Greetings. Welcome to Meritage Homes Second Quarter 2022 Analyst Call. [Operator Instructions] Please note, this conference is being recorded. I will now turn the conference over to Emily Tadano, Vice President of Investor Relations and ESG at Meritage Homes. Thank you. You may begin..

Thank you, operator. Good morning and welcome to our analyst call to discuss our second quarter 2022 results. We issued the press release yesterday after the market closed.

You can find it along with the slides we'll refer to during this call on our website at investors.meritagehomes.com or by selecting the Investor Relations link at the bottom of our home page.

Please refer to Slide 2, cautioning you that our statements during this call as well as the press release and accompanying slides contain forward-looking statements, including but not limited to, our views regarding the health of the housing market, economic conditions, changes in interest rates, the potential benefits of rate locks, community count and absorption, trends in construction costs, supply chain and labor constraints and cycle times, projected third quarter home closings and revenue, gross margin, tax rates and diluted EPS, potential future disruptions to our business from an epidemic or pandemic such as COVID-19 as well as others.

Those and any other projections represent the current opinions of management which are subject to change at any time and we assume no obligation to update them. Any forward-looking statements are inherently uncertain.

Our actual results may be materially different than our expectations due to a wide variety of risk factors which we 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 2021 Annual Report on Form 10-K and quarterly reports on Form 10-Q which contain a more detailed discussion of those risks.

We've also provided a reconciliation of certain non-GAAP financial measures referred to in our press release as compared to their closest related GAAP measures. With us today to discuss our results are Steve Hilton, Executive Chairman; Phillippe Lord, CEO; and Hilla Sferruzza, Executive Vice President and CFO of Meritage Homes.

We expect this call to last about an hour. A replay will be available on our website within approximately 2 hours after we conclude the call and it will remain active through August 11. I'll now turn it over to Mr. Hilton.

Steve?.

Thank you, Emily. Welcome to everyone participating on our call. I will briefly discuss current market trends and provide an overview of our recent accomplishments. Phillippe will cover our strategy and quarterly performance and Hilla will provide an overview of the quarter and forward-looking guidance for Q3 '22.

Let me start by congratulating the entire Meritage team for achieving our long-term goal of 300 community this quarter ending June 2022 with 303 communities.

This milestone required a high level of execution and dedication by all of our employees amidst long-standing supply chain constraints and labor availability present in the market since mid-2020.

We continue to believe that now is the right time to be operating across these new locations as it will allow us to expand our market share from incremental order and closing volume. We think that the low supply of housing inventory and favorable demographics are positive factors for long-term volume of housing demand.

Household formations trends are now slowing despite changing macroeconomic factors. However, we acknowledge that the housing market is softening from the unprecedented demand levels of the last 2 years.

Volatility from rapidly increasing mortgage rates in short amount of time and the Fed's signaling of more to come are challenging affordability and buyer psychology. And Phillippe will share what we are seeing and hearing on the ground in our markets today. Now onto Slide 4 for recent accomplishments.

During the second quarter of 2022, we achieved our highest second quarter sales volume order -- sales order volume of 3,767 homes.

With $1.4 billion in quarterly home closing revenue, a company record for quarterly home gross margin of 31.6% and a lower outstanding share count, we achieved a quarterly record diluted EPS of $6.77 per share this quarter. 13 divisions at Meritage were recognized for customer service excellence awards from Avid this quarter.

Our Southern California division received the prestigious Avid Cup in the production category for the first time in our company's history which is the program's top honor given to one builder in North America each year.

In addition to being named an ENERGY STAR Partner of the Year for Sustained Excellence in 2022 by the EPA, the Environmental Protection Agency, our ninth year for this distinction since 2013. We also earned the 2022 ENERGY STAR Market Leader Award.

These EPA and Avid awards demonstrate our commitment to building better and more sustainable homes while delivering the industry's highest level of customer satisfaction. We also announced the extension of our partnership with Operation Homefront.

This year, where we are immensely proud to 3 deserving military families with brand-new, mortgage-free Meritage Homes in Houston, Nashville and Tucson Metro areas. This quarter, we held our annual Purchasing Summit.

We further strengthened our relationships and mutual commitments to work through the current challenging environment with our key trades and also took this opportunity to collaborate on improving the sustainability of the materials and products that go into our energy-efficient homes. And with that, I'll now turn it over to Phillippe..

Thank you, Steve. Our second quarter order volume reflects both the solid demand in April and May and a softer demand in June. After the June interest rate hike, the overall tone regarding the general market has caused a shift in buyers' expectations.

Since last quarter, we've been offering rate locks to help buyers secure their monthly payments and more recently, have begun offering other incentives in many of our markets to offset slower demand. Today, we are experiencing a return to seasonality as well as a pullback in the urgency to purchase a home that has been present for the last two years.

Additionally, many homebuyers are looking for a quick move-in home that can close in 90 days or less to lock in all uncertainties which currently is primarily available in the resale market.

We believe new home demand and cancellation rates have been impacted by limited available complete spec inventory and will continue to be choppy over the next quarter or two as the existing pool of near-finished spec inventory is mostly nonexistent in the new home space.

We expect to be able to better compete against the resale inventory in the later part of the year as the early stage specs we started this quarter, mature a near completion in the fourth quarter.

Our teams on the ground are focused on navigating the supply chain and labor constraints over the next two quarters to get this inventory back into the short-term moving category, that today's buyer is looking for and which has been the core part of our strategy for the past several years.

Over the next couple of quarters, we also expect the benefits of our disciplined land acquisition process to help us move down the price band as incremental affordable inventory comes online.

This low land basis combined with today's industry-leading high gross margins, provides us the cushion to absorb incentives to a much greater extent at any time in our company's history. We will continue to assess local market conditions and adjust our discounts, rate locks and pricing as needed to ensure we maintain our volume and market share.

I want to reiterate what we've been saying throughout the past few quarters. We welcome a return to a normalized market. As we've always known that the extraordinary market conditions in 2020 and 2021 could not continue indefinitely and were creating anomalies in both ASPs and cost structures.

Our business model was designed for a normalized pace in the three to four net sales per month range. As a seasoned management team that managed through the last downturn, we are navigating the changing dynamics to determine what today's normal is and then we are adjusting our spec and incentives to achieve this goal.

We believe our lower price point and product targeted at today's largest cohorts of the buying population, the millennials and baby boomers will continue to see demand at the right monthly payment.

In line with the current trends, we have been reducing the number of locks under control since January and meaningfully dialed back our land development acquisition spend during the second quarter of 2022 compared to prior year and our prior expectations.

As the housing market continues to evolve, we will continue to focus on strengthening our balance sheet and aligning capital deployment with both operational needs and shareholder returns. Now turning to Slide 5.

Given the long cycle times, we are pleased that our second quarter closings of 3,221 homes were just 52 homes below the challenging comps of prior year. Entry-level comprised 83% of closings, up from 76% in the prior year. In the second quarter of 2022, we lifted sales order metering in most of our communities.

Quarterly orders of 3,767 were 6% higher than the prior year, driven by a 33% increase in average community count.

Despite slowing demand, our second quarter 2022 average absorption pace was 4.4 per month which was down from 5.5 per month in the second quarter of 2021 yet higher than our expected normalized average pace of 3 or 4 sales orders per month.

Entry-level comprised 86% of quarterly orders, up from 81% in the second quarter last year as buyers' preference favored our lower-priced product. Entry level also represented 81% of our average active communities compared to 75% a year ago.

In a slowing market, our order cancellation rates increased sequentially from 10% in Q1 to 13% in Q2 of 2022 and year-over-year from 8% in the last year's Q2. As we noted, some buyers were canceling the contract and electing to purchase move-in ready homes.

Although we believe our rate locks are creating a counterargument to this decision for a large majority of our sold backlog.

We expect to continue to experience a higher cancellation rate over the next quarter or two as buyers reconsider their home purchase decision until rate and the market stabilizes or they elect to purchase an immediately available resale home.

However, we do expect that the cancellation rate to stabilize once this uncertain pool buyer works through their purchase decision. Turning to Slide 6. Moving to the regional trends.

During the second quarter of 2022, average community count increased for all of our regions as we slightly exceeded our target of 300 communities, while demand impacts our regions in different ways. Demand was strongest in our East region.

This was our region with double-digit order growth of 24% this quarter which was primarily due to a 37% increase in active communities, also our largest resale increase this quarter. This more than offsets the 10% year-over-year decrease in average order pace to 4.7% per month.

Strong demand in Florida was evidenced by 46% greater order volume this quarter due to 28% more average communities and 14% higher average absorption rate, the only market with a year-over-year increase in absorption pace.

South Carolina had the highest increase in order volume quarter at 64% year-over-year due to a significant community count ramp-up over the last 4 quarters. ASP on orders fell 5% year-over-year in South Carolina due to our product mix shift to more affordable [indiscernible] communities.

Over the last year, we closed out of a higher-priced first [indiscernible] and opened additional [indiscernible]. During the quarter, nearly 40% of the state's entry-level community sold affordable [indiscernible] product under ASP of $300,000.

The regional order volume for our Central region which is comprised of Texas, was essentially flat year-over-year. A 26% increase in ASP communities was offset by a 22% decline in average orders placed this quarter to 4.7 per month.

Our lack of move-in ready homes in the Austin market due to various production delays caused potential buyers to shift to more readily available resale inventory. Additionally, general demand softened in Houston, further impacting our sales in Texas.

Pricing power in the region led to a 15% increase in ASP on orders compared to the same quarter last year. Our Central region has the largest percent of entry-level communities comprising 83% of average communities.

The West region second quarter 2020 order volume decreased 6% year-over-year as a result of 35% higher average community count that was offset by a 31% lower average order pace.

The West region had the largest year-over-year increase in entry-level communities, resulting in 79% of its average communities selling entry-level products during the quarter compared to 71% in Q2 of last year.

The West had our highest regional increase in ASP on orders this quarter of 17% due to the region's pricing power and its geographic mix shift with a high percentage of California orders. Colorado's orders declined 12% year-over-year with average communities up 28%, while average absorption pace decreased 31%.

This market experienced some of the most notable product availability issues, although we expect to work through most of that backlog by the end of the year.

In Arizona, our quarterly orders decreased year-over-year by 10% due to various supply chain issues which led to a 34% decline in our average absorption pace despite a 35% growth in average communities. Turning to Slide 7.

We accelerated starts to over 5,000 homes in the second quarter from approximately 4,000 homes in the first quarter of 2022, both to replenish our depleted available inventory and to start production in our new communities.

Given the likely softer demand we anticipate for the rest of the year, we will moderate our future spec starts to adjust for this lower sales order volume as we work to complete the inventory we started this quarter.

We ended the period with nearly 4500 spec homes in inventory or an average of 4.7 per community as compared to approximately 2,600 specs or an average of 11.3% in the second quarter of 2021.

While this is significantly under our optimal level of 4 to 6 month supply, we do not anticipate a notable growth in our spec over the next couple of quarters as we continue to monitor the current level of demand. 74% of our home closings this quarter came from previously started inventory, the same level as a year ago.

At June 30, 2022, less than 5% of total specs were completed versus our typical run rate of 1/3 due to sustained demand and supply constraints. Our Q2 cycle time hasn't changed since the start of the year but we're still about 6 to 8 weeks of additional time from our pre-COVID construction schedules.

Given elongated cycle times, we ended the quarter with a backlog of 7,200 units as our conversion rate declined from 63% last year to 48% this year. When the supply chain stabilizes, we anticipate cycle times will shorten and backlog conversion rates will pick up again.

Despite the second quarter -- during the second quarter of 2022, we unmetered our sales efforts and sold inventory early in the construction cycle to both increase product availability and allow our customers to lock in their mortgage rates in a rising rate environment.

We continue to experience further cost pressure for most cost commodities other than lumber while offering increased incentives in most of our geographies. Despite the changing market conditions, we continue to restart 100% of our entry-level homes to streamline our operations.

In fact, we believe these strategies are beneficial in both an accelerated as well as a weakening market. Our pace of restart is based on market demand and allows us to flex with any choppiness in the market by slowing our starts if the current softening demand continues.

Our streamline operations strategy is in full steam since pre-COVID, limited SKUs allow us to remain nimble and substitute our selections with vendors if certain product availability runs low which have helped us and continue to in our supply chain constrained environment.

Our team will continue to hunt for further cost savings as we expect it will become available over the next couple of quarters. I will now turn it over to Hilla to provide additional analysis of our financial results..

Thank you, Phillippe. First, I wanted to provide an update on our rate locks. We believe our save the rate program alleviates the uncertainty for a buyer regarding their monthly payment by guaranteeing the rate at the time of purchase.

We require all homebuyers using our mortgage partner to lock in the rate and we provide applicable financial incentives to do so.

We have purchased several forward rate lock commitments in addition to our backlog rate lock last quarter that are available to all of our divisions at terms that we believe are preferential to what is available in the market today. We think these financial solutions offer us a competitive advantage.

The cost of these rate locks will impact our gross margin in Q3 and Q4. We continue to monitor all of the rate lock options available to buyers and are prepared to provide incremental mortgage rate incentives as necessary. Second, in the current quarter, closing with our build-to-rent partners accounted for approximately 5% of our volume.

We expect both for rents account to mid- to high single-digit percentage of our annual closing volume longer term. We continue to explore additional opportunities where we can leverage this new buyer group through various strategic avenues. Now let's turn to Slide 8 and cover our Q2 financial results in more detail.

Home closing revenue grew 11% year-over-year to $1.4 billion in the second quarter of 2022 due to a 13% increase in ASP on closings even as our entry-level mix grew. Home closing volumes declined 2%, impacted by the continuing supply chain issues pushing some of our late quarter closings into Q3.

Our second quarter 2022 home closing gross margin was a record 31.6% and the 430 bps improvement from 27.3% a year ago mainly resulted from higher ASPs due to sustained pricing power over the last year, the low cost of land for entry level homes, lower interest burden from our 2021 refinancing and the leveraging of higher revenue on fixed costs, all of which more than offset higher commodity costs.

Since new lumber locks take 6 to 7 months to flow through the current construction cycle, higher lumber costs impacted the Q2 financials and will continue to impact our margins for most of the balance of this year.

While we will see the savings from decreased lumber costs late this year and into 2023, it will be muted by the continued cost pressures from other labor and material increases. SG&A as a percentage of home closing revenue was 8.3% for the current quarter, a 100 bps improvement over prior year.

In addition to lower commission expense, our higher revenue and the benefit of technology and our sales and marketing efforts all allowed us to better leverage our SG&A even as we opened 49 new communities this quarter.

We will continue to pursue overhead efficiencies, although we also expect commission and marketing costs to start to increase over the next couple of quarters, reflecting the current market condition. The second quarter 2022's effective income tax rate was 24.6% compared to 22.4% in the prior year.

The higher rate in 2022 reflects the expiration of the 2019 tax payer certainty and Disaster Tax Relief Act under which we earned eligible energy tax credits on qualifying homes closed in 2021. Since an energy tax credit has not yet been enacted beyond 2021, we are not assuming any such benefits at this time.

We are, however, closely monitoring the proposed bill currently being negotiated which does address 45 [indiscernible] extension. Overall, pricing power, expanded margins and improved SG&A leverage, combined with the lower outstanding share count, led to a 55% year-over-year increase in second quarter 2022 diluted EPS to $6.77.

To highlight just a few items from the first half of 2022. On a year-over-year basis, orders were up 9%, closings were relatively flat, our home closing revenues increased 13% to $2.7 billion.

We had a 490 bp increase in home closing gross margin to 31.0%, SG&A as a percentage of home closing revenue improved 110 bps to 8.4% and we generated a 56% increase in net earnings. Turning to Page 9. We maintained a strong balance sheet and ample liquidity during the second quarter.

At June 30, 2022, our cash balance was $272 million compared to $618 million at December 31, 2021, primarily stemming from growth in our WIP inventory and incremental share repurchases. Our net debt to cap was 20.6% as of June 30, 2022. We have nothing drawn under our revolver and no debt maturities until 2025.

We continue to target a maximum ceiling for a net debt-to-cap ratio in the high 20s and we believe that we have sufficient flexibility to navigate the changing economic conditions. Over the next several quarters, we anticipate growth in our cash position that will reduce our net debt to cap ratio.

Our primary focus for our capital spend today is completing our specs on the ground and maintaining a normal level of available inventory. In addition to routinely buying back shares to offset new grants and keep our dilution neutral, we may opportunistically repurchase incremental shares.

We repurchased over 128,000 shares of common stock during the second quarter of 2022 for $10 million and repurchased a total of 1.2 million shares so far this year which totaled about 3% of our outstanding common stock. After these purchases, we have $244 million remaining on our share repurchase authorization.

As we continue -- as we consider our cash spend, we look to balance our operational cash needs with maximizing long-term shareholder value. When looking at our inventory valuation, we wanted to remind everyone that our impairment assessments are conducted at least annually or more frequently when certain criteria are met.

We evaluate all of our real estate assets both those that are active and those in the pipeline for recoverability. Impairments are recorded when the cash forecasted to be generated from the sale of homes in the community is not expected to cover the cost of that community.

Looking at the projected revenue as compared to the cost in our balance sheet, we believe the deterioration in the markets would have to be sustained and significantly more pronounced than what we are anticipating today before material impairments would be incurred. On to Slide 10.

During the second quarter of 2022, we opened 49 new communities and grew our community count from 268 at the start of this quarter to 303 by June 30, 2022. We spent approximately $422 million on land acquisition and development this quarter, down from $551 million in the second quarter of 2021.

Having achieved our community count goal, we plan to be around 300 communities for the rest of the year as we believe a more measured approach regarding future capital spend is warranted, while we gauge demand over the next several quarters.

However, as we are no longer metering our pace, we may experience some early community closeouts which may cause our community count to temporarily dip into the high 200s. In the second quarter of 2022, we secured about 900 net new lots approximately 1/10 of the net new lots we put under control in Q2 of 2021.

Our net new lots translates to 12 new entry-level communities. As we have all of the land we need for 2023 and most of 2024, we are selective in our future land acquisitions. At June 30, 2022, we had over 71,000 total lots under control which was down sequentially from about 75,000 total lots, both the Q1 '22 and year-end.

Based on trailing 12-month closings, we had a 5.6 year supply of lots which is slightly above our target of 4 to 5 years. However, we believe this older land vintage with lower lot basis will give us a competitive advantage when these communities come online.

About 66% of our total lot inventory at June 30, 2022, was owned and 34% was auctioned, in line with Q1 of 2022. As of June 30, 2021, we had 63% owned inventory and a 37% owned auction position. Our auction position is predominantly comprised of acquisitions with staggered purchasing dates in addition to some land bank deals.

Finally, turning to Slide 11. Due to the lack of visibility in the market at this time, we are only providing Q3 guidance.

For Q3 2022, we are projecting total closings to be between 3,500 and 3,700 units, home closing revenue of $1.575 billion to $1.675 billion, home closing gross margin between 27.5% and 28.5% and effective tax rate of approximately 25% and diluted EPS in the range of $6 and $6.80. With that, I'll turn it back over to Phillippe..

Thank you, Hilla. To summarize on Slide 12. Our strategy remains centered on the affordable products pre-starting entry-level homes and streamlining our operations. Our business model is resilient and successful in a slower market as it prioritize cost efficiencies and is dynamic based on changing market conditions.

We've done the legwork to help navigate the limited visibility in the current market. Our land underwriting playbook has kept us disciplined as we grew our community count. So our upcoming openings will continue to have low land residuals and we will be focused on affordability. .

Our record gross margin today provides us the necessary room to implement incremental incentives and absorb higher costs at the same time. With our ample liquidity, we are prepared for a slower market scenario.

We will continue to do the right thing for our customers, like offering certainty with our below-market fixed rate locks while offering a superior product. We believe we can continue leveraging our incremental revenue with our greater scale of community today, even at reduced pace in a slower demand environment.

With that, I will now turn the call over to the operator for instructions on the Q&A.

Operator?.

[Operator Instructions] Our first question is from Stephen Kim with Evercore ISI..

I did have a couple of questions here. First of all, you talked about the rate lock which congratulations on what you did last quarter, by the way, on that. You indicated that you're sort of continuing to offer that and then it's going to weigh a little bit on the gross margin.

You also talked about lumber savings not really showing up until it kind of sounded like late 4Q. So I just wanted to get some sense of if you could quantify roughly the impacts of some of those things.

These rate locks, for example, as we think about a basis point impact, what kind of a headwind should we expect for that? And then maybe with the lumber, if we just segregated out the lumber itself, what do you think the benefit of that may ultimately be maybe at the end of the fourth quarter? And then more broadly, incentives, where do they stand relative to normal right now?.

So when we look at incentives, we're not able to typically break out the incentives than some of our peers do. We look at it in aggregate. We don't break it out between financing incentives and general incentives.

So since we did put that backlog rate lock in place in Q1, we actually had a high volume of incentives running through our numbers in Q1, not through closings, of course but the numbers that were represented in our backlog.

We continued that pace in the current quarter and they probably added maybe another 100 bps of incremental incentives above what we did for our rate locks. So kind of all in, we're right in line with our historical averages.

So I would say it's definitely more than what we were doing a year ago, we only got 100 bps or so higher than where we were in the first quarter sales. It has not yet flowed through to the financial statement.

So if you look at the guidance that we gave last quarter which was a full year guidance, we were projecting a tick down in gross margin anyway for the lumber locks and for the rate lock incentives that we were already flowing through. The incremental cost is de minimis.

We do have some additional reserves as cancellation rates continue to remain elevated and we have to resell those homes. We're giving ourselves some breathing room for potentially additional incentives and part of the reason why we didn't provide full year guidance but we're running kind of right around normalized incentive pace right now..

Got you. That's very helpful. Yes. And I will just say that you gave this gross margin guidance, 27.5% to 28.5% which is, obviously, pretty strong anyway. So that kind of leads to my next question about the way you're balancing absorptions and the incentives that you're planning to offer.

You talked about a 3 to 4x absorption number as being "normal." I will observe though that you all have changed your business mix a bit over the years and you've introduced a number of communities that you've indicated, I think, are lower price, a little more entry-level. Those communities tend to run a little hotter or higher on absorption rate.

So can you give us a sense for what you think is a normal level of absorptions going forward, why that would not be higher than what it may had been in the past because of your mix shift and you are currently at normal levels of incentives.

Does that mean that we should consider what you're doing, let's say, in 3Q, what you do in 3Q that, that would be a normal level of absorption? Just trying to marry the absorption comment being normal with the incentive being normal?.

Yes. This is Phillippe. I think there's a lot of parts to that question. But historically, before we started pivoting to this new strategy 5 years ago, I think our absorption pace ran somewhere between 2.25 to 2.5 per month because we were predominantly a move-up kind of luxury builder.

And so now we expect our business to operate more between 3 and 4 depending on the mix of communities we have between entry level and 1MU. Obviously, right now, we're weighted more towards entry-level intentionally.

And so we would expect in the normal housing environment where interest rates are stable and there's predictability out there for the buyer that we would operate somewhere between that 3 and 4 range. Hopefully, on the high side of that because of the entry-level mix.

Obviously, we said this a number of times, we underwrite entry-level land to 4 a month. That's kind of the ideal state when we look at hurdling our land. And 1MU communities closer to 3, depending on where they're priced in the graph.

You asked about Q3 and I'm sure I'm going to get 1,000 questions about July, so I might well start to answer them right now. But I don't think July is going to represent normal absorptions for us.

We're experiencing much like the rest of the builders, a higher cancellation right now and buyers pivot out of longer cycle time production to more readily available inventory that's becoming more accessible on the MLS [ph]. So July is going to be a bit of an anomaly. It's starting to feel a little bit better out there.

We're seeing some green shoots that things are starting to stabilize. As long as rates start to stabilize, we think those turn into reality for us. Hopefully, August represents a more stable environment as cans start to stabilize. But we'll just have to see right now, cancellations are elevated.

They started becoming elevated in the back part of June when the rate shock really hit and settled in. They sort of stayed there or ticked up a little bit in July. And so July is a bit of an anomaly right now and we'll have to wait and see to see what August and September provide.

The only thing I want to add to that is just the gross sales number feels pretty good which is why we feel pretty good about the underlying demand and also as people are canceling, they're not going exiting the market. They're actually moving to go buy a resale home. So we feel good about the underlying demand.

It's just really the cancellations that are making our net sales numbers now that we'd like to achieve in July..

Our next question is from Truman Patterson with Wolfe Research..

Phillippe, on the cancellation rates, I didn't quite catch it. Did you actually give a number? And with that, just trying to think through you all retroactively locked rates for the backlog to solidify back half closings for the year.

Were these cancellations primarily more recent buyers that had signed contracts? Or were these kind of legacy buyers that maybe signed order contracts in 1Q?.

Yes. So we did provide cancellation numbers quarter-over-quarter and they were 13% in Q2. We didn't provide them month-to-month. I'd say in June, they were ticking up to around 20%-ish. And as we look into July, they're kind of there, maybe a little bit higher but July is not over yet.

We still have a week of activity here and the beginning of July is always a slow time for home sales. So -- but we see them kind of staying the same or being a little bit higher in July. As it relates to the cans rate of recent sales versus "legacy sales," if you will, it's kind of about 50-50 right now.

I wouldn't say there's any -- a lot of Q1, people that followed in Q1, were out probably month-to-month, people that bought in April, May versus June, July. I don't see a lot of people canning that agreed to a [indiscernible] home in early Q1..

Okay. Okay. And then nice order results during the quarter. And clearly, the build-to-rent space, I think your product fits perfectly in the wheelhouse there. Just -- you said that as a portion of orders, I think it was 5% of orders this quarter selling to investors.

What was that in 1Q? I'm just trying to understand if there's been any change in appetite from that buyer recently and then you targeted that 5% to 10% level long term? Just trying to understand how quickly you might be able to get their relationships formed, et cetera?.

It's held about steady between Q1 and Q2, not a material change. And the bulk of that increased from 5% to something higher, is going to come from a full community are coming online for our build-to-rent partners. The individual home sales that are comprising the bulk of that 5% right now. Those are holding relatively in line.

You'll see that uptick late '22 but really in 2023..

And I would just add that the appetite is strong. Many of these build-to-rent operators but they're looking for the same thing, right? They are looking for products that they can purchase now and start to lease up, gives them certainty on what they're buying. But there's a strong appetite out there for this build-to-rent product.

But at the same time, they're reading the tea leaves just like everybody else and making sure that they're purchasing houses at the right value..

Our next question is from Alan Ratner with Zelman & Associates..

Congrats again on achieving the community count goal and the great execution over the course of the last few years here. So I guess first question on the start pace, Phillippe, I think you made a comment that you guys have kind of reset that lower, obviously, given the changes in the market, demand environment, I think that makes sense.

If I heard you right, I think you started somewhere between 5 and 6 homes per month per community in 2Q.

Should we assume that now you're running maybe more in that 3% to 4% range that you kind of view as normal? Or are you resetting it perhaps even lower as you have a pipeline of specs that's been building?.

Yes, it's a great question. I think it's probably going to be 3% to 4% and it might be more like 3% depending on how things look over the next 60 days or it could be 4%. As we said in our script, we just have a lot of new communities that we're trying to get the product out there. As you know, we're an all spec builder in our entry-level communities.

And so having more product in those communities to get the momentum going is critical. But we're definitely slowing it down as we look into August, we're well off the pace that we were in the previous quarter. And I think a 3% to 4% number is probably right.

If August is trending down from July or stabilizing, we'll kind of reset that as we move through the back half of the year..

And that's the beauty of having a cadence of spec start weekly [ph]. We can make those decisions live as you continue to gauge the demand in the marketplace, especially when it's kind of unstable and shifting like we are today..

I mean we had one -- just to give you guys a feel for how agile we are. We had one community where we had a bunch of starts slotted, ready to go, permanent bid out and we just didn't do them. We shouldn't put them in the ground this quarter. So we can move pretty quickly community by community. We're pre permitting a lot of everything.

So we have the product when we need it. And if we need to slow it down, we slow it down..

Great. And I appreciate the color there and I think that makes a lot of sense. And I guess the next piece of that is kind of on the land side. And maybe I'm reading too much into this but I think your lot count did tick a bit lower sequentially.

And we've heard from some other builders, they've walked away from some option deals and I'd imagine you're kind of closely scrutinizing the deals you have under contract.

So can you just talk a little bit about it whether you walked away from deals during the quarter, whether you're kind of in the process of either renegotiating or trying to kick out some of those takedown schedules or if you feel like everything you have, at least in the near term still makes sense to move forward with?.

Yes. This is probably the thing about the capability about our organization that I'm most proud of. During COVID, when COVID hit, we basically stopped everything for 30 days. We didn't drop everything. We stopped everything. And we're rationalizing everything those 30 days.

And then the next 30 days same thing and we pushed deals out and renegotiated deals and through that 90-day period after COVID, we renegotiated a bunch of deals. We got better deal terms on a bunch of deals. And we only dropped a few and that really served us well. We're doing the same thing right now.

We're pausing, we're rationalizing, looking at everything, renegotiating things. We're pushing things out, things that we're supposed to close this quarter, we're buying time to maybe close next quarter. And we're going to read the market for the next 90 days and we may push that out another 90 days.

And I think generally, the land market is going to give it to us right now because they're watching and reading the same news clippings that we are.

As it relates to the activity in Q2, we did -- I wouldn't say we walked from anything but we -- new deals that we were looking at that we were spending due diligent dollars on, we've looked at those deals through a different lens and we stopped spending money on those deals.

So we went back to those sellers, said we weren't going to continue to process the entitlement, asked them to give us some more time were they open to renegotiating. I'd say we had a pretty good hit rate on that.

We bought the time but then there are a few sellers that said, no, we're not giving you that time then we kind of walked away from the due diligence dollars there. But as far as walking from any options, we don't have a lot of those anyway. Most of those are just with land sellers that are really favorable for us.

And actually walking away from a deal that we were supposed to close, we haven't done much of that yet. The primary reason behind that is, a, we want to buy the time to really see how this thing is going to play out, so we don't make the same mistake that a lot of other folks made during COVID.

And second, we -- a lot of the land we have coming through right now is stuff we bought 2 years ago. And the land basis is just very, very attractive to us. And we don't think we're going to ever get that land cheaper than that. And so we have to look at it through that lens and figure out whether we need that land.

Now at the end of the day, if the market is going to slow for multiple quarters here or prolong, we certainly don't need any more loss than the ones we have right now and maybe we need even less. And so we have our bottom 10% of the projects that are going to close over the next 2 to 3 quarters.

And if the next quarter is off and the following quarter is off, we probably won't do those deals. But as we sit here today, we don't have a lot of stuff that we see that we can't rationalize and that we're going to have a big write-off on it..

Just to clarify, what's already kind of been determined to walk away from an early diligence time, the dollars are very small, consistent with what we've done in any other quarter which is why they weren't separately disclosed.

So this is pretty much part of the course for us with kind of a trimming of the deals that no longer [indiscernible] get closer to making the go/no-go decision..

Hilla, just to clarify on that.

When you do make that decision that you're not going to move forward, do those lots immediately kind of get removed from your lot count that you provide to us in the slides, even if you haven't necessarily officially walked away from the deal yet?.

Yes. So just to clarify, we noted that we had only 900 net new lots but it's for 12 communities. If someone do the math, they probably realize that, that doesn't really make sense with a lot size or the lot count that we typically go for and that's because you have an offsetting amount of terminated deals in there.

Our lot -- our per lot size in the current deal was actually, I think, 149. They're consistent with where we've been in the past. So you're seeing the elimination of those terminated deals that were in the count last quarter, netting again. So we were still on a net positive of $900 million.

But yes, the lots that we terminate are immediately removed from the lot count..

Our next question is from Carl Reichardt with BTIG..

Can you talk a little bit about the margins you're seeing on the cans you are able to resell or what you're needing to do to move those please?.

So because our backlog -- thanks, Carl. Because our backlog already has a fairly notable normalized incentive because we put a rate lock on everything in backlog or almost everything in backlog already. We're reselling them at similar incentives. At times, the price is actually a little bit higher because some of those homes are older.

But for the most part, it's not a material incremental margin deterioration outside of that 100 bps additional incentive I mentioned in the first question..

Yes. I mean that's an aggregate comp statement, too. Obviously, certain markets are stronger than others, right? I mean, in some of the markets turning around and reselling that spec is fairly easy and we can sell it at or a better price. In other markets like Houston, for example, we are happy to offer a bit more incentives.

So the markets are moving very differently right now..

So thanks, Phillippe.

When you think about the incentives, the tools you have, the bucket of finance and, I guess, say, lot premium incentives, have you gotten to a point where you needed to look at base price cuts? Have you done that? Has there been any elastic response? And how has backlog reacted in the instances when you have had to cut basis?.

Again, we're a spec builder. So we just have an all-in price for our product. And it's not really a base price minus an incentive, minus rate lock program. It's really just an all-in price and the financing which drives the payment.

So my point being is when we add an incentive, it's the same as reducing your base price in my mind because we're not selling dirt. So as we add these incentives, I guess, you could say, yes, we're lowering the price of the home. But have we gone and actually lowered base pricing on dirt production, not in very many places at all..

I would say net-net the current -- I mean you can see it in our sold ASP, our all-in price, the ASP that we're reporting is increasing, not decreasing.

So the focus in backlog, probably we still have a price advantage all-in compared to the pricing today, except for me, if there's a split that you're doing in a community in a certain month or a certain week but all-in, the prices in backlog, especially with the retroactive rate locks are more favorable than what's on the ground today..

And again, I don't want to make this more complicated than it needs to be. But as our specs mature and they get to a point where consumers are interested in them, we set the pricing of that spec where we think it needs to be to move the house. And whatever that price is, that price is.

And those prices are starting to come down as we offer different ways to move that product in today's market. And I mean, it's not a surprise to everybody but all the public builders have large backlogs that we're trying to close over the next 2 quarters.

So we're certainly trying to give that backlog confidence in the homes they bought and you start slashing your prices, I think that doesn't provide that confidence..

Yes. We also noted the 45 new communities this quarter and those communities closed out or replaced by new communities we certainly have an opportunity if you want to take it to lease that pricing since there's no backlog in those communities.

So over the next couple of quarters as our community count churns and becomes newer, we will have the ability to do what we see the market needs to do if there's continued demand to reduce pricing. Although in today's market and our customer, in particular, they're buying a payment.

They're not really concerned about the price of the house or the ability for us -- when we're rate locking, we're not just locking in a rate, it's almost always with a material buy down to the current market rate and mortgage rate available in the marketplace.

So we're able to lower their payment in quite a bit to a comfortable enough place that, that's what they're driving to. So the incentives that we offer on the financing side are much more meaningful than a reduction in price..

Our next question is from John Lovallo with UBS..

The first one is, in our opinion, at least the market appears to be pricing in more than just demand moderation and the bear case is that there will be meaningful impairments. And I know you talked, Hilla, about some of the things that would need to happen for impairments to happen.

But I was curious if you could put it in simpler terms and just maybe from a gross margin standpoint, what sort of margin level would you need to get to before impairments would become meaningful?.

Sure. So impairments occur at below breakeven, right? We're at 31.6% today. I just reported with pretty normal incentives, right? So we already have some level of incentives built in.

So for impairments to start occurring materially, the entire population of our 300 communities would need to drop by another 20-plus percent, right? We're talking about $480,000 ASP that we just sold, there would be almost $100,000 and each and every home that we sell for us to have these kind of wholesale -- actually, that wouldn't even be impairment, that would just to get us to breakeven.

There would have to be something beyond that to get us to a loss situation. So it's unlikely that would happen if that was the market we would anticipate that the demand overall slows down and you're going to see some really material savings on the cost side which would be offsetting that which would make the spread to below breakeven, even larger.

So is it possible? I mean, theoretically, anything is possible. In today's world where we're sitting, it doesn't look probable..

That's really helpful. Okay. And then understanding that there's uncertainty out there.

But if you're moderating the land purchases or being a little bit more cautious there and your net financial leverage is in good shape, why not put more cash flow into share repurchases?.

Well, I think we've said it a couple of times in the script that it's definitely something that we intend to do but this was not the right quarter for it. This was a quarter of tremendous inventory growth, getting those record high spec starts and a record high backlog kind of churning through. That's where the cash needs needed to be focused.

It's absolutely a focus for us as we continue to progress through the year and into 2023 as we see our cash balance rise. Shareholder returns is a high level of focus for us, not just growth of our inventory. So definitely stay tuned for additional guidance in that direction over the next quarter or so..

Our next question is from Dan Oppenheim with Credit Suisse..

Was wondering in terms of the comments on selling to some of the single rental companies.

How much of that is the -- are you selling some of the canceled homes or completed specs and I'm sort of wondering about the margins on those sales or in terms of the communities to be sold in the back half of the year, how you're looking at? Obviously, it's easier in terms of selling but wondering about the margin impact there..

I think we missed the first part of your question. Can you -- it was a little bit foggy there.

Can you restate it?.

Sure.

Just wondering how much of the sales to the SFR companies how much of that is occurring based on homes that were canceled or completed specs versus sort of planned sales there and wondering about the margins on those or in terms of full communities, what you're expecting in terms of those sales in terms of the margins?.

Yes. So most of the cans we're taking, we're just selling those to a new buyer. I don't think we started packaging those up and moving those to a VFR channel.

We have a specific product throughout our footprint that we're targeting for build-to-rent and the cans that we're seeing from customers, most of that product is not in those communities, those are for owner-occupied business.

As it relates to one of the margins on build-to-rent, up to this point, it's been pretty agnostic because we're able to offset some of the costs, sales and marketing costs whether it's just selling homes or actually selling a whole subdivision which we've only done a couple of those. We have a few more planned for next year.

The margin is essentially the same, at least so far. We'll have to see if things change here over the next couple of quarters. But as we look out into the homes that we have scheduled to close with our build-to-rent partners in Q3 and the full subdivision level ones that we're doing currently, the margins are basically the same..

Our next question is from Deepa Raghavan with Wells Fargo..

You refrained from giving the full year guidance which is understandable at a high level. But it appears your Q4 gross margins could be higher than Q3 only because your spec inventory looks like will become more available which can provide some volume leverage. And also, there's this lumber benefit that starts to percolate by then.

Is that a fair way to think about it? And is there a way to think about how much higher it can be? Is it like 200 bps or so? And the reason I gave a number out there like 200 bps is some of your peers have guided to some pretty healthy benefit from lumber. So I'm assuming it would be pretty substantial for you too..

Yes. So we're comfortable giving full year guidance, I'm not sure giving Q4 guidance is what we're prepared to do today. I think we mentioned in our prepared remarks that the impact of lumber will continue through most of Q4. So I don't know that I would be modeling material savings from lumber coming during that period of time.

I think all of our peers and ourselves included, have noted that there continues to be a push upward on both labor and other materials that are absorbing the majority, if not all, of the lumber savings at this point. Now lumber is locked.

So it's a little bit longer to feel the experience from that, whereas other commodities and labor is [indiscernible]. So changes and declines in that cost could be experienced a little bit sooner. But for the most part, we're seeing still an increase in most other components of the home.

As far as having that spec inventory available, that spec inventory is going to be sold with the same incentive as what we're selling today. So I don't know -- I think we'll be selling at potentially a different pace because we have more inventory that fits the preferred box for our buyers.

But I don't know that we're going to be selling it for a lower discount..

Okay. That's fair. Switching gears to buybacks. I know you said you'll provide a little bit more color later on. But I just wanted to talk a little bit on buybacks, if you're able to provide some color around it.

What level of repurchases would you be comfortable with? I mean you mentioned you want to offset some of the dilution that will come with moderating housing scenario. But it looks like you'd probably have much more firepower than that.

The question is, what is the level that you could be comfortable with going forward with buybacks?.

So we always try to leave -- I should say since 2018, we've been trying to offset the effect of grant. So the neutralization on the dilution is always a goal. Opportunistically above that, we've certainly done a lot more over the years. We have $244 million remaining on our stock repurchase authorization.

So we're certainly prepared to do quite a bit more. And over the last several years, we've not been shy about going back to our Board and getting an increase to that authorization when we felt we needed to. So we're certainly prepared to do more but it's going to be a function of stock price and cash availability.

So that's really going to be the driver for the determination on a go-forward basis..

Thank you, everybody. Thank you, operator. I think that was the final question. Once again, thank you for joining our call. We appreciate your continued trust and support and we hope you guys have a great rest of your day. Thanks..

Thank you. This does conclude today's conference. You may disconnect your lines at this time and thank you for your participation..