Taylor Morrison Home Corporation (TMHC) Q2 2017 Earnings Report, Transcript and Summary

Good morning, and welcome to Taylor Morrison's second quarter [Audio Gap] [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to introduce Mr. Jason Lenderman, Vice President of Investor Relations and Treasury.

Thank you, and welcome, everyone, to Taylor Morrison's Second Quarter 2017 Earnings Conference Call. With me today are Sheryl Palmer, Chairman, President, 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 for the next quarter, and for the full year. 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.

Thank you, Jason, and good morning, everyone. We appreciate you joining us today as we share our results for the second quarter of 2017. We were able to build off of a very strong first quarter and leverage that momentum through the second quarter. The entire spring selling season proved to be very productive, and we found ourselves in one of the strongest selling environments that we've seen since the downturn. That environment was the perfect backdrop for us to apply and take advantage of some of the new tools, processes and enhancements that we've discussed over the last 18 months on prior earnings calls, and I appreciate the opportunity to dig into more details with you. Our performance drove $0.46 of EPS, a 24% increase year-over-year, and a 16% growth in EBT dollars compared to the same quarter last year. We finished the quarter with 2,376 sales, representing nearly a 20% increase year-over-year. Our strong orders growth is something that we've seen across the majority of the portfolio. For the first 6 months of the year, our sales attainment represented about 25% in year-over-year growth. That sales performance has put us in a tremendous position to achieve all metrics of our guidance. With our strong sales pull-forward through May and typical seasonality, we did see our growth flatten, as expected, which supports our pace guidance of 2.3 to 2.4 for the year. Our average community count was 294, which was driven by the solid demand throughout the first half of the year, and our strategy to capitalize on a strong spring selling season, to better set up production in the back half of the year. Our pace was 2.7 per outlet, which is almost 30% greater than it was for the same quarter last year. Perhaps even more exciting to me than our sales performance has been the discipline to manage the price-versus-pace dynamic in the midst of that strong selling environment. We've been able to deliver outsized growth results while maintaining a healthy margin profile. Similar to the first quarter, we were able to deliver strong performance without relying on increased discounts. In fact, for the second quarter, discounts were down sequentially and home margin was up year-over-year. We delivered 1,863 closings with an average sales price of $477,000. Both our closings and margin results exceeded our expectations and are a direct reflection of the hard work and dedication of our teams. Our closings performance has been, and will continue to be, heavily influenced by our focus on maintaining and growing our strong working relationships with our trade partners. The labor environment is still tough, and our ability to manage that risk is critical to our success. Our field teams have exceled at delivering job sites and timely schedules for our trades that are clean and safe. Although we should never expect an even distribution of deliveries across quarters due to our industry's seasonal nature, this progress in scheduling and planning promotes a more efficient production cadence across the organization. We have the mindset that there isn't a quarter more important than another. The first quarter is just as important as the fourth. Similarly, the first weekend a month is just as important as the last weekend a month. If we continue to build on this, I expect to see even more efficiencies across our portfolio. The willingness to develop systems and processes and reconfigure convention is a true testament to finding solutions in a tough environment and not being satisfied with the status quo. We've created a purpose and vision that's centered on operational efficiency and driving accretive returns at all levels of the business. Our field teams, along with our trade partners, should take great pride in their collaborative efforts. One of the telltale signs of being able to strike the balance of operational efficiency and high levels of customer satisfaction is cancellation rate performance. That metric in particular reflects the quality of touchpoint throughout our chain of interaction with the customer. It starts with our prequalification process before recording a sale, considers our design center and sale-to-start process, moves to full mortgage approval, and extends through the entire construction and closing process. And I'm pleased to share that we have one of the lowest cancellation rates in the industry, and at 10.4% for the second quarter, that was the case once again. From a macroeconomic standpoint, our view is that most indicators remain stable to encouraging. Trends in consumer confidence are healthy, which is being driven by positive assessments around current economic conditions, the overall business environment and stability around jobs. Employment levels have been positive with nonfarm payroll improving, and the unemployment rate remaining below 5%. Personal balance sheets continue to strengthen, with real estate values driving a significant piece of that movement. On an industry basis, low supply levels in both new and existing homes continue to drive a favorable demand proposition for home builders. There has been moderate compression on the supply of existing homes with 2017 levels about 10% lower than the same time in 2016. That year-over-year change has provided some of the additional traction seen within our industry sales efforts encouragingly across each of the consumer groups that we serve. In fact, as I look across the business, our most significant pace growth year-over-year was at both the most affordable and at the luxury price points. The current lending environment continues to provide customers with attractive terms to finance their individual home purchases. Rates are still hovering in the 4% range for conventional 30-year mortgages, which is well below historical averages. Overall, I'm very pleased with how we've performed so far this year, and I'm encouraged by the industry and the economy. The back half of the year will provide its own set of challenges and opportunities, and I am confident we will be able to navigate each of them and put the company in a position to deliver the year while setting up the business well for 2018. With that, I'll turn the call over to Dave for the financial review.

Thanks, Sheryl, and hello, everyone. For the second quarter, net income was $55.7 million, a year-over-year increase of 23%, and earnings per share was $0.46, an increase of 24%. Total revenues were $908 million for the quarter, including home-building revenues of over $889 million. Home closings gross margin, inclusive of capitalized interest, was 18.5%. That is a bit higher than guidance, and it is also accretive to last year, which is a good comparison relative to the industry. We continue to believe the full-year margin will be accretive year-over-year. Moving to mortgage operations, we generated nearly $16 million of revenue during the quarter, representing growth of more than 15% over the prior year. Gross profit was about $5.5 million, with a marginal rate slightly above 35%. Our capture rate for the quarter came in at 76%. As you know, we recently integrated our mortgage business into our newer markets, and based on our backlog, we expect to continue to see the capture rate gradually increase back to historical averages in the high 70% range. Mortgage capture is critical to our success, as this gives us visibility into our backlog and confidence in our closings guidance each quarter, as well as continued strong profitability through our mortgage operations. Our mortgage teams consistently deliver, which strengthens our overall business. SG&A as a percentage of home closings revenue came in at 10.7%, which represents a 30-basis-point improvement over the prior year quarter. The investments that we made back into the business in all areas -- people, processes and systems -- have begun to produce leverage by driving scale at the rate we anticipated. We remain focused on prudent cost management to produce the optimal operational balance and generate the most value for our stakeholders. Our expectation continues to be that we will drive year-over-year leverage this year as well as in 2018 and beyond. Our earnings before income taxes totaled $78.4 million, or 8.6% of total revenue, which is an increase of 70 basis points year-over-year. Income taxes totaled $22.5 million for the quarter, representing an effective rate of 28.7%, which is lower than the second quarter of last year. The lower rate includes timing of certain deductions, as well as energy credits recognized during the second quarter but related to earlier years. For the quarter, we spent roughly $309 million in land purchases and development, with the majority of our land-acquisition activity happening in Raleigh, Atlanta, Sarasota and Phoenix. At the end of the quarter, we had approximately 38,500 lots owned and controlled. The percentage of lots owned was about 71%, with the remainder under control. On average, our land bank had approximately 5 years of supply at quarter-end based on a trailing 12 months of closings. We are confident in our land pipeline and we are focused almost entirely on acquiring assets to deliver closings in 2019 and beyond. Our strategy of core-only assets creates great focus and high levels of commonality from market to market when we determine capital allocation. At quarter-end, we had 4,441 units in our backlog with a sales value of over $2.1 billion. Both of those metrics represent a 22% increase compared to the second quarter of last year. We ended the quarter with 1,460 total specs, which includes 259 finished specs. On a per-community basis, we had under 5 total specs and less than 1 finished spec per community. We continue to strategically deploy specs within communities where quick move-in demand exists. We ended the quarter with $246 million of cash, and our net debt-to-capital ratio was 33.8%. We do not have any outstanding borrowings on our $500 million unsecured revolving credit facility and are only projecting to use it on a minimal basis for the year. Overall, we are extremely pleased with the condition of our balance sheet, and it is something that we take great pride in managing. It is the foundation of our financial health, and a true indicator of how bright our future is with the flexibility it provides. This was supported by our recent credit-rating upgrade by Moody's from B1 to Ba3. The upgrade was a result of our ability to grow while keeping our debt leverage low, as well as our increased public float position from the recent sponsor sell-down activity. As we continue to focus on and implement strategies to enhance our returns, we've placed a strong focus on our inventory management. Through specific actions such as the focus on driving pace earlier in the year and the management of spec inventory, we have improved our overall balance sheet efficiency. For the second quarter, our asset turns improved almost 10% when compared to the same quarter last year. This is on the heels of a similar improvement in the first quarter and speaks to the consistency we have been able to drive and plan to sustain. That [inaudible] is driven by the company's collective focus to expand our strengths, as Sheryl mentioned earlier. Our goal is simple: to drive consistent year-over-year accretion to ROE. We fully expect that to happen in 2017 and beyond. We are more than halfway through the year and are quite pleased with our performance. We still have a lot of work ahead, but we have put ourselves in a position to deliver. As a result of that hard work and fast start to the year, we are tightening the range of our closings guidance while bringing up both the bottom and top end of the range, slightly increasing our pace expectations, and adjusting our average community count expectations to account for the strong sales performance in the first half of the year, as well as increasing our margin guidance. For the full year 2017, we anticipate closings to be between 7,850 and 8,150. Our average community count will be about 300. Our 2017 monthly absorption pace is expected to be 2.3 to 2.4 per outlet. Our GAAP home closings margin guidance, including capitalized interest, which is expected to be accretive to 2016, and in the mid-18% range. We believe our focus to get homes sold and started earlier in the year will help to offset some of the usual labor cost pressures the industry sees late in the year, and we have been benefitting from our ability to drive pricing in many of our communities. Our SG&A as a percentage of home-building revenue is expected to leverage year-over-year and be in the low to mid-10% range. JV income is expected to be about $10 million, and we anticipate an effective tax rate between 34% and 35%. Land and development spend is expected to be approximately $1 billion for the year. For the third quarter, we anticipate average community count to be between 295 and 300. Closings are planned to be between 1,875 and 1,975, with GAAP home closings margin, including capitalized interest, expected to be in the mid-18% range. I'll close with an update on the 2 equity offerings that happened during the second quarter, 1 in early May and 1 in late June. In both cases, we issued 10 million shares of Class A common stock and we used the proceeds from the offerings to purchase partnership units from our equity sponsors. Neither of these offerings were dilutive, and our total share count did not change. For the year, we have issued 41.5 million shares of Class A common stock, which means our public float is now over 60%, which is significant given that at the beginning of the year it was in the mid-20% range. Our management team and board of directors remain solely focused on generating the most beneficial outcome for all of our shareholders. Thanks, and I will now turn the call back over to Sheryl.

Thank you, Dave. Let me expand on Dave's last point regarding the recent equity offerings. As he mentioned, our public float is now above 60%, signifying that by definition, we are no longer a controlled company by NYSE rules. Our private equity sponsors continue to be tremendous partners throughout this journey, imparting wonderful strategic guidance and direction as we've evolved over the years. As we continue through this ownership transition, rest assured that our strategy and focus will not waver. We are committed to our 4-pillar strategy and capital allocation philosophy. Together, those guideposts will continue to lead us down the right path. Part of our strategy centers on knowing our customers' needs and wants, and more importantly, adjusting our business model and practices accordingly to meet those needs and wants as [inaudible] develop. In addition to the shopper and buyer surveys we routinely conduct for our market research team, we partnered with Wakefield Research on a consumer survey sampling 1,000 U.S. adults who have purchased or are likely to purchase a new home in the next 3 years. You may recall, in May, we released some of the findings around the outdated "forever home" concept, where we found that 56% of the respondents indicated that over time, they expect to change where and the way they live as their lifestyle evolves, and that it's really becoming more and more unrealistic to find a home that meets all of their current and future needs. It may be tempting to assign this sentiment to millennials, but the data suggests that it's a consistent expectation across all age groups. This was a critical and grounding finding, as it indicates the reality of multiple moves and home purchases that homeowners are expecting to make throughout their lives. Understanding more about what that lifestyle evolution means and how we can best serve our customers for every phase of life is integral to our strategy and our commitment to delivering a best-in-class repeatable customer experience. Coming soon, our next release of survey data dives into the fascinating finds regarding the importance of a blended indoor-outdoor living experience and how significant it is to include more of this into the footprint of a home's design. One data point I'm happy to share ahead of the release is that more than half of the respondents indicated wanting more outdoor entertaining space and are willing to sacrifice a smaller house on a bigger lot to get it. After recently working through our plan catalog in Texas, ridding the plans that are becoming outdated or not meeting growing customer demand, we've introduced 9 new plan series, and each of them include enhanced indoor-outdoor living features to meet this growing trend head on. I'm happy to report, initial consumer response has been very strong. Another important part of a customer's experience in the journey with Taylor Morrison takes place with our mortgage team. They remain an integral part of understanding our customer and developing a lasting relationship that creates significant satisfaction and loyalty. As we look at customers in our pipeline, we continue to see a very strong borrower profile with an average credit score in the mid-740s. Our average borrower had an LTV of 75% with a debt-to-income ratio of 37% on a loan amount of over $340,000. On a more global level, and as we evaluate some of the upcoming changes influencing the mortgage landscape, we're generally encouraged by incremental changes to ease qualification requirements. In July, Fannie Mae announced easing of guidelines pertaining to self-employed borrowers and now allows a maximum debt-to-income ratio from 45% to 50%. After these announcements, Fannie Mae released additional opportunity to ease borrowers' ability to qualify with student loan payments, alimony and, most significant, a new 5/5 mortgage program. It's hard to quantify how beneficial these announcements could be, but we do think it is positive that the mortgage environment is improving for qualified customers. And lastly, to truly understand and deliver on our customers' needs, wants and expectations, and consistently deliver on the customer experience, we must first understand and deliver on the employee experience. I believe our success of delivering, quarter after quarter, consistent results can be attributed to our belief and practice in being a people-first organization. So much of what makes Taylor Morrison the employer of choice for our team members and the builder of choice for our homebuyers is rooted in our ability to put people, employees and customers alike, at the center of everything we do. And in the second quarter, we put a name on it and launched TMLiving, our new employee value proposition. This employer brand ties together all the tangible and intangible characteristics, benefits and overall appeal of working at Taylor Morrison, and gave our team something to really be proud of. We've said it many times before: When you get the employee experience and the customer experience right, the financial results emerge. And TMLiving further supports this cause. Let me close by saying that I believe the company is in great shape, and we have positioned ourselves in a way to maximize our options. While I'm extremely excited about what we've been able to do so far this year, it is our future that is truly encouraging. I'm optimistic about our markets, our focus on being a return-driven business, and in our team's ability to drive significant results. The results we shared today and our plans for the future is all made possible because of our tremendous teams across the organization. They continue to exceed my expectations on a daily basis. Watching what they can do is a constant source of inspiration for me and the entire management team. After all, it's because of them that Taylor Morrison is the most trusted homebuilder 2 years running. I can say with great confidence that our teams live our internal purpose statement every day, which is "building a better tomorrow for your family and ours." With that, I'd like to open the call for questions. Operator, please provide our participants with instructions.

Thank you. [Operator Instructions]. Our first question comes from the line of Mike Dahl of Barclays.

Hey, thanks for taking my questions. Sheryl and Dave, wanted to hone in a little bit about -- on some of the kind of absorption comments, and also tie in some of the spec strategy with that. I think you've been consistent about the message on pushing sales pace a little early in the year to build that backlog and then starting to manage it a bit more as we get through the year. It does look like your June growth came down a little bit, while at the same time, kind of the specs are remaining, I think, fairly consistent quarter-on-quarter as far as what you're seeing per community. So could you just give us an update of just the levers that you're pulling, where you're finding opportunities that continue to put specs in the ground and continue to drive pace a little bit more, but then overall, just what the -- how much of the moderation in growth in June is really that balance that you're implementing, and potentially pulling the price lever?

Sure, we -- hi, Michael. We absolutely can. A lot of questions in there, so let's start with them, and Dave and I will tag-team this. You're right, we absolutely had signaled early in the year, maybe even as late as last year -- early as late last year, that it was our plan to really take advantage of the spring selling season as part of our macro plan on creating more of a planned production evenly throughout the year, and getting the action when it was hot. And so we did that with outsized paces for the first 2 quarters. As part of that, we expected, as you can see through our guidance, for us to complete the full year at somewhere around 2.3 to 2.4, a little higher than we'd initially anticipated, but we felt it was important, even with our difficult comps in June and the third quarter, to get that early. It really provides a better environment for the trade base, and so we wanted to get those -- even recognizing that it wasn't, for us, about managing our hard comps in the third quarter, but setting the year up the right way. So we expected what we saw in June. Part of it, I would tell you, is normal seasonality. I would tell you part of it is by pulling that forward, we absolutely created some reduction in community counts. Part of it was gap-outs because we pulled that forward as a way to bring new land to the market for the third and fourth quarter sales. So we should expect that moderation. The math would clearly suggest that we should see that moderation in Q3 and Q4 for us to get to the 2.3-2.4, which is really all we plan on getting done this year, given what we need -- the communities that we have on the ground, making sure that we can continue to pull those pricing levers. And Dave, why don't you pick up a little bit on the spec strategy?

Yeah, and maybe one thing I'd add, just from a pricing perspective, we saw price increases in about 50% of our communities here in the second quarter, so I think that just feeds into what Sheryl said, just really around product availability on the ground. So we feel like we're selling from a position of strength and that's allowing us to tick up price. Be it modest, we're taking advantage of that. From a spec strategy standpoint, Michael, you're right in that our strategy remains the same. Our goal is to have about 4 to 5 specs per community with about 1 completed spec per community as well. So we're staying well within that. And that just feeds into our overall strategy as far as getting the jump on the year. We've put specs in the ground. We've been able to sell through them. Really, for us, the biggest change is just a more targeted approach, making sure we get quality lots with the most common plans used. And the goal, obviously, is to sell those before we finish construction, and we've done a much better job of that this year. So if anything, it's a little bit more of a margin play for us, when you look at the overall financial results, but specs remain an important part of our overall strategy.

And Dave, maybe the only other thing I'd add -- jump in here if you don't agree -- is that when we look at the margin profile between specs and to-be-builts, we're actually seeing a lot of compression there, so not near as -- you know, what we saw over the last few years.

That's correct. That feeds into our guidance that we've had for this year. Some of that margin accretion is that margin play where we're seeing that delta between the 2 shrink.

Yeah.

Great, that's really helpful. And then, just as my followup, hoping you could quantify, when you're talking about some of the discounts coming down, sequentially, could you give us some numbers around kind of what your average discounts were on both closings and orders in the quarter, and how that compared to a prior quarter?

Yeah, well, we look at it sequentially, Michael. We saw a decline in incentives per house. When you look year-over-year, we were roughly flat. And I'd say it's kind of the normal cadence, what we'd expect for the year. I think most importantly, the way we're trending now, we actually expect it come down year-over-year in Q3, Q4, and be down year-over-year for the total year compared to '16.

Okay, that's great. Thank you.

Thank you. Our next question comes from the line of Nishu Sood of Deutsche Bank.

Thank you. I wanted to talk about the SG&A leverage. Obviously you're getting some SG&A leverage, I think on a kind of 20-, 30-basis-points range, for this year. With the really impressive growth and absorptions and backlog, that would seem to set up an acceleration in SG&A leverage as we head into the back half and into -- as we look ahead into '18. I know you're not giving guidance, but is that the right way to think about that? Or are there are other compensating factors we should potentially be taking into account?

Here, I'll take that, Nishu. Yeah, I think for this year, we anticipate leveraging year-over-year. That's in our guidance. I would say quarter-to-quarter, we might see some variability just based on the level of closings relative to the prior year. But we've made a lot of investments. We're pleased with those investments that we've made. We think those put us in a position to drive continued leverage in 2017 and beyond, so you are going to see it here in the back half of the year. But we remain focused on running a lean operation. I think, for us, what's important is we have the ability to reinvest back into the business, in people, processes and systems, and still drive leverage going forward.

Got it. I mean, honestly, this question is rooted in the historic -- the historically SG&A, lean SG&A, focused nature of your organization, and Sheryl, that's something you've talked about over the years, so that also implies quite a bit of upside. So I imagine that that's still in the DNA, and so that's where the question is coming from.

And I appreciate that, Nishu. And you're right, it's something we've talked about, I think, for as many years as we've known you. It is deep rooted into the DNA of the organization. But at the same time, I think I also acknowledged over the last 2 or 3 years that maybe we had been a little too aggressive there, and it was important with this business and the growth that we've seen to make sure we're investing in it. But to be able to invest the way we have and continue to leverage and stay with what I would call leading SG&A, is something I'm quite pleased with.

Got it. And another question I wanted to ask was about community counts. You've had great absorption growth, obviously. Your community counts have been kind of flattish in this 300, just below 300 range now, and it will stay in that range for about 6 quarters, based on your guidance. Your land spend has also been a little on the lower end during those 6 quarters. It picked up this quarter, but as you mentioned, those are investments for '19. Does that imply, then, that we should kind of think about the potential for a more limited community count growth as we think about '18? Just the land trend would seem to imply that, maybe with some acceleration later as we go forward into the recovery, into -- in '19. Is that the right way to think about that?

Yeah, I think you're going to see growth here. As we said, we'll continue to hold in there with the overall averages of the industry from a community count standpoint, but you're right, last year we did moderate land spend. We didn't find the opportunities in the market, and we've been well positioned with our land bank to be able to be very selective in our acquisitions. As we've rolled into this year and really the end of last year, we actually saw a lot of great activity and pleased with the land that's under contract control on what we've closed this year. So we've seen our growth through community count moderating, for sure, but really through the pace, which we believe from an efficiency standpoint is an overall better strategy. So I think you'll see the combined efforts continue.

Okay, thank you.

Thank you.

Thank you. Our next question comes from the line of Stephen East of Wells Fargo.

Thank you, and congratulations, Sheryl and Dave, on the quarter. And Sheryl, maybe I'll start off on the returns some. Dave talked about inventory turnover being your first target that you're driving, so can you give us a little more color, maybe where you are now, what type of targets you have out there, and any other major drivers that you all are focusing on a lot? And then, I just wanted to understand, sort of following on Nishu's question and the returns, will you be cash-flow-positive? Do you even want to be cash-flow-positive at this point in the cycle, or do you still see the big growth rate out in front of you?

Why don't you take that --

Yeah, Stephen, I'll take that. So from an ROE perspective, we saw accretion here at Q2 year-over-year. Really, we're focused on driving both the numerator and the denominator. You've seen it through the higher pace that we had here in the first half, the tighter inventory management, just real focused on balance sheet efficiency. A lot of that is spec management. We're getting our year's supply down from roughly 10 at the IPO to about 5 now, and driving positive cash flow. We think that's important at this point in the cycle. Not to mention the cost management efforts that we've put in place by still reinvesting in the business. We're driving accretive homebuilding margins year-over-year, and SG&A leverage. So our strategy is simple here; we're focused on driving year-over-year accretion in 2017 and for the foreseeable future when it comes to ROE. From a cash flow --

And Dave, maybe before you go to cash flow, maybe it's worth adding just kind of the change in our land makeup from options deal, as well as the structure of our deals, which is allowing us, I think, also to continue to enhance the returns. As we've moved through the cycle, Stephen, we've really continued to focus the business on where we can get seller financing, put some difference in our structure and the size the deals. So I think all of those added to what Dave has articulated really do help.

Okay, that's really helpful.

And what you'll --

[Multiple speakers] on the cash flow.

Yeah, just a -- real quick on the cash flow. You'll see -- we'll put the 10-Q out here a little bit. Year to date, we're cash-flow-positive, and we're going to continue drive that through the rest of the year. So we'll be able to build on that number as we move through the second half.

Okay. All right, thanks. And then Sheryl, maybe you can, on the demand side of the world, give us some color on what you all are seeing, one by product, and I'm always interested in what you all are doing at Active Adult, but then also geographically, because we've heard some of your competitors talk about Northern California pricing being tough. You all are big in Houston, so you've got the oil. You're launching in DFW with your Taylor Morrison, so a lot going on for you all. If you wouldn't mind giving us some color?

Sure, I'd be happy to. So I can do a little quick around-the-world for you, or at least around our world. Maybe I'll start here in Phoenix. I've heard a lot of others describe the strength of this market, and I completely agree. Phoenix is probably -- not probably, it's running our strongest paces in the company. As I've heard others describe the strength at lower price points, our strength is really across all consumer groups, and in each submarket of the valley. We always say location really matters, and we're being rewarded for it, given our prices at all ends, 400s through 700s, 800s. The market's healthy; closings are up, I think, nearly 28% year-over-year; and inventory is very low. For us, we did lose some stores this year with our early sales strength, and we're down year-over-year, but pace has made up the gap. And we start adding years -- we start adding stores back in the half-back of the year.

Okay.

On California, both the Bay and [ Sac ] continue to demonstrate strong demand characteristics. The supply is, honestly, ridiculously low --

Okay.

And that would mean both new and resale is very, very tight. For us, it's a much better place this year, as we got all our shops open late last year, and so our sales success has been very impressive. I think the Bay has had the strongest year-over-year growth for us. People have talked a lot about the highest price points in the market have been impacted, and I would say that's probably over the $1.5 million range, not really where we play. We've seen strengths across even in the low $1 millions. But in July, we seemed to gain steam even with the strong success we've had at those higher price points, so I think the market continues to be healthy where we are, but I do think as you get into thinner air, maybe it's the $2 million, it does start thinning out. Southern Cal, we definitely have had a reduction in store count. It's really been the greatest impact in year-over-year west sales. And I probably shouldn't leave California without a quick mention on weather. We didn't have impacts early in the year when it came to deliveries, but rather, we did have some on the development side, which impacted our store openings, and some delays in putting starts in the ground, so putting some a little -- putting a little more pressure in California for those teams on the back half of the year. Denver, strong first half by all metrics in the business. The market dynamic's very strong. If I have watch-outs in Denver, it's continued labor pressure. And I do expect the appreciation to moderate there, as we've seen significant growth over the last many, many quarters. Let's move to Texas; I think success across the state, Stephen. Austin paces in sales are up more than 50% year-over-year. The demand environment and consumer sentiment feels really good. I would describe Houston as stabilized. Business is up significantly year-over-year on a reduced community count, and that's in both brands. Cancellations are down. Margin is strong, as we've reported consistently. To your specific point, Dallas, TM, our new brand, opened better than expected, I'd say, with a very strong start in sales. We just, over the last few weeks, have welcomed our first homeowners to their new home. The market has seen some moderation at the highest price point. I would say the market's still healthy, but I think the pace of appreciation is going to slow down and probably needs to. I think we'll also -- I think that will be helpful for the land market as well. Quickly, I'll finish up with the Southeast, feeling good about each of those markets. As Dave mentioned, we're investing in those markets. Building scale in the Carolinas and Atlanta has grown to be one of our largest markets in the business, as measured by signups. Really a great example of predominantly entry-level affordable market with above-average high margin performance. Florida, not much to say there except very robust. Paces were meaningfully up year-over-year, as were closings in each of our businesses. We saw strength across all the consumer groups. As you said, the 55-plus business in each of our divisions was equally as impressive as the first buyer. And in Tampa, the family -- and Tampa would really be the first-time buyer and in Orlando the family buyer, so we saw strength across all consumer sets in Orlando. And let me not end without finishing on Chicago. Say it's holding its own. It's going to outperform their business plan this year. I think we're finding the team's doing a really nice job there finding some light balance sheet land opportunities. Since we've updated the product and pricing, we've found some pricing strength, and the team's executing really well.

All right, that is great. I appreciate it. Thank you.

Thank you.

Thank you. Our next question comes from the line of Michael Rehaut of JP Morgan.

Thanks. Good morning, everyone, and nice quarter.

Thanks, Michael.

First question, I just wanted to circle back for a moment to the gross margin. A little better in the second quarter than the guidance was, and you raised the full year, I think, from low to mid-18% to mid-18%. Dave, I know you mentioned spec margins being a little better playing a role. Just wanted to come back to that and see if that was, in fact, all of the upside for 2Q in the full year, or were there any other factors playing a role, such as maybe price being a little better, or the price-cost dynamic, if pricing was a little better or costs were a little better than expected, if any other drivers were at work there.

Sure, Michael. I'll take the Q2, I guess, relative to our guidance. A lot of that is really mix-driven, I'd say, as far as the bigger beat. But we are seeing some upside. As you mentioned, pricing is playing a factor to that as well. A couple of things in there: Obviously, the specs contributed to some benefit. We're going to see a little bit more of it in the back half of the year, so you're right, we're guiding now to mid-18%. We have good visibility into our backlog for Q3 and Q4; you can imagine, at this point, we've got most all of our homes started, so we have a good handle on the costs. And we're benefitting from some of the purchase accounting last year, the benefit from specs, and then we're also benefitting from some of our strategic procurement and construction efficiency initiatives that we've talked about here in the past. That came in maybe a little bit better than we thought in the second quarter. We got some additional benefit coming now through Q3 and Q4. And then, I'd say, lastly, on the pricing side, we've -- be it modest, we've done a little bit better there on the pricing than we thought as well. So it's really a combination of those things that are giving us the confidence that we're going to see a slightly better margin than we originally thought for the year. Now, we've still got the typical headwind, so mix will play a factor, just depending on the geographic penetration. Labor still remains somewhat of an issue through some of the pressures, but again, we got a jump on the starts this year, so that's going to help to offset some of that. And then, potential commodity increases. But we believe we've factored that into the guidance.

That's great. That's very helpful, Dave. And then, just on the order growth and sales pace, I might have missed it earlier. I know at the end of the first quarter I believe you gave April, but if you could give the order growth by month, that'd be helpful. And also, with regards to the sales pace, obviously with the guidance raised up slightly, just wanted to verify, I guess, for the model, that you're still expecting 3Q and 4Q to, while moderate sequentially, still be up year-over-year. Thanks.

So, the math would suggest, Michael, that obviously our paces in the back half of the year to somewhere between 2.3 and 2.4 would be in your low 2s. So, 2.1, 2.2, depending on the month, right? And depending on the month, like I said, we had some really difficult comps in Q3, but Q4, I definitely expect that we'll be up year-over-year.

And the order growth by month? I'm sorry.

Do you have that, Dave?

Yeah, we were -- we flashed April, May. We're a little bit over 20% for those 2 months. And in June we were right about 2%.

Okay, thank you.

Thank you. Our next question comes from the line of Alan Ratner of Zelman & Associates.

Hey, guys. Good morning, and I echo my congrats on a good quarter.

Thank you.

Sheryl and Dave, I think probably the one thing that really strikes me as I look at your performance is the improvement on the balance sheet, and I know you spent some time talking about that. If I look at your current leverage ratio, and Dave, you mentioned that the goal is to continue generating some cash in the back half of the year, you're probably going to end the year with a net leverage ratio in the 20s. And I know, in the past few years, you guys have had some good success on the M&A side; after you sold Canada, you put that money to work very quickly and have done a good job integrating those deals in the business. So I guess just bigger picture, as you think about the balance sheet as lean and improved as it is, and you look out in the environment at the M&A side, because it seems like the land spending is pretty much on the course you've set forth, how do you see the M&A environment today versus back in '15, when you were pretty aggressive, and is there any other use of cash that we should think about, or are you just kind of content sitting on that for the time being, waiting for an opportunity to unfold? Thank you.

Thanks, Alan. Well maybe I'll hit the M&A, and then Dave, you can pile on, if you want, anything on the balance sheet. I mean, first of all, thanks for the recognition of the balance sheet. I think Dave and team have done just a really good job getting us to a position -- the position that we're in today, really allowing us the flexibility that Dave talked about in his prepared remarks. I don't know that anything's changed from prior conversations and discussions around the markets and M&A. We've always been active looking but have never felt the need, the necessity, to do a deal unless it really does make sense strategically for the business, that it's accretive. When we look at M&A, as we've always said, we look at the best use of cash and how -- what's the best way to deploy that organically, building in certain markets. I talked a little bit about Atlanta, where we did 2 M&As, and now it's come to be one of our largest businesses with some of our highest margins, and we integrated those in about a year. So when you do it and do it well, it's really an opportunity for the organization, and we'll continue to study the market dynamics in some of the markets that we're not in, as well as some of the markets that maybe we see an opportunity to add scale. But it really comes down to the quality of the assets, the culture, the alignment of the customer philosophy, the quality of the team. The deal obviously has to make sense. We're going to look for deals that are quickly accretive on the returns and the operating margin line. And if those -- if we put all those pieces together, yeah, you'll see us active again.

Yeah, and I'd just maybe echo what Sheryl said and build on capital allocation. M&A is a potential lever for us. We're also very focused on just organic reinvestment as well, so when we can be opportunistic, we'll deploy some of that money there. If that's additional, beyond our billion, then we'll pursue that if it makes sense. We also have our share repurchases out there, so that's something else that we'll consider. Again, trying to be opportunistic. But I think right now, we don't mind having the dry powder from a net debt-to-cap ratio perspective. You mentioned we might get into the low 20s. It may have a 2-handle on it, it might be just very low 30%, but we like the position that we're in right now.

Yeah, really. It's the right position at the right time in the cycle.

Absolutely. It definitely should be a competitive advantage for you guys going forward, I would imagine. And then Sheryl, just on the demand environment, I think your comments were -- sounded very positive, very bullish. Is there anything, as you look out, that gives you any concern today? Affordability, job income growth, anything that you can think of that would provide a counter to the pretty bullish comments you had earlier?

Yeah, it's a fair question, Alan. I think I mentioned in some of my comments in a few markets that affordability is a challenge, and it's a close watch for us. And it absolutely drives, to Dave's point, our capital allocation strategy and the way we bring those land deals into the business. So affordability, I think, absolutely. It won't be a new tone for me to talk about the labor market, but I think that's a headwind and a tailwind, because I think it gives us a competitive advantage with -- this year with the jumpstart we've put on the business and how we manage through that. But I think the labor environment really does create that governor that gives us bullishness for a longer cycle. There's been a lot of talk about affordability and bringing that product to market, and I think we've seen a lot of builders shift to that profile. When we look at it, it's about 30% of our first-half-year sales. And it's obviously market-specific, and I mentioned in some of -- in many of our markets, I think our greatest penetrations are in Sacramento, Chicago, Tampa, Atlanta, Charlotte, Raleigh, and really starting to grow in our Austin business. So that's how we'll approach, I think, the affordability piece. If I look across the portfolio, Denver and Dallas have historically really been the only place we haven't served those, but things like bringing Taylor Morrison to Dallas really help us change that. But when I think about some of the additional macro factors that I talked about in my prepared comments, I actually feel pretty darn good about where we are. I do think we'll see market-by-market movement and -- but overall, I feel pretty bullish.

Great, good to hear. Good luck, guys.

Thank you.

Thank you. Our next question comes from the line of Carl Reichardt of BTIG.

Hi, thanks, guys. This is Ryan, on for Carl. On your updated absorption guidance, 2.3 to 2.4, do you think that's a good run rate for Taylor Morrison going forward, or do you think that you can continue to move absorption higher in 2018 and beyond?

You know, it's an interesting question, and the honest answer is, we don't have what we call a good run rate. And so it's hard for me to comment on 2018 yet. But as we've talked about in the past, what we do is we really look at the underwriting of each of the assets in the portfolio when we bring them to market, and those are our expectations for our run rate. And over the last many years, you've seen us articulate paces of anywhere from 2 to, obviously, 2.7 this quarter. And that's not driving for a specific pace, that is driving for the expectation we have of each of the assets, and as we roll those all together, what our expectations are. In some places, we might push it a little harder, but generally, when we kind of lay out our land plan for the year, we wouldn't do that. So there's not what I'll call an ideal. It's really about the makeup that's -- to market at any given time.

And we'll add a little bit more color here in another quarter or 2. A lot of this is just looking at '18, the timing of communities coming online. So a little bit of work for us still to do to roll up that number.

Okay, got it. On -- and then, I think you said in the prepared remarks that you're kind of strategically adding specs to some markets. Can you, I guess, just expand upon that? Are there some markets in particular where it makes sense to increase your inventory?

I think the better way to say it is it's more community-by-community than a particular market. A lot of it just comes down to the buyer type. Obviously, if it's a little bit more towards entry level, that has a higher spec. Mix --

Higher spec as a percentage of mix.

Yeah, of the mix. Higher --

Yeah, [ re-lows ].

So I'd say we look at it more at a community-by-community level than we do an overall market basis.

Okay, great. Thank you.

Thank you.

Thank you. And we have time for one more question. Our last question comes from the line of Alex Barron of Housing Research. Alex Barrón: Thank you, and good job on the quarter. I had a quick question of wondering if you guys had any of those joist issues in Denver? That was my first question. My second question, some other builders, I guess, have made a pretty hard focus on the entry-level segment. I know historically you guys have been more higher move-up, and more recently focused on Active Adult as well, but just wondering on your thoughts on opportunities of moving in the direction more of entry level? Thanks.

So -- thank you, Alex. The first question's really easy: No, we have no impact on the business that we have identified at this point, and we've done a pretty nice scrub. With respect to the entry level, I mean, similar to what I said a couple questions ago, but I think we've consistently articulated our strategy around the importance of protecting the business and the balance sheet with quality of locations. And certainly, where it makes sense and the land's available, that it yields affordable housing, we'll be all over it. Like I said, our penetration right now is about 30% of first-half-year sales is our first-time buyer. Now, granted, our first-time buyer is a little different than maybe others. It's a more professional, and in many instances, a 2-income, and we can see that first-time buyer playing in the $200,000 to $500,000 range. But we can all debate what an A location is, or a C location, but I think the way we look at affordability and making sure we protect the business long-term is that our locations are in the path of growth. And sometimes that will lead us to a market that's truly emerging, but we're not going to put ourselves in a position where we really go out to the peripheral to address that buyer. So I guess the simple answer, Alex, is about a third of the business feels right, and if we can do a little bit more without putting the business at risk with kind of fringe locations, we will. I think we're always looking at the strategy and understanding the best way to play. Recently we've approved a couple pieces in the Inland Empire, but it's really around how we've structured those deals and it's very intentional on timing. And maybe the last thought I'd pile onto that, Alex, is it's interesting: The competitive set is changing, as everyone is kind of going down in price, so I really like the opportunity it's affording us in both the Active Adult and kind of our bread and butter of that first-time, second-time move-up buyer. Alex Barrón: Excellent. Well, best of luck. Thank you.

Thank you.

Thank you. And I'd like to hand the call back over to Sheryl Palmer for any closing remarks.

Well, thank you, everyone, and appreciate you joining us this morning to share our second quarter results, and I hope you have a wonderful day.

Ladies and gentleman, thank you for participating in today's conference. That does conclude today's program. You may all disconnect. Everyone have a great day.