by about $1 from, call it, $10 to $9. So I’m curious what’s driving that? I mean it seems like there’s nothing that’s worse today than it was in May. So maybe you could help us understand that.
Phillippe Lord: It’s just the timing of closings. We haven’t made any assumption changes in the back half of the year. All we’ve done is the timing of closings have been pulled into Q1 and Q2.
Hilla Sferruzza: I’m going to deep dive that just a tiny bit, John. So basically, when we came into Q4 we guided to 14,000 units to 15,000 units. Then we brought up our guidance, $14.5 million to $15.5 million, and then we brought up our guidance again this quarter. So we actually see the year developing better than we expected every time we talk to you, which is really great news, the kind of benefit that we’re seeing from our strategic evolution is that we’re just able to close more of those sales faster. So we’ve just moved the timing of some of those closings. There is no degradation in what we’re expecting for sale volumes. We actually increased our expectation for total full year sales. So it’s really just the fact that we were able to execute on exactly what Stephen talked about, our backlog conversion, those benefits came in a little bit earlier than we had initially expected. So we were able to close our backlog in earlier quarters, but the total sales volume for the year is actually improving in the last two quarters, not deteriorating so we were able to harvest some of those process earlier in the year.
John Lovallo: Yes. Okay. Understood. And then you guys have talked about starting the number of homes in a particular quarter that you believe you can sell in the following quarter. Starts in the second quarter ramped to, I think, 4,319 from 4,142 in the first quarter. So I mean, is it fair to assume that you’re expecting a sequential improvement in orders in the third quarter?
Phillippe Lord: No. I think that were there’s a couple of things, right? We have community count growth. So we’re ramping up starts to marry our community count growth. And usually, in new communities, we tend to ramp up specs more so we can get started. And then we’re carrying more specs to finish because we want to have move-in ready inventory. So that’s really driving the increase in the starts versus our expectation that Q3 and Q4 are going to be stronger than Q1 and Q2. That would be – that would be unusual. It’s a combination of community count growth, and it’s a combination of trying to get all of our communities to a point where we have move-in ready inventory.
Hilla Sferruzza: Also, we’re not [indiscernible] 4,300 and a little over 4,100 feel like kind of the same. To be honest, we make starts decisions month in advance. So we actually thought that was a pretty good notch. Over time, we’ll probably get closer, but that didn’t feel that far apart.
John Lovallo: Okay, that’s helpful guys. Thank you.
Phillippe Lord: You’re welcome.
Operator: Our next question comes from Carl Reichardt with BTIG. Please state your question.
Carl Reichardt: Thanks. Good morning everybody. I wanted to ask about operating cash flow, Hilla. Do you have some expectations you could share with us about 2024. And then in addition, given the model you’re operating your OCF has been much more consistent quarter-to-quarter less seasonal than a lot of the folks that we cover. I’m curious if you’ve got a target in mind in terms of converting – conversion of net income to cash flow or vice versa either way, where more – as you continue to run your inventory faster, more of your net income converts to operating cash flow or free cash flow?
Hilla Sferruzza: Yes, I think that’s a good way to look at it. I think we try to introduce this concept on our last call. We kind of look at our inventory in two different categories. Our WIP our sticks and bricks is turning much, much faster both from the improved cycle time and the way that we’re shifting in our strategy. So you’re seeing that cash conversion happen very, very quickly. At the same time, we’re also growing. So our land investment is increasing, which obviously, as you know, it takes back two years to come to market. So that piece of our balance sheet is growing. We’re improving that with the off-balance sheet piece. We haven’t really talked about it yet on Q&A, but it’s pretty material growth in off-balance sheet utilization this quarter. So we’re getting that cash benefit on our balance sheet. So overall, I think we’re comfortable holding and we’ll want to continue to hold very large cash balance consistent with the other builders. I think we were all a little gun shy during rough times in the cycle over the last 15 years. We’re going to have a big war chest of cash same as everybody else. So you’re not going to see us materially pulling that back on the cash balance that we have today, which pretty much means we’re redeploying what we’re generating back into the business and to dividends and share repurchases, but probably not going something materially beyond that, which means that we’re going to have to utilize off-balance sheet financing to get to the numbers that we need to on our land spend.
Carl Reichardt: Okay. I just wanted to see if you give us a sense as to what OCF might be for 2024. So I’ll leave that. But I did want to add one other element here. So the land that you’re looking at now, my sense is you want to continue to invest in the markets where you’ve already got a deep presence because you want to build your share there. But as you’re starting to look out a couple of years on the acquisitions you’re making in the land market now, could we think about the potential that you begin to expand into some new areas? Or should we expect that you’re going to continue to focus on the key markets that you’re operating in now? Thanks.
Phillippe Lord: Yes. Appreciate the question. As we think about going from where we are at 20,000 units, it really works this way. I think we can grow, first and foremost, market share in the markets we’re already in. Our goal is now to be a top three builder in every market that we’re in. We also have entered four new markets in the last, I guess, 40 years or so, Charleston, Myrtle Beach, Jacksonville and Salt Lake City. So we’re getting those up to scale. So that’s a big focus of ours. And then there are a handful of secondary markets in the South Texas and Florida that we’re looking at. That are also part of that plan. So that’s kind of the hierarchy of our priorities as we work to 20,000 units.
Carl Reichardt: Okay, thanks Phillippe. Thanks, Hilla.
Operator: Our next question comes from Susan Maklari with Goldman Sachs (NYSE:). Please state your question.
Susan Maklari: Thank you. Good morning everyone. Your cancellation rate has been running kind of in that high-single, low double-digit range, which as you mentioned, is really below that mid-teens historical norm. As you think about the new strategy that you’re putting in place, should we expect that, that can continue to come down? Does this feel like a more normalized level going forward? Just any commentary on how that’s coming together and how we should think about the trajectory there as the full implementation of the strategy comes through?
Phillippe Lord: Yes. Thanks for the question. It’s definitely something that we’re studying very carefully. We obviously believe hypothetically that if we’re selling 60-day move in homes, buyers are pretty committed at that point. They’re picking out their furniture at that point. So we feel like our cancellation rate should run lower than folks that aren’t selling 60-day move-in ready homes. So long term, structurally, we believe our cancellation rate could move down meaningfully from where it has historically. But we still need to study that carefully. Certainly, in Q2, we saw a really strong metric and believe that, that could be sustainable.
Susan Maklari: Okay. And then you saw some nice leverage on the SG&A line this quarter. As you think about the back half and the seasonality in the business, just any thoughts on where that can go over the next couple of quarters? And how should we think about some of the investments that will be required around the strategy relative to the leverage that you can achieve?
Hilla Sferruzza: Great question. Thank you, Susan. So most of our committed capital to execute on the strategy is already in place. So you shouldn’t see a big increase and SG&A commitments related to the strategy rollout. We’ve been rolling it out behind the scenes for about 12 months to 18 months. As far as leveraging, as we said, if we’re going to have a lower revenue and lower units in the back half of the year, there’ll be some pullback in leveraging, although we continue to refine our cost structure, and we expect to be able to be under for the full year this year versus last year, and we have a target of 9.5% SG&A leverage longer term. So maybe a little bit of an increase in the back half of the year, but we’re still going to remain under our prior guidance, which is 10% or better.
Susan Maklari: Thanks for the color. And good luck with everything.
Operator: Our next question comes from Alex Barron with Housing Research Center. Please state your question.
Alex Barron: Thank you. Good morning. I wanted to ask, assuming the Fed starts to cut rates later this year, how are you guys in assuming rates start to move towards 6% or lower over the course of next year? How do you guys envision your approach to incentives? Do you feel like you would reduce the incentives to boost margins? Or you would maintain high incentives to boost the sales pace by offering even lower interest rates.
Phillippe Lord: I think lower rates can only be good for our business and for the housing sector in general. I know people are concerned about lower rates and the impact they’ll have on existing home inventory. But I think it’s only a good thing it will help inventory turnover and those folks need to find a home, et cetera, et cetera. And I also think it should help with incentives, clearly. Right now, we’re utilizing incentives to basically need a payment for our buyers. That’s what the dollars are being used for. And I think as rates go lower, we’ll use less of those. And because we are a move-in ready builder, there’s not a lot of other incentives we need to offer. We don’t do options or design centers or lot premiums, the price of the home is the price of the home and so I think lower rates will have nothing but a positive impact on our incentives Meritage Homes.
Hilla Sferruzza: Alex, if we wanted to pull that trigger, we can use it in any way that we can. As we’ve said, it’s only going to be a benefit. If we choose to continue to press on the gas and increase the sales pace, the cost of the incentive will be less, right, buying someone down into something with a four in front of it from almost seven is much more expensive than buying them down to something with a four in it from a six. It’s still a material improvement over what they can get from – in the retail market or from their local bank, but the cost to us would be a lot less. Obviously, for that 100 bps spread. So I think that there’s opportunities every home buyer has their own story. And we have an arsenal tool that we can use to make sure that we’re getting them into the home, but optimizing our margins at the same time.
Alex Barron: Yes, because it would seem if you were to offer lower rates, say, in the 4s or even in the 3s as time goes by, that you could get a big edge over others who would probably not do that. My other question had to do with – you mentioned maybe your next target is to go to 20,000 units. Over what time frame would that happen? Or do you guys have like an annual growth rate that you’re trying to hit over the next few years?
Phillippe Lord: Yes. Some of that will just be dictated by sort of reading the markets and our ability to secure land at the right price to underwrite. But even with those factors in line, we believe we can grow 10% year-over-year. So that’s the minimum, right? If we can do more than that, we will. And so when you think about that, I think you’re looking at a three to four year time line.
Alex Barron: Got it. All right. Well, best of luck. Thank you.
Phillippe Lord: Thank you.
Operator: Our next question comes from Ken Zener with Seaport Research Partners. Please state your question.
Ken Zener: Good morning everybody.
Phillippe Lord: Good morning.
Ken Zener: Just a two part question first. When do you think, given your planning, you’re going to see starts match the order pace given your rollout?
Phillippe Lord: Well, they’re pretty close. We have a little room to go, but we’re pretty close, but we’re also going to see meaningful community count growth over the next six quarters. So for new communities, it won’t match exactly quarter-by-quarter until we get those in. But other than that, what could be the only delta – so like Hilla said, I don’t know January 1 is the cutoff date. We still have some communities and divisions that we’re getting situated here as we roll out the strategy. But as we move into next year, that should be what they should match other than community count growth.
Ken Zener: Okay. And so just so we can understand the progression of your increased land banking given your growth. Can you talk to the mix of finished acquired lots this quarter, so if you bought 100 lots were 30% of them finished given they owned a lot to be either raw or finished and then as well, what’s that been kind of as a percent of sales, so closings from what you acquired finish. Just trying to understand that dynamic as you change your land approach.
Phillippe Lord: Yes, we can follow up with you on this later. I don’t think we have those metrics in front of us, but I think what you’re asking us is as we start to land bank more are we going to be buying just-in-time finished lots from that land bank. Is that the spirit of your question?
Ken Zener: It is a piece of it. And that’s actually – maybe you could clarify, when you’re doing the land banking, are you having the bank the – are you buying raw land from them? Or I assume you’re implying you’d be buying finished lots. Maybe just a clarification.
Phillippe Lord: Yes. So there’s lots of different land banking structures out there. We’ve been running closer to 30% for a while because most of the land banking that we’ve done is with land sellers. And that type of land banking is you take phase takedowns from a farmer or somebody else over time and buy lots when you’re ready to put a shovel in the ground start developing, and it helps us keep some of the land off balance sheet and land bank. There are also traditional land banking structures out there that are – to land bankers who come in and buy the land, pay for the development and then roll you finished lots. We haven’t done a lot of those, but are starting to ramp that up. Over time, that piece of it will provide finished lots. As it relates to the market, there aren’t a lot of finished lots out there. So we’re not finding a lot of finished lot deals. I think over 98% of our land is self-developed.
Ken Zener: Thank you very much. Appreciate it.
Operator: Thank you. And our next question comes from Jay McCanless with Wedbush Securities. Please state your question.
Jay McCanless: Hey, thanks for taking my questions. The first question I had with this new strategy and trying to sell within that 60-day window, is there going to be a lag as you’re opening these new communities until you can actually start selling homes just based on that 120-day cycle time you’re talking about seems like you’re going to have to get some of these homes built before you can actually open the communities. Is that the right way to think about it?
Phillippe Lord: The right way to think about it if we were pivoting, I mean every land and community growth schedule we have now built that into our plan already, and we’ve been layering that in for over a year. We’ve been 100% stack builder for a while. So all we’re doing now is carrying those specs 30 more days or so. So we’re building those into our community schedules. We’re building those into our forecasting, and we’re building those into our underwriting when we actions by land that we know when we open up our communities we need to open up with move-in inventory.
Hilla Sferruzza: To say another way, most people don’t open up communities without any inventory kind of ready to go because it’s a new community, people want to see it, right? So typically, when you open up a new community, at least if you’re a spec builder, whether you’re a 60-day move in or not, you have inventory ready. So as Phillippe mentioned, you’re already in the construction cycle. So maybe you’re just a little bit further along and our 60-day commitment, but it’s not too different than how we’ve been operating.
Jay McCanless: Okay. And then in terms of the gross margin impact from some of the extras you guys talked about in the Analyst Day, the lines, garage code, et cetera. Do you have an average so far of what gross margin impact those extras are going to put on the house?
Hilla Sferruzza: We were conservative and we thought that they would be breakeven. We didn’t know that we had the opportunity to increase prices. We thought we were going to put this stuff in the house because we align with our strategy and we were going to kind of charge cost for it, but we’ve actually been able to earn a nice margin on it. So I would say, worst case, it’s neutral, best case, maybe it’s adding like 5 bps, but we are actually seeing a profit component on that move-in ready package, we probably underestimated the desirability of that package in the marketplace.
Jay McCanless: Okay. And then the last one for me. Could you benchmark where you are in terms of rolling this out? Is it 60% of the account, 70% of account? Any type of frame of reference for where you are in the rollout?
Phillippe Lord: Yes. There’s different tenants, right, where when it comes to move-in ready, we’re 80s-percent when it comes to having turnkey homes, it’s a little bit further and then when the realtor relationship piece, we’re still figuring out. So we expect to have this fully implemented next year. That’s the time line we’re on as you sit here today.
Jay McCanless: Okay. Great, thanks for taking my questions.
Phillippe Lord: Thank you.
Operator: Thank you. There are no further questions at this time. I’ll hand the floor back to Phillippe Lord for close remarks.
Phillippe Lord: Thank you, operator. I’d like to thank everyone who joined this call today for your continued interest in Meritage Homes. We hope you have a great rest of the day and a great weekend. Thank you.
Operator: This concludes today’s call. All parties may disconnect. Have a great day.
This article was generated with the support of AI and reviewed by an editor. For more information see our T&C.
