Tri Pointe Homes - Q2 2023

Transcript

Operator (participant)

Greetings, welcome to the Tri Pointe Homes Q2 2023 earnings conference call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star and zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, David Lee. Please go ahead.

David Lee (General Counsel and Secretary)

Good morning, welcome to Tri Pointe Homes earnings conference call. Earlier this morning, the company released its financial results for the Q2 of 2023. Documents detailing these results, including a slide deck, are available at www.tripointehomes.com through the Investors link and under the Events and Presentations tab. Before the call begins, I would like to remind everyone that certain statements made on this call, which are not historical facts, including statements concerning future financial and operating performance, are forward-looking statements that involve risks and uncertainties. A discussion of risks and uncertainties and other factors that could cause actual results to differ materially are detailed in the company's SEC filings. Except as required by law, the company undertakes no duty to update these forward-looking statements.

Additionally, reconciliations of non-GAAP financial measures discussed on this call to the most comparable GAAP measures can be accessed through Tri Pointe's website and in its SEC filings. Hosting the call today are Doug Bauer, the company's Chief Executive Officer, Glenn Keeler, the company's Chief Financial Officer, Tom Mitchell, the company's Chief Operating Officer and President, and Linda Mamet, the company's Chief Marketing Officer. With that, I will now turn the call over to Doug.

Doug Bauer (CEO)

Thank you, David, and good morning to everyone on today's call. During the call today, we will review operating results for the Q2, provide a market update, and discuss key strategic operating drivers. In addition, we will provide an update on our outlook for the rest of the year. We are extremely pleased with our results for the Q2. The increased buyer demand we saw in the first part of the year was even more robust through the Q2, resulting in an absorption pace of 4.5 homes per community per month. Net new home orders were 1,912 for the quarter, which was a 41% increase over the prior year and an 18% increase sequentially from the Q1.

As a result of the strong sales success, we are raising our full-year delivery guidance. We also expect gross margin expansion into the back half of the year. Glenn will give more detail on our forward-looking guidance later in the call. For the Q2, we delivered 1,173 homes, which exceeded the high end of our delivery guidance through a combination of strong market conditions and our move-in-ready spec home strategy. We opened 17 new communities in the quarter and ended the quarter with 145 active selling communities, which was an 18% increase over the prior year. Our focus has always been building communities in core market locations while executing a diverse and attainable product offering. This philosophy resulted in an average order pace of 6.2 orders per community per month for these new community openings.

The new housing market is experiencing strong momentum fueled by multiple factors. Underlying it all is the persistent, limited supply of overall housing that falls short of current demand. An important component to that supply-demand equation is the scarcity of resale new home supply, with new listings nationwide down 27% from a year ago, according to the National Association of Realtors. This is due to the significant number of existing homeowners who are not selling as a result of their current mortgage rates, which are well below current levels. As reported by the National Association of Realtors, 85% of borrowers are financed with a mortgage rate below 5%. This unique dynamic has reshaped the demand for new housing, establishing new construction as a more reliable and consistent source of inventory relative to the resale market.

As a result, the industry at large has expanded its market share, with newly constructed homes representing 33% of inventory, compared to the typical 13% average, according to the National Association of Home Builders. This surge in market share for builders coincides with strong structural demographics as household formations continue to outpace new supply, with the Gen Z buyer entering the market and millennials reaching their prime home buying years. At the same time, consumers have adjusted to the new normal of mid-6% - low 7% mortgage rates. Along with our healthy sales base this quarter, we were able to increase net pricing at over 70% of our selling communities during the Q2. We achieved this net pricing increase through a combination of lowering incentives and increasing base home prices. We took a measured approach, being mindful of the affordability dynamics.

It should be noted that our Q2 buyers, whose loans were funded through our affiliated mortgage company, Tri Pointe Connect, benefited from an average mortgage rate of 5.8%, significantly below current market rates. Our homebuyers financing with Tri Pointe Connect, representing 78% of our total backlog, have an average annual household income of $193,000, an average FICO score of 747, 82% loan to value, and 41% debt to income ratio. Turning to our key strategic operating initiatives for the year, we have made excellent progress at the halfway point of the year. This is largely due to our talented and hardworking teams, who contribute every day to the strong company culture that we are so proud of.

As testament to the company's belief that our people are our greatest asset, Tri Pointe has once again been named as a 2023/2024 Great Place to Work-Certified company, a designation given to companies for their outstanding workplace culture. One of the key operating drivers for our teams this year has been a focus on reducing costs and cycle times. We have seen the supply chain continue to normalize, resulting in less volatility around costs and a more reliable material delivery schedule. Through value engineering of existing products, focusing on more efficient new product designs, and negotiating with trade partners, we have been able to lower costs on average of 9% since the Q4 of 2022.

The average size of our detached homes sold this year is 2,610 sq ft, a 5% reduction from 2022. Our team has done an excellent job of expanding trade resources and improving build processes to reduce cycle times. These efforts have resulted in a reduction in cycle times, with our average start to completion time frame now running between six to seven months. Another strategic priority is the strength of our balance sheet. We ended the quarter with a record low net debt to net capital ratio of 12.1%. This is a testament to our disciplined financial management and our ability to generate strong cash flow. This creates significant financial flexibility to execute our strategic plans, invest in land to grow community account, delever the balance sheet, and return cash to our shareholders through stock repurchases.

Looking ahead, our strategic focus remains on growing scale within our current markets and market diversification by entering new markets through organic expansion and M&A opportunities. We believe the runway for growth is long-term, and our strong operating teams, coupled with our balance sheet and liquidity, offer flexibility to pull the right levers to increase shareholder value. Now I'd like to turn the call over to Glenn to further discuss the results for the quarter and provide some insight on our outlook for the rest of 2023. Glenn?

Glenn Keeler (CFO and Chief Accounting Officer)

Thanks, Doug. Good morning. I'm going to highlight some of our results and key financial metrics for the Q2, then finish my remarks with our expectations and outlook for the Q3 and full year. At times, I will be referring to certain information from our slide deck, which is posted on our website. Slide 6 of the earnings call deck provides some of the financial and operational highlights from our Q2. We delivered 1,173 homes at an average selling price of $698,000, resulting in home sales revenue of approximately $819 million. Deliveries came in above the high end of our guidance range by 17%, as we were able to take advantage of the strong demand environment and deliver move-in-ready spec homes during the quarter.

Gross margin percentage for the quarter was 20.4% and includes project write-downs of $11.5 million, or 140 basis points. Adjusted gross margin, which excludes interest impairments and deposit write-offs, was 24.9% for the Q2. As Doug mentioned, we have experienced some pricing power in the first half of the year. As a result, we expect to see gross margins in the Q3 in the range of 21%-22% and expanded further in the Q4 to a range of 22%-23%. For the Q2, SG&A expense as a percentage of home sales revenue was 11.9%, which was an improvement compared to our guidance as a result of the better leverage over our fixed costs from the increase in revenue.

Net income for the Q2 was $61 million, or $0.60 per diluted share. We generated 1,912 net new home orders in the Q2, which was a 41% increase compared to the prior year and an 18% increase sequentially from the Q1. Our absorption pace was 4.5 homes per community per month, a 22% increase compared to the prior year. In terms of market color, demand was broad-based across our geographic footprint. In the West, the overall absorption pace was 5.0, with all of our markets performing well above normal seasonal levels. In the central region, overall absorption pace was 3.9, with our Texas markets of Dallas, Houston, and Austin all showing strong demand.

In the East, absorption pace was 4.3, led by outsized demand in Charlotte, as well as strong momentum in the DC metro market. So far in July, we have seen continued strong seasonal demand, with absorptions running 3.5 to 4 homes per community per month. An update on our community count. We opened 17 new communities during the Q2 and ended the quarter with 145 active selling communities, which was an 18% increase year-over-year. We continue to focus on our new community growth and are still on target to open between 70 and 80 new communities for the full year of 2023. We are in a solid land position with approximately 33,000 lots owned or controlled, which provide the foundation for volume and community count growth for the next several years.

In addition, with our strong liquidity position, we continue to actively pursue new acquisition opportunities to fuel future growth. Looking at the balance sheet and cash flow, we ended the quarter with approximately $1.7 billion in liquidity, consisting of $982 million of cash on hand and $695 million available under our unsecured revolving credit facility. Our debt-to-capital ratio was 32.3%, and our net debt to net capital ratio was 12.1%. For the Q2, we generated $62 million of positive cash flow from operations while investing approximately $250 million in land and land development. We repurchased 1.1 million shares during the quarter at an average price per share of $28.43, for a total aggregate dollar spend of $32 million.

I'd like to summarize our outlook for the Q3 and full year. For the Q3, we anticipate delivering between 1,000 and 1,100 homes at an average sales price between $690,000 and $700,000. We expect homebuilding gross margin percentage to be in the range of 21%-22% and anticipate SG&A expense as a percentage of home sales revenue to be in the range of 12%-13%. Lastly, we estimate our effective tax rate for the Q3 to be in the range of 26%-27%. For the full year, we are increasing our delivery guidance to a range of 5,000 to 5,300 homes at an average sales price between $690,000 and $700,000.

We expect homebuilding gross margin percentage to be in the range of 21.5%-22.5% and anticipate SG&A expense as a percentage of home sales revenue to be in the range of 10.5%-11.5%. Finally, we estimate our effective tax rate for the full year to be in the range of 26%-27%. With that, I will turn the call back over to Doug for some closing remarks.

Doug Bauer (CEO)

In closing, I'd like to reiterate how pleased we are with our results in the first half of the year and the underlying strength of the new home building industry. We are optimistic about the strong fundamentals, both in terms of the supply, demand, and balance, which promises to continue into the foreseeable future, and the positive demographics bringing new home buyers into the market. We feel confident that our strategic focus on driving increased orders and deliveries, cost management, and improved returns should enable us to navigate any uncertainties in the U.S. economy while capitalizing on our opportunities to grow both organically and through potential M&A opportunities. With this long-term outlook, we are confident that Tri Pointe is well positioned to continue to enhance shareholder value. I'd like to turn it over to the operator for any questions. Thank you.

Operator (participant)

Thank you. Ladies and gentlemen, at this time, we will be conducting a question and answer session. If you'd like to ask a question, please press star and 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star and 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Ladies and gentlemen, we request you to restrict to one question and one follow-up question per participant. One moment, please, while we poll for questions. Our first question comes from the line of Alan Ratner with Zelman & Associates. Please go ahead.

Alan Ratner (Managing Director)

Hey, guys. Good morning. Thanks for the time, and all the details so far. Great job on the deliveries coming in well ahead of your expectations. It sounds like, you know, demand for quick move-in homes is pretty robust right now, and I'm curious if you could just give a little bit of detail surrounding kind of the mix of your business between spec and build to order, you know, things like margin differentials and just generally speaking, what your strategy is there going forward. I mean, if demand was as strong as it was this quarter for quick move-in homes, are you accelerating, you know, your pace of spec starts? You know, do you anticipate your share of specs rising here over the next few quarters?

Doug Bauer (CEO)

Yeah, Alan, it's Doug, good question. You know, we're always looking to optimize starts, based on demand levels. As you noted, and as we noted, demand still stays strong, seasonally stronger than maybe some seasons. We do target 65% specs, 35% - be built. That's been our strategy. As you go into the advanced deliveries over our guidance for the Q2, a lot of those homes were started obviously in the back half of 2022, we went into the year with a fair amount of homes that were nearing completion and spec. That with the strong demand, we ended up closing more homes, as you noted.

Alan Ratner (Managing Director)

Got it.

Glenn Keeler (CFO and Chief Accounting Officer)

Alan, I'm sorry, Alan. A little more color for your question. This is Tom. Typically, we see about a 200 basis point differential in margin on the to-be-built versus spec. I would note, however, that most of our spec starts seem to get purchased in the middle of the process, so we are still very successful in achieving revenues from, you know, personalization on the homes through our design studio business.

Alan Ratner (Managing Director)

Second question, you know, Doug, you mentioned, still looking for new market expansion opportunities, and I know that's been, you know, a message that you've been conveying for a while now. In the past, you've been maybe a little frustrated with the lack of opportunities, at least on the M&A front. Just curious, with everything going on right now with bank credit, you know, potentially tightening, with obviously, you know, equity valuations moving higher on the public sphere, are you more optimistic about the prospects of potential M&A opportunities over the next, you know, handful of quarters than you have been? Or is the pipeline still looking pretty dry?

Doug Bauer (CEO)

You know, good question, Alan. We're still seeing some strategic opportunities for growth. At the same time, I would say that our primary focus is looking at organic in a couple markets that we're currently in the process of establishing, so more to come on that. Obviously, the organic model is something we know very well. It's how Tri Pointe started. We're pursuing. I would say that's A, and let's call M&A, B. As I look at the credit markets, and talking to the bankers, I think it's going to take a little bit longer for more opportunities to kind of flush out of the system. There is definitely capital constraints.

As all the banks, big money center banks and others are under a lot of pressure raising capital, and so they're very, the credit markets are very tight for the less capitalized builders and land developers. That's another area that we're looking at too. There's, it's a little bit of a longer process as you go through and see where the opportunities could land. I frankly think it'll be towards the end of the year, going into next year, as the credit markets continue to probably slow, continue to slow down their credit opportunities for the small to medium-sized builders and land developers.

Alan Ratner (Managing Director)

Appreciate the thoughts. Thanks a lot.

Operator (participant)

Thank you. Our next question comes from the line of Stephen Kim with Evercore ISI. Please go ahead. Stephen, your line is not muted. If you could please-

Stephen Kim (Senior Managing Director and Head of the Housing Research Team)

I apologize. I was muted. Sorry about that. Strong quarter, but this, you did have a somewhat lower ASP than I think we were expecting, and I think than you guided on closings. I was curious, you know, if you could just talk about sort of what drove that. I assume it was a mix of things that happened to close, maybe more specs or something, and did that weigh on the gross margin? If it is, you know, the spec impact, you mentioned just I think recently to Alan, that you know, that you typically get a 200 basis point lower margin on specs. Tom, you were saying some things that made it seem like maybe right now it's a little better than that.

Just wanted to get some clarity on the differential on spec versus BTO right now.

Glenn Keeler (CFO and Chief Accounting Officer)

Hey, Stephen, it's Glenn. I'll take the first part of your question. The lower ASP in the quarter versus our guide was due to mix. There was a heavier weighting towards Central and East deliveries, just by pulling in more specs from those divisions, and they carry a lower ASP than our, you know, the company average. That's all that was. It also did weigh a little bit on the margin, like you said, and that was just mix related. Like Doug mentioned, some of those houses were started in the back half of the year, which carried a higher cost than what we're currently experiencing now. There was just a little bit of that in the mix.

Stephen Kim (Senior Managing Director and Head of the Housing Research Team)

What would you quantify that as, do you think, Glenn?

Glenn Keeler (CFO and Chief Accounting Officer)

I don't. It was slight, so it's not a big difference. I mean, if you take out the impairments, we were only 20 basis points below the low end of the margin.

Stephen Kim (Senior Managing Director and Head of the Housing Research Team)

Yeah.

Glenn Keeler (CFO and Chief Accounting Officer)

That's all it was, was mix.

Tom Mitchell (President and COO)

Stephen, on the differential, on the spec, the build to order, you know, the 200 BPS is, you know, historical, and I think that is typically when we're seeing, you know, those sales much closer to completion or fully completed units. Right now, with increased demand, we are seeing and having that ability to maybe narrow that gap a little bit. Our revenue through our design studio is actually up by about 170 BPS from where we were last year at this time. It's positive. Our teams are doing a great job, getting people in through the studio and giving them that opportunity to personalize their homes.

Stephen Kim (Senior Managing Director and Head of the Housing Research Team)

Yeah, that's very encouraging and good to hear. With respect to the overall pricing environment, you, I think, said that net pricing rose in 70% of your communities. Could you give us a sense for how that may differ across the, maybe the product types, if there is any differential worth calling out? Regarding your starts, could you just give us a sense for what kind of starts pace we could expect in 3Q?

Glenn Keeler (CFO and Chief Accounting Officer)

Stephen, this is Glenn. I'll take the first part. I don't think there was much of a difference between product segments, if that was your question, between entry level and move up. We were able to increase pricing across the board, obviously being mindful of affordability, especially on the entry level. We took a measured approach, but with the demand, you know, we were able to have good success raising prices. The second question, what was your second question again? On starts pace. We started roughly 2,000 houses in the Q2, you know, approximately. For us, for starts, we look at it on a community by community basis, and it's based on demand in that local market.

We don't have a specific target, but obviously we have the ability to start 1,500 to 2,000 houses, as you've seen us do. It'll just depend on demand and communities.

Tom Mitchell (President and COO)

It seems like normal seasonality relative to starts would be appropriate for you to be thinking about.

Stephen Kim (Senior Managing Director and Head of the Housing Research Team)

Okay, great. That implies somewhat lighter starts in three Q than two Q, right?

Tom Mitchell (President and COO)

As we target and look at seasonality relative to orders and absorption, that's probably correct.

Stephen Kim (Senior Managing Director and Head of the Housing Research Team)

Yeah. Okay, great. Thank you very much, guys.

Operator (participant)

Thank you. Our next question comes from the line of Truman Patterson with Wolfe Research. Please go ahead.

Truman Patterson (Director and Senior Research Analyst)

Hey, good morning, guys. Thanks for taking my questions. First, you know, you all have a healthy land bank, and it doesn't appear you all pulled back, you know, as aggressively as some peers on land development in kind of 2022. Glenn, you mentioned, I believe, 70 to 80 new community openings. I'm hoping you can help us think through potential year-end kind of active community count, you know, any metros, regions of outsized growth and, you know, the potential to carry that into 2024.

Glenn Keeler (CFO and Chief Accounting Officer)

Sure, Truman, that's a good question. Right now, we're forecasting between 155 and 165 active communities by the end of the year. That'll obviously depend on demand and orders that we go through for the rest of this year. The community openings this year were weighted a little bit more towards the Central and East as we're continuing to diversify. We're adding a lot of communities in Texas and the Carolinas and areas like that. That's why you're seeing the direction of ASP that we've talked about on previous calls go down, you know, into next year. It's not because of pricing, it's just because of mix of those more affordable priced markets that we're entering.

Truman Patterson (Director and Senior Research Analyst)

Gotcha. Just following up on Steve's question, hopefully asked a little bit differently, but with you all raising pricing in three quarters of communities, any idea on kind of where apples to apples pricing trended through the quarter? Were there any regions or kind of metros where you actually needed to give, you know, some incremental price adjustments to stimulate demand? Just a housekeeping question. Did I hear you all say July absorptions were trending in the 3.5-4 range?

Glenn Keeler (CFO and Chief Accounting Officer)

That's correct. 3.5-4 range in July so far. For the quarter, just this quarter on average, so a big average across all communities, it was about $16,000 per home or about 2% was the price increase. That was pretty broad-based across the whole geographic area. There's still a few submarkets that are softer, where we may be increasing incentives or doing things to move, you know, standing inventory, but that's gotten smaller and smaller, and I think overall, the pricing power is pretty broad-based.

Truman Patterson (Director and Senior Research Analyst)

Perfect. Thank you all, and good luck in the coming quarters.

Glenn Keeler (CFO and Chief Accounting Officer)

Thanks, Truman.

Doug Bauer (CEO)

Thanks, Truman.

Operator (participant)

Thank you. Our next question comes from the line of Carl Reichardt with BTIG. Please go ahead.

Carl Reichardt (Homebuilding Analyst)

Thanks. Morning, guys. On share repurchases, I know you bought back $32 million this quarter. It's been a big part of the story for a number of years now, reducing the float. Now as business has begun to improve and you're looking to add dirt supply, diversify markets, maybe look at new markets, how do share repurchases fit into the capital allocation plans in the next 2 or 3 years?

Glenn Keeler (CFO and Chief Accounting Officer)

It's still part of our playbook, and it's still something we value and we have our job availability under our authorization. We're going to continue to be opportunistic with share repurchases. Like you said, Carl, we're also investing in our growth. We have our 2024 bonds coming due next year that we're putting ourselves in a position to pay off, depending on, you know, the market and capital needs. Share repurchases are still part of the playbook, for sure.

Carl Reichardt (Homebuilding Analyst)

Okay. I was going to ask about that bond, so thank you, Glenn. In the release, you talked about operational efficiencies being sort of a large focus here, and I'm trying to take that from a phrase to sort of specifics, but are there particulars related to inventory turns, margins, or that you can talk about as targets based on the kind of operational efficiency improvement you're looking at? I'm just trying to take a big picture concept and try to drive it into numbers somehow. Maybe Doug or Tom, you can kind of expand on what you mean by that. Thanks, guys.

Doug Bauer (CEO)

Yeah, good question, Carl. I mean, when it comes to inventory turns, you know, our goal is definitely to be at 1.0 or better. When we look at operational efficiencies across our platform, you know, one of the things that we focused in on this year is a reduction in our plan library and being more efficient with product and reuse of product, still providing a premium brand experience, still providing personalization. When you able to use that product, and this is no secret, you know, you become much more efficient, not only in cost, but also in cycle time. That's just kind of a tip of a number of things that we've been working on over the last couple years. Tom, do you want to add anything to that?

Tom Mitchell (President and COO)

Yeah, I mean, along with those inventory turns, Carl, obviously, there's just a greater focus on improving ROI overall. You know, from the outset of our deal underwriting, we're looking to structure deals differently to enable that, and the teams are really focused on that to maximize our ROI going forward.

Carl Reichardt (Homebuilding Analyst)

Great. I appreciate it, fellas. Thanks a lot.

Operator (participant)

Thank you. Our next question comes from the line of Joe Ahlersmeyer with Deutsche Bank. Please go ahead.

Joe Ahlersmeyer (Analyst)

Hi, guys. Good morning. How are you?

Tom Mitchell (President and COO)

Good morning.

Doug Bauer (CEO)

Good.

Joe Ahlersmeyer (Analyst)

Yeah. Just a quick one for me on the closings guidance. Just maybe thinking about the sources of upside and downside to the midpoint of that. Just given the timing of starts in the Q2, I'd imagine at this point, what you start from here is not going to factor into the fiscal year. Is it more about the availability of building materials? Is it about the demand for your spec inventory? Just kind of talk through the upside and downside to the midpoint.

Doug Bauer (CEO)

Yeah, good question. This is Doug. Yeah, everything that is going to close for this year, based on the guide, is started. Everything we're starting now is going to close in the Q1 next year. We feel pretty comfortable across our 15 divisions, providing that guidance and, you know, hopefully, we'll have some upside to it.

Joe Ahlersmeyer (Analyst)

Got it. Just thinking about 2 dynamics ahead beyond this year. It's been a little bit since your Investor Day, where I know you talked about these things, but if you could maybe just give us an update on medium-term ASP mix headwinds that you expect from geographic shifts and buyer segment shifts. You know, as you cycle through or as you've now probably cycled through your long-term land in California, understand the margin's going to be a function of the market from here. Assuming maybe a stable market, can you just talk about how the land that you own today is going to run through the P&L, how that will impact margin, and maybe what a good benchmark for that return on inventory might be related to the prior question?

Glenn Keeler (CFO and Chief Accounting Officer)

Sure, Joe. This is Glenn. There's a lot in there, but on the ASP question, you know, like we've talked about in the past, there is a mix impact due to our diversification, you know, kind of Central and East. Next year, you could expect, you know, an ASP in the $630 range, you know, which compares to our guidance this year for the full year of $690-$700, and that's where we sit today. Obviously, if pricing changes, you know, that could impact that, but that's kind of where we're at today. That kind of, I think, you know, $620-$630 is a good benchmark for the next few years, based on where we sit today in our community count mix.

When you said ROI, you know, return metrics, it depends on the division and the market, but we try to target between a 12%-15% return on what we call investment, which is kind of your inventory plus your, you know, joint venture investments. I think that, you know, tends to lead to really strong, you know, returns for the total business. That's what we target at the individual divisional level, but that's on that inventory level. What was the other part?

Tom Mitchell (President and COO)

Joe, I'll pipe in on the other question I think was related to, as we have a stabilized market, what do we expect margins to look like in that environment? You know, as we've always said, we've historically and currently underwrite our new land acquisition efforts to an 18%-22% gross margin, and we feel that's appropriate going forward, and we're performing in that range right now and feel really good about it.

Joe Ahlersmeyer (Analyst)

All right. Thanks for all the color.

Operator (participant)

Thank you. Our next question comes from the line of Mike Dahl with RBC Capital Markets. Please go ahead.

Mike Dahl (Managing Director and Senior Equity Research Analyst)

Morning. Thanks for taking my questions. Hey, Glenn, first question is maybe a clarification on margins. When I kind of plug in your 3Q and 4Q guide, I get closer to the high end of that 21.5%-22.5%, but I'm also backing out the impairments year to date. Are you giving a guide that's inclusive of impairments or exclusive of impairments?

Glenn Keeler (CFO and Chief Accounting Officer)

It was a GAAP guide, inclusive of the impairment.

Mike Dahl (Managing Director and Senior Equity Research Analyst)

Okay, got it. ex impairments, it should actually be a bit better than that.

Glenn Keeler (CFO and Chief Accounting Officer)

Right.

Mike Dahl (Managing Director and Senior Equity Research Analyst)

That makes sense. Okay, the second question, you highlighted a couple things on cost and square footage, so 9% reduction in cost, 5% reduction in square footage. A couple questions on this: Is the 9% reduction in cost like for like, or is that a combination of the reduced square footage and then maybe, like, mid-single-digit reduction in costs? That's the first part. The second part is, when you think about that square footage, how much of that is just the geographic mix that you've already discussed versus kind of within existing communities or markets, you're really tailoring the square footage a bit more in, on a like for like basis?

Tom Mitchell (President and COO)

Yeah, Mike, this is Tom. Good questions, and it is very convoluted and hard to pull apart. I'd say the 9% is inclusive of that square footage reduction as well. A good portion of that square footage reduction is coming from the geographic mix relative to our emphasis of moving into a stronger position in the Texas and the Carolinas. We are cognizant of trying to maintain attainable price points in all markets. As we're underwriting new deals, we are looking at ways to get there, and smaller footages is one of those key drivers.

Mike Dahl (Managing Director and Senior Equity Research Analyst)

Okay, got it. Thanks. Bye.

Operator (participant)

Thank you. Our next question comes from the line of Tyler Batory with Oppenheimer & Co. Please go ahead.

Tyler Batory (Executive Director and Senior Analyst)

Hey, good morning. Thank you. A couple questions for me on cycle times. You know, coming into the year, the goal was four weeks of reduction, I believe. Where are you in terms of progress there? Did you see improvement in Q2? Do you think there's more improvement coming in the back half of the year?

Doug Bauer (CEO)

Yes, Tyler, this is Doug. that 6-7 that we indicated does include a 4-week improvement since the end of the last year, and we continue to look for further improvements in our starts the second half of the year. you know, we're pushing for another couple of weeks, anywhere from 2-4 weeks, depending on the product, the division, and so forth. There's always room for improvement in cycle times, especially as we go into the second half of the year.

Tyler Batory (Executive Director and Senior Analyst)

Okay. In terms of the labor side of things, a number of other builders trying to ramp up their starts. I mean, any change in terms of labor availability? I'm also interested, you know, there are some markets where you're a little bit larger, you have a little bit larger market share. There are some markets where you're, you know, a little bit smaller. In those markets where you have a little bit smaller presence, is the labor situation more difficult for you? Is it more challenging to maintain and to develop some relationships with the trade partners?

Doug Bauer (CEO)

Well, whenever you start up a division, where, for example, Raleigh, where our scale is still growing, you're going to have a few more challenges to attract and retain the right trade partners. Labor has always been tight before the pandemic. Our labor force is aging well before the pandemic started. We're still able to scale up with our trade partners, especially in our 15 divisions. We've got tremendous growth that we're experiencing in the Texas and the Carolinas market, especially the Charlotte market. As you do scale up, as you said, you do get more trade partners and become more efficient on both costs and cycle times.

Tyler Batory (Executive Director and Senior Analyst)

Okay. That's all for me. I'll leave it there. Thank you.

Doug Bauer (CEO)

Thanks.

Operator (participant)

Thank you. Our next question comes from the line of Jay McCanless with Wedbush Securities. Please go ahead.

Jay McCanless (SVP of Equity Research)

Hey, good morning, everyone. Glenn, did you give four Q gross margin guidance in your prepared comments?

Tom Mitchell (President and COO)

I did. I said, 22%-23% gross margins in the Q4.

Jay McCanless (SVP of Equity Research)

Okay. That's GAAP, that's including impairments, right?

Tom Mitchell (President and COO)

That's correct.

Jay McCanless (SVP of Equity Research)

Okay. The second question I had, can you guys talk about what percentage of the backlog at the end of 2Q had some mortgage buydowns or, you know, anything where you had to do like a gross margin, negative enhancement or inducement to get that sale made? How does that compare to where that percentage was at the end of, say, fiscal 2022?

Linda Mamet (EVP and CMO)

Sure, Jay, this is Linda. Yes, certainly, we're still finding that financing incentives are very helpful for our customers. Currently, in our backlog of customers that are financing with Tri Pointe Connect, for those that are rate locked, about half of our backlog is rate locked. They're at an average rate of 6.125%, and the average points paid on that is approximately 3 points. That's significantly down from what it was in Q1 and certainly down from the end of 2022, because we're really finding that our customers are much more comfortable with today's new normal interest rates. If they can get a rate in the mid sixes, they seem very happy with that, even if market rates are, you know, around 7%.

Jay McCanless (SVP of Equity Research)

Right. Just thank you for that, Linda. I mean, any idea of where that percentage was at, the actual percentage in 1Q and at the end of the year? Where I'm going with this is just trying to find out, as you have less people who are rate locked, is there a potential gross margin benefit to the company, especially as you look ahead to 2024?

Linda Mamet (EVP and CMO)

Yes, there is. Our incentives on orders in the Q2 were approximately 4.3% of home building revenue. End of last year, you know, rate locks were expensive, forward commitments were expensive. At the end of the year, it was more like a 6% incentive.

Jay McCanless (SVP of Equity Research)

Okay. Okay, great. Thank you. Appreciate you taking my questions.

Doug Bauer (CEO)

Thanks, Jay.

Operator (participant)

Thank you. Our next question comes from the line of Alex Barrón, with Housing Research Center. Please go ahead.

Alex Barrón (President and Founder)

Morning, everybody, and great job on the quarter. I wanted to ask about, as your pricing comes down, as you indicated...

... What should we expect, in terms of, the volume? Is it going to grow because your sales pace is going to be higher than it's been at this point, or is it more based on community count growth to make up for that drop in the ASP?

Doug Bauer (CEO)

Well-

Glenn Keeler (CFO and Chief Accounting Officer)

Hey, Alex, this is Glenn.

Doug Bauer (CEO)

Good question. Oh, go ahead. Go ahead, Glenn. I'll follow up.

Glenn Keeler (CFO and Chief Accounting Officer)

Okay. Yeah, Alex, it is a good question. It is a combination, but largely it is made up in volume and community count growth is how we're making up that revenue, with hopefully plus some, you know, obviously, with our expansion into markets like the Carolinas and going deeper into Texas. That should make up for that ASP, you know, decrease.

Alex Barrón (President and Founder)

Doug, were you going to comment as well?

Doug Bauer (CEO)

No, I would add on to that is, you know, our goal is to increase scale in our 15 divisions. The land opportunities and the capital required to grow scale in the Texas Carolinas markets is much more efficient, as you understand. You know, our goal is to get into and maintain a top 5-10 market share position, and with that scale, we'll get more efficiencies throughout the organization. Absorption rates, because of our more attainable pricing points, will be, you know, in the low to mid threes. We always target one sale per month per community, overall, the mid threes is a good company goal.

Alex Barrón (President and Founder)

Okay. Yeah, because in your presentation, I think you guys just increased the absorption rate to 4.3. Are you saying it's going to go from 4.3 to 3, to the threes?

Doug Bauer (CEO)

No, I, all I'm indicating is from a planning exercise, we typically plan in the mid 3s, as we plan going forward in some of these more attainable price points.

Alex Barrón (President and Founder)

Okay.

Linda Mamet (EVP and CMO)

Alex.

Alex Barrón (President and Founder)

Now-

Linda Mamet (EVP and CMO)

Alex, another-

Alex Barrón (President and Founder)

Go ahead.

Linda Mamet (EVP and CMO)

Another thing to think about there, Alex, is just normal seasonality. We're seeing a lot more normal seasonality this year, so you do see that higher pace in the spring season.

Alex Barrón (President and Founder)

Oh, okay. Oh, okay, it's year to date, it's not full year estimate.

Glenn Keeler (CFO and Chief Accounting Officer)

That's correct.

Alex Barrón (President and Founder)

Okay.

Glenn Keeler (CFO and Chief Accounting Officer)

That's correct.

Alex Barrón (President and Founder)

As you shift towards these lower priced homes and stuff, is there going to be also a shift towards more spec homes, or is it still going to be a mix like you guys have always done?

Doug Bauer (CEO)

We've traditionally been a well, as you know, in California, we're a spec builder, but our traditional mix is 65, 35, maybe down to 60 to 65. That's always been our goal, and it still allows our customers to personalize their homes as we go through different cutoffs.

Alex Barrón (President and Founder)

Got it. In terms of the incentives, Linda, I think you said the average rate is 6.1, if I heard you correctly. Are you finding that people don't need a rate in the fives to necessarily purchase them? Are you finding you have to drive down the rate less than a few months ago?

Linda Mamet (EVP and CMO)

That's right, Alex. Absolutely. Customers are just becoming more accustomed to current market interest rates. They're using less of our closing cost incentives towards financing. They might be using half of it towards financing and half of it towards options, because that personalization is still very important to them.

Alex Barrón (President and Founder)

Got it. Okay.

Doug Bauer (CEO)

Just to clarify, Alex. Alex, real quick. You said, just to clarify, did you say incentives at 6.1%?

Alex Barrón (President and Founder)

No,

Doug Bauer (CEO)

Did you say mortgage rate?

Alex Barrón (President and Founder)

The interest rate. Yeah, the mortgage rate.

Doug Bauer (CEO)

Yeah. Okay. Yeah. Yeah, incentives.

Alex Barrón (President and Founder)

Okay

Doug Bauer (CEO)

on orders in Q2 was 4.3%, as Linda mentioned.

Alex Barrón (President and Founder)

Got it. Okay, well, glad to hear things are getting progressively better. All right, thanks so much.

Glenn Keeler (CFO and Chief Accounting Officer)

Thanks, Alex.

Operator (participant)

Thank you. As there are no further questions, I will now hand the conference over to Doug Bauer for closing comments.

Doug Bauer (CEO)

Well, thanks, everybody, for joining us on today's call. We're very pleased with the quarter and looking forward to a very strong finish. We look forward to chatting with everyone in October. Have a great weekend. Thank you.

Operator (participant)

The conference of Tri Pointe Homes has now concluded. Thank you for your participation. You may now disconnect your lines.