Q3 2020 Pultegroup Inc Earnings Call
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At this time I'd like to turn the conference call over to Jim's ever Sir. Please go ahead.
Thank you Jamie and good morning Lee.
To walk me to Pultegroups third quarter earnings call. We appreciate your time and hope that you were doing well.
I'm joined on today's call by Ryan Marshall, President and CEO, Bob O'shaughnessy, Executive Vice President and CFO.
Most ASCII senior VP of finance.
A copy of this morning's earnings release and the presentation slide that accompanies today's call that accompany todays call.
Posted to our corporate website at Pultegroup Dot com.
So post an audio replay of this call later today.
To highlight that we will be discussing our reported results as well as our results adjusted to exclude the impact of certain tax credits recorded in the period.
Reconciliation of our adjusted results to our reported results is included in this morning's release.
In today's webcast watch we encourage you to review these tables to assist in your analysis of our results.
Also I want to alert everyone that todays presentation includes forward looking statements about the company's expected future performance.
Actual results could differ materially from those suggested by comments made today.
Most significant risk factors that could affect future results are summarized as part of today's earnings release and within the accompanying presentation slides. These.
These risk factors and other key information are detailed in resi she filings, including our annual and quarterly reports now.
Now, let me turn the call over to Ryan Marshall Ryan.
Thanks, Jim and good morning over the past six months it has grown increasingly clear that new home construction isn't economic bright spot and.
And important contributor just to sustaining some level of forward movement in the broader economy.
We certainly do not take this for granted and appreciate the daily lives of millions of people continue to be disrupted.
As such we sincerely hope that you and your families remain healthy interest and are successfully navigating these difficult times.
We appreciate your time this morning, and look forward to discussing Pultegroups outstanding third quarter results.
As you read in this mornings press release gains can be seen throughout our third quarter operating and financial results, including a 7% growth in home sale revenues a one.
A 140 basis point increase in reported gross margin to 24 and a half for Sun.
A 70 basis point improvement in the overhead leverage.
And a 33% increase in adjusted earnings per share.
Well, they're looking at national data or Pultegroup Pultegroup specific numbers housing demand remained strong throughout the third quarter revenue.
Reviewing our numbers for the period year over year unit orders increased 36% and showed strength across all price points buyer groups and geography is.
Along with the ongoing strength in our first time buyer group. We saw notable pickup among our move up and then particular active adult business is good.
Given the potentially higher risks associated with Cove at 19.
Give adult buyers had been a softer part of the market at the onset of the pandemic.
In this most recent quarter, however, not new orders from our active adult communities exceeded over 2000 sign ups for the quarter.
This is the highest level for any quarter in over a decade.
You have likely heard me say before that a robust housing market requires a strong requires strong demand across all the consumer groups.
I believe this is what we're experiencing now as strength among entry level and first time buyers is enabling demand at the higher price points.
Further given limited housing supply and the ongoing price appreciation existing homeowners can more easily sell their existing home and moved to the next property.
Given the positive supply and demand environment, we have taken the opportunity to raise prices across most of our communities in fact more than half of our divisions increased prices across their entire portfolio. What the typical increase realized in the quarter being in the range of 1% to 3%.
Based on recent conversations it's clear that market pricing dynamics are an important topic of discussion for investors and analysts these days pulte.
Pultegroup is typically a price leader, but we're always looking for the right balance of price and pace.
Affordability is still important as well so it is important that we not become overly aggressive and move prices too fast or too high.
Particularly within first time communities.
Given market competition, the normal affordability constraints among entry level buyers pushing prices a few thousand dollars to hide can stall sales very quickly.
The outstanding demand environment has in turn created a production environment that I believe favors the big builders.
Right now builders, who have an existing land pipeline the ability to develop incremental watch and can maintain access to trade resources have a competitive advantage in the market.
I will tell you that our scale was instrumental in the company exceeding its closing guidance for the quarter and as Bob will discuss in enabling us to raise our closing guide for the full year.
[noise] Pultegroup runs a highly efficient construction operation, but market dynamics are such that we must be focused and disciplined and how we are approaching the business and the current operating environment.
On the land side, we've geared up land acquisition and development activities. After spending much of this work earlier in the year when COVID-19 first hit.
For example, our land acquisition spend of $463 million in Q3 was double that of this year second quarter, and almost 70% higher than the same period last year.
While much of our land investment in the quarter was the completion of transactions, we delayed at the outset of the pandemic, we are identifying opportunities to selectively increased land spend where appropriate.
In addition to increasing our land spend I would highlight that we continue to make our pipeline more efficient was 47% of our lives are now controlled via option.
It is important to note that it takes longer to ramp up land production than it does to slow it down, especially in today's environment, but we have a solid land pipeline that will allow us to continue to run our business efficiently.
Consistent with our return focus we are intelligently manning our existing lot inventory to support ongoing sales and minimize gap outs, while driving high returns on invested capital.
On the house side, our construction on procurement teams are doing a great job keeping the production machine running.
As demonstrated by our improved closing volumes.
At the risk of sounding repetitive. This day to day work is also not without its challenges I would highlight that labor is tight across all markets.
Can be adversely impacted by pandemic related absences. So we're working closely with our trades to help ensure resources are available in the near term and as we work to grow volumes in the future.
That said the building materials environment is even more dynamic. These days for example, our Q4 deliveries will feel the initial impact from this year spike in lumber costs and.
And while wood prices appear to have rolled over we will be dealing with the effects of higher lumber cost for several quarters.
Beyond would we have had to manage through sporadic disruptions on everything from appliances in cabinets plumbing fixtures and windows I can.
I cant complement our procurement teams enough for their efforts to minimize construction delays.
In addition to having an outstanding organization to help us manage through today's market conditions, we're working from a position of operational and financial <unk> financial strength.
We ended the quarter with a backlog of almost 15000 homes and a cash balance of $2.1 billion given.
Given these numbers, we're clearly well positioned to deliver strong fourth quarter results, while having the financial strength and flexibility to pursue our strategic business objectives as we head into 2021.
In conclusion, we're extremely pleased with our third quarter results and with how our business is positioned heading into Q4 and the year ahead.
While we grow increasingly confident in the sustainability of housing demand. We are well aware that we are operating within a global pandemic that has not really under control as such.
As such we continue to adhere to the business strategies and disciplines, which have guided our business for the past decade, we re.
We remain focused on achieving high returns over the housing cycle, while intelligently growing our business and allocating capital consistent with our stated priorities of investing in the business paying our dividend.
And returning capital through share repurchase.
To that last point, we have reinstated our share repurchase program beginning in the fourth quarter as it is.
As is our practice, we will provide an update on our purchase activities. When we report our fourth quarter earnings.
Now, let me turn the call over to Bob for a more detailed review of the quarter Bob.
Thanks, Ryan and good morning, everyone and then.
In any market environment, our third quarter results were impressive given that backdrop and challenges of a global pandemic I think the results were exceptional as.
As has been our practice this year I'll be providing a high level review of the quarter along with color on any impact COVID-19 had on our operations and our outlook for the business.
Looking at the business our wholesale revenues in the third quarter were up 7% over last year to $2.8 billion.
Higher revenues for the period reflect a 4% increase in closings to 6454 homes.
In combination with a 3% increase in average sales price to $438000.
I would highlight the closings for the quarter came in slightly higher than our prior guidance as we were able to sell and close more spec units than we anticipated in the period.
A higher average sales price in the third quarter was driven by higher prices within our move up and active adult communities.
First time pricing was down slightly from last year, but this was driven by mix rather than an erosion in sales price.
Demographic mix of third quarter closings was 30% first time, 45% move up and 25% active adult.
These numbers compare last year's mix, which included 28% first time, 46% move up and 26% active adult.
In the third quarter, our net new orders increased 36% over last year to 8202 homes.
Our average community count for the period was 892, which is an increase of 3% over last year.
Average community count for the quarter was higher than our prior guidance as we were successful in accelerating community openings that had been anticipated to incur in the fourth quarter.
Looking at sales activity during the quarter demand at our volumes were relatively consistent across all three months. However.
However, our September orders were modestly impacted by the fact that majority of our divisions took some level of action to manage sign up pace.
Those actions were taken to properly manage our projected production environment with a view towards meeting customer expectations and reducing the risk of input cost inflation.
In addition to the absolute increase in orders we are extremely pleased by the strength in demand across each of the buyer groups.
For the quarter first time orders increased 39% to 2443 homes move up.
Move up orders increased 39% to 3697 homes.
And active adult orders were up 28% to 2062 homes.
As Ryan mentioned, our active adult orders were the highest we've reported for any quarter in the past decade.
Our third quarter cancellation rate was up 12% was down from last year's 15% and our second quarter rate of 19%.
And much more consistent with recent historic trends as well.
As with our orders the cancellation rate was stable over the quarter.
Given the outstanding order activity in the period, we ended the third quarter with 14962 homes in backlog. This.
This is up 29% over last year.
Our backlog value is up an even more significant 32% to $6.6 billion is our highest ending backlog value in more than 10 years.
We ended the quarter with a total of 11451 homes under construction.
Of the homes currently under construction 1755, or 15% were specs.
Our spec inventory down from last year and down sequentially from the second quarter due in large part to the thought in spec starts we put in place the outset of the pandemic come.
Coupled with the robust level of demand we have experienced over the last several months.
It is certainly our intent to increase specs starts and rebuild our inventory over time.
But our near term focus remains on delivering our backlog of sold homes.
Based on the 11451 homes under construction at the end of the quarter, we expect to deliver between 6000 606900 homes in the fourth quarter.
As a result of the improved outlook for fourth quarter deliveries, coupled with the strength of our third quarter deliveries our guidance for full year deliveries has also increased to a range of 24350 to 24650 homes.
Given the average $441000 selling price of homes in backlog, we expect the average sales price on fourth quarter closings to be in the range of $440000 to $450000.
As always the final mix of deliveries can influence the average sales price, we ultimately realize in a quarter.
Moving down the income statement, we are extremely pleased to report that our third quarter gross margin was 24.5%.
This is an increase of 110 basis points over last year's adjusted gross margin.
Sequential gain of 60 basis points from the second quarter of this year.
Our margins continue to benefit from the strong demand environment, which has allowed us to raise prices and door lower incentives in many of our markets in the <unk>.
In the quarter sales discounts decreased 70 basis points from last year to 3.1%.
And fell 40 basis points from the second quarter of this year.
As Ryan mentioned, our future closings will begin to feel the impact of materially higher lumber costs, but we.
But we believe we're in a position to maintain gross margins and cut at current levels over the balance of the year and expect gross margin in the fourth quarter to be consistent with the 24.5% realized in Q3.
On a dollar basis as <unk> expense in the third quarter was $271 million, which was comparable to last year.
Given the increase in 2020 closings in revenues.
We were able to improve SGT expense as a percentage of wholesale revenues by 70 basis points to 9.6%.
Given our third quarter results, we now expect full year adjusted EPS DNA to be there.
To be in the range of 10.1% to 10.3%.
Which indicates overhead leverage in the fourth quarter is expected to be consistent with our Q3 results on a percentage basis.
Gains in overhead leverage in the quarter and for the year being driven in part by the actions. We took earlier in 2020 to lower expenses in response to COVID-19.
Based on the rebound in sales activity compared to our expectations at the time, we took those actions we have.
We have reinstated nearly all of the employees we furloughed.
We have also begun to selectively rehire personnel to maintain proper staffing levels with our sales construction and financial services operations.
While we had always assumed furloughed employees would retain the costs associated with new or rehired personnel have also been included in our estimated guidance for 2020.
Moving over to finance services third quarter pre tax income effectively doubled over the prior year to $64 million.
As has been the case for the prior two quarters the increase in profitability reflects a favorable margin environment.
Higher loan volumes, resulting from growth in our homebuilding operations and higher capture rates.
Our mortgage capture rate for the third quarter was 86% compare.
Compared with 84% last year.
Looking at our taxes income tax expense for the third quarter was $68 million. This represents an effective tax rate of 14%, which is different effective tax rate of 25.4% last year.
Our rate for the quarter was lower than last year because of energy tax credits recognized in the current period.
Going forward, we continue to expect our tax rate to be approximately 25% excuse.
Excluding any discrete permanent differences like the energy tax credits that may arise.
Completing my comments on the income statement, our reported net income for the third quarter was $416 million or $1.54 per share.
Excluding the income tax benefit related to the energy credits, our adjusted net income was $363 million.
Were $1.34 per share.
Prior year net income for the third quarter was $273 million or 99 cents per share with an adjusted net income of $280 million or one dollar one per share.
Switching to the balance sheet, our strong financial performance and resulting cash flows allowed us to end the quarter with $2.1 billion of cash and a net debt to capital ratio of 9.6%.
On a gross basis, our debt to capital ratio was 30.8% down from 33.6% at the end of 2019.
As previously discussed.
We slowed our bees business investment activities in the second quarter as we assess the impacts of COVID-19.
Having become more comfortable with the long term trends for housing demand.
We increased our land acquisition and development spend in the third quarter to $843 million.
Some of this investment represents spend that had been delayed but we remain confident that we will achieve our plans to invest $2.7 billion in total land acquisition and development in 2020.
We ended the quarter with 171500 lots under control.
As Ryan also mentioned we are extremely pleased to report that 47% of the lots are controlled via option as we continue to make progress toward our goal of having 50% of our lots owned and 50% under option.
Let me now turn the call back to Ryan.
Thanks, Bob Let me offer a few final comments before opening the call for questions. The strong demand that we experienced throughout the third quarter has continued into the first few weeks of October at a very high level, we see demand continuing to benefit from a number of factors, including exceptionally low interest rates the ongoing move.
Millennials into home ownership and some level of desire to move away from urban centers.
With COVID-19, forcing houses twos now serve as home Office School Gym Entertainment Center and countless other functions our ability to design homes that can meet the meet the expanded needs of today's buyers gives us yet another competitive advantage in the marketplace.
For closing the call today I want to make sure that we recognize and thank our employees for the tremendous work that they did in the quarter and throughout 2020, thus far.
It's just been a year. Unlike any other weve experienced as a group our team has done an outstanding job adapting to changes in both the professional and personal lives.
While continuing to deliver a superior experience to our home buyers.
It's their commitment to our customers and to each other which allowed pultegroup to again be certified as a great place to work and to be recognized as one of the 2020 best workplaces for women by Fortune magazine and great place to work.
In a world where the competition for the best talent is fierce we view the strength of our culture as an important competitive advantage.
And finally, many of you know and have spoken with Deb still the president and CEO of Pulte financial services.
Doesn't acknowledged leader in the mortgage industry and was just named one of Denver's most admired Ceos of 2020.
I want to publicly congratulate Doug we're truly fortunate to have her a senior leader at Pultegroup, Let me turn the call back to Jim.
Great. Thanks, Ryan we're now fair to open the call for questions. So we can get to as many questions as possible during the remaining time of this call.
We ask that you limit yourself to one question and one follow up.
Jamie if you will now open the queue and we'll get started.
And ladies and gentlemen, we will now begin that question answer session. Once again to ask a question you May Press Star and then one using a touchtone telephone.
If you are using a speaker phone, we do ask that you. Please pick up your handset before pressing the keys.
And any timing that you would like to withdraw. Your question you May press star into once again that is star and then one to join the question queue.
And our first question today comes from Michael Rehaut from JP Morgan. Please go ahead with your question.
Hi, Thanks.
Good morning, everyone and congrats on the results hope everyone has a safe and healthy out there.
First question I had was and I apologize if I missed this earlier.
Just trying to get a sense of the cadence monthly cadence of order trends in the quarter.
And you know.
Obviously.
Positive that you were going to see that strength to continue into the first few weeks of October I was wondering if that was more close to what you're seeing perhaps in terms of.
The exit rate or you know what you are seeing in September.
And also we also any color around the active adult segment, if you're seeing any acceleration there as you noted to a strong.
Order books.
Or interesting.
[music].
Hey, Mike It's Ryan Good morning. Thanks for the question I'll take the Signup question first as I think Bob shared in some of his prepared remarks, we saw very consistent sales order pace throughout all three months of the quarter September was the.
September was the exception to that where we started.
Started to see it slowed down just a tad, but it was self induced by so you know most of our divisions work to restrict sales either via price increases or lot releases or some combination of both and that's that was really an effort Mike in order for us to.
To make sure that we're not getting overly exposed on future cost increases with an elongated backlog as well as managing customer expectations.
I'd highlight the demand curve or the demand situation.
'cause was quite consistent throughout all three months of the quarters. We've seen things continue to be strong in the early early weeks of October both the number and the number of orders that we recorded as well as the demand. So things things are continuing into the fourth quarter, a and b.
Finally, your question on active adult we're really really pleased.
Really pleased with how that business has performed we'd highlighted in Q2 that it had been a softer part of our business. Given you know the the age demographic of that buyer group. They were rightly so being very cautious because.
Because of Cove at 19.
I think as everybody has gotten more comfortable with P. P E and social distancing that buyer has come back into our sales offices.
And you know the thing that I'd I'd I'd repeat as we booked over 2000, new orders in the quarter from.
From our active adult communities, which is the highest that we've had in over a decade.
Right no. That's that's really helpful. I appreciate you pointing that out.
I guess, maybe switching a little bit from.
The incoming order book, he trying to get units out the door.
Your fourth quarter guide implies a backlog conversion rate in.
In the mid Fortys versus 59% a year ago.
How should we think about the ability to deliver.
Deliver this obviously incredible backlog of loans over the next two or three quarters would you.
Would you consider the year over year decline in backlog conversion as we see it in the fourth quarter as maybe being a low point in terms of the year over year differential in that from here, we might be able to see that year over year decline narrow as production wins.
Or you know any type of forward looking thoughts.
Around the ability to.
Obviously produces tremendous amount of homes.
How do you see that playing out.
Yes, Mike we're really pleased with how the production environment.
Is running right now and as I highlighted on in some of my prepared remarks I. Our production teams both the construction and the procurement teams have just done a real nice job of keeping things moving so we're quite pleased with how things are rolling off of the off the production line.
You've probably heard me say before Mike we're not fans of backlog conversion.
I think you can get some really goofy numbers as indicated by some of the percentages that you shared a minute ago I really encourage you to look at a conversion of units in production I think it's a much better indicator of how efficiently. The assembly line is working but I think what you'll find with the guy.
Slide that we've given for Q4 is that the conversion of our production is very consistent with where it's been over the last couple of years as it relates to 2021, Mike we're not giving any guidance on that at this point in time, we'll certainly going to do that as part of our Q4 call.
Our next question comes from John Lovallo from Bank of America Merrill Lynch. Please go ahead with your question.
Hey, guys I. Thank you for taking my questions. The first one maybe getting back to the September orders that were sort of deliberately.
Load down.
Given pricing and this different actions along those lines I'm curious, Brian what degree of pricing did actually take to slow those orders and if it is the other one or $2000. I think you may have mentioned during the call I guess.
Given that labor costs are likely going up I mean lumber still high structural panels are still high I mean, as we move into 2021 is it likely that we're going to see more margin degradation across the across the industry.
Yeah, Mike or John Good morning, we haven't given any guide on 2021 at this point in time.
You did hear us say as it relates to lumber.
That that will be a headwind for us over the next several quarters, just because of the way we buy.
We buy on a 13 week.
Trailing random lengths average, which means you know just kind of now in the back half of the third quarter and as we move into the fourth quarter, we will start.
We will start to see the higher lumber costs come into our margin profile you know as it relates to your question about price increases and slowing sales.
That's that's a tough thing to quantify in a in an answer on a call like this John what I'd tell you is that.
We have been very successful in pushing price as evidenced by a very rich 24.5% margin.
Print in this quarter. So we think we've done a nice job.
Managing the pricing environment, we are sensitive however to that delicate balance of affordability.
And so while I think were maximizing what the opportunity is I think we're we're being careful not to.
We are being careful not to kind of break.
You know the affordability demand model the last thing that I, probably highlight is that it's not just price in some cases, we're managing the sales pace with the number of lots that were releasing.
So you know it's it's a it's a combination of a number of factors that we can use to manage the number of sales that we want to take in an environment like this given given what we are doing on the production side.
Okay. That's helpful and then maybe one for Dan.
Congratulations first of all on your recognition but.
But the question is recognizing here is that at the J B.A., it's nothing 20% of your business a relatively small.
Delinquencies at the FHLB level are sort of mid teens right now nationally I believe I think the average is sort of mid single digits.
Your views on sort of what happens across the industry when the moratorium on foreclosures ends at the end of the year.
Yes, John that's not on the call, but I'll try and answer that its Bob.
You know, it's a fair question.
And I think the answer is that we're hopeful that there will be some sort of continued relief.
I don't know that there is a big appetite today.
Today to introduce that kind of.
Consternation into the market.
If that were.
Were not to be the case, you know I think you'd have.
Some turbulence in the market I don't know what that would translate into in terms of.
Yes, the current sales environment, but certainly it could.
Could create issues interestingly enough you know most of the folks that own today have equity in their homes. So unlike the last downturn.
Where people were upside down one solution here as people can sell their house and pay off the mortgage so I don't want to be pollyannish about it but.
Yes, I'm hopeful at least that this will cause a lot of wreckage in the market.
Our next question comes from Alan Ratner from Zelman and Associates. Please go ahead with your question.
Hey, guys. Good morning, Congrats on a great quarter and glad to hear you're all doing well.
So Ryan I would love to drilling as well on the kind of limiting lot releases or sales activity in September that you guys saw and I guess the first question on that is.
What exactly has the trend in on your cycle times in terms of kind of what you're quoting buyers from contract to delivery time now versus say six months or so ago and yeah. A follow on to that is I'm a little surprised that you are taking such aggressive steps. There just given how strong your community count has held up here and you mentioned actually being able to pull forward some.
Some openings, which is impressive so.
Recognizing you're not quantifying the monthly trends is it still safe to assume that on a year over year basis. Here you are able to grow the order book given the earlier impressive land position.
Yeah. Good morning, now and there is a lot there let me see if I can kind of pick pick through some of that and give you. Some answers as it relates to kind of the order trend over the quarter you know the slight downtick in September was small you know the the year over year numbers in total for the quarter at three.
36% they were fairly consistent as we moved July August September so I, probably don't want to overplay that too much.
You know the big takeaway that I think I'd want you to have is the demand is great to your point, we were successful in getting some communities opened a little earlier.
And it's continued to kind of benefit our business not only in the current quarter, but but certainly you know in future quarters as well as.
As it relates to cycle time, Alan we've been.
[music].
You know seen things extend a little bit longer.
No, it's not anything that I would characterize as overly problematic, but we've seen we've seen that the breaking ground to kind of finish delivery times. It expand just a tad as far as when we're quoting deliveries Allen in most of our system. It's right in the six month range, which has been very.
System with how we've operated the to be built order model for a long time. So we're really not you know other than maybe a few specific communities here. There you know, we're quoting delivery times that would be kind of in the March April timeframe, and that's all reflective of.
What's in our backlog and what our lot availability situation situation looks like so.
I may have missed a couple of the things you ask Alan but maybe you can hit them in a follow up if I missed anything.
No that was perfect Ryan I think you've got everything there.
And then secondly, if you I'm imagining this at the time of the year, where you start to think about your your next year budget and plans and probably are having conversations with your trades involved in that as well and looking at the land.
Looking at the landscape out there, it's pretty clear starts need to accelerate rather sharply over the next few months. So any any color you can give us in terms of conversations you're having with the trades in terms of how they are equipped to deal with that you know this this spike in activity, that's likely to occur or whether they're they're geared up for 21. So.
Start activity and I guess in the context of that any comments I saw the leading builders of America kind of launched a new pilot program to try to improve some of the the labor availability trends there as well so any any color you can give on that front would be great. Yeah, I, probably just expound a little bit on the prepared comments that I made Allen where labor is tight.
And and I believe that as a big builder, which we're certainly in that category, we've got an advantage.
You know the fact that we've got a large backlog we run a very sophisticated orderly shop in terms of start rate and how things move through the production environment.
You know our what our trade partners tell us is they appreciate that they appreciate the consistency. They can send the same crews to the same community every day. They know they've got a consistent level of production.
You know, which helps them be more efficient more profitable. So while things are tight and I think we're going to continue to manage through things and you know absences related to co but you know.
You know as the proverbial proverbial curve ball that you've got to be anticipating you know things like that can certainly have a disruption on a on a trade partner shop.
We think we're pretty well prepared for not only the fourth quarter, but for next year and I give credit to our local teams that have been.
Built and managed and continue to foster the strong relationships that we have with our trade partners. So we think were as is evidenced by you know the guide that we've given for Q4 on the closing front, we think we're in a good spot to finish up.
Finish out the year strong.
Our next question comes from Ken Zener from Keybanc. Please go ahead with your question.
Good morning, gentlemen, okay.
Okay I can.
So what a year this is I think.
I think a lot of people and including myself you know the rubber meeting the road so to speak for the industry is that there is a lot of orders, which you know is pay.
He's paper that goes in the backlog, but your actual inventory is what constrains your earnings.
Fourth quarter as well as next year. So can you talk to this constraint because your backlog to inventory ratio has never been lower at Threeq you. It's about just under 80%, which is obviously leading to your fourth quarter guidance, but I think the big issue here is you know.
Your starts what is the real constraint there. It's I mean, we hear constraints for appliances a yard for windows lately.
Lately I've been hearing after garage doors, obviously, Ryan you commented on labor, but what is it seems as though investors optimism around where starts can go seems to be added a bit of a disconnect from where the industry is.
Able to produce.
Home so what keeps if you see all this demand what really keeps you from accelerating that process sets somehow I know, we have longer construction cycle times, but what keeps you from starting more specs is it your land constraints I know some builders have run out of land for example to grow community count things like that but.
What's that conservative nature that keeps you there or is it something that is industry wide that you really can't get around therefore.
Investors growth optimism might be too high.
As we look forward yeah. Thank you and I can I wish I wish that I could tell you that it was isolated to one thing there.
Reality is it's a lot of things and probably the first thing I'd highlight is permits so.
Municipalities and government agencies have arguably probably been the most conservative in terms of shut down and slowdown we can't.
We can't start at home without a permit so you know that that would be probably the thing that I would highlight as being the initial barrier that we've we've got to overcome.
I think we're doing a nice job doing that and then you go into the various production related kind of delays you highlighted a number of them. We highlighted a number of them in our prepared remarks, where it's been appliances. It's been windows. It's been interior doors, it's been cabinets, none of them have persisted, but you know different things come and go.
Go based on a myriad of factors.
And then you also highlighted lot availability, there's there are constraints around horizontal labor land development labor as well theres constraints around getting plat maps recorded and development plans approved through municipalities again. So you know there there is a there is a little bit of sand in the.
In the gears kind of everywhere.
Nothing that is completely shut the machine down and again I think Thats, where you know the big builders are favored because of our size and our scale and the processes and the systems that we have you were able to you don't really deliver some nice results as evidenced by this most recent quarter, we're incredibly proud of what the business is doing.
We're thrilled about kind of what we've got projected for Q4, and you know as we finish up our planning for next year.
We'll certainly provide some some.
Some more guidance about 2021, as we get to the end of the fourth quarter. So you know I.
I've been in this business a long time, it seems that no matter the business environment that we're operating in there are challenges that we have to deal with.
This this current time no different I can tell you right now, though and I mentioned to some of my team over the past.
Over the past week I'd, rather be dealing with these types of issues and small challenge has been figuring out in an environment, where demand is locking and you can't sell homes. So.
Class problems and I think we're well equipped to deal with them.
Thank you.
And our next question comes from Truman Patterson from Wells Fargo. Please go ahead with your question.
Hey, good morning, guys, great quarter, and thanks for taking my questions.
First I wanted to follow up on on community Count I mean like it actually increased sequentially.
And it was up 3% year over year. This is at the high end of the range that you guys were guiding to at the beginning of the year pretty surprising given all the pause during coded how strong of absorptions have been recently just can you elaborate a little bit more on what's what occurred internally.
And that the Muni level I know you mentioned that theres constraints of the meaning level, but this would kind of indicate otherwise so.
Hopefully you can walk through some of those moving parts and then.
The sustainability of this 892 level as we look into Fourq you were even first half at 21.
Yes, sure I mean, its Bob we obviously, we gave a guide coming into the third quarter.
Where we thought we'd be down a little bit.
The teams are working really hard as Ryan is shared with you.
Yeah, there was probably a degree of conservatism in that because people were.
Just coming out of the pandemic.
Kind of real lock down.
When we were talking to you folks back in July.
So really all we did was pull forward some community count out of what we thought would start in the fourth quarter into the third quarter.
I don't know that there is the ability to continue that through time and so weve.
Done a refreshed look and we think actually our Q4 is going to be consistent with what we told you back in July we had said again down to the 4% in July for the third and fourth quarters.
So we were we are still there.
Yeah, we're obviously working hard to get stuff open yes.
Obviously haven't provided a guide beyond the fourth quarter.
But.
Yes, Theres theres a limit to how much pull forward you can do.
And so again teams did a great job we'd.
We don't think it repeats in the fourth quarter, but we will make every effort.
Okay. Okay. Thank you for that.
And then just jumping over to the land market today, you know with you. All you know bumping up your land spend how would you characterize the land market as it overheated that just normal conditions, you know that's generally pretty competitive.
And are there any metro's of concern you know that is specifically gotten overheating heated lately.
Sure I'm going to try and.
I'd characterize the land market is competitive which you know other than than maybe in the depths of the great housing recession, the great recession, I don't know that I've ever seen land go on sale.
It's just it just doesn't and.
There's there's a finite number of pieces that are within kind of the zones that are allowed to be kind of developed entitled et cetera, and I think we see we see competitive behavior there whether it's from other homebuilders for you've got a commercial on that.
In other uses for most good land parcels so.
I wouldn't I wouldn't characterize it as anything other than competitive.
We're continuing to be smart, we're sticking to our underwriting fundamentals and the way that we have.
Kind of approach land investment, so really no deviation from us on that front.
And I would tell you I don't know that I would characterize any markets is being.
Specific markets is being overheated and and irrational at this point in time.
Our next question comes from Stephen Kim from Evercore ISI. Please go ahead with your question.
Thanks, very much guys I think it's a pretty unusual market right now where it seems like your ability to sell is pretty much just limited by the the available product to sell and so in that regard I'm curious as to how to think about what pulp. These macs.
Production capability is and how to sort of think about forecasting what that.
Forecasting what that might be next year. So.
So one way to why not that I can think about it is that you've given a guide of 6900 deliveries in the fourth quarter I, just sort of multiply that by four would it be reasonable to think that that's your Max production capacity right now or should I be looking at your the orders you took in Threeq, you and say you probably wouldn't have taken those orders if you did.
I think you'd be able to deliver them with good customer service and so maybe.
Four times that number is kind of your Max capacity, how should I be thinking about Max capacity and how much do you think it can grow in any given year for a builder of your size yeah.
Yeah, Stephen that's a all of those are difficult questions to answer because they are essentially all 2021 guidance, which which were not given at this point in time.
I'll I'll do my best to give you a little bit and and what I would tell you is that the the business both from a sales standpoint, as well as our production standpoint, its seasonal we see seasonal fluctuations in demand, we see seasonal fluctuations in what our Max capacity is.
Mostly driven by weather you know you know that we've got a very big Midwest business and it gets more difficult to build homes in the in the middle of winter.
You know in the Midwest, We certainly do it of course, but it's not as good or as fast in the summer months. So we really like the way that the production machine is running right now, we'd certainly endeavor to increase that.
You know as much as we're able based on having available land and available trade resources and you know rest assured we're working on that every single day to get our start rate up because to your point the demand environment is great.
But you know like I mentioned on.
Like I mentioned on one of the earlier questions. We think you know the better way to evaluate the efficiency and the efficacy of the production machine is a conversion of whats in production.
And we think we're we're operating at a very consistent historical level as it relates to that so look we're we're going to do everything we can to put more into the machine.
And that's on both fronts, both on the vertical side as well as on the on the horizontal land side.
I hear you on the the Midwest and the northern parts of the country being a little bit more difficult to produce.
Produce and seasonality therefore, but.
In the fourth quarter.
So one of those quarters, where it gets pretty cold up there and you've given a number there.
So and I'm, assuming you're pretty much going lights out now trying to build as much as you, possibly can so I'm inclined to think that that number times four is probably not a bad gas as to what your Max capacity is today.
Correct me if I'm wrong.
And I'm really trying to get at what.
What your ability is to grow capacity in any given year and what are the things that actually are the limitations on that is it.
Is it.
In your view well unless interest in actually what they are it's more like what the number might be is it reasonable for example to think that a company of your size can grow capacity production capacity on a sustained basis five.
By about 20% a year I mean is that on real reasonable just trying to understand because it's not something we've never really thought about before frankly, you always thought about it on from the demand side.
Yes, Stephen I think the best thing that I can give you is that we have given the guide that we've given for Q4 from a from a delivery standpoint, and we're quite happy about that we've given a CTLA community Count guide to Bob just talked about in an earlier question for Q4 as well.
So you know I think you've got probably as good a insight into the demand environment is probably we do and based on what we've talked about so.
Yeah, I think you look at those things and you factor that into kind of your models for future years. What I'll tell you is that we're what will give kind of room more robust guidance for 2021 at the end of the fourth quarter. So we're as I mentioned a minute ago, we're really seeking to grow our start.
We think that this environment favors the big builders.
And and so we're going to we're going to continue to do an endeavor to do that I think the limiting factors are the saying that they've done and probably is consistent with what you've heard from us in the past its land and labor so.
Can we continue to grow the labor force, we're trying to do.
Trying to do that and you heard a comment from Alan leading builders of America has got.
An effort underway, where we've created a foundation that.
That is solely focused on.
Promoting the wonderful career opportunities that are available within the within the homebuilding industry. So we'd hope to get some traction with that to increase.
You know to increase the labor side land you know I think the biggest impediment. There is frankly the municipalities in working through the development system and.
And then lastly, and I think probably I'd rank it through.
Third on the list as there is a little bit of stickiness and the supply chain.
You know again.
Again, nothing that we haven't been able to manage through but but it does create a little bit a little bit of stickiness.
And our next question comes from Susan Mcclary from Goldman Sachs. Please go ahead with your question.
Thank you good morning, everyone.
So.
My first question is thinking about the active adult segment and the obvious improvement that youve seen there over the quarter.
Most of that do you think is coming from what we're seeing in the existing market. The fact that some of these areas like the northeast the Midwest that were soft prior to this have really seen an improvement in there and it's just become a lot easier for these people to sell their existing home sales and get into these newer units and I guess with that too are you seeing geographic shift.
A lot of people that are coming out of the northern half of the U.S. and the active adult segment in going into some of these southern markets.
Yes, Susan I think Theres couple of things going on.
We're we're seeing a continuing trend of.
Folks, leaving northeastern and Midwest markets, and they're moving south.
That's that's a trend that was going on pre co. Good. It's a trend that has continued post code.
You know so so we continue to see that benefiting our business given that we've got a lot of properties in the south as it relates to the active adult consumer Yeah, We think theres a couple of things going on there one.
This buyer has gotten more comfortable in resuming normal daily activities over the last couple of months and that includes figuring out what they're going to do in retirement and so we think we benefited from a from that buyer reengaging in the in the buying.
Process and then the comment that I made in my prepared remarks, our view is that a healthy housing.
And.
Healthy housing environment requires all consumer groups to be participating and certainly we're seeing that right now given the the the desire the increase desire of individuals to have a single family home. It's created an inventory shortage really in every price point of the market.
Created some pricing opportunities not only for us, but also for the resale side.
And that's made it easier for individuals to sell their home.
They've sold their homes at really great prices, which gives them a lot of options and a lot of choices in terms of what they do on the new side. So.
You know I think what all that adds up to is a great operating environment for our company.
Gotcha, Okay. Thank you John.
My next question is around the buybacks you I think it was really encouraging to hear that you are reinstating that program in the fourth quarter can you talk a little bit about how we should be thinking about the cadence of the buybacks coming back and what's giving you the confidence to do that how you're thinking overall about capital allocation and especially maybe as me.
Think about the accelerated pace of demand the need to keep supplying those lots in supporting the growth and just how you're balancing all those different factors looking out.
Yes, so it's a it's a fair question as as Ryan mentioned on the call.
We'll give you news on what we've done after we've done it as opposed to giving you a guide in terms of what our expectations are for spend.
But but the way we're looking at share repurchases is exactly the same as we were.
Prior to the pandemic and so.
Our capital allocation process.
Process starts with investing in the business to your question that will be our primary.
Source or use of capital second we want to fund our dividend third if we have excess capital we will use it.
Use it to buy back shares.
Yes, again, all against the backdrop of leverage and cash capacity and so with $2 billion in.
In the bank and a business that has.
Strong cash generating.
Right now we.
Can kind of do all of those things I know we've talked about this in the past.
Our.
Expectation based on the guide we gave is we'll spend eight $900 million on land acquisition and development in the fourth quarter, we will pay our dividend.
We think were cash generative after that and so the $2.1 billion in cash probably gets bigger.
We've talked about the fact that we've got to maturity in the first quarter of next year that we are still likely to use cash to redeem.
So 426 or $7 million.
But with all that said, we still have a lot of capacity to invest in the business than we think actually buy back stock. So we.
We always use that lens, we always look out in time as we're thinking about the sources and uses of capital in the business.
So we don't see it as a choice between owed we want to invest in the business or buyback stock.
We will be doing both.
And our next question comes from Mike Dahl from RBC. Please go ahead with your question.
Good morning, Thanks for taking my questions.
Talk more about kind of the pricing power and dynamic you're seeing I think you mentioned.
One 3% price increases I understand that.
Widely varied, but wanted to get a sense on a relative basis, you talked about the constraints at the entry level from the affordability standpoint, but on average is your entry level.
Racing.
Increases trending.
Yes in line or or above or below those numbers that you're you're quoting and I guess the second part of that question is when you talk about the constraints.
Are we talking true hard bumping.
Bumping up again.
When it's at this point or is that more just a feel on.
Moderating and add metering out your price increases to avoid sticker shock.
To your second question, Mike. It is the latter so it's an affordability question not a mortgage capability question.
Now interestingly, our business and we've talked about this before.
Even in that first time space, we are typically a little bit at the higher end up the price range there.
So it was mentioned earlier on the call FHA VA for US is and has been pretty consistently about 20% of our origination so.
So were not.
We don't have a lot of consumers at that lower FICO score, where you might be getting up against.
Capability to borrow.
So I think at the end of the day as we as we look at it. It's just trying to make sure that we're pricing appropriately, but not pushing things so far that people.
Have a choice people always have choice and whether it's rental or competition you don't want to get the affordability equation for that for that more cost conscious buyer out of whack.
Got it Okay and then the second question I had.
Talk about lumber impact starting to.
Starting to hit in the fourth quarter, but as you articulate mostly kind of first half.
Okay issue can you just size up sequentially, what's the what's the margin.
Margin headwind that you've got to absorb in Fourq versus Threeq, you and I know you don't want to get one.
21 guidance, but based on that lag and your backlog.
You do like we have a sense of the magnitude that's coming.
At the beginning of next year and any color you can give us on kind of how that steps up from Fourq you to one Q in terms of just what you've got to absorb.
Pricing standpoint to cover lumber yes.
Yes, Mike we haven't we haven't broken that out you know what we have talked about is that lumber sales through about the sticks packages about 3% to 5% of our costs. So it's it's a meaningful percentage, but but we haven't.
Yes, 3% to 5% of ASP is what the sticks packages. So it's you know it's a it's a decent chunk of money I think what you saw in the fourth quarter or is that we've had some nice price appreciation that we push through the system. You know we had a really nice margin print in the quarter we.
We've given kind of our margin guide for Q4, which we've said is going to be consistent with Q3. So I think what you're seeing is that we've been able to offset.
You know the increases that are coming through the system because of lumber with prices is it.
As it relates to Q1 of next year, we haven't we haven't given any any any guidance on that yet, but we certainly will as part of our Q4 release.
And ladies and gentlemen, with that Weve reached the end of the allotted time for today's question and answer session.
I'd like to turn the conference call back over to Jim Zeumer for any closing remarks and <unk>.
Hey, we appreciate everybody's time today, if you've got any questions certainly feel free to get back in touch with us the email calls and we look forward to talk to me on our fourth quarter call. Thank you.
Ladies and gentlemen, with that we'll conclude today's conference. We do thank you for attending today's presentation. You may now disconnect your lines.