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Edited Transcript of TMHC.N earnings conference call or presentation 31-Jul-19 12:30pm GMT

Q2 2019 Taylor Morrison Home Corp Earnings Call

Aug 2, 2019 (Thomson StreetEvents) -- Edited Transcript of Taylor Morrison Home Corp earnings conference call or presentation Wednesday, July 31, 2019 at 12:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* C. David Cone

Taylor Morrison Home Corporation - Executive VP & CFO

* Jason Lenderman

Taylor Morrison Home Corporation - VP of IR, Treasury and FP&A

* Sheryl D. Palmer

Taylor Morrison Home Corporation - Chairman & CEO

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Conference Call Participants

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* Alex Barrón

Housing Research Center, LLC - Founder and Senior Research Analyst

* Alexander John Rygiel

B. Riley FBR, Inc., Research Division - Analyst

* Carl Edwin Reichardt

BTIG, LLC, Research Division - MD & Homebuilding Analyst

* Ivy Lynne Zelman

Zelman & Associates LLC - CEO and Principal

* James C McCanless

Wedbush Securities Inc., Research Division - SVP of Equity Research

* John Gregory Micenko

Susquehanna Financial Group, LLLP, Research Division - Deputy Director of Research

* Christina Chiu

Barclays Bank PLC, Research Division - Research Associate

* Michael Glaser Dahl

RBC Capital Markets, LLC, Research Division - Analyst

* Michael Jason Rehaut

JP Morgan Chase & Co, Research Division - Senior Analyst

* Scott Evan Schrier

Citigroup Inc, Research Division - Senior Associate

* Truman Andrew Patterson

Wells Fargo Securities, LLC, Research Division - Associate Analyst

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Presentation

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Operator [1]

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Good morning, and welcome to Taylor Morrison's Second Quarter 2019 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 Mr. Jason Lenderman, Vice President, Investor Relations and Treasury.

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Jason Lenderman, Taylor Morrison Home Corporation - VP of IR, Treasury and FP&A [2]

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Thank you, and welcome everyone to Taylor Morrison's second 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 will be happy to take your questions.

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

Now let me turn the call over to Sheryl Palmer.

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Sheryl D. Palmer, Taylor Morrison Home Corporation - Chairman & CEO [3]

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Thank you, Jason, and good morning, everyone. We appreciate you joining us today as we share our results for the second quarter of 2019. I'm proud to say we continued the momentum that we experienced at the end of the first quarter, which led us to successfully exceed expectations on our key operating metrics for the second quarter.

Our performance in the quarter drove $0.76 of EPS, a 46% increase year-over-year, and a 39% growth in EBT dollars compared to the same quarter last year. We finished the quarter with 2,810 net orders on an average community count of 357, leading to an average sales pace per lease of 2.6. This represents a significant increase over our pace of 2.3 in Q1 2019 and is flat against our difficult comp last year. Sales units were up 20% on a year-over-year basis. Unlike the build up a sales momentum through Q1 that's our sales paces increase every month, the Q2 sales momentum was strong and consistent throughout the quarter across all 3 months. Although our community count came in a little lighter than expected, most of that can be attributed to strong sales paces and early closeouts.

Due to the solid spec sales environment during the quarter, we were able to deliver 2,594 closings, which is 30% higher than our results last year and above the high end of our guidance for the quarter. Home closings gross margin inclusive of capitalized interest was 18%, which was also above the high end of our guidance range for the quarter, primarily due to lower-than-expected incentives and some favorable mix impacts. EBT margin was 8.7% for the quarter, despite the inclusion of almost $4 million in AV transaction expenses and debt extinguishment charges.

We are thrilled with the results that we've seen so far this year and know that a large contributing factor to that success has been the hard work that the entire team has put into the integration following the acquisition of AV Homes. I'm very proud to announce that the heavy lifting required for the integration is complete and we are now fully operating as one company. This has been achieved sooner than originally anticipated with the only real lag being the sunset of some legacy AV units under protection in our systems. The synergies from the deal are now running and what will be the annualized run rate. As you likely recall from our 2018 Q4 earnings, we took the synergy estimate up from $30 million to $40 million. Now that we've completed all of the work in negotiations, we are pleased to be able to take that figure up to $50 million in annualized synergies. It has taken tremendous effort from our team members all over the country to get us to this point, which has manifested in the leverage in our SG&A line. We couldn't be more excited about our expanded business, including the open communities and future land pipeline acquired, but mostly the best-in-class talent, that has joined the Taylor Morrison family.

As we put the hard work of integration behind us, it's worth reinforcing how essential this has been to our overall Taylor Morrison strategy. As we detailed in the past, it's really a focus on addressing the barbell of our consumer groups that drive our business. That barbell includes the entry level buyer, which would today's changing consumer somewhat blurs with the first move of cohort on one side and the baby boomer consumer group on the opposite side. It's interesting that we often hear the correlation of Taylor Morrison as a higher price point move up builder. When in reality, these barbell segments actually represent almost 90% of our closings.

Having said that, we do appreciate that our entry level business attracts a more financially secure first time buyer and our 55 plus business generally represents some of our higher price points, as these consumers tend to have more discretionary dollars to spend on home site premiums and upgraded specifications. Certainly the addition of the AV Homes communities will continue to bring our overall price point down in both of these consumer groups. We pride ourselves on being a developer and builder that can opportunistically acquire prime land in core locations, and successfully create distinctive communities that address the needs and wants of our targeted consumer groups.

Also most relevant with the strategic AV Homes transaction is our continued focus on gaining scale in overall market share within the markets where we operate. A key pillar of our growth strategy over the years has been utilizing M&A to grow in areas that otherwise could have taken years to achieve. With this most recent transaction behind us, we now have successfully completed 5 acquisitions, since the end of 2012. In each case we've paid relatively low book multiples to acquire these assets with an average price to book multiple of 1.2 across the 5 deals. This success in acquiring and integrating other builders has contributed to us almost doubling our total annual closings, since 2013. An achievement that furthers our ability to hire the trades of choice and control costs has helped us become an employer of choice within our markets more broadly and has built overall brand recognition, ultimately benefiting our financial position and the relative returns on our capital invested.

We continue to stay focused on adding scale in ways that make financial sense and we believe that our track record has made us an acquirer of choice within the industry. Like any smart dynamic business we're always looking at potential opportunistic pursuit that are accretive to our core business model. This can be accomplished through new product offerings, a new market entry, new buyer segments, or even new business models that leverage a number of these.

Today, we are pleased to announce a strategic partnership with Christopher Todd Communities, a leader in delivering build-to-rent single-family housing communities. While the single-family build-to-rent community platform appears to be in its infancy, Christopher Todd Communities has been nationally recognized for their successful business model with active projects focused in Arizona and a robust pipeline of additional land dedicated towards future single-family rental developments. In this arrangement, Taylor Morrison will complement our core business serving as the land acquirer, developer and builder. With Christopher Todd Communities providing its successful build-to-rent playbook, including community planning, proven plan lineup and property management oversight.

Today's communities are comprised of single-family 1 and 2 bedroom rental smart homes with private backyards and even doggy doors. Each smart gated community has amenities such as the resort-style pools, fitness center with yoga and an event lawn. They are creating a new way to live and we see the many advantages the strategic partnership brings us looking forward. Through this partnership we have the unique opportunity to build on this established platform across the country, in existing Taylor Morrison master plans and newly acquired Taylor Morrison Communities, as well as developing the significant lot pipeline that Christopher Todd Communities already has secured.

To that end, we already have plans for 3 additional developments in the Phoenix area starting to break ground in late 2019, and even more on the horizon in 2020. In the next several years, the initial control pipeline is intended to deliver in excess of 2,000 new single-family rentals in Arizona alone with plans to quickly expand nationally as we leverage the scale of Taylor Morrison's capital structure, land expertise, purchasing power and building operations engine.

In reference to our earlier discussion on the consumers, one of the many reasons we're thrilled to announce this partnership is the clear alignment with our strategy to address affordability in our markets. In understanding perspective customers' need and values, we seek opportunities to serve more people in our market. Many of these consumers desire the product and lifestyle of a single-family community, while balancing finances, flexibility and maintenance free living. Of note, there are approximately 16 million single-family rental homes in the U.S. today of varying age profiles, proving that there is demand for the lifestyle, yet the fast growing new home production dedicated to the space, represents less than 5% share, suggesting that it may be very early in the evolution of this exciting segment.

Christopher Todd Communities enables us to serve more customers, flex our production builder muscles and quickly serve demand for an increasingly appealing niche housing experience. Taylor Morrison's entry into the single-family rental market advances our demand side diversification, while leveraging what we do every day in our core business. The strategy will further increase the velocity of community deliveries given known lease and construction rates for this simplified product. We expect to enhance our time and cost efficient production process for proven and standardized specifications and a concentrated production line building process creating a rapid land-to-lease-up pipeline.

Our Taylor Morrison footprint, unique customer experience focus and operational expertise is a natural alignment with the Christopher Todd Communities brand and community experience. We very much look forward to scaling this partnership, which will ultimately enable us to monetize the communities involved as we seek to optimize asset valuations, which are driven by cap rates and market dynamics. We've consistently talked about the impact that scale can have on our business and this is just another lever that we can use to expand our market presence.

Now I will turn the call over to Dave for the financial review.

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C. David Cone, Taylor Morrison Home Corporation - Executive VP & CFO [4]

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Thanks, Sheryl, and hello, everyone. For the second quarter, net income was $82 million and earnings per share was $0.76. Total revenues were $1.27 billion for the quarter, including homebuilding revenues of [$1.23 billion], both of those figures are up about 29% from the same quarter last year. GAAP home closings gross margin inclusive of capitalized interest, the impact from purchase accounting and mix impact from AV closings was 18%. This result was flat to the rate we saw in Q2 of 2018. This exceeded our second quarter guidance as the mix of inventory homes sold and closed during the quarter was better-than-expected with incentives materially lower than the same quarter last year.

Moving to financial services, we generated approximately $23 million in revenue for the quarter and almost $10 million in gross profit equating to a marginal rate of 42.8%. Our mortgage company capture rate for the quarter came in at 72%. SG&A as a percentage of home closings revenue came in at 10.1%, which represented 40 basis points of leverage when compared to Q2 2018. The addition of AV Homes is continuing to allow us to drive top line leverage.

Given our success in holding gross margins flat to last year and the SG&A leverage we gained, EBT margin came in at 8.7%. This represents about 60 basis points of improvement when compared to Q2 2018. As Sheryl mentioned, that was despite about $4 million of AV transaction expenses and debt extinguishment charges hitting during the quarter.

Income taxes total approximately $28 million for the quarter, representing an effective tax rate of 25.6%. For the quarter, we spent about $300 million in land purchases and development. At the end of the quarter, we had approximately 54,000 lots owned and controlled. The percentage of lots owned was about 80% with the remainder under control.

As we have discussed, we expect to decrease that percentage of owned lots back down closer to our historical average. On average, our land bank had approximately 5.3 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 5,051 units in our backlog with a sales value of approximately $2.5 billion. Compared to the same time last year, this represents an increase of almost 7% in units and an increase of 1% in sales value. The differential in growth between units and value is being driven by our intentional shift in backlog ASP that's a result of our acquisition and additional entry level opportunity that came along with it. We also had 2,194 specs at quarter end, which included 440 finished specs.

Before I give an update of our balance sheet, I'd like to discuss the details of the debt refinancing transactions we completed over the last few months that we believe attractively positions our capital structure for years to come. In early June, we issued $500 million and 8-year senior notes with an interest rate of 5 7/8. We use the net proceeds of this transaction along with cash on hand to redeem the $550 million in 2021 senior notes we had outstanding. At the time. we paid down the total principal outstanding by $50 million to ensure that our total interest expense stayed close to flat as possible given the prior 2021 notes had a slightly lower interest rate. We followed this transaction with an additional $450 million offering 2 weeks ago, these were 8.5 year notes with an interest rate of 5 3/4. The net proceeds of this transaction will be used to redeem the $400 million, 2022, 6 5/8 senior notes that had previously been issued by AV Homes and which we acquired as part of the overall deal consideration. These notes had recently hit their first call period in May of this year.

As I mentioned before, we believe these transactions allowed us to take advantage of the historically low rates that we continue to see in today's market and allowed us to better position our capital structure for years to come by pushing our near senior note maturity out to 2023. It also moves all of our senior notes to an interest rate below 6% with the average interest rate across all 4 sets just below 5.8%. From a liquidity perspective, we ended the quarter with approximately $717 million in total available liquidity. $197 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 no drawn balance on the revolver and our net debt-to-cap ratio was 43%.

During the second quarter, we exhausted our most recent $100 million share repurchase authorization by acquiring 3.8 million shares for $76 million. Since the acquisition of AV Homes, we have acquired 16.9 million shares for $296 million, or an average price of $17.52 per share. This represents almost double the amount of shares that were originally issued as part of the transaction and an average price below where the shares were issued to complete the deal. Although we don't currently have a share repurchase authorization in place that will continue to be a key part of our capital allocation framework.

I'll wrap up by sharing our Q3 guidance. Closings for the quarter are planned to be between 2,200 and 2,400. GAAP home closings gross margin inclusive of capitalized interest and purchase accounting is expected to be in the mid to high 17% range. The effective tax rate is expected to be about 25.5%, and the diluted share count is expected to be about $107 million. For the full year, we are increasing our anticipated closings to be between 9,600 and 10,100. 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 now expected to be in the high 17% range, which is at the higher end of our previous guidance range. SG&A as a percentage of homebuilding revenue is now expected to be in the low 10% range, which is at the lower end of our previous guidance range. JV income is expected to be about $8 million, which has been reduced due to a delay at one of our JV communities in Southern California, that is now expected to deliver closings in 2020. We anticipate an 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.

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

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Sheryl D. Palmer, Taylor Morrison Home Corporation - Chairman & CEO [5]

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Thank you, Dave. Before we move to Q&A, I'd like to take a moment to share a couple of current market highlights. As I mentioned in my opening statements, we saw consistent sales pace throughout the quarter, which really speaks to the relative strength of the market during the spring selling season. It was also notable that we saw a nice strength across all of our consumer groups through the quarter. Although the recent focus for many around the industry has been entry level, it's worth noting that we have also seen significant strength in our move our product lines as well.

A telling example is one of our Austin communities. In the summer of 2010, we acquired a position of almost 1,200 lots in the Crystal Falls community. This would generally have been considered a move-up product for us aimed at affluent buyers. Given the number of remaining home sites, we thought last summer that we had about 7 years of supply left in our larger lot move-up positions. That said, with the paces that we've been able to achieve since then, we're actually going to be in a position to close out of that community in the first quarter of next year.

Another example of a market that is seeing nice strength across all price points is Phoenix. We are obviously excited about the entry level expansion that the AV Homes acquisition brought into this market, but they are also seeing strong demand at the move-up price points as well. There were actually 3 communities in the market that are all in very different areas of the Valley, with price points in the mid 650,000 that's on average sales pace in the second quarter at nearly 5 per month. This is a market where we've been able to diversify our product offerings across all price points and the major core regions within the city and which [are] move into build-to-rent will further expand.

I'd like to end our call today, like I always do by providing an enormous and heartfelt thank you to the entire Taylor Morrison team for their efforts day in and day out to help us achieve our strong performance. I deeply believe our results are a testament to the passion and dedication of our team members across the country.

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

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question comes from the line of Ivy Zelman with Zelman and Associates.

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Ivy Lynne Zelman, Zelman & Associates LLC - CEO and Principal [2]

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Sheryl, this is truly a grand slam performance for you guys. So really excited to see such strong results across all aspects, all metrics, so, you guys should be extremely proud.

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Sheryl D. Palmer, Taylor Morrison Home Corporation - Chairman & CEO [3]

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Thanks, Ivy.

(technical difficulty)

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Ivy Lynne Zelman, Zelman & Associates LLC - CEO and Principal [4]

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In your commentary on, really phenomenal performance. Just looking at the segmentation of the business, and I'd love to dig into build-to-rent a little bit more, but just first on the commentary around the move-up market and doing well across all segments. We've heard some different commentary, specifically on the move-up market and how it's more challenging. So is it really about -- part of the challenge we're hearing is that the existing homeowner is not willing to sell at the price that the markets willing to bear and that there is other factors and maybe it's more a function of salt in some of the markets that are exposed, that you're not as prevalent in. So I don't know, maybe give us some clarity on why you are seeing such strong performance and the market seems to be going the other way for the majority of the builders and even the real estate brokers that we talk with?

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Sheryl D. Palmer, Taylor Morrison Home Corporation - Chairman & CEO [5]

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Yeah. Now I appreciate the question, Ivy. I think we've always said that it really does come down to very local positions. And that quality of locations and really understanding the buyer early in the acquisition process is really going to deem your success. The time you take up front in your underwriting really understanding the supply demand and the attributes of that local market is really going to create the long-term success. And we've talked before about, if you really understand your segmentation and you get your buyer right, we can see, if you identify your first most prevalent first and second buyer group, we can see a margin that is somewhere between 200 basis points and 400 basis points higher than, if you have a mix. And sometimes communities bring along, quite a blend of different consumer groups. But if you really have strong segmentation, you'd be amazed what you can see. So I think when I look across the board, and I could have shared a number of examples across the portfolio, but we took 2 real critical markets and decided to share those. We really are seeing strength across all consumer groups. We're seeing it in the first-timer, as we've articulated. We're seeing great strength with the 50-plus buyer and we are seeing equally good strength. It's a smaller piece, that second move-up as I said is closer to 10%, 12% of the overall business, but we're seeing some of our highest absorptions with that consumer group.

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Ivy Lynne Zelman, Zelman & Associates LLC - CEO and Principal [6]

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Very impressive. And quite the differentiation from the other builders and what we've seen so far. Moving to build-to-rent, Sheryl, maybe just with Christopher Todd, just to clarify you're not going to retain the collateral, the home. They're going to operate what you build. And assuming you're doing that, if I'm correct, this margin is favorable to you on a net-net basis? How the economics differ?

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Sheryl D. Palmer, Taylor Morrison Home Corporation - Chairman & CEO [7]

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So couple of questions in there, Ivy. As far as the partnership, it is a strategic partnership. And as we've discussed for a number of years, the supply-demand disconnect, an overall reduction of rooftops. No, it doesn't matter you're talking for sale upper or for rent based on affordability and consumer characteristics and preferences. And the data really does suggest that we're moving toward this space. And we believe there is a structural pivot in the space all together and recently and then I'll get to the specific deal point. Specifically, Urban Land Institute recently estimated that there is something like a need of 4.6 new rental units over the next 10 years to meet the demand. As far as the structure of the deal, you're going to see a number of strategic kind of partnerships within that. You'll see some that will be wholly-owned, you'll see some JV agreements depending on the asset. Actually the first couple of assets that will build out will be in a JV relationship. And then we will move to owning the property wholly. From there, as I said, I think, I said in my prepared remarks, we will assess the timing of the right time to exit the asset, but it is not our intention to hold the asset long-term. So we'll decide exactly the right time in the lease-up process to sell the asset to maximize pricing and returns. But I would expect it will be within a year of lease-up. And what I am confident is that the holding period of these assets will be significantly less than a typical Taylor Morrison community that we buy and operate today. So long answer to tell you that initially you'll see, you won't see units come through the P&L, because they'll be in the JV structure. But then moving forward, we will handle that on an asset-by-asset basis.

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Ivy Lynne Zelman, Zelman & Associates LLC - CEO and Principal [8]

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So just to follow on that, but that's very helpful. Appreciate it. So on exit of the collateral, the year later, whenever I lease up, what would be the return profile relative to have you gone the traditional route in comparison, anyway you want to quantify that for us?

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C. David Cone, Taylor Morrison Home Corporation - Executive VP & CFO [9]

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Yeah. Ivy, this is Dave. We think the return profile is going to be at or above where we are right now. We also see this as a way to just increase our overall scale when you get into the purchasing and the construction efficiency getting greater scale that local, the local level will improve cost. So we think net-net overall, this combined with our core business will enhance our overall returns.

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Sheryl D. Palmer, Taylor Morrison Home Corporation - Chairman & CEO [10]

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Yeah. And I'll pile on Ivy, because obviously we're going to see efficiency through the process, generate the enhanced returns. We're going to see it through the land process, the quick turns on the building cycle. We're going to be able to dedicate land parcels within Taylor Morrison Communities that we operate today to move through some long land assets that we have. So we're quite excited what this will do for the organization's return profile.

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Ivy Lynne Zelman, Zelman & Associates LLC - CEO and Principal [11]

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It sounds very exciting and accretive to your business, the bottom line. So congrats on the move.

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Operator [12]

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Thank you. And our next question comes from the line of Carl Reichardt with BTIG.

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Carl Edwin Reichardt, BTIG, LLC, Research Division - MD & Homebuilding Analyst [13]

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The absorption pace is great, Sheryl, and -- but I was curious if you could help us break out among different product types entry level move up and active adult or however you want to do it, sort of the differentials over the quarter in terms of those absorption paces by product?

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Sheryl D. Palmer, Taylor Morrison Home Corporation - Chairman & CEO [14]

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And you know Carl, like I said in Ivy's question as I look across the business and the divisions, you know, I would tell you that generally we saw similar paces across consumer groups. So I don't have any real standout. It really does come to the specific expectation of a particular asset. But I would tell you that they all operated within 2 or 3 turns of our overall quarterly pace.

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Carl Edwin Reichardt, BTIG, LLC, Research Division - MD & Homebuilding Analyst [15]

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Okay, great. Thank you. And then back on Christopher Todd. Can you talk a little bit about how they're capitalized at [per call rate]. I think they've got some private equity backing. And just sort of how, what their plans are for growth. Would you expect them to just work with you? Is it more exclusive or something that they might do more largely across the other builders. I'm just trying to get a sense of their growth opportunity and how you can participate in that?

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Sheryl D. Palmer, Taylor Morrison Home Corporation - Chairman & CEO [16]

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You bet. Thank you, Carl. Now this is an exclusive strategic partnership with Christopher Todd, and as so the growth will come together. And as I said in my prepared remarks we'll handle everything on the front end from the land acquisition development purchasing, construction and they're going to be critical in everything from community design to oversight. We'll really be working off of their product and community design playbook. And then they will also provide oversight for the leasing and property management pieces. But our growth, as I talked about will really come through the initial land pipeline that they have secured today, new land that our land professionals across the country will identify as well as looking at the assets that Taylor Morrison holds today.

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Operator [17]

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Thank you. And our next question comes from the line of Scott Schrier with Citi.

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Scott Evan Schrier, Citigroup Inc, Research Division - Senior Associate [18]

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To start off with another one on the Christopher Todd, I'm just curious, based on some of these comments, it sounds like maybe you're taking the risk on the construction part, on the yield on cost components. I'm curious how you think about that? And I don't know if there is any parameters on how much capital you will be investing initially? I know you also mentioned that you're going to be holding these communities for less than a year. Could there be situations that arise where the NOI, maybe looks more attractive, if the cap rates aren't really in the range that you want? Just trying to think about the flexibility of how you're thinking about that. And then on the land side, it seems like maybe some of this land could be land that is -- I don't know if it's suited for an AV entry-level type products. So how do you think about land in the Phoenix market, where you are so strong as far as pursuing it for your normal operations rather than the rental operations?

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Sheryl D. Palmer, Taylor Morrison Home Corporation - Chairman & CEO [19]

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Okay. There is a few questions in there, Scott. So Dave and I will probably tag team them. As far as the risk on the construction side, I don't think we actually see it that way. We see it as a true benefit given our muscle that we have as an organization. When we look at the production process, the product repetition, the concentrated line building cadence. Honestly, this is a company and trade partner stream. It's important to remember that we don't introduce the consumer into the building process. So it makes a very efficient line building. You're going to build this in phases. So your risk would be no different. From a capital standpoint, I would argue, quite a bit less than you would see on the -- for sale side. The next was, as far as the land, you know, as I mentioned before, we will continue to burn through the assets that they have or under control evaluate those assets, bring them on board and then build them. But we'll build them based on market demand. One of the other interesting component of the transaction that we're quite excited about is really the strategic match on the consumer side. So far Christopher Todd has seen in their communities about 50% millennials and 40% boomers. That allows us to really understand the natural alignment as we look at some of our own land holdings. As far as the timing, as I said, we will probably over the next few months really spend the time to determine the right time in the lease-up process; when we look at tax advantages, when we look at highest and greatest value and we'll sell those -- when they are 80% leased up, or will that be 6 months after you have a full property lease. So I think more to come as we get into the next quarterly call.

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Scott Evan Schrier, Citigroup Inc, Research Division - Senior Associate [20]

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And then I know that in the past, obviously, a couple of quarters, you've been focused on rates and what it's done. And I think a lot of the conversation is, the potential to bring the entry level buyers back into the market. But I'm curious more on the first time move-up side of things. Do you think rates, is it something that's bringing buyers into the market. or do you think it's more of a tool that the buyer who is already committed to transact, maybe it now has more ability to pay for options, for lot premiums, potentially a larger model? And just what trends have you been seeing? Have you been seeing an uptick and things like lot in option premiums and things like that?

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Sheryl D. Palmer, Taylor Morrison Home Corporation - Chairman & CEO [21]

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Yeah. Great question. And I would tell you as everything, Scott. It's probably a little bit of both. There are certain positions, more affordable positions that absolutely the improvement in rates brought people back into the market. I think when you look at more of that first, second time move up, I think that really was about confidence they were wanted to buy, it was really about when. And then they're confidence in the actual transaction and what they purchased and how much they specified in their home. We've talked about for at least the last, I don't know 2.5 years of quarters around the spread that our buyers have to buy either a larger house, or an interest rate that could be 300 basis points to 500 basis points higher. So it's not about if they could buy, it really was an emotional decision. And yes, that did manifest itself with improvement in lot premiums, improvement in upgrades that we've seen across the business. So to answer that question, truly you have to get into almost each individual community, because the circumstances are different. But if I were to generalize, I would tell you at the more affordable price points, the movement in the interest rates allowed people to buy and give them more confidence and in the move-up buyer, if you would expect to give them more confidence and allow them to be a little bit freer with the checkbook.

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Operator [22]

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And our next question comes from the line of Michael Rehaut with JP Morgan.

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Michael Jason Rehaut, JP Morgan Chase & Co, Research Division - Senior Analyst [23]

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First question was interested in getting a little bit more clarity on directionality of the gross margins, obviously you had a nice result for the second quarter, you raised the full-year guidance. I guess for the second, for the third quarter you're looking for margins to be down sequentially, maybe as much as 50 basis points, let's say. Just wanted to get the drivers of those, because, I think broadly speaking, more builders, they are not, are looking for things in the back half to benefit them around lower incentive levels, incentive levels that have declined in the first half of the year helping them as well as lumber cost. But just trying to get a sense of the different puts and takes as you look at the back half.

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C. David Cone, Taylor Morrison Home Corporation - Executive VP & CFO [24]

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Sure, Michael. We guided to mid to high 17%, and there is obviously a couple of things making that up. I think specific to us, there is a potential for some geographic mix that may cause some sequential decline in the rate. But also we have the reducing benefit of purchase accounting from the AV transaction, that step down each quarter from the first quarter, so less benefit. In addition to that, we have the overall AV mix impact as you might recall the AV margin on the legacy side we're a little bit lower, and it takes us about 18 months to build those up to the level consistent with the legacy TM side of the business. From a planning perspective around incentives, we anticipate incentives could be slightly up sequentially in Q3. We are leaving a bit of room around incentives just for any potential pressure that we might see on trying to sell and close inventory homes in the quarter. So that's going to come down, overall market demand. As you mentioned, we saw some pretty good strength in the first half of the year, which helped us take up our annual guidance. So, if I look at Q3, I would say that there is probably the potential to be at the high end of the range or even slightly above, if we don't see incentives increase versus Q2.

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Michael Jason Rehaut, JP Morgan Chase & Co, Research Division - Senior Analyst [25]

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And before I ask my second question which will also be on the Christopher Todd relationship, which I find interesting. Are you saying that, you're just not sure about the directionality of incentives, or is there anything to make you think that incentives would go up? I'm a little confused, if you said that it may not go up, you're baking and that might go up a little bit just what's around that, that thought process?

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C. David Cone, Taylor Morrison Home Corporation - Executive VP & CFO [26]

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Again, it goes back to you. We're just leaving a little bit of room around moving through some of our finished specs. We've actually made really good progress from -- at the end of the year, we were about 1.7 per community. We worked that down to about 1.2. We'd like to see it a little bit closer to 1. Some of this is also to maintain some of the momentum of the strong pace that we've seen. So that's where we are around the mid-to-high. Again this is just a component of it. Some of these drivers for us in the quarter are the geographic mix, as well as the reduced benefit of purchase accounting.

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Michael Jason Rehaut, JP Morgan Chase & Co, Research Division - Senior Analyst [27]

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Okay. Thank you. So then just on Christopher Todd, obviously interesting partnership and I can clearly see the demographic and customer diversification element to it, which is great. I guess I'm trying to get a sense of the ultimate size of what this could be. Someone asked before about the amount of capital dedicated to it, you're going to initially go through I guess JV structure. But any sense of kind of the number of units? I think you threw out a 2,000 unit potential across 3 communities in Phoenix, but maybe you can give us a sense of what amount of lands you're kind of portioning for this relationship? And how big it could be over the next couple of years, either from a capital investment side, or a unit side?

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Sheryl D. Palmer, Taylor Morrison Home Corporation - Chairman & CEO [28]

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Okay. So we will give that a shot, Michael. As I think on the capital side, very simply, we'll just say, it's kind of pretty much solid in our planned budget.

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Michael Jason Rehaut, JP Morgan Chase & Co, Research Division - Senior Analyst [29]

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It's going to be within our budget. So the $1.2 billion that we've guided to this year, it will be there. Likely what you're going to see is about $25 million going out in the short-term. That's going to flow through a joint venture structure.

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Sheryl D. Palmer, Taylor Morrison Home Corporation - Chairman & CEO [30]

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Yeah. And then we'll give you more color on the details of that, Michael, as we roll forward. You need to know kind of bigger picture, how big this can be. As I said in my prepared remarks, and then I think one of the follow-up questions, I think the opportunity is relatively unlimited. And we've been studying this space for quite some time and really have recognized what I would call a [C-shift]. In front of us on the traditional multi-family space. So it wasn't a difficult decision for us to enter into this space. It was really about how do we do it in the best way to play. Because we really believed in the strategy and the diversification and it was [accretive] to the business. So over time. I think you'll see this, if you look at the 4.6 million units that are estimated over the next 10 years, I think there's a lot of runway. If you look at what Christopher Todd is going to deliver in Phoenix in 2019, it's about 800 units. So if you look at the 2,000 units that they have controlled, do you look at the opportunities within our land bank, and you look at the market expansions, I mean, we see this being a [formable side] of piece of our overall business. I don't want to get ahead of ourselves. So let us get these first couple of communities open. We're going to learn a lot. We're going to learn a lot about the business model. We're actually, I think learn a lot more about consumer motivations and gain some additional insights on even preferred building science approach, when you look at the simplicity of the building products there. And ultimately, probably becomes a tremendous cross marketing opportunity for Taylor Morrison, one of the stats that I really have enjoyed about learning about the business is, their KPIs are quite impressive compared to what do we call the traditional multi-family. And their retention stats are really interesting. But 90% of the folks within Christopher Todd that don't renew non-renewals move for a home purchase. So I also look at it as I said is an interesting marketing opportunity for the company looking forward.

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Operator [31]

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And our next question comes from the line of Jack Micenko with SIG.

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John Gregory Micenko, Susquehanna Financial Group, LLLP, Research Division - Deputy Director of Research [32]

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You talked about ASP coming down and that's been well-telegraphed through the change in mix and serving a broader group of customers. But the pace commentary and the outlook is flat. And I guess the question is we always think about lower ASP comes with a faster turn, hoping you could reconcile those 2, when you put them together?

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Sheryl D. Palmer, Taylor Morrison Home Corporation - Chairman & CEO [33]

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Yeah. I think that's a little bit of -- I mean, I agree intuitively you would tie pace and price. But as I look across the company, some of our highest paces tend to be on the higher prices. You'll likely remember Jack, that we had a very strong first half paces last year. So we are quite pleased with the paces that we've seen in the first half of the year. And our guidance would suggest that we're going to be generally flat for the full year. And if you consider seasonality in the higher first half, that would make sense. As Dave talked about, ideally, there's a little room within our margin guidance that we're going to continue to really pivot toward pace. But we feel good about the guidance and generally a year-over-year flat number.

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C. David Cone, Taylor Morrison Home Corporation - Executive VP & CFO [34]

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Yeah. I mean, I think back to the incentive level. Overall, we feel good about the margin, which gave us the confidence that we could take up the annual. For the quarter, it's as much around geographic mix than anything. I'd also point you guys to, if you look at our quarterly performance over the last couple of years, from one quarter at the low to the quarter at the high, it's not unusual for us to have a 90 basis point swing. And again that is driven almost entirely by geographic mix. So we feel [get aware] the incentive level are and as Sheryl said we're driving new flat pace year-over-year.

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Sheryl D. Palmer, Taylor Morrison Home Corporation - Chairman & CEO [35]

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And just what it's worth, if you look at the paces across the portfolio without diving into every division, as I said, Phoenix continues very, very strong and that's a mix of all consumer price points. Behind that, my next strongest paces in the company are California. And you know what the price points are there, but that would be Sacramento, Southern California. And then on the opposite end of the spectrum, our paces that would be equal to California would be Orlando, where we have a very strong affordable active adult business. So that's the point. It's really a cross-up price point. And you really have to dig under the skin of the business to understand it.

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John Gregory Micenko, Susquehanna Financial Group, LLLP, Research Division - Deputy Director of Research [36]

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Okay. That makes sense. And then the second quarter here, what are the emerging theme seems to be those that had spec, seem to sell them through faster at better margins, I think, and most of us expected going into the quarter. What do we think is driving that, is that I guess, the worry would be we're pulling forward some demand on rates. Is it a mix and that you've got more first-timers. So the spec product is more attractive. What do you think is driving that, it definitely seems to be a theme throughout the space this quarter?

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Sheryl D. Palmer, Taylor Morrison Home Corporation - Chairman & CEO [37]

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Yeah. I think you have to look at it as the journey that we've been on. So think about where we were at the end of last year. People did, confidence dropped, rates went up. The question was where there people sitting on the sidelines, of course, there were. If you think about rates, if you think about tariffs, if you think about government shutdowns, it really gave people a pause. So I think you move into the first year, the first of the year and what you had was a great deal of unintended inventory by the builders, if we were to be honest about it, because what happened in the fourth quarter slowdown. Confidence started coming back, job numbers were great, the interest rates fell, and there was great, let's call it consumer opportunities because there was an abundance of inventory. And I'm not going to say it got out of hand, I'm certain there were some markets where incentives were stronger than others, but it was absolutely a buyer's market, and there were folks sitting on the sidelines. I think as time has moved on and you've moved through the first half you've moved more into what I would call a normal spring selling season, but one that got extended. And I think it's gotten extended for all the reasons we've talked about and lower interest rates. Certainly have been a benefit. We'll see what happens. Today, I expect that, if everyone's crystal ball is accurate, we're going to see 25 basis point reduction this afternoon. And even though, I think that's baked in. And I don't know that we're going to see a ton of movement on long-term rates. The consumer is going to feel even better about that. And I think that's, that's one of the things that gives us confidence about this elongated spring selling season.

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John Gregory Micenko, Susquehanna Financial Group, LLLP, Research Division - Deputy Director of Research [38]

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Got it. So more catch-up in portfolio, it sounds like.

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Sheryl D. Palmer, Taylor Morrison Home Corporation - Chairman & CEO [39]

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I think so.

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Operator [40]

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And our next question comes from the line of Mike Dahl with RBC Capital Markets.

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Michael Glaser Dahl, RBC Capital Markets, LLC, Research Division - Analyst [41]

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Nice results and definitely a lot interesting on the Christopher Todd relationship. But, so as far as my questions, I'll stick to the core. I just want to understand the commentary, a little bit more about the incentives. I get the forward looking part about giving yourselves a little bit of a cushion, as you kind of tweak your pace and price to deliver what's optimal for the second half. But I was hoping you could give us couple more of stats on what you have seen because I think Dave mentioned those incentives were down year-on-year on the specs in [2Q] (technical difficulty) year-on-year, okay. So can you give us what those levels were in both the closings. And then, if possible just some color on incentives in order trends in 2Q versus 1Q and also versus 2Q of last year?

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C. David Cone, Taylor Morrison Home Corporation - Executive VP & CFO [42]

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Yeah. What we said was incentives for the Q2 deliveries they were in line with Q1 and lower year-over-year. From a year-over-year perspective they were down about 10%. And then as we look at where we were trending in Q2 on new orders, it was relatively consistent. Again we're leaving just a little bit of room. So we're not seeing incentive necessarily tick up at this point. But as Sheryl mentioned and I mentioned some of this is also leaving room just to be flexible on the pay side.

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Sheryl D. Palmer, Taylor Morrison Home Corporation - Chairman & CEO [43]

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And I think what we really like about that stat that just the data shared. When you look at the year-over-year and you look at when these closings for Q2 were sold. That would have been the back half of last year when things got a little tighter. And so you've got that as well as this abundance of spec inventory and even with that we saw that 10% reduction in our Q2 closing incentives.

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Michael Glaser Dahl, RBC Capital Markets, LLC, Research Division - Analyst [44]

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Okay. Got it. That's helpful. My second question is just around the community count just really kind of first-class problem, flip side of selling at a better pace you're closing out early. I know it's early, but just given you have visibility into your land pipeline. Can you at least give us some sense of kind of directionally how we should be thinking about community count into 2020? Should we expect that you can see an inflection from where you're going to end 2019, or is it something that's still going to look a little flatter?

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C. David Cone, Taylor Morrison Home Corporation - Executive VP & CFO [45]

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So I guess, when we're looking out for '19, we gave the guidance of 350 to 360. It is a little early for us to give a lot of detail on 2020, we'll do that obviously in the coming quarters. But our expectation is that we're going to continue to grow the business and we'll see an uptick in community count.

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Sheryl D. Palmer, Taylor Morrison Home Corporation - Chairman & CEO [46]

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Yeah. And the only thing I'd add on to that, Michael, is that, as I look at the community openings that are scheduled for later this year and next year, that's always the most difficult thing for us to guide to and project, because there are so many factors and getting communities open. But we have a lot of wonderful new product lines coming to market in the back half of the year, which should aid our community count in 2020.

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Michael Glaser Dahl, RBC Capital Markets, LLC, Research Division - Analyst [47]

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Okay. Of course. And I guess it's just good to hear that the plan is for growth, whether it's from absorption or community count. Understand the difficulty in predicting that there. Last one on my end. I guess, last day of the month here, but anything you can provide in terms of commentary on July trends?

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Sheryl D. Palmer, Taylor Morrison Home Corporation - Chairman & CEO [48]

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Yeah. Like you said last day of the month we've got 30 days under our belt. And I would say that July is in line with our expectations and relatively consistent with kind of June summer months. So we're happy and pleased with where the third quarter is starting.

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Operator [49]

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And our next question comes from the line of Matthew Bouley with Barclays.

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Christina Chiu, Barclays Bank PLC, Research Division - Research Associate [50]

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Hi, good morning. This is actually Christina Chiu on for Matt. I wanted to ask about the synergy number raised to $50 million. What percentage of this is direct cost? And what percentage is SG&A? And can you also provide any update on timing?

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C. David Cone, Taylor Morrison Home Corporation - Executive VP & CFO [51]

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Yeah. So I guess to kind of go back on the story. Our original number was $30 million, we increased that to $40 million in Q4, and then as you know, this quarter, we finalized it at $50 million here in Q2. Our original break down had about 2/3 of that in the overhead, about a third of it broken out between mortgage, insurance and national rebates. Really the drivers that we've seen since the original number has been across all categories, but most notably it's in the overhead and the national rebates and some of the biggest benefit that we're seeing is also from the increased local scale. So we're seeing better cost there. So we're seeing it both at the national and the local level. I would say that's probably the largest increase. From a timing perspective you're probably -- we're going to see this really come into effect and we'll get the annual benefit here in 2020.

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Christina Chiu, Barclays Bank PLC, Research Division - Research Associate [52]

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Okay, thanks. And then also last quarter you had mentioned that you raised prices in 40% of communities. Is there any update to that on what you're seeing in pricing power?

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C. David Cone, Taylor Morrison Home Corporation - Executive VP & CFO [53]

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Yeah. We continue to see strength in pricing now, be it, they're at modest levels, but this last quarter we saw in a little bit more than half of our communities.

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Operator [54]

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And our next question comes from the line of Truman Patterson with Wells Fargo.

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Truman Andrew Patterson, Wells Fargo Securities, LLC, Research Division - Associate Analyst [55]

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Hi, good morning, everybody, and thanks for squeezing me in. I think I'll leave Christopher Todd alone for the moment and follow-up with you offline. You all seem pretty committed to continued M&A. Could you guys just elaborate a little bit further, are you seeing more deals start to open up? And are you really looking at smaller bolt-on deals, or a little bit larger transformative deals similar to the AV Homes acquisition?

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Sheryl D. Palmer, Taylor Morrison Home Corporation - Chairman & CEO [56]

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Well, as Dave always says, you know, when we look at M&A, it's part of our capital allocation process and it's really comes down to best use of cash. So we're always looking. We are in a good place with the AV integration as we kind of bring that to the finish line. And our balance sheet I think is in really good place. When I think about the kinds of deals that are out there and that we're looking at, it's a combination of what's -- what are the bugs that are out there and really more importantly, what do we believe are the strategic opportunities for the organization. So we actually go seek those opportunities and they come in different sizes. But you can look at a lot of deals to get anything, to get one to the finish line. So we're always looking, as I think I've discussed before it's really about finding something that's accretive to the business, that's got the right culture, that enhances the financial results of the business from a long-term strategic standpoint. So when I think about present activity in the marketplace, it feels like there was a little low earlier in the year. And I think as you move into the summer months lull, bankers get a little bit more, the activity picks up, but I don't think there's any real trend line on the books that are out in the market today. But we'll be in a position of readiness from both an operational standpoint and a balance sheet standpoint, if that right opportunity presents itself.

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Truman Andrew Patterson, Wells Fargo Securities, LLC, Research Division - Associate Analyst [57]

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Okay. Thanks for that. And then jumping over to active adult, it's nice to hear that the absorptions were kind of down in-line with the overall company average. Especially, one of your competitors suggested that trends remain soft. Do you think you could break it out for us a little bit further between what you're seeing in the lower price point, AV Homes active adult communities versus your legacy Taylor Morrison a little bit higher price point communities. Are you seeing any delta there?

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Sheryl D. Palmer, Taylor Morrison Home Corporation - Chairman & CEO [58]

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Yeah. Interestingly enough the paces between legacy AV and Taylor Morrison, when I look at the second quarter are pretty similar. In fact, I think that we saw AV with a slightly, slightly improved. I think it was one turn on the AV paces across the portfolio compared to the overall and Taylor Morrison, which is exactly what we would expect. Specifically your comment on active adult and the softness, when I look at kind of our largest division of 55 plus communities, our paces were higher in Q2 2019, than they were in Q2 2018.

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Operator [59]

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And our next question comes from the line of Jay McCanless with Wedbush Securities.

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James C McCanless, Wedbush Securities Inc., Research Division - SVP of Equity Research [60]

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Hey, good morning. The first question I had on the Christopher Todd deal, I've been expecting one of the builders to jump into single-family rental or building for single-family rental at some point. But I would have expected maybe to go with a larger participant in the field. I mean, you've got AMH backyard, etc. I'm just maybe talk about the reasons for going with a smaller participant in that industry versus one of the larger banks?

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Sheryl D. Palmer, Taylor Morrison Home Corporation - Chairman & CEO [61]

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Yeah. It's an interesting question. You know, as I said, we've been studying this space for quite some time. And believe that strategically it made sense. And then it was about how do you go play. And after spending a good amount of time researching and really speaking to the different players in the space, for us it was about aligning ourselves with the best-in-class and who we believed had the overall best playbook and platform and long-term potential. And so when you look at some of the players, it's about building individual units and groups of units or buying units. When you look at what Christopher Todd has created, it's about creating a different lifestyle community that really hasn't existed before. So we looked at -- should we embarke on this on our own. We felt we were much better off leveraging our capital structure and core skill with someone that actually had the experience and reputation on community design and a product playbook once again and believes in delivering an overall single-family lifestyle community platform, that is well aligned with what Taylor Morrison does. So it actually was a pretty easy decision and let's grow and develop the business in the way that makes the most sense. And it's really about scale and share within our markets really controlling our destiny and community design, the construction scheduling. So all the things we've already talked about actually made Christopher Todd the perfect partner for us.

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James C McCanless, Wedbush Securities Inc., Research Division - SVP of Equity Research [62]

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Got it. And the second question I had, I believe you all said earlier that you're keeping some room open on the incentive front vis-a-vis your gross margin guidance. What are you seeing from competitors or some people starting to raise incentives or you having to be a little more competitive maybe you were 30 days or 60 days ago?

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Sheryl D. Palmer, Taylor Morrison Home Corporation - Chairman & CEO [63]

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No, I don't think so. I mean, you're always going to find those pockets. And you know as we do our tour around the country and we just actually recently had that opportunity to be in every market. You're going to always hear about a builder, that's gotten very aggressive and they're looking for growth in a certain place. But I would say that in overall, I would say it's business as usual.

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C. David Cone, Taylor Morrison Home Corporation - Executive VP & CFO [64]

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Yeah. I think that's right. I mean, maybe a little bit out in some periphery markets you might see a little bit, but I would say, everyone is acting very reasonable right now. And I think that just speaks to the strength of the market right now and the demand.

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Operator [65]

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And our next question comes from the line of Alex Rygiel with B. Riley.

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Alexander John Rygiel, B. Riley FBR, Inc., Research Division - Analyst [66]

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And just real quick, any thoughts on the QM Patch and the possibility of it expiring?

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Sheryl D. Palmer, Taylor Morrison Home Corporation - Chairman & CEO [67]

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You know it's a really good question, one that I haven't really heard much this earning season. And we've been pretty vocal about our concern on the expiration of this patch. We've spent some time on the hill. And the expiration date is as you, I'm sure, know, January 10, 2021, which is very quickly going to impact new homes. We could be dealing with this as early as the first of next year as new borrowers begin the mortgage process and builders rely on that credit approval before the home even starts construction. If these buyers or borrowers aren't -- are no longer eligible and builders are unable to rely on the approval, and we do believe this will impact the business and families. We've provided our buyer profile statistics every quarter for a number of years. So the quality of our portfolio certainly doesn't affect us as much as it may others because they have the financial ability to withstand higher rates and credit tightening. But when you look at the big picture, it's 20% to 30% of GSE's mortgage volume that could be impacted. Long story short, we're hopeful that regulators will appreciate all of the data that's available out there to redefine the definition without necessarily emphasizing a limiting percentage. And really recognized that the qualification metrics should be wholly reviewed. When you look at a consumer and there is not one component of a consumer that makes them a good or bad credit risk. We have to look at LTVs, credit scores reserves. I guess, long story short with the conversations we've had, we are cautiously confident that the MBA, the builder groups, the NAR will have input into this process and allow for a new QM definition to emerge over the next 18 months. And we hope it's not something that gets pushed too long, but it is starting to create a lot of chatter we spent 2 days on the hill. I think it was about 6 weeks to 8 weeks ago, and this was our really exclusive topic.

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Operator [68]

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And our next question comes from the line of Alex Barron with Housing Research.

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Alex Barrón, Housing Research Center, LLC - Founder and Senior Research Analyst [69]

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Yeah. Thank you. I wanted to just ask about the comment you made, Dave about benefit from purchase accounting and that impacting your margins. I thought it's the other way around that the margins get better as time goes back to those less purchase accounting. Can you just clarify around that?

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C. David Cone, Taylor Morrison Home Corporation - Executive VP & CFO [70]

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Yeah. We talked about that in the fourth quarter. This is a little bit unique situation. Typically in an M&A, the acquisition is done above book. We bought this at one-time book. So if you think about how you have to allocate fair value out, it's a little bit different in that you have to allocate some to goodwill and it changes the, brings down the fair value of the land assets that you're acquiring. So what we're seeing that as a little bit artificially low land value coming through, which obviously reduces the cost and increases the margin. In the fourth quarter, which is our first quarter with AV as a combined business that benefit actually offset the AV dragged us from the lower margins that they got historically just because their cost structure is little bit higher. And I mentioned every quarter what we're going to see is, that drag was going to continue for about 18 months, but the benefit was going to step down every quarter. So this is now the third quarter of that benefit to step down. We will get a little bit more benefit next quarter, but then after that, that benefit is gone. And then at that point we'll be close to working AV margins to be something more in line with legacy Taylor Morrison.

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Alex Barrón, Housing Research Center, LLC - Founder and Senior Research Analyst [71]

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Got it. Okay. And then I'm not sure if I heard anything on the delivery guidance. It seems to me based on your orders in the last couple of quarters, I don't follow why the deliveries would be in the range you gave. Anything you guys were expecting why deliveries would step down versus what you just delivered this quarter?

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Sheryl D. Palmer, Taylor Morrison Home Corporation - Chairman & CEO [72]

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Alex, I mean, we over delivered in the quarter to our expectations because of the inventory that we put on the ground in our ability to move through the inventory a little quicker. So some of that is a pull forward, but there is still a universe of inventory that we have in the ground and at the production machine that you just don't pivot that overnight. So we're very confident with our overall numbers and maybe there's a little bit of room as you could tell what the increase in our guidance. But you can't look at a quarter and all of a sudden change the inventory that you have in the ground. I mean everything is already in the ground that will be delivered in 2019.

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C. David Cone, Taylor Morrison Home Corporation - Executive VP & CFO [73]

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Yeah. I think it's important to recall the Sheryl's point that our guidance for the full year, we took the low end and the high end of our range for closing each up by a 100. So this is more of a timing issue around the Q3, where we actually feel very good about the year.

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Alex Barrón, Housing Research Center, LLC - Founder and Senior Research Analyst [74]

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Yeah. I do as well.

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Operator [75]

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Thank you. And that concludes today's question-and-answer session. So with that, I will turn the call back over to Chairman and CEO, Sheryl Palmer for closing remarks.

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Sheryl D. Palmer, Taylor Morrison Home Corporation - Chairman & CEO [76]

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Well, thank you so much for joining us today. We truly appreciate the opportunity to share the quarter and our exciting new news about Christopher Todd with all of you and we will talk to you soon. Have a great day.

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Operator [77]

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Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. And you may all disconnect. Everyone have a wonderful day.