Taylor Morrison Home Corp Q3 FY2020 Earnings Call

Good morning and welcome to Taylor Morrison's Third Quarter 2020 Earnings Conference Call. This conference call is being recorded. I would now like to introduce Mackenzie Aron, Vice President of Investor Relations.

Thank you for joining us for Taylor Morrison's Third Quarter 2020 Earnings Conference Call. With me are Sheryl Palmer, Chairman and Chief Executive Officer, and Dave Cone, Executive Vice President and Chief Financial Officer. Sheryl will start with an overview of our performance and market outlook, followed by Dave who will discuss our financial results. After that, we will be happy to take your questions. I want to remind you that today's call, including the question-and-answer session, contains forward-looking statements that are subject to risks and uncertainties which may cause actual results to differ from our expectations. These risks include those outlined in our release and in our SEC filings, and we are not obligated to update our forward-looking statements. Additionally, we will mention certain non-GAAP financial measures during the call, which are reconciled to GAAP figures in our earnings release available on our Investor Relations website. Now, I will turn the call over to Sheryl.

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 GAAP diluted earnings per share was up 38% to $0.87. 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 history. By month, our sales pace was up by nearly 70% in July, just over 55% in August and approximately 40% in September. Despite leaning more heavily on price to appropriately manage our backlog, our absolute sale 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 up 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. 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. Of course, the strong sales environment has put a renewed emphasis on the critical price versus pace balance. While we have always navigated that trade-off 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. 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. 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, homebuyers 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. Those 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 homebuilding 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. 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. 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. 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.

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. 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. 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, equaled 3.1 per community. This is below our typical run rate due to strong demand for inventory homes. 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 1, 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 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 full year closings guidance partially reflected our view that supply side constraints would likely push a portion of our backlog into early 2021. 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 GAAP 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 governance, the industry is experiencing lumber inflation and potentially upward pressure on labor costs. 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 GAAP home closings gross margin to improve sequentially to about 18%, which would leave full year margins in the mid-16% range, an 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. 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 a 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. 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 time frame 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. 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 the coming quarters, although we remain disciplined to our philosophy of acquiring prime land in core submarkets. 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 control 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. Now I'll turn the call back over to Sheryl.

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 one-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. 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. 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.

Our first question comes from Carl Reichardt of BTIG.

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 at the company, how is it shifting more towards smaller entry-level homes, more lineages type of stuff? And is that going to help your absorption rate next year given their comps are going to be quite hard?

Thank you, Carl. Absolutely. California has many stories to tell. If I start with Southern California, that's where we had the Lyon acquisition, and our business there has increased by five to six times overall. More importantly, the activity levels we've observed in Southern California have nearly doubled. Interestingly, we're noticing this trend across the entire business in that region. The activity levels are particularly higher in the Inland Empire, especially at more affordable price points. Another trend in California is that what used to be around 65% to 75% speculative business is now shifting closer to a 50-50 balance. Looking ahead, I anticipate we will see an even stronger emphasis on the build side. The Inland Empire has experienced a noticeable increase in demand, as working from home has changed perceptions about distance. It's also worth mentioning the Bay Area, as we've seen significant changes there as well. There were several quarters late last year and early this year where we discussed some challenges in the Bay, but we've witnessed some of the best activity levels over the past quarter that we've experienced in a couple of years. Part of this improvement is due to a real decline in our average selling price over the last few quarters, a trend we had already begun, and the addition of William Lyon has certainly helped us.

Yes, Carl. Definitely, I think our perspective has changed. 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. So we're working through our '21 plan right now. So on the Q4 call, I'll probably have a better long-term target for you. But I would expect it to be under what we're saying right now of high 30% range at the end of '21. It's going to be below that, probably on a go-forward basis.

And our next question comes from Mike Dahl of RBC Capital Markets.

This is actually Chris on for Mike. For my first question, just a point of clarification. The community count outlook, you said it was going to be flat to 4Q. Is that on average for next year or ending? And how should we expect that to ramp next year? Should we think of that as more back half weighted?

Yes. It's to the average community count for Q4. And then it's going to be somewhat even, I think, as we move through the year. Again, we're finalizing our 2021 plans right now. You'll probably see slightly higher maybe towards the middle of the year. That will probably be kind of more of that peak point for us. And a lot of this just depends, obviously, on our ability to continue with the strong sales demand. We're assuming 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.

Got it. That makes sense. For my second question, you mentioned that you've successfully adjusted pricing to address inflationary pressures. Looking ahead to next year, how do you plan to balance the pace and pricing now that you have positioned yourself to stay ahead of cost inflation?

I think, globally, that's always a tricky question to answer. And as we 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 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 every 2 weeks. And there are other communities where we're continuing to run. But once again, if I were to like make a comment across the portfolio, the bias would be toward price. If you look at our historic paces over the last couple of years, we've been somewhere in the low to mid-2s 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. Yes, I think you'll find a more natural run rate, somewhere between the 2. I don't think we'll continue to run at the 3.7%, 3.8%, but I don't expect we're going to go back into the mid-2s either.

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, we're going to focus more on price.

And our next question comes from Jay McCanless of Wedbush.

I guess the first one going back to the community count and thinking about '21. With the moves like we're 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 stuck to the land plan you had 3 months ago or 6 months ago?

I guess a couple of comments there. 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. 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 paces 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. I'll kind of move that to just our ramp-up in land spend in Q3. We approved probably 2 to 2.5 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 in active adults and that first-time move-up.

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.

And our next question comes from Jack Micenko of Susquehanna.

You all have done some innovative things regarding the share buyback in light of the recent acquisitions. Considering the leverage comments made earlier, Dave, with the excess capital and anticipated cash flow, is your current focus on reducing debt rather than on buybacks? Is that the correct perspective?

Yes. Let me add a couple of points, and I'll work into answering that question. Obviously, 2020 has been very interesting from a capital allocation perspective 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 million that we did on the most recent refi, and like I said, no debt coming due until 2023. 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 mentioned that...

You said '21.

Oh, sorry, we have no debt due until 2023. As I mentioned, we're back to investing in land and development. Sheryl pointed out that Q3 was significant for us in terms of approved deals. Moving forward, we will consider paying down debt and managing share repurchases based on various factors. We have about $8 million remaining in our current share repurchase authorization, and we may look to extend and increase that as part of our plan for 2021. We will continue to invest the cash we generate carefully to avoid impacting our returns. When we determine how to allocate our capital, we will consider land costs, stock market performance, and current interest rates in the debt market. Given these factors, we are currently leaning more towards reducing debt due to the current macroeconomic environment.

I noticed that the capture rate in the mortgage business has improved quite a bit year-over-year. I think part of that is likely due to integrating the William Lyon's business into the Taylor Morrison operations. Sheryl, is any of this being driven by the increase in virtual services? This means you are receiving more business directly, with less influence from brokers and consultative referrals. Has the more direct-to-consumer approach that virtual services enable also contributed to the improved capture rate? Do you believe that the capture rate in the mid-80s is sustainable?

That's a really interesting question, Jack. I haven't connected those two points before, and I admit I'm a bit embarrassed. The virtual environment has definitely changed how we relate to consumers. It makes sense that companies operating fully online, including our virtual mortgage process, have made the customer experience much smoother. While it's hard for me to quantify, earlier in the pandemic, we also ran a promotion on closing costs, which would have contributed positively. However, I believe our ability to capture customers largely stems from the sales and service experience that Taylor Morrison Home Funding offers, as well as the convenience of our virtual tools. As I mentioned in last quarter's call, our mortgage team was proactive right from the start of the pandemic; they worked to protect our backlog and secure low rates. So, I think it's a combination of multiple factors, but I will look into the relationship between fully virtual deals and mortgage capture, as it's a valuable question.

And our next question comes from Alan Ratner of Zelman & Associates.

Congrats on the great results and glad to hear everyone is doing well on your end. My first question, Sheryl, you guys do a lot of great work on the buyer segments. And I'm curious because 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?

Yes. I think we are. It's modest. It's not a subset that will rise to a consumer set at this point, Alan. But I think we are seeing it absolutely in the active adults that, that consumer is returning. That's always been a good part of that business. And 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 1 and 2 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 run rate on out-of-state. So I think that's where we're capturing the greatest piece of that second home market. Yes. There's a couple of places. I'll start with your second question first. There's a couple of places where I think pricing create a little sticker shock and we 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 absorptions at all. Interestingly enough, Alan, on the affordability side, I probably haven't quoted this for a couple of quarters. But you'll recall that we used to on a pretty regular basis talk about that cushion in the 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 we're watching. But what I think summarizes them well is just the rate cushion they have. 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, 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 is looking at their relationship with their monthly obligation.

And our next question comes from Michael Rehaut of JPMorgan.

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 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?

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. But if I look at the cost... From a comp perspective, on a pace, Maggie, our September and October of last year was the exact same amount. Same number of sales, same pace. Same pace. So once again, the first 3 weeks don't make the month. We've got probably 8, 9 days from when we quoted that, but it's 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 that we're taking, a reduction in incentives and increases in base prices that we're seeing really across the board.

Okay. And then second question, just on those reduction in incentives and the price that you're taking. Could you quantify that at all for us?

There's a range by market and consumer group. As I mentioned earlier, we see a slightly greater opportunity with the move-up, active adult buyer, but it's generally in the 2% to 3% range on average. Some areas are experiencing stronger increases, while others are around 1%. Overall, I would estimate the average across the portfolio to be around 2% to 2.5%.

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.

And our next question comes from Truman Patterson of Wells Fargo.

Actually, this is Paul Przybylski. First, I guess, from your commentary, it sounds like you're just wanting to get your spec package for next spring back to 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?

It's a great question, Paul. There are a couple of things to consider. We're aiming to restore our spec inventory to meet the immediate needs of consumers. For instance, in the Phoenix market, we currently face a two-month backlog nationwide, which reflects the time necessary from sale to permit approval and project initiation. Filling our pipeline with to-be-builts significantly benefits the business by enhancing production efficiency and typically yielding higher margins. This strategy also mitigates risks, especially during downturns, like we saw with COVID, where less committed buyers are more likely to withdraw since they haven't chosen a specific lot or customized their home. It's a balancing act; we appreciate the growth in the to-be-built segment but still want to maintain a reasonable level of inventory.

Yes. So we're prioritizing where that inventory is going in. Most affordable.

With the community count expected to remain flat next year, can you share how many fully developed lots you plan to bring to market from a growth perspective? If the community count remains the same, will you have enough finished lots to boost your sales?

It's a great question, Paul. And we're going through the planning, and we're 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. 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, Paul. You can see that. It's really what can we get in the ground, and when can we get those lots to our construction teams to be able to begin construction.

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?

Yes. 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 collection process. And my numbers so far are from the pilot market, which is one market where we saw 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.

And our next question comes from Alex Rygiel, B. Riley.

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

Yes, Alex, it’s a bit early for me to provide specifics on that. As I mentioned, we're currently working on our plans for 2021, but we do anticipate margin improvement. Part of this will arise as the effects of purchase accounting fade, but more importantly, we expect to benefit from synergies related to the transaction and enhanced pricing power. Despite the challenges posed by lumber costs, we foresee margin improvement next year. I have some confidence in this as I review our backlog for the first half of next year, which already reflects these trends. We will provide more detailed information in the fourth quarter as we finalize our plans.

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 subsequent to COVID?

That's a great question. It's competitive. But if you would have asked me that question anytime in the last 20 years, I probably would have answered it pretty similarly. 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 takedowns, finalizing, going hard on deals, but that was short-lived. No real change in our underwriting at this point as we look forward. But I would tell you, the market is competitive. Sellers have very high expectations given the paces you're seeing in the builder community. 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 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.

And our next question comes from Alex Barrón of Housing Research Center.

Great job in the quarter. Dave, I was wondering, should we expect any further transaction expenses related to William Lyon next quarter? Or are we pretty much done?

Alex, there's probably going to be a little bit I would say maybe $4 million to $6 million that will probably see come through in the fourth quarter, but that should largely take us to the end.

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 we think we can continue to expect going forward?

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 will moderate a little bit, but we'll give you some more detail on that in Q4.

And it's a secondary market lift, but that's all very timing related. The teams did, as I said earlier, just a tremendous job taking advantage of, when we came out of COVID, how we locked the secondary market. So 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.

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.

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.