Meritage Homes Corp (MTH) 2020 Q3 法說會逐字稿

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, Hanna. 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 2, 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, gross margins, SG&A expenses, tax rate 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 1 hour after we conclude the call, and will remain active through November 5. 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, 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 Meritage Homes on our earnings call. As we have previously announced, effective January 1, 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. During the past 5 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 Meritage 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 30, 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 4. 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 decade 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 5. 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 spec 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 the 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 instill the values, integrity and beliefs that live within each of us at Meritage 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 Meritage Homes story.

Slide 6. Now we hit on all cylinders during the 3 months ended September 2020. Our absorption pace for the quarter was up 94% year-over-year. 5 out of the 9 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 represents 60% of our average active communities during the quarter compared to 42% a year ago, which puts us near our target ratio of 65% and 35% between entry-level and first move-up.

Absorption in our entry-level communities were 75% higher than last year, and nearly 1.5x 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 community 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 happen across all existing geographies. We anticipate both continued strong sales demand and choppiness in our community count in the near future. We have wrapped up -- ramped up land investments 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 9 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 9 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 closing, we've 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, often several hundred lots at a time, targeting a 3- to 5-year community life even at an accelerated sales pace.

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 6 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 latter half of next year. At a pace of 50 sales per year, an average of 300 communities could regionally produce 15,000 sales in 2022.

Slide 8. Moving to the regional level trends on Slide 8. 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 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 representing 63% of the central region's average active communities during the third quarter of 2020.

Our orders 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 9 states we operate in, selling an average of 7 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 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 absorptions 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 9. 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 bps increase in home closing gross margin and a 70 bps 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 of revenue in Q3 2020 as our year-over-year increases in closing volumes, reflecting our record-high sales, more than offset the decline in ASP 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. Higher home prices more than offset record lumber costs.

The additional closing volume and the efficiencies achieved from our streamlined operations and national purchasing savings, contributed to a 31% year-over-year increase in total closing profit. As we have previously covered, 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 precut material were 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 70 bps improvement over 10.8% in 2019, due to greater leverage of fixed expenses and efficiencies and higher closing volumes 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 pension the energy tax credit into 2020 under the Taxpayer Certainty and Disaster Tax Relief Act enacted in December 2019. Our effective 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 a 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 bps increase in home closing gross margin and a 90 bps 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 experience 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 set up investments in land acquisition and development. We have plenty of liquidity, including $610 million of cash, nothing drawn on our credit facility and a lower net debt-to-cap in the lowest -- and the lowest net debt-to-cap in our company's history at 16.7%. 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 a heavy backlog 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 land and development this quarter, our highest spend in a single quarter in our history. For the first 9 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% auctioned.

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 uncertainties 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 billion 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, Meritage 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 products, 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 homebuilders, Meritage 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 pace. Layering the leverage of SG&A and streamlined operations on top of closing revenue growth, we are seeing some of the strongest results in Meritage'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 was the combination of the right strategy, ability to execute and the dedication of an 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 to 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 thank you -- 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 well I'll close 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?

(Operator Instructions) And we'll go first to Alan Ratner with Zelman & Associates.

First off, a big congrats to -- so I guess 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.

So I think the -- obviously, the big topic that everybody is focused on today is just this concept of, have we hit a point where builders kind of 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 the 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 of 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 of quarters. Obviously, it's going to be a little bumpy for us in the next couple of quarters, particularly, if these strong sales continue, which I don't see a reason why they won't. But 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 his section, we should be able to sell at least 15,000 homes in 2022. We'll have resource for it. And we're entering 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 serving versus when they get finishing, which is building our backlog.

In addition to that, we're really focused on trying to hit about 3,000 homes start -- 3,000 homes into the spec pipeline, I think we're at around 2,100, 2,200 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 if you're only looking for the next quarter or 2, it's going to be bumpy. But if you want -- 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, it's -- 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 in the shares as well. On the community count 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.

Yes. Obviously, with the ramp-up to 300 communities, you're talking about 30% growth in our community count even if the pandemic didn't occur. And so we have to add different layers to our organization to support that to support the higher scale of communities. So you can expect to see SG&A increase next year year-over-year. It's mostly going to be timed with the community openings. So I would expect that to happen more in the back half of the year than the first half of the year. We're always trying to be very mindful of adding 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 had 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 in the early to mid part of 2022. And maybe Hilla wants to add something to this as well?

Yes. So I think you guys know we have overhead in 2 different components, right? There's a portion of that lives in margin and a portion that lives in SG&A. Both of them, obviously, we're going to have to add headcount in 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. And great luck.

Thank you.

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

And let me throw out my congrats to everyone on the call as well. Now that Brent is officially retired, I've been trying to convince him to move to Phoenix finally. So we'll see what happens there. But first question, clearly, investors are focused on the 18% community count decline, which clearly -- you're a bit of a victim of your own success, really. But hypothetically, if the market's growing, orders in the market are growing at a 20% clip or a 25% clip in the first half of 2021, 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 can 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 or the first quarter of '22, but as I just 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 a 20% greater than it was in 2020. We had a pretty good January and February and 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 of 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. 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 bought a lot of lots. We're continuing to buy lots. We're not seeing resistance to finding lots that fit within our strategy. And we're going to be opening more communities next year than we ever have before. And I think that's 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 that maybe I'll 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 committee count number all in '22. So there will be a point in '21, and we're not giving a target for which quarter where we'll see a material increase in our community count in those communities come with a lot of spec already built on the ground at opening. You'll see the sales top 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 how we will enter the year, a lot of specs in the heavy backlog. And then at some point during the year, we'll have an inflection point where you're going to see everything kind of shift and really accelerate into '22.

And in addition to that, these new communities as they open throughout 2021, will be more heavily skewed to the entry-level to our LiVE.NOW. brand, which come with even higher absorptions than our move-up communities, so which will also propel the sales number as we get later into the year. Okay.

Okay. Fair enough. And then clearly, order growth of 70%, a lot of investors are focused on the 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 2 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 those cycle times extend?

We -- Phillippe anticipated that question. He's got a response ready on that.

Yes. 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 the 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 in 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, 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 challenges, but that's probably the most -- 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.

The first one on the gross margin outlook for 2020. I think that implies 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, I mean, 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?

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 21.5% 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 lots 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 will 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 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?

Yes. 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. That buyer just can't get qualified in a conventional loan. So that's really the governor.

So we have a little -- we definitely have some opportunities to continue pushing in some places because we're still well below FHA. In other places like Phoenix, we're getting there. And there's not a lot of opportunity and upside there. So it's market by market. It's community by community. It's also what the competition is doing. 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 pace in today's market. As we move into next year, there is absolute governor out there that will limit us pushing it much further.

(Operator Instructions) We'll go next to Stephen Kim with Evercore ISI.

Well, yes, we're going to miss you, Steve and Brent, but you know what, we look forward to still seeing you, Steve, on -- or hearing you on the call 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 1.5 years or so, these were 2 aspects of your product mix, which we thought was -- 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. It 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 -- not exactly the entry-level, but maybe the move-up segment of the market, but 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?

So there -- Steve, thanks for the kind words. First of all, I'll miss you guys, too, but I'll still be around. There's synergy in all segments of the market right now. I think you're hearing that from other builders. There's a builder right before us today. They have phenomenal results. I think there's synergy at all price points. And I think the low mortgage rates and the fact that people are spending more time 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-priced zip codes. It's like I've never seen before in my entire career.

Studio M works well for us, are the margins higher than LiVE.NOW.? Maybe a touch, not really, but the margins we're getting at 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 building -- we're chasing bigger deals, 200, 300 lots, 400 lots, 500 lots 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 2, 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 could be in a community a little bit longer, it's better on the bottom line. And it 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 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 a few in California this year to increase our community count there for sure.

But 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? I think 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?

We haven't given guidance into '21 yet. I think you're pretty much spot on. We didn't give specific numbers, but between $1 billion and $1.2 billion is a good expectation for full year 2020. So you kind of do the math, we were at $760 million year-to-date. Obviously, we had a pause for 6 weeks there in the year, so we're going to 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. 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 improved a lot in October. And we're just really excited about these deals and the quality and the contribution they're going to make.

Yes. That's great. Phillippe, 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 little close. I just wanted to clarify something, the FHA loan limit generally rises once a year, right? And it usually rises pretty much -- you'll hear about it. I would think in a couple of months or something or a month or 2. 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 than issue later in the years generally. Is that not right? Am I thinking about that right? So you're -- 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 Phillippe?

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 that. 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 -- this year, we're up 9% or 10% already. And most places, FHA loan limits are around 300 or low 300s for us. So prices are up $25,000 on entry-level products across the board, with the FHA loan limit is still lower for last year. Now we'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 I have fully articulated a couple of times already that we stay inside that number.

Yes. 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 2 years ago. That's why we kind of have this a 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.

And the lower you go on the price points the stronger the demand is. I would say, we have communities under $250,000 in some places. It's almost unlimited. We could sell -- we could sell as many houses as we wanted to do as fast as we wanted to at some of these lower price points. It's just about -- it just comes down to production. And putting the products on the ground.

Yes. And with the forced savings that everyone's had to do because there's nowhere to below all of our money. 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.

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

Okay. We will see you later. Thank you.

We'll go next to Carl Reichardt with BTIG.

I only have 1 question, but just a comment, Steve, congratulations. And 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. Hope you write a book. It really is -- it's been a remarkable what's happened in this company the last several years. You deserve a lot of credit for that.

Thank you.

Yes. Brent, congrats to you too. I'm modeling a better backswing for you. That's what I mean. It can only get...

I am so happy that I am going fishing.

And welcome to 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 metros or states where you think you can really drive LiVE.NOW. penetration and get it higher? Where are you lagging in terms of percentage of your mix?

Yes. 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 had 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 come in, Dallas and Houston are big opportunities for us. Horton's, that largest builder in those 2 metropolitans by a long shot, and we intend to go after that. And then it's been slow -- 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 going to 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 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 start those markets with a little bit of a steam. So as Phillippe articulated, we have some room in our East Coast markets, 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, but that's just an extra cushion for us.

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

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 regular 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 9 or 10 days to go in the month, 2 weekends to go, so I expect it will produce a pretty big order number versus last year for October. And I don't see anything on the horizon that's going to change that dynamic.

Yes. traffic levels are stable to the surprise of us all because, I think, there's this election coming up here in a couple of 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 by the way, traffic levels are extremely stable for this time of year.

We were going to put a gun in every household, we couldn't find them. I am 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, 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 offering. So I just wanted to get a little more clarity around those comments and 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.

Yes. Our entry-level products kind of held consistent for this year. It's our highest producing margin products. 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.

And we'll go next to Alex Barrón with Housing Research Center.

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 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 on 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 could 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 even a little higher than -- would have been higher this quarter and may be higher at year-end. But when we're selling 71% more homes in Q3, and what was the Q2 number? 60% or 70% more, in Q2, just the homes are flying off-the-shelf faster than we anticipate, and it's driving the community count down, but it's going to rebound because we got -- we have the lots. We bought the lots. We have the lots, we have the stores. We're developing them. We're moving through the process. And they will be here. This will be a little bit later because of COVID, and because of the quick sell-out of the communities that we closed out in the last 2 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 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 trends 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 of years as you're heading towards the 300 communities?

Well, the sales pace, it's a historically high level, high levels. We're at almost 6 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 we don't underwrite to that pace. And whether we'll continue with that pace, I don't want to make any predictions. But what was the second part of the question? Was it about the...

Yes, the (inaudible) of community.

Yes. Yes, the ratio is probably where it's at. I mean, we still are investing in 1MU, 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 being 80%, 20% LiVE.NOW. 1MU or even 75%, 25%. The goal is to be 65%, 35% LiVE.NOW. Versus 1MU from a community count perspective. And of course, that will result in a different percentage from the sales pace because we underwrite LiVE.NOW. to a higher sales pace than 1MU.

Okay. Awesome well, best of luck and a good job.

Thanks, Alex.

I think this is our last question, operator, right? Or 2 more?

We have 2 more We'll go next to Susan Maklari with Goldman Sachs.

And congratulations to everyone. My question is around thinking about consolidation for next year, 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?

I get this -- get asked this question every quarter for the last 91 quarters. And it's just so hard to predict M&A. There's so many factors that go into it. So many social issues. What are the goals and objectives of the acquiree? Or is the retirement plan? Or what are they -- 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 acquisitions because we're focused on our strategy, and we're only going to be interested in builders that fit within our strategy. So if the product is outside of the product that we build, it wouldn't be a fit for us. And we just feel like we can grow solidly organically over the long term, and we will be entering some new markets, as I said. So our eyes are always open, but hard to tell what the pace of M&A is going to be.

Got you. 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 pretty -- it's a lot more appetizing than it did a week ago. 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 we're going to be using a lot of this capital. It's 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 and grow the top line and grow the bottom line. And to the extent share repurchases make sense, 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 that's where we are.

We'll go next to Jade Rahmani with KBW.

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

Well, that's a mouthful. I mean, I didn't prepare anything to respond to that question, but it's a good question for sure. Just as I said in the Q&A, I think the industry needed 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 stock -- our shares today, not just us, for everybody is programmed by computers. And every one's got really good news today, yesterday, next week, but 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.

So 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 destiny more. I think there's a lot of innovation coming on the tax -- 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 leaving 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. So appreciate your support, Jade, and thanks for the question.

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

Thank you. Bye-bye.

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