Earnings Call: Q1 2021

Apr 28, 2021

Hello, and welcome to the Meritage Homes First Quarter 2021 Analyst Call. At this time, all participants are in a listen only mode. A question and answer session will follow the formal presentation. As a reminder, this conference is being recorded. It's now my pleasure to turn the call over to Emily Tadano. Please go ahead. Thank you, Kevin. Good morning, and welcome to our analyst call to discuss our Q1 2021 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 caution you that our statements during this call as well as the press release and accompanying slides contain forward looking statements, including but not limited 2, our views regarding the health of the housing market, economic conditions and changes in interest rates, community count and absorption, Supply chain constraints and cycle times, projected second quarter and full year 2021 home closings and revenue, gross margins, tax The current opinions of our 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 press release and most recent filings with the Securities and Exchange Commission, specifically our 2020 Annual Report on Form 10 ks, which contains a more detailed discussion of those risks. We have also provided 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 Hila Thank you, Mr. Ferruzza, Executive Vice President and CFO of Meritage Homes. We expect this call to last about an hour. A replay will be available on our Web within approximately 2 hours after we conclude the call and will remain active through May 13. I'll now turn it over to Mr. Hilton. Steve? Thank you, Emily. I'd like to welcome everyone participating on our call today and hope that you and your families are continuing to stay safe and healthy. I'll start by discussing current market trends and give an overview of the start to the year. Philippe will cover our strategy and quarterly performance. Kilo will provide a financial overview of the quarter and 2021 guidance. The housing market remains very robust, A continuation of the exceptional momentum of 2020. The spring selling season began earlier than normal and is still going strong today. Meredith delivered another record quarter another record performance, including the company's highest Q1 of orders and closings And the highest quarterly homebuilding gross margin since Q1 of 2006. The successful execution of our strategy focused on affordable, Entry level and 1st new home to meet the current demand accumulated in our culminated in our absorption pace A 5.8 per month for the Q1 of 2021, up from 4.3 per month In the prior year, which was the strongest Q1 absorption pace since 2,005. We achieved this pace even as we managed our spec starts and the corresponding orders in most communities to align with the production constraints in the market today. Absent significant interest rate increases, We believe the current market demand will continue the rest of this year and provide the housing industry ongoing pricing power To offset commodity and other cost increases and deliver strong margins. Looking forward, we believe the favorable homebuilding macroeconomic conditions will continue for the next several years. Mortgage interest rates remain very affordable and despite the recent uptick on an average 30 year mortgage rate, 30 year mortgage rates are below 3.25 percent in our backlog. Buyers in the entry level space are mostly buying a payment. So as long as the payment still makes sense, the demand continues to be very strong. Secondly, strong demographic trends persist. Most millennials are having life events that align with homeownership and most baby boomers are becoming empty nesters wanting a smaller home. Lastly, the supply of new and retail homes continues to be constrained and we believe Emergent is well positioned to capitalize on this current environment and will continue to deliver greater year over year volume and drive profitability over the next several quarters. Now please turn to Slide 4. Earlier this month, Valvoline and Meredith's deep commitment to be an early adopter and an industry leader In building energy efficient homes, the EPA awarded Meritage Homes the 2021 Energy Star Partner of the Year for sustained excellence. As an 8 time recipient of this recognition, we challenge ourselves every day to improve upon our environmental stewardship In our communities and the planet as a whole, as evidenced by our recent launch of a new multi speed HVAC system standard in all new homes as of this April. This system operates more efficiently than traditional air conditioning units, allowing owners to better manage the comfort of their home, while reducing their environmental impact and operating costs. In keeping with our commitment to innovation, we also rolled out an enhanced and connected smart home automation suite to complement existing home technologies To complement existing features, we've introduced as a centralized management hub of our entire smart home technologies To enhance functionality for our hardware, we're also adding door sensors and motion detectors to increase safety and security. This quarter, we allowed customers to transact quicker and more easily by adding an on demand homeowners insurance quote to our online financial services operating, which also already included online mortgage pre qualification tools and electronic payment of Earnest Money Deposit. In addition to watching our ESG page on Earth Day last week, detailing our commitment to the environment, our employees' well-being In corporate responsibility, from a diversity, equity and inclusion perspective, we enhanced our recruitment process targeting And even stronger, more diverse next generation of Meritage leaders, both in the field and in corporate. We will continue to financially support organizations that drive more diversity, Equity and inclusion across our nation. Our achievements in energy efficiency, innovation and DE and I We'll continue to add long term value to the customer experience and shareholder return. I'm also proud to announce that we are entering our first new market since 2016 With the completion of several land acquisitions, the new Coastal Carolinas division expands our East region operations into Charleston, Myrtle Beach and surrounding areas in South Carolina. We'll start marketing campaigns in the next few quarters ahead of opening these 5 new affordable entry level communities in 2022. I'll now turn it over to Filip. Thank you, Steve. Given our strong performance in 2020, we are now a top 5 builder in 10 of our 17 markets and we aim to continue gaining market share in all of our geographies. As we've covered in the past, our strategy is to offer quality yet affordable homes in the entry level and first move up markets. That being said, the ongoing surge in housing demand has enabled us to capture strong pricing power in all of our geographies with year over year quarterly price increases of at least 20% on average. Despite these increases, closing ASPs are down a bit year over year And orders and backlog ASPs are up just a small percentage year over year this quarter, all due to our focus on entry level products. For the balance of 2021, we will continue to maximize pricing power wherever possible based on market conditions, while managing our spec starts And the related order pace to better align with current supply channel constraints. We believe this case will allow us to continue to generate elevated gross margins. Despite an increase in FHA limits early this year, our pricing power has allowed us to push ASPs of NGL products above these new FHA limits in some locations. While this is not typical for our industry level communities, we are closely monitoring each location to determine if the increase is impacting demand. We closed 2,890 homes this quarter, up 25% year over year. Home closing revenue of $1,100,000,000 in the current quarter increased 21% compared to 2020. In the Q1 of 2021, we achieved a 24.7 percent home closing gross margin, up 4.70 bps from 20% in the prior year. We sold 3,458 Homes this quarter, which was 11% higher than the same period of 2020. The first store absorptions were up 35% year over year from 4.3 to 5.8 per month and accelerating faster than total order growth, Even as we increase prices and limited orders, demonstrating our capacity to generate significant order volume once we hit our 300 community count target In mid-twenty 2022. In the quarter, strong demand exists in both NG Level and First Move Up products. Entry level comprised over 76% of our orders for the quarter, up from 61% in the Q1 last year. Entry level also represents 73% of our average active communities compared to 49% a year ago. Our FERC move up communities also experienced improved demand year over year with absorption 45% higher than a year ago. Now turning to Slide 6. Moving to the regional level trends on Slide 6. All our regions reflected solid year over year absorption growth in Q1. Our each region led in terms absorption growth with a 67% improvement over the Q1 of 2020. Orders in each region increased 39% year over year for the quarter, which offset a 16% decline in average community count. The East region has the largest increase in entry level communities, resulting in 72% of its average active community selling energy level products during the quarter compared to 36% in Q1 of last year. Tennessee's absorption pace of 6.6 per month was the highest for any of our states in the Q1 of 2021, Back from storms and community count gap out in 2020. Absorptions for our central region comprised of our Texas market increased by 34% over the Q1 of 2020, despite a 21% reduction in average community count. Energy level communities represent 75% of the Central region's average active communities during the quarter, up from 56% from the Q1 of the prior year. Our Q1 2021 absorptions in the West region were up 13% over the same quarter in the prior year, even with a 6% decrease in orders and 16% fewer average communities. On a year over year basis, Arizona increased both order volume and average community count. We've been able to open up new stores here and capture the exceptional demand in one of the strongest homebuilding markets today. The continued demand in California and Colorado led to a 31% decline in the average communities with a corresponding reduction in order A 17%, but 20% higher absorption pace year over year. Energy level communities represented 70% of the West region's average Active communities during the quarter, up from 50% in the prior year. Turning to Slide 7. Of the 2,890 home closings this Quarterly quarter, 71% came from previously started spec inventory, in line with 69% a year ago. We ended the quarter with over 2,200 Average of 11.2 in the Q1 of 2020. At March 31, 2021, less than 10% of total were completed versus our typical runway of 1 third. Maintaining our goal of a 4 to 6 month supply of entry level specs On the ground has been challenging, even as we manage our order pace. Selling more specs in early stage production to meet elevated demand, as well as managing our to correspond with the supply chain constraints drove the lower spec inventory levels as well as the percentage of completed total specs. And similarly, this trend led to the 47% increase in our backlog to 5,240 units at the end of the first quarter. Our backlog conversion rate decreased to 62% in the Q1 this year from 83% last year and will likely remain in a lower than average range given sustained demand as As a result of both selling homes earlier in the construction process and the temporarily lower volumes of spec available for sale due to the longer cycle times. Although supply side headwinds minimally impacted our Q1 results, we are now expecting delays, which is leading to extended construction cycle time of 2 to 4 weeks. We are still committed to our spec strategy, which enables us to pre plan our start and should allow us to pre contract for building materials in advance and minimize the impact of supply chain constraints. Labor challenges are a perennial issue in our sector, Although currently, we have not experienced any notable label issues. We expect our transparency and scheduling visibility will continue to be attractive to local trade, but we continue to monitor for any indication of a tightening labor market. Even in today's environment with supply side delays, Our spec strategy in the entry level communities remains a core tenant for us. This building methodology gives us a competitive advantage, especially when commodity costs are rising. Since the homes we are selling have already started construction, we are able to better manage our profitability and avoid cost risk by locking in costs before pricing the home. Additionally, the quick close timeline of spec home allows customers to lock in a mortgage rate. We believe that our spec strategy has enabled us to increase our market share and will continue to do so as we grow to become a top line builder in all the markets in which we operate. I will now turn it over to Hilla to provide additional analysis on our financial results. Ella? Thank you, Phillippe. Let's turn to Slide 8 and cover our Q1 financial results in more detail. As Felipe noted, the 21% year over year closing revenue growth in the Q1 was the net impact of 25% increase in home closings, partially offset by a 3% decline in ASPs. While ASPs reflect a greater mix of affordable entry level homes, They also include year over year price increases of at least 20% on average due to the favorable pricing environment. The 4 70 5th improvement in Q1 20 20 1 home equipment direct margin to 24.7% From 20.0 percent a year ago mainly resulted from higher ASPs as well as the additional closing volumes and efficiencies gained from continuing to streamline our operations. These improvements mitigated record high lumber prices as well as other commodity price increases. It's been well documented Certain homebuilding materials are generally constrained in today's environment due to ongoing pandemic related supply chain disruptions, some weather events and 12 plus months of elevated demand. These shortages and rising costs are impacting all of the construction industry to some degree. While we're certainly not immune to this phenomenon, we believe our limited SKU comp and predictable construction cadence allows us some advantages to M and G delays. SG and A as a percentage of home closing revenue was 9.8% for the current quarter, a 95% improvement over prior year. The higher revenue and savings achieved from increased technologies, particularly in the sales and marketing channel allowed us to better leverage our SG and A. We believe we can sustain strong margins in 2021 despite higher commodity costs, but we do still anticipate some additional overhead costs related to our growth to 300 communities prior to the incremental closing in revenue from that new business. This will result in an increase in SG and A dollars over the next several quarters, but we expect the incremental revenue beyond 2021 to drive material SG and A leverage in future years. The Q1 of 2021 effective income tax rate was 20.6% compared to 18.1% in the prior year. Both years reflect reduced rates from the eligible energy tax credit under the 45 L provision and some retroactive pickups In 2018 2019 Energy Credit. Overall, in the Q1 of 2021, we achieved price increase And higher closing volume was a more efficient, streamlined operation, while balancing our order pace with production. This produced expanded margin, improved SG and A leverage and an 88% year over year increase in Q1 diluted EPS to $3.44 Moving on to Slide 9. Our balance sheet remains strong even as we continue pushing forward to our 300 community count goal. We achieved several objectives this quarter. Late in the quarter, we issued $450,000,000 of new senior notes priced in $3.78 due in 2029. We We received approximately $444,000,000 in net proceeds on April 15. On March 31, 2021, we issued a notice redemption for all of the $300,000,000 principal outstanding on our 7% senior notes due in 2022 with the redemption date of April 30, 2021. The early redemption of the 22 notes will result in approximately $18,200,000 of early extinguishment of debt charges in the Q2 of this year. We repurchased 100,000 shares for a total of $8,400,000 to partially offset the issuance of annual employee grants. We also received an S and P credit rating upgrade this past February, the 3rd credit rating agency upgrade in the last two quarters. We are now 1 notch alone investment grade from all 3 rating agencies. At March 31, 2021, our cash balance was $716,000,000 Compared to $746,000,000 at December 31, 2020, primarily as a result of Greater Lands Bank and share repurchases. Our net debt to cap remained low at 10.9%. We've previously noted that we have set our maximum net debt to cap target in the high-20s, low-30s range, which which is in line with the quick asset churn from entry level and first move up offerings. Our priorities for the next several years remain the same. We expect to use the bulk of our cash on land spend for our growth strategy and to get spec into the ground. We plan to We look to take the majority of the returns back to work to achieve long term volume growth, drive profitability and gain market share. On to Slide 10. On March 31, 2021, with over 58,000 total lots under control, we had 4.7 year supply of lots Based on the trailing 12 months closing, in line with our target of 4 to 5 year supply of lots under control, we increased our land book by 40% For approximately 41,500, it's March 31, 2020. We're making good progress and remain on track to achieving our 300 community count goal by mid-twenty 22. Despite our accelerated absorption pace, we opened up more communities than we closed in Q1 this year As we already own or control all of the land necessary for our 300 communities, we're currently working through the development of land for the next five We spent nearly $370,000,000 on land acquisition and development this quarter, a 50% increase from last year's Q1 spend. We expect our land spend to be more than $1,500,000,000 annually in 2021 and beyond to sustain and replenish Our 300 communities. We recognize that land type appreciation and additional demand for land from all boaters exists today. We've been able to refile our land pipeline without compromising our underwriting standards. In the Q1 of 2021, We secured 5,900 net new lots more than double the volume in the same quarter of 2020. Our net new lots translated to 43 new communities of which approximately 95% are entry level to maintain our focus on affordable homes in the future. To adjust the higher orders pace of entry level products, the average community size contracted for in the Q1 of 2021 is 129 lots, up 26% from the Q1 of 2020 where the average size was about 102 lots. Acquisition of larger lot sizes limits some of the And enables us to leverage the larger lot comps to reduce community level overhead costs per lot, while minimizing the community count churns and the inefficiencies associated with the opening and closing adult communities. To preserve liquidity, we're using options or staggered purchasing terms where financially feasible. About 60% Our total lot inventory at March 31, 2021 was owned and 40% was optioned, a slight improvement compared to prior year's 63% owned and 37% optioned. Finally, I'll direct you to Slide 11. The pricing environment has been stronger than we anticipated, which This has allowed us to increase pricing by at least 20% year over year on average, driving up our gross margin expectations beyond where they were just 3 months ago. With these higher ASPs offsetting increased commodity costs, for the full year 2021, we are now projecting total closings to be between 11,700 12,700 units, home closing revenues of 4,550,000,000 to 4,850,000,000 Loan closing gross margin of approximately 25 percent and effective tax rate of about 23% and diluted EPS In the range of $13.75 to $14.75 At March 31, 2021, we had 203 active communities, in line with our guidance and slightly up sequentially from 195 communities at December 31, 2020, but down from 2.41 in the prior year. Despite weather and general supply channels slowing, we were able to open up our Communities on time, 30 openings, up 36% from 22% in the Q1 of 2020. We continue to anticipate about 200 communities for Q2 this year and given our strong pipeline for community openings, we expect We'll see an increase of approximately 20% in our community comp by December 31, 2021 from the current level today. As for Q2, 2021, we are projecting total closings to be between 2,800 and 3,100 units, Home closing revenue of $1,100,000,000 to $1,200,000,000 Home closing gross margin of approximately 25 percent and diluted EPS In the range of $3.05 to $3.35 With that, I'll turn it back over to Filip. Thank you, Hilla. To summarize on Slide 12, we believe we are well positioned for increased demand over the next few years by continuing to execute on our end to level and first year strategy. Additionally, our 100% spec building in the entry level communities and our streamlined operations have been successful to date, and we expect our strategy will continue to serve us well in the future. We remain on track to achieving our 300 community count goal by mid-twenty 22, Given our strong balance sheet that allows us to make elevated land investments throughout the quarter to sustain a healthy land position. In the current environment, we will continue to push our pricing power where the market allows, while managing our spec starts and the corresponding order pace in line with supply chain constraints to deliver greater margins and profitability. With that, I will now turn the call over to the operator for instructions on the Q and A. Operator? Thank you. We will now be conducting a question and answer session. A confirmation tone will indicate your line is in the question Our first question today is coming from Alan Ratner from Zelman and Associates. Your line is now live. Hey, guys. Good morning. Congrats on just the amazing Margin performance, it's truly remarkable. So obviously, the demand environment is incredibly strong and I think you guys are Doing a great job of maximizing the pricing. I think that 20% increase definitely sounds higher than some of the numbers thrown out by some of your competitors. So it seems like the only limitation on sales, I guess, at this point is the production piece and how quickly you can get home started. And I think it makes a lot of sense that you're not selling Before starts, just given the uncertainty on the cost side. So, with your sales pace running close to 6 a month, What is your start pace running at right now? And what ability do you have to flex that higher if Possible or if not, if you could just kind of tell us where that's running at, that would be helpful. It's running almost the same, because As you know, in entry level, we're 100% spec. And frankly, in 1MU right now, we're more spec as well because that's what the buyers Our preferring, so it's almost the same. Our ability to ramp up our spec starts It's somewhat limited in today's environment just because of the production issues that we've been discussing. But we do have the ability as we open up these new communities To really come out of the ground strong and line that up. So we can lever it up as our community count growth stabilizes. But there is some limitation out there in the market just with the current constraints that are out there in production. And frankly, we think where we're pacing our communities It's really the optimal pace. It allows us to be really efficient with our trade partners and then maximize margins and control our costs. So we're really comfortable With our current pace, and we're not really looking to flex it up. We're trying to get our growth just through community count growth. Okay, great. That's very And listen, I know this is kind of one of these unfair questions, but just given how strong margins have ramped here over Short period of time, you guys are going to be turning your communities pretty dramatically over the next 18 months. And Without asking you to predict what prices are going to do, how realistic is that these margins can be sustained as you open up a lot of these new communities if pricing We're to return to something a bit more normalized, obviously, not up 20% year over year over the next 12 months. Yes. Well, obviously, land prices are going up. So that's going to drive some of the normalization of margins long term. That being said, a lot of land that we're bringing to the market was bought 2, 3 years ago. So So we feel really good about that basis. We certainly can feel comfortable sustaining these margins through 2021. We have a lot of new communities coming on in the back half of this year and into the first half of next year to get us to the 300. And again, those were bought quite a while ago. So we feel good that we're going to get above average margin as long as pricing Doesn't regret, if you will. But over the long term, when we buy new land today, we're And we're at our underwriting hurdles, not above our underwriting hurdles. And we're also hopeful that cost will moderate over time. Lumber will come back down somewhat once the supply chain has Then more stabilized and we'll be able to get some of these cost increases back. Sounds good. I appreciate that color and insight guys. Good luck. Operator, next caller. Thank you. Our next question today is coming from John Lovallo from Bank of America. Your line is now live. Hey, guys. Thank you for taking my questions as well. Maybe the first one on just the commentary around the FHA limits. I'm curious, how many markets are you selling above these limits? Maybe how quickly you could pivot back if needed? When is the last time you guys have been comfortable doing this? And then finally, what percentage of your customer loans are FHA? Yes. I don't have the exact number, but we certainly can follow-up with you on that. I would say that in the Really hot markets like Phoenix, for example, and maybe some a few other markets, California, We're pushing above FHA and MT level, but it's not across our entire footprint. The FHA increase that occurred this year was substantial. And For the most part, we've been able to stay below that, but we have seen the opportunity to push above that and still achieve our pace That we're looking for in that energy level space. I would tell you as we underwrite new land, we're still looking to breathe below FHA and we're sourcing land Below FHA for future yields, but it's not across the board. And then as it relates to the number of buyers using FHA, Kimberly, how that? Yes. So at the entry level space, which obviously is the bulk of what we do, it's less than a quarter of our buyers are utilizing the FHA So it's not nothing, but it's not the majority of what we do. So while it's critically important for us to stay below FHA in general In today's environment, it's picking up slightly above that. We're certainly seeing our customers having sufficient Capital to put down to get the net balance of loan below FHA and still to qualify. Okay. That's really helpful guys. And then, historically, 2Q absorptions tend to be flat to slightly versus 1Q. But given sort of the tight supply of homes at marriage right now, I mean, would you guys expect to push price to the point where 2Q absorptions could be down sequentially? How should we think about that? I think we're modeling outside of normalized seasonality, we're certainly not modeling faster pace For the rest of the year, as we noted a couple of times in the commentary in the prepared remarks, it's really the production constraints That are holding back the volume. I think Lumen's Builders have made similar commentary that volume could have been higher On the sales side, but it's really production constraints that are holding us back. So I think that's going to be the same governor in Q2 in the balance of the year. Yes. Last year, Q2 was really the start of the surge we saw out of COVID. So We started seeing elevated absorption pace in May June. We obviously have less communities this year than last year, so that's part of it. So it's all about getting the community count growth to really drive the order growth at sort of current pace per community that we're at. Got it. And one more quick one, if I may. Just given just the resin shortages that we've seen in Texas, are you seeing any pressure on the availability of spray foam? I'm sorry, what was are you talking about spray foam? Yes. Yes. Okay. Yes, we saw a little bit of disruption there when the weather Yes, but it was a temporary disruption and it seems to we're hitting it behind us and we're seeing regular production times and I'll cough at this point. Thanks very much, Chris. Thank you. Our next question is coming from Michael Rehaut from JPMorgan. Your line is now live. Thanks. Good morning, everyone. Congrats on the results. What a difference 3 months makes. First question on the pricing, obviously, extremely impressive with the 20%. Just wanted to get a sense, how much prices maybe have moved in the past 3 months, Because obviously that 20% is presumed on a year over year basis. And it would seem that obviously from a Pricing backlog and such that your ASPs are appear to be a bit more stable. So You're obviously at the same time having the impact I would assume a continued significant mix shift from entry levels. So just wanted to get a little more clarity around How that 20% is working right now? Yes, great question. So as you think about The last four quarters, if you will, as we came out of the pandemic, the pricing power has certainly accelerated Through those first quarters and we've seen the strongest pricing power in the last 90 days, if you will. It was also strong in the Q4 of last year. What's changed and why is that the case? I would just tell you the supply side has been the big variable of change as the resale market has not We bounded from the supply side and then clearly new builders are managing their production. The supply environment has really just created a complete This location between supply and demand that's generated in my mind outside pricing power as we move through those 4 quarters. So, I appreciate that. Is it possible to just give us a sense of what prices have moved over the last 90 days then just to get a sense of the more recent level of acceleration? We can provide that. It's maybe 60% the last two quarters and 40% the quarters before that. So it's not Completely disproportionate, we've been increasing pricing pretty much solidly through July with a slight acceleration in the last quarter. Okay. That's helpful, Hill. I appreciate it. I guess, secondly, just going back to the FHA comment, which is of interest, and I think it's important that You kind of noted that your buyer pool is perhaps less dependent on this source of financing And perhaps other builders, but I thought your comments also around the fact that, to the extent that the Sales price is above the FHA loan limit that if I heard you right that the buyers are able to make up for it with a bigger down payment and if They so choose or still want, can still get that FHA loan. So I wanted to make sure I heard that correctly if that's in How you what you said before and also to the extent that you're making these pricing moves In these hotter markets, is it fair to say that I presume that you're not this is something that You're not doing in a vacuum that perhaps there's pricing in certain of these markets that that's just where the price is in certain submarkets And other builders are kind of in the same boat? Yes, I'll take the last piece and then Hilo can give you some more on the FHA. We look at every community weekly. I mean, we have a robust approach to how we price our products, Lots of competitive data, what are other builders doing, not just based on how many buyers we've got lining up outside the door that want to buy a home. So we have a robust community by community pricing meeting that our operators execute every single week to evaluate where they can move prices On the next release of homes and etcetera, and we're managing to stay competitive in the market where we think we need to be price based on our products, Our location and etcetera. And then, Hewlett can talk to you a little bit about FHA. Yes. That's really disappointing. We can't Raise prices and a vacuum. If we raise them and no one else raise them, people wouldn't buy our houses. So we're staying somewhat in line with the market, although I do agree with you, our 20% On average, rate seems to be a little higher than maybe some of the peers that have disclosed so far. And then on the FHA, I'll give you an anecdotal answer. We're definitely very concerned about affordability as we always are being primarily entry level focused At this time, we're looking at budget appraisal all the time, right? We want to make sure that our buyers We qualify for their mortgages and close on the home. There's very few appraisals that don't clear, but those that don't typically the buyers just putting in the excess So our buyers are well qualified and can afford the homes in the market today. Let me just add one sentence on that. Much like one of our larger peers said on their conference call, the FHA moment is a really important goalpost for us. And please welcome to this and I'll speak more to it that we need to position Almost all of our communities, most of our communities at or below the FHA loan limit because that's what we believe is the The affordable landline in the sand. And we've been doing that and we are doing that and that's what we're going to continue to do. Great. Thanks very much. Congrats on the results. Thank you. Thank you. Next question today is coming Stephen Kim from Evercore ISI, your line is now live. Congratulations on the great results. Just wanted to follow-up on a couple of things. First on the FHA thing that people have been talking about. One of the things that's interesting about the FHA as you know is that They raise those loan limits based around what home prices are doing. They do it once a year, so you got a little bit of a ways to go. But As you are contemplating opening up new communities and want to stay below that FHA loan limit, I assume that you are factoring in You're thinking that the FHA loan limit is most likely to rise at a double digit rate by the time these communities are open. Is that correct? That is incorrect. We always underwrite our land at current pricing. And we try to think about underwriting our land at normal absorptions. So we do not We do not underwrite land assuming that there's going to be an FHA ceiling raise and we don't underwrite land assuming that Prices are going to be appreciating from here. That's really the discipline. Now, I can't speak for everyone, but that's Our focus right now, we're moving further out, we're buying bigger deals where we can leverage costs, but our focus is to stay below current FHA limits on buying new land. It's just an additional layer of conservancy that we have. It's totally in the room. When we open up to increase prices, If the market gives it to you and the FHA limit rises and then I don't need to remind you, I know you track it as closely as we do, FHA limits rose until they Right. And when they drop, a lot of us are caught off guard if your target is an entry level community focused. So for us, it's safest To model today, not expectations for growth for tomorrow. Yes, I get it. Great. So that's really bullish then for the outlook for next year. With respect to the communities, I think you indicated that you are 26% Larger on average, I think, for the communities that you're looking to bring on. My question is, are those new communities Geared to run at a higher absorption rate as well or is your intention to live in those communities for longer? Either or. If the market remains elevated, we're hoping to avoid turning over More than a third of ourselves every single year trying to become more efficient. But if we're out there for 4 years instead of 3 years at a 4 month pace or a 5 month pace, that works just fine as well as it relates to how we underwrite the land. So it's a little bit of both, But the primary focus is just to avoid the turn of our communities. If we want to get to 300 communities, we want to open up about 100 a year. As we go to 400 communities, we want to open up 125 to 150 a year, and that's really the math we're running on the size of the deals we need. Yes, very helpful. And then you talked about the I I think earlier in your remarks, I may have missed it, but did you talk about analyzing the loans that are in your backlog that And your buyers and your backlog to determine what kind of mortgage rate they could sustain because I know that a couple of your peers have done that and they sort of suggested that They could see mortgage rates go above 4% and still really not have any stress in their backlog. Wanted to see if you guys have specifically looked at that? Yes, I'll take that one, Steven. So we did the same analysis. We did a 50 and a 100 bps stress test on our existing backlog and a very, very Low percent like 5 ish would have 5 ish percent would have an issue if we had a 100 and bps increase. Now As a reminder, that's just they bought the exact same home. Certainly, they could just tick down to a slightly less expensive house and buy something else. So we think that there's very little Deterioration risk on qualification. Now the question is if you had 100 bps increase, would there just be a pause From a psychological issue, that's a different question, but from a qualification issue, we don't seem to have too many concerns on the financial stability of our buyers. Awesome. Thanks very much guys. Great results. Thank you. Thank you. Our next question today It's coming from Carl Reichardt from BTIG. Your line is now live. Thanks very much everybody. I'm reminded of a few years ago when Steve was talking, wondering about when gross margins We get above 20%. I wanted to ask one just about land and how you're looking at it, You in particular, how much utilization of land banking are you using now versus plain vanilla 3rd party lot developers versus self development on the stuff that you're looking at today? Yes, it's still heavily weighted towards self development. We are seeing in the entry level space, we are seeing sort of structured takedowns with the land seller, But we're doing almost 0 kind of traditional off balance sheet financing with a 3rd party. We have some partners that we are working on relationships with. We need to leverage that to achieve our growth goals. But for the most part, anything that's on option today is through the land seller and it's sort of a structured land seller Stage take down hyper adoption. Okay. Thanks, Philippe. And then we talked about entry level. Can we talk about move up for a second? I mean, I know it's only a quarter of the business now, but Are you seeing similar pricing power, similar margins to the entry level now? And then sort of over the longer run, Where do you think the entry level as a percentage of your business kind of tops out? Where are you comfortable? Thanks. Yes. Certainly, the year over year absorption pace in the two segments is about the same. We've seen an increase there. But our move up communities are absorbing at like close to 5, while our entry level is 6. So there is a discrepancy there. It is a smaller percent of our business right now, but that's mostly just due to the elevated pace that we're getting out of entry level. As we look at new land right now, I would tell you that LiveNow is more attractive to us. We're getting better pricing on LiveNow land and 1MU land. 1 MUN appears to be more frothy and pricey for what we're looking for. So we may see a slight trend from what our Long term goals are for LiveNow over the next couple of years. But at the end of the day, we want to be somewhere between 67% LiveNow And 30% to 40% 1 on you depending on what the strength in the market is. I appreciate it. Thanks, Philippe. Thanks, everyone. You're welcome. Thank you. Our next question is coming from Deepa Raghava from Wells Fargo. Your line is now live. Hi. Good morning, everyone. Thanks for taking my question. I'll start with April commentary. Are you able to comment on the strength of April orders So far perhaps and just how it compares versus how you exited March, I'm assuming your comps are going to be easy as well. So if you can level set Yes. We don't give out guidance in the quarter, but On sales and orders, but the market hasn't done anything different than it was doing for the last 6 months. The supply constraints are still there. The demand is still there. The low interest rates are there. Nothing's Really changed from that perspective. April feels strong. As you pointed out, the March in April comps are A little weird because of COVID last year and then we saw this big surge that occurred in May June when Everyone realized that during COVID, they actually wanted to buy a house. So, but right now, the market doesn't feel like any different than March. And it feels like it's just continuing on and I really just don't see anything out there that's slowing it down right now. Yes. Just to reiterate, I know you guys have our numbers, but we actually had higher sales in Q2 last year than Q1 despite COVID. April was tough, Like May and June covered, so the year over year comps do not ease for us in Q2 over Q1. Got it. Yes. All right. That's helpful. My reference was more April comps, but yes, that's helpful too. So impressive Gross margins, obviously, your pricing power is solid. However, you're ramping up those communities at a time when supply chain has some hiccups and And also these are highly inflationary times. Can you talk to how you're trying not to be impacted more than the market on the because of your overwhelming demand needs, especially with that 300 community count target out there that you are Pretty adamant on hitting. How do you achieve the balance, so you're not impacting more than marketing costs? And I assume your The question is around vertical costs, not land costs? Yes, vertical, that's right. Yes. I mean, We just believe there's 2 things about our strategy that we're leaning into that we think allow us to sort of manage our costs In an environment where costs are stable and an environment where costs are unstable. The first one is Everything we've done to streamline our products, our product is extremely repeatable. We've moved complexity. We've reduced the number of products that go in our products. So we're very streamlined and we have the ability to source products probably differently than you had more products and align ourselves with our vendors and create relationships and plan out our business. The second piece is really just the spec strategy. And every time we open up a new LiveNow community, we open it up with a bunch of sets because that's what those buyers want. And we're able to be really thoughtful. We're able to plan that with our trade partners, cadence out our production appropriately and come out of the ground and manage our costs as best we can. So it's really about the streamlined product. And secondly, the specs It's how we sort of navigate that and we're very comfortable as we open up these communities. We opened up 30 this quarter and we opened them up with Good margins and good cost structure. The production was there. We were able to get the home started and get them framed and move them through. That's really where our strategy is. Okay. So you're not so what I'm hearing is you're Not impacted any more than the market. Your cost base is pretty similar to what the market and the rest of the industry has actually taken on, right? Yes. I mean, I think lumber is hurting everybody the same honestly. I think the only differentiator is whether you're able to actually get The product to your job sites, but everyone's kind of experiencing the cost. We have less products that go into our homes, so we see less cost pressure From all the other products that don't go into our homes. But yes, I think we're all feeling it the same and we certainly aren't feeling it anymore than anybody else. Got it. That's pretty helpful. Thanks very much. Thank you. Our next question is coming from Truman Patterson from Wolfe Research. Your line is now live. Hi, good morning, everyone. Thanks for taking my questions. Steve, I think the Enthusiasm is palpable from the release and the call. So, with that, I was hoping, Steve, you could elaborate a little bit on your thoughts on lumber. You mentioned potentially or hopefully easing, I believe, was the So any thoughts there? And then also on just your cost inflation expectations that are embedded in your 25% gross margin guidance moving forward. Just what sort of acceleration you're expecting to see? Sure. But let's lead to that. If you got a question about fishing, I can probably answer that for you, but I think Yes. I don't think anywhere in our remarks that we Say that we thought costs were going to ease in 2021. Everything we're seeing would suggest that we're going to continue to see pressure. Lumber futures are up. We're about to re lock across most of our footprint and we have material increases that are going on. That being said, we've had the pricing power to more than overcome that and we don't see that Changing anytime soon as we look out over the remainder of 2021. So costs are up, costs are going to continue to go up Until there's some catalysts on the lumber side, I don't see that changing in the near term. And But we think we have the pricing power. The pricing we've already taken over the 1st 90 days and then continue to take As we move through Q2 to maintain our margins that we've guided to. Yes. As we model Truman, when we're giving our guidance, We're building in some expectation of increased commodity costs, right. As we mentioned, there's a lot of rate locks coming up For longer over the next couple of weeks, so we're modeling that in the numbers that we provided in the guidance. Okay. Okay. Thanks for that. And then, you all reiterated your mid-twenty 22 community count guidance Multiple times. It seems like you're gaining some traction there. Community count Flexed positive sequentially, so clearly improvement there and stabilized. Could you just discuss a little bit how conditions may have Changed over the past quarter or 2, your ability to get communities open. There have been additional municipal delays, Any issues in developing land, tightness in your local land and divisional teams? I'm just trying to understand what some of the potential risks are in really hitting that 2022 community count target? Yes. I mean, it's not getting any easier. Municipalities aren't moving any faster and there's a lot more people trying to get communities open That are clogging up the system. Our teams are doing a great job moving through it and executing. No. We've said it before, but we have the land loaded and we're processing it To get to our 300 goal in Q2, I'm extremely confident that we're going to get there. You guys are going to start seeing That number moved up dramatically in the back half of this year and then continue through next year. We're 1 quarter Further into that commitment that we made, I think, in Q3 of last year, and it's only getting more clear, right? Things are happening on time. Weather events haven't occurred and slowed us down. We're getting the land processed, and we're tightening up those timelines. So for us, We're just another quarter more confident in committing to that number. But at the same time, if there was a significant weather event Or cities start to shut down for some reason, which I can't predict, we would obviously be impacted. But Right now, everything is a go and we're very confident about hitting that number. Truman, this is the same as the fire comment. We'd like to on the size of conservatism that we've built in some cushion on that 300 community count as well. So hopefully, we've Appropriately modeled as time delays and potential expansion in municipal approvals to still hit that 300 community count target on time. Okay. Thank you all. Welcome. Thanks, Truman. Thank you. Our next question is coming from Susan Maklari from Goldman Sachs. Your line is now live. Thank you. Hello, everyone. My first question is on the SG and A. I think when you reported back in January, you had suggested that you were targeting something just north 10% for this year, but when we think about where you started the Q1 actually below that 10% and kind of the normal seasonality or the cadence that we usually Does that suggest that that is probably coming down? And if so, what is any kind of new guide there that you can give us? That's a great question, Susan. I think it's a combination of 2 things. Number 1 is the higher ASPs than we had anticipated that 20% lift that we mentioned. That combined with our ability to hold back on some sales and marketing expenditures, whether it's a function of using more technology or Those efforts right now due to the accelerated benefit on both sides. Q1 came in notably lower than what we were expecting and guiding to. It's probably fair to assume that there's some incremental Pickup in leverage for the balance of the year from what we were thinking in Q4. As we mentioned in the prepared remarks, we want There are going to be some incremental dollar spend in SG and A in the back half of the year as we ramp up the community count. Helpful. And then my next question is around the cancellation rate. Can you tell us where that fell and kind of Changes or what's impacting that if there were any meaningful shifts? Yes, he was looking at it. I think it was 11%. We typically see we're going to be somewhere between 15 20, so especially entry level. So it's very low right now. As you can imagine, There's a tremendous amount of urgency with our consumers to hold on to their house and get into their house. There's not a lot of 2nd, guessing the decision and buyer rewards. So it's really low right now. Yes. As Philippe mentioned, the world normalizes. We're very comfortable and in fact we'd like to see that number pick up a little bit more. That means we're getting more people Into the funnel looking at our home, we'd much rather have a wider pool with more fallout than a smaller pool that 100% qualifies at the entry level space. Got you. Okay. Thank you. Thank you. Thank you. Our next question Ladies and gentlemen, that does conclude our question and answer session. I'll turn the floor back over to management Further or closing comments? Well, thank you again for attending our call. We really appreciate Your interest, we look forward to talking to you next quarter. Hope everyone has a great day. Thank you. Thank you. That does conclude today's teleconference and webcast. You may disconnect your lines at this time and have a wonderful day. We thank you for your participation today.