Calvin Boyd - Corporate Treasurer
Sheryl Palmer - President and CEO,
Dave Cone - CFO
Dave Hreha - Corporate Controller
Erin Willis - Director, Corporate Communication
Will Randow - Citi
Ivy Zelman - Zelman & Associates
Michael Rehaut - JP Morgan
Joey Matthews - Wells Fargo Securities
Dan Oppenheim - Credit Suisse
Nishu Sood - Deutsche Bank
Alex Barrón - Housing Research
Taylor Morrison Home Corporation (TMHC) Q2 2013 Results - Earnings Call Transcript August 13, 2013 4:30 PM ET
Welcome to the second quarter 2013 Taylor Morrison Home Corporation Earnings Conference Call. My name is [Batiba] and I’ll be your operator for today’s call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session. Please note that this conference is being recorded.
I would now turn the call over to Calvin Boyd, Corporate Treasurer. Mr. Boyd, you may begin.
Thank you. Please note that some of our comments on today’s conference call refer to non-GAAP financial measures which we believe provide useful information for you [daily] business performance. This information should be considered as supplemental in nature and should not be consider an isolation or as a substitute for the related financial information impaired in the quarters with GAAP.
In addition these non-GAAP financial measures may not be the same as similarly entitled measures with Board of our other companies. Reconciliations to the most directly comparable GAAP financial measures are available on the Investor Relations portion of our website at taylormorrison.com and in our earnings release.
Finally please keep in mind everything we cover during today’s conference call, including the question-and-answer session is subject to the Safe Harbor statement or forward-looking statements within the meaning of U.S. securities laws. This may include statements about our current expectations or forecast of market and economic conditions, our business activities, prospects, strategies and future business and financial performance.
These forward-looking statements are not guarantees of future performance and actual results could differ materially from those suggested by our comments made during today’s conference call. I will call your attention to the description of risk that could effect our future results that is contained in our registration statement of Form S1 and subsequent reports filed with the SEC. Now let me turn the call over to our President and CEO, Sheryl Palmer.
Thank you Calvin and good afternoon everyone. Thank you for joining us for our earnings call to discuss the second quarter financial results. With me on the call this afternoon is Dave Cone, Chief Financial Officer; Calvin Boyd, our Corporate Treasurer; and also in the room is Dave Hreha, our Corporate Controller and Erin Willis, our Director of Corporate Communication.
I would like to begin with a brief overview of our results which demonstrate the continued success of our operating strategy and also discuss general market conditions. Dave Cone will take you through the financial review as well as our guidance for the third quarter and the 2013 year. Then I will provide an update of the operations of the business, after which we will take your questions.
As you know, this quarter includes certain charges of approximately 120 million related to our IPO which closed on April 12, 2013. In addition Taylor Morrison in coordination with our former UK parent company reached a settlement with the IRS on open tax matters relating to the period prior to July 2011 resulting in an expense in a substantially offsetting tax benefit in our operations during our second quarter 2013. Dave will take you through each of these items in more detail in his prepared comments.
During today’s call, we think it’s important to discuss our financial results both as reported and as adjusted to exclude the effect of certain charges, so you can get the full visibility of the strength of the actual business result as well as the accounting and reporting implications of these charges. The accounting effects of our recent IPO, the IRS settlement and corresponding indemnification can be ongoing impact of purchase accounting from our Darling acquisition could over shadow the strength of our operating metrics. However given the timing of these one-time charges, we believe the significant event in the second quarter are now behind us.
In fact I am very please to show with you our second quarter 2013 result. We continue to achieve strength through the spring and into this summer that housing inventories remain low and demand is high. We are delighted to report improvement in virtually all key operational metric adding to more than three years of profitability. This demonstrates how our discipline yet flexible operating platform has enabled us to both perform well and take advantage of industry conditions.
The results we are releasing today continue to reflect a reward for years of diligence and managing the business during the downturn. The quality of our location and our land development capability drives the strength of our backlog from closing revenue and margin growth as compared to the second quarter of last year.
Our team’s conscientious implementation of our strategy and superior execution has allowed us to capitalize on the improvement in the housing market in the first half of 2013. Our strategy began with an ongoing and thorough analysis of matching consumer demand and needs to opportunity. We recognize that our consumer segmentation work through this cycle assisted us in aggressively securing the right land position at what we believe to be a relatively low land cost basis that should continue to benefit the business. This was demonstrated with our 45% increase in community count for the quarter to an average of a 172 outlets.
For the quarter, our home closings revenue increase 62%, while closings were 52% higher compared to the prior year period. In the U.S. home closings revenue increased 84% mainly due to a 58% increase in home closings. We continue to manage the business, community by community and balance price and volume.
Our second quarter 2013 represented our highest Q2 net sales orders for the last five years and our lowest Q2 cancellation rate at 12.4%. Even more compelling our cancellation rate as a percentage of backlogs was only 5.8% compared to 7% in the prior year quarter.
The average sales price on closed homes in the U.S. increased 54,000 or 17% year-over-year to $381,000 with a continued growth generally seen in all of our U.S. market and the greatest year-over-year increase is in price from Northern California, North Florida and Houston. The higher average sales price of homes in our Darling business has also contributed to the overall company increase.
We benefit from our position in home building market that are leading recovery in the U.S. In 15 of our 19 metro areas in the U.S. and Canada, the unemployment rate is lower than the national average. Household formation in our market is increasing and demand for housing including rentals is strong. In fact in our own proprietary consumer research, it indicates that the top reason for house purchase continues to be the desire to see Swenting.
According to recent reports, seven of our markets were recently listed in the top 10 average rent growth markets in the country for the second quarter, meaning we believe the appeal of home ownership will continue to look favorable in the near-term.
At current home prices and interest rates, all of our markets in the U.S. are more affordable for home ownership today relative to renting and to their historic norms. In the face of increased demand for housing, availability of new and existing inventory remains at extremely low levels in all of our markets.
In most of our market, resale inventory is still limited at three months or less with an average of only 2.6 months and all of our markets in the U.S. and Canada, resell inventory is at levels that industry experts continue to consider to be under supplied.
Our California markets continue to have the lowest supply of resale homes relative to the market in which we operate with an average of only 1.3 months of supply. These decreased levels of inventory carry on in to the new home market. We believe that the tight availability of labor and finished lot supply are limiting builders' capacity to meet demand.
We closely monitor activity at the community level in order to maximize profitability and our returns. We view the business as a portfolio and it's critical to be flexible in our approach rather than relying on a one-size fits all approach in managing our operations.
Further, we are intentionally limiting construction releases in some of our communities which slows pace in order to manage our growing backlog, our production and overall customer expectations, while maximizing profitability in our land assets.
We believe Taylor Morrison remains well positioned to take advantage of a continued U.S. housing market recovery as we diligently manage and execute on our strategy.
We continue to see a very competitive land market, however we’ll be improving housing market, brings in new competition, we're still sourcing quality new land opportunities. In fact over the last few weeks I've spent some time in many of our markets turning new land acquisitions and deals from the pipeline and cannot be more pleased with the continued quality of our incoming asset.
We are in the enviable decision of having our land pipeline through 2014 and most of 2015 already in place. The quality and depths of our land positions enable us to continue to be very selective in our future acquisitions, focusing primarily on development fields and exceptional finished lot opportunities, since much of our attention is on sourcing our business needs in 2016 and beyond.
As I discussed earlier, we're very committed to our consumer demand assessments, land analysis and underwriting process to ensure we stay in core locations within our market, where our consumer prefer to live and where we believe we are able to create the highest and best value.
We acquired just over 2200 new launch in the U.S. during the second quarter of 2013, bringing in the North American total to just over 45,000 lots under controlled as of June 30th, including our proportionate share of lots within our joint ventures.
The distribution of lots acquired across the U.S. includes 34% in Florida, where we recently closed on a project called Hacienda in Naples, consisting of 443 lots negotiated on favorable terms in 2012, 27% in Texas fueling both our Taylor Morrison and Darling brand, 25% in California where we acquired two distinguished positions in Irvine, California, Quinterra on the Irvine Ranch and our new position within the Great Park and finally 14% in Phoenix Arizona.
The percentage of lots under control has increased from 23% in Q1 to 26% in Q2 in the U.S. and 74% of the company lots are owned. Our land supply has fallen to 9.7 years of supply at June 30, 2013.
Now, turning our focus to our Canadian operations, which accounted for approximately 14% from our closings for the quarter, as expected we have seen a slight reduction in absorptions from the prior year quarter generally due to our limited supply of offering. We're pleased to report continued strength in our absorption rate four sales per month per community, which is consistent with our long term average.
Recognizing our Canadian business is seasonal but typically slower winter months gave way to an increase in sales in spring. Supply of resale homes in the GTA is still very limited at 2.3 months and Ottawa is healthy is 4.7 months of supply.
Prices are continuing to increase. Recently, the Teranet – National Bank Composite House Pricing Index reported an increase of 1.8% month-over-month in June. Price for us in Toronto was healthy at 3.6% for the last 12 months ended June 30, 2013.
For the six high rise towers to be delivered in Toronto this year and next all of the units in our three 2013 towers are already sold and we have approximately 25 units left to sell within the three 2014 towers.
For the quarter our high-rise business delivered 323 units, of which 93 were wholly owned and 230 were JV units and therefore not included in our reported closing number. Cancellations continued to be at low levels aided by our stringent deposits, mortgage prequalification and Canadian legal requirement of full recourse sales contracts, meaning that buyers remain legally responsible to pay its full purchase price for their unit even in the event of a cancellation.
As we move to our mortgage business Taylor Morrison Home Funding continuous to provide an important benefit to our overall strategy and product delivery in the U.S. Our mortgage operations streamline the home buying process for our customers while driving increased productivity throughout the business.
For an example, anticipating for some time now, the rates would begin to rise and as a precautionary measure during our prequalification process, we have been ensuring that our buyers qualify at higher interest rates than current rates in order to mitigate risk in our backlog.
TMHF reported gross profit at $3.1 million or 954 closings on an average loan amount of $290,900 up from $260,100 in the prior year quarter. Our capture rate remained high at 80%, the mortgage statistics for our buyers continue to be very strong with the high average loan amount and average FICO scores of 745.
63% of our buyers utilized conventional financing and 35% FHARVA was only 2% [USDA], even the historically low interest rates we have 15% cash buyers in the quarter.
Now let me turn the call over to Dave Cone for a financial overview.
Thanks, Sheryl and hello everyone. As Sheryl discussed, we incurred certain charges related to the IPO in the second quarter. These include pretax expense for a $10.1 million loss on early extinguishment of debt related to the redemption of a portion of our existing 7.75% senior notes due 2020.
$29.8 million for the termination of the management agreement with our sponsors and an $80.2 million non-cash charge associated with the reorganization of our equity structure in connection with the IPO.
In addition, we had a $79.6 million charge related to the reversal of a tax indemnification receivable related to our former parent company with a substantially offsetting tax benefit. In connection with the July 2011 acquisition, our former parent indemnified us for certain income tax position.
During the second quarter Taylor Morrison, in coordination with our former parent, settled with the IRS for an amount less than the receivable which resulted in the write-off of the remaining receivable balance.
Excluding, these charges, we had earnings per share of $0.27 on adjusted net income of $32.9 million in the second quarter of 2013, as reported the company had earnings of $0.16 per share on a GAAP net income of $5.3 available to Class A shareholders.
As of the IPO, we now have Class A and Class B shareholders, with Class B representing the majority owners. Certain onetime charges occurring before our IPO and the earnings that occurred prior to the IPO were allocated solely to the Class B shareholders and are not considered in earnings available to the Class A shareholders which represent 27.1% of the ownership of the company.
Net sales orders totaled 1,596 units representing a 26% increase when compared to the same quarter a year ago. Net sales orders in our U.S. operations improved 33% to 1,403 units, while our Canadian operations had 193 net sales orders, down 9% compared to second quarter of 2012. The company’s cancellation rate was 12.4% as compared to second quarter of 2012 at 12.8%. As the market conditions have improved, our deposit amounts have also increased as a percentage of our average selling price giving us greater confidence in the strength of our buyers.
We finished the quarter with an increasingly robust backlog of 4,127 homes. Total backlog at quarter end was valued at $1.6 billion. On a year-over-year basis, this represents an increase of 35% in units and 55% in backlog value with a [15%] increase in average selling price in the backlog. Community absorptions were 3.1 per month as compared to 3.6 per month in the second quarter of last year as our selling price increased with both continued shift in mix to a more move-up buyers that benefited our pricing power and we diligently managed the portfolio to enhance margins and protect select land assets.
In the second quarter of 2013, we opened 20 new communities and closed out 21. Although we have sold out of some communities earlier than anticipated, we still increased community count by 45% over the prior year quarter to 172. Total revenue for the quarter was $508.9 million, an increase of 60% compared to $318.1 million in the second quarter of last year.
Home closings revenue was $496 million for the quarter, a 62% improvement year-over-year. The increase was driven by 52% increase in homes closed to 1,341 during the quarter, coupled with a 7% increase in average selling price to 370,000. In the U.S. home closings revenue increased 84%, closed units increased 58%, while the average selling price increased 54,000 or 17% year-over-year to 381,0000.
In Canada, home closings revenue decline 13%, Canadian closed unit increased 25% and average selling price was down 30% year-over-year, as expected to 305,000 as we previously sold out of higher price communities and approximately 50% of the closings in the second quarter of 2013 came from wholly-owned high rise unit as compared to none in the prior year quarter.
While these high rise buildings are well located, average suite prices are modest ensuring an overall affordable proposition. Breaking down the mix of course homes this quarter, 54% were from the east region, 32% were from the west and 14% were from Canada.
Adjusted home closing gross margin, excluding capitalized interest in the second quarter of 2013, improved to 22.8% compared to 21.6% for the second quarter of 2012. The improvement was driven by a combination of mix and overall price appreciation as we’re able to stay ahead of cost increases. In fact, over 85% of our U.S. communities have price increased during the quarter.
Our adjusted home closings margin growth was partially offset by margin decline in Canada as we sold out of those higher average selling price communities. The mix of wholly-owned high rise units and the purchase accounting impact due to the Darling acquisition.
Work-in-progress units were adjusted higher per unit in the Darling purchase accounting process resulting in a write-up to the acquisition date per value, thus compressing our margins in initial closings. The margin impact of the Darling acquisition purchase accounting will begin to moderate in Q3 and we should be virtually through all of it by the end of Q4 since we have sold the acquired inventory more rapidly than initially planned.
As we work through the purchase accounting we continue to be very excited about the Darling acquisition. And as we look at our Darling backlog in the second half of 2013, it indicates a few hundred basis points of gross margin improvement in the Darling brand when compared to the first half of the year. It’s also worth noting that Darling future option lots carry a significantly lower per unit purchase accounting impact compared to the initial inventory that was under construction at the time of the acquisition.
SG&A expense was $50.2 million or 12.1% of home closings revenue for the quarter compared to 9.4% in the same quarter of last year. The increase is due to various expenses including a reversal of a $7 million legal reserve in the second quarter of last year, Canadian brokerage commissions and Darling selling expenses.
In the second quarter in our Canadian operations we recorded sales, broker commissions relating to our higher rise tower closings but on the prior year period we had none. In addition, we had higher selling costs associated with our Darling homes operations which will moderate as we work through the integration. As we expected the Darling acquisition resulted in temporarily higher costs as a percentage of revenue, but as I will discuss in a few moments we continue to believe SG&A as a percentage of home building revenue will be flat on annual basis compared to last year.
More importantly we continue to focus on this metric as maximizing overhead efficiency is one of our key strength in driving higher operating profit. As adjusted to exclude one-time charges related to IPO and taxes indemnification, our income before taxes was $41.8 million. As reported we had a loss before taxes of $147 million compared to $18.6 million of income for the same quarter last year.
Our income tax benefit for the quarter was $69.5 million. As I mentioned previously we recognized the $79.6 million tax benefit during the quarter for the reversal of the tax receivable indemnification which was partially offset by $5.4 million charge for deferred taxes on interest related to the tax position. Excluding this one-time item our effective rate for the quarter was 36.8% as adjusted.
Turning to the balance sheet, we ended the quarter with $436 million of cash including $50 million of restricted cash and we have no borrowings under our $400 million unsecured revolving credit facility. As you know we successfully completed our IPO on April 12, in which approximately 28.6 million shares were sold at $22 per share for total gross proceeds of $629 million. In connection with IPO the underwriters also exercised their over allotment option for approximately 4.3 million more shares at $22 per share for additional gross proceeds of $94 million.
We used approximately $204 million of the net proceeds from the IPO to redeem $190 million of our 7.75% senior notes due 2020. The remainder of the IPO proceeds was used to purchase equity interest from our sponsors and pay related IPO fees. Concurrent with the IPO, we entered into a new $400 million unsecured revolving credit facility maturing in 2017 replacing our existing $225 million secured revolving credit facility.
In addition, we issued $550 million of eight year senior notes due 2021at a rate of 5.25%. The proceeds from these notes are being used to fund future growth and for general corporate purposes.
We ended the quarter with home building inventories of $2.1 billion. We had 4,128 homes in inventory at the end of the quarter compared to 2,991 homes at the end of the prior year quarter. Homes in inventory at the end of the quarter consisted of 3,224 sold units, 213 model homes and 691 spec units of which only 108 were finished.
As for financial services, Taylor Morrison home funding and title services generated $7.2 million of revenue and $3.1 million of gross profit for the quarter reflecting increases in mortgage loan originations year-over-year. For the third quarter of this year, we anticipate closings to increase by 75% to 80% year-over-year while community count should stay flat relative to the second quarter of 2013.
Income from unconsolidated joint ventures is anticipated to be between $7 million and $9 million reflecting the closings in our joint venture towers [Katur and Encore]. For all of 2013, we anticipate our closings to increase by approximately 50% and gross margins to be accretive compared to 2012. SG&A as a percentage of home building revenue is anticipated to be consistent with last year and income from unconsolidated joint ventures will be approximately $34 million.
Thanks. And I'll now turn the call back to Sheryl.
Thanks, Dave. And I want to say again how pleased we are with our second quarter performance. Our continuing strength and backlog at the end of the quarter provides a firm foundation and excellent visibility for the balance of the year and into 2014. As we look forward, it will be critical to ensure that we keep adequate lots in front of the business to meet future demand. To achieve that, we spent 302 million in land purchases and development during the second quarter and 445 million year-to-date. As we look to the end of 2013, we are still well positioned to spend over a $1 billion in land acquisitions and development for the year.
Approximately one-third of that is planned development spend. Many of the allots acquired year-to-date in 2013 were generally negotiated in 2012 or earlier and are just now being purchased. Interest rates are garnering a lot of attention recently with concern that rising rates will hamper the U.S. housing recovery. We view normalizing interest rates as a positive indicator, signaling that the economy is expanding, employment is improving and banks will be more willing to lend.
From a historical perspective, today’s current rates are still very attractive and enticing for many borrowers. We also understand that rate increase can negatively affect affordability for homes and we believe it's important to separate the discussion about the impacts of our current interest rate environment in to terms of backlog and your prospect. So turning to our backlog, interest rates fluctuation can change monthly payment and qualification thresholds for buyers.
So we would expect someone naturally be disappointed as they had separate expectation on an interest rate with a three handle. We monitor our borrowers and backlog and work with them on extended lot programs and product alternatives to help secure their desired payment. To our comprehensive required pre-qualification purchase process before purchase contracts are written [TMHC] evaluates the ability of our prospects to qualify for financing. Our under writing allows for a probable increase in rates, which we reduces cancellation and denial percentages. It is also important to consider the increased equity many of our backlog purchasers have gained since they went in to contract.
As a housing market recovered, we also increase our deposit requirement in many of our communities. We believe that with expected gained equity for our buyers and increased deposits, our backlog as more financially invested than anytime in recent history.
Now turning to our perspective buyers, we believe that interest rate increases have not really affected the demand for our home. We should expect that writing interest rates may make some home shopper [start] as rates rise from a more than 40 year low and buyers recalibrate what they feel their household can afford and then plan the right time for them to purchase.
Earlier in my comments about consumer research, I mentioned that we have seen buyers driven towards home ownership to usually (inaudible) to cease renting. However there are additional core demand triggers offers still at work in the home purchase process. Buyers continue to tell us they are buy home for reasons such as growing families, relocations and other life stage related [model].
Today we’ve seen some potential buyers with a new found urgency worried that rates will continue to rise (inaudible) to accelerate their home purchases. We continue to be pleased with our sell philosophy, and like I said, we do see normalizing interest rate as providing a more stabilize long term environment.
In July we historically see a seasonal adjustment in our sales from the prior month, as we did this July, but to a lesser extent than the historical trend. We also continue to see very strong traffic. From a cost perspective labor resources continue to be stretched as we see increases in housing demand and builder activity. Although we have made significant progress since earlier in the year, in some markets we have seen some longer cycle times. In other markets we have been able to make considerable progress towards ideal build times due to careful collaboration with our trade partners and an even well released process.
Today the financial impact of these labor and overall cost pressure has been more than offset with sales price appreciation as evidenced by the improvement in our gross margins on a year-over-year basis. Now that some material and labor costs have increased significantly, others such as lumber have dropped substantially. We are pleased to share continued improvement in key operational and financial metrics. We believe the macroeconomic environment has set the foundation for a continued home building recovery and our strength as a home builder and developer positions Taylor Morrison well into the future.
I am proud of our success and the results that we have been able to achieve due to our hardworking and dedicated employees I recognize our teams have been very busy this quarter, but with the positive market evolution we can now also truly enjoy the excitement of our growing business. I want to applaud their efforts and recognize that their individual contributions have created a tremendous success I have been able to share with you today.
At this time we will now open the call to questions. Operator please provide instructions to our callers.
We will now begin the question-and-answer session. (Operator Instructions) and our first question comes from Will Randow. Go ahead (inaudible)
Will Randow - Citi
Just kind of curious in terms of metering sales pace, are you seeing that more so in your July backlog and call it may be your first week or two of August and how should we think about that physically clearly that should impact some of your margins that we would expect?
I would tell you that we have been metering quite a bit of time now, because if you look at how the year stated at and you look how I think we came out of the gate as well as the interest industry, it was really quite strong, and so I think we have to take look at the entire business, decision by decision and make those decisions. I would tell you that there are some communities dependent on competitive environment, our land supply, markets strength, and a number of different factors which will help drive those decisions and some will let drive the little bit harder. But there are further communities across the organization that were holding to really a few last a week or month to make sure that we have the ability now when we are going to be able to start that the construction on them. So it’s really a little bit of everything depending on market-by-market.
Will Randow - Citi
Thanks for that, and just a follow up on Austin. In regards we are seeing at least asking prices builds up pretty rapidly year-to-date. What other benefit are you seeing from that in regards to Darling?
Yes, and Will just to make sure I understood you, did you say Austin because we don't have our Darling brand in Austin.
Will Randow - Citi
No I apologize, the Texas market in general.
Okay. Fair enough. What I would tell you about Texas is once again I probably won’t paint it with one brush. We're seeing sub-market by sub-market we would evaluate. But if I look at, for example, our Houston business, we've had some great pricing power over really year-to-date and I would tell you the same in Dallas. In Austin we’ve probably seen it be a little bit more about a reduction in incentive compared to maybe increases on the base purchase price. I guess it’s the same place, but the strategy shifts a little bit in each sub-market.
Thank you. And our next question comes from Ivy Zelman. Go ahead Ivy.
Ivy Zelman - Zelman & Associates
I'd like to just drill in Sheryl because you gave us so much great information and your recent trends are really great. But I normally love one and a follow up. First on the margin I think Dave you gave us good information on borrowing and the first accounting impacting. Can you quantify that, on what the impact was for margins in (inaudible)?
And then just more broadly Sheryl, I think with your views of the business in a longer term opportunity for recovery could continue. Can you think that generally the market whatever pause there was that we are now seeing a re-acceleration with [pace] hasn't been really stable and realizing that you guys didn't see that or from what you see in the marketplace. Generally we had a lot of mix data points from the second quarter earnings with some company saying they felt the impact, it sounds like that wasn't the case for you. So we're just really hoping maybe you can help us read these (inaudible) a little bit and certainly your July commentary was excellent and helpful but just generally we're already re-accelerating from what had been this pause if there was in the business?
Okay, no, I appreciate that, Ivy. Dave, why don’t you start with?
On the Darling side, so ideally to quantify that. It was about a 95 basis points drag on the overall margin and then we also had a fairly sizeable drag from Canada too as that margin starts to moderate a bit. Overall though the rate increase that we had of 120 basis points, that was primarily driven by rate in the west and the legacy Taylor Morrison communities.
And maybe just to add to that, Dave, I mean if you look at these specific impacts, Ivy, of purchase accounting, I would tell you those lots that were under construction at the time of acquisition, January 1, probably got a write up of eight times of what the future lots did.
And so the impact on that is very significant going forward and what's really happened is we're burning through good news-bad news. We're burning through that inventory quicker so it's coming through fast. But it's definitely creating a drag in the second quarter.
Moving to I think your more global question, Ivy and I'll try to make sure that I cover it. It's been an interesting time and certainly recent commentary; I think commentary has been a little bit mix on what's going on and from our perspective, what I would tell you is we haven't seen a very meaningful effect.
When we look at historic rates, as you know, we are in a very, very good place and very very, affordable and I believe rates don’t really impact demand but affordability but if we go back a few weeks and we look at the reaction that we saw back in early June, it was pretty significant 80 to 100 basis points of movement is really significant and people had a lot of questions. I would tell you that we’ve already seen stabilization as new families are entering into the market and I think they appreciate by all standards that our rates are very, very low today.
And I think as we look forward and we look a kind of the correlations between interest rates and sales, it's actually pretty fascinating over the past 30 years, as you probably know better than me, mortgage rates have posted increases probably 10 times and each of that is time, we’ve seen home prices appreciate and I think we're going to continue to see that in our business.
And so when I look at our local business correlations and I look at industry correlations, I actually feel very good about the trends going forward. I do believe as I mentioned before we came out of the gate, so very strong that I think probably some of the mix reaction that we're getting that you're hearing in the market, is because there's not one size fits all.
I mean with the increase in sales that everybody felt in the first slot, in the first quarter, I think you had inventories restrained, I think you had community close outs, I think people want to managing releases certainly, there was probably some pause on interest rates. But I think all in all is we look forward, the underlying fundamentals of the recovery that we've all been talking about for the last year are still very, very favorable.
You know, household formations, employment, affordability, confidence everything still trending in the right direction and prices are still undervalued compared to the long term fundamentals and buying a home is still more than 30% cheaper than renting.
So most of that still gives me great confidence and I feel really good about the business and that’s why as Dave mentioned you haven't seen this change our yearend guidance.
Ivy Zelman - Zelman & Associates
Perfect. Thank you very much and congratulations guys. Appreciate it.
Thank you. And our next is going to come from Michael Rehaut. Go ahead Michael.
Michael Rehaut - JP Morgan
Thanks, good afternoon everyone, a nice quarter.
Michael Rehaut - JP Morgan
First question I had was on the order trends and Sheryl appreciate all the color commentary, but as you look at the 26% order growth and the 33% in the U.S. I think as in terms of sales per community there was little bit of a deceleration versus last year there was an improvement. And I was just hoping to get a sense of how much of that was intentional? How much of that maybe was mix shift because Darling certainly had an impact.
And I know you were mentioning that the metering of sales or the management of sales pace and release something that you've been doing for a while but was there any greater focus on that or that or you kind of dialed that up a little bit during the quarter given what you did in the first quarter?
Good question, Michael. I would tell you that there was no specific change that I would point to. Having said that what I would tell you is as time moves on and we continue to see our buyer profile be more focused to that first second time move up buyers. Our absorptions, we don't underwrite those deals at the same velocity that we would a first time buyer or another buyer segment.
So when I am look at our sales paces, we continue to be ahead of our expectation. I think, candidly, what we have to come to grips with is what the expectations are because, it depends what you're looking at as a base line. Last year won't be the appropriate base line for us, as our sales price continuous to move up and we might be underwriting some deal, but 2 a month versus 3.5 month.
So if we actually get 2.5 that's very intentional on our parts and as you will consistently hear from us, we will continue to prioritize price over pace. Having said that I'll talk out of the other side of my mouth, there are some communities before, we'll run it a little faster.
So I would tell you most of it, is really intentional based on the actual absorptions that are planned. I would tell you secondary to that based on the success that we've had and our ability to make sure that we can deliver those per expectations at the right cost base. We are being very, very planned about our releases.
Michael Rehaut - JP Morgan
Okay, thanks for that, and I guess the second question is - it also very helpful in terms of breaking out some of the impacts during the quarter in terms of on the gross margin side with Darling and the sales broker commissions in Canada, conversely on the SG&A side, well, I'm sorry those two affected SG&A but also the purchase accounting impact from Darling. Are those expected to mostly moderate in the third quarter?
I know you said that we're to - at least the purchase accounting should continue, but when you think about gross margins being up year over year and for the full year and SG&A being flattish. It would seem to me that, that should pretty much moderate, pretty meaningfully in the third quarter, if I'm not mistaken.
Michael you're correct. As we move to the third quarter, taking Darling as an example and as Sheryl mentioned, we still do that a little bit faster, so some of that that we expected second half of the year has shifted forward. We'll still get some of the drag obviously as we close the wholly owned high rise towers and have a little bit of the selling. But the drag is going to be less in the back half than it was in the first half.
And I think if you look at our percentage of sales being a little bit higher and our SG&A as percent of home building revenue a little bit higher part of that is that $7 million legal accrual reversal, but it is those drags that will moderate and we will fall in-line with last year.
Thank you. And the next question is coming from Adam Rudiger. Go ahead Adam.
Joey Matthews - Wells Fargo Securities
Hi this is Joey Matthews on for Adam. I think you just alluded to this but, I wanted to see what your thoughts were on the increase in G&A and selling and commissions costs this quarter, especially versus the last year’s second quarter, it seems like there was pretty large increase as a percent of sales which I don't think we necessarily expected given the increase in revenue. We thought they would be little bit more leverage. Any thoughts on why if there is anything, one-timing nature in that number this quarter and help going forward?
It's actually the one-time of last year and we've been talking about the $7 million legal accrual reversal that we took in Q2 of ‘12. So that lowered that overall expense and that by itself is almost 250 basis points deal. So when you factor that out actually on the G&A line, we actually would have levered that line. The selling was still a little de-levered because of Darling and the high rise brokerage, but as we go forward, it's going to moderate. Some of it's just timing of expenses and that’s why we still feel comfortable for our year guidance around SG&A being flat for last year.
And just to make sure that we have 100% clarity on what that means with respect to the Co-broke because of the wholly-owned versus the JV towers and our high rise business in Canada, last year we did not have any wholly-owned towers. We actually don’t really do much broker participation if any in our single-family detach business in Canada. So when you have a quarter like you did last quarter, so today it point us the timing, but when you have a quarter like you did last quarter where a 100% of your closings had no Co-broke and this second quarter because we actually have a wholly-owned tower so that will come through the SG&A compared to the JV line. You have 50% of your closings with corporation; it’s going to make a significant difference, so you will see that lumpiness through the quarters as we close wholly-owned towers.
Joey Matthews - Wells Fargo Securities
So on the gross margin you had mentioned the drag from Canada and you had given the specific basis impact from Darling, could you share with us what the Canadian drag was on basis points?
Yeah, if you look at it from the drag perspective, it is about 80 basis points. If you look at kind of all-in on the Canadian margin, it was down about 260 basis points on a standalone. So then take the penetration from sales and that’s how you get to that 80.
And in all fairness state that drag, I mean a piece of that is to the Co-broke, but we also have a very that we closed out of some very high end community. So there is a more permanent shift in our margin in Canada.
Yeah, and that’s fair, I mean our longer-term view is that we expect that Canadian margin to moderate, something more in line with the U.S. And this is the first quarter that we’ve seen that and we continue that to carry on as we move forward.
Our next question is going to come from Daniel Oppenheim. Go ahead, Dan.
Dan Oppenheim - Credit Suisse
I was wondering if you can talk a little bit more in terms of just pace of the order activity, I understand why you talk about the intentional slowing and certainly can see in terms of the trend in the west Victoria, the market fundamentals certainly would dictate that, but looking at the Eastern Texas where that region now has much more [sort of Texas] following Darling. I am wondering about that, where the absorptions especially flat year-over-year with Texas being more of that region, shouldn’t we expect to see a bit more absorption there at this point given what typically see in terms of the business in Texas being higher absorption?
Yeah, and I mean it’s a good question Dan. And if I haven’t been clear on that, I am sorry. I think it’s important to understand that our business in Texas might not be your typical business in Texas and where Texas I think historically has always been known for kind of a high pay, high turn business, kind of low margin, high turn, ours have actually been a very good solid turn and high margin business.
And specifically if you look at the Darling kind of methodology, that’s actually a very semi-custom business model and we do a lot of custom changes in many of our builds there. And so it’s a little bit of a slower turn and it had a much higher price point. So we are actually ahead, as I said before we are actually slightly ahead of our absorptions that we had planned through the acquisition.
So when we look at the total business model there we are actually quite pleased with the pace. I think the other thing is maybe I alluded to but not clear enough, I think it’s important to appreciate that we are going to be very planned in our release approach when you look at the labor constraints that fit in many of our markets today and make sure that we release a note what our costing is before we start construction on home and we are only going to let that backlog gets along ahead of us.
Dan Oppenheim - Credit Suisse
Great, thank you. And the second question you talked related to this in terms of the margins such, or obviously the real focused on that in terms of controlling construction costs and such and understanding there is lot of issues impacting the margins right now, but any chance sort of you can give us a sense of what you see us from a same house margin and backlog in terms of the improvement that you are seeing based on some of the focus on the slowing right now?
We see improvement.
Yeah, we continue to see some accretion in our backlog margins. And Sheryl discussed earlier as we continue to focus on price and we are seeing price increase ahead of cost increases. Plus you know the fact that the impact from Darling is starting to moderate from the purchase accounting, so there is definitely opportunity there in that backlog.
Yeah, so you are going to end up with that improvement that they are speaking to, a little bit offsetting kind of the higher margins we saw in Canada last year.
Dan Oppenheim - Credit Suisse
Okay, thank you.
Our next question is going to come from Nishu Sood. Go ahead, Nishu.
Nishu Sood - Deutsche Bank
I want to ask a question about the community counts, obviously you’ve had a very, very strong community count growth this year helps by the Darling acquisition, you focus on our prior discussions, you’ve also had a very aggressive plans with the 25% order of magnitude community count growth for next year as well. So I just wanted to get an update on that given the state of the market, how demand trends has been going, your management of backlog, etcetera, interest rates, and just an update on that your plans in that regard for next year?
Yeah, actually pretty strong I think as you said Nishu. When we look at next year, I think we plan on 25% really being the minimum; it's actually probably closer to 30%. Obviously there is always timing and when we get those on board from an average standpoint. But the good news is that's really secured. So we feel very good about our community count as we start looking into 2014. Most of that growth I would tell you it's not all of it is coming in the U.S. but it's kind of there already.
Nishu Sood - Deutsche Bank
Got it, great. Thanks. That's very helpful. And on mortgage rates, I know there has been a lot of questions asked already and you touched on this a little bit previously, but I just wanted to focus in on there is a sense among investors that there is a differing effect of rising mortgage rates on the low end buyer versus the move up buyer. And you already gave your broad comments as to how you folk see it, but some of if you could share your thoughts on that low end versus move up distinction as well?
I think that's a very fair comment Nishu. And as we look into each of our markets and talk to the operator, I think what you have on the kind of more move up luxury buyer is someone that can afford the additional rate for them as more do they want to. I think at that first time buyer, it certainly could take some people out of the market. I think more than anything what it really does is have folks reset expectations because once again even if you're dealing with that first time buyer at all historical levels, a 4%, 4.25% interest rate is still very, very good and still better than renting but absolutely, I think that the first time more affordable buyer has to be more impacted in reality and psychologically.
Thank you and now last question is going to come from Alex Barron. Go ahead, Alex.
Alex Barrón - Housing Research
Thank you, I guess wanted to ask in terms of some of the markets they have seen slow down due to increase in the interest rates. And I am just wondering how strategically you guys are dealing with that if you are seeing any communities with the slowdown. Are you increasing incentives yet? Are you just kind of going to weather it out and see what happens?
Yeah, I guess to be quite candid, Alex, I would probably disagree that you could point to a slowness as of just from interest rates to date. I think what you have is a number of different factors that are potentially weighing in to at the top of list being just general seasonality.
But more specifically to answer your question, we have not introduced incentives in the U.S. and as I look at the quarter and I look, I think, Dave mentioned in his prepared comments that we saw price increases in many of our communities and we actually do not see increases in incentives or decreases in any community across the U.S. in the second quarter.
Alex Barrón - Housing Research
Right. I guess, my comments were more pertaining to post-second quarter, because obviously everybody did really well in the second quarter but the slowdown, I think started to happen more like in July. I was maybe thinking more forward-looking.
Yeah, when we look at July trends and I would echo what I said for the quarter, we didn’t change our strategy as far as pricing at all in fact in many communities when I look at the July reports we actually saw price increases maybe not at the same level. I would argue that's actually okay and the right thing for the overall business.
So I guess very specifically no, we do not see any change to the overall strategy in the business as a result of the interest rate.
And I would just, Alex, reiterate our guidance, we still, we're unchanged there for closings and we still believe there some accretion on the margin lines so and that’s taken it as we see it today. So we still feel pretty good for the year.
Alex Barrón - Housing Research
Right and kind of switching gears in terms of the tower business, I guess my understanding is you're going to deliver a lot of those units that are in backlog this year, is there a longer term plan to I guess keep focusing or reinvesting in that business. So is that something that’s going to kind of weighing down as we move into 2014?
Well we have three towers next year, we have obviously the towers this year, we have three towers next year and then we have towers in '16. We continue to invest where it makes sense. We have not done a recent acquisition in high rise. So from a long term strategy standpoint, I would tell you that generally the market has seen an overall shift from the single family detached business to high rise.
And as we look at the next few years the company is really well positioned to deliver towers and 2014, likely not in 15, but then we come back with a couples that we'll deliver in 2016. And as I mentioned in my comments this year everything that’s delivering is sold next year, we have less than 25 units to sell.
Alex Barrón - Housing Research
Got it. Okay, great. Thanks a lot.
Thank you so much. Well, thank you very much. We really appreciate everyone’s attendance on the call today and have a great afternoon.
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