Taylor Morrison Home Corp (TMHC) 2022 Q1 法說會逐字稿

Good morning, and welcome to Taylor Morrison's First Quarter 2022 Earnings Conference Call. (Operator Instructions) As a reminder, this conference call is being recorded.

I would now like to introduce you to Mackenzie Aron, Vice President of Investor Relations. Please go ahead.

Thank you, and good morning. Before we get started, 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 earnings release, which is available on the Investor Relations portion of our website at www.taylormorrison.com.

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 SEC, and we do not undertake any obligation to update our forward-looking statements.

In addition, we will refer to certain non-GAAP financial measures on the call, which are reconciled to GAAP figures in the release.

Now let me turn the call over to our Chairman and Chief Executive Officer, Sheryl Palmer.

Thank you, Mackenzie, and good morning, everyone. I am pleased to also be joined today by Louis Steffens, our Chief Financial Officer; and Erik Heuser, our Chief Corporate Operations Officer. I will share the highlights from this quarter as well as an update on the market environment and the favorable positioning of our portfolio in today's rising rate environment. After my remarks, Erik will discuss our land supply and disciplined investment strategy, and Louis will give a detailed review of our quarterly results and financial guidance.

To begin, we are pleased to share the results of our first quarter performance, which exceeded our expectations across each of our key operating metrics despite the challenges facing our industry from ongoing supply chain constraints, further inflationary pressure and the swift rise in mortgage rates.

Among the highlights, our home closings gross margin improved 450 basis points year-over-year to the strongest level since 2013. Our SG&A percentage declined 120 basis points to the lowest first quarter level ever, and our return on equity improved nearly 900 basis points to the highest return since 2013. Each of these record results reflect the combination of our acquisition journey, which began nearly 10 years ago, and more than tripled our annual deliveries to add critical scale and diversification to our business.

As you have heard me discuss before, since completing our last acquisition 2 years ago, we have been entirely focused on operational priorities designed to leverage our core strength of market scale, prime land positions and consumer-centric products. This primarily includes streamlining and simplifying our production capabilities and driving greater capital efficiency in our land investments.

These are long-term structural improvements to our business that are allowing us to compete more effectively than ever before. This positive momentum is expected to drive even stronger results in the quarters ahead, starting with our backlog of 9,400 sold homes. As a result, I am pleased to share that we are reaffirming our 2022 home closings guidance of 14,000 to 15,000 deliveries, and we are once again raising our 2022 home closings gross margin guidance, which we now expect to improve to at least 24.5%.

This margin would be up over 400 basis points from 2021 and nearly 800 basis points from 2020. And combined with SG&A leverage and the success of our land lighter strategy, we are also raising our 2022 return on equity guidance to the mid- to high 20% range. In both absolute and relative terms, these strong anticipated results reflect our team's focus on operational effectiveness to capture the unique earnings power of our well-balanced and attractive land portfolio.

While rising interest rates and geopolitical issues have added another layer of complexity to the already challenging operating environment, we are confident in our outlook and are focused on delivering a record year of financial performance.

From a demand perspective, activity was healthy and shoppers were engaged across our markets and consumer groups in the first quarter. We raised based house prices in effectively all of our communities while emphasizing higher lot premiums through our competitive bidding strategies and driving higher option revenue with an eye on protecting long-term value in our communities. Collectively, this drove a 24% year-over-year increase in our average net sales order price.

At the same time, we also continued to manage our sales and ended the quarter with a monthly absorption pace of 3.1 net sales orders per community. While strong demand certainly exceeded this level, we intentionally metered sales in the vast majority of our communities and delayed the release of available spec homes until later in the construction cycle to gain increased visibility into cost and maximize price. With the majority of our spec homes in early stages of production and very few finished units, the number of available homes ready to be released for sale was limited. However, as our spec inventory progressed through the quarter, our sales pace accelerated and ended the quarter on a high note.

Additionally, we are leveraging our virtual sales tools to serve our buyers with added convenience and flexibility while also enhancing transaction efficiency. For example, consumers who utilize our online home reservation system to purchase a spec home closed on their purchase nearly 2 weeks faster than those without a reservation. The positive sales momentum has continued thus far into April, and our sales teams across the country continue to report that activity overall remains resilient. However, we should expect that the recent rise in mortgage rates could begin to impact the consumer, particularly in communities focused on the most affordable segment of entry-level buyers, which are only a small minority of our portfolio.

In fact, as I look at our overall portfolio today, I am encouraged by the strength of our buyers, position of our backlog, diversification of our consumer groups and the quality of our land positions.

So let me share some additional thoughts on why these factors drive our continued confidence. Beginning with our sold backlog. These 9,400 homes enjoy strong embedded equity and are backed by deposits of nearly 9% and more than 57,000 per unit, both of which are up significantly year-over-year and are higher than market averages as we have been successfully increasing our upfront collections. This skin in the game as well as our diligent prequalification of nearly all our buyers by Taylor Morrison Home Funding contributes to our below-average cancellation rates, which were among all-time lows at approximately 6% last quarter.

Additionally, our backlog reflects the well-diversified financially secure consumer set we seek to serve with our prime land positions in core submarkets. For example, of our borrowers and backlog, average credit scores are among all-time highs at 752, and average down payments of 24% are higher than a year ago on a larger loan amount.

From an affordability perspective, as I always share, we closely track the interest rate qualification buffer of our buyers financed by our wholly owned mortgage company, Taylor Morrison Home Funding as an important indicator of consumer strength. Unsurprisingly, these buffers impressed in the first quarter alongside higher interest rates, although they remain at healthy levels given rising incomes and credit strength even when considering the most recent rate increases.

Specifically, looking at first quarter closings, we estimate our conventional borrowers could have qualified at an interest rate nearly 650 basis points higher than their actual rate. This strength extends into our backlog where the 82% of borrowers qualify for conventional loan have similarly strong financial positions to absorb higher rates before adjusting loan terms or other offsets. Additionally, representing only 16% of our first quarter mortgage volume and even a smaller share of our backlog, government, FHA and VA borrowers also have solid qualification metrics with the first quarter rate cushion of about 370 basis points as our price points tend to attract high-quality professional first-time buyers.

With rates continuing to move higher, we are working closely with our borrowers in backlog to communicate the impact and to successfully move forward with their home purchase. The visibility and control we gain from the ongoing communication and analysis by our financial services team provides invaluable insight and allows us to use finance as an extension of our sales team, which reduces cancellation risk and improve the overall customer experience.

To that end, to help us maintain strong mortgage capture rates and offer our customers increased protection and peace of mind in today's uncertain rate environment, Taylor Morrison Home Funding recently introduced a new extended rate loss program that allows our new shoppers to cost effectively secure an interest rate for up to 1 year. The buyer will provide a 1% of loan amount fee at the time of lock, which further strengthens their commitment to their home purchase and TMHF borrowers will receive the normal contribution to closing costs. The cost of this program was considered in our original guidance and therefore does not impact our strengthened home closing gross margin outlook.

To wrap, I would like to share a few notable takeaways from our consumer surveys, which included feedback from over 1,500 home shoppers in the first quarter. First, in response to how higher mortgage rates would impact their home surge, only a single-digit percentage of all respond and said they would stop their home search if affordability became a constraint, instead opting to modify their plans either by reducing (inaudible) increasing their down payment or slowing down their search. This is quite different from what surveys indicated as rates increased in 2018 when shoppers were twice as likely to say they would stop their home search at that time, suggesting current demand is much more determined to move ahead.

Slicing the data by location, shoppers looking in core markets are 2x more likely to continue their search than shoppers in new emerging markets who indicate they would stop their search, reinforcing our concentration on prime land positions with proximity to employment, schools and amenities. In fact, only 10% of our communities would be considered emerging markets according to our internal rating system.

The feedback also reveals different levels of resiliency among consumer groups and income levels. For example, more than half of shoppers in our active lifestyle communities indicated that higher rate would have no impact on their home search as compared to just over 1/4 of all other home shoppers. Given their lower rate sensitivity and the above average gross margin and revenue we generate in this segment, our active lifestyle business, which accounts for about 1/4 of our total sales, is an important and attractive element of our portfolio strategy.

On the other hand, shoppers with relatively lower income and those looking for more affordably priced homes are more likely to slow or stop their search compared to higher incomes and higher home prices. Generally, these first-time buyers do not have equity from an existing home to help offset the movement in price and interest rates. These consumer insights help support why we have long prioritized a portfolio approach to our business. Over the past many years, our multiple acquisitions and organic investment, we have intentionally strengthened our market position to add critical market scale and product diversification while staying disciplined to our core focus on serving well-qualified, creditworthy homebuyers with prime land positions. This strategy has been grounded in our view that a diversified high-quality portfolio is best positioned to generate attractive risk-adjusted returns over the course of a housing cycle.

Now I will turn the call over to Erik to provide additional detail on our land portfolio.

Thanks, Sheryl, and good morning, everyone. I will now discuss our strong land position and the disciplined approach we apply to our land investments. Through both our organic land investments as well as multiple well-timed homebuilder acquisitions, we have established a robust land pipeline of approximately 77,000 owned and controlled homebuilding lots, which represented 5.6 years of total supply at quarter end. The majority of this land, including approximately 70% of our own lots, was contracted for in 2020 or earlier prior to the significant increase in land prices that has occurred over the last roughly 18 months.

These lots are booked on our balance sheet at an attractive historic basis, considering today's land pricing, which is a meaningful source of embedded value that should benefit our margins and returns in the coming years. Additionally, because we already own or control nearly all of the lots needed to meet our 2022, 2023 and 2024 anticipated home closings, we are looking out to fulfilling 2025 and beyond for the land investments we are making today.

As a result, we have the flexibility to be highly selective in today's competitive market as we pursue opportunities that we believe will be accretive to our portfolio throughout the housing cycle. We utilize deep market research and consumer insights, scenario analyses and the expertise of our local land teams and Corporate Investment Committee to judiciously examine every investment decision. In fact, last year, when land price inflation was accelerating, we grew our land portfolio by 10% when the industry's lot supply increased by roughly 1/3, highlighting the favorable position we are in to be more patient when deploying our investment dollars.

We are also balanced in our approach as evidenced by the increasing share of our total land spend on development. For example, just over 50% of our first quarter land investment of $394 million was spent on land development versus 30% a year ago as we are working to monetize our well-vintaged land and drive community count growth. For the remainder of the year, we expect to maintain this balanced mix as we target total homebuilding land investment of $2.3 billion to $2.4 billion.

I would add that we have significantly increased the share of our lot supply controlled via options and other off-balance sheet structures to 39% at quarter end versus 32% a year ago. In other words, the 5% year-over-year increase in our total homebuilding lot supply was driven entirely by growth in control lots, which were up 28%, while owned lots were down 6%. Following this success, we continue to expect to increase our controlled home site percentage to approximately 45% by year-end.

By controlling lots through these arrangements, we reduced the amount of inventory held on our balance sheet, minimize long-term risk and meaningfully improve expected returns. This focus on capital-efficient land investment has been supported in part by our strategic financing arrangements with Varde Partners. As we have discussed in recent quarters, these vehicles allow us to efficiently control new lots through programmatic scalable land financing at an attractive cost of capital.

As alluded to last quarter, we are pleased to share that we recently expanded the partnership, again by establishing a dedicated fund to support our build-to-rent operations. Through this arrangement, we will contribute 40% equity to the fund, which equates to approximately 20% on a levered basis, and we expect over $1 billion of balance sheet relief specific to our BTR operations over the next several years. As a reminder, we are excited about this segment as we serve those consumers who are unable or unwilling to commit to homeownership, and we believe that our growing BTR business fills an important void in the market for lifestyle-oriented single-family rental housing.

With that, I will turn the call to Louis to discuss the company's financial review and outlook.

Thanks, Erik, and good morning, everyone. I'll provide an overview of our strong first quarter results as well as guidance on key metrics for the second quarter and full year. To begin, we generated first quarter earnings of $1.44 per diluted share. This was up 92% year-over-year due to strong upline growth as well as a significant improvement in our home closings gross margin, SG&A leverage and a lower share count. Thanks to the strong execution by our homebuilding and financial services team members, we delivered 2,768 homes during the quarter. Combined with a 23% increase in our average closing price to $594,000, this generated home closings revenue of $1.6 billion. .

Our closing volume was slightly above the midpoint of our prior guidance range despite increased supply chain pressure on material and labor availability at various points in the cycle. We continue to take steps to address and mitigate these issues by rationalizing our floor plans and option offerings, enhancing our scheduling processes and expanding our trade base.

In addition, during the quarter, we accelerated our start pace to 4.2 homes per community per month to begin production on nearly all of our anticipated full year closings. This is earlier than normal to account for the longer construction cycle times we are experiencing. We also increased our inventory of spec homes to nearly 8 homes per community at quarter end from approximately 6 homes at the end of 2021.

As we look ahead, we continue to expect to deliver between 14,000 to 15,000 homes this year, including 3,000 to 3,200 homes in the second quarter. These forecasts do not assume any change in supply chain conditions. And from a pricing perspective, we now expect the average price of our closed homes this year to be at least $625,000, which will drive a significant increase in our home closing revenue.

Turning now to margin. Our first quarter home closing gross margin was 23.1%. This was up 450 basis points from the first quarter of 2021 and 770 basis points from the first quarter of 2020. This strong improvement is primarily due to pricing power, improved operating efficiencies and acquisition synergies that have allowed us to better manage and offset costs and lastly, a more balanced spec versus to-be-built mix of sales.

Following this strength, based primarily on the composition of our sold homes in backlog, we expect to generate a home closings gross margin of approximately 24% in the second quarter. And as Sheryl mentioned, we are raising our full year 2022 gross margin guidance by another 100 basis points to at least 24.5%. This would be up more than 400 basis points from the 20.3% in 2021.

While cost inflation has increased to an annualized rate of around 10%, our pricing strategies on the sales floor, combined with our efforts to control costs by leveraging our supplier relationships and streamlining our operations is allowing us to offset this cost pressure and continue to drive stronger profitability.

During the quarter, SG&A as a percentage of home closings revenue was 9.6%, which was down 120 basis points year-over-year. In 2022, we now expect our SG&A to improve to be in the mid- to high 8% range from 9.3% in 2021. This strong leverage is due to top line growth cost management and sales efficiencies from our virtual sales tools.

Now to community count. We ended the quarter with 324 communities. This was up from our prior guidance range, due primarily to the more restrictive sales strategy, as Sheryl discussed. Looking ahead, we expect to end the second quarter with approximately 310 to 315 communities and continue to anticipate ending the year with around 350 communities, followed by further growth in 2023.

And lastly, I will provide a brief overview of our capital position and allocation priorities. Our balance sheet is strong with over $1.4 billion of total liquidity, including $569 million of unrestricted cash and $847 million of undrawn capacity on our revolving credit facilities at quarter end. To further improve our capital flexibility, we recently amended our $800 million revolver, which extended the maturity date from February of 2024 to March of 2027 and provides reduced pricing upon meeting lower capitalization ratios.

Our net debt to capitalization ratio equaled 35.7%, and we remain on track to reduce our net debt-to-capital ratio to the mid-20% range by year-end. And lastly, we repurchased 1.9 million shares outstanding for $58 million during the quarter. At quarter end, we had $172 million remaining on our $250 million authorization. Going forward, we expect to be active and opportunistic in deploying excess capital to repurchase our shares. Thank you to our teams for their dedication and hard work, helping us achieve this strong start to our year.

Now let me turn the call back over to Sheryl.

Thank you, Louis. Before we end the call, I want to highlight that earlier this month, we published our fourth annual environmental, social and governance report. We integrate sustainable business practices across our organization and are proud of the achievements we highlighted in this year's report. This includes our emphasis on fostering greater diversity and inclusion, giving back to our communities and combating the homelessness crisis, doing our part to help establish a resilient housing workforce and advancing environmental stewardship throughout efforts such as our exclusive partnership with the National Wildlife Federation in which we have safeguarded more than 5,000 acres of Wildlife Habitat in our communities. .

This year, we are further advancing our ESG initiatives by committing the resources to establishing our greenhouse gas emissions baseline and developing our long-term strategy to reducing our carbon footprint. We are also continuing to focus on ways to expand our racial and ethnic representation as we seek to build on our legacy of industry-leading gender diversity. These are just some of the exciting initiatives we have underway.

In closing, I'd like to offer my deepest appreciation to our team members for their tremendous efforts and commitment to our customers and our organization. The housing environment remains as dynamic as ever, with favorable demographics, employment trends and limited supply on one hand and rapidly rising mortgage rates, inflation and geopolitical issues on the other. And I am confident our team will continue to successfully navigate these unique times, and we look forward to updating you on our progress.

With that, let's open the call to your questions. Operator, please provide our participants with instructions.

(Operator Instructions) Our first question today comes from Carl Reichardt from BTIG.

Sheryl, I wonder if you could talk a little bit about over the course of the quarter, how the different segments that you sell to performed order-wise, so first-time buyer versus move-up versus active adult and also into April, if you'd let us know that?

You bet, Carl. We didn't see a great deal of difference in the quarter when I look at the year-over-year numbers. Interestingly enough, when I look at the entry-level, active adult, our paces were pretty consistent between those 2. Our highest pace was in the kind of first second move-up total in the business. But when I look year-over-year, pretty consistent. So we're seeing, as I mentioned on the call, seeing really robust demand in all consumer sets through the quarter.

And no real difference in April. When you go across the country, I would tell you that we have some affordable communities in April where you're going through a few more pre-calls to get those folks to contract. You've got active adult positions across the country that are doing really well. There may be a position where that lifestyle buyer is more worried about the macro. So there's no trends that are worthy of kind of speaking to. It's generally pretty good across the board.

Great. And then as a follow-up, you talked about getting starts in the ground earlier this year. So where in the start process, if you have an average point in the vertical construction side, are you beginning to release those homes for sale? And when do you think you can remove those sales restrictions? Kind of what quarter do you feel like you'll have the product up and ready to go with sort of some confidence in cost and completion time?

Fair. You bet. Louis and I will tag team this. On the sales side, I think we're still finding ourselves in a fairly restrictive environment through April. So I would expect those paces to be more similar to what we saw in the first quarter. I'm hopeful because I think it's really a healthier environment for us to get to, Carl, that by the time we get to the latter part of the quarter, we find ourselves in a little bit more open environment.

Would you want to talk about just this - all the starts in the first quarter?

Yes, sure. So as you've seen, our starts have been ahead of our closings as we have increased the number of specs and working down our significant backlog of unstarted homes. Also, as those specs, we've gotten to probably where pretty close to where we'd say on a normalized basis we want to be. And those are progressing. We'll start to be releasing those -- have more release than we have historically. So I think in the future, you'll see our start pace more align with our future sales as the year progresses.

And Louis, once you agree that generally, we've got a pretty good mix across the portfolio, we have some communities. It really comes down to supply-demand by community, community bases, Carl, that we are releasing very early in the process, and there are some where we might be holding closer to frame complete. .

Yes. I'd say market-by-market a little bit differ.

Okay.

The next question today comes from Alan Ratner from Zelman Associates.

First question, maybe expanding a bit on the price point segment question. It sounds like maybe no discernible differences yet. But Sheryl, maybe I'm reading between the lines, but I definitely sense a bit more optimism going forward on your comments about move-up and active adult in terms of that buyers' ability to withstand the move in rates we've seen, which I think is logical. .

If I go back last quarter, you kind of signaled that maybe your new community openings this year would be a bit more disproportionately weighted towards entry level. I think at the time, you kind of signaled maybe our sales price mix is a little bit lower as these new communities open up. So I guess I'm just curious what your thinking is, your plan is? As far as segmentation of the business going forward, has this move in rates, assuming it's here to stay, which is a big assumption, obviously? Has that altered your thinking as far as the desirable mix of the business as you think about land acquisition going forward?

Thanks, Alan. There's a lot in there. Maybe EriK and I will tackle it. But I would tell you that the overall mix of the business, when I look at the consumer groups and you're seeing over the quarters, Alan, 3%, 4% movement between the segments year-over-year, I kind of like where we're at. I mean that 1/4 of the business being that lifestyle community, I love the diversity of the portfolio.

You've seen the entry level move down to about 30%. As we've talked before, even in that entry-level cohort, you have quite a difference between those positions from a very affordable I look at the FHA buyer in our portfolio, and it's, I think, about 3.7% of our backlog. So it's a very small piece. As I look at the communities that are coming on board, throughout the year. I think it's a pretty consistent mix to what we have kind of in the portfolio today.

EriK, any real movement?

Yes. I would just reiterate, I think that the balance is: a, very intentional; and b, as we take a step backward, we look at kind of the underwriting in terms of what's coming through that we can expect to see over the coming years, it's pretty consistent, and that's intentional. We spent a lot of time kind of discerning what that project will look like and to be that consumer will be. That's all.

We're delighted. We're bringing more Esplanade communities to the market across the country. So you'll continue to see the strength there. And then I would say the balance is pretty consistent, really would, Alan.

Yes, that's very helpful. I appreciate that color there. And second topic I'd love to drill in on, first off, I commend you guys for giving that disclosure on the lot vintage and talking through that because I think it's very helpful, and I believe you're the only ones that talk about it that way. So thank you for that.

Sure.

I guess when I look at your lot pipeline, and I think you kind of highlighted that 70% of owned lots were contracted before 2020. So clearly, there's a nice runway there for strong margins even if home price appreciation does moderate here. I guess if we isolate the 30% that has been tied up since COVID or over the last 18 months, what's the sensitivity on those lots?

If we're in an environment where cost inflation stays at this 10% annualized level for a year plus, incentives start to inch higher prices start to stop going up, what happens to the margins on that land when they eventually flow through to delivery? And that might be a couple of years out. I'm not sure the timing on whether those are finished lots, raw developed, et cetera?

Yes. Once again, I think Erik and I will tackle this, but let me just make sure that you heard us correctly. When we talked about kind of the growth of our lot inventory under owned or controlled, what we said is last year, we increased it by 10% when the industry went up by an average of 30%. So we've been able to be very selective.

When we think about the actual land we're bringing on, even though we've purchased it in the last year, Alan, you'd have to appreciate that, especially on the active adult side, some of these projects are under diligence for months or under contract for months and months well into a year, 1.5 years.

So actually, when we look -- I mean, Erik, do you want to talk a little bit about the residual and how that stacks up compared to like the prior 10 years?

Yes, it's a great question today, Alan. And I think you had a number of things in there. I think as we think about the blend of kind of the type of land coming through, I would say that's relatively consistent. We'll get finished lots anywhere we can, but we know we're going to have to self-serve and develop them a lot. And I think we also alluded to that half of our spend is being dedicated to development these assets that we previously procured.

From a residual standpoint, to Sheryl's point, we track that pretty closely. The residual ratio actually in the deals that we're underwriting today, is slightly less than what we've seen in the last couple of years. That obviously is in step with kind of an elevated ASP, but I can assure you that we run lots -- use of the word, the right word sensitivities in terms of what the -- to these projects look like at various scenarios and kind of conditions going forward.

I think the last thing, Erik, would just be when we look at kind of the margin return margin expectations, over the last 12, 24 months, they've actually been some of the highest we've seen in years and years. So even if the market were to settle back, given all the narrative that's out there, Alan, I think we see ourselves in a very good position. .

Yes. And I mean, the market is competitive, right? Pricing is elevated, but as we spoke to, we're judicious, and we've got the ability to kind of be very selective in our acquisitions today.

Yes.

Yes. And definitely, the lot count growth trailing the industry, I view that as a positive as well and obviously, signals the strong position you guys had heading into this period here. So thanks for all the color. I know it's a tough question to answer, but it's helpful hearing you talk through that. So thank you.

No, appreciate it.

The next question today comes from Jay McCanless from Wedbush.

Wanted to ask on the rate topic, maybe a different question. Are you starting to see some land that you may have passed on before start to come back to market as these mortgage rates move up and maybe some people have to rethink their assumptions around their original purchase of those lines?

Go ahead.

Yes. Unfortunately, not as of yet. And I don't think conditions have really kind of force that conversation yet. So the short answer is we've not seen meaningful capitulation in the land market to date. And frankly, there's usually about a 9-month lag if that were to occur. And so certainly not today. But again, I think that really comes back to us being -- having the ability to be judicious and really selective in the ones that we are bringing to you.

And once would you agree, Erik, that generally that 9-month lag follows, I mean, a real reduction in the market in sales because we've talked about before, Jay, there's this remarkable correlation between builder sales and appetite for land. But that's just not been the case yet.

Yes. We just -- we don't have that kind of arrow in the quiver yet, and there's a delay, so not yet.

Okay. That's good to hear. I guess my second question is, you talked about with the supply chain wanting to do some SKU rationalization, but then also talked about option. I guess option revenue starting to move up. Maybe being a build-to-order builder, how much can you really cut those SKUs? And I guess have you started to see some gross margin benefit from cutting those? And at the same time, how are you judging that relative to your wanting to maximize that type of revenue with the customer?

It's a great question, Jay. We've talked for the last couple of years to the Street about our Canvas program. So absolutely, I think even as a build-to-suit and we're, I would call us a fairly balanced builder, I know going into '21 and coming out of '20, we had a very strong tube build business, which actually hurt us a bit last year with what we saw lumber and everything. And a big part of that, and that kind of optionality that consumers had really did take a toll on the business. So I think you see us today as a much more balanced spec and to-be-built.

When I look at the Canvas and the simplification strategies across the business, I would say across most consumer groups, they've only taken hold. And I think the consumer appreciates some of the simplification and just the overwhelming process that exists in the design center. I would say the one exception to that is generally that active adult business. We've talked in the past about our option revenue in the active adult business being significantly higher than the overall portfolio. We've talked about seeing that price opportunity not just in options, but on the land side. And I think our options are something like 2x the company average.

Having said that, we actually have introduced our Canvas packages very successfully in our Florida business that probably started there, to be honest, even amongst the active adult, but there is a subset of that, that I think will continue to want that optionality and opportunity to really customize the design selections. So it's a long answer to say that I think you'll see both, but I really don't think there's a product category in total that won't benefit from the simplified model.

The next question today comes from Alex Rygiel from B. Riley Financial.

Sheryl, can you give us a quick update on the bill-to-rent -- your build-to-rent business and the overall market for that?

Yes. Actually, I think I'll ask Erik to do that since he manages that entire process as well as kind of the deal that we just signed with R-Day. So we can talk about just an update since our last call and the success we're having and then maybe the new land deal.

Yes. Alex, thanks for the question. Yes, we're about 2.5 years into it. And it may be just coming off the last question, it's wholly aligned with kind of the simplification efforts of the company as you think about only 2 or 3 fuller plans and being able to produce an aspirational 20 homes a month. So we're kind of moving our way from 9 to 10 markets.

As a reminder, it is a hybrid model. So it's kind of a single family living experience but within the context of kind of an apartment-like community. And the good news is there's not a whole lot of them across the country. So we do continue to believe that we're relatively early on in the venture. Maybe just to give you kind of a brief update on one of our early communities here in Phoenix, we did able -- we were able to get 20 a month produced and leased. We were able to pre-lease 90% of the units before the first move-ins, and we expect to sell that asset by year-end.

From a pipeline standpoint, we've got 2 going vertical 3 going horizontal and then a pretty good pipeline of 35-plus coming beyond that. And then to Sheryl's point, from just a capitalization standpoint to make sure that we can kind of affordably scale this business, we recently announced the relationship with Varde Partners that really would enable us to grow it and scale it, but really be able to do so without really hindering the core business.

Yes.

And then Sheryl, just to follow up on that, how do you think about that business in a rising rate environment?

Actually, pretty excited. I think that missing middle piece, Alex, is really when we started this, we started 2.5 years ago, but I would tell you the work on it started probably 3.5, 4 years ago. And then we -- once we have that, the business thesis then was about how do we play. And part of the original thesis was at some point in time, rates will go up and this missing middle piece of apartments to the single-family rentals, the hole is tremendous.

So we see the benefits, one, for the consumer in these really well-located positions, allowing them to have a lifestyle (inaudible) family opportunity in a lifestyle gated secure community. We also see this as a wonderful test kitchen for lack of a better description from a building science standpoint.

And then lastly, we see it as an opportunity to garner these relationships with this consumer set that allows them to naturally progress when they're ready into homeownership through building the relationship with Taylor Morrison. So this is the culmination of 3, 4 years of work, Alex. And I would tell you, we can never planned the timing. But given the kind of macro environment, I don't think we're better positioned.

Yes. Great. And I would add simply that maybe on the front end of your question relative to cap rates, it's certainly part of our underwriting, just like the core business, right? The scenario sensitivities, we're very mindful of that. But at the same time, we actually like the fact that rents tend to be less volatile than sales prices and housing. So even though we have the core business, and that will remain the core of our Taylor Morrison, but rents can be a hedge of an inflationary environment. There's lots of money in the space chasing it. And another reminder, at an average of 150, 175 homes in a community, we have the ability to be relatively flexible and to pivot in this business as well.

Yes. We'll move through each of these very quick. Yes.

The next question today comes from Matthew Bouley from Barclays.

This is Ashley Kim on for Matt today. So can you talk about if you're still seeing long wait list of communities home selling relatively quickly or any kind of bidding activity that may confirm that you could take more orders today if you had the supply?

Certainly, Ashley. Through the first quarter, as we said, we manage the pace and a large majority of our communities and the strategy on how we that is very different across the country. Some markets, it's through the HABO, the highest and best offer. Some it's through just a natural release process every couple of weeks, some it's lotteries. I think that continues.

When I look at the HABOs as we've moved into April, we still have markets that HABOs would be the key strategy Honestly, I'm very hopeful that we start moving away from that strategy. We moved off of it. I would tell you it was probably third, fourth quarter last year, came out the gate strong, has to go back into it. But it's not a wonderful experience for the customer. It's a very frustrating experience. So ideally, just like I said, a few minutes ago. I'm hopeful that as we move through Q2, we get to a play that allows us to have a more open sales floor and a more natural experience.

The other thing is we're really benefiting from, Ashley, is I would tell you back in the end of February, in addition to our kind of online reservation system, we actually modified it for both our to-be-built and our spec reservations where we started acquiring a deposit because the reset frenzied environment, not just walking in the (inaudible) but on the web where people were trying to tie it multiple houses. So we wanted them to have more skin in the game.

Just since -- I mean, over the last, I would tell you, 8 weeks, we have done hundreds and hundreds of website deposits. So hopefully, that (inaudible) shares with you just the consumer acceptance and need of this virtual environment and the demand that we're seeing.

That's helpful. And then if I could ask, how cycle times progressed compared to last quarter? And any signs of relief that could suggest improvement through the year, even if that's not kind of the underlying assumption?

Yes. Ashley, yes, I would definitely say the labor and supply chain environment has remained equally difficult as it was in the fourth quarter. Our cycle times last year, since the beginning of COVID, probably extended 6 to 8 weeks and this first quarter, probably another 1 to 2 weeks.

We're seeing significant municipality delays in inspections as well as we've talked about material and labor availability issues, although we feel like we've taken significant steps to allow us the comfort and confidence with our closing projections. This year, 97% of our units were closed or under production at the end of the first quarter compared to 87% last year. As we pivoted to starting more specs, 28% to 24% of our backlog were sold (inaudible) versus less than half that. And I think Sheryl spoke about earlier, our option and SKU rationalization process is also helped significantly improve the building process so that at least our homes cycle times on specs is a little bit quicker and having some of that simplification in our portfolio now helps us ensure our confidence in our deliveries this year.

So we're all anxiously awaited (inaudible) real...

not counting on a birthday.

The next question today comes from Truman Patterson from Wolfe Research. .

Actually, it's Paul Przybylski. I guess on your growth -- on your gross margin guide increase, any way you could break that out how much is being derived from maybe those internal efficiency gains versus a more favorable price/cost relationship or maybe just some conservatism in the original outlook.

It's really hard to break it down with the simplification, how much that contributes. I think in our script, we noted that we're seeing approximately a 10% annualized cost increase, which includes the higher lumber costs that we're anticipating in the second half. Q2 will have the best tailwinds from lumber. But sequentially, Q3 will probably be our highest point in lumber this year. Near the end of Q4, we'll start to see a little bit of tailwinds near the very end of the year. And then going into first quarter of '23, we'll start to see a bit of relief there. But each quarter, we'll see sequential growth despite the increasing lumber headwinds in the third and fourth quarter.

And I don't know that I would call it conservatism, Paul. I would say appropriate, given the timing and the volatility of what's out there. That's why we've used the words at least in some of our guidance, and we've hopefully articulated the confidence in the growth because there's a lot of moving parts right now.

Okay. Fair enough. I guess you mentioned the year extended rate lock, what percent of your buyers are actually taking you up on that offer? And then as we look over maybe the past 4 to 6 weeks, have you noticed any deceleration in your pricing power trends?

You bet. So as far as the rate lock, we just introduced this, I mean, we've always had rate locks, right? But I would tell you the extended rate lock in, I would call an extended rate lock, Paul, really anything that over 60 days. But since the middle of April, we've had over 380, nearly 400 locks that have an expiration date over 60 days. And then I would tell you, we had probably 100 in the last 10 days, these extended locks, which would be 6-, 9- or 12-month locks, I would tell you we've seen more in the last 10 days than we've probably seen in the last 5 years in total.

So the buyer has really got an appreciation for the environment we're in and the -- and there's no harm to them because of rates settle back they get a free onetime float down. So it really does give them the ability to have the confidence on what the absolute high end of their payment would be, and it's been really well received. And then as I mentioned in my prepared remarks, the fact that they're having to put 1% out gives them some skin in the game because right now, the environment is fairly frothy for different reasons, right?

You've got the large banks that are doing everything they can to grab share given the fact that the refi business has really, really dried up. And then you've got the independent mortgage bankers and brokers that are just fighting for their lives. And so the REITs out there have been relatively silly that have been offered. So for us, this gives us a really -- getting that capture gives us really great visibility into our customers and their ability to get to the closing table.

Okay. And then any color on your pricing power trends over the past 4 to 6 week?

When I look at the first quarter, Paul, the -- we actually saw pricing accelerate through the quarter each month. We did a company-wide increase as we went into the new calendar year. But then when we look at the numbers, we continue to grow that through March. I would say, in April, I don't have the monthly stats yet because I'll get those at the end of the month, but based on the feedback I'm hearing, it would be your normal environment where we're still taking increases as we release new lots to the marketplace.

I'm hopeful, once again that the size of these increases continues to moderate. I know we've -- everyone has been doing what they can to keep up with the cost pressures that we've been seeing. But the sustainability, I mean, I think we just saw the numbers come out this week of year-over-year, 20% again. This is not a sustainable formula. So I'm hoping we get to kind of a more normalized place.

The next question today comes from Ken Zener from KeyBanc.

In relation to starts, and you guys did comment about most or if not all your guidance actually under construction. Do you mind, Sheryl, I know we spoke about this in the past, the actual inventory units? I know the 10-K that you report includes some backlog that's not started, just so we could get a sense of what those starts are adding to on an actual unit level.

Yes, sure. We ended the quarter with 11,000 -- sorry. If there is a follow-up, please go ahead. .

Go ahead. No, go ahead.

Yes. We ended the quarter with 11,265 units under construction. One of the areas like I spoke about earlier, we've made huge strides in reducing our sold not started. Q1 of '21, we had 2,708 units sold not started, and we're down to 825. So really working to get our backlog that's been aging, started and another reason for some of the accelerated starts the last couple of quarters.

Right. No, that makes a lot of sense, and I appreciate that disclosure. Related to that, I guess you usually file it in your K, but do you have the actual WIP inventory then that you're running against those units?

We can get it to you afterwards, Ken.

Great. And then how do you think -- I appreciate that. Yes, I realize that was a kind of [one to]. And then the deposits, it's very interesting, right, that you're -- how do you take deposits online? Is that -- I'm just curious as to the efficiency of that in terms -- excluding someone that might be would try to buy 2 or 3 houses? Do you see that deposit limiting them? And is that a PayPal? Or is that just -- I find that very interesting. If you could expand on that a little.

Yes. No, we're the first ones to do it and quite excited about it. It's a technology, I think called Stripe. But really what the process is, Ken, is -- it's a modest, it's $100 at this point. I think you'll see over time that that's going to become something very different and how people can make down payments and the process will continue to be enhanced. But right now, what they're doing is they're really reserving a lot for 48, 24, 48 hours in time for us to deliver them the contract.

And -- but the fact that they have to give their credit card, give a deposit, the technology also prevents them because I would tell you, when we first introduced people were going in and putting those deposits on multiple lots. So the technology has got a little smarter and now the same e-mail address can't do it. And at some level, you're trying to control it. But what we really want is to put the energy and the consumers that are really most interested and qualified.

And so the conversions that we're seeing, we saw our top conversion have been in this platform of to-be-built reservations where they could go in and pick a lot and pick a house. That's second to our spec reservations. I would expect when we have a good 30, 60 days under our belt, we will find our strongest conversions here because people actually have to wipe out their credit cards. But we will be in all markets, I think, by -- within the next 30 days with that reservation with that $100 deposit, -- so it's pretty exciting. Continue to watch for the enhancements.

Very innovative.

The next question today comes from Mike Dahl from RBC Capital Markets.

This is Ryan Frank on for Mike. So my question is really on kind of the demand environment and your decision to prioritize production over sales right now given kind of your maybe dislike for some of these higher and fast and final offer and things like that. So can you talk about why you're pursuing the strategy now to start more than you're selling when you kind of want to be selling faster?

Well, I'd say first, based on the supply chain challenges, we made a conscious decision to start more specs and selling them a little further along in the process. So that we had more confidence in the closing dates to make the experience for our customers better. So I would say we've pretty much made that pivot at this point with over 2,700 specs under construction. And now that those are moving further along, we will start to see the releases of those increase over time.

So that pivot has been occurring in the last couple of quarters, essentially there at the -- what we consider the optimum spec level. So we'll start to see more of those being released going forward over the next couple of quarters.

Yes. And the only thing I'd add to that, Ryan, is coming out of the experience last year and the supply chain challenges, it's really important that when we sell a to be built, that we do everything we can to expedite that start. I mean, Louis reviewed the numbers of how many we had sold not started last year, that's a very painful process for a consumer. So we felt it was most critical to enhance the journey. We have a large to be build population and that we focus our energy on getting those starts in the ground: one, because of their need; and two, because of our ability to get them delivered for the year.

Okay. That's helpful. And then, I guess, if, let's say, demand were to stay at the current level, would you try to match sales pace with start pace over the coming quarters?

Yes. I think as we've said, our intent would be that we've really done the good work the last 2 quarters where you've seen the starts elevated over sales and because the intent is that they should really align. And so I think as you look forward, that should be what you expect from us.

Okay. And then I guess on the flip side, if demand were to slow, would you then slow your start pace at this point? Or would you kind of maintain a little bit of a gap?

Well, you're going to manage to a spec inventory that makes sense by community, and you're going to continue to put our to be built in the ground. So yes, if the market shifts, you're going to look at your sales, your spec pay and decide what's the right trajectory by community as you always do. But -- so yes, there would obviously be some sort of alignment there.

Yes. And the really big indicator for us will be how many finished specs we have. At the end of the quarter, we had 20. So we'll keep an eye on that. But if we see a buildup of our finished back inventory, we think adjustments going forward.

Yes. And arguably, when you look at what's the perfect kind of place from an inventory, you want some at all stages. So when you look at the 320 communities, we're about 300 finished spec short. So we've got a ways to go.

The next question today comes from Dan Oppenheim from Credit Suisse.

I was wondering, I guess, just given that last question, maybe just continue with that in terms of the specs in terms of talking about it based on sort of the level of finished specs. Would you -- like is your -- if you think about the second quarter, would your goal for the end of the quarter, are you trying to get to think about sort of an appropriate level of specs per community overall so that the level having 8 at the end of this quarter, does that seasonally want to think maybe we go a little bit lower there, but how are you thinking about that through the end of the second quarter? And are you really managing it based on finished or just overall specs there in this environment?

It's a combination, Dan, and good to talk to you. It's been a while. It's a combination. You want some finished specs. You want buyers that are coming in certainly as you move through the second quarter, school season ending, you want inventory that buyers have the opportunity to quickly move on. What we've said for probably since the acquisition of William Lyon is that, that kind of 7 to 8 is about the right number for us when you look at across the portfolio. And in today's environment, I think, has been even more important.

So you look at your product mix, look at your community mix across the country and kind of rightsize that. But we feel pretty good about the total numbers right now. So yes.

Great. And then in terms of the community count, you had talked about the sort of obviously the dip down in the second quarter. And then thinking about where it will end the year, is that -- how much of that is sort of based on getting a lot of those open in the fourth quarter just before the end of the year? Or how much should we see coming through the third quarter before the fall season there?

We'll sequentially Q3, as you said, start to see the improvement in our outlet count. For the year, we're counting on somewhere around 150 openings and first is 130 closing to get us at net 20 by the end of the year, increasing the overall outlets.

Yes. And for the third -- or the second quarter, we said that we would be to have [310 to 315]-- so you might see a modest dip before you see that sequential enhancement. Probably the largest increase in the fourth quarter.

The final question today comes from Alex Barrón from Housing Research Center.

I know you guys generally track the other state buyer. So I was curious how that's tracking today versus a year ago, whether it's similar or higher, how are you guys looking at that? And the second question is, I'm not sure if you discussed stock buyback plan. I might have missed that, but just your thoughts on that at this time.

You bet. I'll start with the first one and let Louis take on the share repurchase. Out of state, we've talked about this a little bit each quarter, Alex, and it's interesting. We're continuing to see both shoppers and buyers. When I look at the first quarter compared to first quarter a year ago, I would tell you our out-of-state buyers have doubled. Where it gets more interesting for me is when I kind of deep dive and are there any trends that we're seeing. And it really does fall into the active adult category.

We have some parts of the country where, like I would tell you, California, generally, that's a very local buyer that buys in our lifestyle communities in California, with very little exception. But then when I start traveling through the rest of the country, company, whichever, I can see some tremendous shifts. I can see as much as in Phoenix, for example, I can see 25% to 40% coming from other states and really being led by California, probably 30% from California and another 10%, 15% from some of our other (inaudible) like Washington or Colorado. In Florida, a huge penetration from New York, New Jersey and Illinois, Nevada, very significant Arizona, California. So it's a great deal of that. Obviously, you have your reloads across the country for business. But I would tell you a great deal of that migration is happening in the active adult business.

Alex, and related to your second question, we expect a strong year of operating cash flow based on our improved earnings outlook. Additionally, based on that increased shift to more controlled lots will also generate significant additional cash flow. And based on that, first and foremost, we want to reinvest in our existing core business. Second, I'd say we want to follow through on our meeting our net debt guidance to be in the mid-20s by the end of the year.

And then lastly, we're going to continue to be opportunistic as we really believe our stock is undervalued, but mindful again of our upcoming maturities in the upcoming years.

There are no additional questions waiting at this time. So I'd like to pass the conference over to Sheryl Palmer for closing remarks. .

Thank you. We really appreciate the opportunity to share our first quarter results with everyone. I can't miss the opportunity to send out another shout to our field team and thank them for the great work in the first quarter and probably most importantly, to recognize our National Admin Day and really thank our support who keeps our company running day in day out for all their great work.

Take care. We look forward to seeing you next quarter.

That concludes the Taylor Morrison's First Quarter 2022 Earnings Conference Call. Thank you for your participation. You may now disconnect your lines.