Meritage Homes Corporation

Good day, everyone, and thank you for standing by. Welcome to the Meritage Homes third quarter 2020 analyst call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Emily Tadano. Please go ahead, ma'am.

Thank you, Hannah. Good morning and welcome to our analyst call to discuss our third quarter and year-to-date 2020 results. We issued the press release yesterday after the market closed. You can find it along with the slides we'll refer to during this call on our website at investors.meritagehomes.com or by selecting the investor relations link at the bottom of our homepage. Please refer to slide two cautioning you that our statements during this call as well as the press release and accompanying slides contain forward-looking statements including but not limited to our views regarding the health of the housing market, disruptions to our business by COVID-19, economic conditions and changes in interest rates, Community Count and Absorptions, Projected Full Year 2020 Home Closings and Revenue, Growth Margins, SG&A Expenses, Tax Rates, and Diluted Earnings Per Share, as well as others. Those and any other projections represent the current opinions of management, which are subject to change at any time, and we assume no obligation to update them. Any forward-looking statements are inherently uncertain. Our actual results may be materially different than our expectations due to a wide variety of risk factors which we have identified and listed on this slide, as well as in our press release and most recent filings with the Securities and Exchange Commission, specifically our 2019 Annual Report on Form 10-K and subsequent quarterly reports on Forms 10-Q, which contain a more detailed discussion of those risks. We have also provided a reconciliation of our certain non-GAAP financial measures referred to in our press release as compared to their closest related GAAP measures. With us today to discuss our results are Steve Hilton, Chairman and CEO, Hilla Sferruzza, Executive Vice President and CFO, and Phillippe Lord, Executive Vice President and Chief Operating Officer of Meritage Homes. We expect this call to last about an hour. A replay will be available on our website within approximately one hour after we conclude the call and will remain active through November 5th. I'll now turn it over to Mr. Hilton. Steve?

Thank you, Emily. I'd like to welcome everyone participating on our call today and hope that you and your families are continuing to stay safe and healthy. Before continuing the call, I'd like to take a quick moment to say thank you to Brent Anderson, who is retiring as the Vice President of Investor Relations at Meritage after 15 years. He's done a great job representing the company to our investors and analysts, and he will be sorely missed. I'd also like to introduce Emily Tadano, our new head of IR. Good luck, Emily. You have big shoes to fill, and I hope you're with us at least for the 15 years like Brent. Now this is the last time I'll address you as Chief Executive Officer of Meredith Homes on an earnings call. As we have previously announced, effective January 1st, Phillippe Lord will transition to the CEO role and I will retire after 35 years and become the Executive Chairman of Meredith's board. I will continue to participate on these calls, but Phillippe will be taking the lead. Phillippe and I have worked closely together for 12 years From the past five years as Chief Operating Officer, Phillippe was the co-architect of our strategy to focus on the entry level and first move up markets while driving operational excellence and efficiencies throughout our organization. I feel confident that Meredith will continue to be an innovative leader, provide exceptional quality and value to our customers, and grow to new heights under Phillippe's stewardship. I look forward to partnering with him in our new roles. So let's talk about the quarter ended September 30th, 2020. Meritage had many remarkable achievements. We delivered our highest quarterly orders, our strongest absorption since 2005, record quarterly closing revenue, and our best quarterly closing gross margin since 2014, despite record high lumber prices, while also achieving our lowest net debt to capital in our company's history. These outstanding results are due to both solid market dynamics and our strategy. So I'll start with slide four. We sold 3,851 homes this quarter, which was 71% more than the third quarter of 2019, and surpassed the quarterly record we had just set in the previous quarter this year. Although we are still in a worldwide COVID pandemic, favorable macroeconomic factors for the new home industry that began last quarter continued in Q3, including historically low mortgage interest rates, increased demand for healthier and safer homes, limited supply of existing home listings, and a decades-long supply shortage of new homes in the market. All these dynamics create the advantageous backdrop, which combined with our strategy, focused on affordable entry level and first move-up homes, translated into another record-setting quarter for Meritage. Moving on to slide five. We believe we have a solid strategy and are executing at a high level. We are achieving strong closing revenue growth with an increase in both pace and price. While we are increasing prices in all our geographies in alignment with local market conditions, we are not turning down sales where demand exists. We can and will capture demand whenever possible because of our available spec homes. Our SPAC building strategy has allowed us to sell at a greater pace and take market share. In Q3 of 2020, we accelerated our main investments by spending nearly $300 million and put a record 9,000 new lots under control. Our balance sheet remains very strong, which provides a long runway for growth as well as a safety net in the event of another downturn. We have maintained plenty of liquidity and a low debt leverage even as we invest significantly for additional growth in all our existing markets. While the accelerated sales trend resulted in some early community closeouts this quarter, we are still on pace to achieving 300 active communities by early to mid 2022, and consistent with our strategy, our new entry-level communities will have a high volume of spec inventory immediately available for sale at community openings, which can be closed relatively quickly. I'll now turn it over to Phillippe to discuss more of the recent trends. Phillippe?

Thank you, Steve. Before I begin, and on behalf of the entire company, I would like to thank Steve for 35 years of incredible leadership, that has guided the company through both successful and turbulent times, as well as instilled the values, integrity, and beliefs that live within each of us at Merridge today. Steve's commitment to our employees, customers, and shareholders, as well as his vision and execution, led us to the company's all-time records today. I would also like to personally thank Steve for his mentorship and guidance over the last decade. I am deeply honored to have the opportunity to serve this organization and its employees as the upcoming CEO and to continue working together with Steve in this next chapter of Meriden's home story. Slide six. Now, we hit on all cylinders during the three months ended September 2020. Our absorption pace for the quarter was up 94% year over year. Five out of nine states had absorption increases over 100% year over year this quarter. Much of this sales outperformance is due to the strength in the entry-level market. Entry-level represented 60% of our average active communities during this quarter, compared to 42% a year ago, which puts us near our target ratio of 65%-35% between entry-level and first move-up. Absorption in our entry-level communities were 75% higher than last year, and nearly 1.5 times the pace of first move-up communities. Entry level comprised almost 70% of total orders for the third quarter, up from 54% in the third quarter last year. Our first move-up communities also experienced improved demand year-over-year, with absorptions 86% higher than a year ago. Slide 7. The outsized demand in Q2 and Q3 of 2020 led to 23 early community closeouts this quarter. These sell-outs happened across all existing geographies. We anticipate both continued strong sales demand and choppiness in our community count in the near future. We have ramped up land investment and will continue to do so to replenish our pipeline to keep up with demand and grow our community count. We have been aggressively securing new lots since mid-April following a pause due to COVID-19 related shutdowns. During 2019, we put 17,000 new lots under control, which translates to 134 new communities. We put approximately 16,000 new lots under control in just the first nine months of 2020, almost as much as all of 2019 and nearly 80% more than 2018's 9,000 new lots. This translates into about 123 new communities put under control during the first nine months of this year, with dozens more to come in the fourth quarter. At September 30, 2020, with nearly 48,000 total lots outstanding, representing 4.4 years of lot supply based on a trailing 12-month closings, we have increased our land book by almost 30% from September 30, 2019. As part of our entry-level strategy, the average size of our communities has also expanded. We have been putting larger land positions under contract, offered several hundred lots at a time, targeting a three to five year community life, even at an accelerated sales place. Year to date September 30, 2020, our new lots under control were 81% entry level with an average community size of 130 new lots. We are scheduled to open up more than 150 communities in 2021, compared to opening 75 communities in all of 2019 and approximately 100 communities projected for full year 2020. after being shut down for six weeks due to COVID-19. We believe that our aggressive pace of securing new lots and a strong pipeline of community openings will start to meaningfully show increase in community count in the later half of next year. At a pace of 50 sales per year, an average of 300 communities could reasonably produce 15,000 sales in 2022. Slide eight. Moving to the regional level trends on slide eight. All of our regions reflected solid year-over-year performance in Q3. Our central region, comprised of Texas, led in terms of order growth this quarter with an 82% increase in orders over the third quarter of 2019, despite a 14% decline in average community count. The central region's absorption doubled to 6 per month compared to 3 per month in the third quarter of 2019. Entry-level communities represented 63% of Central Region's average active communities during the third quarter of 2020. Outorders in the West Region were up 68% over the third quarter of 2019, driven by an 88% increase in absorption with 10% fewer average communities. Entry-level communities represented 63% of the West Region's average active communities during the quarter. California produced the largest year-over-year growth in orders at 158% for the quarter and the highest absorptions of all nine states we operate in, selling an average of seven per month during the quarter of 2020, which was an increase of 137% in absorptions year-over-year. Average community count in California also increased 9% year-over-year for the third quarter of 2020. We are seeing the success of the shift to newer affordable entry-level communities in California come through in the community count and sales performance there. Our East Region experienced order growth of 63% on an 87% increase in absorption year-over-year for the quarter, offsetting a 30% decline in average community count. 50% of our average active communities in the East Region were entry-level during the quarter. I will now turn it over to Hilla to provide additional analysis of our financial results. Hilla?

Thank you, Phillippe. Let's turn to slide nine. We generated 56% earnings growth year-over-year in the third quarter of 2020 compared to the same period in 2019, as we had significant growth across all key metrics, with 21% closing revenue growth, 170-bit increase in home closing growth margin, and a 70-bit improvement in SG&A as a percentage of home closing revenue. This quarter's closings were up 24% year over year, with 71% of closings coming from previously started spec inventory. At September 30, 2020, approximately 14% of total specs were completed, less than the last couple of quarters, understandably, as we're selling more specs in earlier stages of production. Although this dynamic is also driving a decrease in our backlog conversion rate over the last several quarters, our backlog conversion rate for the third quarter was 68%, which is slightly up year over year, evidence that our construction pace is keeping up with sales. We generated over $1.1 billion in revenue in Q3 2020 as our year-over-year increases in closing volume, reflecting our record high sales, more than offset the decline in ASPs on closings, resulting from the shift in product mix towards entry level. Our closing gross margin improved 170 bps to 21.5% for the third quarter of 2020 from 19.8 a year ago. Thank you for joining us. We have been able to continue to harvest savings in our material costs by reducing skew counts to achieve preferred vendor pricing and bulk purchasing discounts while taking advantage of pre-cut material where available. Our streamlined production also allows us to obtain preferred labor pricing from our trade. SG&A, as a percentage of home closing revenue, was 10.1% for the current quarter, which was a 75th improvement over 10.8 in 2019 due to greater leverage of fixed expenses and efficiencies and higher closing volume, as well as cost savings from technology enhancements, particularly as related to sales and marketing efforts. We also benefited from a lower tax rate with the extension of the energy tax credits into 2020 under the Taxpayer Certainty and Disaster Tax Relief Act enacted in December 2019. Our expected tax rate was 19.5% for the third quarter this year versus 24.4% last year. Our third quarter diluted EPS of $2.84 also benefited from our repurchase of 1 million shares in the first quarter of 2020. To highlight just a few items for year-to-date results September 30, 2020, on a year-over-year basis, we generated an 86% increase in net earnings orders were up 40%, closings were up 26%, we had a 250 BIP increase in home closing growth margin and a 90 BIP improvement in SG&A as a percentage of home closing revenue. The strong start to 2020 and rapid recovery that started in mid-April more than offset any pullback experienced from COVID-related uncertainties in late Q1 and very early Q2. Moving on to slide 10. Our balance sheet continues to be very strong, even as we step up investments in land acquisition and development. We have plenty of liquidity, including $610 million of cash, nothing drawn on our credit facility, and the lowest net deficit cap in our company's history at 15.7%. We grew our spec inventory back to an average of 11.2 specs per community this quarter after dipping in the second quarter to about 9.3. We are committed to increasing our per store spec count by year end with inventory on the ground available for a quick close. We anticipate our heavy backlogs and increased volume of available specs entering into 2021 will result in improved backlog conversions and solid closing into next year. Slide 11. Our land acquisition and development strategy is very nimble and we can aggressively increase our purchases when the housing market is hot and also pull back quickly when the housing market slows. We spent nearly $300 million on land and development this quarter, our highest spend in a single quarter in our history. For the first nine months of 2020, we spent nearly $760 million on land acquisition and development, which was more than 28% higher than the same period of last year. We are using options or staggered purchasing terms to secure more lots, which allows us to preserve our liquidity. About 58% of our total lot inventory at September 30, 2020 was owned and 42% was optioned, which improved compared to September 30, 2019 with 66% owned and 34% optioned. Finally, I'll direct you to slide 12. 2020 will be a record year in spite of the pandemic. We anticipate continued strength in Q4, but caution, these results could be impacted by uncertainty surrounding the election, COVID-19, or financial market volatility. For the full year 2020, we're projecting total closings to be between 11,200 and 11,500 units, home closing revenue of 4.2 to 4.4 billion, home closing gross margin of approximately 21 to 21.5%, an effective tax rate of 20 to 21%, and diluted EPS of $10.25 to $10.50. With that, I'll turn it back over to Steve. Thank you, Hilla. Turning to slide 13. To summarize,

Meredith Homes today is a different company than when I co-founded it in 1985. Our culture and our strategic shift has been transformative. I'm proud of the innovative product, energy efficiency, superior quality, and affordability that we have delivered in every home that we've built. Now as one of the leading entry-level and first move-up homeowners, Meredith is well-positioned to capitalize on current market demand and Deliver Strong Results into the Future. Demand is through the roof, pun intended. Our closing revenue growth benefits from our focus on affordable product, which allows us to push both price and pay. Layering the leverage of SG&A and streamlined operations on top of closing revenue growth, we are seeing some of the strongest results in Meredith's history. Our financial flexibility to grow comes from having a strong balance sheet with excess cash and the lowest net debt to capital we've ever had. We are focused on growth by accelerating land investments to get to our goal of 300 community count by early to mid 2022. We are driving an increase in ROE and creating value for our shareholders. All this with the combination of the right strategy, ability to execute and the dedication of incredibly talented team. I truly believe the opportunities for future growth and success are boundless for Meritage. I'd like to personally thank our employees in helping us transform Meritage Homes. The executive team had a vision for this company and our people made it a reality. And on a personal note, I want to say thank you to the investment community for your long-term interest and support for our company and for my leadership. After 91 quarters, of your thoughtful and brilliant questions. I'm not sure how we'll cope without the anxiety of the quarterly full-body scan. You don't know how much I will really miss all of you. That concludes our prepared remarks. I'll now turn the call over to our operator for instructions on Q&A. Operator.

Thank you. If you would like to ask a question, please signal by pressing star followed by the one on your telephone keypad. Also, if you are using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Once again, it is star one to ask a question. And we'll go first to Alan Ratner with Zellman and Associates.

Hey guys, good morning. First off, a big congrats to everybody on the line, Steve, Brent, Emily, Phillippe. Steve, I think I speak for everybody that we will certainly miss you on these calls as well, but best of luck in the next chapter. I think obviously the big topic that everybody's focused on today is just this concept of have we hit a point where builders have to intentionally slow the pace of activity For a multitude of reasons, and obviously nobody is expecting 70% growth to continue here. But the community count is a big topic, and I think a 300 target by mid-22 is certainly extremely positive and optimistic. And I guess the question is, what does that cadence look like? There's obviously concern that you have enough product on the ground heading into the selling season for next year. So is it going to be somewhat smooth through the year, back half-weighted, front half-weighted? But I guess on top of that, perhaps the better driver of your growth is spec inventory as opposed to communities since such a high percentage of your sales are spec. So can you maybe give us a little bit of a target of what you're hoping to have on a year-over-year basis, your spec count heading into 21, just so we can get some idea of the planning on growth?

So there's a lot to unpack there, Alan. I appreciate the question and I appreciate yours and Ivy's support over these last couple decades. It's been a great ride, and you guys have provided us some very thoughtful coverage and research, and we really appreciate that. I appreciate that. I think it's important for investors and analysts to look a little more long-term than just at the next couple quarters. Obviously, it's going to be a little bumpy for us on the next couple quarters, particularly if these strong sales continue, which I don't see any reason why they won't. but you know we got we have the lots it's not a question of if it's a question of when these communities are going to come and they're going to produce really solid long-term growth for our company I mean as Phillippe said in this section you know we should be able to sell at least 15,000 homes in 2022 we'll have the stores for it and we're entering this This coming year, with a really big backlog, because we've been selling homes earlier in the cycle times, even though we've been selling predominantly specs, we're selling them when they're just starting versus when they're just finishing, which is building our backlog. In addition to that, we're really focused on trying to get about 3,000 homes into the spec pipeline. I think we're at around 21 or 2200 now. So we're going to ramp up our specs for the spring selling season, which will also help us with our deliveries next year. But, you know, if you're only looking for the next quarter or two, it's going to be bumpy. But if you're a long-term investor and you're thinking about where this company is heading long-term, and long-term is not that long, we're talking a year away, it looks pretty good. And I'm pretty darn excited about what we have in our pipeline. And I think investors should also.

Very helpful, Steve. I appreciate that context. And certainly with the bumpiness, you do have the balance sheet to take advantage of any shorter-term disruptions that might occur on the shares as well. On the community account growth, it's going to be extremely strong. Are there any SG&A expense considerations we should consider here as far as front-loading some expenses that might be associated with opening those communities, and when would those show up?

I'm going to let Phillippe and Hilla take that one. Yeah, obviously with the ramp up to 300 communities, you know, you're talking about, you know, 30% growth in our community count, even if the pandemic didn't occur. And so we have to add, you know, different layers to our organizations to support that, to support the higher scale of community. So you can expect to see SG&A increase next year, year over year. It's mostly going to be timed with the community, the community opening. So, you know, I would expect that to happen more in the back half of the year than first half of the year. We're always trying to be very mindful of adding, you know, the overhead as we start to see the revenue occur specifically in the field overhead piece. So it's going to be more weighted towards the back half of next year, but clearly we've added land folks and land development folks. We have more land that we're processing today than we ever have in the history of the company as we strive to get to the 300 communities early to mid part of 2022. And maybe Hilla wants to add something to this as well.

Yeah, so I think you guys know we have overhead in two different components, right? There's a portion that lives in margin and a portion that lives in SG&A. Both of them, obviously, we're going to have to add headcount and some capacity to grow the company Neither one is going to be very meaningful, right? There's going to be offsets in other directions. So you're not maybe going to see continued improvement in our SG&A leverage, but you're not going to see a material deterioration either. So just wanted to make sure we have some guardrails on those numbers.

Very helpful. Thank you very much and great luck.

Thank you.

We'll go next to Truman Patterson with Wells Fargo.

Hey, good morning, everyone, and let me throw out my congrats to everyone on the call as well. Now that Brent's officially retired, I've been trying to convince him to move to Phoenix finally, so we'll see what happens there. But, you know, first question, you know, clearly investors are focused on the 18% community talent decline, which clearly, you know, you're a bit of a victim of your own success, really, but Thank you for joining us. Do you think you all will be able to meet the market and really offset some of this community count volatility through an elevated absorption pace? I'm also thinking you're replacing 75% of your communities effectively in 2021, which should have a higher lot count, maybe a little bit better absorption pace. But if you just walk us through maybe that hypothetical.

Well, I mean, I can't give you a specific guidance for the first quarter of 21 and the first quarter of 22, but as I said, it's going to be a little choppy if you just focus on the community count number. But with the higher absorptions we're getting, we should be able to produce some decent sales numbers. I don't know if we're going to be able to get to 20% greater than it was in We had a pretty good January and February this year. So as I said, look more closely at the backlog and the spec count that we have going into 21, which should produce some really good earnings numbers for the first couple quarters of 21. After that, we're going to have to rely on the community count to start to kick in and propel us into some really good 22 numbers. And I don't know what else I could really tell you. You know, the community count, it's an issue, but it's a short-term issue. It's not a question of if, it's a question of when. We've bought a lot of lots. We're continuing to provide lots. We're not seeing resistance to finding lots that fit within our strategy. And, you know, we're going to be opening more communities next year than we ever have before. And I think that long term, and I feel really good about the quality of the communities that we're opening, the locations of the communities that we're opening. And again, it's going to produce really solid long term results.

So we can't give 21 guidance yet. We're going to obviously do that next quarter on our next quarter call, but just a couple of directional items that I think we addressed in the prepared remarks and maybe bear repeating. There will be an inflection point at some point in 21 in the community count, right? We're not going to get to that 300 community count. are all in 22, so there will be a point in 21, and we're not getting a target for which quarter, where we'll see a material increase in our community count, and those communities come with a lot of specs already built on the ground at opening. You'll see those sales pop at that time, and then you'll see the closings come very shortly after. So I think that we kind of tried to provide a little bit of a path there by addressing Thank you for joining us today.

So, which will also propel the sales number as we get later into the year.

Okay, okay, fair enough. Thanks for that. And then clearly, you know, order growth is 70%. A lot of investors are, you know, focused on builders' ability to convert those into closings in the construction cycle. But is your construction cycle extending? Steve, I couldn't tell if you actually mentioned that earlier, but kind of two parts to that. Are you seeing any labor shortages, having a lot of issues getting starts on the ground, and then on the flip side, are you seeing any product shortages that are leading to cycle times extend?

We anticipated that question. He's got a response for you on that.

Yeah, so cycle times, at least from our perspective, are not expanding. Sales are expanding. which means we have to get more specs in the ground. And as Steve had articulated, we're chasing the specs a little bit. We've ramped up our starts capacity dramatically out of COVID. So we're starting more homes than we've ever started in history. It's just that we're selling more homes than we've ever sold in history. So we're in this inflection point where we're trying to ramp up specs with community decline going the other way. So that's really what's stretching out the backlog conversion. But the cycle times, we're still building homes extremely quickly. Labor is performing very well. We're not seeing any issues there. Capacity is there. You guys know and are aware of the supply chain dynamics, specifically around lumber, although we've seen that level off and supply chain loosen up recently there. So from our perspective, at least, because we're a spec builder, because we've streamlined our operations, labor is performing really well. We're seeing cost pressure. We're able to cover that cost pressure with the pricing and the market. and Cycle Times are actually probably even a little bit lower than they were we continue to dial it in and are building homes really quickly and then on the start side you know that's the biggest challenge just starting as many homes as we are today and the municipalities approving the permitting that's a bit of a bottleneck but as I said earlier we are starting more homes than we ever have in history so we're working through those those challenges but that's probably the The area of biggest opportunity if we were to increase capacity from here.

All right. Thanks, everyone, and good luck on the upcoming quarter. Thank you.

We'll go next to John Lovallo with Bank of America.

Hey, guys. Thank you for taking my questions. The first one, you know, on the gross margin outlook for 2020, I think that implies a 4Q gross margin of somewhere around 22.5%, which is up 250 basis points or so, I think, year over year. I guess the question is how much of this is pricing versus some of the savings that you guys have talked about? And in terms of the latter part there, the savings on the labor front that you guys have worked out on the horizontal and vertical side, do you anticipate being able to hold on to those as activity picks up here, or do you think you're going to have to give some of that back?

Hi John, thanks for the question. So I think for us, because we're a spec builder a part of the lumber increases is already reflected in our Q3 number because of our pretty quick cycle times there's another portion of the lumber increases that's going to be coming through in Q4 but we're definitely able to offset that like you said if you kind of do a back of the napkin math you can see that we're projecting an increase in margins in Q4 to hit our target of 20 to 21 and a half for the full year blend so that's coming from Higher ASPs and some continued efficiencies we're seeing because on the cost side, at least in Q4, we are still going to have some increased cost pressure from lumber locks that were in place when we started those homes. So we're not really predicting anything yet for 2021. We're assuming lumber is going to stay steady even though there's probably some green shoots that'll come down a bit. But for right now, mostly what you're seeing is efficiencies that we're finding in the product, the ability to leverage that fixed overhead component in margin and price increases.

Okay, got it. And then, you know, just looking at the full year guide again and trying to back into the 4Q outlook, it would appear that at the high end, the ASP would step up again here pretty nicely. Are you guys concerned at all about pricing folks out of the market in terms of affordability? And what can you do to sort of offset that potential impact?

Yeah, this is Phillippe. We are very mindful of that, which is probably why every community has its own story. The Live Now brand, it's really important that we stay below FHA. We think that's the governor. As we look at the market and you look at entry-level communities that operate above FHA, they're not seeing the demand that we're seeing. Thank you for joining us today. But that's really the story for us. We're about pace. We're about leverage. That's what the entry-level business is all about. And so we are mindful of our pricing, although we've been able to get both price and price in today's market. As we move into next year, there is an absolute governor out there that will limit us pushing it much further. That's helpful.

Thanks a lot, guys. Thank you.

And as a quick reminder, if you'd like to ask a question, that is star one. We ask that you please limit yourself to one question, one follow-up question. We'll go next to Steven Kim with Evacor ISI.

Yeah, thanks a lot, guys. Well, yeah, we're going to miss you, Steve and Brent. But you know what? We look forward to still seeing you, Steve, or hearing you on the calls. And best of luck with everything, Brent in particular. My question starts off, I guess, talking about Studio M and California communities. I remember over the last year and a half or so, these were two aspects of your product mix, which we thought were going to be pretty important to watch. The ramp in communities that you have been planning for a couple of years now in California looks like it's hitting just at the right time. Meanwhile, Studio M I'm intrigued about. You didn't talk too much about it, I don't think, on this call, but one of the other builders today was talking about how there's been a lot more energy at the higher end of the market, not exactly the entry level, but maybe the move-up segment of the market, which Studio M seems to go after. So can you talk about what you saw specifically with the target market for Studio M and whether your California and Studio M products carry with them higher margins? that we can be looking forward to next year.

Steven, thanks for the kind words. First of all, I'll miss you guys too, but I'll still be around. There's energy in all segments of the market right now. I think you're hearing that from other builders. There was a builder right before us today. They had phenomenal results. I think there's energy at all price points. And I think the low mortgage rates and the fact that people are spending more times in their homes with COVID has created demand in all price points. I think I'm shocked to see some of the multimillion dollar, $10 million homes that are selling some of these high price zip codes. It's like I've never seen before in my entire career. Studio M, You know, it works well for us. Are the margins higher than Live Now? You know, maybe a touch. Not really, but the margins we're getting out of Live Now are solid. We're seeing more opportunities for land, though. It's less competitive for us in the Live Now segment than it is in the 1MU segment. I think I alluded to this last quarter in our call. We're chasing bigger deals, 200 lot, 300 lots, 400 lots, 500 lot deals for our entry level communities because the absorptions are much higher and because we're trying to reduce the churn, the community count churn. If you buy a smaller community and you're only in it for a year or two, You know, you're starting up, you're finishing up, you're opening models, you're closing models. There's a lot of overhead labor that goes with that. It's hard on the organization, but if you can be in a community a little bit longer, you know, it's better on the bottom line. And it, you know, allows our land people to not have to work as hard to find replacements. So we're finding less competition for those bigger parcels. We only have a few big public builders that we compete with. We don't compete with as many private builders for those parcels and even some of the publics. So our, you know, our land acquisition has been a bit skewed in that direction. That's not to say that we don't love Studio M and we don't believe in 1MU because we do and we are buying those parcels and we're going to continue to do so. And we've opened, you know, a few in California this year to increase our community count there for sure. But, you know, with respect to California specifically, it's a tough place to find land and it's risky and you got to pay up and it takes a long time and there's a lot of hurdles. So we're happy that we're doing better there. But it's a big challenge for us and for all builders for that matter.

Got it. Your land spend ran at $300 million this quarter. Hilla, you mentioned that was the highest you've seen, I think, ever. But it actually, I'm guessing that that number is probably going to rise in the fourth quarter. I was wondering if you could comment on where you think you're going to wind up for the year. If you said it, I missed it. I'm guessing around $1.1 billion or something like that still. And what you think is a reasonable outlook for next year?

So we haven't given guidance into 21 yet. I think you're pretty much spot on. We didn't get specific numbers, but between a billion and a billion two is a good expectation for full year 2020. So we kind of do the math, we were at 760. A year to date, obviously we had a pause for six weeks there in the year. So we're gonna be accelerating that. You can expect that number to continue to accelerate. We'll give more specific guidance, but there's no way to get to that 300 community count without continued acceleration in 21 and 22. So you can go ahead and kind of model something a little north of that.

There's a big wave of land purchases, land deals that we've approved, development dollars that we need to spend. coming through that will absorb a chunk of our cash and our retained earnings. And it's coming and hopefully we can make it even bigger because we've got a lot of lots coming through our land committee in this fourth quarter. We've already approved a lot in October. And we're just really excited about these deals and the quality and the contribution they're going to make.

Yeah, that's great. Philippe, you made a mention about the FHA loan limit, how you still had a little bit of room. A couple of places maybe we're getting a little close. I just wanted to clarify something. The FHA loan limit generally rises once a year, right? And it usually rises pretty much, we'll hear about it, I would think, in a couple of months or something or a month or two. So theoretically, to the degree that the entry level will at some point bump up against some kind of affordability challenges due to the significant price increases, that actually is a little bit more of an issue later in the years. Is that not right? Am I thinking about that right? So you have a fair amount of headroom generally the first half of the year in the spring and selling season and all that. Am I missing something there, Philippe?

No, you're not missing anything. That's exactly right. So we'll see the revisions next year and what kind of opportunity that creates based on market comps and clearly prices are up across the board. So we do expect some sort of increase there to give us some opportunity.

Let me just add on, but you know, we're dealing with last year's FHA number right now and prices have been rising. It's been widely reported and it's not fiction, probably 1% a month. so we're not you know this year we're up nine or ten percent already you know and most places FHA loan limits are around 300 or low 300s for us so you know prices are up you know 25 grand on entry-level products across the board but the FHA loan limit is still Still lower for last year. Now it'll adjust at the end of this year. But I don't know if you can go to the bank on the fact that it's going to adjust completely in line with what our prices have increased. So we've got to be mindful, as we've articulated a couple times already, that we stay inside that number.

The one nice thing to remember, though, kind of putting a bow around everything, is that when we approved the deal and we were underwriting to FHA at that time, it was two years ago. That's why we kind of have this little bit of headroom. We're getting close to where the FHA limit is today, but that's why we've been able to increase the amount that we have because we were underwriting to the then FHA limit when we bought the land.

I mean, the lower you go in the price band... The stronger the demand is, I would say we have communities under 250,000 in some places. It's almost unlimited. We could sell as many houses as we wanted to as fast as we wanted to at some of these lower price points. It just comes down to production and putting the product on the ground.

Yeah, and with the forced savings that everyone's had to do because there's nowhere to blow all of our money, You know, you've got down payment not a hurdle for people anymore. And then I've heard FICO scores are basically hitting record levels for folks across the nation. So all of that, I assume you're seeing in your business and benefiting from as well, right? Yes.

Yes.

Great. Thanks, guys. Good luck and look forward to speaking with you still afterwards. All right.

Okay. We'll see you later. Thank you.

We'll go next to Carl Richard with BTIG.

Thanks, everyone. I only have one question, but just a comment. Steve, congratulations. It took a lot of courage for you to make such a significant business transformation in a company that you co-founded and ran for 30 years. I hope you write a book. It's been remarkable what's happened in this company in the last several years. There's a lot of credit for that.

Thank you.

Thank you. Ren, congrats to you two. I'm modeling a better backswing for you. That's what I'm asking. It can only get better. And welcome to you, Emily. I just have one question, which is if I look at Live Now and your penetration, obviously it's really significant in Phoenix and other places, but as you're looking out the next couple of years, what are the metro's were states where you think you can really drive Live Now penetration and get it higher. Where are you lagging in terms of the percentage of your mix? Thanks, guys.

Yeah, the big opportunities for us are really in Texas and the East Coast. In the West, I think the maturation of Live Now is really where it's going to be, although we have some opportunities in Colorado. because that's just such an affordability issue out there. But we've really pivoted in Texas, as we said. We're up huge in Texas with Live Now. It's driving a lot of the performance there, and we have a lot of Live Now stuff coming. Dallas and Houston are big opportunities for us. Horton's the largest builder in those two metropolitans by a long shot, and we intend to go after that. and then it's been a little bit slower for us in our newer markets on the East Coast and Florida, but that's all coming dramatically here. In Orlando, when you look at community count growth, it's all gonna come from Live Now and the rest of Florida. And then a lot of stuff coming in Atlanta, Nashville and the other parts of Carolina. So it's really on the East Coast and Texas is the biggest opportunities for us. to really continue that penetration and move the needle.

I'd say also additionally that we're not ready to announce this yet, but we are going to be announcing soon some new markets. We're working vigorously now on several new markets and hopefully by next quarter we'll be able to make some specific announcements about which markets they are and we'll be able to started those markets with a little bit of steam. So as we've articulated, we have some room in our East Coast market, particularly in Florida, I think, to grow our Live Now brand, but we'll also have some new markets to go along with that.

And that 300 community count does not contemplate new markets, so that's just an extra cushion for us.

Yeah.

That is great to hear. All right, congrats. Thanks, all.

Thanks, Carl.

We'll go next to Michael Rion with JP Morgan.

Hi, this is Elad Hillman on for Mike. First, congrats on the results and best of luck to Steve and Brent on your retirement. My first question was, I was curious if you could comment on traffic levels and sales pace so far in October and if the market is starting to show any signs of slowing or irregular seasonality.

October continues to be strong. I'd say maybe not quite as strong as September because of a little bit of seasonality. But I think we've already surpassed last year's sales number for October with nine or 10 days to go in a month, two weekends to go. So I expect it will produce a pretty big order number versus Last year's for October, and I don't see anything on the horizon that's going to change that dynamic.

Yeah, traffic levels are stable to the surprise of us all because I think there's this election coming up here in a couple weeks that usually slows things down. So surprisingly, the market isn't even paying attention to the election, at least from a housing perspective, or maybe they are, and they're all buying house for shelter. But either way, traffic levels are extremely stable for this time of year.

We were going to put a gun in every house, but we couldn't find them. Just kidding. Sorry.

Really great to hear. And then I wanted to clarify something from earlier in the call. On prior calls, generally entry-level gross margins, you know, the Live Now products were noted as higher than the first-time move-up, with maybe the gap narrowing a little bit helped by the Studio M. But I think now you mentioned that move-up gross margins may be at parity or even a bit above the entry-level offerings. I just wanted to get a little more clarity around those comments to make sure I was hearing it right.

I'll let Hilla give you the specifics, but... The pricing power in the entry level is really strong. So I think that's where we're seeing the better margins. Just the demand down at that lower price point is really producing a supply-demand disconnect that's allowing us to push prices probably more than the higher end. So I still believe our margins are higher in entry level than first move up, but I'll have Hilla give you the specifics.

Yeah, our entry level product kind of held consistent for this year. It's our highest producing margin product. First time move up actually did increase a bit. There's a little bit more pricing power, but it still lags a bit behind entry level when we're looking at them on a relative basis. Got it.

Thank you. Thanks, guys. You're welcome.

and we'll go next to Alex Barron with Housing Research Center.

Yeah, thanks guys and congratulations on the retirement and all the big turnaround of the company. I wanted to just focus in on the 300 communities and so forth. I just wanted to verify, is this all Based on organic growth, or is there any expectation that you would have to, you know, acquire a builder to get there?

It's all organic, and we pretty much have all the land under contract, the stores to do it. So it's not like we got to go out and buy a whole bunch of land to make that happen. We already got the land. So we have a high degree of confidence in getting there in early to mid-22. And it may be choppy along the way, as we said, because we may sell out of some communities faster like we did this quarter. We closed out 58 communities this quarter. We would have closed out those communities next quarter or the quarter after. So our community count would have maybe been a little higher, would have been higher this quarter and maybe higher year end. But when we're selling 71% more homes in Q3 and what was the Q2 number? 60 or 70% more in Q2, you know, just the homes are flying off the shelf faster than we anticipated and it's driving the community count down. But it's going to rebound because we have the lots. We bought the lots. We have the lots. We have the stores. We're developing them, we're moving them through the process, and they will be here. It just will be a little bit later because of COVID and because of the quick sellout of the communities that we closed out in the last two quarters.

Okay, that's all good. I don't see any problem with selling out early. It just means you're taking buyers out of the market. The other question I had was with regards I think you said about 70% of the sales this quarter were entry level and I think you also said that the size of the communities that you're buying is growing so basically should we expect that the trend in sales pace will keep increasing and should we expect basically that the percentage of entry level will also keep going up over the next couple years as you're heading towards the 300 communities?

Well, the sales pace, you know, it's a historically high level, high levels. We're at almost six per month per community. I mean, I think it's higher than much of our competition I was looking at and higher than we've ever been. I can't tell you that, you know, that we don't underwrite to that pace. And whether we'll continue with that pace, you know, I don't want to make any predictions. But what was the second part of the question?

Was it about the... Yeah, the ratio is probably where it's at. I mean, we still are investing in one MU. As Steve said, it's a little harder to find that land. The deals aren't big enough. It's more competitive. But we are finding that land. It's just slower. but I don't think we're looking at, you know, being 80, 20% live now 1MU or even 75, 25. You know, the goal is to be 65, 35, you know, live now versus 1MU from a community account perspective. And of course that'll result in a different percentage from a sales pace because we underwrite live now, you know, to a higher sales pace than 1MU.

Okay, awesome. Well, best of luck and good job. Thanks. Thanks, Alex. I think this is our last question.

Jen, operator, right? Or two more.

Yes, we have two more in queue. We'll go next to Susan McClary with Goldman Sachs.

Thank you, and congratulations to everyone. My question is around, you know, thinking about consolidation for next year. You know, given everyone's trying to load up on their lot positions, have community count ready to go, and we recently saw one of your peers buying a smaller private builder. Do you think that we could see more of that in the industry next year as we look out?

You know, I get to ask this question every quarter for the last 91 quarters and it's just so hard to predict M&A. You know, there's so many factors that go into it. so many social issues. What are the goals and objectives of the acquiree? Is there a retirement plan? What are their plans? What are they thinking? I'm sure there could be, but I wouldn't say that we're seeing more deals now than we saw a year ago. Frankly, it's been kind of quiet. We're probably going to be more particular about Thank you for joining us. Hard to tell what the pace of M&A is going to be.

Gotcha. Okay. And then just following up on that, can you talk a little bit about capital allocation shareholder returns? Given the kind of bumpiness that you're forecasting for the next couple of quarters, the liquidity that you do have on the balance sheet, can you talk to what your willingness would be to restart share repurchases? One of your peers earlier today commented that they're going to start to do a little bit of that in the fourth quarter. How are you thinking about it?

Well, based on the share price today, it looks a lot more appetizing than it did a week ago. You know, we're opportunistic when it comes to share repurchases. I think we certainly want to try to buy at least enough shares to cover the dilution from our share issues. But, you know, we're going to be using A lot of this capital is on our balance sheet today. I mean, we're not going to stay at a 15% net debt to cap. We're going to be using the money to buy land, to grow the top line, to grow the bottom line. And to the extent share purchases make sense, you know, we'll take advantage of them and pursue them. We're not a dividend paying company. We never have been. We continue to explore the concept, but we haven't made any commitments to doing that. And, you know, that's where we are.

Okay, great. Thank you. Good luck.

Thanks, Susan. Last caller.

We'll go next to Jade Romani with KBW.

Yes, thanks very much for taking the question. Just for Steve, as you think about the road ahead for the home building industry, maybe over a multi-year, longer-term time horizon, I was wondering if you have any parting words since this is your last conference call for for the industry or any message you want to send as it relates to the value being provided to the individual home building communities, the industry's overall efficiency, or future drivers of shareholder returns?

Well, that's a mouthful. I mean, you know, I didn't prepare anything to, you know, respond to that question, but it's a good question for sure. You know, just as I said in the Q&A, I think the industry needs to be a little more longer-term thinking. We seem to have a very short attention span and horizon. And I think so much of the trading in our stocks, our shares today, not just us, but everybody is programmed by computers. And everybody's got really good news today, yesterday, next week with the share prices are going down. Pretty hard to figure that out. I mean, Everybody just woke up to the fact that the comps are going to get tough next year. I think the industry continues to innovate. I think the way we build houses has to change. Homes are really built pretty much the same way they were built 40 years ago. We don't control our labor. We're dependent on trades and contractors. We've got to figure out how to control our own debts anymore. I think there's a lot of innovation coming on the sales side. We've seen a lot already. There's probably more coming. There's a lot coming in the back office on how we manage the financial functions of the business. So I'm excited to see where this is going to go. And I think it's going to be fun. It's going to be interesting, and I think Phillippe and his team are going to do a phenomenal job. Me, I'm going to be fishing for a while, but I'll still be around and I'll still be on these calls and keeping in touch and leading the board and working with Phillippe on our long-term vision and our strategy. I'm so excited for my own future, and I'm excited for the company's future as well. Appreciate your support, Jaden, and thanks for the question.

Thank you very much.

Okay. Thank you. That wraps up our call today. We'll look forward to talking to you all at the end of our fourth quarter. We should have our earnings released at the end of January, and we'll talk to you then. Take care. Thank you. Thank you. Bye.

And that concludes today's conference. Thank you for your participation. You may now disconnect.