Taylor Morrison's (TMHC) CEO Sheryl Palmer on Q1 2018 Results - Earnings Call Transcript

Taylor Morrison, Inc. (NYSE:TMHC) Q1 2018 Results Conference Call May 2, 2018 8:30 AM ET

Executives

Jason Lenderman - VP, IR & Treasury

Sheryl Palmer - Chairman & CEO

Dave Cone - EVP & CFO

Analysts

Ivy Zelman - Zelman & Associates

Michael Rehaut - JP Morgan

Stephen East - Wells Fargo

Nishu Sood - Deutsche Bank

Matthew Bouley - Barclays

Jack Micenko - SIG

Jay McCanless - Wedbush

Operator

Good morning and welcome to the Taylor Morrison First Quarter 2018 Earnings Call. Currently all participants are in a listen-only mode. Later we’ll conduct and question-and-answer session and instructions will be given at that time. As a reminder, this conference call is being recorded.

I would now like to introduce Mr. Jason Lenderman, Vice President, Investor Relations and Treasury.

Jason Lenderman

Thank you and welcome, everyone, to Taylor Morrison's first quarter 2018 earnings conference call. With me today are Sheryl Palmer, Chairman and Chief Executive Officer, and Dave Cone, Executive 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 a financial review of our results along with our guidance. Then Sheryl will conclude with the 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 risks 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, Jason. We appreciate you joining us this morning as we present Taylor Morrison's results for the first quarter of 2018. Getting right to it, I'm delighted to share that we exceeded our expectations in several operating metrics, including sales, home closings gross margin, and earnings per share. Now, as we mentioned on last call, we started the year with an exceptionally strong sales pace of 2.5, and since then have only continued to see that accelerate. We closed the quarter with a sales pace of 2.8, our best pace since the first half of 2013, representing a 40% two-year growth rate. It's important to note that we recognize these strong paces across our portfolio, touching each market, consumer segment, and price point.

For the quarter, sales were 2,443, with an average community count of 288. Achieving strong paces and growth in orders, even with fewer communities open than in the first quarter of 2017, points to our team's ability to deliver on our customers' expectations. Having the right product in the right locations with a trusted customer experience from beginning to end yielded our solid results. Our performance in the quarter drove $0.41 of EPS, a home closings gross margin of 18.8%, and an EBT margin of 7.9%, both improving 80 basis points over first quarter last year. I'm pleased to see this accretion in margin rate, which is due in part to mix and attributable to the strengthening of our operational efficiencies and cost savings practices.

Our teams across the country continue to embrace ways of working smarter, not simply harder, to enrich both the lives of our team members and our customers. All in our quest to achieve operational excellence, one of our three strategic focus areas for the year. By way of example, we are nearing the completion of our salesforce rollout across all divisions, a move that will not only continue to drive operational excellence, but also help our goal of delivering a differentiated customer experience, another one of our three strategic priorities. Since I've touched on two of our three priorities for the year, I'll also mention the third, which is strategic growth.

As discussed on prior calls, we understand and appreciate that scale matters and our goal of growing meaningfully in ways that complement our product, consumer segments, and Company culture is a big one for us this year. Now that I've had a moment to highlight some of our achievements for the quarter, I'd like to touch on the timing impact of our 2017 third and fourth quarter starts, following last year's hurricanes and the push in Q1 closings. For the quarter, closings totaled 1,547 three less than our stated guidance. As our trades put in an amazing effort to support us during the fourth quarter of 2017, we underestimated the length of time it would take the impacted markets to recover after losing days, and in some instances weeks, getting foundation starts into the ground.

With local access to the trades tightening and some finish trades shifting focus to rebuilding efforts, our ability to close and deliver homes to our 100% standard of completion and QA protocol was impacted. As an organization, we simply will not compromise our home delivery standards. Having said all of this, we are not changing our guidance for the year, as this is purely a first-half timing issue.

Our strong sales pace has continued into the second quarter and with solid market fundamentals surrounding us, we remain confident about current and future market conditions. Consumer confidence continues to rise and there is a general sense of optimism in the job market, with the labor participation rate increasing and the unemployment rate remaining in the low four percentage range. Continued low levels of supply for both new and existing homes creates a promising runway and a favorable demand proposition for us. While interest rates increased rapidly earlier in the year, they have since moderated and as evidenced by the continuation of our strong sales pace, we are not experiencing any negative impact to our business. In fact, we think there is some potential to continue to capitalize in a probable rising interest rate environment.

After a long period of sustained low mortgage rates, the activity has created a sense of urgency as well as an opportunity for us to use our mortgage services as a viable sales tool. Our qualification assessment and buyer education on the impact of interest rates on their monthly payments provide imperative real-time information, helping our customers to buy with confidence. We use our seller incentives to maximize our overall offering for our home buyers based on their individual needs. For example, covering closing costs to offset the required cash needed out-of-pocket or buying down a buyer's interest rate.

To get a sense of how our customers and home shoppers across our markets are feeling, given the increased press and attention on the matter, we began surveying those touring our models, specifically asking them about interest rate movements and any impact that might have on their home buying decision. The data revealed that even if interest rates were to increase from today's estimated 4.5% to 6%, nearly 90% of our shoppers would continue their home search and buying plans, though it may increase their down payment expectation, change their mortgage product, or reduce the size of the home they choose. But ultimately, it won't stop them from buying. We also found it interesting that about 10% of the shoppers indicated if rates continue to climb, they may pause their search efforts to see if rates might head back down. Knowing our shoppers' mindset related to the possibility of rising rates helps us better predict our sales patterns and plan for the appropriate mix of inventory starts amidst our to-be-built business.

As we have discussed the last couple of quarters, our strong borrower profile gives us confidence that those in our backlog could absorb additional rate increases and still qualify for their home purchase. That, combined with the fact that we just aren't heavily weighted in the price point that is likely to be most affected by rate changes, provides further assurance that we won't be adversely impacted.

Currently, our pipeline of FHA buyers could qualify with a 3.3% higher interest rate and our conventional buyers could absorb up to a 5.75% higher than current rates and still qualify for the home they are under contract for. On average, our borrowers have strong credit and personal balance sheets, a loan-to-value of 76%, with a debt to income ratio of 37% on a loan amount of approximately $347,000. Over the last 13 quarters, this strong borrower profile has averaged a credit score of 740 or higher, helping to keep our cancellation rate at 9.3% for the first quarter, which remains one of the lowest in the industry.

Overall, I'm encouraged by the health of our industry and the economy and the clear impact they are having on our sales success. It is an exciting time to be in homebuilding and an even more exciting time to be part of the Taylor Morrison family. With a strong backlog and a solid April sales pace, we are well positioned to see an equally encouraging second quarter, despite the tough sales comps from 2017.

With that, I will turn the call over to Dave for the financial review.

Dave Cone

Thanks, Sheryl, and hello, everyone. For the first quarter, net income was $47 million and earnings per share was $0.41. Total revenues were $752 million for the quarter, including homebuilding revenues of $733 million.

Home closings gross margin inclusive of capitalized interest was 18.8%, representing an increase of 80 basis points when compared to last year. The year-over-year improvement is driven by product mix shifts across the organization, operational enhancements that are helping to offset cost increases, and lower capitalized interest. On a gross margin basis, we came in at 19%.

Moving to our financial services, we generated more than $14 million in revenue for the quarter. Our mortgage company capture rate for the quarter came in at 75%. SG&A as a percentage of home closings revenue came in at 11.9%, about even with the first quarter of 2017. While our first quarter is typically our highest SG&A rate of the year, this has been compounded as we are seeing some of our closings shift to the back half of 2018. As we move through the year, the increased closings growth will drive SG&A leverage and we continue to believe we will achieve SG&A in the low 10% range, consistent with our guidance.

Our earnings before income taxes were $59 million or 7.9% of revenue. Income taxes totaled about $12 million for the quarter, representing an effective rate of 19.8%. This is significantly lower than the first quarter of last year due to tax reform. In addition, our Q1 tax rate came in more favorable due to legislation passed this February which extended energy tax credits retroactively through the end of 2017. Those energy credits resulted in a one-time benefit of $3.8 million for the quarter.

For the quarter, we spent roughly $202 million in land purchases and development. At the end of the quarter, we had approximately 37,000 lots owned and controlled. Our percent controlled has been increasing over the past several years as we seek out more favorable deal structures. The percentage of lots owned was about 70%, with the remainder under control. On average, our land bank had approximately 4.7 years of supply at quarter end based on a trailing 12-month of closings. From a land pipeline perspective, we are almost exclusively now focused on securing land for 2020 and beyond.

At the end of the quarter, we had 4,392 units in our backlog with a sales value of more than 2.1 billion. Compared to the same time last year, this represents an increase of 12% in units and an increase of 13% in sales value for those units. In addition, we had 1,537 total specs, which includes 201 finished specs. On a per community basis, we had just over five total specs and less than one finished spec per community as we continue through the spring selling season. The year's sales success so far has reduced our finished spec levels a little lower than we'd prefer, but I think we can all agree it's a good problem to have. We've had nice success in selling our inventory homes while they are still under construction.

We remain committed to efficient inventory management, in which spec inventory plays a significant factor. This continued focus has led to asset turns increasing 8%, with inventory turns also up nearly 10% for the quarter, as we have now driven year-over-year accretion in both these metrics for at least six consecutive quarters. Our recent performance fuels our beliefs that we should drive accretion and return on equity year over year even before considering the impacts of tax reform.

We ended the quarter with about 288 million of cash and our net debt to capital ratio was 33.1%, which we believe is one of the lowest in the industry. While we don't have any outstanding borrowings on our credit facility, we do plan to use it for normal working capital requirements in 2018 and expect it to be paid off well before year-end.

Our balance sheet continues to be a significant point of strength and a tool that provides flexibility when developing our capital allocation and growth strategies. In fact, as we discussed on our last call, our strong balance sheet provided us the ability to purchase about 200 million of our shares at the start of 2018.

I will wrap up the financial review by sharing our guidance. As Sheryl mentioned, we are not changing our closings guidance for the year and still anticipate closings to be between 8,400 and 8,800. Our community count will be flat to last year and our 2018 monthly absorption pace will be between 2.4 and 2.5.

GAAP home closings margin, including capitalized interest, is expected to be accretive to 2017, in the mid to high 18% range. As I mentioned earlier, our SG&A as a percentage of homebuilding revenue is expected to be in the low 10% range. JV income is expected to be between 8 million and 10 million, and we are lowering our anticipated effective tax rate to be between 24% and 26%. Land and development spend is expected to be approximately 1.1 billion for the year.

For the second quarter, we anticipate average community count to be between 295 and 300. Closings for the second quarter are planned to be between 1,800 and 1,900. GAAP home closings margin, including capitalized interest, is expected to be approximately 18%.

Thanks and I will now turn the call back over to Sheryl.

Sheryl Palmer

Thanks, Dave. Before opening the call for questions, I will spend some time providing an update on several of our markets, beginning in the West. Our three California divisions are experiencing strong demand and have seen a healthy increase in traffic and sales paces compared to the first quarter of 2017. Resale inventory remains especially low within these markets and the lack of supply continues to support price appreciation in many of our communities. While the recent rise in interest rates has not impacted our demand across our price points, affordability continues to be a concern in California. Land remains very competitive within the state, but we continue to find ways to remain true to our strategy of pursuing core locations.

In Southern California, for example, the affordability factor as well as a booming job market in the Inland Empire really supported our case to seek attractive deals within the Riverside and San Bernardino County submarkets. Our JVs in Southern California also experienced strong demand in the first quarter, particularly at our Sea Summit community, nestled along the coastline in San Clemente, where buyers are feeling some urgency due to the declining number of available home sites. In fact, we have seen a significant pickup in sales year over year in our coastal market communities. In Sacramento, we saw a 30% increase in sales pace compared to the first quarter of 2017. The demand is coming from both organic household formations in addition to Bay Area migration, which is at an all-time high. It's interesting to note that a significant portion of the migration is the 55-plus buyer group.

More people are moving to the Sacramento region from the Bay Area than to Seattle, Denver, and Phoenix combined. That said, our Bay market still had an excellent quarter with truly impressive sales due to three new communities opening well ahead of schedule and gaining significant interest and traction with those buyers. Phoenix continues to be one of our strongest, most consistent divisions within the portfolio. Like California, resale and new home supplies remain low in the market, allowing us to push prices in most of our communities, helping to offset some of the construction cost increases we are seeing. Housing starts are up 20% year over year, adding pressure to the tight labor resources in the market.

Our Sky Crossing joint venture opened in April and even ahead of the model's opening, we saw preopening contracts of more than 10% of our total home sites within this community. This is a particularly good example of our focus on core locations and why strategy really matters. Kudos to our Phoenix team for their hard work and diligence this past quarter, landing them the highest margin and second-highest sales pace in the Company. Similarly, Denver saw one of our highest first-quarter sales pace increases. The whole market experienced conversion rates at the highest level going back 15 years. While paces are strong, the market is expected to reach a peak housing deficit of nearly 32,000 units this year. As one might expect, this lingering shortage is causing affordability concerns across the market, although I'm quite pleased with the team running one of our higher Company paces at 3.6 in Q1 with a backlog ASP in the low 500s.

Turning to Texas, we have seen an increase in sales demand across all three markets compared to the first quarter of 2017 and couldn't be more pleased with the performance of our Dallas, Austin, and Houston businesses. With rising oil prices, we are seeing increased traffic and demand in Houston. Just this January, we combined our Darling Homes and Taylor Morrison businesses in Houston under one management team, collectively becoming the third largest builder in the market and combined now serving all consumer groups meaningfully across both brands in addition to Houston's active adult lifestyle brand, Bonterra. In Dallas, we experienced the wettest month on record with over 16 inches of rain in February.

Although it didn't appear to slow down sales activity, the rain did impact our cycle time slightly and our ability to get slabs poured early in the year, pushing many Q2 closings to the back half of 2018. Our Austin business continues to surprise us to the upside, with expected growth near 20% year over year, with no additional communities added to their mix and one of the highest average price points in the marketplace. The fundamentals in our North Carolina market remains positive with regard to employment, population growth, and increase in home starts. Both Raleigh and Charlotte are experiencing a low supply of resale housing, causing some affordability concerns across the MSA. To meet some of the demand for affordable housing, our Raleigh division will open its first master plan townhome community this fall, which will offer affordable product in a very prestigious submarket.

Sales remain quite robust in the Atlanta market. In fact, our backlog units are up more than 20% from Q1 last year, while the backlog value is up more than 50% and our pipeline ASP is up just over 25%. Finishing with Florida, I am very pleased with the success we continue to see in our active adult lifestyle communities across the state. The spring selling season was so strong that we sold more condos in our Sarasota Esplanade community within the first few months of the year than we sold in all of 2017.

I'm delighted by how we started the year and the solid first-quarter performance we have to show for it. Our footprint, the balance of our portfolio, and the diverse buyer segments seen across our markets make me optimistic about continuing the momentum in the quarters to follow. But nothing fills me with greater confidence than the individuals who make up the Taylor Morrison family, who have a level of resiliency and passion I believe truly unmatched. It is this demonstration of spirit and pride that I see in our team members every day which assures me that together, we will deliver on our full-year guidance. I'd like to close with a thank you to all our teams for delivering results that support our focus on being a return-proven business.

With that, I would like to open the call to questions. Operator, please?

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from the line of Ivy Zelman with Zelman & Associates.

Ivy Zelman

Sheryl, there has been a lot of disruptors entering the market in terms of in the real estate services brokerage industry as well as in the mortgage industry. And just thinking about the new home market versus resale, there seems to be a widening of the premium that the consumer is willing to pay. First, if you can comment on that, if you are seeing that premium widen and if you think it's sustainable. And is it related to some of the new home amenities that might be more towards a smart home? Or anything that might really pull an incremental buyer in that's differentiated from prior periods of housing strength?

Sheryl Palmer

Yes, thanks, Ivy. Absolutely, you are right. We have seen that gap widen actually quarter over quarter over the last probably 24 months. I don't think we will continue to see it get wider, but I do think you will continue to see the gap. And I think you hit it right. For a long time, we talked about the impact of old versus new and energy and how you refurbish these houses. I think now you have to add technology to it, even though everything has gone wireless, the ability to take some of these older homes and really get them to today's technology standards is very, very difficult. And when you think about what the consumer really wants across all price points, you are right it absolutely is on the smart home.

Ivy Zelman

Could you elaborate what you are doing specifically, if anything, to provide the consumer a smart home?

Sheryl Palmer

Yes. So it's a little bit different across the markets. We are looking at some programs that I'm not prepared to announce yet across the portfolio. We are testing, piloting, I would tell you, in some markets right now and then we will go a little broader. But it's everything around just disrupting the overall customer experience really from start to finish. And that would be everything from first contact in our Internet communications all the way to the customer journey once folks come in our front door and how we take them through the construction process and how they are living in their house with new technology. I'll comment on specifics as we get a little further along.

Ivy Zelman

Great. Can I sneak in one more, please? There has been a lot of questions on prior calls related to potential automation in the construction process. And there's obviously Katerra is big in the market in terms of a new disruptor. Are you right now ready to talk about anything that you are working on? Or any expectation that you will increase backward integration and providing more ways to improve overall cycle times with automation?

Sheryl Palmer

Yes, good question. We challenge business every day, continue to explore more efficient options. Lots of work is being done on it. A few of us in the Company have been very involved in our past lives on prefabbed walls, steel construction, really the manufactured efficiencies that you would expect. We are doing it today in some markets selectively. But because of our experience, we know the good and we also know the pitfalls. I would tell you that I think it's an industry we will continue to explore: sustainable, cost-efficient solutions I think that have been discussed on many of the calls.

As I said, there's a lot of smart people spending a great deal of time on it to gain efficiency. But it really is complicated as you break apart the pieces. If you think about it, what we are really trying to solve for is the labor arbitrage between plant operations and field operations, as the material costs don't change as long as you really do get waste out of the system, which a controlled environment certainly helps with. The other great opportunity is cycle time improvement, and the other headwind offsetting that is the cost of transportation. I would tell you today, our success has been on the QA side: scheduling, product efficiency, truly planned production, partnering with our suppliers' trades, efficiency in the field one trade at a time to get days out of the schedule. Over time, I would expect that technology will play a greater role but I think we are a little ways apart still.

Ivy Zelman

Very helpful. Good luck, Sheryl. Thank you.

Operator

And our next question will from the line of Michael Rehaut of JP Morgan. Your line is now open.

Michael Rehaut

Thanks. Good morning, everyone. First question I had was on the sales pace. And you mentioned that came off to a great start for the year, record for the first quarter and in April. I was curious if you could kind of help with breaking that down between entry-level and move-up. And what areas, if you are seeing greater year-over-year differences between one segment and the other? As well as if you could provide any color in terms of any regional standouts?

Sheryl Palmer

Yes. You know, the nice thing here, Michael, is, like I said in my prepared comments, one of the things that has us feeling so good and bullish is it really is across the portfolio. When I look at the results, literally division by division, the majority of our divisions are up year over year from a sales pace standpoint. We have a couple of that are flat. And generally the one or two that are down -- I mean, I can look even to the numbers and say it's because of the timing of new openings. And that would be across our first-time business, our urban business, our active adult business, and our first and second move-up, and across all markets. So it's rare that we see kind of everything rowing in the same direction, but actually it's really across the business.

Michael Rehaut

That's very helpful. And certainly, the comment around strength around different parts of the customer segment mix is a little different. I mean, certainly, most builders are saying move-up is fine, but overall pointing to a much higher degree of strength in the entry-level. So that's encouraging.

Sheryl Palmer

Yes. And I would tell you that is just not the case with us. We are absolutely seeing it in the first-time, second-time move-up and the active adult, which tends to be at a much higher price point.

Michael Rehaut

Yes, it's definitely observed and a positive for your business. I guess secondly, just shifting to the margins for a moment, it came in a touch above our estimates. Maybe there was some shift in timing issues, as you guided the second quarter closer to 18% and you reiterated the full year. But I was curious as you look at the full year if you could just kind of remind us how you are thinking about some of the cost inflation elements of the equation. And obviously, you are getting pricing to more than offset that, but I was just curious if you kind of break down materials and labor as well as perhaps lot costs where you are seeing the biggest areas of inflation, and if there is positive mix or just pure price that's more than offsetting that?

Dave Cone

Sure, Michael. Good morning. I will maybe start on the cost side, and I think it's going to be consistent with what you are hearing. From a direct billed cost standpoint, we're probably seeing that we are up maybe a little bit more than 1%. Lumber continues to move around..

Michael Rehaut

That's year over year? That's year over year, Dave?

Dave Cone

Right. So lumber continues to move around. As you know, we have price locks in place. OSB has been a little bit volatile as well. Other places where we continue to see increases are around concrete and steel. Obviously with the tariffs, that's had some impact. So we are seeing some increases in block and retaining walls, brick and tile roofing. But overall, steel makes up a relatively small component of the overall costs. But you also touched on it. I mean, labor continues to be the challenge in many of our markets as we see those high-volume market.

But through a lot of the work we have done around construction efficiency initiatives, strategic procurement, and value engineering some should cost work, we have been able to offset a fair amount of those cost increases. From a margin perspective for the year, as we look out, we continue to expect benefits from strategic procurement and construction efficiencies. We are going to benefit from lower capitalized interest, and we do continue to believe pricing will stay ahead of cost. We saw price increases in about 50% off our communities. But we will continue to battle through the pressure. We will see higher land costs roll through, as they have every quarter for the last couple years.

So that always puts a little pressure. And we will see continued cost pressure from the hurricanes. That is going to linger for a little bit longer. So when it comes down to it, I think we are going to continue to see these pressures, both on the labor side, especially as we move towards the end of the year, and then the commodity side as well. But we do believe that based on where we see our backlog going, what we have been able to do with pricing, that we are going to have to continue to -- that we will continue to see year-over-year accretion on our margin. Probably the one callout, though, is the second quarter, we are going to see a sequential decline from the first quarter. And that is largely due to mix issues. And then we will see that tick back up in the third and fourth quarter.

Sheryl Palmer

And to Dave's point on the pricing power, we saw improvement and the ability to raise prices in more than 60% of our communities in…

Dave Cone

50%.

Sheryl Palmer

50% in the last quarter. So as Dave said, that gives us some great confidence that we will be able to continue to stay ahead of these pressures.

Operator

Thank you. And our next question will come from the line of Stephen East with Wells Fargo. Your line is now open.

Stephen East

Maybe on the closings a bit, it came in less than we were expecting, but you have talked a lot about labor issues. Maybe you could elaborate on what you're seeing there, where you are seeing it. The West, I'm assuming you are seeing some there because that was one of the lower backlog conversions you have had this cycle. So just trying to understand what is going on from a closing perspective and how much of it is driven by labor.

Sheryl Palmer

Yes, a couple different things there, Stephen. As I said in the comments, when you think about the slight shortfall we had in the quarter, it really did come down to starts that we didn't get in the ground much more than it did around labor. As you know, we exceeded our expectations in Q4. And everything that we had under production in Q4 in the hurricane-affected markets, we were actually surprised to the upside on how everyone rallied and got them to the finish line. But we had a lot of development activity going on at the same time.

And so when we lost some days and weeks in both Texas and in Houston and parts of Florida, we really expected the teams to be able to pull that back in, in the quarter when those starts got delayed a few weeks. But quite honestly, as time went on and you started losing some of the trades, let's say, in Houston to a place in the cycle, in the construction cycle, where everyone is now finished on or moving toward the finish trade part of the cycle, we just couldn't quite pull -- a week would have made all the difference in the world and we just weren't willing to compromise our closing processes to do that. So the labor impact was specifically in our Texas and Florida markets.

Stephen East

And then on the West…

Dave Cone

Yes, on the West, Stephen, I guess a couple things. One, I would say our Q1 conversion was probably more in line with what we saw kind of middle quarters last year. A lot of it was driven by Phoenix and California, mainly the Bay Area. If you look, we are a little bit lower in Phoenix year over year, but we are actually above where it was two years ago. So some of that is to Sheryl's point around development and some timing. From a Bay Area perspective, some of that is centered around timing of buildings -- when they are closed, we get the COEs on those. And I think what you're going to see is probably something on the lower side for conversion in the second quarter, but then it is going to tick up pretty significantly in the third and fourth quarter. Whereas in the Central, you are going to see that grow as we move through the year, and you will also see that on our East region as well.

Stephen East

And then a couple questions on the land buying. One of your competitors stated that they were seeing less competition in the move-up segment of land acq as a lot of the builders have pivoted toward entry-level. One, I wanted to get your thoughts on whether you think that is actually happening in your markets. And then two, in our meeting, you all discussed tweaking your land buying process a bit to avoid the big misses, if you will. Maybe you could elaborate on what you all are doing there. And is that something that we would start seeing -- if you are looking at land today, we wouldn't really start seeing until 2020 or so?

Sheryl Palmer

Yes. I just want to make sure I understand what you are implying by big misses so I answer the right question. On the first question, Stephen, you are exactly right. And we have been talking about this for probably close to a year, that the unintended benefit of this kind of flight to the fringe and affordability from other builders has made what's a very difficult tight market actually a little better in certain submarkets, where we are not seeing the level of competition in the core on that first-time move-up. So we are going to continue to stay true to our knitting and believe it's been helpful. So I would agree with what I heard from a couple competitors as well. Can you give me a little more color on the big misses?

Stephen East

Yes, sure. You were talking about -- you all probably do a better job than anybody we see out in the field as far as targeting the consumer, the right consumer for your product. But when we were talking, you've said when you do miss, it gets pretty painful in your gross margin hit, etcetera. So you've started to evolve that process. I was just wanting to know maybe what you are doing there. And when do we start to see those misses get mitigated. Is that more a 2020 event or would we see that in 2019?

Sheryl Palmer

I understand what you're -- I recall the conversation. Sorry about that. So specifically, you know we spend a lot of time on consumer targeting. And sometimes we tend to act a little contrarian to others. And I think this affordability thing is a very good example, where if I were to go back through the last cycle, we were probably the first to really jump into that first-time move-up, second-time move-up buyer because we knew kind of the big-box syndrome wasn't going to be here forever. Just like now, even though a piece of our business is that affordability factor, we are going to get there a little bit different way.

What we found through the analysis we do on our underwriting is that if we completely target and completely nail our underwriting on the first- and second-time intended consumer group that our margin is probably somewhere close to 300 basis points, 400 basis points higher than if we end up getting that a little wrong and it ends up being the third or fourth tier of consumer that we've targeted with our product selection. We are seeing that benefit every day as we are opening up new communities. But you are absolutely right. You will really start seeing that come through the land in 2019 and 2020.

Dave Cone

Yes, to that point I would say when we look at our guidance for 2018, we had a bit of a bullish view when putting that out there. And that is still is in place, given we feel we are going to be accretive year over year. And that is on top of being accretive 40 basis points in 2017 over 2016.

So as we look forward, I think what you are going to see is this come in a little bit each year. It is not going to come in necessarily in all one year, because this has been more or less an evolution of a process. And I think at the end of the day, though, it is also going to help us to continue to fight off some of these rising costs.

Sheryl Palmer

Yes, very much so.

Stephen East

Got you. Okay. All right, thank you.

Operator

Thank you. And our next question will come from the line of Nishu Sood with Deutsche Bank. Your line is now open.

Nishu Sood

Thank you. I wanted to start on the Darling. That I think has been a part of your folks' operations now for about five years. The combination in Houston, and especially as Steve was mentioning, you folks have a pretty thoughtful approach to targeting customers. So why combine the operations now? Why only in Houston? So maybe if you could explore that a little bit more, please.

Sheryl Palmer

Yes. So actually, the two operations are set up pretty similar between Dallas and Houston. Recognizing the differences -- when we were in Dallas, we only were in Dallas with the Darling business up until last year. And then we added the TM brand and started closing houses I think in the fourth quarter of 2017. But that is under one division president with some folks on the team focused on both brands. Very similar to what we have now in Houston. And I would tell you this has been a journey. We have obviously over the last 12 -- call it 12 months been garnering some efficiencies in the back office. So we've done things like purchasing account -- purchasing has got a little bit of a combined team, but we also have two dedicated resources. Finance has been a consolidated team for a while now.

The primary reason to do it was really we are going to stay focused and there are dedicated resources on both teams. But when we look at land acquisition, we look at the people side and being able to really respond to market needs and working with the developers. And not actually competing for land within one marketplace. Having one thoughtful leader looking at the overall business opportunity makes more sense and where we can maximize land assets with putting both brands in. So it's actually just the completion of some work that's been going on for some time. And in no way should it be considered any change to our expectations around the Darling business and holding that brand at a very different standard. The value -- the attributes of both brands are quite different and we will continue to protect that.

Dave Cone

I think it's as much of internally, we recognize this consolidation versus externally I think people are going to see the two distinct brands, they are staying. But at the most basic level, this included us simply putting both brands in the same office. So they are in the same location. And that's helping us to garner some efficiencies. As you can imagine, it's a little bit easier to walk down the hall than if you have to drive down the street. So that is just another added benefit for us.

Nishu Sood

Got it. And the second question I wanted to ask was Sheryl, you laid out an interesting thesis about the unusual seasonality of demand in 4Q,that it didn't slow down between October and December. And so strength carried into January. Obviously, optimists pointed to strong underlying housing fundamentals and skeptics are more thinking about pull-forward of a demand because of rising rates. How has that played out now as you've gone through 1Q? And any further insights there on what drove that and how that might play out the rest of the year?

Sheryl Palmer

Yes, it was nice to see the acceleration. When I compare Q1 2018 to Q1 2017, we saw just over 25% acceleration from the first month in the quarter to the last. So it felt pretty good, and then seeing that continue in April as we announced was also very positive. We get the question, and there has been a lot of -- I've heard a lot of discussion on the calls around is this a pull-forward. And as I shared on the call, we've done a fair amount of research since the first of the year really understanding if that is the case. And I would say consumer confidence is more important to the business than any of this chatter on interest rates. When we are talking about -- I mean, in the big picture still modest, but over the last quarter, I recognize significant compared to what we have seen in the last few years.

Further in the data, as we really dissected it, we were able to look at generally the view, as I said, of about 90% of these shoppers that were surveyed. This really isn't going to impact their home buying decision. And when you dissect it by consumer group, it does get a little bit more interesting, where when you look at that move-up buyer and the boomers and the silent generation, they are absolutely not impacted or even moved by any change in interest rates. You do get a little bit more sensitivity at that most affordable price point. And even the millennials, the way they are looking at it, because they are not as likely to pay cash, they are probably more likely to scale down than change their desire, which is generally motivated by a life change.

And then there's some other things that excite me about it as I look around, some of what we are seeing and some of the opportunities ahead. For example, just announced last week was this new 97%/3% Freddie Mac program I think is pretty exciting. It's called Home Now and it's really the first impactful program we've seen in quite some time, I'd say since the FHA lower limit. We've seen a lot of programs in the past, but they've also come with a lot of restrictions. But this is going to be a great alternative to FHA borrowers that are limited with low loan limits. The new Freddie program is at conforming limits of 453,000 and it is a 3% down 30 year financing program with no geographical or income limitations. It is only first-time buyers and it's going to be available in July. So I think there is more and more opportunity that will continue the momentum for us.

Operator

And our next question will come the line of Matthew Bouley with Barclays. Your line is now open.

Matthew Bouley

I guess first, I just wanted to follow up on the gross margin guidance questions from earlier. I think, Dave, you highlighted some mix issues as a near-term impact here in the second quarter. I guess just how long do you expect that issue to persist? And I guess just trying to hone in on your visibility around the re-acceleration in gross margins in the second half. Thank you.

Dave Cone

It's a great question. I would say mix is always there. If you were to maybe step back and look at margin year over year, we expect to drive accretion. But we will see some movement quarter to quarter based on mix. So depending on the amount that maybe some of our new businesses that have come on, they are generally still at a slightly lower margin rate, if we over penetrate in that area, then that brings down the mix, which we will see in Q2. Another example would be around the West in times if they over penetrate brings down the rate, obviously does wonders for the gross margin dollars. But to answer your question directly and to be clear, we are going to see mix impact us and see some sequential decline in Q2. And then we will see that again grow in Q3 and Q4. And that will get us to our stated guidance about the mid- to high-18% being accretive year over year.

Matthew Bouley

Second question, I wanted to ask about your comments around spec. Because it looked like your overall spec count climbed 17% or so, but of course finished spec was down year over year. Is that just a reflection of kind of extended build cycle, labor-related? Or has there been any kind of shift in your spec strategy here, perhaps in a rising rate environment? Just your overall thoughts on that.

Dave Cone

Sure, yes, absolutely. We are big proponents of specs, especially when we can sell them before they are completed or just after they are completed. The margins are generally in line with our to-be-built margins and sometimes even higher. So the tick-up that you really saw was specs in process. A large part, like we did last year, is just trying to get a jump on the year, trying to get as many in the ground as we can. What we really focus on is managing the completed specs. We try to have, call it, one, just under one per community. And we've been able to be under that now for some time. And as I said in the prepared remarks, we wouldn't mind having a few extra completed specs because we have some strength in many of our markets, as you can see through the pace that we delivered in Q1 as well as April.

Sheryl Palmer

You know, and it's also interesting, because there has been a lot of questions around are people moving forward and wanting to get into houses quicker because of the potential of rising interest rates. And when we look at the analysis in our business, we are actually finding a significant amount of -- and that was when we look at Q1, we also thought we could have sold more specs to cover some of the hurricane start delays. But actually, when we look at our to-be-built business as a percentage of our total business, it's not moving down at all. If anything, I would tell you in some markets, it's actually moving up, further supporting that people aren't overwhelmed by some of this rate movement.

Operator

Thank you. And our next question will come from the line of Jack Micenko with SIG. Your line is now open.

Jack Micenko

I might have missed it. Did you give the actual unit number of what you thought might have gotten pushed out? And then is it safe to assume that number, if you give it to us, is all going to come into 2Q?

Sheryl Palmer

No, we didn't give any specifics because it's hard to identify exactly which of those units. But I would tell you that if you look at our general view on where we try to give our guidance, you can tell we fell a few units short. And yes, you are going to have some of that obviously push into Q2. And then you've got some offsets to Q2, like for example what we told you about Dallas.

Dave Cone

Yes, and maybe just more simplistic math, Jack. I think if you look at our closings for the quarter and just divide by 13 weeks, you could see we are about a week off. And we will probably continue to see that in the second quarter. But as Sheryl mentioned, it's going to be -- the deliveries are coming in the second half. The starts are in the ground.

Sheryl Palmer

The starts are in the ground.

Sheryl Palmer

The starts are in the ground. And so that is why we feel good about the full year.

Jack Micenko

And then you've talked for some time, I guess, about the operational improvements. And you pointed to that as part of the reason the margin came in better this quarter. From the outside looking in, can you help us understand -- I guess when I listen to you speak, it sounds like there are construction value engineering operational initiatives. There are sort of back-office consolidation cost initiatives, and then there is what seems to be salesforce CRM-type digital marketing initiatives. Is that the right way to think about the three main areas? And then could you maybe give us a sense, because it relates to margin, what inning maybe we are in and where you are in each of those?

Sheryl Palmer

I would tell you I don't think the game -- I'd start with I don't think the game ever ends, Jack. That we continue to -- our second story will become our third story because we will continue to seek to improve everything about the business and look under every rock. But I think your buckets are exactly right. I gave the salesforce analysis on the phone -- I mean, in my prepared comments and how we are, by the end of May, we will be 100% rolled out within the Company. We are already starting to see the benefits.

And I really can't begin to quantify what that looks like on the sales floor when we give our sales agents back time. Obviously, we've talked a lot about over the last couple quarters, one, the cost efficiency, our purchasing effort, our scheduling efforts. The way we are working with our trades, the way we are value engineering our plans. I mean, it every single part of the business that we laid out about 18 months ago, two years ago. And those initiatives are well to the finish line, and there's another whole group of initiatives right behind them.

Jack Micenko

I guess to summarize, it would be safe to assume then that there should be a potential margin benefit from these things after everything else that happens in labor and land and everything else? But operationally, some tailwind to margin into 2019 and 2020 and that sort of thing?

Sheryl Palmer

Yes, absolutely. And you would expect you get a lot more than holding ground, that you actually get the benefit coming through. But what we can't predict right now is what happens to land prices to offset that cost, commodities, all the things that Dave spoke about in his comments.

Dave Cone

I think we are very focused at driving accretion at the EBT line. And that's going to vary. It's going to come sometimes through margin, sometimes through cost, hopefully through both. But that kind of just rolls into our overall philosophy. It starts with our capital allocation strategy, driving to the best use of cash, efficient inventory management, driving pace, driving inventory turns -- asset turns. That should all lead to improved EBT and ROE accretion year over year.

Operator

Our next question today comes from the line of Jay McCanless with Wedbush.

Jay McCanless

The first one I had -- I know you all discussed in the prepared comments about the 55-plus and the empty nester buyer. Can you talk about what's happening in your active adult communities, how sales pace is going there? And then also, maybe in your non-targeted communities, what type of empty nester demand growth you are seeing?

Sheryl Palmer

Jay, when we look across the portfolio, there is actually only a handful of those communities that are actually deed-restricted. The majority, if I think about our Florida communities, probably 80%-plus of those are targeted, not restricted. But they certainly live as 50-plus communities when I look across the portfolio, about a third of our buyers fall into that category. A high percentage of those fall into these lifestyle communities and some of them coexist within our family communities.

You know that we are, and have been very, very bullish on this age group for quite some time. I mean, they have got the strongest balance sheets of any age cohort. They have the greatest likeliness to buy over the next 10 years of any consumer group. We have had success in all of our communities across the portfolio, our lifestyle communities. And it's really around differentiating that service lifestyle opportunity for these consumers. I mean, the plans -- it's in our plans, it's in our amenity packages.

I had the opportunity last week, because we were recognized for our community service and some filming was being done in Esplanade, and meeting with a number of homeowners who were gracious enough to be interviewed on this programming. And it's hard to express the way they look at this journey, but they are so excited to be able to have this lifestyle experience and be amongst friends and folks just like them that it just feeds on itself. So when I look at the traffic and I look at the sales, I look at how we started specifically in Florida on the season against very, very tough comps, we did well across the entire portfolio of active adult.

Jay McCanless

That's good to hear. The second question, playing a bit of devil's advocate here, we have been doing a lot of work on that Freddie Mac program you highlighted earlier. And we'd also point out the fact that Treasury Secretary Mnuchin said there is not going to be a push for GSE reform this year. Why not take the more active stance and a more aggressive stance in expanding your entry-level price point offerings? It seems like the government wants more of those homes. They are willing to give what we think are some pretty aggressive terms on these new mortgage programs to make that happen. Is there a potential for you guys maybe to either acquire that talent or that land? Or are you developing some initiatives on your own to target more entry-level price points?

Sheryl Palmer

So, I agree with you completely, Jay, on GSE reform. Based on all the work we have done on the Hill, I don't expect we are going to see that this year, maybe even in this election cycle, to be honest. It's a very complicated topic. If you look at 2017, the affordable first-time buyer was about a third of our sales. Obviously, it's very market-specific and we have larger penetrations in parts of the portfolio. But I think we have articulated the strategy fairly consistently around the importance of projecting the business and the balance sheet long term with core locations.

Certainly where it makes sense and the land is available that yields affordable housing, we are all over it. You know, we can sit here and debate what an A location is or a C location, but we all know that the path of growth in truly emerging submarkets are critical and not markets that screech to a halt when the markets show any sign of weakness. So simply speaking, I think when I look at the overall business, about a third of the portfolio feels right. And we can do that without putting the business at risk and without going out to the fringe markets and the peripheral. Not that we are not there, because like I said, it is about a third of our overall business today.

Operator

I am showing no further questions in the queue at this time. So it is my pleasure to hand the conference back over to Ms. Sheryl Palmer, Chairman and Chief Executive Officer, for some closing comments or remarks. Ma'am?

Sheryl Palmer

Thank you. And really appreciate everyone's time today and look forward to speaking to you to share our Q2 results. Have a great week.

Operator

Ladies and gentlemen, thank you for your participation on today's conference. This does conclude the program and we may all disconnect. Everybody have a wonderful day.