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Meritage Homes Corp (NYSE:MTH)
Q3 2020 Earnings Call
Oct 22, 2020, 11:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

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

Emily Tadano -- Vice President, Investor Relations

Thank you Hannah. Good morning and welcome to our analyst call to discuss our third quarter and year-to-date 2020 results. We issued the press release yesterday after the market closed. You can find it along with the slides we will refer to during this call on our website at investors.meritagehomes.com or by selecting the Investor Relations link at the bottom of the home page. Please refer to slide 2 cautioning you that our statements during this call as well as the press release and accompanying slides contain forward-looking statements, including but not limited to our views regarding the health of the housing market, disruptions to our business by COVID-19, economic conditions and changes in interest rates, community count and absorptions, projected full-year home closings and revenue, gross margins, SG&A expenses, tax rates and diluted earnings per share, as well as others.

Those and any other projections represent the current opinions of management, which are subject to change at any time, and we assume no obligation to update them. Any forward-looking statements are inherently uncertain. Our actual results may be materially different than our expectations due to a wide variety of risk factors, which we have identified and listed on this slide as well as in our press release and most recent filings with the Securities and Exchange Commission, specifically our 2019 Annual Report on Form 10-K and subsequent quarterly reports on Forms 10-Q, which contain a more detailed discussion of those risks. We have also provided a reconciliation of our certain non-GAAP financial measures referred to in our press release as compared to their closest related GAAP measures. With us today to discuss our results are Steve Hilton, Chairman and CEO; Hilla Sferruzza, Executive Vice President and CFO; and Phillippe Lord, Executive Vice President and Chief Operating Officer of Meritage Homes. We expect this call to last about an hour. A replay will be available on our website within approximately one hour after we conclude the call and will remain active through November 5.

I'll now turn it over to Mr. Hilton. Steve?

Steven J. Hilton -- Chief Executive Officer & Chairman of the Board

Thank you, Emily. I'd like to welcome everyone participating on our call today and hope that you and your families are continuing to stay safe and healthy. Before continuing in this call I'd like to take a quick moment to say thank you to Brent Anderson, who is retiring as the Vice President of Investor Relations at Meritage after 15 years. He's done a great job representing the company to our investors and analysts and he will be sorely missed. I'd also like to introduce Emily Tadano, our new Head of IR. Good luck Emily. You have big shoes to fill and hope you are with us, at least 15 years like Brent. Now, this is the last panel I'll address you as Chief Executive Officer of Meritage Homes on an earnings call. As we have previously announced, effective January 1, Phillippe Lord will transition to the CEO role and I will retire after 35 years and become Executive Chairman of Meritage's Board.

I will continue to participate on these calls, but Phillippe will be taking the lead. Phillippe and I have worked closely together for 12 years. During the past five years as Chief Operating Officer Phillippe was the co-architect of our strategy to focus on the entry-level and first move-up markets while driving operational excellence and efficiencies throughout our organization. I feel confident that Meritage will continue to be an innovative leader, provide exceptional quality and value to our customers and grow to new heights under Phillippe's leadership. I look forward to partnering with him in our new roles. So let's talk about the quarter ended September 30, 2020. Meritage had many remarkable achievements. We delivered our highest quarterly orders, our strongest absorption since 2005, record quarterly closing revenue and our best quarterly closing gross margins since 2014 despite record high lumber prices, while also achieving our lowest net debt to capital in our company's history.

These outstanding results are due to both solid market dynamics and our strategy. So I'll start with slide 4. We sold 3,851 homes this quarter, which was 71% more than the third quarter of 2019 and surpassed the quarterly record we had just set in the previous quarter this year. Although we are still in a worldwide COVID pandemic, favorable macroeconomic factors for the new home industry that began last quarter continued in Q3 including historically low mortgage interest rates, increased demand for healthier and safer homes, limited supply of existing home listings and a decade long supplies toward new homes in the market. All these dynamics create the advantageous backdrop, which combined with our strategy focused on affordable entry-level and first move-up homes translate into another record same quarter for Meritage.

Moving on to slide 5, we believe we have a solid strategy and have executed at a high level. We are achieving strong closing revenue growth with an increase in both pace and price, while we are increasing prices in all our geographies and aligning with local market conditions. We are not turning down sales where demand exists. We can and will capture demand whenever possible because of our available spec homes. Our spec homes strategy has allowed us to sell at a greater pace and take market share. In Q3 of 2020 we accelerated our land investments by spending nearly $300 million and put a record 9,000 new lots under control.

Our balance sheet remains very strong, which provides a long runway for growth as well as a safety net in the event of another downturn. We have maintained plenty of liquidity and a low debt leverage even as we invest significantly for additional growth in all our existing markets. While the accelerated sales trend resulted in some early community closeouts this quarter we are still on pace to achieving 300 active communities by early to mid-2022. And consistent with our strategy our new entry-level communities will have a high volume of spec inventory immediately available for sale at community openings which could be closed relatively quickly.

I'll now turn it over to Phillippe to discuss more of the recent trends. Phillippe?

Phillippe Lord -- Executive Vice President and Chief Operating Officer

Thank you Steve. Before I begin and on behalf of the entire company, I would like to thank Steve for 35 years of incredible leadership that has guided the company through both successful and turbulent times, as well as instill the values, integrity and beliefs that live within each of us at Meritage today. Steve's commitment to our employees, customers and shareholders as well as his vision and execution led us to the company's all-time records today. I would also like to personally thank Steve for his mentorship and guidance over the last decade. I am deeply honored to have the opportunity to serve this organization and its employees as the upcoming CEO and to continue working together with Steve in this next chapter of Meritage Homes story.

Slide 6, now, we hit on all cylinders during the three months ended September 2020. Our absorption pace for the quarter was up 94% year-over-year. Five out of nine states had absorption increases over 100% year-over-year this quarter. Much of this sales outperformance is due to the strength in the entry-level market. Entry-level represents 60% of our average active communities during this quarter compared to 42% a year ago, which puts us near our target ratio of 65% to 35% between entry-level and first move-up. Absorption in our entry-level communities were 75% higher than last year and nearly 1.5 times the pace of first move-up communities. Entry-level comprised almost 70% of total orders for the third quarter, up from 54% in the third quarter last year.

Our first move-up communities also experienced improved demand year-over-year with absorptions 86% higher than a year ago. Slide 7, the outsized demand in Q2 and Q3 of 2020 led to 23 early community closeouts this quarter. These sellouts happened across all existing geographies. We anticipate both continued strong sales demand and choppiness in our community count in the near future. We have ramped up land investments and we'll continue to do so to replenish our pipeline to keep up with demand and grow our community count. We have been aggressively securing new lots since mid-April following a pause due to COVID-19 related shutdowns. During 2019 we put 17,000 new lots under control which translates to 134 new communities.

We put approximately 16,000 new lots under control in just the first nine months of 2020 almost as much as all of 2019 and nearly 80% more than 2018's 9,000 new lots. This translates into about 123 new communities put under control during the first nine months of this year with dozens more to come in the fourth quarter. At September 30, 2020 with nearly 48,000 total lots outstanding representing 4.4 years of lots supplied based on a trailing 12-month closings, we've increased our land book by almost 30% from September 30, 2019. As part of our entry-level strategy, the average size of our communities has also expanded. We've been putting larger land positions under contract often several hundred lots at a time targeting a three- to five-year community life even at an accelerated sales place.

Year-to-date September 30, 2020 our new lots under control were 81% entry-level with an average community size of 130 new lots. We are scheduled to open up more than 150 communities in 2021 compared to opening 75 communities in all of 2019 and approximately 100 communities projected for full year 2020 after being shut down for six weeks due to COVID-19. We believe that our aggressive pace of securing new lots and a strong pipeline of community openings will start to meaningfully show increase in community count in the latter half of next year. At a pace of 50 sales per year and an average of 300 communities could reasonably produce 15,000 sales in 2022. Slide 8, moving to the regional level trends on slide 8, all of our regions reflected solid year-over-year performance in Q3.

Our central region comprising Texas led in terms of order growth this quarter with an 82% increase in orders over the third quarter of 2019 despite a 14% decline in average community count. The central region's absorption doubled to six per month compared to three per month in the third quarter of 2019. Entry-level communities representing 63% of central region's average active communities during the third quarter of 2020. Our orders in the West region were up 68% over the third quarter of 2019, driven by an 88% increase in absorption with 10% fewer average communities. Entry-level communities represent 63% of the West region's average active communities during the quarter. California produced the largest year-over-year growth in orders at 158% for the quarter and the highest absorptions of all nine states we operate in, selling an average of seven per month during the quarter of 2020, which was an increase of 137% in absorptions year-over-year.

Average community count in California also increased 9% year-over-year for the third quarter of 2020. We are seeing the success of the shift to newer affordable entry-level communities in California come through in the community count and sales performance there. Our each region experienced order growth of 63% on an 87% increase in absorptions year-over-year for the quarter, offsetting a 30% decline in average community count. 50% of our average active communities in the East region were entry-level during the quarter.

I will now turn it over to Hilla to provide additional analysis of our financial results. Hilla?

Hilla Sferruzza -- Executive Vice President and Chief Financial Officer

Thank you, Phillippe. Let's turn to slide 9. We generated 56% earnings growth year-over-year in the third quarter of 2020 compared to the same period in 2019 as we had significant growth across all key metrics with 21% closing revenue growth, 170 bps increase in home closing gross margin and a 70 bps improvement in SG&A as a percentage of home closing revenue. This quarter's closings were up 24% year-over-year, with 71% of closings coming from previously started spec inventory. At September 30, 2020 approximately 14% of total specs were completed, less than the last couple of quarters understandably as we're selling more specs in earlier stages of production.

Although this dynamic is also driving a decrease in our backlog conversion rate over the last several quarters, our backlog conversion rate for the third quarter was 68%, which is slightly up year-over-year evidence that our construction pace is keeping up with sales. We generated over $1.1 billion of revenue in Q3 2020 as the year-over-year increases in closing volume reflecting our record high sales more than offset the decline in ASP home closings resulting from the shift in product mix toward entry-level. Our closing gross margin improved 170 bps to 21.5% for the third quarter of 2020 from 19.8% a year ago. Higher home prices more than offset record lumber costs. The additional closing volume and the efficiencies achieved from our streamlined operations and national purchasing savings contributed to a 31% year-over-year increase in total closing profit.

As we have previously covered, we have been able to continue to harvest savings in our material cost by reducing SKU count to achieve preferred vendor pricing and bulk purchasing discounts, while taking advantage of pre-cut material where available. Our streamlined production also allows us to obtain preferred labor pricing from our trade. SG&A as a percentage of home closing revenue was 10.1% for the current quarter which was a 70 bps improvement over 10.8% in 2019 due to greater leverage of fixed expenses and efficiencies and higher closing volume as well as cost savings from technology enhancements particularly as related to sales and marketing efforts.

We also benefited from a lower tax rate with the extension of the energy tax credits into 2020 under the Taxpayer Certainty and Disaster Tax Relief Act enacted in December 2019, our effective tax rate was 19.5% for the third quarter this year versus 24.4% last year. Our third quarter diluted EPS of $2.84 also benefited from our repurchase of 1 million shares in the first quarter of 2020. To highlight just a few items for year-to-date results September 30, 2020, on a year-over-year basis we generated an 86% increase in net earnings, orders were up 40%, closings were up 26%. We had a 250 bps increase in home closing gross margin and a 90 bps improvement in SG&A as a percentage of home closing revenue. The strong start to 2020 and rapid recovery that started in mid-April more than offset any pullback experienced from COVID-related uncertainties in late Q1 and very early Q2.

Moving on to slide 10, our balance sheet continues to be very strong even as we step up investments in land acquisition and development, we have plenty of liquidity including $610 million of cash, nothing drawn on our credit facility and a lower net-debt-to-cap -- in the lowest net-debt-to-cap in our company's history at 15.7%. We grew our spec inventory back to an average of 11.2 specs per communities this quarter after dipping in the second quarter to about 9.3. We are committed to increasing our per store spec count by year-end with inventory on the ground available for a quick close. We anticipate our heavy backlog and increased volume of available specs entering into 2021 would result in improved backlog conversions and solid closing into next year.

Slide 11, our land acquisition and development strategy is very nimble and we can aggressively increase our purchases when housing market is hot and also pull back quickly when the housing market slows. We spent nearly $300 million on land and development this quarter our highest spend in a single quarter in our history. For the first nine months of 2020 we spent nearly $760 million on land acquisition and development, which was more than 28% higher in the same period of last year. We are using options or staggered purchasing terms to secure more lots, which allows us to preserve our liquidity.

About 58% of our total lot inventory at September 30, 2020 was owned and 42% was optioned which improved compared to September 30, 2019 with 66% owned and 34% optioned. Finally, I'll direct you to the slide 12. 2020 will be a record year in spite of the pandemic. We anticipate continued strength in Q4 but caution these results could be impacted by uncertainty surrounding the election, COVID-19 or financial market volatility. For the full year 2020 we're projecting total closings to be between 11,200 and 11,500 units, home closing revenue of $4.2 billion to $4.4 billion, home closing gross margin of approximately 21% to 21.5% and effective tax rate of 20% to 21% and diluted EPS of $10.25 to $10.50

With that, I'll turn it back over to Steve.

Steven J. Hilton -- Chief Executive Officer & Chairman of the Board

Thank you Hilla. Turning to slide 13, to summarize, Meritage Homes today is a different company than when I co-founded it in 1985. Our culture and our strategic shift has been transformative. I'm proud of the innovative product, energy efficiency, superior quality and affordability that we have delivered in every home that we build. Now as one of the leading entry-level first move-up home builders, Meritage is well-positioned to capitalize on current market demand and deliver strong results into the future. Demand is through the roof, pun intended. Our closing revenue growth benefits from our focus on affordable product, which allows us to push both price and pace.

Layering the leverage of FC&A and streamline operations on top of closing revenue growth, we are seeing some of the strongest results in Meritage's history. Our financial flexibility to grow comes from having a strong balance sheet with excess cash and the lowest net debt to capital we've ever had. We are focused on growth by accelerating land investments to get to our goal of 300 community count by early to mid-2022. We are driving an increase in ROE and creating value for our shareholders. All this was the combination of the right strategy, ability to execute and the dedication of incredibly talented team.

I truly believe the opportunities for future growth and success are boundless for Meritage. I'd like to personally thank our employees in helping us transform Meritage Homes. The executive team had a vision for this company and our people made it a reality. And on a personal note, I want to thank you, I want to say thank you to the investment community for your long-term interest and support for our company and for my leadership. After 91 quarters of your thoughtful and brilliant questions, I'm not sure how we'll close without the anxiety of the quarterly full body scan. You know how much I will really miss all of you.

That concludes our prepared remarks. I'm going to turn the call over to our operator for instructions on Q&A. Operator?

Questions and Answers:

Operator

Thank you. [Operator Instructions] And we'll go first to Alan Ratner with Zelman & Associates.

Alan Ratner -- Zelman & Associates -- Analyst

Hey guys. Good morning. First off a big congrats to I guess everybody on the line, Steve, Brent, Emily, Phillippe. Steve I think I speak for everybody that we will certainly miss you on these calls as well but best of luck in the next chapter. So, I think the -- obviously the big topic that everybody is focused on today is just this concept of have we hit a point where builders kind of have to intentionally slow the pace of activity for a multitude of reasons and obviously nobody is expecting 70% growth to continue here but the community count is a big topic and I think a 300 target by mid '22 is certainly extremely positive and optimistic.

And I guess the question is what does that cadence look like? There's obviously concern that you have enough product on the ground heading into the selling season for next year. So is it going to be somewhat smooth for the year, back half weighted, front half weighted? But I guess on top of that perhaps the better driver of your growth is spec inventory as opposed to communities since such a high percentage of your sales are spec. So can you maybe give us a little bit of a target of what you're hoping to have on a year-over-year basis your spec count heading into '21 just so we can get some idea of the planning on growth?

Steven J. Hilton -- Chief Executive Officer & Chairman of the Board

So there's a lot to unpack there Alan, appreciate the question and I appreciate yours [Indecipherable] support over these last couple decades. It's been a great ride and you guys have provided us some very thoughtful coverage and research and we really appreciate that. I appreciate that.

Alan Ratner -- Zelman & Associates -- Analyst

Thank you.

Steven J. Hilton -- Chief Executive Officer & Chairman of the Board

I think it's important for investors and analysts to look a little more long-term than just at the next couple of quarters. Obviously, it's going to be a little bumpy for us on the next couple quarters, particularly these strong sales continue, which I don't see a reason why they won't. But we have the loss. It's not a question of if; it's a question of when. These communities are going to come and they're going to produce really solid long-term growth for our company. I mean as Phillippe said in his section, we should be able to sell at least 15,000 homes in 2022. We'll have resource for it and we're entering this coming year with a really big backlog because we've been selling homes earlier in the cycle times even though we've been selling predominately specs.

We're selling them when they're just starting versus when they're just finishing, which is building our backlog. In addition to that, we're really focused on trying to get about 3,000 homes started -- 3,000 homes into the spec pipeline, I think we're at around 2,100 or 2,200 now. So, we're going to ramp up our specs for the spring selling season, which will also help us with our deliveries next year. But if you're only looking for the next quarter or two, it's going to be bumpy. But if you want -- if you're a long-term investor and you're thinking about where this company is headed long-term -- and long term is not that long, it's -- we're talking a year away. It looks pretty good and I'm pretty darn excited about what we have in our pipeline and I think investors should also.

Alan Ratner -- Zelman & Associates -- Analyst

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

Steven J. Hilton -- Chief Executive Officer & Chairman of the Board

I'm going to let Phillippe and Hilla take that one.

Phillippe Lord -- Executive Vice President and Chief Operating Officer

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

Hilla Sferruzza -- Executive Vice President and Chief Financial Officer

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

Alan Ratner -- Zelman & Associates -- Analyst

Very helpful. Thank you very much and great luck.

Steven J. Hilton -- Chief Executive Officer & Chairman of the Board

Thank you.

Operator

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

Truman Patterson -- Wells Fargo Securities -- Analyst

Hey, good morning everyone and let me throw out my congrats to everyone on the call as well. Now that Brent's officially retired I've been trying to convince him to move to Phoenix finally. So we'll see what happens there. But first question -- clearly, investors are focused on the 18% community count decline which clearly you're a bit of a victim of your own success really. But hypothetically, if the market's growing, orders in the market are growing at a 20% clip or a 25% clip in the first half of 2021. Do you think you all will be able to meet the market and really offset some of this community count volatility through an elevated absorption pace? I'm also thinking you're replacing 75% of your communities effectively in 2021, which should have a higher lot count, maybe a little bit better absorption pace. But can you just walk us through maybe that hypothetical?

Steven J. Hilton -- Chief Executive Officer & Chairman of the Board

Well, I mean I can't give you a specific guidance for the first quarter of '21 or the first quarter of '22 but as I said it's going to be a little choppy if you just focus on the community count number. But with the higher absorptions we're getting we should be able to produce some decent sales numbers. I don't know if we're going to get to 20% greater than it was in 2020. We had a pretty good January and February and this year, so as I said, look more closely at the backlog and the spec counts that we have going into '21, which should produce some really good earnings numbers for the first couple of quarters of '21.

After that we're going to have to rely on the community count to start to kick in and propel us into some really good '22 numbers. And I don't know what else I could really tell you -- the community count, it's an issue, but it's a short-term issue. It's not a question of if; it's a question of when. We bought a lot of lots. We'll continue to buy lots. We're not seeing resistance to finding lots to -- that fit within our strategy. And we're going to be opening more communities next year than we ever have before. And I think that long-term and I feel really good about the quality of the communities we're opening, the locations of the communities that we're opening and again, it's going to produce really solid long-term results.

Hilla Sferruzza -- Executive Vice President and Chief Financial Officer

So we can't give '21 guidance yet. We're going to obviously do that next quarter, on our next quarter call, but just a couple of directional items that I think we adjust in the prepared remarks that maybe -- maybe bear repeating. There will be an inflection point at some point in '21 in the community count, right? We're not going to get to that 300 community count number all in '22. So, there will be a point in '21 and we're not getting a target for which quarter where we'll see a material increase in our community count in those communities come with a lot of specs, already built on the ground, eye opening. You'll see those sales top at that time and then you'll see the closings come very shortly after. So, I think that we kind of tried to provide a little bit of a path there by addressing how we will enter the year, a lot of specs in the heavy backlog, and then at some point during the year, we'll have an inflection point where you're going to see everything kind of shift and really accelerate into '22.

Steven J. Hilton -- Chief Executive Officer & Chairman of the Board

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

Truman Patterson -- Wells Fargo Securities -- Analyst

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

Steven J. Hilton -- Chief Executive Officer & Chairman of the Board

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

Phillippe Lord -- Executive Vice President and Chief Operating Officer

Yeah. So, cycle times at least from our perspective are not expanding. Sales are expanding, which means we have to get more specs in the ground and as Steve had articulated we're chasing the specs a little bit. We ramped up our starts capacity dramatically out of COVID. So we're starting more homes than we've ever started in history. It's just that we're selling more homes than we've ever sold in history. So we're in this inflection point. We're trying to ramp up specs with community decline going the other way. So that's really what's stretching out the backlog conversion. But the cycle times we're still building homes extremely quickly. Labor is performing very well. We're not seeing any issues there. Capacity is there.

You guys know and are aware of the supply chain dynamics specifically around lumber although we've seen that level off and supply chain loosen up recently there. So from our perspective at least because we're a spec builder because we've streamlined our operations, labor is performing really well. We're seeing cost pressure. We're able to cover that cost pressure with the pricing in the market and cycle times are actually probably even a little bit lower than they were. We continue to dial it in and are building homes really quickly. And then on the start side -- that's the biggest challenge just starting as many homes as we are today and the municipalities approving the permitting. That's a bit of a bottleneck. But as I said earlier we are starting more homes than we ever have in history. So we're working through those challenges. But that's probably the most -- the area of the biggest opportunity if we were to increase capacity from here.

Truman Patterson -- Wells Fargo Securities -- Analyst

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

Steven J. Hilton -- Chief Executive Officer & Chairman of the Board

Thank you.

Operator

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

John Lovallo -- Bank of America Merrill Lynch -- Analyst

Hey guys. Thank you for taking my questions. The first one on the gross margin outlook for 2020. I think that implies 4Q gross margin of somewhere around 22.9%, which is up 250 basis points or so I think year-over-year. I guess the question is how much of this is pricing versus some of the savings that you guys have talked about and in terms of that -- the latter part of the savings on the labor front that you guys have worked out on horizontal and vertical side. I mean, do you anticipate being able to hold on to those as activity picks up here or do you think you're going to have to give some of that back?

Hilla Sferruzza -- Executive Vice President and Chief Financial Officer

Hi John, thanks for the question. So I think for us -- because we're a spec builder, a part of the lumber increases is already reflected in our Q3 number because of our pretty quick cycle times. There's another portion of the lumber increases that's going to be coming through in Q4 but we're definitely able to offset that like you said if you kind of do go back to the napkin math you can see that we're projecting an increase in margin, in Q4 to hit our target of 20% to 21.5% for the full year blend. So that's coming from higher ASPs and some continued efficiencies we're seeing because on the cost side at least in Q4, we are still going to have some increased cost pressure from lumber lots that were in place when we started those homes. So we're not really predicting anything yet for 2021. We're assuming lumber is going to stay steady even though there's probably some green shoots that will come down a bit. But right now, mostly what you're seeing is efficiency that we're finding in the products, the ability to leverage that fixed overhead component in margin and price increases.

John Lovallo -- Bank of America Merrill Lynch -- Analyst

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

Phillippe Lord -- Executive Vice President and Chief Operating Officer

Yeah. This is Phillippe. We are very mindful of that, which is probably why every community has its own story. The LiVE.NOW brand it's really important that we stay below FHA. We think that's the governor as we look at the market and you look at entry-level communities that operate above FHA, they're not seeing the demand that we're seeing that buyers can't get qualified in a conventional loan. So that's really the governor. So we have a little -- we definitely have some opportunities to continue pushing in some places because we're still well below FHA. In other places like Phoenix we're getting there and there's not a lot opportunity and upside there. So it's market-by-market, it's community-by-community, it's also what the competition is doing. But that's really the story for us. We're about pace, we're about leverage, that's what the entry-level business is all about. And so, we are mindful of our pricing although we've been able to get both price and price in today's market as we move into next year, there is an absolute governor out there that will limit us pushing it much further.

John Lovallo -- Bank of America Merrill Lynch -- Analyst

That's helpful. Thanks a lot guys.

Steven J. Hilton -- Chief Executive Officer & Chairman of the Board

Thank you.

Operator

[Operator Instructions] We'll go next to Stephen Kim with Evercore ISI.

Stephen Kim -- Evercore ISI -- Analyst

Yeah. Thanks a lot guys. Well, yeah, we're going to miss you Steve and Brent. But you know what; we look forward to still seeing you Steve on or hearing you on calls and best of luck with everything Brent in particular. My question starts off I guess talking about Studio M and California communities. I remember over the last year and a half or so, these were two aspects of your product mix, which we thought were going to be pretty important to watch. The ramp in communities that you have been planning for a couple of years now in California looks like it's hitting just at the right time.

Meanwhile, Studio M I'm intrigued about. You didn't talk too much about it, I don't think in this call, but one of the other builders today was talking about how there's been a lot more energy at the higher end of the month -- not exactly the entry-level, but maybe the move-up segment of the market which Studio M seems to go after. So, can you talk about what you saw specifically with the target market for Studio M and whether your California and Studio M products carry with them higher margins that we can be looking forward to next year?

Steven J. Hilton -- Chief Executive Officer & Chairman of the Board

So, Stephen thanks for your kind words first of all. I'll miss you guys too but hope you're -- I'll still be around. There's energy in all segments of the market right now. I think you're hearing that from other builders. There is a builder right before us today with phenomenal results. I think there's energy at all price points. And I think the low mortgage rates and the fact that people are spending more times in their homes with COVID has created demand in all price points. I think I'm shocked to see some of the multi-million dollar $10 million homes that are selling some of these -- high priced zip codes. It's like I've never seen before in my entire career.

Studio M works well for us. Are the margins higher than LiVE.NOW? Maybe a touch, not really, but the margins we're getting out of LiVE.NOW are solid. We're seeing more opportunities for land though, it's less competitive for us LiVE.NOW segment than it is in the one of new segment. I think I alluded to this last quarter in our call -- we're building -- we're chasing bigger deals, 200 lots, 300 lots, 400 lots, 500 lots deals for our entry-level communities because the absorptions are much higher and because we're trying to reduce the churn, the community count churn, if you buy a smaller community and you're only in it for a year or two, you're starting off, you're finishing off, you're opening models, you're closing models. There's a lot of overhead labor that goes with that.

It's hard for the organization. But if you could be in a community a little bit longer, it's better on the bottom line. And it allows our land people to not to work as hard to find replacements. So we're finding less competition for those bigger parcels. We only have a few big public builders that we compete with. We don't compete with as many private builders for those parcels and even some of the public. So our land acquisition has been a bit skewed in that direction. That's not to say that we don't love Studio M or we don't believe in what end users would do and we are buying those parcels and we're going to continue to do so. And we've opened a few in California this year to increase our community count there for sure. But with respect to California specifically it's a tough place to find land and it's risky and you've got to pay up and it takes a long time and there is a lot of hurdles. So we're happy that we're doing better there. But it's a big challenge for us and for all builders for that matter.

Stephen Kim -- Evercore ISI -- Analyst

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

Hilla Sferruzza -- Executive Vice President and Chief Financial Officer

We haven't given guidance into '21 yet. I think you're pretty much spot on. We didn't get specific number but between a $1 billion and a $1.2 billion is a good expectation for full year 2020. So you kind of do the math here at 760 a year to date. Obviously we had a pause for six weeks during the year. So we're going to be accelerating that. You can expect that number to continue to accelerate. We'll give more specific guidance but there's no way to get to that 300 community count without continued acceleration in '21 and '22. We can go ahead and kind of model something little north of that.

Steven J. Hilton -- Chief Executive Officer & Chairman of the Board

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

Stephen Kim -- Evercore ISI -- Analyst

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

Phillippe Lord -- Executive Vice President and Chief Operating Officer

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

Steven J. Hilton -- Chief Executive Officer & Chairman of the Board

Let me just add a bit. We're dealing with last year's FHA number right now and prices have been rising, and it's been widely reported and it's not fiction probably 1% a month. So, we're not -- this year we're up 9% or 10% already, and most places FHA loan limits are around $300,000 or low $300,000s for us. So, prices are up $25,000 on entry-level products across the board, but the FHA loan limit was still lower for last year. Now, adjusting for this year, but I don't know if you can go to the bank on the fact that it's going to adjust completely in line with what our prices have increased. So, we've got to be mindful as Phillippe articulated a couple of times already that we stay inside that number.

Hilla Sferruzza -- Executive Vice President and Chief Financial Officer

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

Steven J. Hilton -- Chief Executive Officer & Chairman of the Board

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

Stephen Kim -- Evercore ISI -- Analyst

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

Steven J. Hilton -- Chief Executive Officer & Chairman of the Board

Yes.

Phillippe Lord -- Executive Vice President and Chief Operating Officer

Yes.

Stephen Kim -- Evercore ISI -- Analyst

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

Steven J. Hilton -- Chief Executive Officer & Chairman of the Board

Okay, thank you.

Operator

We'll go next to Carl Reichardt with BTIG.

Carl Reichardt -- BTIG -- Analyst

Thanks. Good morning everybody

Steven J. Hilton -- Chief Executive Officer & Chairman of the Board

Hey Carl.

Carl Reichardt -- BTIG -- Analyst

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

Steven J. Hilton -- Chief Executive Officer & Chairman of the Board

Thank you.

Carl Reichardt -- BTIG -- Analyst

Congrats Steve. I'm modeling a better backswing for you. That's what I'm.

Steven J. Hilton -- Chief Executive Officer & Chairman of the Board

[Speech Overlap]

Carl Reichardt -- BTIG -- Analyst

And welcome to Emily. I just had one question, which is if I look at LiVE.NOW and your penetration obviously is really significant in Phoenix and other places. But as you're looking out the next couple of years, what are the metros or states where you think you can really drive LiVE.NOW penetration and get it higher? Where are you lagging in terms of a percentage of your mix? Thanks guys.

Phillippe Lord -- Executive Vice President and Chief Operating Officer

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

Steven J. Hilton -- Chief Executive Officer & Chairman of the Board

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

Hilla Sferruzza -- Executive Vice President and Chief Financial Officer

And that 300 community colleges does not contemplate new markets. So that's just an extra cushion for us.

Carl Reichardt -- BTIG -- Analyst

That's great to hear. All right. Congrats. Thanks all.

Steven J. Hilton -- Chief Executive Officer & Chairman of the Board

Thanks, Carl.

Operator

We'll go next to Michael Rehaut with J.P. Morgan.

Elad Hillman -- J.P. Morgan -- Analyst

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

Steven J. Hilton -- Chief Executive Officer & Chairman of the Board

October continues to be strong. I'd say maybe not quite as strong as September because a little bit of seasonality, but I think we've already surpassed last year's sales number for October with 9 or 10 days to go in the month, two weekends to go. So I expect that we'll produce a pretty big, a pretty big order number versus last year's for October. And I don't see any -- I don't see anything on the horizon that's going to change that dynamic.

Phillippe Lord -- Executive Vice President and Chief Operating Officer

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

Steven J. Hilton -- Chief Executive Officer & Chairman of the Board

We were going to put a gun in every house, so we couldn't find them. I'm just kidding. Sorry.

Elad Hillman -- J.P. Morgan -- Analyst

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

Steven J. Hilton -- Chief Executive Officer & Chairman of the Board

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

Hilla Sferruzza -- Executive Vice President and Chief Financial Officer

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

Elad Hillman -- J.P. Morgan -- Analyst

Got it. Thank you. Thanks, guys.

Steven J. Hilton -- Chief Executive Officer & Chairman of the Board

Welcome.

Operator

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

Alex Barron -- Housing Research Center, LLC -- Analyst

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

Steven J. Hilton -- Chief Executive Officer & Chairman of the Board

It's all organic and we pretty much have all the land under contract, stores to do it. So it's not like we got to go out and buy a whole bunch of land to make that happen, we already got the land, so we have a high degree of confidence in getting there and early to mid '22 and.

Alex Barron -- Housing Research Center, LLC -- Analyst

Okay.

Steven J. Hilton -- Chief Executive Officer & Chairman of the Board

It may be choppy along the way and as we said because we may sell out of some communities faster like we did this quarter, we closed out 58 communities this quarter, we would have closed out those communities next quarter or the quarter after. So our community count would have maybe been a little higher -- would have been higher third quarter and maybe higher at year-end. But when we're selling 71% more homes in Q3 and what was the Q2 number 60% or 70% more in Q2 -- the homes are flying off the shelf faster than we anticipated and that's driving the community count down. But it's going to rebound because we got -- we have the lots. We bought the lots, we have the lots, we have the stores. We're developing them, we're moving them through the process and they will be here and this will be a little bit later because of COVID and because of the quick sell out of the of the communities that we closed out in these last two quarters.

Alex Barron -- Housing Research Center, LLC -- Analyst

Okay, that's all good. I don't see any problem with selling out early. It just means you're taking buyers out of the market.

Steven J. Hilton -- Chief Executive Officer & Chairman of the Board

Exactly.

Alex Barron -- Housing Research Center, LLC -- Analyst

The other question I had was with regards -- I think you said about 70% of the sales this quarter were entry-level. And I think you also said that the size of the communities that you're buying is growing. So, basically should we expect that the trends in sales pace will keep increasing and should we expect basically that the percentage of entry-level will also keep going up over the next couple of years as you're heading toward the 300 communities?

Steven J. Hilton -- Chief Executive Officer & Chairman of the Board

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

Alex Barron -- Housing Research Center, LLC -- Analyst

Yeah, I think the community.

Phillippe Lord -- Executive Vice President and Chief Operating Officer

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

Alex Barron -- Housing Research Center, LLC -- Analyst

Okay, awesome. Well, best of luck and good jobs thanks.

Steven J. Hilton -- Chief Executive Officer & Chairman of the Board

Thanks Alex, I think this is our last question, operator right, oh two more.

Operator

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

Susan Maklari -- Goldman Sachs -- Analyst

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

Steven J. Hilton -- Chief Executive Officer & Chairman of the Board

I get to ask this question every quarter for the last 91 quarters and it's just so hard to predict M&A. There's so many factors that go into it. So many social issues -- what are the goals and objectives of the acquire is a retirement planned or what are they -- what are their plans, what are they thinking sure there could be but I wouldn't say that we're seeing more deals now than we saw a year ago, frankly it's been kind of quiet -- we're probably going to be more particular about acquisitions because we're focused on our strategy and we're only going to be interested in builders that fit within our strategy, so their product is outside of the product that we build, it wouldn't be a fit for us and we just feel like we can grow solidly organically over the long-term and we will be entering in some new markets as I said, so our eyes are always open but hard to tell what the pace of M&A is going to be.

Susan Maklari -- Goldman Sachs -- Analyst

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

Steven J. Hilton -- Chief Executive Officer & Chairman of the Board

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

Susan Maklari -- Goldman Sachs -- Analyst

Okay, great. Thank you. Good luck.

Steven J. Hilton -- Chief Executive Officer & Chairman of the Board

Thanks Susan. Last caller?

Operator

We'll go next to Jade Rahmani with KBW.

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

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

Steven J. Hilton -- Chief Executive Officer & Chairman of the Board

Well, that's a mouthful. I mean you don't prepare anything to respond to that question. That's a good question for sure. This is I said in my -- in the Q&A, I think the industry needs to be a little more longer term thinking. We seem to have a very short attention span and rising. And I think so much of the trade in our stocks are shares today, not just us, but everybody's programmed by computers. And everybody's got really good news today, yesterday, next week with the share prices are going down, pretty hard to figure that out. I mean everybody I guess just woke up to the fact that the comps are going to get tough next year. So, I think the industry continues to innovate. I think the way we build houses is -- have to change.

Homes are really built, pretty much the same way they were built 40 years ago. We don't control our labor. We're dependent on the trades and contractors. We've got to figure out how to control our own destiny more. I think there's a lot of innovation coming on the tech, on the sales side. We've seen a lot already. There's probably more coming. There's a lot coming in the back office on how we manage the financial functions of the business. So, I'm excited to see where this is going to go and I think it's going to be fun, it's going to be interesting and I think Leif and his team are going to do a phenomenal job. Me, I'm going to be fishing for a while but I'll still be around and I'll still be on these calls and keeping in touch and leading the board and working with Phillippe on our long term vision and our strategy and I'm just so excited for my own future and I'm excited for the company's future as well. So appreciate your support Jade and thanks for the question.

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

Thank you very much.

Steven J. Hilton -- Chief Executive Officer & Chairman of the Board

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

Phillippe Lord -- Executive Vice President and Chief Operating Officer

Thank you, bye.

Operator

[Operator Closing Remarks]

Duration: 66 minutes

Call participants:

Emily Tadano -- Vice President, Investor Relations

Steven J. Hilton -- Chief Executive Officer & Chairman of the Board

Phillippe Lord -- Executive Vice President and Chief Operating Officer

Hilla Sferruzza -- Executive Vice President and Chief Financial Officer

Alan Ratner -- Zelman & Associates -- Analyst

Truman Patterson -- Wells Fargo Securities -- Analyst

John Lovallo -- Bank of America Merrill Lynch -- Analyst

Stephen Kim -- Evercore ISI -- Analyst

Carl Reichardt -- BTIG -- Analyst

Elad Hillman -- J.P. Morgan -- Analyst

Alex Barron -- Housing Research Center, LLC -- Analyst

Susan Maklari -- Goldman Sachs -- Analyst

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

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