Taylor Morrison Home (NYSE:TMHC) Q3 2020 Earnings Call

0:00 Good morning and welcome to Taylor Morrison's third quarter 2020 earnings conference call. Currently, all participants are in the listen-only mode. Later, we will conduct a question and answer session and instructions will be given at that time. As a reminder, this conference call is being recorded. I would now like to introduce Mackenzie Aaron, Vice President of Investor Relations.

0:27 Thank you. We appreciate you joining us for Taylor Morrison's third quarter 2020 earnings conference call. With me today are Sheryl Palmer, Chairman and Chief Executive Officer, and Dave Cohn, Executive Vice President and Chief Financial Officer. Sheryl will begin the call with an overview of our performance and market outlook, while Dave will take you through the highlights of our financial results, after which we will be happy to take your questions. We ask that you please limit yourself to one question and one follow-up. Let me remind you that today's call, including the question and answer session, includes forward-looking statements that are subject to the safe harbor statement for forward-looking information that you will find in today's news release.

1:12 These statements are subject to risks and uncertainties that could cause actual results to differ materially from our expectations and projections. These risks and uncertainties include but are not limited to those factors identified in the release and in our filing to the Securities and Exchange Commission, and we do not undertake any obligation to update our forward-looking statement. I would also like to remind everyone that we will refer to certain non-GAAP financial measures on the call, which are reconciled to GAAP figures in our earnings release, which is available on the investor relations portion of our website. With that, let me turn the call over to Sheryl.

1:50 Thank you Mackenzie and good morning everyone. We appreciate the opportunity to update you on our recent results and business strategy. Certainly the year has unfolded differently than we could have ever anticipated. Yet I'm so pleased with how our team has navigated the unprecedented environment while also working through an integration allowing us to deliver our stronger than expected third quarter performance. Our adjusted diluted earnings per share increased 53% year-over-year to $1.01, excluding transaction-related expenses and refinancing charges, while our gap diluted earnings per share was up 38% to $0.87.

2:39 Building upon the rebound in activity that began in May, our sales remained strong throughout the third quarter. Our net orders increased 74% year over year, driven in part by the benefit from our acquisition of William Lyon Homes in February and a continuation of robust demand. This marked notable acceleration from 23% growth in the second quarter. Our monthly absorption pace increased 53% year over year to 3.8 sales per community. The highest quarterly level in our public company's history. By month, our sales pace was up by nearly 70% in July, just over 55% in August, and approximately 40% in September.

3:32 Despite leaning more heavily on price to appropriately manage our backlog, our absolute sales pace remained in a relatively consistent range throughout the quarter, and has even accelerated thus far in October from September's run rate and is expected to be at more than 50% year over year for the month, reflecting the remarkable resiliency in today's housing market. Our industry is clearly benefiting from several tailwinds, including historically low interest rates, limited inventory, and a shift into the new home market by consumers in search of clean, healthy, and functional spaces for their families. These trends have magnified favorable demographics that were in place prior to the pandemic and will likely persist long after it. Collectively, these dynamics renew our conviction in the long-term opportunity for housing that we are all well positioned to capitalize on after years of strategic transformation into the nation's fifth largest homebuilder.

4:38 The sales success we experienced during the quarter was driven across nearly all our geographies and consumer groups. Across the country, all our markets experienced year-over-year growth, with notable strength in our Phoenix, Northern California, and Southwest Florida markets. Among our buyer groups, sales pace in our entry-level segment was generally consistent with the second quarter, while activity in each of our move-up and active adult segments improved meaningfully. Notably, our active adult consumers are increasingly engaged with our sales team, and we are seeing real traction, particularly among returning out-of-state buyers as we enter the winter selling season for our lifestyle communities.

5:28 Of course, the strong sales environment has put renewed emphasis on the critical price versus pace balance. While we have always navigated that tradeoff at the community level to fully maximize profitability and returns on an asset by asset basis, we have generally prioritized price at this point in the market rebound. We implemented a nationwide price increase in August, reduced our incentives across the board, and achieved price increases in virtually all our communities. As Dave will elaborate on, we believe the pricing increases we have realized thus far are sufficient to cover anticipated lumber and other cost inflation as we look ahead to 2021.

6:14 While there is further runway to raise prices in the current environment, particularly in the move-up and luxury segments, we also recognize the need to be mindful of preserving affordability for our prospective buyers. particularly at the affordable entry level. We will continue to carefully manage our price and pace in each community based on demand trends, our supply pipeline, and the competitive environment. I want to also spend a moment discussing our industry leading virtual selling tools and digital capabilities. As we discussed last quarter, we introduced two additions to our online suite earlier this year. Self-Guided Tours of Inventory Homes and Online Home Reservations.

7:04 Following on those successes, we are in the process of rolling out standardized option packages that will be available in both our in-person and online sign centers offering curated feature selections to streamline our design process. I am pleased about the positive impact these tools have on the overall customer experience and equally encouraged by the longer term financial benefits on the business. For instance, home buyers that use one of our virtual tools are less likely than other buyers to use a real estate broker. Additionally, the internet was our top lead source for buyers for the second consecutive quarter at 46% versus 38% for brokers.

7:54 Both trends present opportunities to reduce our commission expense over time. Additionally, the adoption of standardized option packages will help us improve our material costs and processes and reduce our cycle time. While these initiatives are still in the early innings, we remain committed to finding innovative ways to drive improved operating efficiencies, enhanced margins, and increased returns. Shifting gears to another exciting development, it has been one year since we announced our entry into the Build to Rent market via strategic partnership with Christopher Todd Communities, and I'm happy to share an update on our progress. At the time, we expressed our optimism that the Build to Rent market presented opportunities to leverage our core home building and land acquisition expertise in a new way, helping to increase our delivery velocity, enhance our production process, and diversify our offerings to meet consumer demand.

8:55 Given the clear deficit of affordable single-family housing across the country and shifting consumer preferences post-COVID away from dense traditional apartments to more spacious single-story living, our confidence in this opportunity has only increased over the last year. We have broken ground on two communities in Phoenix with five additional projects in their pipeline expanded into four new markets, completed a strategy playbook to be utilized across our divisions, and are in the process of finalizing our new national product library. We have plans for further expansion in 21 as we continue to quickly scale the partnership. Once the communities reach stabilized rental levels, we intend to monetize the assets and are in the process of evaluating potential exit strategies for 2022 and beyond.

9:49 Most importantly, the relatively streamlined and concentrated production provided by our build-to-rent operations will add further depth to our overall scale, allowing us to capture greater construction efficiencies that should be accretive to our margin and return profile over time. As I said earlier, we expect housing activity to remain healthy for the foreseeable future and believe our market presence is well suited to meet that demand. However, we also remain cognizant of the uncertainties and risks facing the economy related to the ongoing pandemic, uneven employment recovery, waning government stimulus, and of course, next week's presidential election.

10:34 Regardless of the economic backdrop, our strategy is designed to allow us to navigate the cyclical environment equipped with both financial and operational flexibility. Now let me turn the call over to Dave for his financial review.

10:49 Thanks, Sheryl, and good morning, everyone. I am pleased with the strong financial results we delivered in the quarter. We also made further progress in deleveraging our balance sheet as we refinanced a portion of our 2023 and 2025 senior notes in July and then paid off the remaining balance of those same notes in September for a total reduction of $285 million paid with cash on hand. We also paid down $200 million of our corporate revolver. These actions will lower our annualized interest expense by approximately $21 million. As a result, our net debt to capital ratio declined by over 400 basis points sequentially to 41.6% at the end of the third quarter.

11:34 Since our acquisition of William Lyon Homes in February, we have reduced our net debt balance by a total of $497 million, or approximately 17% as we have efficiently reduced the leverage assumed in the transaction at a pace faster than originally projected. Given the progress made thus far, we now expect our net debt to capital ratio to decline to approximately 40% by year end and the high 30% range by the end of 2021. Overall, our balance sheet is in strong shape with nearly $1 billion of total available liquidity including approximately 550 million of cash on hand. Going forward, we will continue to look for ways to opportunistically manage our balance sheet with an eye towards further deleveraging.

12:25 In addition, we intend to pay down all or substantially all the remaining revolver balance by the end of the year. The robust sales environment that Sheryl discussed left us with a company record backlog of 7,761 units representing a sales value of approximately 3.8 billion, up 48% from a year ago. We are focused on managing our production schedules to deliver these sold homes in a timely manner for our customers while also rebuilding our spec inventory to more normalized levels. Specifically, at the end of the quarter, our spec inventory inclusive of finished specs equal 3.1 per community. This is below our typical run rate due to strong demand for inventory homes.

13:13 We anticipate building our total spec inventory over the next two quarters to more normalized levels as we prepare for next year's spring selling season. We will continue to target finished specs per community at just over one, which is slightly above the level we ended with this quarter. Moving to closings, we delivered 3,469 homes, a 51% increase over the same quarter last year. This was ahead of the expectations that we shared last quarter given a faster than expected sales pace of our inventory homes. As we discussed on last quarter's call, our prior four-year closings guidance partially reflected our view that supply-side constraints would likely push a portion of our backlog into early 2021.

14:02 However, the strong success in the third quarter and continued momentum into the fourth quarter is allowing us to increase our closings guidance to approximately $12,500 for the full year. Turning to margins, our gap home closings gross margin was 17.2%, inclusive of capitalized interest and purchase accounting, which exceeded the expected range we shared last quarter. On an adjusted basis, our margin equaled 17.8%, which excludes an approximate 60 basis point impact from purchase accounting. Driven by the strong housing environment and supply governors, the industry is experiencing lumber inflation and potentially upward pressure on labor costs.

14:47 However, rising home prices are helping to offset these headwinds and we have already seen lumber inflation start to ease. As a result, in the fourth quarter, we expect JAP home closings gross margin to improve sequentially to about 18%. which would leave full year margins in the mid 16% range and increase over our prior estimate. The impact of purchase accounting is expected to moderate to approximately 25 basis points in the fourth quarter, leaving the full year impact at roughly 125 basis points. Overall for 2021, we do not anticipate any material impact from purchase accounting next year and expect sequential margin accretion as we start to see the advantages from the acquisition synergies, operating efficiencies, and pricing trends in our backlog.

15:37 SG&A as a percentage of home closings revenue improved 210 basis points year over year to 9% as we have continued to capture the benefits of increased scale, strong market conditions, and cost control measures. For the full year, we now expect our SG&A percentage to be in the high 9% range. Looking ahead to 2021, it is important to note that while we expect to continue to leverage scale benefits, these savings will be partially offset by an increase in costs as we return to more normalized course of business post the pandemic. Regarding our ongoing integration of William Lyon Homes, we are running slightly ahead of where we initially planned to be at this point and expect to be mostly complete by the end of the fourth quarter.

16:24 The one area that we are eager to make further headway on are the cultural and relationship aspects of bringing together two companies that have naturally been more challenging in a remote work environment. Given the progress made to date, we can once again reaffirm our 80 million annualized synergy target. We have completed our overhead rationalization and renegotiation of national procurement contracts and are now in the process of working through local cost programs with our field purchasing teams. Overall, we remain confident in our ability to close the gap between legacy William Lyon and Taylor Morrison's normalized margins within the 12 to 18 month timeframe we initially laid out. Moving now to our community count land portfolio, we ended the quarter with an average of 393 communities down from 411 in the second quarter, but up from 346 a year ago.

17:17 While we opened nearly 50 new communities across our footprint during the quarter, the elevated sales pace experienced over the last several months has naturally resulted in accelerated closeouts of existing communities. As a result, average community count in the fourth quarter is anticipated to be approximately 375 to 380, and as we look out to 2021, we expect our average community count to remain roughly flat from the fourth quarter level. We invested over $370 million in land and development during the quarter, bringing the year-to-date total to $1.1 billion. We expect to further ramp up the pace of our land investment in coming quarters, although we remain disciplined to our philosophy of acquiring prime land and core submarkets.

18:04 We already own or control nearly all of the lots we need to support our growth in 2021 and are focused on investing to support further community-count expansion in 2022 and beyond. At the end of the third quarter, our land pipeline carried a supply of approximately 68,200 owned and controlled lots, which represented 4.8 years of supply based on pro forma Taylor Morrison and William Lyon home closings over the last 12 months, of which 3.4 years were owned. Lots controlled represented 29% of our total lot supply, up from 19% a year ago. As we underwrite new land deals, we remain focused on incrementally expanding our controlled share to maximize returns and minimize risk.

18:51 Now I'll turn the call back over to Sheryl.

18:54 Thank you, Dave. To wrap up, I would like to share a few thoughts about where we go from here. Over the last seven years, we have completed six acquisitions, expanding our total market count by a third since 2013 to 21. We have calibrated our footprint to ensure we are located in the markets that have the strongest macroeconomic drivers in place to drive sustainable long-term growth through a full housing cycle. We have also expanded our local market share to provide critical operating efficiencies and greater depth in each of our consumer segments. This intentional transformation of the organization has provided us with a national platform that is focused on generating industry-leading returns.

19:42 While we still have significant work ahead of us to achieve our long-term strategic goals, our top priority is demonstrating the benefits of our expanded scale. With the team portfolio and products in place, we see opportunity to leverage our size to reduce construction costs, Utilize our industry-leading virtual sales tools to streamline overhead and optimize our balance sheet to drive sustainable cash flow growth to reinvest into the business and maximize returns. We are committed to taking full advantage of our competitive strengths as we get through the final stages of our latest integration effort and enter 2021 as a fully aligned team.

20:27 Before we move to Q&A, I want to end with a note of gratitude to our teams for their tireless commitment to our organization and customers. I'm excited about our outlook and look forward to continuing to update you on our progress in the coming quarters. And lastly and most importantly, I sincerely hope each of you and your families have been healthy during these times, and I wish you the best as we continue to move forward. Now I'd like to open the call to your questions. Operator, please provide our participants with instructions. Thank you. As a reminder, to ask a question, you will need to press star 1 on your telephone. To withdraw your question, press the pound key. Our first question comes from Carl Richard of BTIG. Your line is now open.

21:11 Good morning, everybody. Nice to talk to you. Good morning, Carl. Carl. I wanted to ask just about California, Sheryl, given your expanded presence there. Can you just talk to me a little bit about how the coastal markets are comparing to the inland markets? And then as you look at your mix in California into 21 and maybe overall the company, how is it shifting more towards smaller entry-level homes, more lionish type of stuff? And is that going to help your absorption rate next year given the comps are going to be quite hard?

21:41 Well, thank you, Carl. Absolutely. Absolutely. So California is the tale of a number of stories. If I start in Southern California, obviously you know that was home base for the Lion Acquisition. So our business there is up five, six times in totality. More importantly, I think the market, the paces that we've seen throughout the Southern California business has almost doubled. And we're seeing that, interestingly enough, Carl, across the entire business there. Certainly the paces are higher in the Inland Empire at the more affordable levels. The other shift we have in California is, you know, that business probably used to be 65, 75% specs, and now it's probably moving to a more 50-50.

22:33 And I think as we look forward, we'll even see even a stronger to be built business. The IE, to your point, has really seen accelerated demand. I mean, with folks being able to work from home, what used to be kind of far out is actually not at all. Probably an honorable mention to the Bay as long as we're talking about California because we've seen such a shift there as well. I mean, there were a number of quarters Late last year, earlier this year that we talked about some of the pressures in the Bay. We've seen some of the best paces over the last quarter that we've seen in a couple of years. Part of the contribution there is a real shift in our ASP down over the last couple quarters.

23:24 We had already started down that road, and then certainly with the addition of William Lyon, it's only helped us.

23:32 Okay. Thanks, Sheryl. and then Dave can I ask just sort of what do you think given how fast you've been able to reduce the debt here and as you look going forward likely you're going to be more cash flow generative on a go forward basis too. What kind of target debt to cap are you looking at for the company overall over time? Is it changing at all? Can you operate with lower levels of leverage? Thanks a lot all. Thank you.

23:57 Yeah Carl definitely I think our perspective has changed. You know we always said that We're very comfortable operating around the 40% net debt to cap ratio, but we are focused on driving down that leverage. And as we commented, we expect to be high 30% by the end of next year. And when we look at our cash needs, we don't have any debt maturing until 2023. We have a strong ability to generate cash flow and really no need to take on additional debt to grow the business. We're working through our 21 plan right now. So the Q4 call will probably have a better long-term target for you. But I would expect it to be under what we're seeing right now of high 30% range at the end of 21. It's going to be below that probably on a go-forward basis.

24:48 Makes sense. Thanks very much for taking the questions. Thanks, Carl. Thank you, Carl. Thank you. And our next question comes from Mike Dahl of RBC Capital Markets. Your line is now open.

25:00 Hi, this is actually Chris Don from Mike. Thanks for taking my questions. For my first question, just a point of clarification, the community count outlook, you said it was going to be flat for Q. Is that on average for next year or ending? And how should we expect that to rank next year? Should we think of that as more back half weighted?

25:18 Yeah, it's to the average community count for Q4. And then you know it's going to be somewhat even I think as we move through the year again we're finalizing our 2021 plans uh right now you'll probably see slightly higher uh maybe towards the middle of the year uh that'll probably be kind of more of that that peak point for us and a lot of this just depends obviously on our ability ability to continue with the strong sales demand we're assuming you know an elevated pace kind of more in line with what we've seen recently If we see that move a little bit higher, then obviously that might accelerate some closeouts.

26:02 Got it. That makes sense. And then just my second question, you guys mentioned that you've been able to realize pricing to fully meet the inflationary pressures. So I guess when you look past that into next year, how are you guys thinking about the case-first price given that now that you've kind of lapped the You know, I think globally that's always a tricky question to answer.

26:35 And as we've said in our prepared remarks, I mean, if you have a pivot, I would say it's certainly a bias toward price today. We want to make sure that we really do time our sales and our production capacity, you know, hand in hand. We make these decisions at a local level, at a community-by-community basis. I would tell you that there are markets and communities today that we are metering out sales, and we're releasing lots on every two weeks. And there are other communities where we're continuing to run. But once again, if I were to make a comment across the portfolio, the bias would be toward price. If you look at our historic paces over the last couple years, we've been somewhere in the low to mid twos per community per month. You can see we've made tremendous traction this year, and that was certainly one of the objectives of the organization, to really focus on pace.

27:37 I think you'll find a more natural run rate somewhere between the two. I don't think we'll continue to run at the 3738, but I don't expect we're going to go back into the mid twos either.

27:47 and just with our low-spec inventory, I think that speaks to that focus on price. Inventory is so tight right now. As Sheryl said, we want to maintain kind of that production cadence as well. But with the tight inventory, you know, we're going to focus more on price.

28:04 Got it. Appreciate the call.

28:05 Thank you. Thank you. And our next question comes from Jay McInglis of what place should one set open?

28:15 Good morning. Thanks for taking my questions. I guess the first one, going back to the community count and thinking about 21, with the move like we were talking about, Sheryl, to further outreaches of the Inland Empire, are you all looking at shifting maybe some openings or do you have the flexibility to shift some of your openings to these more far-flung regions or are you basically kind of

28:44 I guess a couple comments there. You know, when you look across the board and you look at the demand, as I said, we're seeing it in all price points and all consumers. And so good news, right? We're selling faster than we anticipated. Looking forward, that doesn't really allow us to bring in communities sooner. So when I look kind of to 21, I think the formula starts to look a little bit different than we would have thought last year. We'll be generally flat in community count, but we'll expect elevated paces as we've been talking about, which I think creates a more efficient business.

29:31 Absolutely, with the addition of William Lyon Homes and some of the shifts we had made, we are... Looking at more affordable positions across the board. And it's more than just the Inland Empire. I really think it's about how you control that land. As you know, we've talked enough times about the average size of our communities has moved down a bit so that you can be prepared for anything the market gives you. Because right now, those communities and those places are doing very well. But when interest rates move over time, we're not going to put all of our eggs in that one basket. So I do like the diversity of our portfolio. I think with that strategy, you should expect to see significant closing growth next year. The team is just so focused on kind of longer-term growth.

30:25 I'll kind of move that to just our ramp-up in land spend in Q3. We approved probably two to two and a half times the land in Q3 than what we've done for probably the last five years. So once again, it's about how we control that, but it's really across all price points, including the more affordable price points, but also an active adult and that first-time move-up.

30:52 I think the same can be said. We're trying to accelerate our spend on the development side as well, but It's obviously a long runway to get there. That's not going to impact 21 as much. It's hopefully going to set us up for a stronger 22, 23.

31:04 That's great. And then wanted to ask on cycle times, where are those running now and availability of labor, municipal headwinds? Can you just talk around that and what impact those are having on cycle times?

31:24 Sure, you know, cycle times overall are generally flat, slightly better than this time last year. Surprisingly, we haven't seen much impact of cycle times, at least yet related to the pandemic. But we're continuing to watch this closely, you know, and working with our trades and municipalities. I expect some level of pressure in Q4 as builders are trying to deliver their year. That's kind of more of the normal course. I think municipalities have probably been most impacted from the pandemic as far as their availability. That said, I think they've done a fairly nice job in working with us and working across the industry to help us get either communities open or deliver closings.

32:09 Yeah, I think it's about how you look at the cycle times. I mean, if you look at today's points, kind of start... Thank you for joining us. I mean pulling a permit today is very different than what it used to be and some have gotten their arms around it and others are still struggling. So you've seen some permit movements. So we've been really trying to dissect our kind of cycle times to look at where are we from sale to actual start and how do we continue to improve that and help the municipalities and then how do we retain the cycle times on the construction, the vertical side of the business.

33:09 Thanks for taking my questions.

33:12 Have a good one, Jay. Thank you. And our next question comes from Jack McIndoe.

33:20 Hi, good morning. You all have, you know, really done some creating and things around the share buyback, you know, following some of these acquisitions. And I guess the question, taking into account some of the leverage comments you made earlier, you know, So with that excess capital, with the cash flow going forward, it sounds like your first call now is on de-leveraging over buyback. Is that the right way to think about it?

33:53 Yeah, let me add a couple of points and I'll work into answering that question. You know, obviously 2020 has been very interesting from a capital allocation perspective, you know, with the pandemic. Right now we're feeling really good about our cash position, overall liquidity. and that's with the recent pay down as we mentioned the $200 million on our revolver plus the $285 that we did on the most recent refi and like I said no debt coming due until 2021. At this point we've essentially returned to our normal capital allocation philosophy of reinvesting back into the business through land and development spend. So Sheryl said you know you mentioned that Oh, sorry. No debt due until 2023. Sorry.

34:46 Like I said, we're back to spending on land and development spend. Sheryl mentioned Q3 for us was a big quarter as far as deals that we've approved. From there, we're going to look at paying down the debt and the shares, both depending on several factors. We have about $8 million left on our current share repurchase authorizations. We'll obviously look at maybe extending that, increasing that as we go through our 21 plan work. But we're going to continue to invest with the cash we generate, and that's going to be in a way that we can avoid any kind of drag on our return. When we look at how we're going to allocate that capital, it's going to be up against the cost of land where the stock is trading and where interest rates are in the debt market. I'd tell you right now, given all those factors, we're probably leaning a little bit more towards the debt deleverage, just given the current macro environment.

35:44 Okay. Thanks for that. You know, I noticed the capture rate in the mortgage business is up quite nicely year to year. I'm thinking a part of that is probably integrating the William Lyons business into the Taylor Morrison piece, but Sheryl, is any of this being driven by this increased virtual meaning? You've got folks coming directly to you. There's less of that broker influence, consultative referral. Is the more direct-to-consumer approach that virtual is allowed also helping tax rate? Is that number in the mid-80s sustainable, do you think?

36:26 You know, that's just a fascinating question, to be honest, Jack. I had not correlated the two, I'm embarrassed to say. The virtual environment has certainly changed our relationship with the consumer and it makes sense that the folks that are operating 100% virtual, that our process and our virtual mortgage process has made that customer experience so much easier. Very difficult for me to quantify. In addition to that, you know, in all honesty, early in the pandemic, we did do a promotion on closing costs. So that would have helped it a bit.

37:13 But I actually think the capture is coming through the sales and the service experience that Taylor Morrison Home Funding provides our customers, the ease of the experience, all of our virtual tools. And as I probably talked about on last quarter's call, Right when the pandemic hit, I mean, that team, our mortgage team, went to work to protect that backlog, lock-in rates, all those things that literally they jumped on day one that kept our can rate so low. So I think it's not just one thing, but I will now look for the correlation on, you know, if I look at the deals that we're seeing completely virtually, I will try to correlate that to mortgage capture. It's a great question.

38:00 Thank you. Thank you. Thank you. And our next question comes from Alan Ratner of Zellman & Associates. Your line is now open.

38:12 Hey, guys. Good morning. Congrats on the great results. I'm glad to hear everyone is doing well on your end.

38:17 Thank you.

38:18 My first question, Sheryl, you guys do a lot of great work on the buyer segments, and I'm curious because we've seen We've seen on the mortgage side some pretty significant increases in second home demand. And I'm curious, I know it's probably not a big part of your business, but I'm curious if you're seeing any increased activity among second home buyers in your business right now.

38:39 Yeah, I think we are. It's modest. It's not a subset that, you know, will rise to a consumer set at this point, Alan. But I think we are seeing it absolutely in the active adult that that consumer is returning. you know that's always been a good part of that business and you know our highest paces in the quarter were the active adult business which is just fascinating if you look at the low that we had had you know one and two quarters ago where the only business we could really see there was in-state because they weren't getting on planes now they're driving further in fact I was just looking at the out-of-state numbers and this past quarter we were pretty close to our normal I think that's where we're capturing the greatest piece of that second home market.

39:31 Interesting. Second, you talked a lot about the price versus pace dynamic and how closely you guys are watching affordability. I'm curious if you could share with us any particular metrics maybe you're looking at. Prices are up a lot, obviously. Rates are down significantly. So is there a particular metric, whether it's monthly payment, debt to income, that you kind of have on your dashboard as something that might be an indicator that things are going up too much? And I'm just curious if there's any anecdotes you can give us about maybe instances where you actually have seen some resistance to price increases or you feel like across the board there really hasn't been.

40:11 Thank you for that question. It's a really good one. Yeah, there's a couple places. I'll start with your second question first. There's a couple places where I think pricing created a little sticker shock and we, you know, took a pause, let the consumer adapt, but I would say generally the price increases across the business before we get to the affordability question have been well received and as you can see by our paces, they have not slowed down in collections at all. Interestingly enough, Alan, on the affordability side, you know, I probably haven't quoted this for a couple quarters, but you'll recall that we used to on a pretty regular basis talk about that cushion in both the FHA and the conventional buyer on what they are spending and what they can afford to buy. And either you would see that in added interest rate or you'd see that in buying a bigger house. So all of the stats that you articulated absolutely were watching. But what I think summarizes them well is just the rate cushion they have.

41:13 and we're seeing on the FHA side still somewhere between 300 and 500 basis points. So once again, they could afford a rate somewhere between 300 and 500 basis points than what they are locking in today or they can buy a bigger house and on the conventional side, it's actually increased, Alan. It's something closer to 600 to 700 basis points. I mean, that is significant and so it talks a lot about where rates are but I think it talks more to the way the consumer's looking at their relationship with their monthly obligation.

41:51 Appreciate you sharing that with us and thanks a lot.

41:54 Good luck. Take care. Thank you. And our next question comes from . Hi, good morning. This is Maggie on for Mike. My first question is just on the pickup in sales pace that you pointed to in October versus September. And I think that you said that absolute pace was relatively consistent throughout the quarter. But I was just wondering, as you look from that maybe 40% in September to up in the 50%-ish range in September, October, is there anything else or any change or improvement that's driving that or is that mostly a function of a bit easier of a comp?

42:44 No, I don't think it's an easier comp. I just think it's all the factors that we've been talking about, Maggie. It's a really fair question because you would expect a much greater seasonal influence at this point.

42:58 But if I look at the comp... From a comp perspective, on a pace, Maggie, our September and October of last year was the exact same amount.

43:09 Same number of sales. Same pace. So, you know, once again, the first three weeks don't make the month. We've got, you know, probably eight, nine days from when we quoted that. But, you know, if it's you know a tenth higher or a tenth lower. I think the point for us is that the demand continues strong and we're seeing it across the board and that's even with some of the pricing you know that we're taking you know reduction in incentives and increases in base prices that we're seeing really across the board. Okay thank you and then a second question just on those Reduction incentives and the price that you're taking. Could you quantify that at all for us?

43:59 You know, there's a range, obviously, by market and by consumer group. As I said, I think in my remarks, we have probably a little greater opportunity in that move of active adult buyer. But, you know, somewhere in the 2% to 3% on average. I think we've got places where we're seeing stronger increases, and you've got some where you're kind of in the 1%. But I would say the 2, 2.5 would probably be an average across the portfolio, Matt.

44:27 And we're seeing that in our backlog, not just in the deliveries we had in Q3, but it's still holding strong in the backlog. Got it. Thank you.

44:36 Thank you. Thank you. And our next question comes from Truman Patterson of Old Fargo. Thanks.

44:45 Actually, this is Paul Chabot speaking. First, I guess from your commentary, it sounds like you're just wanting to get your spec package for next spring back to on par with where it was this year. Is there any particular reason, given strong market dynamics, that you wouldn't want to try and push that a little bit higher?

45:08 It's a great question, Paul. You know, a couple things there. We're trying to get it back. I think that's fair that you want to operate with a certain level of spec inventory and be available for those consumers that have an immediate need from a moving. Having said that, excuse me, having said that, you know, where we've got, you know, I'll take a market like Phoenix where, you know, we probably have a two-month backlog pretty much across the country. a two month backlog sold not started which is about right when you think about the time from sale to pulling a permit and starting. If you can fill that pipeline with to be built it does a lot for the business. It creates a very strong efficiency in the production cadence. It generally would deliver a higher margin profile and I think de-risks the business over time because as Things Slow Down, you know, COVID was a great example of that. It's those buyers that aren't as emotionally committed that will be the first to back away because they haven't picked the lot, they haven't designed the house to their very personal taste. So it's a balancing act for us.

46:19 We like the shift in the to-be-built business, but we do want to have a reasonable inventory

46:25 on hand. Yeah, so we're prioritizing where that inventory is going in. Yeah, obviously, you know, the most affordable price points is where we would like to see the biggest pickup.

46:35 Okay. Hey, I guess, you know, with your community count expected to be, you know, somewhat flat next year, any color you could provide on the number of fully developed or lots that you can bring to market next year from, you know, a growth perspective? If your community counts flat, will you have a number of, you know, an opportunity through increased finished lots to increase your sales?

47:02 You know, it's a great question, Paul, and we're going through the planning. And I'm not dodging next year because we've tried to give you guys a great amount of color on 21. But we actually have all of our budget meetings next week. That is the million-dollar question. You know, if you think about in April, May, we really slowed down development on any phases that had not started or that were at a comfortable place until we really understood the impact. so now getting that machine up both on the horizontal side and the vertical side is part of what you're seeing in Q4 but on the horizontal side I think most importantly we have to see what that kind of 90-day slowdown does to the capacity in 2021 and that's why we'll be in a better position to give you kind of closing numbers because it's not sales all you can see that it's really what what can we get in the ground and when can we get those lots to our construction team to be able to begin construction.

48:04 And just one quick final one. You talked about your move to a standardized design package. Some of your peers have quantified margin benefits from that. Do you have any targets you'd like to share with us?

48:18 Yeah, you know, I'm a little hesitant because it's early days. We have rolled out our Canvas package, which I'm quite excited about. It's about five or six. standardized packages and we've absolutely seen some margin enhancement in that selection process and my numbers so far you know are from the pilot market which is one market where we saw is you know as much as a couple hundred basis points we are now live in seven divisions with probably four or five more happening before the end of the year or January and then we have the other eight probably coming on in the first half. So you'll start to see a pickup. I would say aspirationally I would expect that to be a couple hundred basis points. You'll really see the impact of that on the P&L in 22.

49:10 Okay. Thank

49:12 you. I appreciate it.

49:13 Thank you so much. Thank you. And our next call-out stream call-in from Alex Reigel, B. Riley, your line is now open.

49:23 Thank you. You mentioned the expectation for sequential improvement gross margins in 2021. You've addressed this in a couple different ways on the call, but can you kind of come back and sort of summarize and maybe even quantify some of those drivers to gross margin improvement in 2021?

49:39 Yeah, Alex, it's a little early for me to quantify that. As I mentioned, we're working on our 21 plans right now, but we do expect accretion. Some of that is going to come as purchase accounting lapses but more importantly as we benefit from the synergies from the transaction as well as pricing power even with the impact of lumber we anticipate margin accretion next year and I can tell you you know what gives me some confidence of that as I look at our backlog for the first half of next year we already see it there so but we'll come back to you with more of the specifics in Q4 as we finalize our plans.

50:21 And circling around to land purchases, what does the availability look like right now out there in the marketplace? And how has the cost of land changed, you know, subsequent to COVID?

50:38 That's a great question. It's competitive. But, you know, if you had asked me that question anytime in the last 20 years, I probably would have answered it pretty similarly. You know, we didn't really see a blip with COVID. Maybe the only blip we saw was we got land sellers to delay action. So no change on price, no change on cost, but maybe we got a little bit more time on, you know, takedowns, finalizing, going hard on deals. But that was short-lived. You know, no real change in our underwriting at this point as we look forward, but I would tell you the market's competitive. Sellers have very high expectations given the paces you're seeing in the builder community.

51:24 People are moving through their land quicker than anticipated, and the sellers are pretty savvy and see that. And so it's more of the same. I can't tell you if there's any great deal, but like I said, our teams are doing a tremendous job navigating and looking for those opportunities and building on the relationships they have in the markets. Thank you. Thank you. Thank you. And our next question comes from Alex Baron of Halden Research Center. Your line is now open.

51:57 Yeah, thank you, and great job in the quarter. Thank you. Dave, I was wondering, should we expect any further transaction expenses related to William Lyon next quarter, or are we pretty much done?

52:10 Alex, there's probably going to be a little bit. you know I would say maybe four to six million that we'll probably see come through in the fourth quarter but that should largely take us to the end.

52:24 Got it and the other question I had was you guys got some pretty good leverage in the financial services segment is that something that you know you think we can continue to expect going forward?

52:41 We're going to probably see that moderate a little bit into 21. Some of that is just the way that we're doing some of the incentives. So like I said, it'll moderate a little bit, but we'll give you some more detail on that.

52:56 It's a secondary market lift, but that's all very timing related. The team did, as I said earlier, just a tremendous job taking advantage of, you know, when we came out of COVID, how we locked those secondary markets. Hard to say that it will continue at that level, but I think we'll continue to see the strong capture, and then we'll see how the secondary market treats us.

53:21 Okay, great. Well, thank you, and best of luck.

53:25 Thank you so much. Thank you. And ladies and gentlemen, this does conclude our question and answer session. I would now like to turn the call back over to Sheryl Palmer for any closing remarks.

53:36 Thank you for being with us today. Appreciate the opportunity to share our Q3 results and wish you all a very good quarter. Stay safe. Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.