Lennar Corp (LEN) 2020 Q4 法說會逐字稿

Welcome to Lennar's Fourth Quarter Earnings Conference Call. (Operator Instructions) Today's conference is being recorded. If you have any objections, you may disconnect at this time.

I will now turn the call over to Alexandra Lumpkin for the reading of the forward-looking statement.

Thank you, and good morning. Today's conference call may include forward-looking statements, including statements regarding Lennar's business, financial condition, results of operations, cash flows, strategies and prospects. Forward-looking statements represent only Lennar's estimates on the date of this conference call and are not intended to give any assurance as to actual future results. Because forward-looking statements relate to matters that have not yet occurred, these statements are inherently subject to risks and uncertainties. Many factors could affect future results and may cause Lennar's actual activities or results to differ materially from the activities and results anticipated in forward-looking statements.

These factors include those described in yesterday's press release and our SEC filings, including those under the caption Risk Factors contained in Lennar's annual report on Form 10-K most recently filed with the SEC. Please note that Lennar assumes no obligation to update any forward-looking statements.

I would like to introduce your host, Mr. Stuart Miller, Executive Chairman. Sir, you may begin.

Great. Good morning, and thank you, everyone, for being here. This morning, I'm here in Miami, once again, scaled down and socially distanced crew that includes Diane Bessette, our Chief Financial Officer; Dave Collins, our Controller; Bruce Gross, the Chief Executive Officer of Lennar Financial Services; and of course, Alex, who you just heard from; Rick Beckwitt, and Jon Jaffe, our co-Chief Executive Officers and Co-Presidents are joining us from Colorado and California, respectively. And they're on the line and will participate as well.

We're going to attempt to keep our remarks brief in order to have plenty of time for your questions. I'll give a brief macro overview and perspective. Rick will talk about land and community count. Jon will talk about sales, production and construction costs, and Diane will give a more detailed financial overview with highlights and with guidance. Then we'll attempt to answer as many questions. (Operator Instructions)

So with that, today, I'd like to start by thanking the coast-to-coast associates of Lennar for extraordinary work in an extraordinarily challenging year. We started 2020 with great expectations in an expanding market, which came to an abrupt stop with the unexpected arrival of COVID and then left back into high gear to address the market with unusually strong demand that was desperate for a home, a refuge and a brand-new concept, the hub of everyone's life. The associates of Lennar adapted and adjusted, learned new ways to interact and to transact; work from home and put people first; cared for our communities across the country with acts of kindness and acts of charity; and on top of all of this, turned in pristine fourth quarter and full year 2020 results that are perfectly aligned with our company strategy and once again positioned Lennar as America's most profitable homebuilder.

Diane, Rick, Jon and myself have the privilege to prevent -- to present their results, and additionally, to guide with great confidence the expectations for another excellent year in 2021. As a macro overview, let me say that the housing market is simply very strong. And demand for homes, new and existing, is greater than the limited supply. It has simply never been this easy to sell as many homes as we would like in every market and every price range across the country. The American dream of homeownership is once again an essential aspiration of the American population and the resolution of the current pandemic will not slow the growing demand. Low mortgage rates and ample deposit money from savings, from vacations not taken, movies not seen, restaurants not visited and, of course, stimulus dollars from the government are driving customers to purchase a home, a larger home, a home with a yard, an office, a nicer kitchen and a place to call their own.

Apartment dwellers can afford a first-time home, and demand is strong and growing. The iBuyer participants led by Opendoor and early Lennar strategic investment are providing a liquid marketplace to sell and purchase entry-level homes with clean and safe digital engagement as they evolve and provide frictionless transactions. With constrained supply, entry level and workforce homes are trading faster and prices are moving higher. This enables yesterday's first-time buyers to sell for higher prices and more accumulated equity than expected, enabling them to seek and ultimately purchase larger, more spacious homes for their growing families and pushing demand and prices higher in those ranges as well, thus enabling second-time homebuyers to do the same. The positive demand Fed pricing cycle with far less friction has been activated throughout the housing market.

The underproduction of homes for the past 10 years has created a housing shortage. And with strong demand, the home prices are moving higher. Demand is growing as the millennial generation, which postponed family formation over the past 10 years, has pivoted quickly and is making up ground towards traditional family formation trends. Concurrently, the proposition of home as more than shelter is becoming a hardwired way of life rather than a COVID-driven reaction.

While these trends are exacerbating the well-documented affordability crisis across the country as workforce housing is limited and getting more expensive, the solution it seems will be in growing supply by building more housing. We are starting to see exactly that trend in this morning's ramp up -- in the ramp-up with today's starts and permits numbers, but we still have a lot to make up. These conditions have given rise to strong though controlled sales pace, pricing power, very strong gross margins, even stronger net margins, managed costs and the challenge of land scarcity.

As it relates to Lennar's strategy in the current environment, we have controlled sales pace and matched it with production and our valuable land position. Our 16% sales growth is matched with and reflects our production and delivery pace while we increased starts 28% over last year, accelerated land development and began purchasing additional land for the future as we look ahead for sustainable growth over the next years. Of course, along side our homebuilding team, our financial services group has contributed exceptional earnings while creating an ever-better customer experience.

While some had question our controlled and managed sales pace, the virtue of our strategy has been borne out by our 25% fourth quarter gross margin, our 17.4% fourth quarter net margin, our $2 billion fourth quarter homebuilding cash flow and our almost $2.5 billion bottom line for the full year. Additionally, our expected, sustained and orderly growth in 2021 continues the story for the future. As we noted last quarter, we are expecting historically strong margins for the foreseeable future and throughout 2021, and we expect our bottom line to grow faster than our top line.

quarter, we are expecting historically strong margins for the foreseeable future and throughout 2021, and we expect our bottom line to grow faster than our top line. With confidence, we expect to deliver between 62,000 and 64,000 homes in 2021 with between a 23.75% and 24% gross margin as compared to the 22.8% full year gross margin in 2020. In the first quarter of 2021, we expect to deliver between 12,200 and 12,500 homes with a 23.5% to 23.75% gross margin. Our program is rock solid, and you can expect the cash flow and returns on capital and equity will continue to improve as well. Diane, of course, will give more detail in her comments.

Let me briefly turn to our ancillary business divisions and our drive to focus on our core homebuilding and financial services business. While we continue to refine and grow our excellent ancillary business divisions, they are becoming a decidedly smaller part of the overall company picture. Retrospectively, we are very pleased that we sold our Rialto subsidiary some 2 years ago before we navigated the turbulence of this past year and enabling us to focus on our core business units. As noted in past conference calls, we've been working on strategies to better position our blue-chip multifamily platform called LMC, along with our emerging SFR, or single-family for rent platform, as well as our strategic investment in Fivepoint, our California land development company and our growing technology investments platform, which we call Lennox.

As a heads up, we are making progress on rationalization of these divisions. And we'll give greater clarity on our specific strategy as it is refined and become certain over the next 2 quarters. This resolution is no longer a long-term strategy but is more immediate as we focus on driving higher returns with less noise in our numbers from lumpy profits and losses.

In that regard, we expect Opendoor to begin trading as a public company in the near future, and we expect to record a cashless profit from appreciation in our investment in that platform, although we will not have an estimate of that gain until trading begins.

We will be required to record a profit on the day trading begins, but upward and downward movements in the stock will be recorded quarterly as quarterly marks and adjustments will flow through earnings. The company is not consolidated as we do not have a control position.

Opendoor pioneered the iBuyer space, and jointly, Opendoor and Lennar developed a seamless move-up program that today is becoming an industry standard. By coordinating and redefining the move-up buyer sale of their first home, while moving up to a larger home, the customer experience is becoming a frictionless, coordinated and joyful engagement. And of course, less friction means more transactions and more transactions at a lower cost to all parties involved.

Needless to say, our well-known technology initiatives have contributed meaningfully to our readiness for current economic and structural shifts while helping to improve our core business and drive our SG&A to a historic low of 8.1% for 2020.

Concurrently, our meaningful investments in technology companies have not only informed change within Lennar but are proving to be successful investments in their own right. Once again, we congratulate Opendoor on their successful migration from start-up to maturity to public company, and we welcome them in advance to the public market.

In conclusion, let me say that our results and our expectations for next year are solid in all respects, and they reflect our focused strategy to balance growth, margin, cash flow and returns.

Today and for the foreseeable future, the home is becoming more and more an essential way to live that we live and the quality of our lives. The home used to be just shelter. Now it's the hub of our entire life. It is our shelter and our multiple generation shelter. It is also our office, our gym, our recreation center and our school. It is WiFi connected, and it is automated. It is sustainable, and it is environmentally sensitive. It is both a healthy home and a health system. Home is where families thrive in the best of times and a refuge in the toughest of times.

At Lennar, we've never been better positioned financially, organizationally and technologically to thrive and grow in this evolving and exciting housing market.

With that, let me turn over to Rick.

Thanks, Stuart. As you can tell from Stuart's opening comments, the housing market is very strong. Our team is extremely well coordinated, and our financial results continue to benefit from a solid execution of our core operating strategies. Topping that list continues to be improving our returns on capital and generating increased cash flow. With that in mind, we have been laser-focused on increasing our percentage of option homesites and reducing our years supply of owned homesites.

During fiscal 2019, we set a goal to have 40% of our homesites controlled via options and similar arrangements by the end of fiscal 2021. At that time, our controlled position was about 25%. We entered fiscal 2020 with 33% of our homesites controlled and ended this year at 39%, a 600 basis point improvement.

On a nominal basis, this reflected an increase of over 15,000 option homesites during the year. This increase reflects the strength of our relationships with local developers and other strategic partners and their desire to work with us to increase our option position given our size and scale in our markets.

In fiscal 2021, we expect to continue to expand on our existing relationships and enter into new regional and national land platforms to further enhance our land-light strategy. Based on this progress, we are in excellent position to achieve our revised goal of 50% controlled homesites by the end of fiscal 2021. During 2020, we also made significant progress on reducing our years owned supply of homesites by 4.1 years to 3.5 years. This represented a reduction of over 22,000 home sites.

Based on this progress, we are on target to achieve our previously announced goal of a 3-year supply by the end of fiscal 2021. As expected, the combined impact of increasing our controlled position, reducing our own position and our strong profitability drove significant homebuilding cash flow. During 2020, we generated $3.8 billion of homebuilding cash flow, which enabled us to pay off $2.1 billion in debt, including prepaying all of our senior debt due in fiscal 2021. This drove a meaningful improvement in our balance sheet as we ended the year with $2.7 billion in cash, no borrowings under our $2.4 billion revolving credit facility and a homebuilding debt-to-capital and net debt-to-capital of 24.9% and 15.3%, respectively, both all-time lows.

As we continue to execute on our land-light strategy and if we achieve our 2021 improved year-end goals, we are positioned to continue to generate significant cash flow.

Now I'd like to spend a few moments talking about growth and community count. In fiscal 2020, our community count declined by 8%. This was driven by an accelerated pace of sales and deliveries in our active communities. A decision to get out of the lower absorption, higher price point and lesser performing communities we acquired from CalAtlantic and a delay in opening new communities as we pause development activities during the initial stage of the COVID-19 pandemic. Notwithstanding the 8% decline in community count, we achieved a 16% increase in new orders in the fourth quarter of 2020 driven by a 27% increase in sales per community. While part of that increase in absorption pace was driven by improved market conditions, part of it was due to the fact that we targeted acquiring larger, higher volume entry-level communities that can deliver more homes per month than smaller communities. As we continue into fiscal 2021, our growth will continue to come from a higher overall absorption pace as well as an increase in community count. In 2021, our community count should increase by about 10%, most of which will happen in the middle part of the year, which should put us in great shape for the back half of 2021 and provide continued growth for fiscal 2022. While we continue to be focused on increasing our community count, we are intensely focused on replacing our existing communities with larger, higher volume communities as this allows us to better leverage our overhead, improve our bottom line and increase our returns and our cash flow.

Before I turn it over to Jon, I want to echo Stuart's comments and thank all of our associates and our trade partners for an excellent year. Through your hard work and collaboration, we accomplished many great things in 2020, and we are in excellent shape to execute on our core operating strategies in 2021. I'd like to turn it over to Jon now.

Thank you, Rick, and good morning, everyone. Matching sales pace with our production pace has been a key strategic focus, has enabled us to drive excellent performance. By pairing production and sales, we have maximized margins and driven bottom line profitability. In the current environment, we've been able to maximize gross margin by systemically containing construction cost even while there's upward pressure. Additionally, we've been able to manage our SG&A lower, thereby increasing our net margin and overall profitability. I would like to briefly describe our strategy, performance and expectations for sales, production and construction costs in order to shed some light on how the strategy has been central to our accomplishments this quarter and in fiscal 2020.

It begins with our time-tested everything's included program. So our trades and construction associates know exactly what they will be building, and our customers know exactly what they are buying. We work with our strategic trade partners, the value engineer, our plans and rationalized plan count and SKUs to continuously simplify the supply chain and construction process. This proved to be extremely valuable in the current COVID-disrupted supply chain environment. Virtually every manufacturer in our industry has had some level of disruption at the manufacturing facilities due to COVID.

Next, we focus on being disciplined and consistent about executing the most efficient production-oriented machine in the homebuilding industry. The execution begins with setting even flow production rates at each community determined by a specific start pace and a product-based cycle time template, which we call level scheduling. This pace can be adjusted upward or downward as the market requires.

A start and production plan for forward planning is then communicated to every one of our trade partners so they can plan for labor and material needs and efficiently deploy people and provide materials and products as needed. This forward communication and coordination drives efficiencies that do not exist in a more erratic and less predictable sales-driven model. By leading with a production-first process, we were able to quickly increase our start pace after pausing production in March and April to understand the impact of the pandemic in Q2. We were able to evaluate the improving market conditions and quickly increase our even flow production to achieve an average start pace of 4.3 homes per month per community in Q4, which was up from 3.4 in Q4 of '19, a 41% increase in pace. We expect to increase that pace to 4.5 homes per month per community in the first quarter and to maintain that pace throughout the year.

We then match sales at the community level to the community's production pace by using pricing and incentives to determine the exact market pricing for that pace and efficiently match sales to the pace of production. In other words, our sales pace is defined by our desired maximum efficiency production pace, not by momentary changes and market conditions.

The sales process is also disciplined and simple and is best described as FIFO, or first in first out. The first home started in each community is the first home sold, and we move right down the line, plan type by plan type, avoiding selling too fast for our production pace by restricting what is available for sale through the management of our FIFO approach.

By selling homes in the same order of our starts, we manage the business to have our homes sold in time to -- for our customers to receive their mortgage approvals prior to the home being completed. Additionally, in today's robust selling environment, this disciplined approach allows us to maximize our pricing power to increase both margins and cash flow, and we end up carrying very few completed homes on our balance sheet.

In Q4, this approach drove our 25% gross margin, and we ended the quarter with 0.7 completed inventory homes per community or just 776 homes for the entire company as compared to 1.6 homes per community or 2,086 homes in the prior year. Balancing our sales pace with our production pace also helps reduce SG&A as fewer inventory homes helps lower our broker spend while creating greater efficiencies in our divisions through the even flow of sales, starts and deliveries. More importantly, this balanced and predictable program is key to being builder of choice for the trades and to very effectively managing costs in a market defined by labor shortages and cost pressures.

In conclusion, our strategy of a managed approach to production and sales pace certainly proved its value in the back half of 2020. As we look to next year, we are certain that we will continue to drive higher gross margins, lower SG&A, higher net margins and a stronger bottom line as a direct result of this carefully managed strategy.

I also want to add my thanks to all of our associates and trade partners for all of their great focus and hard work in the year like no other.

I'll now turn it over to Diane.

Thank you, Jon, and good morning, everyone. Although you've heard some of our financial results from Stuart, Rick and Jon, I'll begin by recapping certain of our Q4 2020 highlights and then provide guidance for 2021.

So let's start with the balance sheet. There are 3 areas that I want to touch on: inventory, cash flow and debt.

So starting with inventory. We executed on our strategy to become land lighter, improve returns and generate increased cash flow. At quarter end, we owned 187,000 homesites and controlled 119,000 homesites. This resulted in our year supply owned decreasing to 3.5 years from 4.1 in the prior year and our homesites controlled increasing to 39% from 33% in the prior year. We continue to make progress in reaching our goal of 3-year supply owned and 50% homesites controlled by the end of fiscal '21.

And then turning to cash flow. We generated $2 billion of homebuilding cash flows for the quarter and $3.8 billion for the year. Our confidence in our operating platform and ongoing cash flow generation enabled us to increase our annual dividend payment during the quarter to $1 per share from $0.50 per share. This increase is one component of our overall strategy of focusing on total shareholder returns.

And then looking at debt. We continue to make progress with our strategy of reducing our debt balances and leverage ratio. Our strong cash flow generation enabled us to pay off $1.2 billion of debt during the quarter and $2.1 billion during the year. The fourth quarter included the early redemption of all senior notes, which was approximately $900 million that were due in fiscal '21.

With that payoff, we now have no senior note maturities until fiscal 2022. These actions, combined with our increased equity base, resulted in a year-end debt to total capital ratio of 24.9%. This is the lowest debt to total capital ratio we have ever achieved.

And just a few final points on our balance sheet. Our stockholders' equity increased to $18 billion from $16 billion in the prior year, and our book value per share increased to $57.55 from $50.49 in the prior year.

And finally, during the quarter, we were pleased to be upgraded by Moody's to an investment-grade rating. This rating joins the investment-grade rating previously received by Fitch.

So in summary, our balance sheet is very strong, and we will continue to remain focused on generating long-term returns for our shareholders.

And so with those balance sheet highlights, let me now briefly review our operating performance, starting with homebuilding.

For new orders, we ended the quarter with new orders of 15,214, a 16% year-over-year increase. And as we focused on matching sales and production, our new order dollar volume was $6.3 billion, up 22% from the prior year. Our sales pace was 4.3 for the quarter compared to 3.4 in the prior year. We ended the quarter with 1,177 active communities, and our cancellation rate was 12%.

For the quarter, deliveries totaled 16,090, down 2% year-over-year. This was largely a result of the production loss to COVID-19 earlier in the year. Our gross margin was 25%, up 350 basis points from the prior year. This was a result of strong pricing power, which allowed us to increase sales prices and our continued intense focus in construction costs. Our SG&A was 7.5% as a result of creating an efficient operating platform and continuing benefits from technology. This is the lowest quarter SG&A percent we have ever reached.

This resulted in a net margin of 17.4% for the quarter, which is the highest quarter percentage ever achieved. And our financial services team also executed at high levels, reporting $151 million of operating earnings. Mortgage operating earnings increased to $125 million compared to $57 million in the prior year. Mortgage earnings benefited primarily from an increase in volume through a higher capture rate of increased deliveries, 81% versus 78% last year and a lower percentage of cash buyers combined with an increase in secondary margins. Title operating earnings were $28 million compared to $23 million in the prior year. Title earnings increased primarily due to an increase in closed orders and a reduction in cost per transaction. LMF Commercial had operating earnings of $1 million compared to $3 million in the prior year due to lower securitization volume.

And with that brief overview, now let's turn to guidance. I'll provide -- I'll first provide detailed guidance for the first quarter and then some high-level guidance for the fiscal year, starting with homebuilding. We expect Q1 new orders to be in the range of 14,500 to 14,800 homes and our Q1 deliveries to be in the range of 12,200 to 12,500 homes. Our Q1 average sales price should be around $390,000. We expect our Q1 gross margin to be in the range of 23.5% to 23.75%. Note this margin is lower than Q4 2020 due to the normal seasonal pattern. As a reminder, we expensed field costs in the current period, so there is typically a headwind to Q1 gross margin as compared to Q4 gross margin due to the lower homebuilding revenues in Q1. We expect our Q1 SG&A to be in the range of 8.9% to 9%. And for the combined homebuilding joint venture, land sale and other categories, we expect Q1 earnings of approximately $5 million. We believe our financial services earnings for Q1 will be in the range of $110 million to $115 million. And for multifamily operations, we expect a loss of approximately $2 million to $4 million.

For the other category related to the legacy Rialto assets and our strategic investments, we expect Q1 earnings of approximately $5 million. We expect our Q1 corporate G&A to be about 2.1% to 2.2% of total revenue. The first quarter contains certain front-loaded expenses that will not occur in the remainder of the year. Our corp G&A expense for the year should be consistent with fiscal 2020. We expect our tax rate to be approximately 25.3%, and the weighted average share count for the quarter should be approximately 310 million shares. And so when you pull all this together, this guidance should produce an EPS range of $1.64 to $1.74 per share for the quarter.

And now turning to the full year fiscal 2021, here are a few high-level guidance points. We expect to deliver between 62,000 and 64,000 homes with an average sales price for the year of approximately 386,000 to 388,000. Our fiscal '21 gross margin is expected to be in the range of 23.75% to 24%. We expect continued price appreciation and leverage from field expenses throughout the year, somewhat offset by higher lumber and other anticipated cost increases. Our fiscal '21 SG&A should be in the range of 7.8% to 8%, and we expect our community count to grow 10% by the end of the year. Financial services earnings should be in the range of $400 million to $425 million, and we expect our tax rate to be approximately 25.3%.

And finally, before I turn it over to the operator, I'd like to say thank you to the accounting and planning teams whose hard work and focus enabled us to hold our year-end conference call today, December 17, 2.5 weeks after year-end. Thanks to all of you, it is very much appreciated.

And with that, let me turn it over to the operator for questions.

(Operator Instructions) Our first question comes from Stephen Kim with Evercore ISI.

Congratulations to everyone for your strong performance. And your guidance was also extremely interesting for us. Many aspects of the guidance were very, very positive. And the one area that I was curious about, trying to gauge the level of conservatism that you've incorporated is in your ASP guide for closings. I observed that your order price, ASP rose almost 3% sequentially from the third quarter. That would seem to suggest that -- because I assume there was some mix shift in that, negative mix shift, I assume that, that means that like-for-like pricing is up about -- at least 1% per month in the quarter. And I was curious if this level of like-for-like pricing accelerated throughout the quarter or not. And if so, if you could provide a little bit of color on the closings ASP guidance, which I think is looking for a decline. I assume that's mixed, but I just wanted to ask the question.

Yes. Steve, I'll answer that. So a couple of points. If you look at the ASP and new orders for the third quarter, remember, some of that did close in Q4. So that was part of the ASP in Q4. Additionally, if you look at the ASP in backlog, which is around that same range, note that the number of homes in backlog is about 30% of the midpoint of our guidance. So the point there is that while some of that will bleed through, there are other communities coming on and quite a few during the year or those that have not started producing new orders yet that are lower down the price point as we continue to really focus on affordability. And so while what you're seeing is a small snapshot of what you'll see in the quarter, there are other pieces -- I'm sorry, a small snapshot of the year, there are other pieces that will migrate that price down.

Got it. Great. Could some comment on the like-for-like pricing that we saw in the quarter. I would assume that you probably saw at least 1% per month. Can you give us some color around that?

Yes. I'm not sure we're going to give a percent, Steve, but we did see like-for-like pricing throughout the quarter.

And did it accelerate at all, Rick?

It was a gradual increase through the quarter, Steve.

But let's just say, Steve, you're clearly seeing pricing power. So when you look at like-for-like, you're definitely seeing acceleration as we went through the quarter. Just remember that we are -- we have been focusing on entry level a little bit more, although that upwards spiral and demand entry level giving to move up and move up to second move-up is taking place at the same time. So we're balancing our product offering. So everything that you're seeing is part of averaging, including the like-for-like increases that were clearly seen through the quarters and as we go forward.

Great. That's kind of what I was looking for. Second question relates to capital allocation. It seems clear from your opening remarks and just the results, the company is moving to a higher level of profitability here for the foreseeable future with controlled land spend and an already pretty under-leveraged balance sheet. Meanwhile, you got the multifamily and the other ancillary business platforms that seem to be, if anything, nearing a harvesting stage.

So bottom line, the question of what you're going to do with all this cash flow and the cash that you're going to be having is becoming very relevant. You already retired a lot of the debt that we had coming up. So how should we be thinking about your plans for capital allocation? And specifically, I'm curious as to how you think about the appropriateness of a stock buy back -- an increase or an acceleration in your stock buyback program?

So let me start by saying thank you for pointing that out because that's exactly what we're focused on. I hope you're hearing a great deal of confidence in our operating platform and what we think is going to happen with our profitability and our cash flows and our migration and land position through 2021 because it does suggest and indicate that our cash position will continue to accelerate.

So the starting point in our office here is to focus on total shareholder return. And I think that we are laser focused on thinking about -- and you've seen the beginnings of that with the increase of our dividend. We weren't shy about that. We recognize the cash flow that we were seeing in its direction. And we made a migration in dividend last quarter. You've seen that we have accelerated some of our debt reduction, which only tends to delever the company. And some might say that we're under-levered. We're not apologetic about that. But at the same time, the cash flow that we are witnessing gives us a myriad of opportunities together with our ancillary businesses to think about how we generate higher returns.

As I said in my comments, you're going to hear more about this over the next couple of quarters. But a stock buyback is clearly not off the table, and it is something that we're looking at as we look at how we generate higher returns as we move forward. But I hope you're hearing that there's a great deal of confidence in our earnings and cash flow picture right now.

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

Congrats on the really strong results, and glad to hear everyone's doing well on the line there. Stuart, I apologize, my audio cut out for a minute or 2 during your comments. So if you addressed this, I apologize. But a few years ago, you kind of threw out a longer-term growth target of, I think, it was about 5% to 7%. And part of that, I think, was where you maybe saw the market going. But I think more of that was just where you felt the business was most efficient in terms of growth over a longer time period.

And I'm curious based on kind of some of the guidance you've given for next year, it sounds like you're ramping your production to 4.5 starts per month, which would imply something well in excess of that type of growth level. And I'm just curious, based on what's transpired this year with COVID and some of the demographic tailwinds that you're seeing, whether that target range has shifted higher and you think that perhaps the business can grow efficiently at perhaps a little bit of a stronger growth rate than that?

Good. Fair question, Alan. The reality is that in an orderly growth market, as we were witnessing going into 2020, we felt that the appropriate growth level, and given our cash flow and returns focus was in that -- it was actually 4% to 7% range. But as COVID came into the market, paused us and then accelerated the housing market, production levels and the needs of the homebuilding business, in general, have accelerated rather dramatically. And we have clearly adjusted our growth targets.

So what you're seeing for next year is between a 15% and 20% growth rate that we've embraced and we are focused on going forward. And we are continuing to use market-driven indicators to define our growth rate as we go and work towards 2022. If you look at the indicators right now, we're probably on target to be growing at a similar rate for 2022. So you'd have to put aside that 4% to 7% range because we're going to have to find a way and the industry is going to have to find a way to grow at an accelerated pace as we are supply constrained. And the market is just calling on the homebuilders to produce more and to produce more affordable housing. So we are part of that picture. You saw it in starts and permits this morning, a surprise to the upside. We're starting to get to that 1.5 million level production. It's probably weighted a little bit more towards multifamily right now, but single-family seems like it's going to follow suit. And we're just going to need more dwellings in the country. The appetite for housing is accelerating.

Alan, this is Jon. I'd also would add to Stuart's comments that as we focused on simplifying our product offering and our production machine, it's also enabled us to really keep what we view as a maximum efficiency level at a higher pace. We're doing this with smaller product, lower price point and just an overall more efficient production operation.

I appreciate both of your comments there. And I think it dovetails a little bit into my follow-up, which is your strategy this year, I think, has certainly been extremely prudent, and you're seeing the benefits of that on your gross margin. And Jon, I appreciate all your comments about the -- kind of digging into the weeds a little bit on the moving pieces there on maintaining that consistent production level.

On the other side, some of your competitors have been much lumpier in terms of their growth rates. And I think as we look at the backlogs across the industry, for example, and what's poised to be a huge step-up in production in order to satisfy that demand, it kind of feels like there's going to be some stress on the supply chain as we roll into '21. And while you're managing your business effectively, do you anticipate any repercussions from that? What I'm really thinking about is labor inflation, potentially the dynamic we saw a few years ago where builders were kind of stealing trades off of each other's job sites to get homes built and delivered on time. Do you think there's any risk to your business as a result of what you're seeing from other builders right now?

Alan, I think there's no question, as I mentioned in my comments, that the environment we're in today is defined by labor shortage and pricing pressure. But you've heard consistently from us for many, many quarters now over the years about our focus on our builder of choice strategy. And that's holding us in really good stead and being able to coordinate forward plan with our strategic trade partners and to really manage and offset the cost increases that are out there in the environment. And more importantly, the predictability of our labor needs and be able to think way ahead with our trades as to those needs so they can properly plan and be ready for us.

Let me add and say that what you've seen from us is a very steady hand, steady through the noise. Other builders have produced higher growth rates and sales paces. We've stayed focused on our business plan, our strategy. And I think it's a steady program that enables us to maximize the engagement with the supply chain and to remain consistent. And I think that Jon and Rick have been a steady rudder through those waters. And I think it's going to continue to reflect on strong bottom line, strong cash flow and a lot of predictability.

Our next question will come from Carl Reichardt with BTIG.

Stuart, I had a sort of bigger picture question for you is as the vaccine -- the COVID vaccine is distributed out and moves through the country, hopefully, quickly, I think we might anticipate some shift in consumer expenditures back to all the things so many consumers have not been able to buy and do for the last year or so. Are you anticipating if that happens for there to be a negative impact on expenditures on housing? And if so, how would you recognize and react to that?

No. Well, first of all, I do hope that there is going to be a shift back to the restaurants and the movie theaters and the vacations. I think that a robust economic recovery requires some of that reversion to normal lifestyle. So I'm optimistic that there will be a kick back to normalcy. But I don't think that, that's going to have a negative impact. I think it's going to have more of a positive impact on the housing market.

I think that interest rates are low and they're going to remain low. Stimulus money will come through the government. I believe that it will, can't prove it but I think so. And I think that a stronger economy and a broader-based strong economy is going to be better for housing. I think that the current strength in the housing market derives from both the millennial generation really kicking into high gear and family formation. And frankly, in an awkward way, COVID has facilitated that accelerating. And then, of course, the COVID-driven recalibration for how people are using their homes, I think there will be some stickiness to some of the habits changed.

So I think, overall, we've all learned some new habits and some new customs and tricks, but I think a lot of it revolves around having the home of your choice and having your home be the hub of your life. And so I'm pretty optimistic about where the housing market is over the next years.

Remember, Carl, that over the past 10 years, we have been under-producing housing. And we're going to have to make up ground there. So for the foreseeable future, I think we're going to see strength in the housing market.

And then Jon or Rick, can you talk a little bit about the evolution of the FIFO inventory release matched to sales? And I'm kind of curious if that's becoming more of a help to governing your sales rate than just raising prices to try to slow sales down. It was an interesting walk through, Jon. I'm just kind of curious how it's evolved. And if it's company-wide and how it's working to maximize margin and pace at the same time.

Sure. I'd be happy to address that. So our FIFO pricing and sales strategy is not something new or COVID-related. We established this process in one of our divisions out West, in Reno, and really fine-tuned it and saw its effectiveness in not just maximizing pricing power, but really creating efficiencies throughout the process that affects every part of what we do. We actually rolled it out at a division presidents' meeting about 2 years ago and started with some pilot divisions, saw its effectiveness in all different types of markets and have rolled it out throughout the entire company. So this exists in every one of our divisions. And to your point, is it just about maximizing pricing power by having a limited number of homes available, it really allows us to very carefully manage and match that sales pace to production pace and to be very forward-looking about any adjustments that we need to make in pricing and incentives up or down as the case might be to very meticulously manage that pace. And it just creates consistency and even flow that affects earlier G&A levels to be leveled instead of having to be positioned for peaks and valleys.

Our next question comes from Truman Patterson with Wells Fargo.

Let me add a nice results as well. So question on cash flow. You all generated $3.8 billion in builder cash flow on net income of only, I think, $2.4 billion this year. When we're looking out to 2021, how should we think about the free cash flow conversion of net income? And clearly, there are likely a handful of moving parts between continuing to bring down your own lot supply, reinvesting in option land, et cetera, and possibly rebuilding some of that spec pipeline. Hoping you can walk us through some of the moving parts there.

Yes. So I'm going to ask Rick to weigh in on this. But before he does, let me just say that we've learned that there are some tricky parts of the calculation and the guidance that we can give, and we recognize that cash flow is one of those. Growth at a higher level is a headwind to cash flow. The migration of land from owned to controlled, a greater percentage and a lower year count is a tailwind to cash flow. So we've been careful not to lay out -- because the parts will move around to lay out specificity. But go ahead, Rick.

So I'm not going to answer that, Stuart. That's a mouse trap. I guess, all I would say is as we continue to morph and execute on reducing the years owned and that gets into option, there's no doubt that, that is a significant generator of cash. And the unknowns, as Stuart has identified and as you have appropriately pointed out is as we build the level of inventory to ramp up to that 62,000 to 64,000 home delivery pace, that's a reinvestment of cash. And so there's a lot of moving pieces in here. And I'm sure Diane will give you more color on this in the follow-up call.

But look, let me say this, as we look ahead to 2021, we have a great deal of confidence that our cash flow is going to be very strong. You're absolutely right. This past year, we earned just under $2.5 billion net income and drove $3.8 billion in cash flow. Some of that is migration of our land strategy. That land strategy is going to continue through 2021. So we're fully expecting that we're going to have very strong cash flow through the year, but we're not guiding in specificity.

Okay. Okay. And just real quickly on that owned land supply, do you think you can bring it down below 3 years eventually?

I think that if you look at where we started at over 4 and the transformation that we've had in a very short period of time, we're really enthusiastic about getting to 3. And we're just going to have to see how low we can get it. There's definitely a possibility to get it below 3. Definitely a possibility. But there's a balance because we have some markets, particularly the Western markets that in order to be a big, large player in those markets, you have to self-develop. So Jon has done a great job -- Jon and the team have done a great job in working through and creating some very unique structures to help us get there. And so I would just say stay tuned.

And I think the laser focus of the management team is to think about land and the system around land as a just-in-time delivery system, and we are going to get closer and closer to that aspiration.

Okay. That's very helpful. Second question on gross margins. You all focused on driving pricing to kind of cap absorptions and cover the FIFO costs, if you will, more than the other builders. And clearly, based on your gross margin guidance, it appears your homes are selling at a premium in the market. This might be hard to quantify or a bit of an unfair question, but is there any way you could possibly quantify what magnitude your homes might be selling at a premium? And as we move forward, as kind of market conditions potentially normalize, where there's a bit more balance between supply and demand, do you think that premium potentially shrinks over time?

I don't think it's so much a premium as I think it's an orderly process that is driving the average higher. And so I think we're competing in a market where customers understand what the value proposition is. I think it's just process-driven that we are just driving a higher sales price by an orderly process of production and sales.

And so I wouldn't think of it as a like kind premium. If you go out to the market and look at our 1,500 or our 2,000 square foot home next door to someone else's, I think it's just a matter of process.

And I think our product strategy, our everything's included program makes it much easier for our customers to make a buy decision because they don't have to make any choices. And that's a big differentiator.

And I would just briefly add that if you think about our FIFO strategy, we price to market what the market will bear, not to what our competitors are pricing.

Our question comes from Michael Rehaut with JPMorgan.

Congrats, everyone, and glad to hear everyone's doing well. And congrats to Allison as well, Allison Bober. Great to hear the news there. First question, just around gross margins. Great success there and a real realization of the price-over-pace strategy or steady pace and driving price. Wanted to delve in a little bit to, if you can kind of break down the upside in the 4Q results, where that came from, if it was more just better-than-expected pricing power during the quarter or mix.

And then as you look into '21, it seems like your -- the guidance would imply 4Q margins down year-over-year as we get towards the end of the year. And I just didn't know if there was any conservatism there, and you had mentioned lumber and maybe labor inflation. But historically, when you're in an inflationary cost inflation environment, you're able to at least offset that with future pricing power oftentimes, as we've seen in the past. So kind of a 2-parter there. Again, first, drivers of the 4Q upside; and then how to think about margins in particularly the back half of '21.

Rick?

So I guess I'd say with regard to the overall gross margin guidance for the year and the trajectory through the year, I'd really like to start off by pointing out that there's a huge -- over 100 basis point year-over-year increase in the gross margin guidance. And there certainly are some things that are impacting the margin as we work through it. One is lumber did increase pretty dramatically, and we're now in the throes of dealing with that, although we've done a great job in offsetting -- raising prices.

The other driver is the overall increase in our option deliveries. By increasing the share of option versus controlled, we have the tendency to have a little bit lower margin -- gross margin on that because someone else is taking the risk of owning that land. And so I don't think you'll see quite as much drive throughout the year as we've seen in the past because of those 2 things.

And then on the 4Q upside?

Yes. I think there's an adequate amount of conservatism as we look out 4 quarters. We're going to have to wait and see how the pricing power plays through. And so I think we tried to give a lot of detailed guidance and some directional guidance for the -- detailed guidance for the first quarter and directional guidance for the year. And as Rick notes, our averages for the -- our average for the year is 100 basis point improvement, which is sizable. We'll have to see how pricing power meshes with production costs.

Mike, and I probably would just add on Q4 2020. It was -- if you look on a per square foot basis, it was equally split with increase in the ASP per square foot with -- combined with equal decrease in construction cost per square foot. So pretty balanced between the both of them.

Okay. Appreciate it. And secondly, Stuart, I heard in, I was paying attention here, in one of your answers, addressing closings growth for '21, and I believe it was talking around prior kind of growth outlooks in maybe mid-single-digit area. Now we're looking at 21% and 15% to 20%. I believe you had said that you could do a similar growth rate in 2022, which is, at this point, also solidly above consensus estimates and where the Street is and probably most investors. I just wanted to revisit that comment.

And if that was talking more just to your production potential and what you think you can kind of further drive through your infrastructure or based on community count growth and your shift to higher turning -- or I'm sorry, higher volume communities that this is more of a 15%, 20% growth rate based on, again, your community count pipeline. And obviously assuming a continued, steady or improving market, you indeed are looking at something of a higher -- just higher growth rate continuing into '22. Just wanted to get a little more definition on that comment.

Well, listen, Mike, let me start by saying thank you for listening carefully to the things that I say, not everybody does that. And I just want to appreciate the fact that you were listening carefully.

So you're exactly right. I said what I said and I said what I meant. If you think about what we have daylighted in the entirety of the call today, we have daylighted an expectation that our community count will be growing through 2021. We have daylighted that we are focused on more productive, larger communities producing higher volume rather than smaller incremental communities. We have daylighted that some of our community count has dissipated as we have worked through some of the smaller, less productive CalAtlantic communities and close them out.

We have daylighted our matching of production together with our sales pace and migrating our production pace upward over the course of this year, over the next quarter even. We are ramping up not just our productivity per community, but the style of community that we're intending to purchase.

And if you kind of bring that forward through 2021 and into 2022, you can't help but -- unless the market tells us and data tells us to hone down or turn down the spigot, you can't help but start to think and project forward that '22 will continue a growth trajectory that is somewhat similar. And we're building a greater confidence in our ability to look ahead and to do that, assuming market conditions remain strong.

Then going back to my comments in the opening, I think that if you think about the confidence that we're projecting about market conditions, thinking about a 10-year hiatus or production deficit that underlies the current market conditions and the general growing demand with limited supply for the foreseeable future, the market is asking us to grow at a greater growth rate, and we're building confidence that we're going to be able to meet that challenge. So you heard me right. Thank you for listening, and that's exactly what we intended to say.

Great. And I guess in closing, we'll say happy holidays to everybody. Thanks for joining our year-end call, and we look forward to updating in the future. Thank you.

Thank you. That does conclude today's conference. Thank you for participating. You may disconnect at this time.