MDC Holdings Inc (MDC) 2022 Q2 法說會逐字稿

Good day, and welcome to M.D.C. Holdings 2020 Second Quarter Conference Call. (Operator Instructions) Please note, this event is being recorded. I would now like to turn the conference over to Derek Kimmerle, Vice President and Corporate Controller. Please go ahead.

Thank you. Good morning, ladies and gentlemen, and welcome to M.D.C. Holdings 2022 Second Quarter Earnings Conference Call. On the call with me today, I have Larry Mizel, our Executive Chairman; David Mandarich, Chief Executive Officer; and Bob Martin, Chief Financial Officer.

At this time, all participants are in a listen-only mode. After finishing our prepared remarks, we will conduct a question-and-answer session at which time we request that participants limit themselves to one question and one follow-up question. Please note that this conference is being recorded and will be available for replay. For information on how to access the replay, please visit our website at mdcholdings.com.

Before turning the call over to Larry and David, it should be noted that certain statements made during this conference call, including those related to MDC's business, financial condition, results of operation, cash flows, strategies and prospects and responses to questions may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements involve known and unknown risks, uncertainties and other factors that may cause the company's actual results, performance or achievements to be materially different from the results, performance or achievements expressed or implied by the forward-looking statements. These and other factors that could impact the company's actual performance are set forth in the company's second quarter 2022 Form 10-Q, which is expected to be filed with the SEC today. It should also be noted that SEC Regulation G requires that certain information accompany the use of non-GAAP financial measures. Any information required by Regulation G is posted on our website with our webcast slides.

And now I will turn the call over to Mr. Mizel for his opening remarks.

Thank you for joining us today as we go over our results for the second quarter of 2022, provide an update on current business conditions and discuss the outlook for our company. MDC reported earnings of $2.59 per diluted share in the second quarter of 2022, representing a 23% increase over the second quarter of 2021. Home sales gross margin for the quarter improved 370 basis points year-over-year to 26.8%.

New home deliveries and average sales price came in at the high end of our previously stated guidance for the quarter as our team did an excellent job overcoming construction delay and delivering homes and what has become a more difficult operating environment. We also ended the quarter with a solid backlog worth over $4.4 billion, putting us in a great position to continue to deliver strong revenues and operating profits as we enter the back half of 2022. We are extremely pleased with our financial and operating results for the second quarter. Our order results fell short of our expectations.

Beginning around mid-May, we began to see a slowdown in traffic and order activity which became more pronounced as the quarter progressed. In addition, our net order results were negatively impacted, an increase in cancellations as a higher number of buyers in backlog were either unwilling or able to move forward with their purchases. We believe this negative shift in buyer sentiment was a natural reaction to the macro headwinds that have become increasingly difficult for buyers to overcome in the quarter, including a sharp (inaudible) in mortgage rates, surging inflation and an overall uncertainty surrounding the health of our economy.

Our sense is that these demand headwinds will persist for at least the remainder of the year, which will likely put a damper on our order results as both buyers and homebuilders adjust to this new reality. Despite these near-term challenges, we remain confident in the long-term outlook for our industry and our company. We believe the demand drivers that propel our industry over the last few years continue to exist, including a large population of millennials entering their prime home buying years, they mean boomers relocating to adjust their lifestyles and migration trends from high- to low-cost areas of the country.

In addition, while we have seen a recent increase in new and existing home inventories, they remain both well below historic levels while rents in many markets continue to rise. MDC is well positioned to benefit from the industry trends over the long term. Thanks to our affordable product focus and our geographic exposure, our homebuilding operations are in some of the most attractive homebuilding markets in the country with favorable job-to-permit ratios, strong employment basis and rising incomes.

We have spent the last several years retooling our new home offerings to address affordability concerns in our markets and to target a broader pool of buyers. These homes are in well-located areas of the market and feature some of the quality and craftsmanship that Richmond American Homes are known for but in a scale-down footprint and price point. While no builder is immune to the broader market forces that currently affect our industry, we believe that being in the right markets and the right type of product will lead to better results over the long term and give us a distinct advantage over many of our competitors.

Another advantage our company has is the well-capitalized nature of our balance sheet, which allows us to operate from the position of strikes during this period of uncertainty. We ended the quarter with a debt-to-capital ratio of 34% and a net debt-to-capital ratio of 24%. The total liquidity stood at $1.74 billion at the end of the quarter with $590 million in cash and cash equivalents and $1.14 billion available under our unsecured revolving credit facility.

With a low leverage profile and ample liquidity, we are well positioned given the current level of market uncertainty and can potentially take advantage of strategic opportunities should they arise. We have always run our company to be successful through the entirety of a housing cycle, not just in the good times. This means we stay disciplined in our acquisition of new land deals adhere to our build-to-order business model and limit the amount of speculative inventory in our communities.

While this discipline may curtail some of the upside during the market peaks, it limits our exposure during the market troughs. It allows us to pay an industry-leading dividend of $2 per share on an annualized basis, which equates to a 5.5% yield based on recent price levels. We believe these attributes, along with the strength of our balance sheet and the experience of our seasoned management team or factors, long-term investors should consider when evaluating an investment in the homebuilding space.

With that, I'd like to turn the call over to David, who will provide more detail on our operational performance this quarter.

Thank you, Larry, and thanks to everyone for joining us on the call today. The second quarter of 2022 was marked by great execution and strong profitability across our homebuilding platform as well as by a slowdown in order activity, which was fairly widespread. New home deliveries came in at 2,536 for the quarter, which was 7% lower than last year's total, but above the midpoint of our previously stated guidance.

The supply chain environment continues to be challenged as our company-wide cycle time increased by 5 days on a sequential basis. However, we are starting to see some improvement of the availability of labor and trades, particularly on the front end of the construction process, which hopefully will provide some relief. Our home sales gross margin approached 27% in the quarter as we have been able to keep price increases ahead of rising input costs over the last several quarters.

Each of our homebuilding regions posted gross margins in excess of 25%, highlighting the broad-based nature of our pricing power. Divisions with the highest gross profit profile included Phoenix, Southern California and Riverside California. As Larry mentioned, we began experiencing a slowdown in order activity starting around mid-May, which carried them into June, resulting in an absorption pace of 2.3 for the quarter.

On a regional basis, the East posted an absorption pace of 2.6, the West 2.4 and the Mountain region 1.8. Buying activity has been fairly resilient through the first quarter and into April. However, the combination of higher interest rates and lower consumer confidence began to take a negative toll on home buyer sentiment during the quarter. This also led to an increase in cancellations, which further impacted our net order results. It should be noted that some of the cancellations were a result of proactive efforts to confirm their homebuyers and backlog that were scheduled to close in the coming months would be able to do so.

We believe the quality of our backlog is in a much better place as a result of these actions and feel good about the revenue and profits we expect to generate from these closings. While we are disappointed with the net order results for the quarter, we believe we are in a good position to adjust our sales efforts and adapt to the new reality. We have very little standing inventory at the end of the quarter that would be susceptible to heavy discounting, thanks to our build-to-order business model. We also have several incentive tools at our disposal, particularly as it relates to financing and lowering a buyer's monthly payments, which should offset some impact of a higher mortgage rate.

Fortunately, our gross profit and margin profile gives us the ability to be more focused on our sales efforts and still post healthy profits. Given these positives, along with the natural advantage that comes with having product and well-located communities, we feel good about our ability to adapt to the new market environment.

Now I'd like to turn it over to Bob, who will provide more detail on the results for the quarter.

Thanks, David, and good morning, everyone. During the second quarter, we generated net income of $189.5 million or $2.59 per diluted share, representing a 23% increase from the second quarter of 2021. Pretax income from our homebuilding operations increased $52.8 million or 28% from the second quarter of 2021 to $240.3 million. This increase was driven by our gross margin from home sales, which improved by 370 basis points to 26.8% as well as home sale revenues, which grew 6% year-over-year to $1.45 billion.

Our financial services pretax income increased slightly during the second quarter of 2022 to $18.7 million. This increase was primarily due to our insurance operations, which benefited from increased premium revenue within our captive insurance companies. While our mortgage operations continued to be impacted by increased competition in the primary mortgage market, it did benefit from an increase in interest rate lock commitments with many homebuyers electing to take advantage of long-term lock opportunities and interest rate buydown programs. The accounting treatment for these rate lock commitments had a favorable pull-forward effect on pretax income in the quarter.

Our tax rate increased from 24.9% to 26.8% for the 2022 second quarter. The increase in rate was primarily due to the federal energy-efficient home tax credits, which have not been extended in 2022 and a decrease in the windfalls recognized upon the vesting and exercise of equity awards. We delivered 2,536 homes during the quarter, which represented a 7% decrease year-over-year, but exceeded the midpoint of our previously estimated range for the quarter of 2,400 to 2,600 closings.

The average selling price of homes delivered during the quarter increased 14% to about $572,000. This was primarily the result of price increases implemented over the past 2 years and was partially offset by a shift in the mix of our closings during the quarter from California to Florida. Our backlog conversion rate remained well below historical norms as our average sale to close cycle time reached nearly 10 months for those homes that closed in the second quarter.

While we continue to reflect current labor and supply chain conditions in our delivery projections, deliveries in the second half of the year should benefit from the construction status of homes currently in backlog, as 62% were beyond the frame stage of construction at the end of the second quarter compared with just 40% in the prior year.

We currently anticipate home deliveries for the 2022 third quarter of between 2,200 and 2,500 units. And we expect the average selling price of these units to be between $580,000 and $590,000. There is a heightened risk of underperformance relative to our forecast this quarter due to the increased volatility of economic and industry conditions. Also, because of the increased volatility, note that we are not reaffirming our full year deliveries guidance at this time, though we did have enough backlog units under construction as of the end of the second quarter to meet the range of deliveries we shared last quarter.

Gross margin from home sales improved by 370 basis points year-over-year to 26.8%. We experienced improved gross margin from home sales across each of our segments with our East and West segments having the largest year-over-year increase. These improvements were driven by price increases implemented across nearly all of our communities during the second half of 2021 and the first quarter of 2022, which have been partially offset by increased building material and labor costs.

While the gross margin of homes in backlog remains healthy, they have decreased slightly from their peak earlier this year as a result of higher lumber costs and uptick in sales incentives. As a result, we are currently expecting gross margin from home sales for the 2022 third quarter of between 24.5% and 25.5%, assuming no impairments or warranty adjustments.

Our total dollar SG&A expense for the 2022 second quarter increased $5 million from the 2021 second quarter, driven by increased general and administrative expenses. Our SG&A expense as a percentage of home sale revenues decreased 20 basis points year-over-year to 9.2% as we continue to drive improved overall operating leverage.

General and administrative expenses increased $10.9 million from the prior year quarter to $72.9 million. This increase primarily resulted from an increase in salary-related expenses due to higher average headcount as well as increased stock-based and deferred compensation accruals. We currently estimate that our general and administrative expenses for the third quarter of 2022 will be approximately $75 million.

Our marketing and commission expenses both decreased year-over-year, resulting in a 70 basis point improvement in these costs as a percentage of home sale revenues. Marketing expenses are likely to trend higher in coming quarters as we continue to open new communities and increase our marketing spend in an effort to drive more traffic to our sales centers.

The dollar value of our net orders decreased 40% year-over-year to $882.1 million due to a 48% decrease in units, which was slightly offset by a 16% increase in our average selling price to $628,000. Our gross absorption pace during the quarter was 3.7 homes per community per month, which represented a 32% decrease year-over-year. While we don't like to see a year-over-year decrease, keep in mind that the slowdown occurred against the backdrop of both higher borrowing rates and a nearly 10% increase in our home prices from the beginning of the first quarter to the beginning of the second quarter. We continue to closely monitor pricing and incentives on a community-by-community basis and make adjustments where necessary.

Cancellations as a percentage of beginning backlog increased from 5.7% in the second quarter of 2021 to 9.7% in the second quarter of 2022. While this increase seems large in the context of the prior year, our historical quarterly cancellation rates prior to the pandemic were consistently above 10%. We saw incentives on new orders increased during the quarter from historically low levels of the past 2 years. In addition, we utilized rate lock and interest rate buydown programs during the quarter to address affordability concerns and we'll continue to use these tools to help drive orders and strengthen backlog in the near term.

Our active subdivision count was at 207 to end the quarter, up 11% from 187 a year ago. This increase was driven entirely by our West segment with our East and Mountain segments both experiencing year-over-year decreases. Our Nevada and California market saw the largest year-over-year increase in community count, adding a total of 22 net new active communities. We expect our active community count to continue to increase through the remainder of the year, and we continue to forecast double-digit percentage growth in our active community count from December 31, 2021, to December 31, 2022.

Due to the market uncertainty we have discussed at length during this call, we slowed our pace of land activity during the quarter as we approved just 607 lots for acquisition during the second quarter of 2022. We acquired 1,763 lots during the quarter, mostly in April, resulting in total land acquisition spend of $159 million, down 48% from $308 million in the 2021 second quarter. We also had $151 million of land development spend during the 2022 second quarter, up modestly from $130 million in the same quarter last year.

We incurred $15.5 million of product abandonment charges during the quarter as we decided not to move forward with a number of projects at various stages of due diligence given the current level of industry uncertainty. As a result of stepping away from these projects, we saw our controlled lot supply decreased 4% year-over-year to 33,130 lots. However, we believe the supply is still sufficient to meet our operating needs for several years, consistent with our philosophy of maintaining a 2- to 3-year supply of land. As of quarter end, we had $40.9 million in cash deposits and $11 million in letters of credit at risk associated with the 7,296 lots currently under option.

As Larry highlighted, we ended the quarter in a strong financial position with total liquidity of $1.7 billion and no senior note maturities until 2030. While we did see an increase in our overall speculative inventory as a result of cancellation activity during the quarter, we ended the period with only 46 completed unsold homes. With slower land acquisition activity this year, we saw operating cash flow jump to $171 million for the first 6 months of 2022 as compared with only $12 million for the first 6 months of 2021.

Our financial position and cash flow will remain a key focus for us, especially as the economic picture remains unclear. If uncertainty in the market persists, we believe there may be an opportunity to pursue new acquisition opportunities with better terms and/or better pricing than has been recently available.

In summary, we are pleased with our results for the first half of 2022 and believe that our homes currently in backlog position us to deliver strong home sale revenues and operating profits in the second half of the year. While we are likely to continue to experience headwinds given the rapid rise in interest rates and other market uncertainties, our strong balance sheet, seasoned leadership and disciplined approach to operating the business will allow us to continue to successfully navigate market challenges as they arise.

That concludes our prepared remarks. We will now open up the line for questions.

(Operator Instructions) Today's first question comes from Stephen Kim with Evercore ISI.

Appreciate the color and detail. First question I had was related to the cancellations. Obviously, it was a bit high as you pointed out. You said some of this was due to you cleaning the backlog. Basically, it was on your part. I was wondering if you could sort of maybe quantify that, also maybe give us a sense for the vintage of the cancellations, when were those contracts initially signed generally, if there was something to say there? And we calculated your earnest deposits as a percentage of our sales price of about 2% last quarter, just kind of on the low side relative to your peers. And I was wondering if there was any plans to increase the amount of earnest money that you collect from your buyers? And if not, maybe why not?

Steve, this is Dave. I'll answer a couple of questions. I think we pretty much have decided that in addition to the 2% earnest money, we'll also take additional earnest money at our gallery for some houses and Bob can talk about that. And two, I think, what we said is with all this uncertainty, what we did is we went through our entire backlog and said, hey, if somebody -- if we've got somebody that's on the edge or maybe won't go forward, let's figure out how to cancel them or figure out how to put them in a loan program. But we were very proactive on our entire balance sheet.

And in addition to that, we wanted to make sure that we had a lot of these people that were locked in with our mortgage program either on a current lock or with an extended lock. And so we were very proactive to make sure that if we had cans, then we can move them over to a spec and they're selling. Bob could probably tell you a little bit but more about aging.

Yes. So I think the majority of our cancellations were for homes that it sold within 3 months prior. So pretty early in the construction phases, there were some that went out further than that, but mostly closer to the point of sale within 90 days. And it makes sense that we would have some fallout as some consumers came in, in, say, February, March, which were really good months for us sales-wise and then just saw a big shift in rates. I think it was important that we went through the backlog extra carefully and made sure that there weren't consumers in there who didn't really have a good chance of ultimately closing. we don't want to be building houses for those consumers who'd rather just deal with it now. And we always go through our backlog and make sure it's clean.

But again, especially important when rates are changing so significantly. I don't have a specific number, I guess, to quantify for you that relates to the kind of extra cleaning of the backlog. I think it's just a part of our normal process. And obviously, cancellation rates are higher because of the shift in rates. So far in July, it looks like we're going to have a little bit lower cancellations overall than June, but that's only 1 month. Overall, July is looking a lot like June did.

Okay. Yes. That's helpful. And thanks for the color on July. Second question related to the land options. We noticed that you walked away from a bunch, and you talked about your option count. I believe it's like a little less than half a year's worth by our calculation. I wanted to ask why you decided to walk away from so many as opposed to renegotiate terms? Because it would seem that you would walk away if you anticipate that land prices, effectively that you could lock in with your options, would drop relatively soon. But our understanding is that the land market tends to be kind of sticky. It takes a while for -- land sellers will generally just renegotiate terms as opposed to cutting the price in that process. If it takes a while, I was curious why you opted to walk away at this point instead of just extending the terms and then maybe walking away later if things don't pan out. Could you just sort of talk us through your thought process there?

Yes, Steve, it's Dave, again. Actually, what we did is we went through every transaction, and we looked at where it was, where it was in the market. And one of the things that we've seen is that I think at this point, a lot of the sellers were maybe a little more unflexible on negotiating either extensions or a reduction in price. And what we've seen over the last 4 years is when these things happen, prices have a tendency to go down and talking to a lot of the land sellers now, we're seeing that, hey, prices are going to go down. Certainly, terms are going to get softer.

So we decided the most prudent thing for us to do today was to be objective. Let's look at the ones we have and say, "Hey, we really don't want to do these, do the reduction in given the earnest money or due diligence costs and just move forward and find some other deals or at some point, we'll renegotiate with these current sellers." Bob, what do you have to add to that?

Yes. I think there are some instances where lots got pushed out, there was some renegotiation on certain deals. But there's others where we had to make a decision in Q3 the takedown was coming. And like you said, on the stickiness factor, we were kind of at the front end of the rate increase. So not all of our sellers (inaudible) the same way in terms of the trajectory of lot prices or deal flow. So we made some decisions. And I think as David indicated, I think, we'll see more capitulation in coming quarters on pricing in terms potentially.

Got it. That was really helpful. I mean, would it be fair to just say that because your overall land holdings are rather lean to begin with, then most of what you would have an options might be subject to more immediate takedown terms than maybe some other builders. And so that's why you guys maybe more than others reacted the way you did, whereas you had a lot of land, let's say, you wouldn't feel that same pressure. Is that a fair characterization?

I could probably answer it a little differently, Steve. I think the way we looked at it, as we said, listen, we've always had, what I call, a very short land supply. So when we looked at maybe the change in absorptions going forward, some of this land coming our way in the next quarter or 2 or 3, we said, you know what, let's just take a look at what we think absorptions might be in the future, and we think we'll get some softer terms and better pricing going forward. So let's just move, not put it on our balance sheet right now and just stick to an ending and say, "Hey, we're going to have 2 or 3 years of land based on kind of current absorptions."

And our next question today comes from Deepa Raghavan with Wells Fargo. Hi.

Can you talk about some of the market dynamics in your portfolio? You gave us absorption pieces, but can you talk about some of the markets that surprised you positively or negatively in terms of volume or pricing?

Yes. I guess I would start with, I guess, on the East Coast in Florida. We saw some resilience there. It's not to say that they're immune from what's going on with rates, but we're in some affordable markets out there, namely Orlando and Jacksonville, and they've become a more significant part of our operations, I think, in part because of the affordability factor, great climate out there and other factors. So I think that's one that's been really good for us as of late.

Okay. What are -- I mean, you talked about July a little bit. You said July looking largely like June at this point in time, but at the same time, you said cancellations probably taking slightly lower. What's driving the cancellations lower? Is it the incentive -- the higher incentives you're putting through more marketing spend, more commissions? Can you talk through that? And as part of the same question, where are we with regards to your incentives, commissions, marketing and advertising spend? Are those back to pre-COVID levels? Or are you still pretty far from those pre-COVID levels, 2 parts there.

Yes. So I would say, it's always hard to say -- tell in terms of cancellation rate. It's only 1 month worth of data. I guess I would point to a couple of things that, as David indicated, we really try to make sure that we were taking a serious look at backlog and not getting ourselves in Q2 if there was somebody who just wasn't able to make it to the finish line under our judgment, we didn't think they'd be able to make it the finish line. We have some great visibility to that, given our relationship with our lender HMC. So that's one thing.

I would say beyond that, we had a pretty big spike up in rates overall that correlated with mortgage interest rates. The 10-year spiked up to, what, 3.5, and now it's settled back down, and mortgage rates have gone through that same sort of roller coaster. So it's a little early to say that rates have stabilized at this point. But at the very least, kind of that initial shock up seems to have abated just a little bit. So that might have something to do with it that a consumer says, "Hey, I missed the huge spike up and now that it's settling down a little bit", they feel a little bit more comfortable moving forward. But really, that's just kind of speculation on my part. We'll see what happens in the coming months.

On the part, where are you with your incentive commission spend marketing versus pre-COVID levels?

More like a 6-part question. (inaudible) about that part, but thanks for reminding me. I would say, as Eric -- or somebody indicated on the call, maybe it was Larry or David, we do expect that marketing could come up a little bit. I mean it just stands to reason we were spoiled by not having to advertise as much because people were really very forthright getting to our sales offices and signing a contract just this very high level of demand we've seen over the course of the past year or so.

And we're making sure that we're doing more on the marketing side. So I don't have a specific number. We're just on the front end of that, but we'll continue to evaluate the market and see what additional is needed to make sure that people can find our sales offices and see Richmond first before they see others out there.

On the incentive side, for the quarter, we ticked up a little bit. I think we were just above 3% in the prior quarter, and we're about 4.5% in the second quarter. That's just on new sales. So about, call it, 150 basis points of movement there. I think you asked about commissions as well. Not huge changes in the commissions at this point. I think that's been a little stickier. Of course, you're out there looking at what our competitors are doing with outside brokers to make sure that we're competitive, but not a whole lot of movement there yet.

That's very helpful. Good luck.

Our next question comes from Truman Patterson at Wolfe reserves.

I wanted to follow up on Stephen's prior question about lot option deposit walkaways. Was there a certain geography or metros for these projects that you all stepped away from? And also for the remainder of the 7,000 option lots that remain, I imagine that you're sharpening your pencil and any chance you could quantify the magnitude of the deals that might be closer to not really hitting your underwriting criteria anymore.

Why don't I start and just say a couple of words. I mean we've looked at all of our options that go out for the entire company. And I think what we decided is that in a couple of markets, we thought absorptions were going to go down substantially. So when we looked at kind of our land pipeline, we said to ourselves, you know what, if we thought the absorption is going to go down substantially, maybe the lots that we had earned our option were a little long. And so in that case, we decided to kind of move on. Maybe Bob can give you a little color on a couple of markets.

Yes. I mean I would describe it as very similar to how you did, David. I mean really, we were looking at all of the markets and probably had write-offs in just about everyone, most, if not all. And I think the second part of your question, you're kind of asking about what would we expect to see some more in the future. And I imagine you will see it a bit of a higher level than you normally see it. I think every quarter, you typically see some sort of walk away, whether that's just due diligence costs for outright deposits, but I would imagine it's going to remain a bit more elevated. I don't have a specific percentage of those 7,000 lots. But I think we're going to have to continue looking at it pretty hard.

Okay. Okay. And then kind of a 2-part question here. But first, Larry and David, you've all been through multiple cycles. And clearly, right now, we're going through a down cycle, and it's early right now, but you all have brought up a couple of times about the potential for land price declines. Just trying to understand how you all view the market over the next 12 months and that light just based on current conditions compared to past experience? And then part 2, just hoping you can help us quantify the incentives that you all have been bumping up in orders, we'll call it in June or July kind of relative to first quarter incentive levels in orders?

I'll take question one. I'll let Bob do number 2. But I think -- I don't know which cycle, Larry and I are on 5, 6, many cycles. But I will tell you that what we've experienced in the past -- and we can see today that land prices are clearly softening up, terms are getting softer. And in our experience in the past, when these things start going down a little bit, generally speaking, they maybe go down a little bit more.

So I think as an abundance of caution, I think all of us in our management team said, hey, we use the term time out. Let's call it time out, and let's see what's going on. We definitely have enough lots for the next short period of time. And we've got terrific land people in all the markets that got their antennas up. So we can see that definitely some prices are going down and terms are definitely being softer. That's one I'll let Bob answer the other one.

Yes. So Q1, we're at about 3% on sales for the incentives part of thing gross sales. And for Q2, we bumped up to about 4.5%. June, a little bit higher than that. I don't want to parse too much into monthly stuff because I don't know that's necessarily indicative of where we're going to be longer term, but you saw that 3 to 4.5 shift, and we'll continue to adjust to the market.

Okay. Okay. Perfect. And for clarity, that is for kind of orders, correct?

Yes, gross orders.

Okay. Perfect. Good luck in the upcoming quarters.

Thank you.

And our next question today comes from Alan Ratner with Zelman & Associates.

I guess first on the cancellation topic. I think, obviously, everybody in the industry saw a pickup in June, but it seems like yours might have been a bit more than others, and it sounds like at least some of that was you guys being proactive. As you think about those cancellations, what percentage have you had to estimate or buyers that perhaps you could have saved if you increase the incentives a bit more, whether maybe it was a rate buydown or something to kind of keep them to be able to qualify for that loan and you just decided that financially, that didn't make sense? Or were these cancellations truly buyers that were kind of either not going to move forward for one reason or another, regardless of kind of what you threw at them?

I'll answer part of your question. I think when our team went through every cancellation that was possible, we always look and say, hey, can we put you in another mortgage program or can we buy it down? And so we had some of those that just couldn't fit. They might have a change of circumstances also. But we did have a number of people that just said, "Hey, I'm qualify, got a mortgage and moving on." Maybe Bob can give you a little more color.

Yes. Well, I think, maybe said another way, we saw an uptick in the percentage of the cancellations related to what we call remorse, just kind of more of a psychological kind of reason. So you talk to consumers and maybe in addition to being financially impacted, just rates being higher and having a harder time qualifying because of that. It just seemed like they weren't in the right frame of mind, just given the volatility in interest rates, being worried at locking too high. I think we heard from a number of consumers who said, well -- and I think rates are going to come back down. And I just didn't want to lock right away and proceed forward. So that kind of psychological element by which maybe the consumer just wasn't willing to move forward. That was a bigger part of the cancellations than it's been, say, a year ago.

Got it. Okay. That's helpful color. I appreciate that, Bob. And Dave, Second, if I think back to when I first started covering your company in 2005, I think you guys were definitely one of the earlier builders to kind of recognize the changing market and respond to that. I know you guys exited a number of markets early on in the downturn. If I look at this quarter here, I see a lot of similarities to how you responded back then walking away from options maybe before some of your peers did purging or cleaning up the backlog pretty diligently. Though yet, just listen to your comments, it doesn't sound like you're anticipating a multiyear downturn in front of us here.

So can you just kind of talk about a little bit how you're thinking about maybe some of the newer markets that you've entered over the last 12 or 18 months? I mean I think a number of those markets are ones we're hearing are probably under some of the most pressure today from a pricing and absorption standpoint, thinking like a Boise in Austin and Nashville, and it makes sense given how much price appreciation there's been there. So can we expect maybe some pruning of the footprint as well if this kind of current trend persists for another few quarters? Or are you still committed to those markets?

First of all, you've followed us for a long time. And so you know that we're very careful. I think the new markets we started in, we started really small, okay? And I think we like the markets. But overall, I think, when you think about land, I think one of the things we're looking at is we have just finished 2 years of what I call really phenomenal absorptions by us and others. So we think going forward, we don't see it, Larry and Bob and I don't see it like '05, where we could see a lot of headwinds on what I call, no peaky mortgages, a lot of things that were happening in '05 and '06 with easy to get a mortgage. And so we see it a lot differently today. We think the markets -- there's still a lot of demand for what we do. We just think absorption is going forward are going to be less, and we want to deal with it. Bob, what do you have to add to that?

Yes. And for that reason, I think, we have a greater opportunity to continue to be successful in the new markets, even we've got a great balance sheet. We've got great liquidity to reinvest in those markets. But just like any of our other markets, some of the deals that we originally thought would work might not work anymore.

So if we have success in retooling those pipelines, I think, we've got an opportunity to move forward. But we're going to look at it objectively. As you indicated, we're not afraid to make the decision quickly. And if a market is just not working out over multiple quarters, we'd certainly take a look at it just like we take a look at acquisitions in our long-standing markets.

I really appreciate the thoughts. And just to kind of put a bow on this, none of those markets fit that description at this point, where you're seeing kind of the warning signs and you feel like the...

Well, I think, we evaluate all the markets all the time every day. And I think one of the things that's great about our business model is we don't go long on land, okay? And we're not going to go long on land. And we think that our build-to-order market, build-to-order strategy really kind of works, and we're seeing some successes in these new markets.

And our next question today comes from Jay McCanless with Wedbush.

Actually, to take Alan's question on the next level, what, if anything, are you seeing right now that says maybe a little less focus on entry level or a change in your go-to-market with the product that you have out right now? And then also maybe just remind us what your entry-level percentage is at this point?

Jay, it's David. I'll kind of start. I think one of the things that we have, and Bob will give you all the percentage in our entry levels called the Seasons. And we think it's really -- it's a terrific product, and we're essentially building just about every market that we're in right now. And one of the things that it does flex a little bit on pricing depending on the market. We have Seasons that range all the way from -- in Florida, we arranged around $300,000. And then in the Bay or in California were $600,000 with the same kind of product.

But we think the affordability is great. The build to order is great. And so -- and Bob goes through the percentages, but we think that product is pretty darn good, and we've got it essentially in every market that we're in. In fact, a couple of markets like Orlando, we just -- all we do with is Seasons. Bob, you've got some percentages.

Yes. For the past couple of quarters, what we view as our affordable offering, which includes Seasons, it was about 2/3 of what we did on sales, kind of our net sales metrics. Just Seasons alone was about 57% of our sales in Q2, and that's even up a little bit. A year ago, it was 51%. So I think Seasons continues to resonate. And part of that is what David mentioned that ability to flex to different types of consumers. And the fact that we didn't necessarily cater it to just a first-time buyer and has some nicer features you can still do build to order and put a nice finishes higher ceilings, just things like that, that make it feel nicer, makes it appeal to different categories, I think really is a good thing in this kind of market when you need a little bit more flexibility with your product. So it continues to be a good story for us.

So then if you think about the cancellations, both the consumer-driven and NBC-driven cancellations in the second quarter, was it -- which buyer group is it mostly focused on kind of this aspirational entry-level buyer? Is it more first move-up or second move-up?

I mean I think it was the same kind of percentages. Almost exactly across all 3.

Okay. And then -- and Bob, I apologize. I missed your commentary about the number of homes that you guys have at frame right now in backlog and what impact that might have on absorption for the rest of the year.

I think the comment was, you look, a year ago, I think we only have maybe 40% in frame plus in backlog, so at least frame complete. This year, we have closer to 60%. So that gives us a better starting point as we start the back half of the year. I think the counterpoint is back-end trades have certainly been difficult. That's taking longer. But we like the fact that we are ahead of the game in terms of getting through frame.

And our next question today comes from Alex Barron with Housing Research Center.

Yes. I was hoping you could provide the number of starts in the quarter, and I don't think I have last quarter's either, so just for comparison. And then related to that, what are your thoughts on future starts? Are they going to match kind of the sales pace similar to that?

And another question, a lot of builders are saying that there's a lot of demand for comps that can close in 30 to 90 days, but you guys seem to be sticking to the build-to-order strategy. So just your thoughts around that.

Alex, it's David. I'll kind of start. I think what we said is, hey, we're going to stick to our netting and we're only going to build, build to order. But what we have is we've had some cancellations. And so when we have some cancellations then -- which we don't have a bunch of finished houses, but we're going to stick to our netting. And then we're going to build the order as we get sales. We're not going to build ahead of them. We're going to build them when we've got a mortgage approval and we want to get started. But Bob can give you a little bit of color on starts, where we're at.

Yes. So just getting to the exact numbers, I think, David handle the strategy pretty comprehensively. So for Q2 2022, 2,429 starts is what we did. Now note that, that's above the roughly 1,400 sales that we have. And the reason it's above is we were kind of starting some that were sold in prior periods still. But now are sold not started has gotten down to a lot lower levels. So I wouldn't anticipate that big of a delta in the future. Q1, I'm not sure if you're talking about Q1 or the prior year quarter, but Q1 was 3,330, and then Q2 of 2021 was $3,657.

Ladies and gentlemen, this concludes our question-and-answer session. I'd like to turn the conference back over to the management team the your final remarks.

We appreciate everyone being on the call today, and we look forward to speaking with you again following the reporting of our Q3 results.

Thank you. This concludes today's conference call. We thank you all for attending today's presentation. You may now disconnect your lines, and have a wonderful day.