Taylor Morrison Home Corp

NYSE:TMHC

Earnings Call Transcript 2019-Q1

[Operator]

Good morning, welcome to Taylor Morrison First Quarter 2019 Earnings Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded. I'd now like to introduce Mr. Jason Lenderman, Vice President, Investor Relations and Treasury.

[Jason Lenderman, executive]

Thank you, and welcome, everyone, to Taylor Morrison's First Quarter 2019 Earnings Conference Call. With me today are Sheryl Palmer, Chairman and Chief Executive Officer; and Dave Cone, Executive Vice President and Chief Financial Officer.

Sheryl will begin the call with an overview of our business performance and our strategic priorities. Dave will take you through a financial review of our results along with our guidance. Then Sheryl will conclude with the outlook for the business, after which we'll be happy to take your questions.

Before I turn the call over to Sheryl, let me remind you that today's call, including the question-and-answer session, includes forward-looking statements that are subject to the safe harbor statement for forward-looking information that you'll find in today's news release. These statements are subject to risks and uncertainties that could cause actual results to differ materially from our expectations and projections. These risks and uncertainties include, but are not limited to, those factors identified in the release and in our filings with the Securities and Exchange Commission. And we do not undertake any obligation to update our forward-looking statements.

Now, let me turn the call over to Sheryl Palmer.

[Sheryl Palmer, executive]

Thank you, Jason. We appreciate you joining us this morning as we present Taylor Morrison's results for the first quarter of 2019. I'll start today by discussing our results for the quarter, and then I'll give you my best insight into what we think that means for the broader homebuilding environment before turning the call over to Dave to review the details of the financial results.

Getting right to it, I'm delighted to share that we exceeded our expectations in our operating metrics for the quarter including orders, closings, homebuilding gross margin and SG&A, which produced a strong EPS result of $0.46. We ended the quarter with 2,615 net orders on an average community count of 372 leading to an average sales pace of just over 23.

Given the Q4 environment, it's important to look at how that sales pace built within the quarter. January saw a slight sequential pickup in pace from December, but we really started seeing traction in February and then continued to see a pickup in March with the [ 2A ] pace. It's also worth mentioning that our cancellation rate for the quarter improved nearly 700 basis points sequentially from Q4 and at 13.3% in the first quarter was consistent with our historical norms.

Lastly, on sales, we saw the market strength continue into April and expect that our pace will generally be in line with our historic transitions from March to April as we see some slight month-over-month moderation.

Closings for the quarter came in at 1,938, which is a 25% higher result than last year and slightly above the high end of our guidance for the quarter. We'll take some time at the end of the call to address specific insights into each of the markets, but I would say that our strength in closings was primarily driven by our 3 California divisions: Phoenix, Denver, Houston; and both divisions in the Carolinas.

Home closings gross margin, inclusive of capitalized interest, was 18.2%, which was also above the high end of our guidance range for the quarter with some favorable mix impacts on closings previously expected in Q2.

EBT margin was 7.4% for the quarter or 7.8% when adjusted for AV transaction expenses in the quarter. As our integration of AV Homes advances, we are highly focused on gaining the efficiencies needed to drive our margins up towards our historical averages.

When we look into the synergies realized so far and look at the efficiencies on a project-by-project basis, we're still very confident with the updated synergy run rate we gave last quarter of $40 million.

We've talked openly over the last couple of years about the benefits in gaining overall scale of the business, which we think combined with our highly concentrated first time, first-time move up and 55-plus segments improves our competitive positioning in each of the markets where we build and ultimately leads to improved profitability and cash flow generation.

In the first quarter, these 3 segments represented nearly 90% of our closings, approximately 500 basis points of improvement from the prior year quarter.

We've executed on this strategy with 4 acquisitions in the last 4 years. The largest obviously being AV at the end of last year, which really complemented our affordable first time in 55-plus buyer business.

We're pleased to see this strategy is starting to bear fruit in our operating results as our Q1 sales and closings, both set all-time first quarter highs for the company by a pretty wide margin. What's more, we're equally pleased to see that so quickly after the AV acquisition, we achieved a first quarter low on our SG&A as a percent of homebuilding revenue at 11.5%.

Now that I've highlighted Taylor Morrison's results for the quarter, I'd like to take a step back and reflect on where we think we are in the market and what we're seeing from a big picture perspective. As we talked about on our fourth quarter call, there were a number of factors that had uniquely come together in the back half of 2018 that led potential buyers to take more of a wait-and-see approach than they had in recent years. Some of those factors began to alleviate in Q1. The two that probably received the most attention are the recent change in trajectory of mortgage rates and the overall direction of the stock market.

The 10-year treasury rate has dropped pretty steadily since November of last year and now sits about 2.5%. And while mortgage rates aren't always tied to the 10-year treasury rate, we've seen similar downward trends with that metric as well.

Buyers were being quoted more than 5% in November of last year, and at the time of our last call in February, 30-year fixed rates have fallen to around 4.5%. Since then, they've dropped even further to just over 4% representing a nice tailwind for the industry.

In fact, as we calculate the annual mortgage payment savings for our average customer, they would save around $2,400 per year compared to the same mortgage closing locked in November or December of last year.

In order to maximize our conversion opportunities in the slower rate environment, we converted our successful 2/1 rate buydown that we spoke about last quarter into a nationally marketed program that allows for permanent rate buydown at 3.75%.

We've seen tremendous success with these programs driving traffic into our communities. Foot traffic is up more than 24% year-over-year and perhaps equally or more important web traffic, which is a leading indicator for the business is up 32% year-over-year.

Benefiting from the added traffic, we saw reductions in sales incentives from Q1 2018 driving part of our home margin upside in the quarter. We believe that also aiding our traffic is the stock market momentum over the last quarter. The Dow Industrial Average hit a 52-week low in mid-December, and as I'm sure everyone on this call knows, it has seen a pretty steady increase since that point, recently closing at an all-time high.

Some markets have consumers that are particularly sensitive to the stock market volatility including tech employees in Northern California that have higher percentages of personal wealth tied up in stock-based compensation and some 55-plus buyers in Florida. We believe the roughly 20% stock market increase we've seen over the last few months has provided positive impact in the consumer's overall financial psyche and has created a renewed energy on the sales floor.

We believe the overall economy remains on steady footing. Unemployment remains at historical lows. Job creation levels are healthy and population and household formation growth continued to be solid.

As we have discussed over the last many quarters, our conviction on the healthy prospects for homebuilding is strongly linked to most markets remaining underbuilt by nearly 25%. In addition, the demographic tailwinds appear favorable with strong boomer migration rates from the Midwest and East to the Sun Belt states and the largest group of millennials entering lifestyle stages that indicate preferences for single-family ownership.

Before I turn the call over to Dave, I'd like to quickly touch on a mortgage topic that has been getting some attention as of late. The announcement from the FHA on tightening their total mortgage scorecard to address the overall health of their book. The [ FHA ] has publically stated its belief that it could impact 4% to 5% of FHA in certain mortgages annually, and as you can imagine, it has an even reduced impact on Taylor Morrison buyers given our smaller mix of FHA loans originated and the higher relative credit quality of those FHA buyers we do have.

In Q1, 6% of Taylor Morrison home fundings closed mortgages were FHA, which represents under 3% of our total closings. When FHA announced these changes, TMHF reviewed their loans in process and found less than 1% had multiple [ risk ] factors that may require a manual underwriting. But given the overall quality of the loans, we were able to get them approved under the new guidelines. No loans have been denied since that change.

We appreciate the advantage we have with our in-house financial services team assisting our customers from the very beginning of the buying process, ensuring they have the right finance programs to meet their short- and long-term needs. We pride ourselves on staying at the cutting edge of changes in the mortgage industry, and we'll continue to monitor further developments, but we believe the potential impact from this change is immaterial.

Now I'll turn the call to Dave for the financial review.

[C. Cone, executive]

Thanks, Sheryl, and hello, everyone. For the first quarter, net income was $51 million and earnings per share was $0.46. Total revenues were $925 million for the quarter including homebuilding revenues of $900 million. Both of those figures are up about 23% from the same quarter last year.

GAAP home closings' gross margin includes the capitalized interest, the impact from purchase accounting and mix impact from AV closings was 18.2%. This exceeded our first quarter guidance as margins on homes sold and closed during the quarter were better than expected due to lower incentives utilized and planned as well as some benefit from favorable geographic mix. More specifically, we saw a nice strength in margins throughout the West region during the quarter where are all 4 divisions had year-over-year increases in margin rate. On a total gross margin basis, we came in at 18.6%.

Moving to financial services. We generated approximately $16 million in revenue for the quarter and just over $5 million in gross profit equating to a margin rate of 33.2%. As we look at our TMHF buyer, the average FICO score was 752 during the quarter, which is the highest level in several years.

We have long prided ourselves on the credit quality of Taylor Morrison buyers at every price point, so it's great to see that continuing to increase incrementally.

SG&A as a percentage of home closings revenue came in at 11.5%, which represented 40 basis points of leverage compared to Q1 2018. The addition of AV is allowing us to drive the top line leverage.

EBT margin was roughly in line with our results in Q1 of last year when we account for the $4 million in transaction expenses that hit this quarter from the AV acquisition.

Income taxes totaled about $17 million for the quarter representing an effective tax rate of 24.7%.

For the quarter, we spent about $255 million in land purchases and development. At the end of the quarter, we had approximately 55,000 lots owned and controlled. The percentage of lots owned was about 79% with the remainder under control.

As we discussed during our Q4 call, we expect to decrease that percentage of owned lots back down closer to our historical average.

On average, our land bank had approximately 5.4 years of supply at quarter end based on a trailing 12 months of closings including a full year impact of AV. From a land pipeline perspective, we are almost exclusively focused on securing land for 2021 and beyond. At the end of the quarter, we had 4,835 units in our backlog with a sales value of just under $2.4 billion. Compared to the same time last year, this represents an increase of approximately 10% in both units and the sales value for those units.

In addition, we had 2,117 total specs at quarter end, which includes 561 finished specs. We spoke during our Q4 call about the fact that our spec levels were slightly higher than normal, but that it would position us for a strong Q1 and spring selling season. That has played out well so far with our division selling more than 1,200 gross specs during the quarter, and we are continuing to replace that inventory in line with market demand.

From a liquidity perspective, we ended the quarter with more than $676 million in total available liquidity. $172 million of that liquidity was cash on hand and the rest is from our $600 million corporate revolver excluding normal course letters of credit that have been issued against it. At the end of the quarter, we had a drawn balance on the revolver of $35 million and our net debt-to-capital ratio was 44.3%. This is higher than this time last year due to the AV transaction, but we anticipate driving this ratio back down below 40% going forward.

During the quarter, we were authorized by our Board of Directors to buy back up to $100 million of stock. In Q1, we acquired 4.3 million shares for about $77 million or an average repurchase price of $17.93. In April, we have acquired an additional 1.4 million shares for just under $27 million through last Friday, the 26th, at an average price of $18.63. This leaves us with approximately $49 million remaining on our current $100 million authorization. This continues to be a key pillar of our capital allocation strategy given the attractive returns provided by repurchasing our stock at a discount to the underlying book value per share.

I'll wrap up by sharing our Q2 guidance. For the quarter, we anticipate community count to be flat to slightly down on a sequential basis. Closings for the quarter are planned to be between 2,225 and 2,425. GAAP home closings gross margin inclusive of capitalized interest and purchase accounting is expected to be in the mid- to high 17% range. Effective tax rate is expected to be about 25% and the diluted share count is expected to be about 108 million.

For the full year, we anticipate closings to be between 9,500 and 10,000. Our community count will be in the 365 to 375 range. Our 2019 absorption pace is expected to be consistent with our 2018 performance. GAAP home closings gross margin, inclusive of capitalized interest and purchase accounting, is expected to be in the mid- to high 17% range. Our SG&A as a percentage of homebuilding revenue is expected to be in the low to mid-10% range. JV income expected to be between $11 million and $13 million, and we anticipate effective tax rate of about 25%. Land and development spend is expected to be approximately $1.2 billion for the year, and we expect our diluted share count for the year to be around 108 million.

Thanks, and I'll now turn the call back over to Sheryl.

[Sheryl Palmer, executive]

Thank you, Dave. Before we move to Q&A, I'll spend a few minutes covering the latest with regards to what we're seeing with consumer trend and activity in each of our major markets. We mentioned on the last call that our West region had held up well through the slowdown in the fall, particularly in Phoenix and the Bay Area and the relative momentum continued throughout the first quarter. Closings in all 4 of our western divisions were up nearly 25%, which led to a cumulative 30% increase in closings for the region.

Dave has already mentioned a strong homebuilding margin performance in each of these 4 divisions. Although total sales orders were down slightly during the quarter for the region, Phoenix and Southern California both had double-digit increases, but they had a year-over-year decline in sales primarily due to their company leading pace during Q1 of last year. However, the Bay is delivering orders in 2019 consistent with our expectations.

The East region had a strong first quarter after experiencing more moderation than others during Q4. Sales and closings for Q1 were up 14% and 22%, respectively. This strength was driven by Charlotte, Raleigh and North Florida, which has made up of our Orlando and Jacksonville divisions.

Although we saw some volatility in the fourth quarter in our Southwest Florida business, we've seen some nice recovery there following the same trajectory as I mentioned earlier with month-over-month improvement. Due to a strong 55-plus business, Southwest Florida was able to hold pace with where they were in the first quarter of last year.

In the Central region, sales orders were up about 6% driven by a strong growth in Austin and Dallas, with Dallas benefiting from the addition of the AV communities.

Closings for the region were up almost 26% with Denver, Houston and Dallas being the largest contributors.

As mentioned on prior calls, we know we had some work to do on the AV Dallas backlog and rightsizing product and price but are quickly seeing the benefit of the team's strong focus. We've also seen continued strength in Austin where our team continues to maximize the opportunities being presented by the combination of a strong economy and key community positions in desirable submarkets.

So before closing, I'd like to share some more about our approach to addressing environmental, social and governance issues within the broader framework of our business operations. We see tremendous value in examining our performance in these areas in order to build long-term sustainable value for our shareholders. That is why on Earth Day, we released our first Corporate Responsibility Report. In it, we share our efforts to incorporate sustainable values into how we operate our business, give back to our communities through volunteer and charitable activities, structure our governance practices, manage our workforce and engage our key stakeholders.

As Taylor Morrison grows and refines its ESG performance metrics and goals, we're committed to consistent transparent communication of our progress to ensure our shareholders have a clear understanding of our company and strategy. A key highlight that further differentiates Taylor Morrison within the industry is the formation of a strategic partnership with the National Wildlife Federation. This esteemed organization is advising our land teams on habitat conservation best practices while providing engagement opportunities for team members, customers and our communities all helping to position us in an industry -- as an industry leader in environmental stewardship.

I'd like to thank the Taylor Morrison team members across the country for remarkable first quarter. I have such confidence in their ability to flourish in any environment and know that 2019 will be a year to remember.

With that, I'd like to open the call to questions. Operator, please provide our participants with instructions.

[Operator]

[Operator Instructions] Our first question comes from Michael Rehaut from JPMorgan.

[Michael Rehaut, analyst]

First question I had was just on the longer-term trajectory as you see it for Taylor. Obviously, Sheryl you kind of walked through some of the acquisitions updating on AV Homes, and it's been a busy few years for you guys. With that being said, I was interested in -- if you were to kind of just look at your current footprint today if the opportunity stand in front for you. Obviously, you have a lot of competitors out there that have gotten bigger as well, some of the biggest have gotten bigger or continue to get bigger in particular. How do you see over the next couple of years, assuming a steady housing market backdrop kind of this slower-growth dynamic that we're in. How do you see your own organic growth opportunities? I think historically you kind of framed it within a 5% to 10% annual growth rate. I don't know it may be perhaps a little bit better at points. But is that the right way to think about it? But just, in general, where do you see the opportunity set from an organic standpoint?

[Sheryl Palmer, executive]

Yes. Good question, Michael. I would say there's not anything real new from what we've talked about 3 quarters. We look at the long-term trajectory. We continue to expect somewhere around mid-single digits. We've talked for quite some time about the importance of scale in the local markets, which is what's driven our strategy with these local market acquisitions to continue to build that scale, so we can really be a leader in: 1, talent; 2, kind of first looks at land and making sure we're controlling the ability to get the trades on-site and keep them there.

We'll continue to look at the organic growth as Dave often describes in our capital allocation and continue to look at opportunities for acquisitions where we believe they strategically make sense and provide accretive growth to the organization. I think the last thing that would be worth mentioning is the continued focus we have really on our -- excuse me, our barbell approach with the millennials, that first-time buyer segment, that professional first-time buyer segment and the 55-plus, both in the affordable 55-plus as well as the consumer that we've been serving in our more luxurious active adult lifestyle communities.

[Michael Rehaut, analyst]

Great. I guess, secondly, perhaps for Dave, but obviously, Sheryl weigh in please if you have thoughts. Just talking -- question more around the guidance for sales pace or absorption to be roughly flat year-over-year. Obviously, in the first quarter, you were down -- we have an estimate down roughly 17% in terms of your absorption rate, and it was kind of even across the regions. But from a total company standpoint for the full year, obviously, there's a much easier comp in the -- as we get towards the end of the year. But that's one of your smaller order quarters typically. So I was just wondering if you're going to make up the difference from a year-over-year standpoint primarily in the fourth quarter, or if you see any kind of more positive growth sooner than that in the second or third quarter even?

[Sheryl Palmer, executive]

So as you mentioned, we did have a reduction in pace year-over-year, but that was quite expected, Michael, and I think that's why it was in line with the consensus as we had some of our strongest compares in first quarter going into second quarter. So we're real delighted with the first quarter sales success and that has continued through April. I mean this is right off, probably 8-hours old, but it looks like in April, we'll have done about a 2.5 pace. So given the April 3.5 weekends with the Easter compared to the 5 weekends in March, I'm quite delighted with that as well.

So first, in quarter, we knew we had very difficult comps. I think when you look at pace, you have to look at pace in line with incentives. There are certain communities that we're going to drive pace very hard, continue to work with the incentives and make sure we move through. And then the others, we're going to protect because from a margin standpoint, that land can't be replaced. When I look at the trajectory kind of the openings and closings for the balance of the year, I actually expect some good strength in new positions offsetting some of the drag of closeout. But our desire will be to make sure that we stay very aggressive from a pace standpoint as we make our way through the year.

[Michael Rehaut, analyst]

And obviously that still -- that your gross margin trajectory incorporates some of that aggressiveness from an incentive standpoint?

[Sheryl Palmer, executive]

Of course.

[C. Cone, executive]

Yes, it does. I mean we're leaving a little bit of room there to use incentives that help deliver that pace. And we're very focused on turning the assets and driving returns.

[Operator]

Our next question comes from Paul Przybylski from Wells Fargo.

[Paul Przybylski, analyst]

I was wondering in your press release, you talked about the active adult segment gaining some momentum. I was wondering if the activity there is extending beyond the traditional selling season? And if you're seeing any difference in the performance between the lower price, AV, active adult communities versus your more traditional Taylor Morrison active adult communities?

[Sheryl Palmer, executive]

No, I think and the good news, Paul, is we're actually seeing strength. It was a slower slug like I mentioned kind of in the fourth quarter, particularly in Southwest Florida. But we really saw that momentum build in Florida as we started through the first of the year, and we saw that in both the legacy Taylor Morrison communities as well as the AV communities and that would be at all price points. I'm quite excited this will be over the course of this year, introducing some new active adult and more affordable positions in other parts of the country. But it's a strong focus for the organization because I think you know a high percentage of our overall lots, about 1/3 of our lots will serve that consumer group. And we're just getting going there.

[Paul Przybylski, analyst]

Okay. And then on the AV integration, you mentioned you're still comfortable with the $40 million in synergies. How much of that has been captured so far? And how does that break out between gross margin and SG&A?

[C. Cone, executive]

Yes. So for the [ $40 million ], I mean, our estimate was about 2/3 of that is in overhead, about 1/3 of that is in various other categories: mortgage, insurance, national rebates. We've captured a lot of the -- call it, the office overheads. We're seeing that come through now. That's helping us from an SG&A standpoint. A lot of other stuff will come over call it the remainder of this year, and we should be on an annualized run rate for our $40 million estimate in 2020.

[Operator]

Our next question comes from Alan Ratner from Zelman & Associates.

[Alan Ratner, analyst]

Congrats on a strong quarter. Great to hear the market strengthening here. So high level for you Sheryl. I guess on the synergy targets remaining on track there is very encouraging. But you guys are about 8 months into the deal closing now. And I'm just curious if you look back or you kind of dig in there, is there anything on the scale side that the markets maybe where, you've seen the greatest increase in scale? Is there anything you've been surprised at as far as the benefits are concerned, maybe not just the tangible synergies, but things like dealing with land sellers, dealing with the trades, anything you can kind of share for us where you feel like the business is really improved or changed given the increase in scale you've gotten from the deal?

[Sheryl Palmer, executive]

Yes. It's a great question, Alan. And I'd say there's been a lot of very positive movement and some to our surprise, but I think we had actually planned for a good part of it. It was just hard to quantify some of that, for example. We knew that as we scaled up the business, we would rebid on the national. That was the first we saw come through. The national rebates come through the business, very, very quickly. We started on that literally the day we announced the deal. I think the opportunity that we've been pleased with and we'll continue to, I think, see some more movement is on the local scale, and it's not just on the AV synergies. It's about -- it's something that -- some tangibles, some not, but as you think about rebidding our communities even in the Taylor Morrison legacy business, it's getting the advantage of the cost on the overall scale, not just in the new AV business or maybe we have them catch up to where our costing was.

I think availability of trades and being able to really give the trade some visibility of what the next 6 months, I mean we've really entered into strong partnerships with our trades across the organization on production planning to allow them to better plan for their business. And I'll tell you that's where scale really does matter. So I think it's really been at the field level, and I think we continue with the strength in the Taylor Morrison culture and the scale of the business, continue to attract some very strong talent. Obviously, we got some wonderful talent in the acquisition within AV, and as we're continuing to scale up, it's allowing us from a recruiting standpoint to really go into the market and look at great talent.

[Alan Ratner, analyst]

Very helpful, Sheryl. And second question, if I could. You mentioned a few of the tailwinds during the quarter that really benefited the business lower rates, the stock market. As you look up and down your buyer pool, what would you say was the most evident as far as buyer behavior as a result of these tailwinds? Did you see buyers maybe choosing to do more option and upgrades or buy a bigger house than maybe they could have afforded 3, 6 months ago given the move in rates? Or was it more kind of drawing some of those more marginal buyers into the market that maybe couldn't have qualified or just were a little bit worried about devoting such a high percentage of their income to housing?

[Sheryl Palmer, executive]

Yes. And yes, Alan, really across the board. I think we saw it really everywhere, and I think that's what made it so nice because as we said in fourth quarter and sometimes it's better to be lucky, we really believe that this was more of a psychological thing. For our buyers, that's an affordable thing because also macro factors hadn't changed. For example, you heard us talk well -- for well over 2 years now about our buyers ability to buy a larger house. And that's really been evidenced through the fact that they could afford a rate on the FHA site around 300 basis points and on the conventional side around 500 basis points more than what they're qualifying for today. So even though they could afford, there was a lot of other noise in the fourth quarter, be it stock market, be it government shutdowns, all the things that we don't want to talk about anymore that really kind of drove the kind of a psychological impact.

So what we've seen is this renewed energy on the sales floor and certainly, at the most affordable price point, absolutely it put folks back into the market. That's a smaller piece of our business because when you look at our first-time buyer, it tends to be a smaller percent of that 1/3 of the business is -- are the consumers that are really scratching their land to homeownership, but it did allow them to get back into the game. And then I think it gave more confidence to the professional first-time buyer. But having said that, there's some interesting new stats around millennials gaining financial footing and their growth in income has really allowed them not to have to pull on down payment assistance and they're in the best job environment. So I think there all these factors that are working in our favor and in fourth quarter, I think it was exactly the opposite, but in totality, it's just giving the consumer significant more confidence.

[Operator]

Our next question comes from Scott Schrier from Citi.

[Scott Schrier, analyst]

Nice to see a good quarter and having the confidence to put out some guidance. I want to ask another question about your comments about some of those savings as a result of the interest rates. Do you view this as an opportunity in certain markets to push price? Or is it more of a good way to keep the momentum in sales going? We've heard some commentary about a lot of inventory on the ground in certain markets. So if you could speak to that dynamic with respect to some of your markets and demographics, that would be helpful.

[Sheryl Palmer, executive]

Yes. I think it's a little bit of both, but I would say generally more pace. We're taking some cautious price increases. And I think Dave's number was about 40% of our community.

[C. Cone, executive]

Yes, 40%.

[Sheryl Palmer, executive]

Which, not real different than prior quarters, right Scott, but the difference is how big were those price increases you'd like to gift the consumers in backlog, a little equity there, but they're small. And if we have to pick moving pace or price candidly, we're going to pivot to pace, but I'd still say that it's very much on a community-by-community basis.

There are some communities new to market that we start a little lower that we get some momentum rolling and then we start moving some price. We also have some markets that continue to be very strong like a Austin, a Phoenix, and we're probably moving price a little bit more in those markets, but still albeit at small levels. So if I had to pick one, I would say pace. But once again, with 40% of the communities gaining some price movement, I think that's good.

[Scott Schrier, analyst]

And then I want to ask about your gross margin guidance following a strong quarter, which you discussed in your comments, some of the activity out West. Looks like we're going to expect pretty consistent margins throughout the year. And I'm curious if you can talk a little bit about some of the drivers, what types of mix changes do you expect through the year versus what's happening on the cost side and the incentive side.

[C. Cone, executive]

Sure, Scott. I think when we look at the year, some of this is going to be dependent on how the spring season finishes up, so we'll see how that unfolds. But if we look at the drivers, couple the benefits, obviously, we're getting the benefit from purchase accounting, but that will start to decrease each quarter throughout the year. And we should also see some lower input costs most notably in lumber and OSB in the second half of the year just given where pricing has gone -- or costs have gone on those commodities.

Probably, the headwinds for us, we have a little bit of a mix drag from the AV acquisition. That product is generally at an overall lower-margin rate than the legacy TM and it takes us about 18 months to normally bring those margin levels up to kind of the company average. We'll look at discounting incentives to help drive pace as Sheryl mentioned. That will be based on market conditions. And then lastly, certain input costs, things like trade, labor, tariffs, probably some little bit of risk there, probably more so on the tariffs. We anticipate some volatility there, mainly in steel, due to the continued threats of additional tariffs.

[Operator]

Our next question comes from Jack Micenko from SIG.

[Jack Micenko, analyst]

So just wanted to start with maybe your spec strategy going forward. Can we first get your finished spec levels from a year ago? And just your thoughts on how you're thinking about spec strategy with AV in the mix, especially as we consider one of your peers having a lot more inventory in the ground this year than years prior?

[C. Cone, executive]

Sure. Yes, when we look at what we're targeting today, it's about 4 to 5 -- sorry 5 to 6 in process and finished specs per community. That's up from where we were probably a year ago, more about 4 to 5. And that's largely driven by the addition of AV. It's a little bit higher spec business for us, and we like that. In the first quarter, we ended up with about 5.7 specs, 4.2 of those were in process, 1.5 were finished. So we were pretty successful driving through our spec inventory in the first quarter we sold as we mentioned about 1,200 specs. So we were able to drop that down to roughly 6.3 is what we had in the fourth quarter. So I think as we go forward, you're going to see us kind of sit more in that 5 to 6 specs per community range.

[Sheryl Palmer, executive]

And I think to your question about the amount of inventory out there. You're absolutely right. As we came into the new year, there were some builders with very heavy inventory, which has guided their behavior through the first quarter. I think generally, the discounts we've seen in the marketplace and this is on average. Builders have really put their dollars to work with inventory. And I think they see movement in that inventory, but it hasn't been wholesale discounting across new builds as well. So very -- market, actually more important, very community specific on the kinds of pressure that we're seeing based on the inventory at some of our larger peers.

[Jack Micenko, analyst]

Okay. Got it. And then just on the flat sales pace guide. Could you maybe just walk us through your assumptions if we were to break that down by legacy Taylor Morrison versus AV, just to get a sense for improvements or pressures there year-over-year?

[Sheryl Palmer, executive]

We actually don't provide it. We're not providing that detail because we've blended the 2 businesses and the AV signs are gone, and it's all Taylor Morrison. I would say that generally, we're working to get the AV paces to the -- it depends on the market but to the legacy TM paces. So I would look at them relatively consistently because once again we have all consumer groups being served in those markets. I think if we look at pace in totality, obviously, we're guiding to an annual pace of what we saw in the first quarter, and we're going to -- as I mentioned earlier, we're going to look at our incentives to make sure that we can garner that pace. But I would say it's pretty even across the brands.

[Operator]

Our next question comes from Carl Reichardt from BTIG.

[Carl Reichardt, analyst]

David, just to clarify on the margin guide for the year. I think you mentioned that you're kind of assuming there's going to be some incentive because I don't know if you're just assuming that's seasonal or not. If that's right, let's assume that you didn't have to raise incentives in any meaningful way. What would kind of the margin guide be? What are you assuming in terms of the aggressiveness of incentives in your guide?

[C. Cone, executive]

Yes, I mean, you'll definitely be at the higher end of what we're guiding to. We're saying mid- to high 17%. So we're allowing us a little bit of room to deliver on that pace, but it would definitely be on that -- the higher end.

[Sheryl Palmer, executive]

And I think some of that, Carl, is also when I look at the number of closeouts that we have for the year, just to make sure that those don't linger on. We felt a little bit of lingering through the first quarter, which is why our community count was a little higher than expected. And we're closing as many communities as we're opening this year, and we need to get through those quickly. So we're making sure that we're prepared for that.

[Carl Reichardt, analyst]

Okay. You've just answered my next question, Sheryl.

[Sheryl Palmer, executive]

[indiscernible]

[Carl Reichardt, analyst]

That was -- you anticipated. So let me ask another one. So as you're looking at your land spend this year and the kind of lots you're buying, can you talk about how the mix of assets you look at for 2021, which is what you said you're buying for, will differ from your sort of legacy land assets, especially sort of that move to the barbell? If you could put some numbers on that, that will be very helpful.

[Sheryl Palmer, executive]

I don't know if I can give you numbers. I don't know that I would have those on my fingertips. And -- you can have the best of plans, but what you actually get to the finish line could give you some movement there, Carl. But what I would tell you is that the divisions are absolutely focused on 2 or 3 key things. One is the affordable kind of millennial, the first-time buyer and really, the first-time buyer in all buckets, the 55-plus. And those are -- you'll see that manifest itself in some smaller active adult communities, not just the legacy large ones that you've seen. A smaller percentage would go to the [ move up ] buyer. There are some markets that we will still see that, but it's a smaller piece of the overall land spend.

[C. Cone, executive]

Probably, the one thing I'd add there is as Sheryl said, we'll see the mix change, years of supply will probably stay roughly there, but we're trying to move a little bit more towards options versus owned. So kind of get back to our levels that we had maybe pre-AV. And I think you'll see that kind of pan out over the next several quarters and probably couple of years.

[Sheryl Palmer, executive]

That's important, Dave, and thank you because I also forgot to mention that when I say what the divisions are focused on, the other things we're focused on is really, as Dave mentioned, the options, which is the size of the land deal. So even as we look at potentially 55-plus lifestyle community, how do we secure that loan, how do we structure it? But in totality, we're seeing the number of lots that we would control in an individual land deal has moved down. And I think we'll continue to do so.

[Operator]

Our next question comes from Matthew Bouley from Barclays.

[Matthew Bouley, analyst]

I wanted to ask about the competitive environment and kind of how that's evolving here. Maybe, Sheryl, it will be interesting to hear kind of regionally or key markets. Anything worth highlighting, perhaps, where you've seen that greater competitiveness persisting? And then, which kind of markets have started to, I guess, more normalize?

[Sheryl Palmer, executive]

Yes, let me kind of walk through real quickly because as I think about it, each of the market depends if you're talking about competition at the [ sales floor ] or competition in the land market, but I think you're seeing overall, this market sentiment. Phoenix, if I start there, Phoenix demand and traffic is still very strong at all price points, but it's a very competitive marketplace. When I look at the overall communities that are in the marketplace and the growth year-over-year, it's generally held flat in Phoenix at about 550. But cycle times are running longer in Phoenix than they have, which is creating a lot of angst for the consumers. So I think Phoenix would be one of those hypercompetitive.

As I look at the Californias, hard to bucket them all together, but I think Sac continues just having a healthy season, so no real news to report there. Bay is probably worth a call out given a lot of the kind of media noise it's gotten lately. But the competition appears to be holding pricing pretty well in those markets. We're seeing strength really at all price points. We actually just opened a community in Mountain House in February in the first quarter with only 6 or 7 weeks reporting, we put almost 20 sales on the Board. So we're continuing to see really strong movement in Northern Cal. When I move to Southern Cal, it was definitely the slowest of the businesses to move through the first quarter. January and February were not as robust as we've seen in the past years but March was really quite strong. I mean, the buyers there are definitely feeling more cautious during the spring selling season. A lot of it, I think, is around the objects we talked about in Q4 with the press because that's continued in Southern California and fluctuating rate. But in March, we really did see all consumer groups come back to the market.

The Chinese buyers are still a little scarce, but they're there. They're just there probably at a price point under $1 million in supply. It's actually holding pretty good at about 3 months. So as I move through the rest of the country, Denver continues to be very, very strong. I'd say there's a lack of affordable housing and so that is creating a lot of angst for the consumer, and we've continued to see pricing move very strong in that marketplace. As I go to Texas, that's some really nice recovery in the business and that's really across the board really regardless of price point in some market. We've spent a lot of time talking about Dallas and that market continues to be very submarket specific. In Houston, I'm really delighted to see kind of year-over-year growth in just about every metric. And Austin continues strong. And then I think we talked a little bit about Florida already. We really saw the 55-plus consumer come back as we moved our way through the first quarter. And Las Vegas would be the -- Chicago holding steady. The Carolinas and Atlanta. Atlanta, that's probably worth to call out. We've seen some great strength there over the last probably 8 weeks with sales really picking up. And last year, many might remember that we pulled a number of new communities kind of off the shelf to rework product from the legacy business, and we're going to see some nice community count growth as we move through the year, and we're really saying that start to pay off in orders on the sales floor.

[Matthew Bouley, analyst]

Okay. Sheryl, I really appreciate all that detail. And then just one for Dave. I think you mentioned still some purchase accounting benefit in the quarter. Is there any I guess quantification there? And how should we expect the purchase accounting impact or, I guess, benefit to be over the next couple of quarters?

[C. Cone, executive]

Yes, for this quarter, for Q1, the benefit was offset by the lower margin drag from the AV business. They are roughly about 60 basis points. And I think you'll see the drag kind of sit there around 60 basis points for the next several quarters. The purchase accounting benefit will probably drop by about 20 basis points for each of the next couple of quarters.

[Operator]

Our next question comes from Nishu Sood from Deutsche Bank.

[Nishu Sood, analyst]

I wanted to just go back to the community count question. I think you mentioned a few things but just wanted to kind of revisit that. So in the mid-February, you were looking at, I think, 350 to 360 community count. Came in much stronger than that. You mentioned some AV impact that there was pretty strong community count growth across your regions. What specifically drove the delta versus your expectations? You had pretty good demand, so I expect your closeouts were anticipated. So just wanted to revisit that, please.

[Sheryl Palmer, executive]

No, it really was the closeouts. We did have strong demand, but it was really when you look at the way we count community count Nishu, it's when you have less than 5 sales, I believe, to book you -- is when the community falls off. And I think we just had in certain communities and that was probably about 7 or 8 communities, we ended up with 6 sales or 6 upsells remaining and so those still became part of our community count.

[C. Cone, executive]

And we often say community count is probably the hardest thing that we guide on between trying to get the timing of the closeout as well as trying to predict when new communities are coming online just due to some of the delays that we've seen either on the development side or through the municipalities.

[Sheryl Palmer, executive]

It's a catch-22 because I -- as much as I wish we had those few sales to build a count -- community count difference, I'd rather that be the answer than the fact that we didn't get a lot of communities opened, but that really wasn't the case.

[Nishu Sood, analyst]

Got it. Got it. And -- okay, so that's helpful. That kind of helps me with the -- my second question as well. Obviously, everyone looks at the absorption pace. So it sounds like if it was slower-than-expected closeouts obviously based on the definition that you were laying out that it probably wouldn't have been a boost to absorption, and so the absorption pace was probably little bit better even than the numbers would have indicated. Am I kind of thinking about that correctly?

[Sheryl Palmer, executive]

I'm not sure because I think if you'd closed out that, your community count would be lower, which would have boosted your pace Nishu. If you could have actually significantly because if I'd gotten one more sale in 9 communities, it would have -- I would have dropped off 9 committees only for 9 sales. I would have actually...

[C. Cone, executive]

That would have boosted. I mean you're getting a pace both on the numerator and the denominator of the calculation.

[Sheryl Palmer, executive]

Yes.

[Nishu Sood, analyst]

Wait. No, no, I think we're saying the same thing. If you would -- if the community counts came in stronger than expected because let's say, you brought forward openings and maybe even had some grand opening sales event...

[Sheryl Palmer, executive]

You know that I brought them. I don't want to accept that because that's very hard.

[C. Cone, executive]

My point was just it's hard to predict. Yes, we don't -- we normally don't accelerate the openings.

[Sheryl Palmer, executive]

So really what it is, is you ended up with more communities based on potentially it could have been one sale per community drove a community and inflated community counts in my opinion.

[Operator]

Our last question comes from Alex Barrón from Housing Research.

[Alex Barrón, analyst]

Yes. So I was looking back a couple of years and it seems like your orders typically are a little bit less in second quarter than first quarter. Do you think this year might be an exception to that?

[Sheryl Palmer, executive]

No. I think that, that seasonal trend would be -- well, it depends if you're talking pace or your talking total orders...

[Alex Barrón, analyst]

Just absolute units.

[Sheryl Palmer, executive]

Yes, absolute units. When I look at absolute units just given -- I think, our paces are going to be down just given the strong comp we have, but I think absolute orders will be up given the acquisition.

[C. Cone, executive]

If you look at overall mix -- look at our mix penetration, yes, you normally see it to be slightly lower with Q3, Q4 roughly about the same.

[Alex Barrón, analyst]

Okay. And great. And then as regards to the margins, I'm not sure if I didn't hear or maybe missed it. If you guys comment on what the incentives represented maybe as a percentage of ASP versus a quarter ago or a year ago?

[C. Cone, executive]

Sure, when we look at Q1, the deliveries we had, we were in line with our incentive level in Q4, but that was, we're a bit lower versus Q1 of last year.

[Alex Barrón, analyst]

A bit lower or even percentage wise.

[Sheryl Palmer, executive]

Lower year-over-year.

[C. Cone, executive]

Lower year-over-year. Incentives were a little bit lower year-over-year in Q1.

[Operator]

Thank you. This concludes our Q&A session. At this time, I'd like to turn the call over to Sheryl Palmer, Chairman and CEO, for closing remarks. Please go ahead.

[Sheryl Palmer, executive]

Well, I just want to thank everyone for joining us this morning to share our first quarter results. We're quite pleased with the outcome and was delighted to share with the market, and we look forward to talking to you next quarter. Thank you.

[Operator]

Thank you, ladies and gentlemen, for attending today's conference. This concludes the program. You may all disconnect. Good day.