Greetings, and welcome to the Meritage Homes Second Quarter 2020 Analyst Call. [Operator Instructions] Please note that this conference is being recorded. I will now turn the conference over to our host, Brent Anderson, Vice President of Investor Relations. Thank you. You may begin.

Thank you, Jason. Good morning, and welcome to our analyst call to discuss our second quarter and first half 2020 results. We issued the press release yesterday after the market closed, and you can find it along with the slides we'll be referring to during this call on our website at investors.meritagehomes.com or by selecting the Investor Relations link at the bottom of the homepage. Turning to slide 2. We'll caution you that any statements made during this call as well as the press release and the accompanying slides contain forward-looking statements, including, but not limited to, our views regarding the health of the housing market; potential adverse impacts related to the COVID-19 pandemic and the second wave of infections; community count, absorptions, projected third quarter and full year home closings and revenue, gross margins, SG&A expenses, tax rates and diluted earnings per share; as well as economic conditions and 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've identified and listed on this slide as well as in our press release and our most recent filings with the Securities and Exchange Commission, specifically, our 2019 annual report on Form 10-K and quarterly reports on Forms 10-Q, which contain a more detailed discussion of those risks. We've also provided a reconciliation of certain non-GAAP financial measures referred to in our press release as compared to their closest related GAAP measures. Our speakers today are Steve Hilton, Chairman and CEO of Meritage Homes; Hilla Sferruzza, Executive Vice President and CFO; and Phillippe Lord, Executive Vice President and Chief Operating Officer. We expect to call the last about an hour, and a replay will be available on our website within approximately an hour after we conclude and will remain active through August 6. I'll now turn it over to Mr. Hilton to review our second quarter. Steve?

Thank you, Brent. I'd like to welcome everyone participating on our call today and hope that you're safe and well. It's hard to believe that just three months ago, we were discussing the sharp drop in March orders due to the nationwide shutdowns intended to slow the spread of the COVID-19. And today, we're discussing record orders for the second quarter and demand for our homes that even surprised us. It's been anything, but a normal spring selling season. I can't remember another time like this in all my 35 years leading Meritage. We'll review some of the highlights of the quarter and explain what we believe is driving our success and how we're positioned for continued earnings growth. I'll preface it by saying that while the market is broadly benefiting all builders, we believe our strategy and execution will continue to place Meritage among the best-performing homebuilders to own. I'll start with Slide 4. We reported in mid-May that our orders for the month of April were down to 15%, which was less than we had projected just a few weeks earlier and look like May orders could meet or beat May of 2019. We ended up setting an all-time record in May for single month orders, selling a total of 1,320 homes, which we then surpassed in June with a new record of over 1,500 orders. New orders were up 44% higher than last year, and June was up 66% over last year. We finished the quarter with 3,597 total orders, another all-time record for Meritage and 32% higher than the second quarter of 2019. What's most surprising is that all those records came in the midst of a pandemic that is still dominating the news and affecting nearly every aspect of our daily lives. We firmly believe…

Thank you, Steve. This was an unexpected, but remarkable quarter in many ways. We never imagined we'd be facing the conditions we found ourselves in at the beginning of the quarter, and I'm proud of the way our entire organization stepped up to the challenge to deliver the results we did. We demonstrated empathy and compassion for our customers and for one another, a never-give-up attitude, creativity, teamwork and perseverance to rise to the occasion time and time again. I want to thank each member of our team for living up to our core values and delivering the best for our customers every day. I will now provide some highlights and the recent trends on Slide 8 before turning it over to Hilla to review our financial results for the quarter. The market faced a grim outlook at the start of the quarter, but we've already taken steps recommended by the government and health organizations that would enable us to continue to sell, build and deliver homes in a safe and healthy manner. When demand surfaced in May and shelter-in-place orders began lifting, we were prepared to meet it. Our virtual selling capabilities and safety measures allowed us to continue to operate and ultimately meeting and exceed expectations for the second quarter. We sold about five homes per month on average in our communities during the second quarter, 42% more than we did in the same quarter last year. In fact, 48 of our communities sold more than 10 homes last month. Much of it happens due to our entry-level position, which represented 57% of our total active community count at June 30, 2020, compared to 41% a year ago. And entry-level made up 70% of total orders in the second quarter, up from 51% in the second quarter last…

Thanks, Phillippe. Let's turn to slide 10. We generated 78% earnings growth in the second quarter of 2020 over 2019 as we outperformed across all key metrics with 20% home closing revenue growth, a 300 bps increase in home closing gross margins and 70 bps improvement in SG&A leverage. Closings were up 23% over the second quarter of 2019 with 74% of closings coming from previously started spec inventory and a backlog conversion of 78%, compared to 70% last year. We generated over $1 billion of revenue in Q2 2020 as our increases in home closing volumes more than offset the declines in community counts and ASPs, consistent with our strategy. Clearly, our margin improvement demonstrated the savings achieved from our streamlined operations through product and process simplification as well as efficiencies of scale. Margins also benefited from pricing power over the last several quarters but we carefully manage price increases to keep volumes up and recognize that leverage comes from each additional sale. In the second quarter this year, we also had some temporary cost concessions running through our cost of sales that accounted for approximately 20 to 40 bps of the improvement, although we expect most of those to expire in the next couple of quarters. The 21.4% gross margin included contract termination walkaway charges of $3.3 million or approximately 30 bps in the second quarter of 2020. By comparison, we had about $0.5 million of similar charges in the second quarter of 2019 or an impact of about 10 bps. Our 70 bps improvement in SG&A was primarily due to additional closing revenue in Q2 that improved our leverage of fixed expenses. While we took immediate action to reduce discretionary expenses in late March, we thankfully did not have any reductions in force. As demand began to…

Thank you, Hilla. We're in unprecedented times. National unemployment levels are very high, and there's still a global pandemic that is yet to be brought under control. We're doing our part to protect our employees, trade partners and customers and we encourage everyone to be respectful and, at least, do the basics, wear a mask, social distance and wash your hands. At the same time, we're enjoying a very strong housing market and helping thousands of families move into their first new home. We're hitting on all cylinders with a solid strategy, strong balance sheet and a great team that is executing at a high level. We're setting new records while preparing to celebrate our 35th anniversary and are very well positioned for continued growth. While there's still a great deal of uncertainty on many levels, we're confident that we're up to the challenges of whatever lies ahead. I'm proud of our entire Meritage team for putting customers first and bringing their best efforts to deliver great results every day. That concludes our prepared remarks. I'd like to thank you for your support of Meritage Homes, and we'll now take questions. Operator?

[Operator Instructions] Our first question comes from Alan Ratner with Zelman & Associates. Please state your question.

Hey guys, good morning. Congrats on truly a remarkable quarter and, obviously, great execution during this very difficult time frame. So my first question, just looking at the guidance for the back half of the year, it seems very strong and, obviously, a continuation of the good trends you've seen through the quarter. When I look at your spec or supply of specs, it's roughly flat year-over-year, yet you're expecting continued growth, at least, in closings, in the back half. So I guess my first question is do you see any supply side constraints to ramping that spec supply over the next few months, either as far as labor is concerned, municipalities, dealing with permitting? Or are you kind of gradually maybe shifting the sales strategy a little bit willing to sell a little bit more presale, given some of the constraints on the labor side?

So I'll give you kind of a complex answer. Of course, early in the pandemic, we pulled back on spec starts, but we quickly reengage in that area late April coming into May. I think we've started about 1,000 specs last month. And in addition, we've started to build orders on top of that. We're going to be trying to start even more specs this month. So we do have two feet on the gas to get our spec inventory back up. At the same time, there are some COVID-related supply chain issues out there with different vendors who've had factories closed that have slowed down the delivery of certain items, but it hasn't impacted our business yet. We're being very mindful. We have had isolated COVID-related issues with trades, but we've been able to work around it. And we don't see any reasons why we can't continue to stay on our plan for the rest of the year due to COVID.

One other data point to add is on the spec count per store, even though, it dropped to nine on the entry-level side, we were at 14 last quarter per store, and now we're at 12. So a fairly limited drop. It's actually just kind of a shift of the communities and the mix and what we're doing in our noncore assets and the spec levels there. So overall, the drop on the entry-level, which obviously is 70% of our business right now, is fairly limited.

Got it. That's very helpful. Second question. Obviously, you're expecting a lot of growth on community count over the next 1.5 years, over 20%, and presumably, that's probably what you're targeting, just overall growth in the business as well. So I guess my question is what would you need to see that would cause you to maybe change the current path you're on as far as both feet on the gas here, Steve? Unemployment remains very high, yet you're seeing strong demand on the ground. So would it simply have to be just orders starting to pull back quite a bit from the current levels? Or is there anything from a macro perspective that would perhaps give you a little bit of cause for concern?

No. It's as simple as you just outlined. And we talk to our customers every single day. And for some reason, we see orders starting to pull back. We certainly investigate the reasons for that. But our land strategy is to be able to provide our product in the right locations at compelling value-based price points. And we think that's the sweet spot of the market going forward, the entry-level and first move-up. And we've been able to find quite a bit of land that we're pretty happy with that we're going to be bringing on next year to be able to grow our community count going forward. So I don't see anything on the horizon right now that dampens our enthusiasm for growth.

To add to that, Alan, we demonstrated that we can pull back very, very quickly. In March and early April when it was very uncertain and visibility was near 0, we were able to pull back on spend very quickly. So while we're two feet on the gas, should there be another pickup in the economy or in the sector, we certainly can pull back quickly.

Our next question comes from John Lovallo with Bank of America. Please state your question.

Hey, guys. Thank you for taking my questions. The first one, Texas and Arizona have been two of your hotter markets, obviously, now being a little bit more impacted by COVID. Over the past couple of weeks, have you seen any changes in consumer behavior given the heightened concern around the virus?

No. Pretty much the opposite. The Arizona market, in particular, as I said, show no signs of retreat. And we continue to have strong demand in our sales office here even in the midst of the increasing pandemic and very warm weather that we have down here in July. So no, not at all.

And highly qualified buyers. We're not seeing buyers that don't have jobs or are worried about their jobs, don't have strong balance sheet to buy home, not seeing a bunch of investors show up to the party. It's just true household formation and household demand for the affordable houses.

Yes. And we gave guidance on the call that in our release that our cancellation rate dropped to 15% blended, but that dropped from 20% in April down to 13% in June. So we're seeing a fairly rapid decline in cancellation rates. To Phillippe's point, the buyers that are coming in are well-qualified.

That's really encouraging. Okay. Great. And then in terms of the community count outlook that you guys laid out, how should we sort of think about the cadence of that through early 2022? And should we expect a similar sort of ramp in SG&A as those communities get come to fruition?

Well, the community count is going to be down this year, flattish to down, particularly considering we're selling through a lot of communities even faster than we expected. Many communities got delayed due to COVID. We are experiencing challenges in many cities getting our plans approved and getting through the entitlement process. But we have a huge, for lack of another description, rat moving through a snake here, for next year, where we got a big pipeline of communities coming online throughout 2020, 2021, and we should be at or pretty close to our goal of 300 communities opened by the end of 2021. And you can certainly do the math on that what that means for our orders and deliveries

No. Our guidance, obviously, for the remainder of the year, built in the declining to flattish community count for 2020, what quarter it's going to pop in 2021, I don't think we're prepared to give that guidance yet.

But, yes, by the end of the year as we...

Absolutely.

I can't tell you quarter-to-quarter what it's going to look like.

Our next question comes from Truman Patterson with Wells Fargo. Please state your question.

Yeah, good morning everyone and thanks for taking my question. Great quarter. So first, about the balance sheet and capital allocation, 20% net debt to total capital, almost $500 million of cash on hand. Just thinking about what you're going to do going forward? Is this purely to reinvest in the business and land and really grow the company? Are you looking to reduce debt further or possibly start a share repurchase program, M&A? Just trying to get your thoughts because you're in a pretty strong situation right now.

Strategy number one is to grow the business organically. Invest in more land, grow community counts. And I see us deploying most, if not all, of our capital in that strategy. We don't have any plans to reduce our debt. We only plan for the moment to buy our stock back. We've been pretty opportunistic about that. We did buy back one million shares early in the quarter. What's the average price on that?

It's on $60.

At $60. But we're not buying shares right now, and I don't expect that we will be buying any shares in the next quarter. But as I said earlier, we have 50 almost 50 potential unit land deals for almost 50 potential communities that either are approved or potentially going to approve this month. That's not to even talk about what's on our plate for the next month and the months ahead for the remainder of the year. So we have a really robust land pipeline, and we're going to be directing our capital toward that.

Okay. Okay. And then also, I hopped on a few minutes late, so I apologize if you have addressed this. But could you give an update on July order trends? I would imagine we're coming up on tougher comps year-over-year. So maybe there's some settling on the growth rate. But are the absolute units kind of in line with the June levels? And then any disparity recently among the regions really in kind of June and July that we should know about? Or have they been pretty much trending in line with what they did in 2Q?

I wanted to give you a specific number on what I think June is going to be. We had a lot we had quite a debate here before the call, but I got outvoted on that. I can tell you, July is going to be very strong, very strong and maybe not as much as June, but certainly in line with May.

Okay. On kind of an absolute basis?

On a percentage basis increase.

Our next question comes from Stephen Kim with Evercore ISI. Please state your question.

Yeah, thanks very much guys. Yes, exciting times. I wanted to see if I could ask a little bit about what you're seeing in terms of the ability to push price? I imagine this is something that you're managing on a community-by-community basis. And you've been obviously seeing the mortgage rates coming down. I'm curious about the ability to push price across the both the entry-level as well as some of your move-up product. Are you finding that the drop in rates is creating an opportunity more on the pricing side than on the ramp in sales? In other words, it's push it's affecting price more than pace because I think some people had felt like maybe the lower rates is pulling forward demand or something like that, whereas, my view is that it would probably just allow you to price higher, and that probably actually operates on a bit of a lag. Curious what your thoughts are with respect to that and if there's any difference between entry-level and move-up in that regard?

I mean, our business model, like a few other large entry-level-focused builders, is really driven by pace more than price. And leveraging our overhead is absolutely critical to our strategy. So with that said, May, we did certainly, in May, we weren't pushing price in May because we were coming out of that people were just coming back and we didn't really know how strong demand was going to be. We didn't start to push price more in June, but we probably left some dollars on the table. We could have done more on price. But then as we run into July, we've hit the price button a little harder and are pushing price harder in July. But that said, we're still going to have robust order growth. We're probably not going to be as aggressive on price as other builders are, because we want to keep up that strong absorption level, that strong pace. But in Phoenix and in many other markets that we're in, yes, there's a lot of opportunity to probably get even more price because it's a very, very strong demand market right now. Phillippe, I don't know if you want to add to that.

Yes. I mean, we are getting price and pace right now because the market is so strong. As Steve said, we certainly focus on pace coming out of the shelter-in-place environment. We had a big deficit, and we weren't sure what the market was doing. But starting in June and July, we've been able to get price and pace. As far as the mindset or the kind of the thesis around pulling demand forward, we talked about this a lot around here. I don't see this being a demand pull-forward scenario. I think the lower mortgage rates is actually increasing demand. I think the pandemic is increasing demand. I think all the things that we mentioned in our call is actually increasing the demand pull, pull the buyers versus pulling it forward. We are seeing buyers that we hadn't seen before because they are currently looking for a new home and they were not looking for a new home. In fact, they were not planning on moving prior to the situation, whether it's the mortgage rates and they just feel like it's too good of an opportunity at this point or whether they feel like the house doesn't suit them anymore or it's just a fantastic time or they have money in the bank that they didn't have before. I don't think we're pulling demand forward at this point. I think we actually have increased demand in the market

Yes. No, that's very encouraging. Just a clarifying point, Steve, you were talking about how you definitely want to be able to push price sorry, push pace over price, and you might not raise prices as much as some of your peers. I mean it would seem from your results that you've already got a little bit of the gap in price gap between you and the competition already established and you're able to sort of outsell a lot of your competitors. So to the degree that the whole marketplace sees pricing move up, there will be no reason to see that your pricing growth from here would be less than the market would there because you already have that gap established. Am I thinking about that right? Or are you actually saying you think you will raise prices from here less than what the market might otherwise dictate?

No. I think we'll be in line with the market. Look, in most situations, our LiVE.NOW. communities compete with other entry-level builders that were not the lowest price. So buyers are going to pay a little bit of a premium for a Meritage home because of the energy efficiency, because of the home automation, because of the extra design that we get and you get great value. You're going to pay a little bit more for our home than brand X or brand Y. But we have to be mindful of what that spread is. And to the extent that brand X and Y are raising their prices, we'll be raising ours in line with theirs to maintain that appropriate premium. And so they'll get theirs, and we'll get ours.

And you had another question on one and new we've seen pricing power in one and new as well. There's been just as much pricing power as that one and new buyer versus the entry-level buyer, sometimes they overlap, frankly. But there's been strong pricing power, everything under $400,000, really, if you look at kind of our global footprint.

Got it. And then just last one for me. Am I right in thinking that for your affordably minded buyer, the ability to come up with the down payment and having elevated levels of student debt have historically been two of the bigger impediments that your buyers had to get over? And if so, I'm curious as to whether or not you've seen those ease in part by virtue of the forbearance on student loans that got put in place with the CARES Act that goes through September.

There's not necessarily a direct correlation that we've tracked in a survey. Although we do see the ability to come up with a down payment for whatever the reason may be, student loan forbearance being one of those. It's been easier to come up with a down payment ironically during this time. So that could certainly be one of the drivers.

I mean a lot of them were managed from mom and dad.

Our next question comes from Michael Rehaut with JPMorgan. Please state your question.

Thanks, good morning, everyone, And congrats on the results again. First question, wanted to hit on some of the comments around virtual and how it relates to the SG&A? We recently put out a survey and one of the interesting results was the real strength, and it's something that you guys have been talking about over the last several months, but well over half of the respondents that have bought or planned to buy and that are focused on new homes would be comfortable buying a home without visiting it in person. And so obviously, that kind of fits with a lot of the strength that you've seen from the digital side, from the virtual side and all the investments we've put in. I'm curious how that might translate over time to your SG&A cost structure. If you kind of thought about this from a leveraging standpoint, the investments that you've put in place, if it could even impact your broker fees and such, just any thoughts around there over the next couple of years in terms of how this might impact the SG&A side of the business would be interesting.

And that's something that we're thinking about every day, along with our competitors, we're thinking about that as well, how we reduce that cost. Only 44% of our customers came to our community with the realtor, even though, our realtor co-broke is above 70%, but they were registered with realtors prior to their visit. Many of our customers are getting some real estate commissions back through the realtors, which I think is keeping that co-broke rate really high. But really, it's about it starts with our website. The whole virtual selling process starts there. Our website traffic was up 82% in Q2 over Q2 of the year before. It makes sense because of the pandemic. But it also connects to our inside sales team. We have a really strong inside sales team that works those leads on the website, and they set a lot more appointments than they ever had before, both in-person appointments, but mostly virtual appointments. So we're in the early innings of figuring out how we can squeeze the cost out of the SG&A. We have now for several a couple of years in building less models. Most of our communities only have one model versus we used to have two or three or four in the old days. So we've been reducing that cost. We've been reducing the cost of how we furnish those models and we've been reducing the cost of our sales offices. So a lot of the hard costs that go into the marketing have changed. But we are having to spend more money on digital, with the Google and the Zillow of the world, to position us on the Internet. It's an important part of our marketing plan. So yes. I hope that over an extended period of time, as some of the things we learned from the pandemic become part of the new normal, that our marketing costs come down, but I don't think it's going to happen overnight.

Yes. We're definitely in the early innings, Mike. I think that there's we're learning a lot of great lessons right now. For sure, we'll be able to harness some efficiencies in what we're seeing being accomplished virtually, these drivers are often in higher technology spend, but it's a much smaller increase on the technology side versus the manual components or some of the processes and incremental marketing collateral that we were providing previously. So there's certainly a lot of opportunities for us. But like Steve said, this isn't a Q3, Q4 kind of an event. We're learning what works. We don't want to turn off the spigot to the sales machine. So we're trading cautiously, but you can expect some declines over the next year or so, not in that area.

No. That's helpful. And obviously, I think it's an area of opportunity over the next couple of years, without a doubt. I guess, secondly, maybe another kind of bigger picture question. You guys have obviously had a tremendous amount of success with the LiVE.NOW. and how you've kind of turned the company over in the last two three years. You're reiterating your community count outlook effectively or maybe slightly delayed, but with the big plans for next year. And obviously, near term, you're focused on managing through this current highly volatile backdrop. But curious around taking a step back, there are some parts of your geographic exposure that you could add to potentially over time. Obviously, Las Vegas is very close. And I know you've had a lot of reservation, Steve, about that market in the past. But with LiVE.NOW., you would think that, that could be very well-suited for that market. Also even in the Pacific Northwest, where Seattle and Portland have hit affordability issues over time. You could argue that, that's another market, maybe that there could be some good traction. So how do you think of those markets, bigger picture, from a portfolio standpoint? And is this something that if you are thinking about it, you would be thinking about more from an organic standpoint or an acquisition bolt-on standpoint?

Good question, Mike. There are some new markets that we're working on entering on an organic basis. There's some in the West and there's some in the East, and maybe we can give you some more color on that on our next call in November. But we are working behind the scenes to formulate a strategy for us to organically enter some new markets in 2021. It's not part of our plan to get to 300 communities. But as we continue to grow our market share in all the markets that we're in, we realize that we'll have to add some new markets at some point and we're going to do that primarily organically. If there's an M&A opportunity that comes about, that's interesting, we'll certainly pursue it. But we can't wait for that and we're going to be coming up with a plan to enter some new markets organically. So we'll tell you more about that next quarter.

Our next question comes from Adam Baumgarten with Credit Suisse. Please state your question.

Hey, good morning. Do you guys expect any labor savings over the balance of the year as you may have been able to renegotiate some contracts earlier in 2Q? And if so, would you expect that to revert given such strong demand in the industry right now?

So this is Phillippe. When the pandemic occurred, we were able to recontract and get some meaningful savings that have played itself out in Q2 and potentially into Q3. Those contracts generally were set up to sunset after 90 days because none of the trades wanted to commit to a long-term deal because no one knew really what was going on. We're seeing those sunset for the most part because demand is now up across the board. So we got some cost and labor savings. That should play itself out both in it did play itself in Q2, it should play itself out in Q3. As we move into Q4 and Q5, we're probably back to our previous cost structure, I don't expect to see labor savings going forward. I don't we're not seeing a lot of pressure on labor. Labor seems to be in a good place across most of our categories. Capacity seems good. I do expect to see cost pressure. I think you guys know lumber has reset at a pretty good high here. So we do expect to see some cost pressure in the back half of this year, and we'll see how that kind of shakes out over the next six months. But I don't expect to see any savings going forward.

And we quantified that the impact from those 90 days reset that Phillippe addressed, we're about 20 to 40 bps. And as you said, we don't really expect to see those continuing much beyond where we are right now.

Got it. And then just second, are you seeing any meaningful land price appreciation just as competition may be increasing for these entry-level lots?

Yes. I mean, the land market is always competitive when it's not a bad situation. I think we saw in April that a lot of builders stepped away from deals and took a pause on deals. Land prices didn't come down. Land prices are sticky. So as the market recovered in May and June, there wasn't a lot of people willing to negotiate off the original price even with the pandemic backdrop. And as we're moving forward, especially in some of our hotter markets, Phoenix is one that you're seeing price land prices go up. But again, we're really tight on our strategy. We're really tight on what works. We know what the right price of the land is, and we're staying disciplined on that. But certainly, there is land pressure in some of the top markets, and we're seeing builders compete for finished lots, even in the secondary markets and tertiary markets, so certainly seeing land prices increase in the hotter markets.

Our next question comes from Jade Rahmani with KBW. Please state your question.

Yes, thank you very much. Do you have any statistics you might be able to share regarding the percentage of demand currently being driven by move-outs from multifamily?

No. We don't track that. I mean we do track that people moving for rentals, but we don't distinguish if it's from a single-family rental or multifamily rental. What is that number? We have that to about 50%?

We have it. I'm sorry, we don't have that number in front of us. We can get that back to you. But we do track, like Steve said, whether you're moving from an owner-occupied versus a for-rent situation. So we can get you that number. But we don't break out whether it's a multifamily rental versus a single-family rental.

Okay. Even within the rental market, just given the distribution of units, I would expect the majority is from multifamily of move-outs from those rentals. Also, if you could quantify what the average household size of Meritage's typical homebuyer is? Are these families with children? Or are they in the first-time homebuyer bucket, perhaps in relationships, but not yet at the children stage?

Yes. We track that as well. It's pretty granular, but...

I think it was like 3.2.

Yes.

So I think half our buyers are traditional families and the other half are either young adults planning to have a family or working to have a family or mature couples that already had their families and their kids have moved on.

Our next question comes from Carl Reichardt with BTIG. Please state your question.

Thanks everybody. I wanted to ask about lot supply, year-on-year supply. Obviously, it's a backward-looking number at 4.2. Is that kind of where you guys are comfortable? And is it the 60/40 split owned option. Is that sort of target where you want to be? Or over the next couple or three years, do you think you could move that your supply up? Are you interested in that or that option, the owned mix then would that change in any way?

We've historically operated in that four to five-year band. I think we're it's our intention probably to stay in there. We are focused on IRRs and continuing to improve our return on equity. So although we want to get larger communities that we can stay in longer and reduce the churn, we have to be mindful of what the impact is to our balance sheet. I think we certainly would like to do more options to the extent that they're available. But they generally don't come without a cost. And they're not it's not as easy as it may sound to convert from an own strategy to an option strategy. It's not like it was in the last cycle. Cost is pretty high in the cycle. And so I don't expect it to change very much from really where it is today.

Yes. Just to say, I think Steve hit the nail on the head. The availability of liquidity that we have, we're not really willing to pay up to have options to be or land to be optioned off balance sheet. Having said that, the 40% is the highest it's been in quite a while. So if you look at the last eight to 10 quarters, we're very slowly inching up as we're finding deal structures that aren't necessarily land-based off book, but deal structures that will work with existing seller is to allow us to leverage cash a little better.

Yes.

I mean if you're self-developing out the exerts, I'm guessing, you can turn those lots faster anyway. So that makes sense. I also just wanted to ask a little about Studio M and the first time move-up side, which has had some good absorptions. Can you just give me an update on how Studio M is rolled out? And maybe talk a little bit about the margin profile of that business relative to entry-level.

Yes. I'll take the rollout, and then Hilla will talk about the margins. But it's effectively rolled out everywhere. That was kind of the last year initiative. So we had a couple of stragglers that came into this year, but we are now effectively rolled out across our entire footprint. We have pretty much our entire backlog is moving. We don't have any sort of KL backlog that's on the old process, even in some markets that were the last ones to convert. So we're effectively rolled out across the company, and it's a highly successful program. And Hilla can comment on the margins.

Yes. I think we've said previously that the margins on entry-level are our strongest margins in the company. First time move-up is strengthened. The margin there has strengthened with the rollout of Studio M. Obviously, we're able to leverage costs and efficiency a little bit better. So we're actually seeing those improve as well. There's still a little bit of a differential with entry-level, just a little bit ahead, but they're pretty much in line with one another.

Mr. Hilton, we're just about at the bottom of the hour. Do we have time to take another question or two? Or would you like to conclude?

One more question.

Our final question comes from Alex Barron with Housing Research Center. Please state your question.

Hey, guys. Thanks for squeezing me in. And Great job on the quarter. I wanted to ask, is there any physical constraints or any reason why if there are the buyers, they are ready to buy, why can't do another 1,500 pace? In other words, is there a labor constraint? Is there a land finished lot constraint? Anything like that, that would prevent you from continuing at that pace, assuming the buyers were there.

I'm going to repeat your question because you were cutting out just a little bit. I think your question was, is there any constraint where we couldn't deliver another 1,500 lots of sales in closing, any labor or material constraints that would block us from that level of performance? The quick answer is no, but I'll let Phillippe or Steve expand on it.

I mean the only constraint we have right now is our community count. We have a decline in community count. We're selling out of things faster than we previously thought. And so we're going to continue to drive higher absorptions on a sort of declining community count over the next couple of quarters. But as far as having the homes, being able to start the homes, the capacity in the labor market to build those homes, there's nothing preventing us from doing that. It's really about can we get the volume out of the community count that we have as we sort of go through the next couple of quarters.

Okay, great. And when you said that you're starting 1,000 specs, I'm assuming that, that wasn't including that was only the specs. In other words, if you're doing 1,500 sales and you're starting 1,000 specs, that kind of implies you would be starting 500 built-to-order homes. Is that correct?

Yes. Not quite that many, but close. We our starts have been a little behind our sales the last couple of months because the sales were more than we expected. But we're as we get into July and August, we're going to get back on track to match up those numbers more closely. But that has been a bit of a challenge.

But you're correct. The 1,000 specs are not all sales, but some of them are dirt, obviously.

Yes. Thanks, Alex. I'm sorry, we couldn't get you on sooner. Operator, I think, we can take we think, we can take one more question. Maybe one more out there, operator?

Yes.

Yes. Our next question comes from Susan Maklari. Please go ahead. with your question.

Thank you. Thanks for squeezing me in. I guess first question is Jeff sic Steve you touched a little bit on the M&A environment earlier. But can you talk a little more about what you're seeing out there in terms of opportunities to maybe pick up some land deals or some smaller privates? Has anything changed over the last couple of months?

Only if you promise you write something nice about us.

I just wrote something nice about you last night.

Okay. Okay. No. There hasn't been a lot changed on the M&A front. We just haven't seen anything that's that compelling. I don't think COVID scared a bunch of builders into selling their companies. Actually, one of the titans of M&A just passed away a few weeks ago, Mike Honn, who did many deals with the company in their early stages in the 1990s and 2000. He was an icon in that segment of the industry. We mourn his passing. But yes, there hasn't been a lot of M&A activity that we've seen. And certainly, we're going to be more picky with how it fits with our business strategy.

But we were able to be opportunistic on some dropped land deals from other builders in the COVID environment. We actually picked up enough land deals from other builders and resurrected our own land deals that we initially dropped to end up net positive on the land deals that we dropped and then picked up from COVID, in addition to our regular pipeline of community activity.

Yes. And in the early stages of the pandemic, we parted ways with the land deals that we had approved that we like to lease that we felt like had the biggest risk and then we went out and saw a lot of deals that others had, we liked and we grabbed.

Okay. All right. That's helpful. And then on the mortgage market side, obviously, it seems like things there remain accommodated to buyers. Is there anything that you've seen that's really changed over the quarter? Or anything that could change your ability to qualify people looking out?

No. I think we're going to be sharing the analyst slides right here after the call. You'll see the historical trends are DTI, as a company, still at low 38% and no real changes for us. Everything is still humming along.

It's like, surprisingly, like just no change. I mean, you would expect to see some type of changes, there's just 0 change.

Yes.

That wraps up our presentation today and our Q&A. We thank you for participating in Meritage Homes' second quarter call, and we'll look forward to talking to you again in late October. Thank you.

Thank you. All parties may disconnect. Have a great day.