Q3 2019 Earnings Call
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Thanks, Julie and good morning, everyone. Joining today's call to you review Pultegroups operating and financial results for our third quarter ended September Thirtyth 29 team.
Joining me on today's call her Ryan Marshall, President and CEO , Bob O'shaughnessy, Executive Vice President and CFO , Jim Ossowski Senior Vice President Finance.
For those who may not seen our caught a copy of our Q3 earnings release, it's been posted to our corporate website Pultegroup dotcom, along with a copy of the presentation slides that accompany this morning's call.
A replay of this call will also be posted to our website later today.
I want to highlight that is part of today's call. We will be discussing our reported results as well as our results adjusted to exclude the impact of a warranty charge taken in the period.
A reconciliation of our adjusted results to our reported results is included in this mornings release and within the webcast slides accompanying our call. This morning, we encourage you to review these tables to assist in your analysis of our results.
So on alert all participants that today's discussion will include forward looking statements about expected future performance and Pultegroup.
Actual results could differ materially from those suggested by comments made today.
The most significant risk factors that could affect our results.
Summarized as part of today's earnings release and within the accompanying presentation slides.
These risk factors and other key information are detailed in RCC filings, including or annual and quarterly reports now let me turn the call over to Ryan Marshall right.
Thanks, Jim and good morning, I'm excited to speak with you today about Pultegroups outstanding third quarter results. In addition to discussing our financial performance I'm pleased to report that home buying activity remains strong and even accelerated in the third quarter.
Benefiting from the positive demand environment, and our strong local market positions I would highlight that our third quarter orders increased 13% over last year, and we reported our highest third quarter order volume since 2006.
For the past several years U.S. housing demand has been supported by an ongoing economic expansion low unemployment and positive consumer confidence numbers.
It will come as no surprise, however, when I say that the catalyst for this most recent rise in housing demand has likely been the decline in interest rates and its impact on the affordability equation.
The housing market where years of price appreciation has created affordability challenges for many buyers the decline in rates has helped ease the problem.
Given this improvement in affordability, we're optimistic about the sustainability of housing demand and the potential for new home sales to continue marching higher.
As Bob will detail Pultegroup reported strong third quarter operating and financial results that met or exceeded our prior guidance in a number of key areas.
Within our quarterly results you can also see continuing progress against some of our broader operating strategies first we continue to realize success and expanding our presence among first time buyers as orders increased 39%.
Broadly defined our business objective is to better index or consumer customer mix to the markets. We serve with the goal of growing first time to about one third of our closings.
In this most recent quarter first time buyers represented 31% of orders and 29% of closings. This is up from 25% of orders and 26% of closings last year.
Consistent with this objective 34% of our lots under control in the third quarter are targeted to serve first time buyers.
Given this mix and the development timelines of our lots in our pipeline, we expect to see an ongoing modest expansion of our first time business as we progress through 2020 and beyond.
Second in addition to making progress and shifting the mix of lots. We control. We continue to increase our use of lot options to help enhance returns and mitigate certain market risks.
We ended the quarter with 161000 lots under control of which 42% were held the option.
Our target is for 50% of Pultegroups lots under control to be held via option.
Consistent with this goal I would highlight that 68% of the lots we approved for purchased during the first nine months of 2019 included some form of option.
I can't recall a year when we were as successful in securing so many option transactions.
Our local land acquisition teams are doing a great job tying up lots under such options structures.
This includes the American West transaction, where we put 3500 lots under control.
Two thirds of which are under option.
And finally, consistent with our long term focus on effectively allocating capital in support of generating high returns, we invested approximately $700 million in the business in Q3, while returning $166 million to shareholders through dividends and share repurchases.
In total we have returned almost $340 million to shareholders in the first nine months of the year, while still ending Q3 with $760 million to $69 million in cash and a net debt to capital ratio of 27.6%.
By intelligently investing in our business and running an efficient homebuilding operation, while effectively allocating fivex available capital we continue to generate some of the highest returns in the industry.
For the past 12 months.
Return on invested capital was approximately 18% while our return on equity was almost 19%.
Multi group continues to rank among the industry leaders on Bulls return metrics.
In conclusion, we remain highly constructive on current demand dynamics and the long term opportunities for the housing cycle as well as our competitive position within the markets we serve.
At 644000, new home sales over the trailing 12 months, we believe the industry continues to under supply the country's housing needs.
With strong market positions tremendous financial flexibility and an unwavering commitment to our home buyers. We believe pultegroup can grow its operations, while continuing to generate high returns on our invested capital and equity.
Now, let me turn the call the Bob for a more detailed review of the quarter.
Thanks, Ryan and good morning, everyone as highlighted in this mornings release, we reported an acceleration in sales activity as pultegroups third quarter or orders increased 13% over last year to 6031 homes.
Orders were higher across all buyer groups and reporting segments and the 13% increase in quarterly new orders is the largest percentage increase we've generated since the end of 2017.
Analyzing Q3 sales by buyer group shows orders among first time buyers were up 39% to 1860 homes, while orders among move up and active adult buyers both increased by 4%.
2579, and 1592 homes respectively.
During the third quarter, we operated out of 865 communities, which is up 4% over last year.
Adjusting for the 4% increase in community count our absorption pace for the quarter was up a strong 9%.
The increased absorption pace was driven by a 22% increase from our first time communities and an 8% increase from our music move up communities.
Absorption pace at active adult was down 9% against a strong third quarter comp that was up approximately 10% last year.
Moving to our income statement wholesale revenues for the third quarter increased 3% over the prior year to $2.6 billion.
Our higher revenues were driven by 3% increase in closings to 6186 homes as our average sales price of $426000. This year is consistent with last year.
Given the stronger demand conditions, we experienced in the quarter, we were able to sell and close more spec homes, which had a positive impact on our Q3 closing volumes.
Looking at our average sales prices in more detail, our move up and active adult prices, both increased 3% to 491004 hundred $11000 respectively.
Pricing for our first time homes decreased 6% to $340000.
The lower ASP is in first time reflects a change in mix relating to our efforts to increase our entry level exposure.
Particularly through community openings in the southeast, Florida and Texas.
In total and consistent with our efforts to better index, our business the market demand and increase our first time buyer business.
Closings by buyer group for the third quarter were 29% first time, 45% move up and 26% active adult.
This compares with 26% first time, 49% move up and 25% active adult last year.
Our backlog at the end of the third quarter totaled 11638 homes, which is up 4% over last year.
We ended the quarter with 11482 homes under construction, which is an increase of 2%.
Of the homes under for production, 74% or 8529 were sold with the remaining 26% being built to spec.
At 26% spec production is consistent with last year and inline with our target range.
Based on our contract backlog in the units we had under construction at the ended the quarter, we expect deliveries in the fourth quarter to be in the range of 6000 606800 homes.
Inclusive of this guidance, we are increasing guidance for the full year closings to be in the range of 23000 to 23200 homes.
With the backlog ASP of $430000 at a relatively stable pricing environment. We continue to expect our average sales price of closings in the fourth quarter to be in the range of 425000 to $430000.
This is consistent with our third quarter results and the guidance, we gave on our second quarter earnings call.
Continuing down the income statement, our reported gross margin in the third quarter was 23.1%, while our adjusted gross margin for the period was 23.4%.
The adjusted gross margin excludes a $9 million pre tax charge related to estimated cost to complete warranty repairs and a closed out community.
Our adjusted gross margin was up 30 basis points from our second quarter reported gross margin of 23.1% as we benefited from a stronger demand environment.
It was down 60 basis points compared to the third quarter of last year as profitability was impacted by higher land labor and material costs and slight changes in product mix.
Is the third quarter, our option revenues and lot premiums increased 1% over the prior year to $82966 per home.
Sales discounts in the quarter totaled 3.8% or $17000 per home, which is up 80 basis points over the third quarter of last year, but down 10 points sequentially.
Discounts are now down 20 basis points from the beginning of the year.
While demand dynamics are clearly better we're being careful our pricing actions as we believe affordability, though improved.
Still in issue with a particular markets and buyer segments.
With that being said, we do see the opportunity through cost controls and select pricing actions to continue generating high gross margins. We currently expect our fourth quarter gross margin to be the range of 23.2% to 23.4%.
Arrest, DNA and third quarter was $271 million or 10.3% of home sale revenues, which is inline with our previous guidance.
Prior year SGN expense for the period was $253 million were 9.8% of home sale revenues.
The increase in yesterday dollars was driven by a number of factors, including I.T. spend.
Operating costs associated with the American West transaction increased model home cost and compensation.
Based on our performance through the first nine months of the year, we reiterate our guide for full year SG they'd be in the range of 10.8% to 11.3% of home sale revenues.
In the quarter, our financial services operations generated pre tax income of $32 million, which is an increase of 64% over the third quarter of last year.
Our performance was driven by higher volumes as the businesses benefited from our increased homebuilding volumes and higher capture rate as well as from improved margins in our mortgage operations due to the favorable interest rate environment.
In total our mortgage capture it in the third quarter increased to 84% from 75% last year.
Our income tax expense for the third quarter was $93 million or an after or an effective tax rate of 25.4%.
This compares with $95 million for an effective tax rate of 24.7% last year.
We currently expect our fourth quarter tax rate to be 25.3%, which is in line with previous guidance.
Reported net income for our third quarter was $273 million or 99 cents per share while our adjusted net income for the period was $280 million were one dollar one per share.
Reported net income in the third quarter of last year was $290 million or one dollar one per share.
Our diluted earnings per share was calculated using 274 million shares which is decrease of 11 million shares are approximately 4% from Q3 of last year.
The decrease in share count is due primarily to the company is ongoing share repurchase activities.
In the third quarter, the company repurchased 4.1 million common shares for $136 million for an average price of $32, a 93 cents per share.
The first nine months of 2019, we repurchased 7.7 million shares of stock for $244 million for an average cost of $31 in 86 cents per share.
As Ryan noted, we ended the quarter with $769 million of cash and the net debt to capital ratio of 27.6%.
Our gross debt to capital ratio at the ended the quarter was 34.6%.
Looking at our land activity during the quarter, we invested a total of $693 million and land acquisition related development.
This brings our nine month land spend total this year, including the American West transaction in April to $2.2 billion.
We continue to expect to spend approximately $2.9 billion on lands in 2019.
And finally at the end of third quarter, we controlled approximately 161000 lots of which 42% were healthy option.
Now, let me turn the call over to Ryan for some final comments on market conditions Ryan.
Thanks, Bob before opening the call the questions. Let me provide a quick review of our market performance in the quarter. In addition to our orders being up 13% over the last year, we realized order gains across all geographic reporting segments and buyer groups, which attest to the broad based strength in buyer interest.
Drilling down a little.
We realized generally good demand up and down the eastern third of the country with particular strength in the Carolinas in Florida.
Florida continued to be a standout with strong demand across each of its key markets.
Looking at the middle of the country, Texas continued to experience strong demand across its markets with orders up 10%.
Demand in the Midwest held up as orders increased 9%, but the move up part of the business in these markets remains very competitive.
And while the GM strike appears to be on track to be settled we did see an impact on demand in many of our Midwest markets, resulting from the lengthy labor dispute.
Driven by the strength of Las Vegas, including our American West acquisition, and Arizona, Our West area continued to improve.
During the first few weeks of October buyer interest remains strong as we've seen continued high levels of buyer interest and overall demand.
We're supportive economic conditions and a low interest rate environment, we look for buyers to remain active right through the end of 2019.
Let me close by thanking all of our employees who've done such an outstanding job this year, serving our customers and each other.
Thanks to your hard work, we continued to be an industry leader operationally financially and most importantly, what the quality of home and experience we delivered to our customers.
We've also recently been certified as a best places to work company by the Best Places to work organization in an environment, where the competition for talent is fierce we see being an employer of choice as a tremendous advantage.
I'll now turn the call back to Jim.
Great. Thanks, Ryan.
Well if you open the lines will start our today.
As a reminder to ask a question you have on each press star one on your telephone to try question Press defense. Thank you. Please involves all the compiled acuity roster.
Your first question comes from the line of Carl Reichardt with BP I'd. Your line is open.
Thanks, Good morning, guys.
Carl but that your last comment Ryan I was curious about.
Idea that expecting bashed remain active through the end of 2019 are you seeing in October and do you expect to see sort of an anti seasonal strength in traffic and how does your spec situation hold up to be able to to maybe turn some of those late coming in orders into deliveries. This this year.
Yes, Carl we've continued to see nice strength from the buyers as we've been the through the first three weeks of October it's been it's been continued strength similar to what we saw throughout the third quarter. So I feel very good about that.
In terms of bucking the seasonal trend.
I think it's hard to kind of box.
The normal things that are going on in lives and holidays and things of that nature, but certainly the improved affordability environment that we're in.
I think is got to.
Has got to play well for the entire industry and certainly us as far as your question on specs Carl.
You know probably less of a spec opportunity for us as we move into the fourth quarter relative to what we had in Q3 in Q2.
That being said, we've got a few more spec units in the system right now than what we did a year ago, but it's not meaningful to the overall overall number.
Great. Thanks, Ryan and then my follow up is just on on lot options, you're running 42, now and you're hoping to get to 50. So are we to infer that you're starting to see an expansion of developers who are willing to do lots with you on an option basis or are there new structures coming our land bankers, returning and I'm just interested since many builders when to expand in that direction.
And whether or not the infrastructure underneath the land site is going to allow for it. Thanks.
Yes, Karl it's been a concerted effort on our part to move in that direction and we put.
If you go back.
About three years ago. When you first started hearing me talk about this we put a goal out there.
Weve I think been using.
Wisdom and judgment in the way that we are able to secure option transactions there is.
Certainly a cost associated with those and so I think we've continued to make good economic.
Decisions that that that makes sense for our business in where we use in where we don't.
We're not using a land bankers widely throughout the system. So most of these options are truly with the land seller.
I think our reputation our performance the brands that we bring to the table certainly help.
Make.
Make the offering if you will and doing business with with US a compelling one and we're going to continue to.
You know try and drive that number closer to the 50% target that we set.
Thanks, Ryan Thanks, guys.
Sure.
Your next question comes from the line of Stephen Kim from Evercore. Your line is open.
Thanks, very much guys. Good results just wanted to follow up by could on Carls last question there about land spend.
Obviously given.
Things being equal any builder, including yourself with probably.
Rather pushed a little bit of the risk onto the land sellers. So it always comes down to terms and pricing.
And so you addressed the fact that you're not using land bankers widely.
But you acknowledge that there is an additional costs and so I was curious if you could also broaden that into the financial terms.
How are the terms trending are you putting more down for instance, or are there certain so certain types of work that you're committing to do.
If you could just sort of talk a little bit about whatever change in terms of happening that's allowing you to make this shift to greater options.
While still retaining the judgment and then second part of that question is you gave a goal for the ratio of options, but for modeling it might be more useful if we actually had a target for actual year supply of land owned.
Rather than just the ratio of option to total.
Yes, Stephen adds to the second one we've been I think pretty clear that our goal would be to have three years owned three years option.
So thats our target is as our teams are out building.
And negotiating the land transactions that were looking at individual transactions.
And if we're getting out and depends on markets. We've got points of view on length in different markets too.
But on balance we'd like the book to be.
Roughly three years on three years option in terms of terms.
Really no significant change and I think it's really the way we're approaching it so rather than.
Sort of a blanket to the field thou shalt do something whether it's two years old or a certain amount of optionality.
These are individually negotiated it's why I think you've seen a fairly measured increase in this over time.
We've not seen a push or a need to put more money down we don't see significant off sites or performance guarantees. So I would tell you the options today look a lot like the options we've been.
Working into the system for the last few years.
But it's the reason you can't you don't see US go from 40% to 60% overnight, it's because we're negotiating deal by deal.
That's really encouraging thanks for that.
Bob I guess second question I had related relates to the commentary you had made about rates a ryan.
You had indicated that.
Rates were obviously a benefit to you threw out the quarter and you anticipated that rates would likely stay relatively low and that that therefore that would help demand through the end of the year just wanted to drill.
Into that a little bit more is there a threshold you have in mind above which and I'm talking about a rate threshold above what's your outlook would reasonably need to change and could you talk a little bit about.
The delay that we saw and you saw I think in terms of your demand response in your markets, even though rates have kind of been falling all year. If you can talk a little bit about the sensitivity the lag, perhaps and if theres a threshold in mind above what's your outlook would reasonably need to change.
Yes, Stephen I did highlight rates because I think it was really the last leg of the stool in the affordability equation to come through so the way that we'd like to look at it we've got rates, we've got home prices and we have wage changes all three of those things and.
And how they're working in unison.
I believe contribute to that affordability equation.
With a fairly benign pricing environment, we haven't seen a whole lot of price change.
Wages that are actually starting to meaningfully increase as well as interest rates coming down to the level that they are currently out.
In our view really improved affordability and I think that's what has.
Really given demand to kick in the pants.
From the buyer side, so we feel good about that.
Our view that that can be sustained through the end of the year.
I think we'll continue to bode well for what new orders look like.
As far as is there a threshold I don't think there is I think it comes down to what does that affordability equation look like and can.
The average consumer afford the average new home price the new home price. That's that's what I believe it really boils down to.
The last thing I'd, just say maybe on interest rates, whether they're going up or they are going down I think it really matters why.
And so what's the rest of the narrative that's going on in the overall economy.
And how that ultimately plays on the consumers wellbeing and their overall confidence in the economy.
Okay. Thanks, Thanks, guys.
Your next question comes from the line of Matthew Blair from Barclays. Your line is open.
Good morning, Thank you for taking my question.
So.
Looking at the at the sales pace.
You did 2.3 for the quarter.
Seems to be a high for pulte for the cycle. So I.
I know Ryan you highlighted kind of the buyer sensitivity around just home prices in general in this market, but is there kind of any expectation at this point that perhaps you could meter that growth a bit and push price further at this stage or just Conversely, as you guys. Just keep mixing towards first time buyers is not really the right way to think about it.
That really sales pace should kind of structurally move higher at this point.
Yes, Matthew Thanks for the question good to hear from you and I guess, a couple of things that I would tell you. It number one our focus has and will continue to be on driving return on invested capital.
We don't underwrite to gross margin.
And so we are on a community by community basis, working the levers between pace in price to drive what we believe is.
The optimal return outcome.
As far as.
Our overall sales mix.
Certainly our per community sales pace has been helped by our gradual shift to more first time business entry level business, which tends to come with a higher per month sales average.
So as I think you heard in our prepared remarks, you will continue to see a little more of that overtime, but.
As we near our target of about one third of our closing volume coming from that buyer group.
Finally, do your question on prices and is there an opportunity for to go higher certainly.
The market is strong.
But but affordability I think has got to continue to carry the day.
And we're still kind of balancing right on the that were teetering on the edge of.
A lack of affordability in so I think our hesitancy there would be to push it too far.
And.
Take that affordability equation that seems to be working right now.
Got it understood thanks for that detail and then.
Secondly, the I wanted to follow up on the on the gross margin side I.
I think the Q4 guidance is calling for somewhat flattish to perhaps slightly down.
Gross margin sequentially and I know, Bobby just highlighted that sales discounts to continue to move lower a bit. So just any other kind of puts and takes in there that might drive kind of that flatter trend in Q4. Thank you.
Yes Fair question, Yes, I think it's always worth reminding everyone. We do have.
The highest margin mix in the in the.
In the builder space.
And were protective of that but you heard Ryan say, we actually manage against return.
Yeah, we do have more expensive lands coming through each time, we sell a new house that the lancome behind the little bit more expensive.
And on the pricing side, we do see some opportunities to raise price, but we always want to ryans point.
Be mindful of overall, a fail availability and affordability.
So mix matters in that.
Certainly as Q4 comes to fruition, you'll have a lot of builders out there working to liquidate their standing inventory and so we think that will impact pricing. So as we look at the universe, we really like our margin physician.
But we want to make sure we're productive with our assets, we want to make sure our asset turns or our efficient.
So we feel really good actually about the margin profile were put now for Q4.
The only other thing I'd I'd add to that is keep in mind given that were mostly a to be built order model.
You know a large part of what will deliver in Q4 is already in our backlog.
And while we've got a few spec opportunities.
You know those those any kind of improved pricing environment reduced discounts don't move the needle a ton at this point for Q4.
But as Bob highlighted in his prepared remarks, we are seeing an improvement in the discounting environment.
And I think that is reflective of the continued.
Strength, we've seen from buyer demand.
Alright got it thanks again.
Your next question comes from the line of John Lovallo from Bank of America. Your line is open.
Hey, guys. Thank you for taking my questions.
First question is the strengthen your first time business was clearly encouraging.
But there are some hesitation and that seems to still kind of be lingering with active adult and maybe to a lesser extent on the move up side. So is there an opportunity to be a little bit more proactive perhaps with incentives as we move into the fourth quarter here are you comfortable with the current strategy.
Hey, John its Ryan Thanks for the question, we actually feel really good about our active adult business.
We saw a 4% increase in new orders in the in the active adult business I think what youre likely referring to is the decline in absorptions on a year over year basis, we are down 9%.
I think without getting into kind of too much detail Bob highlighted that it was up against a pretty stiff comp from last year that was up 10% at that point in time.
As we looked at it.
Couple of other things that I'd just highlight for you on the active adult side, we've got.
We've got existing communities, where we have added incremental product offerings into an already existing location.
The way that we keep track of it and reported that counts as an additional community.
I had the absolute gross number of sales out of those locations is increased but in some cases it causes the per community number.
It's dilutive to the per community number.
The other thing that we think we've got going on inside of our active adult businesses. We moved from some of our really large flagship.
Communities and into our smaller faster turning.
Kind of closer in locations.
The per community sales out of those smaller locations tend to be a little bit lower.
Now the return profile.
Is every bit is good the margin profiles every but it's good.
But the absolute level of upfront investment.
Some of these smaller communities is less and so they don't need to generate the same type of monthly sales to make it work. Those are those are few the things.
That.
We've done and.
So I think I think I touched on all those things John Im not sure if theres anything else that was missing there, but we maybe get it in a follow up if I missed anything.
That's helpful. Thank you Ryan and then.
Maybe just a quick update on American west and its contribution to orders in the quarter.
Yes, we're really pleased with that we.
Orders in the quarter is 145.
And the integration has gone really well sales activity is strong we expect closings Q1 next year.
Okay. Thanks, guys.
Your next question comes the line of Mike Dahl from RBC. Your line is open.
Good morning, Thanks for taking my questions Nice results. Thanks, Mike.
I've got a two follow up questions on.
The pricing side, so I think grinding clearly articulated the balanced approach, which makes sense given what we lived through over the past year.
But just wanted to try to get a sense of if you can provide.
Just percentage of communities, where you've been able to raise pricing either on it would be great. If you could break down by.
Based price versus.
Yes, where you've just lowered incentives, but any color you can give on just breadth of price increases.
Yes, Mike Mike I don't have that level of detail here that I can provide on the call.
Broadly what I would tell you is that.
You saw an increase in average sales price in our move up.
You saw an increase in average sales price in the active adult we saw an increase in our options spend and our lot premiums and we've seen a little bit of a decrease in discounting. So there's been little bits and pieces kind of across the board.
Our gross margin for the for the quarter was strong we came in slightly above the guide that we provided and so I think.
Well, we're being cautious we have seen a favorable pricing environment thats been beneficial to the overall profitability of the business.
Okay got it.
Second question a follow on.
Specifically related to specs you highlighted that has been contributor to some of the upside around the closings in the quarter and then to your point on margins. It doesn't seem like it's coming out of real drag to margins do you have the.
The spread on spec versus their margins for the quarter and how that compared to the prior two quarters.
Yes, we try not to give all that much detail around that Mike I think.
What we've highlighted is that we did see some closing opportunity.
If you recall, we came into the year.
With a little more spec than we thought we've kind of work through most of that it came through the closings in Q2 in Q3 largely.
You saw a little bit of upside relative to our margin guide.
Some of that mix some of that is the spec contribution because it does have.
A higher than historical margin. So typically we would have expected the margin profile to be a little bit less than it was reflective of the demand environment. So.
On balance it was a good thing.
I don't want to try and drill into that much futility.
Okay that helps thank you.
Your next question comes from the line of Alan Ratner of Zelman and Associates. Your line is open.
Hey, guys. Good morning next quarter.
So.
First question, just going back to the option discussion for a second if we could.
So first off congrats on the progress there.
No in the past and and you kind of alluded to this but down yes understanding you underwrite to an ROI calculation can you talk a little bit about what the margin spread on a typical option deal that you do versus.
Development deal looks like and just kind of thinking about what that that means to mix shift going forward.
If we look at the percentage of your closings. This quarter that were I guess originally option deals how does that compare to the current 42% up your your land Buck that that's under option.
Yes to your second question I don't know that uptime I had we can do a little bit of homework for you.
In terms of the forward book I think.
It varies honestly because these options all because we're doing them individually they will have kind of different shapes and sizes.
So the size of the community matters are we buying raw lots on option or finished lots on option.
So at the end of the day it.
For us it just becomes part of the pipeline of land coming through so we don't we don't actually analyze it or or track it by wasn't an option or not.
Because again the return is that they were focused on.
I think like anything else, if you're asking people to take a little more risk there is little more costs associated with that.
And we see that obviously, but you're clearly some of the lots were doing today were purchased on option two three years ago.
And yet to give with that we're still able to generate the rates of return and the margins. We are yeah and it to that point Alan I'd, just add on to Bob's comment that we've been doing options for a long long time, it's not.
It's not like we were doing non and then we went to the 42% we said at today.
We just felt there was an opportunity to increase it closer to that 50%. So you're certainly going to see a higher mix of option lots start the mix into the overall closings, but.
You know to do kind of the point Bob made it will be it will be mixed into the overall business and we'll provide you.
Kind of what the the forward guide looks like is it as it speaks to the margin profile for future years, when we get there.
Okay, I appreciate that Ryan and I totally understand that you've been doing this for a while that's why I want to just kind of attempt to quantify what that mix looks like understanding that it's always been a part of your business.
Second question, Ryan I know you've been obviously very focused on innovation within the sector. Both on the construction side as well as and mortgage related consumer related. So I was just curious if you can update us if there's anything you're seeing on the ground that you're particularly excited about or that the company is embarking on that might change the way you either build houses sell.
Houses anything along those lines.
Yes, I think two things on there.
I would give a shout out to our finance financial services team.
They have done just a wonderful job in innovating in the eyes of the consumer and making it easier to apply for and go through the mortgage process.
As they move throughout the cycle.
And I think.
The results are evident in the 84% capture that we had in in the current quarter. It's a win it's a win for our company and I think our customers are getting.
Great satisfaction and high kind of overall net promoter scores and things of that nature by by being with our internal mortgage company. So.
You know to dubs still who who runs our financial services organization. Her team I think there just on the.
A wonderful job.
In taking care of our customer so nice innovation, there and we've got some some neat things coming down the pipeline in the future that will continue to make it better.
The second thing element I'm really excited about as it relates to homebuilding operations is the offsite manufacturing opportunities that continue to.
Evolve and.
Theres great conversations there and we continue do have significant dialogue and be at the table with.
Other partners and vendors and manufacturers that I think can meaningfully change.
The way that.
The way that we build houses in the future, we know labors getting more and more tight.
And so the opportunity to get some efficiencies in the way that we produce will significantly.
Help too.
Solve some of the problems that that I think are inherent in a shortage of labor. The last thing is.
Hi buyers.
We're seeing some some nice things.
Happening there that I think are helping us in helping the consumers.
Reduce the amount of friction that's involved in marketing and selling a home so.
They opened doors offer pads Nok.
Et cetera, all of those companies or companies that were working with as well.
All right appreciate it thanks.
Your next question comes from the line of then Ken Zener from Keybanc. Your line is open.
Good morning, gentlemen.
And.
As DNA forgiving Tenda eight to 11.3 for the year.
It's kind of implying in.
For Q from Threeq, you consistent with last year.
So I understand that could you just Bob go into a little detail why when you have higher revenue you're asked two days going up just so I can understand that.
Yes, we talked about account in our prepared remarks, and we had a couple of areas, where we had some increased spend first design.
Yes, there we are investing in the business we've got several projects.
And our IP.
Is.
I see department has a lot going on and these are projects that will take care.
Candidly a number of years to finish and so we're working through that.
You also see American West we had highlighted that that will continue we've got spend so if you think about what we did we bought the lots.
But didnt buy the backlog, but we took the people. So there continue to sell and build homes. So we've got overhead costs associated with that in the business that will continue in Q4, and we won't get the closings until next year.
We do have more models with more communities opened that will continue so really it's more of the same in Q4 as to what you saw on Q3.
Yeah.
What we guided to so this is this a spend that we knew was coming.
We've talked about that really the leverage will get out of the business overtime, we will be volume oriented.
And so you add the business grows we think we can be more efficient.
But really nothing in Q4 or Q3 that we didnt see coming.
True, but I guess to the extent and you highlighted specific items. This year. We saw that same trend last year. I mean is that something just about how you kind of capitalized in terms of Capex your business.
My question.
Not sure I follow can last year, you didn't get asked DNA leveraged.
Hi, there.
In the fourth quarter.
Even though you had more revenue so I'm, just saying if thats something particular to how you guys right pursue I, yes, I think.
I think I think if you're looking at last year's specifically certainly compensation would have been a bigger part of the conversation because we've got annual plans that long term plans and we had a pretty good year last year and so that was reflected in that.
But I don't I don't think Theres anything structural certainly last year over this year for last year and this year that.
Would cause us to think that we're losing leverage will dig into it though we'll see if there's anything else.
Your next question comes from the line of Rohit Seth from Suntrust. Your line is open.
Hey, Thanks for taking my question.
Just with your comments on land spend in closing on communities during the quarter. I mean, just hopefully can you share any thoughts on the direction in community count or next six to 12 months.
We havent given any guide via we'll do that as we release, our fourth quarter earnings in January .
Okay.
Alright, Thats all had thank you.
Your next question comes from the line of Michael Rehaut from Jpmorgan. Your line is open.
Hi, This is actually Bobby on for Mike.
First I wanted to ask about the cadence of orders throughout the quarter.
Do you see strong demand across all three months or where any money.
Stronger than others.
Maggie almost all three months proved to be similar similarly strong relative to prior year, who is a it was an overall balanced quarter.
Okay. Thanks.
I wanted to ask about though your west segments.
You pointed to improvement this quarter, driven by Vegas, and Arizona and last quarter, you had mentioned southern California you.
Still seeing kalenjin conditions, but they kind of seem to be stabilizing and we were beginning to see.
Turn of buyers to your communities I was wondering if you could give an update on what you saw in California This quarter.
Yes, Southern California.
I would characterize is continuing to improve I'm not completely out of the woods, but we're seeing we're seeing some green shoots.
And northern California is a market that I think is still challenged by affordability.
In particular in the Bay area, which is where most of our assets are concentrated.
That part of the country continues to be a little slow.
Hi, Thanks, guys.
Thank you.
Your next question comes from the line of Truman Patterson from Wells Fargo. Your line is open.
Hi, Good morning, guys. Thanks for taking my question Andrew.
And nice results as well.
Just wanted to talk about your first time buyer strategy you know, it's now 34% of lots. It seems like you guys might let that drift.
Higher.
Going forward, just slightly but how comfortable do you feel letting.
This segment get in size based on the current market conditions, you guys had really robust demand there.
Then maybe could you just elaborate a little bit on your strategy really to target that buyer from oil product and land perspective.
Yes, driven we obviously a very pleased with the results that we saw out of that first time space.
And we're going to stay disciplined in kind of the way that we see the broader market through cycles, certainly it's a consumer that's doing really well in the current cycle, but I don't know that we would want do wildly shift our focus completely to that side and lose sight.
Of the other strong segments, we have in our business in the active adult to move up so.
Weve intentionally kind of targeted at about a third of our business.
The mix of lots that we have is right in line with that and you'll start to see.
That come through on our closing mix, a little bit more each and every quarter and so we continue to be very pleased.
As far as how we're targeting that buyer. It really is about affordability I think it's also about making the process easier and so theres a few things that we're doing and simplifying the way that we market communicate and sell to that buyer.
And you know, we're we've got a number of kind of test projects that were running.
In our Texas business and in some of our businesses in the West and we're excited about kind of what that holds for the future of our first time and entry level business.
Okay.
Thanks for that.
I'm going over.
The labor environment, hoping you guys can give us an update on that what you're seeing.
Very nice rebound in the housing market. The past few quarters are you starting to see wage inflation accelerate or are you starting to see no availability issues start to reroute, that's causing lengthening construction cycles or anything like that.
You know true it's a great question Interestingly no we haven't.
You know to this point at any rate the availability is their pricing is not aggressive I think part of that has to do with the mix of homes that are being built so as you move down into these entry level lower optionality smaller floor plans.
Especially for the folks that are building more spec those those homes are a lot more efficient to build and so I think you can move more through the system with the labor that we've got.
And I think the entire industry is benefiting from that so.
Good news is at least at this point knock on wood, it's been pretty good environment, We had given a guide for our labor and material input cost.
To be up about 2%. This year, we actually think thats closer to 1% now part of that is that the labor environments and pretty attractive.
Okay. Thank you.
Thanks Terry.
Your next question comes on line of check my sense from.
Your line is open.
<unk>.
I wanted to revisit Kens question, a little bit DNA side, I know you called out some onetime or is it fair for us than to assume.
Some of those expenses this year, we're more temporary and we'll see incremental leverage going forward or.
Bob as you rightly commentary suggests maybe this is more of a flat line.
On the ratio.
Certainly for the ITC, what we do obviously as we we've got some costs that are capitalize them and systems come online, we actually depreciate them that I think is a kind of an increase in cost others. If we've got expenses just associated with running the department. That's a period costs and so that can go up or down depending on.
The level of spend we talked about American West, obviously, we'll get leverage on that but we start to see closings beginning in January of next year.
So we havent given the guide for next year once again, we'll do that as part of our.
Q4 earnings release.
But like I said I don't think there's anything structurally that makes us think that we're losing leverage in the business at all Jack the only and the only thing maybe just a pile on there is the leverage that we're seeing as well within the guide that we've provided I think Bob's commentary about the increase over prior year and some of that.
Things of that he called out.
There.
To show the differential in total spend this year relative to last year.
Okay.
And then on mortgage.
Really nice results there looking back.
I'm not sure you've done a better.
Three Q margin to that business maybe ever.
Got to three legs right you guys capture rate better you've got more volume.
But.
You've got to be doing something on the on the on the cost originate side. It looks like is that fair to assume and our margins in that business.
Absent the first to sort of just inherently improving as you.
Maybe invest in that business, just curious with what's driving these really good margins.
It's it's it's sort of all those things if you if you think about the environment. The mortgage originators are operating in today.
Falling rates.
A big Rifai business going on right now.
So the the market is attractive and we're taking advantage of that.
But you raise a great point, we've actually reduced our cost to produce loans.
Which is every bit as impactful to our bottom line.
And you talked about third leg obviously.
9% increase in capture is a big volume generator for us and so.
We've we kind of hit on all three in this most recent quarter.
The refi business might start to slow down so the the rate environment might become a little bit more challenging as the.
Call at the next 612 months.
But what we've got there is a really efficient team and one that is focused on customer satisfaction in order to drive that continued improved.
Capture rate environment. So.
The team is.
Taking advantage of the market that's there, but also getting better at what they do.
Which will be an annuity for us.
All right. Thanks, taking my questions. Thanks Jess.
Your next question comes from the line of Jay Mccanless wet.
Bus your line is open.
Good morning, everyone.
First question I had what do you expect for community count for Fourq you.
The guide we've given Jay is 3% to 5% year over year same quarter.
Same quarter to prior year same quarter.
And then the second question I had just trying to catch up with the share repurchase what was.
The actual share count at quarter end.
The the weighted average share count was to 74, the outstanding shares is 271 million.
And then the last question I had was on on active adult.
I know you've talked in the past about shifting to some of the smaller faster turning communities. What would you say the percentage of total del Webb or some of these newer generation communities versus the old or larger communities.
Well, we'll certainly in terms of the number of communities. The majority is the new were smaller faster turning.
I'd have to do the math to see what percentage of the sign ups was or closings came out of those but.
Yes, there are not very many of those big bold, but I used to call the cruise ship del webs left.
Okay. Good here, thanks for taking my questions.
Okay.
Your next question comes from the line of Mark Weintraub from Seaport Global Your line is open.
Thank you good quarter, two quick cleanup questions.
One just on on share repurchase.
How price sensitive to you consider yourself to be or is it you have thought of cash flow to be could put to good use and share repurchases.
Gets it gets a percentage of that cash flow.
Yes.
See I feel like a broken record with this one sometimes but yeah. We've we've got a very clearly articulated capital allocation policy first and foremost in the business.
Pay our dividend through cycle, obviously raised our dividend this year, 20%.
Then you know we've introduced debt. So you saw us who some of our capital to buy in some of our near dated.
Debt.
In this year.
And that we would use excess capital to return to shareholders.
Having said that we're not stock pickers, so we're not trying to time the market.
But we do have a view on value and so as we look over time.
It really is over time and today, we have 700 and almost $70 million in cash.
Strong cash generation of the business, but we're looking over a three year horizon in the business.
And so I think you'll always always see us active in the equity market.
Our our spend is influenced by a what are we going to put in the business and what do we think about that other possible uses of capital and to an extent the share price as well so.
We're not we're not making bets, yes, we've got a process we go through with our board.
That is pretty thoughtful actually in terms of how we actually invest in the business ended our stock.
Okay understood and then just second given the questions on labor et cetera, and you made the point.
On Offsite manufacturing is something you're exploring.
How soon might we start seeing more aggressive measures on offsite manufacturing what type of timeline.
On those initiatives.
Yes, Mark it's something that I think we've said, we'll take some time to play out.
It's it's a it's a business that I think will meaningfully changed the the landscape of homebuilding over the next.
Three to five years, and even probably more over the five to 10 year cycle. So.
We've we've really worked to simplify our business over the last 10 years. The number of floor plans that we have in our portfolio how efficient they are to build we've been preparing.
To move a significant chunk of our volume.
It is well designed and simplified into a factory environment.
We're already using a high percentage of wall panels about 60% of the homes that we frame and would are already using prefund pre manufactured wall panels and pre manufactured trusses. So its outlook I think its closer than you think and Thats already.
Starting to be embedded into our business, but I do believe that that over the kind of medium term you'll start to see even more changes.
To the industry and to our business for sure.
Great appreciate the color.
Your next question comes from the line of Buck Horne from Raymond James Your line is open.
Hi, Thanks, guys I'll try to make is pretty quick I think Bob you mentioned your labor and materials cost inflation was trending more towards one per cent. This year can you, possibly break that apart in terms of the labor and materials side in terms of how those.
Theres trend cost trends are faring and just as we're looking ahead. How do you have you guys planning for lumber costs.
With some of the mill shutdowns out there and do you think that could start to rise on your into 2020.
Yes.
We havent slice the onion that thing in terms of what percentage of the costs are doing what.
But what we did highlight for the is that.
In the 2% guide of material input costs that it was against the backdrop, we're lumber was down and so the the increase was labor.
Because most of the other input costs are pretty flat year over year.
And so what what that should be telling is lumber has been what we expected and labor has come in a little bit.
In terms of what do we think about the lumber market.
Certainly the supply dynamics matter the demand dynamics matter.
I will give you our view on what we think that means for 2021, we will release, our our earnings and by then I think we'll have a bree good view into people's expectations for both of those supply and demand dynamics around lumber.
So we will give you our view on how we think it's going to influence the business next year.
Okay, Great and my second question, just as demand and overall fundamentals have improved I'm wondering if the environment for M&A opportunities has evolved at all and is there potentially interest in finding another partner like an American west if there is another market that.
Deal like that would exist as the.
The appetite or the environment evolved on M&A possibilities.
Buck.
I would put M&A into the priority that Bob laid out our first priority in terms of capital allocation, which is to invest in the business and that's that's the category that we look at M&A in.
For the most part when we're looking at M&A. It is it is because we've we've got an interest in a market, we're not in or Theres a land pipeline.
You know that available that we will continue to help support our market position.
American West certainly fit into that we had a great Vegas operation.
We've made it even stronger with the addition of Americanwest.
We've got an always on appetite for M&A.
But it needs to line up with where we're going strategically.
Is it helping us with the.
Amount of lots that were looking to have in the way. Those those lots are structured is helping us with the consumer group is helping us with a market. We're not interested in M&A just for volume sake.
Is I think the key points that I'd I'd want to share with you as it relates to M&A.
Great. Thanks, guys congrats.
Spot.
Your next question comes from the line Alex Barron with housing research. Your line is open.
Yes. Thank you.
To ask about your first time buyer entry level.
Segment.
How does the margins there compared to to the rest of the company I've heard some.
Companies comment that there's a little bit lower than move up on some say that they're 200 basis points higher so I'm just kind of curious where do you guys again.
Yes, Alex its Ryan we've got we've got a nice margin profile that business right now.
It's it's largely because that's where the majority of the growth has been and that's where we've seen a lot of price appreciation. So the margin profile is actually just a tad higher than our move up right now historically speaking, it's been the lower margin profile, but the inventory turns.
More than offset that and you see a very similar return profile as you do in any of the other segments.
Okay, Great and then can you remind me what percentage of the business. It is today and where would you guys seem that going in the next couple of years.
It's 29% of our closings in the current quarter and we see it going to about a third of our business overall.
Got it and lastly is there any reason why you're.
Interest expense wouldn't go down as percentage of revenues next year. It doesn't seem like your current interest expense was the same as your interest incurred so I'm just trying to reconcile those.
Yes, it's a fair question obviously.
With the leverage that we took out of the business. This year, we see a lower cash cost.
All of our interest gets capitalized and amortized over time, and so you'll see that influence over the next couple of years honestly.
Our.
Capitalize interest charge in our gross margin.
So all things being equal if revenues stayed the same you'll see it be a little bit of a tailwind in our margin overtime.
Alright, great. Congrats once you.
There are no further questions at this time I will turn the call back over to the presenters for closing remarks.
Great. Thanks, everybody for your time. This morning, we'll certainly be available over the course of the day to have any other questions and we'll look forward saucony on Q4.
This concludes today's conference you may now disconnect.