Taylor Morrison Home Corp

NYSE:TMHC

Earnings Call Transcript 2021-Q3

[Operator]

Good morning, and welcome to Taylor Morrison's Third Quarter 2021 Earnings Conference Call. Currently all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will be given at that time. As a reminder, this conference call is being recorded. I would now like to introduce Mackenzie Aron, Vice President of Investor Relations.

[Mackenzie Aron, VP, IR]

Thank you and good morning. I am joined today by Sheryl Palmer, Chairman and Chief Executive Officer; and Dave Cone, Executive Vice President and Chief Financial Officer. Sheryl will provide an overview of our performance and strategic priorities, while Dave will share the highlights of our financial results, after which we will be happy to take your questions. In the interest of time we ask that you please limit yourself to one question and one follow-up.

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 Sheryl.

[Sheryl Palmer, Chairman and CEO]

Thank you Mackenzie and good morning everyone. We appreciate you joining us today. I will begin today’s call with the highlights of our third quarter performance and the market environment and then provide an update on our strategic focus on operational and capital efficiency. I am pleased to share that our team has delivered a strong quarter that met or exceeded our expectations across each of our key operating metrics as they overcame the intense supply side challenges facing our industry. Most notably we delivered 3,327 homes which was within our prior guidance range at a significantly stronger than anticipated home closing gross margin of 21.2%. This margin improvement of 400 basis points year-over-year and 210 basis points sequentially is largely a reflection of revenue and cost synergies from our William Lyon acquisition that we had indicated would begin to materialize at this stage of our integration. These advantages helped to more than offset the timing and cost pressure from material and labor constraints that intensified during the quarter and are unlikely to abate in the foreseeable future.

With these bottlenecks introducing a much greater than normal degree of uncertainty into near term production schedules and delaying our construction timelines by two to four weeks, we are adjusting our prior full year home closings guidance by approximately 5% to around 14000 units. However, despite these delays we are increasing our home closings gross margin expectations to the low 20% range this year followed by at least 200 basis points of improvement to a margin in excess of 22% in 2022 based on our confidence in continued synergy realization, operational enhancements, and the strength of our sold backlog.

As you would expect, we are proactively working to stay ahead of further supply chain challenges by communicating closely with our trade partners and suppliers to ensure visibility into our vertical and horizontal development cycles, control costs, and maintain our commitment to delivering an exceptional customer experience and fully complete houses for our home buyers. In addition, during the quarter we started 3.5 new homes per community per month, made further progress in rebuilding our inventory of spec homes, and continued to align our sales pace with production. Because of this disciplined approach and our attractive land pipeline and product portfolio, we are in a strong position to capitalize on favorable market tailwinds while also navigating supply related disruptions.

From a demand perspective, activity was healthy across each of our consumer groups and geographies albeit at a more normalized and sustainable level of activity compared to earlier in the year. Notably in contrast to typical seasonality, we experienced accelerating month-over-month sales momentum in both order volume and absorption pace as the quarter progressed and October is on track to post similarly strong results. Amidst this positive demand backdrop, we continue to strategically limit sales releases in approximately 70% of our communities to manage our backlog and balanced pace versus price to maximize our return potential. Among our consumer groups, the 55 plus active lifestyle segment once again experienced the strongest trends with year-over-year growth in both orders and absorption pace as these fires have the financial resources and motivation to move ahead with their purchase decisions.

Representing over a quarter of our year-to-date net sales, we believe the 55 plus active lifestyle demand is poised to continue to outperform as demographic household growth is forecasted to be more than two times the overall market rate over the next five years within our footprint and the 73 million strong baby boomer generation progresses through peak retirement ages. The national expansion of our premier lifestyle brand Esplanade is well timed to meet this growth with a consistent strategy that continues to perform well in its core Florida markets and has exceeded expectations to date in its West Coast communities.

Across the business, forward looking indicators such as community traffic, conversion rates, and consumer credit metrics suggest demand and buyer interest remain healthy and supportive of further pricing power. However, as I indicated last quarter we are cognizant of the impact of higher prices on consumer sentiment and affordability and expect market dynamics, including the pace of price inflation to stabilize at more sustainable levels which we're already beginning to see evidence of. This outlook is reflected in our pricing strategies which are calibrated at a community level to optimize performance and in our disciplined land underwriting assumptions which have remained grounded in long-term market fundamentals and a preference for prime core locations. In addition are well balanced consumer diversification and the relative strength of our buyer profile provide additional layers of risk mitigation.

Specific to our consumer’s financial health, our home buyers financed by Taylor Morrison Homes funding which held an 83% capture rate had credit scores, income, debt ratios, and down payments that were stable or improved from the prior quarter and a year ago. Because of this trend our buyer’s ability to absorb higher pricing remained significant with the estimated buffer between their average actual interest rate and the maximum rate allowed for qualification purposes after considering compensating factors remaining at roughly 700 basis points for conventional borrowers 500 basis points for government borrowers, both of which were more favorable than historic norms by approximately 50 to 100 basis points. This is not to suggest that our buyers would want to or be willing to absorb a rate shock of that magnitude but rather indicate that the financial durability of our consumer set is strong and both absolute in historical terms.

In addition, we continued to see our diverse consumer groups are spending more on higher square footage floor plans and the home site of their choice as well as enhanced design specifications to meet their needs and preferences which have clearly evolved post COVID. This ongoing trends can be partially attributed to migration trends as we continue to see a growing share of out of state buyers particularly from higher cost markets such as California, New York, and New Jersey to Texas, Nevada, and Florida. It is also worth sharing that when we parse our consumer survey data we have seen a growing trend of home shoppers expecting to pay more of their income towards housing with the greatest impact among first time home buyers. With low interest rates enabling this trend today, we are monitoring these metrics closely and taking proactive steps to ensure continued affordability and design flexibility such as intentionally increasing lower square footage floor plans within our spec home inventory.

From an operational perspective, our priority remains to streamline and simplify our business to effectively leverage our scale and improve construction efficiency. As you have heard me discuss in recent quarters, we are focused on operational strategies designed to create a more efficient, predictable, and profitable business now that we are past the integration phase of our transformative multiyear acquisition journey. This strategic focus is already delivering strong results as evidenced by the 400 basis points year-over-year improvement in our third quarter home closings gross margin.

Let me now provide an update on the work under way to continue this positive momentum going forward. First, our teams are working closely to optimize our product portfolio by evaluating our floor plan as option offerings for value engineering, cost rationalization, and consumer appeal with the greatest runway for improvement still within our William Lyon impacted markets. To frame the financial opportunity from such efforts, our Florida operations are a compelling example from which to start. Without the operational complexities inherent in other markets where we have been more acquisitive, Florida is furthest along in leveraging the power of shared architecture floor plan repetition and option rationalization. This contributed to an average year-to-date home closings gross margin advantage of nearly 300 basis points and cycle time benefit of about one month compared to our markets on the West Coast that have the most opportunity for product and process consolidation due to more recent acquisition impacts. As we achieved similar operational efficiency across the country, we expect comparable results to drive meaningful margin and return accretion in the coming quarters.

Second, our purchasing departments are driving further skew rationalization to improve our procurement processes, control costs, and manage production timelines, an effort that has become even more critical in helping us overcome material shortages. Over the last three quarters we have reduced our option count by nearly a third, exceeding our goal for this year and expect to achieve further gains in utilization rates as we roll out enhanced national specifications. This progress is supported by the success of our Canvas standardized design packages, which have gained swift traction in our entry level communities and increasingly in our move up price point. These curated option palettes offer a more consumer friendly design experience that removes the complexity of a traditional design center approach. The average revenue of these packages is aligned with the historical range of options spend in our design centers by consumer groups at an improved margin and more efficient production timeline.

And lastly but certainly not least from a sales and marketing perspective, we are continuing to lead the industry in the digitization of home buying to empower consumers to complete their home shopping journey with the same ease and flexibility they have come to expect from the world of €-commerce. Over the last year and a half, we have introduced industry leading capabilities to reserve inventory homes online, which was then expanded to enable consumers to select a home site and floor plan and design a to be built home online. Building on these advancements, we recently launched a first of its kind digital community that empowers consumers to schedule a visit online, independently tour and virtually design and reserve a home. Because of the functionality of these tools, we eliminated the need for a traditional on site sales team by designing our model homes with Amazon's Alexa to seamlessly guide home shoppers through their visit with informative and interactive touch screens and QR codes. They can then reserve a home and select their Canvas Design Package online either immediately on site or later from the comfort of their couch.

Please take a look at the new slide added to our third quarter investor deck once it is posted later today for more details. Since our model opening in this groundbreaking community on October 1st, we have already enjoyed an overwhelming positive response with an interest list of more than 1300 prospective buyers and a reservation to sales conversion rate that is two and a half times higher than our company average despite no in person sales team and lower than normal external broker participation rates. With similar results across each of our virtual capabilities, we have meaningful opportunity to leverage these tools for a more cost effective sales strategy. Following this community's early success, we have two additional digital communities expected to open under our New Venture brand in the coming months and look forward to continuing to expand this promising new chapter of our virtual evolution that provides a seamless and on demand home buying experience that we believe is unparalleled in our industry. I am proud that we achieved these milestones because of our team's forward looking approach to technological innovation and serving our home buyers on their terms that predates the pandemic driven acceleration in consumer adoption.

Our focus on these operational strategies to drive stronger earnings are matched by an equal commitment to enhancing our capital efficiency to achieve greater balance sheet and cash flow optimization. The new land financing vehicles that I announced last quarter are an important element of this strategy by enabling us to meaningfully decrease the upfront capital intensity of our investment in land acquisition and development and accelerate our pivot to an asset lighter balance sheet. We have quickly operationalized these new vehicles, with the initial assets slated to close this year representing total expected balance sheet relief of approximately 850 million over the life of these projects. These and other arrangements that enable us to cost effectively increase the controlled percentage of our land portfolio are accretive to our long-term return expectations and importantly mitigate cyclical risk.

We have also been active in returning excess capital to our shareholders with approximately 8.6 million shares repurchased year-to-date, while also remaining committed to reducing our net debt leverage to targeted levels below 30% next year. Collectively, these operational and capital initiatives are expected to drive our return on equity to the high teens range this year, followed by further improvement to over 20% in 2022. These return expectations would mark new company highs and meaningful accretion over historical results as the enhanced scale and operational advantages that we achieve through our strategic journey have transformed our ability to sustainably generate long-term value for our shareholders. Now let me turn the call over to Dave for his financial review.

[Dave Cone, EVP and CFO]

Thanks Sheryl and good morning everyone. In the third quarter we generated net income of 168 million or $1.334 per diluted share, marking a 54% year-over-year increase. Net sales orders totaled 3,372 while our monthly absorption pace was a healthy 3.3 net sales orders per community, with notable month-over-month strength throughout the quarter that persisted into October despite continued sales restrictions in the majority of our communities. In addition, our cancelation rate remained below historical averages at 6.7%. Among our consumer groups we experienced the greatest strength within our 55 plus active lifestyle segment, which increased 700 basis points to 27% of our total net sales orders, with above average lot premiums and design spend compared to our entry level and move up consumer groups, this mixed impact combined with ongoing market strength drove a 31% increase in our average net order price to $641,000.

At quarter end, our backlog was 10,273 homes, representing a sales value of 6.1 billion, up 63% year-over-year. Our community account averaged 338 which was ahead of our prior guidance range. We expect our community count to remain in line with this level in the fourth quarter, driving our full year average guidance range slightly higher to 335 to 340. With approximately 78,000 lots under control, we have a strong land pipeline to support future community growth, particularly as we reach 2023. However, supply side challenges have also extended into horizontal land development and if these issues persist or worsen, it could delay the timing of some community openings in the back half of 2022.

Turning to closings, we delivered 3,327 homes which was within our prior guidance range. However, as Sheryl noted earlier, because of the unpredictability of material availability, elongating construction timelines, and severe labor constraints, we now expect to deliver about 4,600 homes in the fourth quarter and around 14,000 homes for the full year. This represents a 5% reduction from our prior full year guidance range and attempts to fully account for the fluid day-to-day operating environment that our construction and purchasing teams are navigating in the field. Each market is experiencing challenges at different stages of the construction process and generally speaking, bottlenecks are more severe as we move East along our coast-to-coast footprint with the least amount of pressure in our California markets.

As our teams work to stay ahead of these challenges to deliver sold homes to our home buyers in a timely manner, we have also rebuilt our inventory of spec homes to more normalized levels in advance of the upcoming spring selling season. At quarter end, our total spec inventory equaled 5.3 homes for community, nearly all of which were under construction. This was up from 4.7 homes per community at the end of the second quarter.

Our home closings gross margin improved 400 basis points year-over-year to 21.2%. This exceeded our prior guidance of approximately 20% due primarily to stronger than expected pricing and volume of inventory homes sold and closed during the quarter. In the fourth quarter, we expect a home closings gross margin of about 21% given favorable pricing and operational leverage that is expected to more than offset higher construction costs. This drove an increase in our full year home closings gross margin guidance to the low 20% range. Following the strength, we now expect at least 200 basis points of year-over-year improvement to a home closings gross margin in excess of 22% in 2022. This positive trend reflects the sustainable and structural changes on our scale and production efficiency that we have achieved throughout our strategic growth and operational enhancements. Our SG&A as a percentage of home closings revenue was 9.5% and we continued to anticipate a full year SG&A ratio in the mid-9% range despite the reduction in our home closings guidance.

Turning now to our land portfolio, we invested approximately 478 million in land acquisition and development during the quarter and continue to expect our total land investment to be approximately 2 billion this year. Our total lots supply increased to approximately 78,000 home sites representing 6.2 years of total supply and four years of owned lots. At quarter end, 36% of our lots were controlled via options and other arrangements, which was up approximately 700 basis points year-over-year. Going forward, we expect to expand this share further as we utilize the new land vehicles that were announced last quarter, as well as our traditional asset light land strategies, such as joint ventures and seller or project financing. We expect these tools to enable us to cost effectively increase our option land position to at least 40% within the next year, thereby improving the capital efficiency of our land portfolio, reducing long-term risk and enhancing our returns.

Shifting to our balance sheet, we ended the quarter with 1.1 billion of total liquidity including 373 million of unrestricted cash and 722 million of available capacity on a revolving credit facilities. Our net debt to capital ratio equaled 41.1%, deleveraging our balance sheet remains a top capital allocation priority and we continue to expect our net debt to capital ratio to reach the low 30% range by year end, followed by a further decline to below 30% in 2022. In recognition of our -- and improving our leverage since our acquisition of William Lyon, I am pleased that S&P Global recently revised its outlook to stable and affirmed its credit rating.

Lastly, during the quarter we repurchased 3.3 million shares outstanding for $92 million, bringing our year-to-date total to 8.6 million shares for $237 million. We have repurchased just over half of the shares issued in connection with our William Lyon transaction, and more than a third of our total shares outstanding since 2015. Going forward, we expect to continue to utilize share repurchases opportunistically to return excess capital to our shareholders. Now I'll turn the call back over to Sheryl.

[Sheryl Palmer, Chairman and CEO]

Thank you, Dave. To recap, our strong third quarter performance reflected the strategic and operational focus our teams have been driving towards since our acquisition of William Lyon Homes a little over 18 months ago. We have communicated that milestone as a critical pivot point from which we would begin to meaningfully benefit from the synergy and scale opportunities that became available to us after integrating into one company. Going forward, our focus is squarely on operational execution to fully take advantage of our scale, product, and geographic positioning and balance sheet strength. While the unprecedented level of supply chain disruptions have added complexity and timing delays into the current operating environment, market fundamentals remain positive and our fourth quarter is still expected to mark a significant inflection in our growth and profitability that will carry into 2022 and beyond.

As we enter this exciting next phase, I'm thrilled to announce that after an exhaustive search of both internal and external candidates to identify the best qualified person to succeed Dave following his retirement at year-end, we have appointed Lou Steffens as our next Chief Financial Officer. Lou is one of Taylor Morrison’s most tenured and proven leaders with over 30 years of homebuilding, operational, and financial experience and is uniquely qualified to lead our company in the next leg of its strategic journey. From his role as President of Mergers and Acquisitions in which he led and executed each of our six acquisitions and integration, and his background in finance and operations as an Area and Divisional President in various markets across the country, he brings an invaluable depth of knowledge and expertise to our finance team that we expect will expedite the execution of our strategic plan and elevate the level of cohesion between our finance and field operations.

Since gaining the scale and diversification we set out to achieve with our M&A strategy, Lou has most recently shifted focus to lead our results management office, where he has spearheaded the rationalization of our operations and other initiatives that are contributing to our enhanced margin and returns. He has been instrumental in deploying strategies to enhance the profitability and resiliency of our business, and is deeply familiar with our capital markets, accounting and financial planning processes, making him well suited to seamlessly step into this new role effective January 1st, after a collaborative transition with Dave.

With this announcement, it's equally bittersweet to approach the end of Dave's decade long history at Taylor Morrison, in which he oversaw our transformation from nearly a 5000-unit home builder at the time of our initial public offering in 2013, into one that is on track to deliver approximately 14,000 units this year, with further momentum ahead. Along this journey, he has been a true partner for me, an effective leader to our team, and a key contributor to our company's culture that will be missed dearly by all. However, we are excited that he'll be able to spend more time with his family after achieving so much in his professional career. And I wish him all the best in his next chapter.

And lastly, I want to end with my deepest appreciation to our teams across the country who are working tirelessly to deliver our largest year-end ever during this unprecedented operating environment, all the while maintaining their commitment and passion to delivering an unmatched customer experience for our homebuyers. To our construction, sales, and mortgage teams that are on the front lines making this happen day in and day out, I sincerely truly thank you. Now I'd like to open the call to your questions. Operator, please provide our participants with instructions.

[Operator]

Thank you. [Operator Instructions]. Our first question comes from the line of Matthew Bouley with Barclays. Your line is now open.

[Ashley Kim, Barclays]

Hi, this is Ashley Kim on for Matt this morning. So really nice gross margin result now, look here, can you just quantify any pressure on gross margins you're experiencing from supply chain constraints, whether that's outright cost inflation or the loss leverage on delayed closings, anything along those lines?

[Dave Cone, EVP and CFO]

Yeah, Ashley, I'd say on the direct build costs we saw, call it low single digits increase sequentially from Q2, that excludes the lumber though. I mean, lumber is actually working in our favor now as you know. The pricing power is more than covered cost increases year-to-date. To quantify it's hard because there's so many moving pieces though, what we're seeing right now and we're definitely seeing increased costs, some bounties, but again pricing power is there to help offset that. We're working closely with our trade partners to ease some of that burden as well.

[Ashley Kim, Barclays]

Thanks, that's helpful. And then, just on the sales pace, are you finding that you're still kind of capping sales to the same extent that you were throughout this year?

[Sheryl Palmer, Chairman and CEO]

Hi, Ashley. As we said in the prepared remarks, it's about 70% of our communities, but you really have to deep dive into that, because they look different. Some of those might be that we're releasing a certain number of lots on a monthly basis. And we provide kind of notice to the public and then do lotteries. We certainly aren't seeing the level of hobos. I'd say there's only a handful across the country. Mostly it's really to just align with production. We're not holding back specs, we're pretty much releasing those at the start of construction. So I'd say it's a very healthy market, but it's normalized from where we were earlier in the year.

[Ashley Kim, Barclays]

That's helpful color, I will leave it there. Thank you.

[Sheryl Palmer, Chairman and CEO]

Thank you, Ashley.

[Operator]

Our next question comes from the line of Mike Rehaut with J.P. Morgan. Your line is now open.

[Unidentified Analyst, J.P. Morgan]

Hi, I'm Doug Wood [ph] calling in for Mike Rehaut. In terms of incentives, where are you guys currently versus around three months ago?

[Dave Cone, EVP and CFO]

Yeah, so from an incentive standpoint, if you look at the Q3 deliveries, they're down meaningfully year-over-year and also down sequentially from Q2. In our backlog, we do have reduced incentives on a go forward basis. I would tell you that, out in the market in general, are they starting to come back a little bit, I would say we're seeing it probably more in the periphery albeit more than anything. But it's still very, very modest.

[Sheryl Palmer, Chairman and CEO]

Yeah, I think as we look across our portfolio, Dave, really our incentives continue to be focused on mortgage. Beyond that they're very, very sparse anywhere in the country.

[Operator]

Our next question comes from the line of Truman Patterson with Wolf Research. Your line is now open.

[Paul Przybylski, Wolfe Research]

Thanks, it's actually Paul Przybylski on. I guess starting off with your 4Q closing guide, it implies an increase year-over-year conversion rate, which hasn't really happened I guess for the past four quarters or so. What gives you the confidence that you're going to be able to get those homes across the finish line given the supply constraints, the bounties, above all whole industry making the year-end push?

[Dave Cone, EVP and CFO]

Yeah, Paul and I want to be clear, you're talking about backlog conversion when you're saying conversion rate?

[Paul Przybylski, Wolfe Research]

Yes, I am.

[Dave Cone, EVP and CFO]

Okay. So maybe just a minute on kind of how we got here. The material shortages, they've been an issue for some time. We're watching it closely. It's been difficult to predict, given the unprecedented challenges that we're faced with, as an industry as well as, as a country. Based on what we did 90 days ago and I would say even 30 days ago, we expected to deliver on our original guidance. However, we saw delivery dates on material slide more meaningfully over the last month. And even if all the material that we need were to show up before year end, we think that we would struggle to get the labor there to install it. So we adjusted our guidance to take that into consideration and that shift in material deliveries and probably those labor challenges that are there, it's still a big quarter for us. Our teams, our trade partners are all poised to deliver. I mean, this is effectively just a little bit of a timing push of what we're seeing what we thought would be in Q4, just going into early 2022.

[Sheryl Palmer, Chairman and CEO]

And Paul, the only thing I would add is, your point is well taken. It's a big quarter, it's going to be a big December for us, it'll be the company's largest. We're having to pull lots of different levers to make sure we're ready. But we've been working on that for some time. That will include weekend signings to get through mortgage and closings. We believe we've taken all of that into account. The challenges you've seen across the industry, there are some that become very unpredictable until the day they happen. But we think we have the universe to do this. But it's a unique environment and something we've not seen before but the teams have done really a masterful job even getting into our closing range in Q3. So it's a big push, but we're planning on getting there.

[Paul Przybylski, Wolfe Research]

Okay, and then on your 4Q gross margin guidance, it's flat quarter-over-quarter and you guiding your elevated closings. Is there higher lumber costs, what's kind of the swing there because I would have thought you would have been up a little bit just from the leverage perspective?

[Dave Cone, EVP and CFO]

Yeah, I mean, when you look at kind of Q3-Q4 for us Paul, we've talked about that being more of the inflection point from a margin perspective. But you are seeing it in lumber. The biggest pressure is coming from lumber. We actually anticipate lumber, the cost peaking here in Q4. And then it will start to step down a little bit in Q1 and Q2, but more meaningfully stepped down in the second half of next year.

[Sheryl Palmer, Chairman and CEO]

The only other thing worth mentioning, Paul, is at the end of the day it's going to come down to mix. So when we look at what we've pushed into next year, those generally tend to be the bigger, more complicated houses. Some of those carry higher margins. If we bring any of those over the finish line this year, it could have an impact. But it's the pressure of lumber and then it's really -- it's good news for 2022, right Dave. But it does keep us kind of flat for the year.

[Paul Przybylski, Wolfe Research]

Okay, I appreciate it. Thank you.

[Sheryl Palmer, Chairman and CEO]

Thank you.

[Operator]

Our next question comes from the line of Carl Reichardt with BTIG. Your line is now open.

[Carl Reichardt, BTIG]

Thanks morning, everybody. It's Carl on for Carl.

[Sheryl Palmer, Chairman and CEO]

Good to hear your voice Carl.

[Dave Cone, EVP and CFO]

Good morning Carl.

[Carl Reichardt, BTIG]

It is, hi Mackenzie. So I want to go back to the comment you made about the 70% sales mix. So Sheryl or Dave or anyone, what are the -- are there specific guideposts we should be looking forward to then conclude that it's now time to remove those restrictions, I mean, what do we need to see or you need to see in order to feel comfortable that now you can start reducing those restrictions? And I think just because I think this is a part of it, can you tell me of the three and a half homes per community per month that you started in 3Q, what percentage of those were specs versus pre-sold?

[Sheryl Palmer, Chairman and CEO]

You bet, we will tag team. I wish I could tell you that there's just one thing that we need to look at here. This is a decision that's got to be made community by community. One event -- one of the big areas is really the production capacity and the marketplace because as you've heard, I think us and everybody else talked about Carl, it's really about trying to align production and sales. And as you can see, we've put our stars a little bit ahead of ourselves to make sure that we're bringing more inventory into the business. And we've made, had some good movement this year, and will continue to grow that to get us ready for the spring selling season. And so even though we're managing sales in a number of our communities, I still think it's a more normalized environment, because it's not like we're seeing these massive weightless, we're still seeing some, we are generally selling through them. If we weren't able to sell what we were releasing, that would probably be a signal that we would be more just open. And we are open and like I said about 30% of our communities. So I think its production capacity. I actually expect Carl, that as we move into the spring selling season, we're going to see a very strong spring and that could put us back in a more managed sales program again. So it's going to be supply chain generally, market conditions generally, supply and demand in the individual local markets that will really drive that. And then Dave, you want to talk about the kind of the spec starts in total?

[Dave Cone, EVP and CFO]

Yeah, I mean we've been increasing our percentage of specs relative to where it was a year ago. As you know we kind of got that down a little bit lower. We were focused on to be built. But as we've kind of moved through the year, we've been able to put more specs in the ground and you can see that just based on our spec level. In our inventory, we're about 5.2 specs as a total company per community, again, which is up a pretty good chunk. So we're still running more to be built than specs and that'll continue to be the case going forward. But we like the position that we're in from a spec perspective.

[Sheryl Palmer, Chairman and CEO]

Yeah, because I would say looking historically, Carl, I mean, being a to be built business has always been something that's been very favorable over the years for me. It certainly wasn't the first couple of quarters this year. But now I think that trend reverses and you'll see that as we pulled through. So I think we have a healthy number of specs today's but we want to get probably closer to that six to seven, especially in our more affordable business. But we're delighted now that the to be built I think will be a more advantageous mix for us.

[Carl Reichardt, BTIG]

Okay, thank you both. I appreciate that. And then Sheryl another comment you made in the prepared remarks was about out of state hires. And I wondered if you would expand on that if you can, can you talk about the percentage of your deliveries that are two out of state buyers, how that's changed, and what the impact in your mind -- what impact that's had on your sales prices, in other words, is it an arbitrage opportunity both coming from expensive places to cheap places, what does that do to the local buyer who may be looking at prices saying this is too and these are too expensive, seems like an important dynamic and so I just like if you can just expand and give us some more color on how you look at that? Thanks very much.

[Sheryl Palmer, Chairman and CEO]

Now, you bet Carl, you actually -- it's a savvy point that you bring up because in some of our markets, I think our teams would specifically outline that with the price movement that we've seen, it's much more difficult for the local consumer to adjust to that pricing. And as I mentioned in the prepared remarks, we're seeing a strong influx from really what I would call high cost market and that would be your California, that would be your kind of Northeast markets. And they come to the markets let's talk about the Northeast coming into Florida with a very different expectation on what they can -- what they're selling their house for and what they can afford to buy. So they're able to spend more and buy up. And that's why I think we're seeing what we are. And once again, I'll use Florida, when I look at what we have in backlog, an example would be Carl, what these folks are able to spend on locked premiums and options. If I look at our third quarter locked premiums, and I compare those to my whole 2020 year, they're up about 40%. When I look at the 2022 backlog, they are up again a similar amount. The options, also very telling, they're putting more money into the house are up about 10% over 2020 and when I look at 2022, they're up about another 20%. That is really the power of the migration trends that we're seeing. If I look at our California, we're seeing probably two times the penetration that we've seen historically in places like Nevada, Arizona, Texas, Colorado, from California, and I think that's why we continue to see the pricing power that we have.

[Carl Reichardt, BTIG]

Great, thanks for that. Appreciate it.

[Sheryl Palmer, Chairman and CEO]

You bet.

[Operator]

Our next question comes from a line of Alex Rygiel with B. Riley. Your line is open.

[Alex Rygiel, B. Riley]

Thank you and very nice quarter. First question here, you sound very confident in capturing 200 basis points of margin growth to 2022 and that would be fantastic. Can you break that down a little bit between the lumber price mix, so on and so forth?

[Dave Cone, EVP and CFO]

Yeah, Alex it's hard to break down all the moving pieces just because of all the activity that we're seeing out there from a pricing, from a cost. But yeah, to reiterate, we expect homebuilding closing margin in excess of 22% for next year, which is up from our prior comments. Our confidence on the margin improvement, it's evident in our 2022 backlog we built so far. And you might recall, we came out six months earlier than we normally would to talk about the 2022 margin just given that level of calm confidence. We do anticipate seeing margin improvement sequentially over the next several quarters. We're excited that we're at this inflection point, after being focused the last few years on integration activities. We talked a little bit about it earlier, we expect lumber impact on deliveries to start to increase in Q1 and Q2, be more meaningful in the second half. But we've also left a little bit of room in our 2022 margin guidance for any upside if lumber were to go above kind of the current level. So we created a little bit of buffer there in case that were to happen. But we're going to be back in 90 days with a little bit more specific margin guidance for 2022.

[Sheryl Palmer, Chairman and CEO]

Yeah, And I would just add a couple of things. I think Dave's exactly right, it's hard to break it apart, Alex because there are so many moving parts and pieces. So I probably simplify it and say all the work that we've been talking about on these operational enhancements are really coming through, that's number one. Number two, we didn't have any spec inventory at the beginning of last year and so what we had was the drag of these lumber -- the lumber impacts on our to be builds. Now you've got all that benefit working for you. The pricing, because we had contracts locked in in 2020 and they got the damn, they got the negative impact of the lumber. Now what you have is our pricing has caught up to market with our new contracts and you've got specs that are real time, along with the operational enhancements, the 200 basis points that David describing we are extremely confident about. And I think we'll be able to give you more detail around that next quarter.

[Alex Rygiel, B. Riley]

And you've been progressing down the path of digitizing the home buying process for some time now. Where do you think we are in this number one, process from your standpoint and number two, consumer adoption of it?

[Sheryl Palmer, Chairman and CEO]

I think that's the exciting part Alex is, the consumer is asking for it. And so I think as an industry, we've probably talked in the past that we've been somewhat antiquated in adopting kind of this whole world of e-commerce in this demand environment. We said housing was different. Well, the consumer doesn't feel that way. Certainly COVID I think changed the perspective of our industry. But what's been really interesting is we've been talking to the consumers that have been subscribing and when I look at kind of all of the virtual tools, and I look at the conversion rates, and I look at what we're hearing from the consumer, I'll give you a couple examples. Our conversion rate on inventory homes that are being reserved is about 17%. Our conversion rate on to be build homes that are being reserved is about 19%. These are two times generally in general industry conversion rates. When I look at our reservations just in the last 30 days, nearly 800 reservations came through our system. And then when we talk and by the way, those 10 generally tend to come with a lower realtor. But then when we talk to the consumer, so with our new project venture, we have been interviewing every consumer to see why they, how they enjoyed it, why they did it. And the biggest takeaway from all of the exit surveys is that people enjoy having the freedom to do this on their own. And that's kind of the way with all on demand services. So I think the adoption is really strong and we are in such early days, I think when this becomes more of the norm, you'll see continued efficiency that can be built from here.

[Alex Rygiel, B. Riley]

Thank you.

[Sheryl Palmer, Chairman and CEO]

Thank you.

[Operator]

Our next question comes from the line of Jay McCanless with Wedbush. Your line is open.

[Jay McCanless, Wedbush Securities]

Hey, good morning, everyone. Thank you for taking my questions. The first one on the act of adult, the growth that you're seeing there, is the growth there being driven across the board by some of the legacy communities you acquired a few years ago as well as the newer communities, or is most of the growth weighted to those newer communities?

[Sheryl Palmer, Chairman and CEO]

Hi, Jay, I would tell you it's both. I really would. We have some new communities in California, but we also have a number of new communities throughout Florida. And I think they're all doing quite well. I think really the brand acceptance of Esplanade and the brand growth of Esplanade has also helped. I also think you have to just think about the change in attitude that's come with this consumer having been through COVID. I think there's a real urgency in their buying decision. I think social interaction and all the things that come with an Esplanade are of key importance to this consumer group. We talked about the migration from some of these high cost markets, the Midwest, I think that's also playing into it. And then in all fairness, I think it's important to say when you look year-over-year, they didn't come back to the market as quick as other consumer groups. So when I look at the pace and total absorption, I mean improvement, some of that I think is because last year wasn't as strong as it could have been. I think it really started picking up in Q3. So I'd say there was kind of a half of a quarter lag there. But I think it's all of it.

[Jay McCanless, Wedbush Securities]

Okay, that's great. Thank you, Sheryl. And then my second question on the fully automated communities, I guess, maybe where does that go as a percentage of total community count, and the homes presumably that these buyers are picking a package, etc. I mean, these homes that should have a shorter cycle time, even then your traditional entry level product where you have a salesperson in there, I just wanted little more depth around where does this go as part of the business but then also does that help shrink down your overall cycle time because these homes are, I guess, very low option level, etc.?

[Sheryl Palmer, Chairman and CEO]

Yeah, it's a great question. And I don't want to get over my skews [ph]. I love the question. I'm quite excited about the new venture brand. So if I look at our first community in Orlando, what I would tell you is those are all pre panelized houses. So just that the simplification of the product absolutely drives efficiency and reduces cycle time. When you have the buyer in the mix, and you've got different options being selected, you just can't help elongate that. So I'd say yes, we will get greater efficiency. I think you'll see this move to other consumer groups, but I think our first few pilot communities will be at the more affordable, fully panelized product which will absolutely lead to your point, reduced cycle time. Where do we go from here, it's really early days. I think we're very excited for these communities this year. I think the consumer will tell us I have great expectations that as we move into 2022, we will continue to introduce new venture communities. It's probably a little early for me to tell you what it will be as a percentage of the portfolio, but I think as we bring new communities to market, it gives us the opportunity to say what's the best way. I'm not sure we're prepared to do it in the active adult environment yet, because that's the consumer that probably needs a little bit more interaction. I think it's also -- we know it's a consumer that enjoys the design center experience and spends a lot of money there. So we will look at the portfolio and understand the best places, but I think you'll continue to see growth through the portfolio.

[Jay McCanless, Wedbush Securities]

That's great. Thanks for taking my question.

[Sheryl Palmer, Chairman and CEO]

Thank you.

[Operator]

Our next question comes from the line of Alan Ratner with Zelman and Associates. Your line is open.

[Alan Ratner, Zelman & Associates]

Hey, good morning. Nice quarter and congrats to Lou and to Dave. It is exciting. My first question, hoping you can give a little bit of forward-looking kind of thoughts into the mix of your business, and you obviously flagged the active adult share going up. When I look at your pricing, obviously pricing in the market is up a ton but your pricing has increased well in excess of peers, I look at your order price, it's up almost $200,000 over the last year and a half, two years. And it's running, over 100,000 above what you delivered this quarter. And I'm trying to figure out, going forward what's the right mix of your business to think about because, obviously if your price is going to be going up 100 plus $1,000, next year on deliveries that's pretty impactful to the model. At the same time, if you're selling more kind of higher end move up homes, even active adult homes, I would guess there's probably a down shift in absorptions over time at those higher price points. So can you give a little bit of clarity in terms of where you see the business going and try to strip out some of the quarterly volatility here?

[Sheryl Palmer, Chairman and CEO]

Yeah, I think we'll tag team this one, Alan, but good question. When you look at the mix, this quarter of sales, I think it will give you a pretty good indication of what kind of the next 12 months look like. So I think when we come back next quarter, you'll probably see an ASP, no surprise, given the backlog numbers that will be higher. Certainly the quarter is highly influenced by the high percentage of active adult sales in the quarter. For all the reasons we've talked about. I want to be careful though, because active adult is not always -- the active adult brand doesn't have to be exclusively the higher price point. We have some of our active adult offerings that are much more affordable price points. But when I look at the introduction of the new communities that really impacted the quarter, I look at the Sacramento price point, I look at the Temecula in California, you have just higher price point active adult positions, as well as some of the country club offerings in Florida. I think you'll see active adult to be a healthier blend of the total portfolio but we have a lot of new affordable positions coming into 20 -- coming to market in late 2022 that I think will probably bring down the overall company ASP as we move into 2023. Dave.

[Dave Cone, EVP and CFO]

I think based on where you're seeing ASP orders Alan, obviously, it's going to trend to something higher for an ASP in 2022 versus 2021. But I'm with Sheryl, as we look out in the business and the growing affordable segment, I think you're going to then see that revert back starting in 2023 and we'll see some moderation.

[Alan Ratner, Zelman & Associates]

Okay, that's really helpful just to talk through that. And then I guess just near the second part or third part of that question was just kind of thinking through absorptions and the mix of the business, because a few years ago before you did Lyon, if I remember correctly, you were thinking about like a two and a half per month absorption pace being the target. And, obviously the market has improved a ton since then but you're running probably closer to three and a half this year. So, putting aside whatever the market is going to do, is there a kind of a right absorption rate that your underwriting land deals to today that you think about is as a sustainable run rate?

[Sheryl Palmer, Chairman and CEO]

You know, and once again, Dave, let's share, we both feel about this. But certainly we saw peak absorptions early in the year and I think we all know that those were not sustainable, especially if you look kind of globally outside of just Taylor Morrison, the number of new communities that will come back into the marketplace. I think you should have expected to see absorption rates grow given kind of across the country Alan, we're probably down about 20% communities. As those come back to market over the next 12 to 24 months, I think you'll see just absorption across the industry stabilized. The math would suggest that demand stays where it is today. We don't underwrite to a target rate. We rarely look at each piece of land. But I think your general view on something higher than what our historical number was in the low twos to mid twos, that takes you over three probably makes more sense if you look long-term.

[Dave Cone, EVP and CFO]

Right, and I would just add, I mean if you look at the strategic acquisitions we've done over the last couple of years Alan, some of that was designed around pace and increasing turns. So something with a three handle on it seems more likely on a go forward basis.

[Alan Ratner, Zelman & Associates]

Got it. That's very helpful. I appreciate all the insights there. So good luck.

[Operator]

Our next question comes from the line of Mike Dahl with RBC Capital Markets. Your line is open.

[Ryan Frank, RBC Capital Markets]

Hey, this is Ryan Frank on for Mike. Thanks for squeezing me in here. And then also just wanted to say congrats from Mike and myself, Dave, to you and your retirement, Lou on the new role. So looking forward to working with you.

[Dave Cone, EVP and CFO]

Appreciate that Ryan.

[Ryan Frank, RBC Capital Markets]

So in the interest of time, I'll just ask one here, it's a little bit of a two parter, but last quarter starts were roughly five per community, and this quarter it is closer to three and a half. So can you just piece out kind of what was driving that, whether it's seasonality or supply constraints, events, kind of given those dynamics how confident are you in the 2022 and 2023 community count targets that you guys laid out last quarter?

[Dave Cone, EVP and CFO]

Yeah, I mean, from a community count perspective, that is by far the toughest thing for us to predict. There are so many moving pieces from availability of the trades to the municipality approvals. The good news is we have the land ahead of us to grow the communities. But we're currently seeing the challenges on the horizontal side of the business. Labor is always a challenge and I'll tell you that's being magnified in this environment. Material shortages are also hitting the horizontal side. One of the largest shortages is coming from pipe to support community infrastructure, especially sewer pipe. We've seen shortages of labor and materials across all aspects of homebuilding but we're definitely seeing the bottleneck here in the horizontal side. I mentioned in the prepared remarks if the challenges persist or worsen on the horizontal side, we could see some delays. But we're constantly evaluating our cadence of community openings, taking the necessary actions to bring the communities online. What better insight into 2022 around the community count on our next call, so we'll give you an update on that in about 90 days.

[Sheryl Palmer, Chairman and CEO]

Yeah, you know, it's interesting because I think everyone's fully up to speed on the supply chain challenges that have hit the vertical side of our business. 60-90 days ago, pipe wasn't an issue. I mean, you've gone from zero to now pipes probably three, four months delays. So what we really have to dig through honestly, is the stuff that was scheduled to open in the back half of the year. And, we have virtual tools that will assist us even preopening but that's the color we really want to dig into so we give you an accurate view on the 2022 community candidates that we have all the land. So we're in a good place. 2022 is fully subscribed and 2023 is actually quite, quite strong as well. Dave also want to talk about the starts because we did see a peak start in Q2.

[Dave Cone, EVP and CFO]

We did. I mean, I would argue that we were well above four and that was a level that is very difficult to sustain. A lot of that was we saw some of the higher demands we are trying to meet that. We were trying to put specs on the ground, but also when I think a lot of folks in the industry we're dealing with weather challenges. So there was a little bit of a catch up. We ran in Q3 from an orders perspective, a three-three pace, starts pace was about three five per community. I would tell you, that's a little bit of a healthier spot for us where we'd like to be. And we'll hopefully be somewhere in that kind of mid threes from a start perspective going forward as well.

[Ryan Frank, RBC Capital Markets]

Got it. Thank you. Thank you very much for the time.

[Sheryl Palmer, Chairman and CEO]

Thank you.

[Operator]

Our last question comes from the line of Alex Barron with Housing Research. Your line is now open.

[Alex Barron, Housing Research]

Thank you and good job on the quarter. I wanted to ask about share repurchases. I know you guys stepped up, there's little left on the authorization. So can you guys comment generally on your thoughts around share repurchases going forward?

[Dave Cone, EVP and CFO]

Sure Alex. Yeah, we have a 100 million remaining on our current authorization. We are going to continue to be opportunistic and kind of weigh our investment options from there. I will tell you the focus continues to be on share repurchase and probably so in the foreseeable future. I mean, first of all we strongly feel that we are undervalued and reinvesting through share repurchase is going to be accretive driver from ROE. Also with that, we have a strong focus to bring down our debt but we are a little bit handcuffed right now vis-à-vis the premiums to kind refi and pay down some of that debt. But everywhere quarter that goes by, those premiums come down, the map looks a little bit better. But short of paying down some of that debt, you're going to see us continue to focus on share repurchase. Once we get through this authorization we will like we always do go back to our Board and talk about potentially putting another one in place and we will give you an update when and if that happens.

[Alex Barron, Housing Research]

Okay, thanks and also along those lines any thoughts on starting a dividend?

[Dave Cone, EVP and CFO]

It's a good question. It is actually one that we debate I would say a couple times a year both with the management team and our Board. I would tell you right now our priorities are as I said focused on paying down debt and then taking advantage of our stock given that we feel it's still undervalued. We are probably a couple of years from a dividend but that's something that we will continue to address going forward.

[Alex Barron, Housing Research]

Great, thank you very much.

[Operator]

Thank you. There are no further questions. I'll now turn the call back to Sheryl Palmer for closing remarks.

[Sheryl Palmer, Chairman and CEO]

Well, thank you very much for joining us today. We were excited to share our Q3 results and look forward to speaking to you in the New Year. Take care.

[Operator]

Ladies and gentlemen, this concludes today’s conference call. Thank you for your participation. You may now disconnect.