Meritage Homes Corporation (MTH) Q3 2019 Earnings Report, Transcript and Summary

Good morning and welcome to the Meritage Homes Third Quarter 2019 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Brent Anderson, Vice President, Investor Relations. Please go ahead.

Thank you, Carrey. Good morning and welcome to our analyst call to discuss our third quarter 2019 results. We issued the press release yesterday after the market closed and you can find it along with the slides that we’ll be referring to during this call on our website at investors.meritagehomes.com or by selecting the Investor Relations link at the bottom of our homepage. Turning to Slide 2, I’ll remind you that any statements during this call as well as within the press release and slides contain forward-looking statements, including projections for full year 2019 operating metrics such as home closings, closing revenue and gross margins as well as overhead and diluted earnings per share in addition to the expectations of our market trends. 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 our most recent filings with the Securities and Exchange Commission, specifically our 2018 Annual Report on Form 10-K and subsequent 10-Qs, which contain a more detailed discussion of those risks. We’ve also provided a reconciliation of certain non-GAAP financial measures referred to in our press release as compared to the closest related GAAP measures. With me today to discuss our results are Steve Hilton, Chairman and CEO of Meritage Homes; Hilla Sferruzza, Executive Vice President and CFO; and Phillippe Lord, Executive Vice President and Chief Operating Officer. We expect to conclude the call within an hour and a replay will be available on our website within approximately one hour after we conclude the call. You can find those instructions in our press release. It will remain active through May – excuse me, November 6. I’ll now turn it over to Mr. Hilton to review our third quarter results. Steve?

Thank you, Brent. I’d like to welcome everyone participating on our call today. I’ll begin on Slide 4. As you saw on our results reported yesterday, we had another very good quarter across all key operating metrics. Our performance is the direct result of our strategic shift to entry level and first move-up which are the strongest areas of demand across our markets. We’re not only providing buyers what they want in terms of affordable high quality homes, but we’re building, selling and delivering those homes efficiently and cost effectively by simplifying and streamlining our operations. Because of that, we’re growing at a faster pace in the market and taking market share, while improving our margins and operating leverage to deliver better earnings and grow our shareholders’ equity. We’re generating positive cash flow and strengthening our balance sheet and providing adequate capital to reinvest for future growth. This year has been a stark contrast to the turbulence we experienced in the third and fourth quarter of 2018, which we respond to by slowing our land spend for a few quarters and offer additional incentives on homes in the back half of 2018. Demand returned in the first quarter of this year and it’s persisted through the second and third quarters, meeting the normal seasonal decline we would have expected to see in the second half of this year. Our order for the third quarter were up 24% year-over-year, which pushed our year-to-date order growth to 17% over 2018, despite a small decrease in community count. Those results are due to the steadfast sound strategic plan and solid execution. I commend our entire Meritage team for making it all happen. I’ll now turn to Slide 5. We delivered 54% year-over-year order growth in the entry-level market with our LiVE.NOW homes. They also made up 54% of our orders for the third quarter of 2019, up from 43% in last year’s third quarter and [52%] [ph] in this year’s second quarter. 43% of our communities at quarter end were entry level compared with 33% of the total communities a year ago. While year-over-year comparisons to the third quarter of 2018 were easier in the first two quarters. The success at our entry level LiVE.NOW homes clearly exceeds the broader market in terms of year-over-year growth. In addition to the success of our entry-level product enhancements we’ve incorporated into our first move-up operations are starting to pay dividends, positively impacting our financial and operating results. Our first move-up homes are providing buyers what they want. We had a double-digit increase in absorptions in our first move-up homes over last year’s third quarter. And as expected, those resources were not as lofty as our LiVE.NOW absorptions but made a material contribution to our year-over-year growth. Move-up buyers love the new Studio M designer collections in the low stress transparent process of personalizing their homes. Consequently, they are spending more on higher margin upgrades to enhance the interiors of their homes. You can learn more about that at our Investor Day in New York on November 19th. If you haven’t yet registered, I highly encourage you to do so. I’ll turn it over to Phillippe to discuss some of the highlights of our sales trends.

Thank you, Steve. Demand was strong across all three regions, especially in the entry-level space, where we offer a great value proposition with our LiVE.NOW homes. Our 24% increase in orders for the third quarter of 2019 was mostly driven by our segment, though we did see broad improvement across first move-up as well. I’ll provide some additional color beginning with the West region on Slide 6. Our orders in the West region were up 38% over the third quarter of 2018, driven by a 29% increase in absorption coupled with a 7% increase in average active communities. Community count growth was primarily in California where we have opened several new communities at lower price points in great locations. While California remains the highest priced and least affordable markets are focused on moving down the price band is increasing our absorption pace. Our absorptions of $9 per community on average in California was a 25% year-over-year increase and in line with the company average. Arizona again produced the strongest absorption across the company at an average of 12.5 orders per average community for the quarter, up 51% year-over-year, which drove 39% order growth and 42% growth in total order value. The market is strong in Arizona and the 3% increase in ASP was primarily due to a reduction incentive in 2019 versus a year ago. We increased our average community count in Colorado by one community over the past year, though absorptions were down 6% year-over-year to 7.76 per community for the quarter. The Colorado market is still steady, but not as red hot as it has been in the past last couple of years, especially at the higher end price points above 500,000. Affordability is the most significant challenge in Denver, and we are working hard to open more affordable duplex and [care home] [ph] communities replacing older move-up communities. We expect that shift will increase absorptions, while reducing our ASP in Colorado in future quarters. Overall, the West was our best performing region this quarter in terms of growth and absorptions, order volume and total order value, which was up 36% over the third quarter of 2018. Slide 7, Central Region. Moving to the Central region, Texas had a 26% increase in absorption that was partially offset by a 19% decline in average communities, as we sold out communities faster than anticipated, entering the process of bringing more communities online over the next few quarters. That resulted in 2% order growth for the quarter over last year. A 7% reduction in ASP from our shift to entry-level and first move-up offset the 2% increase in order volume, resulting in a 5% decline in total order value for Texas. Slide 8, East region. We are very pleased to see continued improvement in our East region. Year-over-year order growth in East region has increased consecutively each quarter throughout the year. The East produced 32% order growth in the third quarter, with a combination of 7% more average active communities for the quarter and a 23% increase in average absorptions. Total order value was up 27% year-over-year as order volume growth was partially offset by a 4% decrease in ASP to greater entry-level product mix. The strongest market was Tennessee, where orders increased 62% over last year’s third quarter due to an 11% increase in average communities and a 46% increase in absorptions. The national market continues to be strong at a more affordable price points. Demand also approved in Georgia, where our orders for the quarter were up 55%, mainly driven by a 69% increase in absorptions partially offset by a 7% fewer communities on average. The newer communities is opened in the last couple of quarters are generating good volume. Orders were up 35% in North Carolina, due to a 13% expansion in average community count and a 20% increase in absorptions over the last year, primarily from our LiVE.NOW communities. Absorption held steady, but orders were down 15% year-over-year in South Carolina due to the close out of some strong communities this year, which reduced our average community count by 17% compared to last year. We’re opening some new LiVE.NOW communities over the next couple of quarters that it should increase our absorption pace there. Florida generated 27% increase in orders over the last year’s third quarter, resulting from a 20% increase in average community and a 5% higher average absorption. Slide 9, we closed 12% more homes in the third quarter of 2019 than last year, with just 2% more orders in backlog entering the quarter. As a result of having more spec homes available for quick move in which is a critical part of our entry-level strategy. 62% of our third quarter 2019 closings were from spec inventory, up from 49% a year ago. Those spec closings also increased our backlog conversion rate which was 66% in the third quarter this year compared to 60% last year. We ended the third quarter of 2019 with about 2,000 spec homes in inventory or an average of 11.2 per community, compared to an average of 9.8 a year ago. However, only 23% of those specs were completed as of September 30th, 2019 compared to the 30% in 2018. We are selling more spec homes before completing construction for quick move in, especially in the entry-level space. I will now hand it over to Hilla to provide some additional analysis of our financial results Hilla?

Thank you, Phillippe. I’ll provide some more details on our P&L results as well land and operating metrics, beginning with Slide 10. Our third quarter home closing revenue was up 7%, a 12% more unit closings partially offset by a 4% reduction in our average sales price, resulting from our mix shift towards entry-level homes. Despite the lower ASPs, the additional entry-level closings delivered increased margins in addition to increased revenues. As we said before, we’re not sacrificing margin with entry-level homes. In fact, our entry-level homes are producing the same or better gross margin than our move-up homes. Our home closing gross margin was 19.8% for the third quarter of 2019, a 170 bps higher than a year ago. Third quarter 2018 gross margin was reduced by 30 bps due to a $2.6 million charge from exiting a non-strategic move-up community. For the first three quarters of this year, home closing gross margin improved 70 bps to 18.5%. SG&A expenses were down 30 bps as a percentage of home closing revenue for the third quarter of 2019 compared to 2018. Year-to-date 2019 SG&A expenses were just slightly higher than 2018, mostly due to high brokerage commissions from incentives in late 2018 and early 2019. We also incurred severance and accelerated equity compensation costs of about $3.1 million earlier this year that impacted our year-to-date SG&A leverage. Interest expense increased $1 million for the quarter and $8.1 million year-to-date compared to last year, primarily due to less interest capitalized to assets under development, which is mostly the result of faster construction times and turnover inventory that’s part of our spec building and simplification strategy. We expect interest expense to be eliminated in 2020 as all interest occurred should be capitalized after we retire our senior notes due early next year. We now expect to complete that debt redemption later this year. Pre-tax earnings for the quarter were 29% higher than the third quarter of 2018 and we generated a 35% increase in diluted earnings per share for the third quarter over last year, reflecting the benefit of our share purchases in the second half of last year and first quarter of this year. The 4% decline in year-to-date net earnings was primarily due to higher interest expense in 2019 and first quarter 2018 net earnings benefiting from a favorable legal settlement of approximately $4.8 million, which accounted for the comparative decline in net other income. In addition, our effective tax rate was 3% higher for the first nine months of 2019 compared to 2018. Our tax rate in 2018 benefited from a one-year extension of energy tax credits for all qualifying homes closed in 2017, which totaled $6.3 million, while the tax credits have not yet been renewed for 2018 or 2019, they are still in the extenders bill, so we’re not rolling out the possibility that we could capture that tax benefit in the future. Turning to a few highlights of our balance sheet and cash flow items on Slide 11, we spent approximately $275 million on land and development in this year’s third quarter, putting over 5,500 lots under control. This total spending was about $82 million more than last year’s third quarter total of $193 million. This was our highest quarter for land development spending in the last two years and the largest number of lots put under control during the single quarter in over seven years. As Steve noted, we’re rebuilding our pipeline for new communities and are looking to materially grow our market share over the next two to five years. We ended the third quarter of 2019 with total lots supply of 37,300 lots compared to approximately 34,400 lots at September 30, 2018, holding our year supply constant at approximately 4.2 years based on trailing 12-month closings. About 66% of our lot inventory was owned and 34% was optioned at September 30, 2019. Our net debt to capital ratio was 31.3% at the end of the third quarter 2019, down from 36.7% at the end of last year and 43.6% just two years ago at the end of September 2017. We expect it to continue to be lower than our historical average as our stockholders’ equity continues to increase with limited changes in our debt. Turning to Slide 12, we’re encouraged by the outlook for interest rates and optimistic that demand for our homes and communities will remain strong. Based on our results in the first three quarters of this year, we’re projecting full year 2019 home closing of approximately 8,900 to 9,100 units and total home closing revenue around $3.5 billion. We anticipate home closing gross margin to be in the mid to high 18% for the year, with the fourth quarter being in the mid 19% range. We expect SG&A as a percentage of home closing revenue to be just slightly higher for full year 2019 compared to 2018 due to the increased commission expense earlier this year that we’ve discussed and about 10 bps of costs relating to opening and operating our new Studio M showroom. With a tax rate between 24% and 25% for the year, we expect to generate approximately $5.50 to $5.70 of diluted earnings per share for the full year 2019. With that, I’ll turn it back over to Steve.

Thank you, Hilla. In summary, we were pleased with our third quarter and year-to-date 2019 results and believe we’ve differentiated Meritage with our LiVE.NOW product for the value conscious buyer and our Studio M design centers for first move-up buyers. We’re also streamlining and simplifying our business to drive greater efficiencies and profitability. It’s a winning equation for our customers, employees, trade partners and shareholders. I’m proud of our entire Meritage team for putting our customers first and working hard every day to make the company successful. We’re confident in our abilities to make the most of the opportunities ahead of us and we expect to continue to grow and deliver increased shareholder value. Thank you for your support of Meritage Homes, and operator, we’ll now open it up for questions.

We will now begin the question-and-answer session. [Operator Instructions] The first question will come from John Lovallo of Bank of America.

Good morning, guys and thank you for taking my question. First question on Texas community count being down about 20% year-over-year. I know you guys are working hard to get that community count number back up again. When can we anticipate you returning to growth again in community count in Texas?

You know we’re sorting through that right now you know, really for the whole business. We have an internal goal to get our community count to 300 communities by the end of ‘21. And we bought a lot of lots this last quarter and we bought a lot of lots this year. We probably bought more lots this year and so far in three quarters we did all last year as Hilla already articulated. We’re going to give you more guidance next quarter on specific community count growth numbers you know for next year on a more detailed basis, but right now we’re just trying to figure out you know precisely where those are going to fall. We certainly been challenged in a lot of markets, getting communities online, because of entitlement and development delays and land developer delays, but we’re working hard to grow our community count and expect that over the next couple of years we’re going to have a meaningful improvement.

Okay, that’s helpful, Steve. And then as a follow-up, the efforts that you guys laid out to grow market share, I mean, do you anticipate that this is going to be done largely organically or there you know arrangements or acquisitions that could help facilitate that?

No, we’re really planning to do it organically. I mean, certainly through absorptions and community count growth, what we’ve seen over the last year has been primarily absorptions of course. We’ll always have our eyes open for smart acquisitions. We just haven’t seen any that makes sense lately. So we’re not counting on those to come forth, but you know if the opportunity presents themselves and they make sense we’ll certainly try to take advantage of it.

Okay, thanks very much.

Thanks.

The next question comes from Alan Ratner of Zelman and Associates.

Hey guys, good morning. Congrats on another strong quarter. So first question on the gross margin. You know you guys have been talking for a while about the goal of getting back to 20% then you basically got there this quarter, you know, big increase sequentially. Steve, can you talk about just the drivers that contributed to that improvement? Were you guys more aggressive raising prices this quarter, any quantification there? And it sounds like from your comments you think that’s sustainable based on the 4Q guys, but maybe just let us know if there was anything one-time or mix related that are in there that we should be aware of? Thank you.

No, it’s just generally the shift, the strategic shift that we’ve made to the entry-level on the first move-up product. The entry-level product we’ve opened over the last few years, has higher margins you know, lower incentives, better underwriting, we have less land development, but stronger segment of the market. The 2MU and above segments that we want you know way out of have more incentives, slower absorptions, higher impact on our overhead and you know has dragged the margins down in previous years. Additionally our 1MU product with our new Studio M model has really also helped us improve margins. We’re getting better cost by bundling these options and reducing the number of SKUs and we’re also able to drive higher revenues through the design center, because the customers really liked the offerings that we have and are spending more. And the products that we sell in the Studio M design center have higher margins than the home itself, so that drives our margins up as well. So it’s a strategy, the strategy is everything and it’s really making the difference.

Just one other point to add, Alan, I think we’ve been around that you know, high 18%, 19%, 20% in most of our regions for the last couple of quarters. The kind of big success story of this quarter is really the East region. So just as a point of comparison, last year’s third quarter, the East region delivered 16.3% gross margin, this year there were at 18.5%. So the story of the change of our product and the success of the entry-level are really coming to fruition for the East region is really helping before they were dragged on the consolidated margins, now they’re kind of holding the line and are consistent with the company margin.

Yeah, I’d also say that I’m sure we’re going to get this question about construction costs, but you know, we’ve done a really good job this year and actually driving our construction costs down through the value engineering and limiting and improving our product offerings. So even though there’s cost pressures across the board on construction cost on a net basis, our costs are flat and down across most of our regions.

That’s great and I really appreciate that guys. Second question, you know the backlog conversion has been a huge tailwind for you guys this year and obviously the spec strategy plays a lot into that. If I back into the midpoint of your guidance for 4Q closings, it looks like you’re expecting conversion maybe just to take a bit lower year-over-year. So I was curious if you can comment on that or are you starting to see any labor constraints pop back in now that your orders and everybody else’s have been so strong or is there something else just timing related that’s contributing to that?

Not really, I mean you know, labors just been constantly a challenge, but it’s not any worse, you know this quarter just back half of the year than it was previously You know there’s always issues out there with weather you know, we had weather issues of this month already, we had a tornado that tore through Dallas. We’ve had a bad storm last weekend that went through Florida and in the south and you know we’re just trying to be prudent on you know, not letting it all hang out there and trying to deal with some of the unforeseen circumstances that always present themselves, particularly in the fourth quarter of the year.

I understand, thanks for that. Good luck guys.

Thanks.

The next question will come from Michael Rehaut with JPMorgan.

Hi, this is Elad on for Mike. I was wondering about incentive trends in the quarter and particularly, year-on-year maybe also in California, it’s encouraging to see the better results, but I’d like to get more detail on the second time move-up over there in the quarter and how many more communities you have to close out? And any incentives you had to offer there? Thanks.

I’m sorry, I just want to make sure I understood the question. Are you asking about close out communities in California?

I’m asking broadly about incentive trends across the company, and then further any close out communities in California.

Just generally about traffic trends throughout the company. So traffics remained relatively steady throughout the quarter, we really haven’t seen anything meaningful beyond sort of the typical seasonal pullback, but even that has been a little bit needed, I think the interest rates are driving a lot of that. And then obviously our LiVE.NOW positions I think that traffic tends to be more consistent throughout the year. So traffic trends are pretty strong in California specifically, you know, other than what you’ve heard from everybody else that it’s lower, our traffic transaction picked up through the quarter. Again a lot of that has to do with the fact that we’ve opened up some new communities that are better positioned in the market and are driving better traffic trends for us overall.

Okay. I was referring to incentives.

Incentives, okay. Okay, sorry we had a bad connection and we didn’t pick that up. So incentives just as we began with – I’ll talk about incentives generally for the company and then I’ll talk about incentives for California. So in general, incentives have been declining throughout the year. We haven’t had to incentivize our homes as much as the market has grown, gotten stronger. Certainly Arizona is a place where we really pulled back incentives, in Texas, we’ve been able to pull back, Florida, you know, the South has remained relatively consistent. California incentives are pretty much static. They increased in the back half of last year in the first quarter based on kind of the market trend, but we haven’t had to dramatically increase those throughout the year, although we do have some meaningful incentives out there in the market to combat sort of market conditions and what other competitors are doing.

Okay, thank you. It’s very helpful.

The next question will come from Paul Przybylski of Wells Fargo. [Operator Instructions] Paul, go right ahead.

Yeah, thank you. To follow on Alan’s question. Steve, you’ve had mentioned that 20% of being your gross margin goal is, as LiVE.NOW has matured, do you think that there is upside to that number you know moving forward into ‘20 and ‘21?

Maybe but you know, not much. I mean, entry-level house is a volume game. It’s not a price and margin game and you know as some of our larger peers have demonstrated you know, I guess it’s really [inaudible]. You know, it’s really pace over price and you know we want to deliver a very compelling price sensitive value conscious product. So I think we would choose higher volumes than higher margins.

Yeah, I think generally in LiVE.NOW, Paul, it’s very price sensitive. And so you know, you raised your prices, pushed your margins, you can do that incremental sale. The incremental sale is really critical. The incremental to sales, so we’re both very focused on driving those incremental sales, while holding our gross margins where they’re at. And you know, as we see the ASP declining, an extra two sales per community, one sale per community over pushing our prices, two grand, three grand and four grand where that price sensitive buyer becomes very sensitive it makes sense –

Yeah, the opportunity Paul is going to be on the net margin, on the pre-tax net margin, because by holding the gross margin and pushing the volume, we’re going to be able to leverage our overhead to drive a higher net margin. So I think that’s where the game is going to be for us. And I really want to get that net margins back to 10% or greater, that’s going to require that you know, we get over our SG&A down to 10% or less.

Okay. And then looking at your land strategy, how should we think about you know, community size relative to your historical model you know, with LiVE.NOW? And then also you know, the community density within particular markets, are you going to have fewer or larger communities versus the historical model? And then following on that, is there any opportunity to increase the option portion of your land position?

We’re going to have more larger communities than we had before. We’re really trying to steer away from the small communities, to reduce the community count churn. Hilla, would you have any stats on our average community count?

Yeah –

Or Average community size?

Our average community size is 122 units, which continuing to creep up over the last several quarters as we’re putting larger communities under control. So just to clarify, Paul it’s not – as Steve said, it’s not fewer or larger communities, it’s more larger communities, because it’s the same number of months, right the absorption pace is faster. It’s actually the same as the smaller size 2MU communities as far a year of supply lots.

Yeah, I mean you think about trying to get four or five a month out of each LiVE.NOW community you know, 150 lots sounds pretty good for LiVE.NOW.

Yeah, as we get more and more comfortable to go to more peripheral markets, because we’re seeing extraordinary absorptions due to low ASP price points in those peripheral markets, you know, we’re going to continue to buy more stores out there. You know, the pool for – buyer pool under 300,000, a lot of our markets is really, really, really deep. And we’re really trying to seize that opportunity everywhere that we built.

And I think the second part of your question was options, and we are putting more lots under option I think this last quarter it was a meaningful movement in that direction. As Steve said, as we’re looking in these other markets, these tertiary markets, there seems to be more lots available for options and so we expect our lots under option to grow sequentially as we continue to tie up LiVE.NOW further out.

Thank you. I appreciate it.

The next question comes from Stephen Kim of Evercore ISI.

Hey, thanks very much guys and – sorry, can you hear me better now?

Steve, can you speak up –

Yeah, sorry about that it was – yeah, apologies. Good job in the quarter, exciting stuff. Looking forward to the Analysts Day. I guess I’m going to zoom the lens out a little bit. I just want to make sure I understand how we should be thinking about the leg up in gross margins on – you’ve given a lot of information and I realized that, but I just want to try to sort of step back and say or make sure I understand what drove the big year-over-year increase in the gross margin this quarter? I know we’re talking about the fact that LiVE.NOW has good profitability and you’re continuing to leg into LiVE.NOW, but that was an ongoing factor you know, all year. I mean that was present in the 2Q results as well. But your year-over-year growth in margins wasn’t nearly what we’re seeing this quarter. Similarly I know you mentioned, Hilla that the East saw 220 basis point increase in margins year-over-year, obviously that would seem to have contributed something there. Was that something that happened in the third quarter that was not present last quarter? And if so, why? And the remainder of the big jump in year-over-year improvement in gross margins. Can you help me understand what that was? Were there some cost issues, lumber you know or something like that –

Well Stephen it’s all the ingredients that go into making the cake and you know it’s a mix. And we have a lot of really, really good entry-level communities that we’ve opened this year. They’re really performing well, both in the West and in the East. I mean, we have some entry-level stores here in Arizona, they’re doing you know extraordinarily well and we’ve opened more stores you know, clearly in the South that have driven that margin higher. And as I said before, we made a lot of progress this year on managing our cost and as we value engineered all this product and brought more of the streamlined energy efficient entry-level product online, we’re able to produce it at a lower cost that also have some margin. The Studio M although it’s pretty new and we don’t have every single market open, but we have many markets open where it’s showing fantastic results and delivery you know much better margins in our design centers. So you know, it’s not a one thing, it’s a lot of things and we think all those things are going to continue. And we’re going to be able to maintain you know better margins than we’ve produced over the last few years and get as close to that 20% gross margin. And we’re very confident on that.

And it’s the margin too, we had to incentivize our staffs as much as we’ve moved through the year as we did in the first quarter, beginning in the second quarter when we were as confident in what we were seeing in the market, specifically the entry-level space.

And the drag from our non-entry-level and first time move-up that becoming very limited. As we said, you’ll see a little bit of noise in Q3-Q4 and then it’s de minimis rolling into 2020. It was a much bigger portion of our volume in 2018 so as Steve said, a little bit from here, there and everywhere, the higher closing volume is additional leverage. All other pieces are in line with what we would have expected to see and what we would expect to continue to see.

We feel good about producing meaningful EPS growth just by maintaining our costs, increasing our margins and you know, driving better absorptions to look, which will allow us to leverage our overhead. And if we can drag some top line revenue growth on top of that, that will make it even better, but even without that we’re doing a good job bringing up the bottom line.

Yeah you know it all goes into making what seems to be a pretty tasty cake. So good job there.

Yeah, sexy cake.

I wanted to ask – my second question related to your leverage. If we sort of continue to see this kind of performance on a going-forward basis, it isn’t going to be too long before your net debt to cap is going to get down to levels that I don’t ever recall seeing for your company. And you know, so I guess I’m curious as to how you think about the proper level of leverage. You’ve talked about a pretty aggressive goal out to 2021, you obviously feel very good about the way the market is looking for the foreseeable future, your land purchases are up significantly and obviously that’s going to be something that you’re going to ultimately build homes on probably a couple of years out at least. So how should we be thinking about your lower threshold, if you will, on the leverage? Does it make sense to have your leverage drift down below, let’s say it’s more down to a 20% level net debt to cap or is that too low? And if you can just talk a little bit about that?

You know, I’m not going to put any specific targets out there, but certainly it’s going to be lower going forward than it has been in the past. I’m really bullish on the housing market, primarily due to demographic shift that we’re experiencing you know, the 8 million millennials that are buying homes, they’re propelling the entry-level business, the first move-up business. But you know, when I go home at night and I turn on the TV you know and I watch all the cable news channels you know makes my head spin and you don’t know what’s going to happen. So I want to be very prudent about you know the macro economy. I want to be very prudent about you know what our balance sheet looks like and where we are you know, a lot of people think we’re late in the cycle. I don’t necessarily agree, because I think the demographics you know as I said earlier you know pretend well for the housing industry. So you know I could be wrong, but I just want to have one foot on the gears and one foot on the brake and be prudent about it and that’s what we’re doing.

So Stephen, as you see I don’t think that we’re going to give a bottom number of what net debt to cap should be, but I think we’re definitely comfortable with it being not in the mid-40s, where we’ve traditionally been comfortable and that assuming growth. So we’re not going to be fixated on a number in an effort to reduce our balance sheet leverage at the cost of growth. We think that we can get there with the aggressive goal that that Steve mentioned of 300 communities by the end of this 2021, that’s certainly going to require quite a bit of cash. So we’re focused on both the ability to harvest cash so much quicker from our simplification strategy and our entry-level fact that just allowing us to turn our balance sheet faster. So we don’t have an exact target that we’re willing to share at this point. But you will see it continue to creep down although you know, it’s not going to get into the teens or anything, but it is going to continue to creep down, but not at the expense of income statement growth.

Great, thanks a lot guys.

Thanks.

The next question will come from Carl Reichardt of BTIG.

Hey guys, how are you? I had two for you. One, I had a chance to stop by CUM not that long ago and Steve you talked a little bit about it. Can you sort of tell me if you look at the old way of selling options and upgrades to first time move-up customer versus now? Maybe quantify how much more in a house you’re getting and how much the increase in margin might be? I know the time savings for the customers is terrific and the choice set is more organized and also more limited, but I’m just trying to get a mathematical sense of what it’s doing to your numbers?

I'm going to put that over to Phillippe, because he’s closer to that and he’s really architected the strategy so I’m going to let him answer that question.

So if I got it right, I think there were sort of three questions there. There was you know are people spending more money and what’s the math on that? And we’re seeing people spend about 2% more money than they were before.

2% of the home price.

2% more of the home price, correct.

$5000, $6000, $7,000 a house.

Right depending on the market. I think the second question was you know, is there any sort of time benefit and clearly you know people are going to our design studios in one appointment being able to select everything in a couple of hours you know traditionally we would see them come back three or four times in a traditional design center. So we’re able to get them through the process, get their homes started more quickly you know obviously deliver better quality et cetera. So we’re definitely shrinking our cycle times and our ability to turn those homes over to our customers. And we the final question was the kind of margins we’re making –

A better cost.

Yeah, margins are obviously being driven by better costs. I mean it’s actually being driven by better costs, but also, I think we’re able to drive better value to the customer through the pricing equation and so our margins are you know up about 40 bps or so on our cost. So you know we traditionally would have thought of you know, making about 45% or so and we’re making closer to 50% on those options that buyers are putting into the home.

Phillippe, thanks so much. That’s really great. That’s great detail. I appreciate that. And the second question, I’ll try to keep it to one. So obviously, Steve a lot of your peers are making a move that is not exactly similar, but certainly want to go lower end out to more hinterland markets, look at smaller lots, do smaller houses. How our land prices feeling to you, especially as you’ve been aggressive making this move, whether it’s smaller peers looking to go into this business gradually or more aggressive peers looking to go whole hog? I’m just kind of curious what you’re seeing and does it differ much by region or state? Thanks.

Well, first I’d say good luck to my peers you know, you’re not going to be successful unless you have the product to go with it, because you can’t go to the old product that we were all building at a cost competitive levels on these less expensive peripheral lots and expect to compete successfully. So you know, it’s a much more complicated move than just running out to the periphery and find those lots and it’s something we’ve been working on for several years to get to this point. But I’d say you know, we’re very, very encouraged by the lots that we’re finding the way that we’re seeing to feed our LiVE.NOW product and our entry-level segment, Phillippe and I’ve been on the road in almost all of our markets over the third and fourth quarter of this year. And you know, we’re seeing a lot of great deals and you know a lot of lots that at a good price is now to market by market thing. And you know, some markets like Phoenix for example you know, it’s getting tough to find an affordable lot. But markets in the South, markets in Texas even in Florida you know we’re really, really, really bullish on what we’re seeing. So you know we’re going to satisfy that pipeline so we can produce community count growth.

Thanks, Steve.

It looks like we have just a couple of questions left. Do we have time to take them today?

Yes.

We’ll take the next question from Jade Rahmani of KBW.

Thank you very much. Can you talk to how active you are with the so called, iBuyer’s companies like Opendoor and Offerpad, maybe if you could give some color around what percentage of transactions iBuyers are accounting for whether it’d be out of your own closings, you know buying the existing home in the move-up side or just in terms of activity in the overall market?

So we partner with a couple of the large iBuyer names that you’re familiar with that kind of split across the country by geography where they’re most active. We don’t use them to buy our own inventory, but we do use them when our customers come in with a home to sell. We partner with them as a way to turn a contingent sale into a fixed sale. So I think it’s definitely accretive on the margin. It’s not a huge volume of our business, but we are seeing the impact of that become more meaningful.

I think we’ve done – our buyers have done a few hundred.

Couple of hundred, yeah.

A few hundred transactions over the last year. So you know I don’t think we offer it in every single market. We offer in maybe half our market.

It’s rolling out throughout the rest of the country; it will be in every –

Yeah, so you know it’s less than 5%.

Yes.

Okay. And I was wondering if you’re considering potentially selling new homes to iBuyers who would then warehouse them, aggregate them and potentially sell them to single-family rental companies or other real estate investors?

Unless you want to make money some of their homes.

Okay.

Our volume, their position is the key –

We got –

Our labor is working on our direct customers, not necessarily if you sell it to an iBuyer that then sells it to you, a single-family now you have another person that’s taking kind of the profit, if you we were thought to rental, we would just talk to them more directly.

Yes. I mean rental buyers want to pay as the same thing that our regular customers pay us, we’re very happy to sell them houses, but we’ve yet to find those guys. So we have a lot of demand for our products, so we’re going to continue to you know, sell those traditional markets.

Thanks.

Thanks.

The next question will come from Alex Barron of Housing Research Center.

Hey guys, great job on the quarter. I wanted to ask you so on your Slide 5, you were showing 43% of your communities are now entry-level versus 33% a year ago. And I recall last quarter, you said, I think 80% plus of the lots you were buying were towards entry-level. So, as you move towards the 300 communities by 2021, where do you see that entry-level percentage of communities going?

Above 50%?

Is it closer to the 80% than the 50%?

No, I mean if we were 80% entry-level, we’d be selling hardly any move-up homes, because you know we’d sell more homes in entry-level we would move up, so it’s not going to get that high. But you know it could be somewhat above 50%. And it’s just going to be based upon the opportunities that we can find and what opportunities we can find for 1MU that we like. And you know it need to be travelling faster on our fee you know, it’s really not about having an exact target. It’s really about where the demand is and where we can find the land that fits.

Then you’ll continue to see a large amount of lots that we purchased be in the LiVE.NOW space just because we got so much work to do to get even to the 50% in some of our markets. So we’ll continue to see that trend for a bit, but we’re still buying quite a bit of move-up, first move-up there as well and we have a lot of first move-up projects currently in our existing land book.

Got it and in terms of your margins, obviously you guys had a pretty good margin improvement this quarter. So I’m just trying to get a sense of where are your entry-level margins compared to the move-up margins at this point in time and you know, what does that say about the future?

The entry-level margins are north of our first time move-up, so don’t forget, we still have a little bit of a drag from other stuff that’s closing, but not entry-level or first time. So once that other falls off of our radar, then the margins in total will lift, but we’re seeing some lift in the entry-level above, so what you’re seeing at the entire company is kind of running at about 20, we’re a little bit north of that in the entry-level.

Okay, great. Well keep up the good work. Thanks.

Thanks Ally.

And this concludes our question-and-answer session. I’d now like to turn the conference back over to Steve Hilton for any closing remarks.

Well, thank you very much for your support and for engaging on our call today, and we look forward to talking to you in January for our yearend results. Thank you. Have a great day.

Thank you, sir. The conference is now concluded. Thank you all for attending today’s presentation. You may now disconnect your lines. Have a great day.