Taylor Morrison Home's (TMHC) CEO Sheryl Palmer on Q2 2014 Results - Earnings Call Transcript

Aug. 5.14 | About: Taylor Morrison (TMHC)

Taylor Morrison Home Corporation (NYSE:TMHC)

Q2 2014 Earnings Conference Call

August 5, 2014 4:30 PM ET

Executives

Erin Willis – Director, IR and Corporate Communications

Sheryl Palmer – President and CEO

Dave Cone – VP and CFO

Analysts

Michael Rehaut – JPMorgan

Adam Rudiger – Wells Fargo

Alan Ratner – Zelman & Associates

Stephen East – ISI Group

Will Randow – Citigroup

Alex Barron – Housing Research Center

Jim Krapfel – Morningstar

Operator

Good afternoon and welcome to the Taylor Morrison Second Quarter 2014 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. As a reminder, this conference is being recorded.

I would now like to introduce Ms. Erin Willis, Director of Investor Relations and Corporate Communications.

Erin Willis

Thank you, and welcome to Taylor Morrison’s second quarter 2014 earnings conference call. With me today are Sheryl Palmer, President and Chief Executive Officer; and Dave Cone, Vice President and Chief Financial Officer.

Sheryl will begin the call with an overview of our business performance and our strategic priorities. Dave will take you through the financial review of the second quarter, as well as our guidance for the third quarter and full year 2014. Then Sheryl will provide some detail around our sales, land activity, and outlook for the business after which we will be happy to take your questions.

Before I turn the call over to Sheryl, let me remind you, that today’s call, including the question-and-answer session includes forward-looking statements that are subject to the Safe Harbor statement for forward-looking information that you will find in today’s news release. These statements are subject to risk and uncertainties that could cause actual results to differ materially from our expectations and projections. These risks and uncertainties include, but are not limited to those factors identified in the release and in our filings with the Securities and Exchange Commission, and we do not undertake any obligation to update our forward-looking statements.

Now, let me turn the call over to Sheryl Palmer.

Sheryl Palmer

Thank you, Erin and good afternoon, everyone. We appreciate you joining us today, and we are pleased to share our second quarter 2014 results. We had another solid quarter and continue to recognize the benefit from executing on our long-term strategy which we believe provides us some resilience as the markets continue to normalize. For the second quarter, EPS was $0.45 on net income of $55 million. Our long-term strategy as we have discussed in the past, is built on four main pillars.

First, our land acquisition investment strategy remains focused in core locations within our five states; Arizona, California, Colorado, Florida and Texas in the U.S. and Ontario in Canada. Our targeted land acquisition in core locations has not changed despite any evolving market conditions. We have the luxury of having a robust land bank consisting of what we believe to be prime strategic asset in core locations, as such, we have resisted the move to the French market. With our existing land bank, we can be opportunistic and search out for sites that should enhance the portfolio. I believe the success we have had in our community is in large part due to the disciplined processes and research we employee in our site selection and underwriting, as well as consistent quality execution by each of our teams in the field. We also have a just-in-time development philosophy so we are well prepared for the lots we need to operate our business. This allows us to be more prudent with our cash spend and not carry excessive inventory on the ground.

Second, our consumer and community positioning is directed mostly to move our buyers who continue to be more financially secure, as well as the reemerging professional first time buyer. Our consumer and community positioning continues to evolve with changing consumer preferences and qualifications. As you have heard me say before, early in the downturn, we made a conscious strategy shift towards capturing the more financially secure move-up customer segment. We still believe this is the correct primary strategy for the company, and we intend to stay disciplined and focused primarily on that consumer cohort and not operate reactively outside of our strategy.

Having said that we are pleased that Taylor Morrison continues to attract the first-time buyers in many of our communities at more affordable price points complimenting our healthy capture of move-up buyers. Similar to previous quarters, 21% of our buyers said this was their first home purchase. Our first-time buyer profile has migrated over the last year to more closely resemble that our targeted move-up buyers in many key metrics such as credit scores, savings, education, job stability, and household income as compared to what has typically been the traditional, affordable, and entry level consumer. For example, looking at the first-time homebuyers in the U.S. we used our lending subsidiary, Taylor Morrison Home Funding during the first half of 2014. This group had an average credit score of 721. They had an average household income of $108,000 and purchased a Taylor Morrison Home with an average sales price of $378,000 and 15% down payment. This compares favorably to our move-up buyers who had an average credit score of 746 and household income of $142,000. They had an average down payment of 27% of the purchased price.

Our disciplined prequalification process and our community and product strategy has attracted a pool of well qualified consumers at price points across the spectrum. In addition, Taylor Morrison Home Funding continues to provide credit and qualification improvement [ph] to assist the consumer before they enter into a purchase agreement. This combined with our counseling of first-time buyers enjoying the housing markets provides a continued benefit to the company in both, the sales and closing process.

As there has been an overall increase in community count among filters, buyers have significantly more choices today out in the market and staying true to our strategy of careful positioning of communities to reflect what consumers are seeking has rewarded us with more than our fair share in many of our markets. I’d like to share some examples with you from this past quarter. In Phoenix, we ranked second in closings through June, and first in home search which is somewhat unexpected given our higher average price point, and the overall increase in community count in this market. Candidly, it’s a perfect example of why continuing to stay the course with our strategy in core locations is so very critical. Even when demand softens in the market, communities with the desired geographic and local attributes continues to outperform the overall market.

Orchard Hills in urban California is an example of a community that we feel is particularly well targeted towards its intended move-up an international buyer. I’m happy to report that sales in these million dollar plus communities have sold 25 since we’ve opened in May. We opened with two other basic positions in the community, and enjoy the most affordable positions with home starting at $1.3 million.

Lastly, I’d like to share news about two of our newest 55-plus community; Skyestone located in Denver, and Bonterra in Houston. As the boomer population moves into retirement, we have been focusing on increasing our offerings to fill the needs of this buyer group across the country. We opened Skyestone early in the year and have sold approximately 50 homes across two product lines. This particular A’s [ph] restricted community in Denver is the result of diligent research and to discovering what a very active buyer in Denver would want in such a community.

Bonterra in Houston grand opened this past weekend. It offers over 700 attached home sites with resort-style amenities, and a full activity schedule positioned to best appeal to the Houston 55-plus buyer. Again, a lot of research went into identifying what the consumer would most value anymore intimate A’s restricted community. This community sold 20 homes in pre-sales efforts in the last couple of weeks leading up to the grand opening. I had the opportunity to attend the grand opening this past weekend, and we had a remarkable turnout with approximately 2000 customers showing up for the festivity. Based on the number of appointments booked, we will have a very busy sales team catching up on all the sales contracts over the next few weeks. This is a very exciting new community for us.

The third pillar in our strategy is our efficient cost structure. We remain committed to protecting our culture of cost efficiency where Taylor Morrison team members are challenged to run the business as if they own it. This level of dedication has enabled us to continue to drive leverage throughout the business.

And finally, the fourth pillar is our commitment to maximizing shareholder value by optimizing profit and volume with a focus on delivering EPS accretion. At the risk of being repetitive, our operating philosophy on price versus volume continues to be our operational priority. We evaluate our product releases, pricing and sales strategies at a community level each week in our divisions. This allows us to take full advantage of the local competitive supply and demand dynamics in order to optimize our profitability on achieving desired sales pace and return metrics consistent with our project underwriting.

In the quarter, net sales orders totaled 1709 which were up 7% year-over-year, and ahead of our expectations. In the U.S., sales increased nearly 9.5% compared to the prior year period. Absorptions in Canada increased but overall sales fell nearly 10% due to fewer open communities. Company-wide community absorptions were above our expectations for the quarter at 2.7 per month, while our average selling price for second quarter sales increased 17% relative to the sales in the prior year period, resulting in a net sales order value increase of 25% to $797 million.

We increased prices in nearly half of our communities and incentives decreased across the business. Other many markets found the spring selling season to be a bit less robust compared to last year. Overall we still believe this normalization of the housing markets is best for the long-term health of the industry. Recognizing our absorptions today continue to exceed our expectations of 2.2 to 2.5 per community per month, we adhere to our commitment of choosing profit over volume as we believe our land positions in core locations are prime properties and are highly desirable. Additionally, we continue to focus on progressive and relevant consumer targeting while protecting our efficient cost structure that provides us the flexibility and resiliency to respond to expected market ups and flows through a cycle.

Certainly one of the effects from the severity of our downturns as you have heard us discuss since April of last year is the constrained labor market in the United States. Over the last few quarters, you have likely heard other builders say this as well. It is worth reiterating that labor continues to be a challenge for our trade partners, service professionals, and many municipalities around the country. Considering the tight resources, we have been pleased with our team’s ability to progress our homes. In fact, we were able to bring in nearly a hundred homes initially planned for the third quarter deliveries into Q2 as indicated by our improvement in home closings over our expectations. As the year progresses, we anticipate resources could be more scarce, similar to the end of last year, and determine that it was beneficial to bring as many closings forward as possible.

That being said, the resources constrains, including those municipalities have delayed a handful of our community openings for 2014. Some of our openings have pushed from one quarter to the next impacting our expected average community count for the year. The slight delay in these openings will not affect our previously provided closings guidance for 2014.

Obviously replacing the labor gap will continue to take time and we believe that as a measured recovery process, the infrastructure in the housing market should continue to rebuild. We have heard industry commentary that with younger generations migrating towards higher education, and baby boomers enjoying retirement, the industry is working to rebuild the infrastructure which lacks skilled workers required to meet the growing demand. A shortage in labor continues to reinforce our current desire to generally focus on price over volume, and protect our premier locations within our land bank.

Moving to our Monarch operations, the Canadian market continues to perform well. New home starts for the first five months of the year were up in both, Ontario and Toronto by 4% and 8% respectively. Both resale and new home sales continue to post gains. Total Toronto new home sales for the first five months of the year were up 42% from the same period last year. June resale transactions were up 15% year-over-year, and average selling price rose 7%, and increasing listings and continued attractive mortgage rates accredited for some of the growth in sales and home prices.

Due to planning regulations promoting urban intensifications in the GTA, there has been a shift towards the larger number of high rise developments away from traditional single-family detached community. As a result, available product for sale in the market has got from three detached units for each high rise units to the inverse, three high rise units for each single family unit. Total new home supply in the market has not changed and remains within the long-term average of 25,000 to 30,000 units.

For the company’s operations in Canada, monthly absorptions were up 27% to 5.2 per outlet per month, compared to the prior year. However, we had an average of five fewer communities which drove a decline of 10% in net sales. As an example of the continued market momentum, one of our community successes inclined their chronic states [ph], a single family detached community in our Toronto market that opened models in the first quarter. So far this year, we have sold 25 homes out of one selling effort to a move-up family buyer with higher end finishes and features with an average sales price over 900,000 Canadian dollars.

We also continue to expect 2014 to be another big year for our high rise business which three tower deliveries, two of which are wholly-owned. We have recently started delivering units within one of the wholly-owned buildings and our JV Tower for our 2014 closing. Also our next tower deliveries in 2016 are already 92% pre-sold. We have also opened a new joint venture tower, Reva [ph], for presales. A tower which is located on the waterfront is one of our high rise master plans has seen steady demand. As with all of our towers, we do not report sales until we meet the presales threshold of 70% and launch the tower for construction. As a reminder, these units are presold with full recourse contracts.

Before I turn the call over to Dave, I would like to reiterate, just hopefully [ph] with the results achieved again this quarter with our strategic focus in land investment, our buyer targeting, and our ability to execute efficiently in both, our U.S. and Canadian operations. Our results this quarter show that our long-term strategy has continued to be a profitable one.

Now, I will turn the call over to Dave for the financial overview.

Dave Cone

Thanks, Sheryl. I’m pleased to share with you our results from our second quarter. As Sheryl mentioned, we had diluted earnings per share of $0.45 on net income of $55 million in the second quarter of 2014 driven by an increase in home closings of approximately 7% to 1,438, and an increase in average sales price of 21% to $448,000.

Total revenue for the quarter was $658 million, an increase of 29% compared to $509 million in the second quarter of last year. Home closings revenue was $644 million for the quarter, a 30% increase year-over-year. In the U.S., homes closings revenue increased 33% while closed units increased 12%, and the average sales price increased $71,000 or 19% year-over-year to $452,000.

In Canada, home closings revenue increased 4% as the average sales price increased 34%, while home closings decreased 22% relative to last year. Breaking down the mix of homes closed this quarter, 58% were from the East region, 32% were from the West, and 10% were from Canada. Consolidated adjusted home closings gross margin, excluding capitalized interest, was 23.6%, representing an 80 basis points increase over the second quarter of 2013 due to our continued focus on price over volume.

Our U.S. adjusted home closings gross margin increased 170 basis points to 23.7%, as compared to 22% in the second quarter of the prior year, also driven by average sales price increases ahead of costs. Canadian adjusted home closings gross margins was 23.4%, as compared to 28.8% in the same quarter last year. As we detailed on our last few calls, and it’s important to reiterate, Canadian margins continue to have a tough compare through 2014, as we work through a mix shift.

As for financial services, we generated $8.2 million of revenue during the quarter on 738 closings, with an average loan amount of $322,000 representing a 12% increase in volume, and a 11% increase in loan value over the prior year quarter. Gross profit was $3.5 million. TMHF remains key to our execution strategy as we require every homebuyer to complete a pre-qualification process with TMHF before entering into a purchase agreement. This helps us to better understand our buyers while increasing the probability of bringing them to the closing table. With a capture rate of 72%, we are able to manage our pipeline more effectively. As you know, the mortgage business has been very competitive off-late. As the lack of refinancing in the market had shifted, most mortgage providers have focused on purchase transactions. Even with this increased competition, TMHF once again delivered strong results.

SG&A expense was $64 million, or 10% of home closings revenue for the quarter, compared to 12.1% in the same quarter of last year. This represents 210 basis points of improvement for the quarter, partly due to timing of compensation related to last year’s bonus which reflected additional expense for the over performance we saw in first half of 2013. The bonus expense for 2014 is in line with our plan, so the Q2 SG&A year-over-year basis point improvement does not represent a normal run rate for the remainder of this year. Equity income from our joint ventures was $8.1 million, as compared to $8.5 million in the same period last year.

Our income before taxes increased 53% to $80 million, or 12.1% of revenue, compared to $52 million, and 10.2% after adjusting for the pre-IPO charges and other items from the second quarter of 2013 described in our press release. As a reminder, the second quarter of last year contains certain charges related to the IPO transaction totaling $120 million. In addition, our former parent company and the IRS reached a settlement resulting in an $80 million expense, and a substantially offsetting tax benefit in the second quarter of last year.

Income taxes totaled $24.1 million for the quarter, representing an effective rate of 30%. During the quarter, we reversed the evaluation allowance on deferred tax assets of $2.5 million, as well as recognized benefits of certain tax credits.

Consolidated backlog at quarter end was valued at over $1.73 billion, compared to $1.57 billion at the end of the second quarter last year. The U.S. backlog value was up 26% year-over-year to over $1.4 billion, with a 21% increase in average selling price to $496,000. Our Canadian backlog value was $309 million, down 30% due to unit decline, while the backlog ASP increased 7% to $347,000. Last year’s Canadian second quarter backlog included a wholly-owned high rise tower of 421 units which closed later in 2013. It’s worth noting that in the third quarter you will see a sequential drop in our North America ASP of approximately 5%, due to the mix of single-family versus high rise units in our Canadian business. ASP is expected to rebound in Q4 or it should be slightly higher than Q2 of this year.

Turning to the balance sheet, we ended the quarter with more than $300 million of cash, we have $40 million in outstanding borrowings under our $400 million unsecured revolving credit facility. Our net debt to capital ratio was 46.2%. As you know, we continue to invest in our business with planned third quarter spend that will push our net debt ratio closer to 50%. The net debt to cap ratio should finish the year in the mid 40% range as we monetize our investments.

We ended the quarter with home building inventories of $2.7 billion, we had 4,443 homes in inventory compared to 4,128 homes at the end of the prior year quarter. Homes in inventory at the end of the quarter consisted of 2,910 sold units, 296 model homes, and 1,237 inventory units of which only 242 were finished.

Now turning to our guidance for fiscal year 2014, we anticipate community count to finish at approximately 210 averaged communities, which represents an estimated 27% increase in the U.S., and a reduction of two average communities in Canada. We expect 6,700 to 7,000 closings for the year. We now anticipate home closings margin to be down approximately 50 basis points relative to 2013. We continue to see accretion in the U.S. although it has moderated due to mix while we continue to see downward pressure as Canadian margins normalize. Despite some decline in margin rate, we are seeing a significant increase in margin dollars per unit as there is a larger penetration of sales in high ASP communities which typically generate higher margin dollars but a lower margin rate.

In the second quarter, our gross margin dollars per unit increased 22,000 to 106,000, a 25% increase. In addition, we anticipate year-over-year leverage in SG&A, and to be under 10% as a percentage of home building revenue for the year. Income from unconsolidated joint ventures is expected to be approximately $21 million to $23 million. For the third quarter of 2014 we anticipate our community count to be consistent with Q2, and closings between 1,650 and 1,750 units. Income from unconsolidated joint ventures is anticipated to be between $10 million and $12 million.

Thanks, and I’ll now turn the call back to Sheryl.

Sheryl Palmer

Thanks Dave. Overall, I’m happy to report that even with some choppiness in few market, our communities have generally performed a bit ahead of our expectations. Our sales were flat sequentially between April and May, and fell slightly in June. This was consistent with typical seasonal trends, and we continue on track with our acquisition underwriting. So far in the current quarter, July sales were up nicely year-over-year and slightly ahead sequentially, but historically sales are flat. Traffic was up in each of our U.S. markets in the quarter and slightly down in Canada with the reduction of active outlet. I believe 2014 will show ongoing strength in the business with strong traffic and orders, and moderating pricing power, and continued cost pressures as we continue to move through the year.

As we’ve outlined in prior calls, we expected some choppiness throughout the recovery, and lets be candid, it’s been tougher out there than expected. Labor and cost pressures will continue to be difficult in the near term as the infrastructure of the industry rebuilds and uncertainty remains about one building is expected to markedly increase back to historic levels. Most importantly, we believe we are still well positioned and we have set the business up for continued strength. We continue to be optimistic about the prospects of the housing industry and our ability to execute. As we look at the big picture, we believe the fundamentals are falling into place for a measured and sustainable growth trajectory as employment, incomes, and household growth build.

Also let’s not forget that average rents continue to grow and recent report show renting at a 38% premium over average mortgage payment. Appreciating these factors, advisors via home ownership should continue to be more appealing to future home owners.

Turning to our land operations, in the quarter we spend $290 million in land purchases and development, and plan to spend approximately $1.2 billion for the year. As I have already mentioned, we will continue to be opportunistic and add quality land positions in premier locations where consumers want to live, but we do not need to add lots to the portfolio for short-term needs. While certain local market dynamics may not be favorable for present land investment, we can back off buying in those locations and will invest many where we feel will generate the highest returns on capital. We continue to position ourselves to take advantage of a protracted recovery.

The North American total land bank as of June 30 was 44,200 lots, owned and controlled, excluding lots held in unconsolidated joint ventures. The percentage of lots owned was approximately 77% with the remainder under control. Our land bank had approximately 7.3 years of supply at June 30 based on trailing 12-months of wholly-owned home closing. The distribution of lots acquired in the second quarter includes 45% in Florida, 27% California, 23% in Texas, and 5% in Phoenix, Arizona. As should be expected in this stage of the recovery, we continue to see a reduction in the average community size of our acquisitions and pursue creative deal structures to optimize shareholder returns.

As we look into the future, we believe we are well positioned to provide shareholder value through the recovery with our full cycle strategy. Our focus continues to be on community execution and managing a quality customer experience, given the involving mortgage and environment and constrained labor resources. Thanks to the Taylor Morrison’s Darling, Monarch, and Taylor Morrison Home Funding teams for another great quarter.

Thank you and we will now open the call to questions. Operator, please provide instructions to our callers.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) We have a question from Mike Rehaut from JPMorgan. Please go ahead.

Michael Rehaut – JPMorgan

Thanks. Good morning – good afternoon, everyone, nice quarter.

Sheryl Palmer

Thanks, Michael.

Dave Cone

Thanks, Michael.

Michael Rehaut – JPMorgan

First question I had was on the order trends. You mentioned that they came in – I think the sales pace is little bit better than expected. The year ago comps get a little bit easier, particularly in the third quarter, and you mentioned also that July was up a little bit sequentially versus I think, typically down. As things are trending, would you potentially expect sales pace to be up a little bit in the third quarter and the fourth quarter as – again, the comps get that much easier?

Sheryl Palmer

It’s a nice question, Michael. If you kind of go back to the beginning of the second quarter, really April was the only quarter that I would tell you year-over-year we were just slightly down. We were up nicely in May, June, and even up as you would expect with the comps, even up a little greater than that in July. When I look at sales year-over-year, certainly I would expect that trend to continue from an absolute numbers standpoint. But when I look at sales pace, sales per community, I would actually tell you that as we’ve moved through kind of the peak selling season in the spring, I would not expect our pace to move up per community. We’ve guided throughout the year somewhere between 2 to 5, obviously, that’s going to be accelerated in the first half of the year but it should average out to that as we move through the full year.

Michael Rehaut – JPMorgan

Okay, I appreciate that. And – I guess, secondly on the community count guidance, I guess it looks like you’ve lowered it roughly 10% in terms of what you expect to end or average for the year versus previously. If I have the numbers right, maybe I’m a little off from using year end, but – I – certainly a little bit of lowering of guidance, maybe it’s more like 6%, 7%. Is that – I guess it’s all being driven by different elements of community delays. How much is perhaps more even intentional as perhaps you’re pulling back the range as you want to see demand continue to normalize in certain markets. And if there is any regions that you’re seeing it more than others because again it would kind of result in some lowered growth expectations, and just trying to think about next year as well.

Sheryl Palmer

Yes, let me try to make sure I capture the full intent of your question. You’re right, it’s not 10%, it’s probably closer to 5% if you were to go up to the high end over the range. What it really breaks down to Michael, it’s probably a community per division, and so – from a U.S. standpoint, we’re still going to be up some 27% year-over-year, and I would tell you it’s all of the above. We certainly have a few communities that we’ve had some municipality delays, we’ve certainly had some community delays early in the year, primarily in Texas when we really lost about – I hate to ever use – but we really lost about 90 days. And when you start pushing out a community, a quarter starts impacting your average, there are a couple of communities we actually sold out a little ahead. So there is not one trend that gets you to that, and then you have Canada, where we had a high rise tower also, complete sales. So there is not a particular trend or issue, just a little bit of everything as you look across the company.

Michael Rehaut – JPMorgan

Okay, thank you.

Sheryl Palmer

Thank you so much.

Operator

And the next question comes from Adam Rudiger from Wells Fargo. Please go ahead.

Adam Rudiger – Wells Fargo

Hi, thanks for taking my questions. I understand the profit versus pace and it’s been working because of the mix to the higher home prices. I was wondering when you thought that mix shift on prices would start to stabilize, and where that might then translate into unit growth and revenue growth that were more in line with each other? And then once that happened, are you okay with the flattening top line best that it translates into or as long as – in that environment if you’re in the – they targeted 2.2 to 2.5 order pace, are you comfortable with a flat top line if that’s what occurs? Sorry, there was a lot in there [ph].

Sheryl Palmer

Yes, I mean we will continue to be focused primarily on profit growth, right, that’s going to be our primary objective. From a unit growth standpoint, we continue to look at our strategy on a community-by-community basis, because candidly there are some communities depending on the local dynamics where we’ve already pivoted from price to volume. Having said that, as I look across the Board, generally we focus on price versus pace, so we really do make that decision in every individual community and for us it’s about balancing the impact of the overall portfolio. So I think by balancing that portfolio what that really does gives us Adam is it continues to give us nice accretion on the overall unit numbers as we continue to add new communities. Certainly it should give us additional accretion on the top line generating with the efficiency, we’ll continue to recognize and down to the bottom line for us.

Dave Cone

And if I could just jump in there, you know, I think we’re going to see the top line continuing to grow as Sheryl said. And then, as the mix changes kind of within the region, that’s obviously going to have some impact per share. Ultimately, we remain committed being focused on growing the EBT line which for us is a balance between gross margins and SG&A leverage, in combination with our pace. So as we look at those leverage, we’re always trying to maximize our returns, really for us return on invested capital, by really – trying to drive, trying to maximize it and you start driving pace, you’re going to burn through your inventory a little bit faster than we had probably prefer. So it makes it difficult I think in the long-term to maximize the – kind of the full depth of our assets. So for us we really look at optimizing kind of our returns, our return on invested capital which is really balancing those levers throughout the cycle. So for us there is a difference between maximizing and optimizing rate [ph], it’s settled but we still think it’s an important one.

Adam Rudiger – Wells Fargo

Okay, thank you. And then, can you – any – I’m not asking – I’m sure you’re not going to give guidance but any general comments you can make on your expectations for 2015 in terms of margins, just directionally?

Sheryl Palmer

Yes, it is something we’re ready to do that Adam. Certainly as we get into next quarter, we’ll be prepared to look at 2015 for the group.

Adam Rudiger – Wells Fargo

Okay. Thanks for taking my questions.

Sheryl Palmer

You bet, thank you.

Operator

And we have a question from Alan Ratner from Zelman & Associates. Please go ahead.

Alan Ratner – Zelman & Associates

Hi guys, good afternoon, and nice quarter.

Sheryl Palmer

Thanks, Alan.

Alan Ratner – Zelman & Associates

Sheryl, on the community countdown, when you look at the reduction in the guidance there, I’m getting to something like 15, 20 communities from year end. When you think about the seasonality of the business and obviously, ideally it’s like to have as many communities opening up into the spring and selling season is possible. In the municipality delays that you’ve sighted, is this something where we should expect to see kind of catch up in 1Q next year, or would you expect these to kind of get blood out more evenly and this is kind of just – kind of a stop gap in the system that maybe you guys didn’t quite appreciate as much previously?

Sheryl Palmer

You know Alan, like I said, I wouldn’t tell you that there is a stop gap that will just bleed a bunch of – that will just throw a bunch of communities into the system in any particular quarter. Our openings – we have something like 120 new communities this year and our openings were fairly well timed throughout the year. But as I said, as you start seeing for whether, municipality delays, you start losing two or three months in that process and it really did impact the overall. So – no, I don’t expect – and the reason it didn’t impact our closing guidance this year is because candidly, it was probably some of the mid-year openings that weren’t contended for closings this year. So I think you’ll continue to see those come through over the next few quarters.

Alan Ratner – Zelman & Associates

Got it, thank you. And the mortgage data you gave us was very helpful as well, I might have missed it but do you happen to have the DTI statistics for your first-time buyers and move-up, as well?

Sheryl Palmer

I do.

Alan Ratner – Zelman & Associates

Then I guess it will be upfront and then back in, that would be helpful.

Sheryl Palmer

Do you have it right there?

Dave Cone

Yes, 37%.

Sheryl Palmer

So 37% Alan.

Alan Ratner – Zelman & Associates

That’s for the first half?

Sheryl Palmer

No, that’s actually the total – for Q2, it would be the average DTI. First-time – yes, I actually do have it, it’s 41%.

Alan Ratner – Zelman & Associates

Great.

Sheryl Palmer

On the true first-time homebuyer.

Alan Ratner – Zelman & Associates

Got it, thanks a lot.

Sheryl Palmer

Okay.

Operator

And we have a question from Stephen East from ISI Group. Please go ahead.

Stephen East – ISI Group

Thank you, good afternoon. Dave, would you mind walking through a little bit – with little bit more detail – the guidance on your gross margin coming down – perhaps you talked about Canada normalizing with U.S., a bit slower than expected, maybe what’s going on there?

Dave Cone

Sure. I don’t know that the U.S. is slower than expected, really in the U.S. – and this is for the back half, we have a mix shift coming from California which we achieve a very high margin dollar there but a lower margin rate than kind of our company average. And California is expected to make more of our closing as part of our west region than they have in previous quarters. So, as we recognize closings in some of these higher ASP communities like Urbane Ranch [ph] in Southern California. We see excellent margin dollars per unit, and in fact, in some cases the margin dollar per unit in California exceeds the ASP in some of our other communities across our footprint. We look at those margin dollars as an example for the second quarter, just in the U.S. that was 25% to $107,000. We anticipate that same margin dollar growth per unit year-over-year in the third quarter, but it’s going to apply a little bit of pressure obviously into the third quarter, into the fourth quarter.

Sheryl Palmer

I might add something to that Steven, clearly, as we improve our mix in California and you look at some of these very high end communities, probably most infamous [ph] things like we are buying ranch. I mean these are generating very, very significant dollars per door and so it’s kind of this catch22, you certainly want that improvement in your overall but that’s what’s going to drive your bottom line, but it’s going to put pressure on the rate. But all-in-all, we believe it’s absolutely the right thing to do.

Stephen East – ISI Group

Okay, thanks. And then, one follow-on to that and then – a different issue, on the cost inflation side, what are you all seeing on this square foot basis? And then, Sheryl, if you could just talk about a little bit regionally, the demand trends you’re seeing and you mentioned the west and I was just trying to understand your community count growth versus your absorption rate decline, and then particular part of the U.S. and so, that’s really what I was looking for.

Sheryl Palmer

Okay. So, on the build cost, I think that was your first question Steven?

Stephen East – ISI Group

Right.

Sheryl Palmer

We’ve seen approximately 2% to 3% since the beginning of the year with the first quarter taking about two-thirds of that pressure, and second quarter taking about one-third of that pressure.

Stephen East – ISI Group

Okay.

Sheryl Palmer

Those increases as you might expect vary a bit, market-by-market, however framing labor, dry wall materials, and labor specifically – generally more on the labor side was probably the piece that was consistent across most of the businesses, lumbers, probably the one that fluctuates the most, outside of – obviously, with the exception of our Florida business. So, we’ve seen some ups and downs but generally, I would tell you that through the first half of the year maybe – actually it’s a little slower than we might have anticipated. As I look forward, we’re going to do everything we can to manage those pressures but as I said in my prepared comments, I expect that builders have significant deliveries for the second half of the year, we’re going to see that labor pressure pick up, similarly to what we saw at the end of last year.

Stephen East – ISI Group

Okay.

Sheryl Palmer

Okay. On a market – so, now I’m going to move to the market. Yes, the market-to-market – let me just go through some really quick comments. As I start with Florida, we’ve had nice community count growth there anticipated for this year. We’ve had really nice sales growth and our average selling price depending on the market has probably moved anywhere between 15 to low 20 percentage rates. Our closings probably have had the highest growth in the country when I look at our Florida market. So traffic remains strong, closings are strong. The active adult business there continues very, very favorable. Texas, as I’m sure you’ve heard from everyone, continues to be really nice across all of our Texas market, I would tell you from a community account standpoint. We didn’t have significant growth; our investment in Texas was obviously within the Darling business. Our ASP had a very significant range depending on the product profile of low single digits to mid-teens, closings also at nicely year-over-year. And what I’m quite pleased about in Texas is really the margin, I mean Texas has always been known for this high turn low margin, and we continue to see that be a very nice high turned high margin business for us, and when I look at progress Darling has made in 18 months, I mean, my hats off to them.

When I look at California, probably the largest percentage growth on a community count basis but the numbers are significantly smaller, so you got to put it in context. Sales have grown handsomely year-over-year, obviously with that community count growth even with a very significant – let’s call it 20% year-over-year average sales price increase. And as Dave alluded to, our margin per door in California is about 50% higher than the rest of the country, or the company. So I think that’s slight impressive. We’ve talked a lot about Phoenix and we’ve mentioned that we increased our market share and how we’re ranking in starts and closings, our absorptions in Phoenix continue to exceed the company’s consolidated absorptions. So with all the noise out there, we’re actually quite pleased with our paces there.

In a year-over-year premature down, there is significant variation by location, if you recall some of my comments from last quarter, and some of the out markets where permits have really fallen off out in the peripheral. From an incentive standpoint because I would expect that question, really in Phoenix, where we’ve seen incentives pop-up, are really in the master plans. The good news for us, is we don’t participate in a lot of big master plan communities. I think we’re actually are into – and one, we’re in a sellout mode. And that’s really – when you look at the concentration, that’s really where we’ve seen – I think the market has seen some of the pressure points. But having said that, what I would really like to share with you about out Phoenix and – I think I’ll focus on Phoenix because it will probably be the first one to truly benefit. Some of the change in guidelines were seeing for conforming loans that are effective August 16 this year, and we’re quite excited about them. Effective really next week, Fannie [ph] has modified the seasoning requirements on deed in blue, pre-foreclosure sales, charge-offs of certain bankruptcy events that now have a four-year waiting period versus the seven-year waiting period for conventional – confirming loans on higher LTVs. This is a really big deal and believe it’s a great opportunity for us in the marketplace. I mean, if I take a market like Phoenix where the SHA loan limits adjusted from $346,000 last year to $271,000 on the first of this year. It obviously impacted a significant portion of the market who have a need for loan greater than $271,000 but now bound by a seasoning timetable for conforming loans but no longer three years with FHA. And if you think about that, that dates back to 2007 if you’re thinking about a 7-year seasoning, and not to mention, a higher down payment compared to FHA.

Generally we are probably one of the builders least affected by the adjusted loan limits given our average sales price. But I look at last year and it probably affected about 20%, 25% of our communities, and this year, the first half of the year it was probably close to double that. But if you think about the change next week – and the reason we believe it’s so exciting, one could argue that the last six months, potential buyers have really had the deck stacked against them. I mean we should see this universe grow every quarter, if you think about the borrowers, they plan to use FHA and had seasoned – plan on using FHA financing early in this year and had seasoned past the three-year point and came to the market only to learn that the property they desired didn’t fit within the revised FHA loan amount. They actually had to go back to the sidelines and with four more years to take advantage of the confirming loan limits up to $417,000.

In addition to the seasoning, they also learned that down payment requirements might be a little bit higher at 5%. I think the bright spot on the down payment requirements is that if I look at the guidelines for gifting, they are much more lenient today than old conventional conforming limit. But you put all of that together and we see just a wonderful opportunity in Phoenix and obviously, that will branch out to the rest of the country.

Stephen East – ISI Group

Okay, that was very helpful. I appreciate that.

Sheryl Palmer

Thank you.

Operator

And we have a question from Nishu Sood from Deutsche Bank. Please go ahead.

Unidentified Analyst

Thanks, this is Ravi [ph] for Nishu. So when – I came about that kind of the profit over volume statements that you’ve made throughout the call, what kind of implications does this have on your land spend and your community count outlook. I mean, should we start to see land spend decline a little bit, and as you’re focused on margins and therefore you’re not going to be opening as many communities? And how should that trend into next year?

Sheryl Palmer

I don’t know that I would jump to that conclusion. Our land spend will be based on really the market conditions that we see. For this year, what we’ve said is we should end the year at about 210 average community count which is about 27% up, year-over-year in the U.S. We haven’t given any community count guidance for next year or spend guidance, but I’m not sure that the price over pace really impacts the way we would look at individual market supply and demand conditions.

Unidentified Analyst

Okay, got it. And then, you mentioned a few examples of active adult communities. So are you making more of an overall push into active adults? And what percentage of your communities are active adult right now and how large are these projects relatively to your other product lines?

Sheryl Palmer

We’ve been talking about our movement into adult really for a number of yes, so this isn’t a new push, this is in the right locations where the demand exist, we’ve been opening communities over the last few years, we’ve opened communities in Florida, obviously I spoke about a new one in Houston and new one in Denver this year, we’re opening one is Boston, Southern California, so really a little bit across the Board. When I look at – in the quarter, the mix – and I look at those sales and closings – I would tell you that active adult in the U.S. was about 15% of our closings through the portal and about the same on the sales side.

Unidentified Analyst

And how larger are your projects compared to the other, your other projects, are they similar size or –

Sheryl Palmer

As I commented, we tend to look at these more [ph] at 55-plus communities, and across the Board they would range anywhere from a few hundred units to – probably our largest is over a thousand, just over a thousand.

Unidentified Analyst

Alright. Got it, thank you.

Sheryl Palmer

Thank you so much.

Operator

And we have a question from Will Randow from Citigroup. Please go ahead.

Will Randow – Citigroup

Hey, good afternoon, and thank you for taking my questions.

Sheryl Palmer

Hello, how are you?

Will Randow – Citigroup

Good, good, thanks Sheryl. I appreciate of color and the changes you mentioned that are upcoming. I was hoping you could discuss your thoughts on two related topics. The first thing, have you seen any impact from FHA Hawk program in terms of benefit, that’s the counseling program to reduce your upfront fees, as well as overall collect cost of the mortgage? And then second, do you have any initial thoughts on the draft for private mortgage insurance given that we’ve seen a big pick up in that with FHA back loans as we’ve seen FHA loans lose share?

Sheryl Palmer

Yes, I would tell you that on the Hawk side, we really haven’t seen anything that’s impacted the business from – on Hawk, and probably, mostly because of just our general consumer profile. On the insurance side, I think we’re going to see that overtime. I’m hopeful that we’re going to see some movement there on insurance but I don’t think we’re going to see a lot of changes there candidly, till the end of the year, I think on the – just on the regulatory front in total, there is certainly some opportunities in front of us on FHA, on fees, I just think given the current environment it’s going to take sometime.

Will Randow – Citigroup

And then just on – in terms of the sub-market color you provided on Phoenix, and that really putting on a ton of incentives outsides a master plans. Have you seen that market stabilize in the same way we’ve seen that some of the markets have probably have been – you mentioned Mark [ph] on the last call, if I remember correctly. Have you seen kind of stabilization year-over-year in orders, not necessarily absorptions versus down pretty dramatically in the first half?

Sheryl Palmer

I think that well positioned communities in Phoenix continue to deal really well. We don’t happen to have any penetrations in there, that they use that to show the extreme of what’s happened from a permit standpoint year-over-year. But when I look at our new communities and when I look at one of our competitors new communities that opened in desirable sub-market, they do just fine. So if I take that and I take kind of the adjustment period that I think the market needed to go through because I think we would all agree that there is a lot of movement quite quickly in about 12 or 15 months. And then, you kind of layer on I think the opportunity that we have one the change coming that I just described on Fannie [ph], I think the markets going to be just fine.

Will Randow – Citigroup

I appreciate the color, and congrats on the quarter.

Sheryl Palmer

Thank you, I appreciate it.

Operator

And we have a question from Alex Barron from Housing Research Center. Please go ahead.

Alex Barron – Housing Research Center

Good afternoon, and great job on the quarter.

Sheryl Palmer

Thank you.

Alex Barron – Housing Research Center

I just wanted a little bit on the guidance for the deliveries this year, so you’ve given us third quarter and I guess we can back into fourth quarter, but just to make sure – I guess that implies on units in Canada, is that correct? Is that like tower or what’s going on there?

Dave Cone

Are you talking about moving for the fourth quarter Alex?

Alex Barron – Housing Research Center

Yes, yes. And then, I guess a follow-up to that would be – you guys have some plan in place for that – there is not a huge drop fourth quarter of 2015?

Dave Cone

Well, I think – I’ll start maybe on the reverse order. Our high rise business does create some lumpiness, so we do see that from time-to-time. We delivered three towers last year between wholly-owned and JV, three towers this year compared to ‘12 where we didn’t have any. So, there will be some lumpiness from that high rise business. But…

Sheryl Palmer

So you will see a drop off.

Dave Cone

You will see a drop off.

Sheryl Palmer

Yes, I think we can be certain of that since we don’t have a tower next year. Sorry.

Alex Barron – Housing Research Center

No, that’s fine. I guess I just wanted to make sure I was understanding that correctly. And then, I guess my other question was, I think you guys are trading at a pretty low level compared to other builders. Would you just consider like some type of a share buyback if you think your shares are undervalued at these levels?

Dave Cone

Probably not right now. I think as we look at – we’re to deploy our capital, we still think investing in the business is going to provide the ultimate, greatest return for us in the longer term.

Alex Barron – Housing Research Center

Okay, great. Thanks.

Sheryl Palmer

Thank you.

Operator

And we have a question from Jim Krapfel from Morningstar. Please go ahead.

Jim Krapfel – Morningstar

Hi, good afternoon. Thanks for taking my question.

Sheryl Palmer

Sure, how are you Jim?

Jim Krapfel – Morningstar

Good, thanks. In your prepared remarks, you’ve mentioned your just-in-time development philosophy, I just like to hear you elaborate on that a little bit and what you see longer term in terms of your land purchase needs, maybe as a percent of land that you see under options and how much you would like to ultimately engage in from the permitting and the developments of land. Just can’t see how you approach the capital intensity of the homebuilding industry.

Sheryl Palmer

Yes, and what was the first part of that question. Just in time development, thank you. Okay, on the first part of your question Jim, if you look back historically, I think builders got themselves in trouble in a couple of places, right. One would argue that there was a lot of land brought at the top of the market, and I think the other challenge that some builders had was – the paces were so strong and the development that got in front of builders put a lot of finished lots on the ground. So, we take that – we take both ends of the land equation quite seriously, and the teams have a significant rigor around their development strategy, and how many lots they put in front of the business, and they bring those request through our investment committee to make sure that we don’t ever end up in a place, you don’t want to run out of lots but we don’t want to have a two year supply of lots in front of the business. And because we have a longer land bank, we’re not trying to fill whole – we’re trying to purchase finished lot. So we just said it’s really a balancing act to make sure that we don’t get cut short but we don’t invest that capital quicker than we need to.

When I look at our land purchase needs moving forward – as we’ve said, we expect in total between land and development to spend somewhere around $1.2 billion this year. One of the things that we are seeing this year and I think we’ve talked about it in prior quarters is, we are seeing the development side of our business ramp up compared to prior years given the amount of acquisition that we’ve done the last two or three years, we’re now actually investing to bring that to market. In addition, I would tell you that we will always look to optimize the deal structure and if options make sense, and we’re in a market where we can do that, that will always or seller financing, that will always be our priority. We’ve been averaging somewhere between 70%, 75% – around 25%, 30% controlled, to the extent that we can continue to control more as compared to own it, that would always be our first preference.

Jim Krapfel – Morningstar

Thank you, that’s very helpful.

Sheryl Palmer

Thank you.

Operator

We have no further questions at this time.

Sheryl Palmer

Okay, thank you very much everyone today for joining our Q2 call. Have a wonderful evening.

Operator

Thank you, ladies and gentlemen. This concludes today’s conference. Thank you for participating. You may now disconnect.

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