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Meritage Homes Corp (NYSE:MTH)
Q3 2019 Earnings Call
Oct 23, 2019, 10:30 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning, and welcome to the Meritage Homes Third Quarter 2019 Earnings Conference Call. [Operator Instructions]. I'd now like to turn the conference over to Brent Anderson, Vice President, Investor Relations. Please go ahead.

Brent A. Anderson -- Vice President, Investor Relations

Thank you, Jerry. 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. During this slide to 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 expectations about 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 have 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 1 hour after we conclude the call. You can find those instructions in our press release, and 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?

Steven J. Hilton -- Chairman Chief Executive Officer

Thank you, Brent. I'd like to welcome everyone participating on our call today. I'll begin on slide four. As you saw the 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 several markets. We are not only providing buyers what they want in terms of affordable high-quality homes, but we're building, selling and delivering those home efficiently and cost effectively by simplifying and streamlining our operations. Because of that, we're growing at a faster pace than the market and taking market share, while improving our margins and operating leverage to deliver better earnings and grow our shareholders' equity.

We generated positive cash flow and strengthening our balance sheet and providing active capital to reinvestment 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 responded to by slowing our land spend for a few quarters and operate additional incentives on homes in the back half of 2018. The main return of the first quarter this year has persisted through the second and third quarters, meeting the normal seasonal decline we would have expected to see in this second half of this year. Our orders for the third quarter were up 24% year-over-year, which puts our year-to-date order growth to 17% over 2018, despite a small decrease in community count.

Those results are due to a sound strategic plan and solid execution. I commend our entire Meritage team for making it all happen. I'll now turn to slide five. We delivered 54% year-over-year order growth in the entry-level market with our LiVE.NOW. homes. We also made up 54% of our orders for the third quarter of 2019, up from 43% in last year's third quarter and 52% 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 of the third quarter of 2018 were easier than the first 2 quarters, the success of 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, we enhances we've incorporated to 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 loved the new Studio M designer collections and the low stress, transparent process of personalizing their homes.

Consequently, they are spending more on higher-margin upgrades to enhance the interiors of their home. You can learn more about that at our Investor Day in New York on November 19. If you haven't yet registered, I highly encourage you to do so. I'll now turn it over to Phillippe to discuss some of the highlights of our sales trends.

Phillippe Lord -- Executive Vice President and Chief Operating Officer

Thank you, Steve. Demand was strong across all 3 regions, exceptionally in the entry-level space where we operate great value proposition with our LiVE.NOW. homes. Our 24% increase in orders for the third quarter of 2019 was mostly driven by a 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 six. 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 price and least affordable market, our focus on moving down the price band is increasing our absorption pace. Our absorptions of 9 homes per community on average in California, with 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 incentives in 2019 versus a year ago. We increased our average community count in Colorado by 1 community over the past year.

Though absorptions were down 6% year-over-year to 7.6% 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 townhome 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 in absorptions, order volume and total order value, which was up 36% over the third quarter of 2018. slide seven, 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 and are in 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 the order volume, resulting in a 5% decline in total order value for Texas. slide eight, East region. We are very pleased to see continued improvement in our East region. Year-over-year order growth in East region had increased consecutively each quarter throughout the year. The East produced 32% order growth in the third quarter, with a combination of 7% and 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 natural market continued to be strong at the more affordable price points. Demand also improved in Georgia, where our orders for the quarter were up 55%, mainly driven by a 69% increase in absorption, partially offset by 7% fewer communities on average. The newer communities opened there 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 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 closeouts 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 several quarters that it should increase our absorption pace there. Florida generated 27% increase in orders over last third quarter -- last year's third quarter, resulting from a 20% increase in average community count and a 5% higher average absorption. slide nine. 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, 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 2,800 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 30, 2019, compared to 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?

Hilla Sferruzza -- Executive Vice President and Chief Financial Officer

Thank you, Phillippe. I'll provide some more details on our P&L results as well as land and operating metrics, beginning with slide 10. Our third quarter, home closing revenue was up 7%, a 12% more unit closing, partially offset by a 4% reduction in our average sales price, resulting from our mixed shift toward entry-level home. Despite the lower ASPs, the additional entry-level closings delivered increased margin in addition to increased revenue. 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, 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 nonstrategic move-up community. For the first 3 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 commission from incentives in late 2018 and early 2019. We also incurred severance and accelerated equity compensation cost 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 time and turnover of inventory as part of our spec building and simplification strategy.

We expect interest expense to be eliminated in 2020 as all interest incurred should be capitalized after we retire our senior notes due early next year. We now expect to complete that debt redemption later this year. Pretax 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 repurchases in the second half of last year and first quarter of this year. The 4% decline in year-to-date net earning 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 9 months of 2019 compared to 2018.

Our tax rate in 2018 benefited from a 1-year extension of energy tax credit for all qualifying homes closed in 2017, which totaled $6.3 million. While these tax credits have not yet been renewed for 2018 or 2019, they are still in the extenders bill. So we're not ruling 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 and development spending in the last 2 years, and the largest number of lots put under control during a single quarter in over 7 years. As Steve noted, we're rebuilding our pipeline for new communities and are looking to maturely grow our market share over the next 2 to 5 years.

We ended the third quarter of 2019 with total lot supply of 37,300 lots compared to approximately 34,400 lots at September 30, 2018, holding our year's 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 2 years ago at the end of September 2017. We expected 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 the demand for our homes and communities will remain strong. Based on our results in the first 3 quarters of this year, we're projecting full year 2019 home closings 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 '18, to 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 the 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.

Steven J. Hilton -- Chairman Chief Executive Officer

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.

Questions and Answers:

Operator

[Operator Instructions] The first question will come from John Lovallo of Bank of America.

John Lovallo -- BofA Merrill Lynch -- Analyst

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?

Steven J. Hilton -- Chairman Chief Executive Officer

We're sorting through that right now 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 so far in 3 quarters than we did all last of year, as Hilla already articulated. We're going to give you more guidance next quarter on specific community count, growth numbers for next year in a more detailed basis. But right now, we're just trying to figure out precisely where those are going to fall.

Our -- we've certainly been challenged in a lot of markets, getting communities online because 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.

John Lovallo -- BofA Merrill Lynch -- Analyst

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 are there arrangements or acquisitions that could help facilitate that?

Steven J. Hilton -- Chairman Chief Executive Officer

No. We were really planning to do it organically. I mean certainly through absorption bank community count growth. What we've seen over the last year has been primarily absorptions, of course. We're always -- have our eyes open for smart acquisitions. We just haven't seen any that make sense lately. So we're not counting on those to come forward. But if the opportunities present themselves and they make sense, we'll certainly try to take advantage of it.

John Lovallo -- BofA Merrill Lynch -- Analyst

Okay, thanks very much.

Operator

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

Alan Ratner -- Zelman & Associates -- Analyst

Hey, guys, good morning.Congrats on another strong quarter. So first question on the gross margin. You guys have been talking for a while about the goal of getting back to 20% and you basically got there this quarter. Big increase sequentially. Steve, can you talk of 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 guide, but maybe just let us know if there was anything one-time or mix related in there that we should be aware of.

Steven J. Hilton -- Chairman Chief Executive Officer

No. It's just generally the shift, the strategic shift that we've made to the entry-level and the first move-up product. The entry-level product, we've opened over the last few years has higher margins, lower incentives, better underwritings. We have less land development bucks, it's a stronger segment of the market. The 2 MU and above segments that we're winding our way out of have more incentives, slower absorptions, higher impact on our overhead and has dragged the margins down in previous years. Additionally, our 1 MU product was 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 like the offerings that we have in our -- are spending more. And the products that we sell and the Studio M design center have higher margins in the home itself, so that drives our margins up as well. So it's a strategy. Strategy is everything. And it's really making a difference.

Hilla Sferruzza -- Executive Vice President and Chief Financial Officer

One other point to add, Alan. I think we've been around that 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, they were 18.5%. So the story of the change around product and the success of the entry-level really coming to fruition for the East region is really helping. Before, they were a drag on the consolidated margin. Now they're kind of holding the line and are consistent with the company margin.

Steven J. Hilton -- Chairman Chief Executive Officer

Yes. And also, it's a -- I was sure we're going to get this question about construction cost, but we've done a really good job this year and actually driving our construction cost down through the value engineering and limiting and improving our product offering. So even though there's cost pressures across-the-board on construction costs, on a net basis, our cost are flat to down across most of our regions.

Alan Ratner -- Zelman & Associates -- Analyst

That's great. Second question. 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 a tick a bit lower year-over-year. So I was curious if you can comment on that. 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?

Steven J. Hilton -- Chairman Chief Executive Officer

Not really. I mean labor has just been constantly a challenge, but it's not any works this quarter or this back half of the year than it was previously. There's always issues out there with weather. We had weather issues this month already, we had a tornado that tore through Dallas. We've had a bad storm last weekend that went through Florida and the South. And we're just trying to be prudent on -- not let 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.

Alan Ratner -- Zelman & Associates -- Analyst

Understand, thanks for that. Good luck, I guess.

Operator

The next question will come from Mike Rehaut with JP Morgan.

Elad Elie Hillman -- JP Morgan Chase & Co, Research Division -- Analyst

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 want 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?

Hilla Sferruzza -- Executive Vice President and Chief Financial Officer

I'm sorry. I just want to make sure I understood the question. Are you asking about closeout communities in California?

Elad Elie Hillman -- JP Morgan Chase & Co, Research Division -- Analyst

I'm asking broadly about incentive trends across the company. And then further any closeout communities in California.

Phillippe Lord -- Executive Vice President and Chief Operating Officer

Just generally about traffic trends throughout the company. So traffic has remained relatively steady throughout the quarter. We really haven't seen anything meaningful beyond sort of a typical seasonal pullback but even that's been a little bit muted. 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, other than what you've heard from everybody else that it's slower. Our traffic trends actually picked up through the quarter. Again, a lot of that has to do with the back, and we've opened up some new communities that are better positioned in the market and are driving better traffic trends for us overall.

Elad Elie Hillman -- JP Morgan Chase & Co, Research Division -- Analyst

Sorry. I was referring to incentives.

Phillippe Lord -- Executive Vice President and Chief Operating Officer

Incentives? Okay. Sorry, we had a bad connection and we didn't pick that up. So incentives -- this is Phillippe, again. 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. Texas we've been able to pullback. Florida. 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 trends. 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.

Elad Elie Hillman -- JP Morgan Chase & Co, Research Division -- Analyst

Okay, thank you very helpful.

Operator

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

Paul Allen Przybylski -- Wells Fargo Securities -- Analyst

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

Steven J. Hilton -- Chairman Chief Executive Officer

Maybe, but not much. I mean entry-level housings of volume gains. It's not a price and remarking aim and as some of our larger peers have demonstrated, I guess, specifically, Horton. It's really pace over price and we want to deliver very compelling, price-sensitive, value-conscious products. So I think we would choose higher volumes than higher margins.

Phillippe Lord -- Executive Vice President and Chief Operating Officer

Yes. I think, generally, in LiVE.NOW, Paul, it's very price-sensitive. And so you raise your prices, push your margins. You can lose that incremental sale. The incremental sale is really critical, the incremental 2 sales. So we're very focused on driving those incremental sales while holding our gross margins where they're at. And as we see the ASP declining and extra 2 sales per community, 1 sale per community over pushing our prices $2,000, $3,000 or $4,000 or that price-sensitive buyer becomes very sensitive. It makes sense to [Indecipherable].

Steven J. Hilton -- Chairman Chief Executive Officer

Yes. The opportunity, Paul, is going to be a 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 reduce our -- 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 margin back to 10% or greater and that's going to require that we get over our SG&A down to 10% or less.

Paul Allen Przybylski -- Wells Fargo Securities -- Analyst

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

Steven J. Hilton -- Chairman Chief Executive Officer

We're going to have more larger communities than we have before. We're really trying to steer away from the small communities to reduce the community count churn. I don't know. Do we have any stacks on our average community council or average community size?

Hilla Sferruzza -- Executive Vice President and Chief Financial Officer

Yes. Our average community size is 122 units, which continues to creep up over the last several quarters as we're putting larger communities under control. So just to clarify, Paul, we're -- it's not -- as Steve said, it's not fewer larger communities, it's more larger communities because it's the same number of months, right? If the absorptions pace is faster, it's actually the same as the smaller size 2 MU communities as far as your supply lot.

Phillippe Lord -- Executive Vice President and Chief Operating Officer

Yes. I mean you think about trying to get 4 or 5 a month out of each LiVE.NOW. community, 150 lots sound pretty good for LiVE.NOW.

Steven J. Hilton -- Chairman Chief Executive Officer

Yes. 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. We're going to continue to buy more stores out there. 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 and everywhere that we build.

Phillippe Lord -- Executive Vice President and Chief Operating Officer

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

Hilla Sferruzza -- Executive Vice President and Chief Financial Officer

Thank you, I appreciate it.

Operator

The next question comes from Stephen Kim of Evercore ISI.

Stephen Kim -- Evercore ISI Institutional Equities -- Analyst

Good job in the quarter. Exciting stuff, looking forward to the Analyst Day. I just -- I guess to zoom the lens out a little bit, I just want to make sure I understand how we should thinking about the leg up in gross margins on a -- you've given a lot of information and I realize 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 all year, I mean, that was present in the 2Q result as well but your year-over-year growth in margins wasn't nearly what we are seeing this quarter.

Similarly, I know you've 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 margins and gross margins, can you help me understand what that was? Where there some cost issues, lumber, or something like that?

Steven J. Hilton -- Chairman Chief Executive Officer

No, Steve. It's all the grease that go into making the cake, and it's a mix. And we have a lot of really, really good entry-level communities that we've opened this year that are really performing well, both in the West and in the East. I mean we have some entry-level storage here in Arizona. They're doing extraordinarily well and we've opened more stores 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 this streamlined energy-efficient entry-level product online, we're able to produce it at a lower cost that also helps the margin. So Studio M, although, it's pretty new and we don't have every single market open, but we have many markets opened where it's showing fantastic results and delivering much better margins in our design center. So it's not 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 better margins than we've produced over the last few years and get us close to that 20% gross margin and we're very confident in that.

Phillippe Lord -- Executive Vice President and Chief Operating Officer

And it's the market too. We haven't had to incentivize our specs as much as we've move through the year as we did in the first quarter, beginning of second quarter when we were as confident in what we're seeing in the market specifically the entry-level space.

Hilla Sferruzza -- Executive Vice President and Chief Financial Officer

And the drag from our nonentry-level and first-time in record becoming very limited. As we said, you'll see a little but of noise in Q3, Q4. And then it's di minimis growing into 2020. It was a much bigger portion of our volume in 2018. So as Steve said, a little bit from here, there, everywhere, the higher closing volume and additional leverage. All those pieces are in line with what we would have expected to see and what we would expect to continue to see.

Steven J. Hilton -- Chairman Chief Executive Officer

We feel good about producing meaningful EPS growth, just like managing our costs, increasing our margins and driving better absorptions which will allow us to leverage our overhead. And then if we can -- if we could drive some top line revenue growth on top of that, that will make it in even better. But even without that, we're doing a good job bringing up the bottom line.

Stephen Kim -- Evercore ISI Institutional Equities -- Analyst

Yes. No. It all goes into making what seems to be a pretty tasty cake. So good job there. I wanted to ask my second question related to your leverage. As we -- 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 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 after 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, 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?

Steven J. Hilton -- Chairman Chief Executive Officer

I'm not going to put any specific targets out there, but certainly, it's going to be lower moving 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 with 8 million millennials that are buying homes are propelling the entry-level business and the first move-up business. But when I go home at night, I turn the TV, and I watch all the cable news channels, makes my head spin, and you don't know what's going to happen.

So I want to be very prudent about -- in the macro economy. I want to be very prudent about what our balance sheet looks like and where we are. A lot of people think we're late in the cycle, I don't necessarily agree because I think that the demographics, as I said earlier opportune ball for the housing industry. So I could be wrong, but I just want to have 1 foot on the gas and 1 foot on the brake and be prudent about it, and that's what we're doing.

Hilla Sferruzza -- Executive Vice President and Chief Financial Officer

So Stephen, I agree with Steve. I don't think we're ready 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 have traditionally been comfortable. And that's 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, as Steve mentioned, of 300 communities by the end of 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 specs, it's just allowing us to turn our balance sheet faster. So we don't have an exact target that we're willing to share, if it's 25. You will see it continue to creep down, although 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.

Stephen Kim -- Evercore ISI Institutional Equities -- Analyst

Thanks a lot guys.

Operator

The next question will come from Carl Reichardt of BTIG.

Carl Edwin Reichardt -- BTIG -- Analyst

Two for you. One, I had a chance to stop by to see you 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-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.

Steven J. Hilton -- Chairman Chief Executive Officer

I'm going to put that over to Phillippe because he's closer to that and he's really the architect of the strategy. So I'm going to let him answer that question.

Phillippe Lord -- Executive Vice President and Chief Operating Officer

So if I got right, I think, there was sort of 3 questions there. There was -- 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.

Hilla Sferruzza -- Executive Vice President and Chief Financial Officer

2% of the home price.

Phillippe Lord -- Executive Vice President and Chief Operating Officer

2% more of the home price, correct.

Steven J. Hilton -- Chairman Chief Executive Officer

$5,000, $6,000, $7,000 a house.

Phillippe Lord -- Executive Vice President and Chief Operating Officer

Right. Depending on the market. I think the second question was, is there any sort of time benefit. And clearly, people are going through our design studios. In one appointment being able to select everything in the couple of hours. Traditionally, we'd see them come back 3 or 4 times in a traditional design center. So we're available to get them through the process, get their home started more quickly. Obviously, deliver better quality, etc.. So we're definitely shrinking our cycle times and our ability to turn those homes over to our customers. And I believe the final question was the kind of margins were making.

Steven J. Hilton -- Chairman Chief Executive Officer

The better cost.

Phillippe Lord -- Executive Vice President and Chief Operating Officer

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

Carl Edwin Reichardt -- BTIG -- Analyst

That's really great. That's great detail. I appreciate that. And 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 are land prices feeling to you, especially as you've been aggressive in 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?

Steven J. Hilton -- Chairman Chief Executive Officer

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

Carl Edwin Reichardt -- BTIG -- Analyst

Thanks

Operator

And it looks like we just have a couple of questions left. Do we have time to take some today?

Steven J. Hilton -- Chairman Chief Executive Officer

Yes.

Operator

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

Jade Joseph Rahmani -- Keefe, Bruyette, & Woods, Inc -- Analyst

Can you talk to how active you are with the so-called iBuyers, companies like Opendoor and Offerpad. Maybe if you could give some color around what percentage of transactions iBuyers are accounting for? Whether it be out of your own closings, buying the existing home in the move upside? Or just in terms of activity in the overall market?

Hilla Sferruzza -- Executive Vice President and Chief Financial Officer

So we partner with a couple of the large iBuyers names that you're familiar with to kind of split across the country by geography where they are 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 sell into a fixed sale. So I think it's definitely accretive on the margin. It's not a huge volume of our business, so we are seeing the impact of that become more meaningful.

Steven J. Hilton -- Chairman Chief Executive Officer

I think we've done -- our buyers have done a few hundred.

Hilla Sferruzza -- Executive Vice President and Chief Financial Officer

A couple of hundred, yes.

Steven J. Hilton -- Chairman Chief Executive Officer

A few hundred transactions over the last year. So I don't think we offer it in every single market. We offer them in maybe half of our markets.

Hilla Sferruzza -- Executive Vice President and Chief Financial Officer

It's rolling out throughout the rest of the country. It will be in every market.

Steven J. Hilton -- Chairman Chief Executive Officer

Yes. So it's less than 5%.

Hilla Sferruzza -- Executive Vice President and Chief Financial Officer

Yes.

Jade Joseph Rahmani -- Keefe, Bruyette, & Woods, Inc -- Analyst

Okay. And I was wondering, if you would -- 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.

Steven J. Hilton -- Chairman Chief Executive Officer

Not if you want to make money selling new homes.

Hilla Sferruzza -- Executive Vice President and Chief Financial Officer

Our volumes are sufficient to keep -- our neighbor is working on our direct customers, not necessarily and if you sell it to an iBuyer that then sells it to a single-family REIT, then now you have another person that's taking a cut of the profit. If we were to sell to a rental, we would just sell to a rental directly.

Steven J. Hilton -- Chairman Chief Executive Officer

Yes. If rental buyers want to pay us the same thing that our regular customers pay us, we'd be very happy to sell them houses, but we've yet to find those guys. So we got a lot of demand for our products so we're going to continue to sell those traditional markets.

Jade Joseph Rahmani -- Keefe, Bruyette, & Woods, Inc -- Analyst

Hey, guys, great job on the forum.

Operator

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

Alex Barron -- Housing Research Center -- Analyst

Great job during the quarter. I wanted to ask you, so on your slide five, you're 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 percent of the lots you were buying were toward entry-level. So as you move toward the 300 communities by 2021, where do you see that entry-level percentage of communities going?

Steven J. Hilton -- Chairman Chief Executive Officer

Above 50%.

Alex Barron -- Housing Research Center -- Analyst

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

Steven J. Hilton -- Chairman Chief Executive Officer

No. I mean if we were 80% entry-level, we'd be selling hardly any move-up homes because we sell more homes in entry-level than we would do in move-up. So it's not going to get that high. But 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 1 MU that we like and we'd need to be trekking faster on our feet. 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.

Phillippe Lord -- Executive Vice President and Chief Operating Officer

You'll continue to see a large amount of lots that we purchased be in the LiVE.NOW. space just because we have 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.

Alex Barron -- Housing Research Center -- Analyst

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 what does that say about the future

Hilla Sferruzza -- Executive Vice President and Chief Financial Officer

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 so 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 just seeing that the entire company is, kind of, running at about 20, we're a little bit north of that in the entry-level.

Alex Barron -- Housing Research Center -- Analyst

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

Operator

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

Steven J. Hilton -- Chairman Chief Executive Officer

Well, thank you very much for your support and for engaging our call today. And we look forward to talking to you in January for our year-end result. Thank you. Have a great day.

Operator

[Operator Closing Remarks]

Duration: 50 minutes

Call participants:

Brent A. Anderson -- Vice President, Investor Relations

Steven J. Hilton -- Chairman Chief Executive Officer

Phillippe Lord -- Executive Vice President and Chief Operating Officer

Hilla Sferruzza -- Executive Vice President and Chief Financial Officer

John Lovallo -- BofA Merrill Lynch -- Analyst

Alan Ratner -- Zelman & Associates -- Analyst

Elad Elie Hillman -- JP Morgan Chase & Co, Research Division -- Analyst

Paul Allen Przybylski -- Wells Fargo Securities -- Analyst

Stephen Kim -- Evercore ISI Institutional Equities -- Analyst

Carl Edwin Reichardt -- BTIG -- Analyst

Jade Joseph Rahmani -- Keefe, Bruyette, & Woods, Inc -- Analyst

Alex Barron -- Housing Research Center -- Analyst

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