PulteGroup, Inc.

Good morning and welcome to the fourth quarter 2020 Pulte Group, Inc. earnings conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing star then zero on your telephone keypad. After today's presentation, there will be an opportunity to ask questions. Participants will be limited to one question and one follow-up. To ask a question, you may press star then one on your telephone keypad. To withdraw your question, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to James Zumer, Vice President of Investor Relations and Corporate Communications. Please go ahead.

James Zumer, Vice President of Investor Relations and Corporate Communications, Thank you, Andrew, and good morning. I'm pleased to welcome you to Folky Group's fourth quarter earnings call. The period ended December 31, 2020. We appreciate your time this morning and offer belated best wishes for the new year. I'm joined on today's call by Ryan Marshall, President and CEO, Bob O'Shaughnessy, Executive Vice President and CFO, and Jim Osowski, Senior VP of Finance. A copy of this morning's earnings release and the presentation slides that accompany today's call have been posted to our corporate website at faultygroup.com. We'll also post an audio replay of this call later today. I want to highlight that we will be discussing our reported fourth quarter numbers, as well as our results adjusted to exclude the impact of certain reserve adjustments and tax benefits recorded in the period. A reconciliation of our adjusted results to our reported financial results is included in this morning's release and within today's webcast slides. We encourage you to review these tables to assist in your analysis of our business performance. Also, I want to alert everyone that today's presentation includes forward-looking statements about the company's expected future performance. Actual results could differ materially from those suggested by our comments made today. The 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 risk factors and other key information are detailed in RICC filings, including our annual and quarterly reports. Now, let me turn the call over to Ryan Marshall.

Ryan? Thanks, Jim, and good morning. I appreciate everyone joining today's call. I hope that your new year has started well and that you remain healthy and safe. It goes without saying that COVID-19 and the resulting challenges made 2020 a year unlike any that we've experienced before. Let me just say right up front that I'm extremely proud of how our entire team responded and how our organization remained engaged and focused during some very difficult times. Thanks to the sustained efforts of our dedicated team, We successfully navigated through a year that started strong, slammed to a halt, and then accelerated into the strongest demand environment this industry has experienced in more than a decade. As you read in this morning's press release, Pulte Group completed an exceptional year by delivering outstanding fourth quarter results that included a 24% increase in orders, a 220-point increase in gross margin, and a 31% increase in adjusted earnings per share. We also ended the quarter with $2.6 billion of cash and a net debt to capital ratio below 2%. Reflecting a lot of hard work by an amazing team, Pulte Group realized a 6% increase in full-year closings to 24,624 homes and a corresponding 7% increase in full-year home sale revenues to $10.6 billion. Benefiting from our ability to expand home building growth and operating margins, along with dramatic gains in our financial services business, we converted the 7% top line growth into a 29% increase in pre-tax income of $1.7 billion. Our outstanding results extend beyond our income statement. as we generated $1.8 billion in operating cash flow in 2020 after investing $2.9 billion in land and development during the year. Beyond investing in land, we increased our dividend by 17%, effective with the payment we made this month and repurchased $171 million of our common shares in 2020, despite having suspended the program for six months because of the pandemic. I am also extraordinarily proud to note that consistent with our focus on generating high returns over the housing cycle, we realized a 23.7% return on equity for the year. With 2020 complete, we enter 2021 in a strong financial position and with numerous opportunities to drive further business gains. Obviously, we can't control how the pandemic plays out, but we are optimistic that the multiple vaccines getting distributed mean that we can see a light at the end of this long tunnel. Bob will provide specific guidance as part of his comments, but let me offer a view of how we are looking at the business and how we plan to operate in the year ahead. We expect a strong demand environment, which the housing industry experienced for much of 2020, and in reality for many quarters prior to COVID, can continue well into 2021. We said for years that we thought housing starts needed to be around 1.5 million to meet the natural demand created by growth in population and household formations. We finally reached 1.5 million starts in 2020, but we have underbuilt relative to this number for years. Given this unmet need and the potential mix shift in demand toward more single family and away from apartment living, we believe demand can remain strong going forward for our business. Beyond the demographic tailwind, we also believe that the pandemic has caused a permanent increase in the number of people who will be working from home full or at least part-time. Such a shift has profound implications in terms of what people need from their homes, as well as where their homes can be located. For example, we believe a remote working dynamic expands the buyer pool and because it can allow people to purchase more affordable homes and further out locations. At the same time, working from home has the potential to increase the intent to buy new homes, which offer floor plans and technology features that better meet the needs of today's homebuyers. With such a strong demand environment, it works to our advantage to be among the nation's largest builders with access to land, labor, and material resources. We entered 2021 with more than 15,000 houses in backlog, 180,000 lots under control, of which half are controlled via option, and longstanding relationships with suppliers and trade partners. The combination of these factors should allow us to increase 2021 deliveries by more than 20% over the last year. As we've demonstrated over the years, I am confident in our organization's ability to operate the business successfully and to get homes built. But I do think it's fair to acknowledge that there are points of friction in the system. Labor remains tight, although the change in administration may allow for some relief, assuming immigration policies are eased. At the same time, product manufacturers are battling supply chain issues and the occasional COVID-related disruption within their plants. Although I must say our suppliers have been tremendous partners, going above and beyond in many instances to provide the materials we need. Given high expectations for the company's operating performance and our balance sheet strain at year end, I believe we are exceptionally well positioned to execute on all of our capital allocation priorities. More specifically, we are targeting land acquisition and development spend of $3.7 billion in 2021. This is an increase of roughly $800 million over our 2020 investment that we think appropriate given the growth in our operations. Beyond our expected land investment, we have made great progress in planning for and selecting the location of our next offsite manufacturing plant. We still have a few details to work out with the owners of the sites under consideration, but we hope to finalize a plant agreement within the next couple of months and then begin installing the requisite production equipment later this year. Our ICG operation in Jacksonville has exceeded our expectations. so we are excited to get this new plant up and running sometime during the first quarter of next year. Along with investing in the business and continuing to fund our dividend, as you read in this morning's press release, we will be using available cash to pay down $726 million of our outstanding debt in the first quarter. And finally, we will continue to return excess funds to shareholders through our share repurchase program. In response to the uncertainties caused by the pandemic, We had suspended share repurchase activities during the second and third quarters of last year. As detailed in our press release, we resumed the program and repurchased $75 million of stock in the fourth quarter, bringing our full year total to $171 million. We have repurchased more than one-third of the company's shares since initiating the program, and we expect to remain an active buyer of our shares going forward. Housing demand was outstanding in the back half of 2020, with strength across all geographies and buyer segments. And I'm certainly pleased to report that this strength has continued unabated through the first few weeks of January. The housing industry has been extremely fortunate in being an economic engine, but we do not take this for granted, nor will we forget how devastating COVID-19 has been for thousands of businesses and millions of people. It is certainly our hope that we are rapidly approaching the end of this pandemic. Let me now turn the call over to Bob.

Thanks, Ryan. Good morning, everyone, and let me add my best wishes and express my hope that we can all navigate the coming year in health and safety. As indicated in our press release, our fourth quarter financial results were impacted by the following items. A $16 million net pre-tax benefit from adjustments to insurance-related reserves. a $22 million pre-tax charge from adjustments to financial services reserves, and a tax benefit of $38 million resulting from energy tax credits and deferred tax valuation allowance adjustments. Where appropriate, I'll reference the impact of these items during my review of the quarter. For our fourth quarter, home sale revenues increased 5% over last year to $3.1 billion. The increase in revenues for the period was driven primarily by a 4% increase in average sales price to $446,000, as closings were up 1% to 6,860 homes. The increase in average sales price for the period reflects a strong pricing environment for all buyer groups. We're pleased to report that on a year-over-year basis, our average sales price was higher for our first-time, move-up, and active adult buyer groups. The demographic mix of our closings moves slightly in the quarter and reflects changes caused both by the pandemic and by our strategic investment to serve more first-time buyers. Consistent with these dynamics, our fourth quarter closings in 2020 consisted of 32% first-time, 46% move-up, and 22% active adult. In the fourth quarter of 2019, closings were comprised of 31% first-time, 45% move-up, and 24% active adult. Our net new orders for the fourth quarter increased 24% over last year to 7,056 homes, while our average community count for the period was down 2% from last year to 846. The decrease in community count reflects the slowing of our land activities earlier this year in response to the pandemic, as well as the faster closeout of communities due to the strong demand environment and related elevated absorption paces. Demand was strong across the entire period and actually accelerated toward quarter end, as December orders were higher than November and essentially flat with October. Given the strength of ongoing demand, our divisions are taking specific actions to manage sales pace and production so our backlog does not get overextended. We are also being thoughtful about adjusting price to help cover rising house costs, especially the cost of lumber, which moves significantly higher in the quarter. Consistent with what we experienced during the third quarter, demand was strong across all of our brands, including the ongoing acceleration in demand among active adult buyers. In the fourth quarter, first-time orders increased 27% to 2,084 homes. Move-up orders increased 17% to 2,994 homes, while active adult orders increased 33% to 1,978 homes. In fact, our Q4 active adult orders were less than 100 units below the all-time quarterly high we reported in the third quarter of this year. After a pause in the first half of 2020, active adult buyers have clearly gotten off the fence. Our fourth quarter cancellation rate was 12%, which is down from 14% last year. Based on the strength of our sales, our year-end backlog increased 44% over last year to 15,158 homes. Backlog value at year end was $6.8 billion, compared with $4.5 billion last year. We believe our large backlog and continued strong demand for new homes has the company extremely well positioned to realize significant year-over-year growth and closings in 2021. At the end of the fourth quarter, we had a total of 12,370 homes under construction, of which 1,949, or 16%, were spec. In the fourth quarter, we focused on closing sold inventory, but we're actively working to increase production of sold and spec homes throughout our markets. Our large backlog makes this process a little easier, and we're working closely with our trades and product suppliers to ensure the needed capacity to deliver more homes going forward. With 12,370 homes under construction at year-end, we expect deliveries in the first quarter of 2021 to be between 6,300 and 6,600 homes. At the midpoint, this would be a 20% increase in closings over last year. This growth rate is in line with what we expect for the full year as we are targeting deliveries to increase approximately 22% to 30,000 homes for all of 2021. Given the strength of our move up in active adult sales, along with price increases realized across all buyer groups, our average sales price in backlog was up 4% over last year to $448,000. Based on the prices in backlog, we expect our average sales price on closings to be in the range of $430,000 to $435,000, both for the first quarter and for the full year 2021. As we've said in the past, the final mix of deliveries can influence the average sales price we deliver in any given quarter. Reflecting the benefits of the favorable pricing environment and our ongoing work to run a more efficient home building operation, our fourth quarter gross margin of 25% was up 220 basis points over last year and 50 basis points from the third quarter of this year. Driven primarily by increases in lumber and labor, our house costs will be higher in 2021. However, given strong demand conditions, we expect to pass through most of these costs through increased sales prices. As a result, we expect gross margins to remain high and be approximately 24.5% for both the first quarter and the full year. Our reported SG&A expense for the fourth quarter was $280 million, or 9.1% of home sale revenues. Excluding the $16 million net pre-tax benefit from adjustments to insurance-related reserves recorded in the fourth quarter, Our adjusted SG&A expense was $296 million, or 9.7% of home sale revenues. Last year, our reported fourth quarter SG&A expense was $262 million, or 8.9% of home sale revenues. Excluding an insurance reserve adjustment of $31 million last year, our adjusted SG&A expense was $293 million, or 10% of home sale revenues. At the outset of the pandemic, we took action to adjust our overheads in anticipation of a more difficult operating environment. Although nearly all furloughed employees have rejoined the company and we've hired back many of the employees we released, we still expect to realize improved overhead leverage in 2021. At present, we expect SG&A expense in the first quarter of 2021 to be in the range of 10.5% to 10.9%, which is down from 11.9% last year. For the full year, we are targeting an SG&A expense of 10% of home sale revenues down from 10.2% on an adjusted basis last year. Our financial services operations continue to deliver strong results as we reported fourth quarter pre-tax income of $43 million, which is up from $34 million last year. It's worth noting that our fourth quarter 2020 results include the $22 million pre-tax charge from adjustments to our mortgage origination reserves as we settled claims tied to mortgages issued prior to the housing collapse. The increase in pre-tax income in the quarter from our financial services business reflects continued favorable rate and competitive market conditions, along with higher loan volumes resulting from an increase in mortgage capture rate. Our mortgage capture rate for the quarter was 86%, up from 84% last year. Our reported tax expense for the fourth quarter was $86 million, which represents an effective tax rate of 16.4%. and which reflects the tax benefit of $38 million resulting from energy tax credits and deferred tax valuation allowance adjustments recorded in the period. In 2021, we expect our tax rate to be approximately 23.5%, including the benefit of energy tax credits we expect to realize this year. Finishing out my review of the income statement, we reported net income for the fourth quarter of $438 million, or $1.62 per share. Our adjusted net income for the period was $404 million, or $1.49 per share. In the comparable prior year period, the company reported net income of $336 million, or $1.22 per share, and adjusted net income of $312 million, or $1.14 per share. Benefiting from the outstanding financial performance and resulting cash flows generated by our home building and financial services operations, we ended the quarter with $2.6 billion of cash. In addition, at the end of the year, our gross debt-to-capital ratio was 29.5%, which is down from 33.6% last year, and our net debt-to-capital ratio was 1.8%. In the fourth quarter, we repurchased 1.7 million common shares at a cost of $75 million, or an average price of $43.69 per share. For the full year, the company returned $171 million to shareholders through the repurchase of 4.5 million common shares at a cost of $37.58 per share. As noted in our earnings release, we expect to pay down $726 million of our outstanding senior notes in two separate transactions during the first quarter of this year. First, we'll exercise the early redemption feature effective February 1st on $426 million of senior notes originally scheduled to mature on March 1st of this year. In addition, we initiated a tender offer this morning for $300 million of our 2026 and 2027 senior notes, which we expect to complete on February 26th. Assuming full execution of the tender, the retirement of the $726 million will save the company approximately $34 million in annual interest charges and, on a pro forma basis, lower our gross debt to capital ratio to 23.7%. In the fourth quarter, we invested $942 million in land acquisition and development, which brings our full year 2020 spend to $2.9 billion. As Ryan mentioned, given our positive view of the market and the expected strong cash flow generation of the business, we currently expect to increase our investment in land acquisition and development to $3.7 billion in 2021. And finally, we ended the year with slightly more than 180,000 lots under control, of which 91,000 were owned and 89,000 were controlled through options. I want to highlight that, based on these numbers, we've effectively reached our stated goals of having 50% of our land pipeline controlled through options. And given our guidance targeting 30,000 closings in 21, we've also reached our goal of having three years of owned lots. Land acquisition can be lumpy, so the numbers can move around. but we remain disciplined in our investment practices and focused on enhancing returns and reducing risks through the use of options. Now let me turn the call back to Ryan.

Thanks, Bob. When I took over as CEO in 2016, there were several areas where I saw an opportunity to enhance our long-term business performance. Among the targets we put in place were to expand first-time to be one-third of our business, to lower our lot position to three years of owned lots, to control 50% of our land pipeline via option and increase our growth rates while continuing to deliver high returns for our shareholders. Given our 2020 performance and our expectations for 2021, it is gratifying to say that we've achieved these initial goals. With this foundational work in place, we can now continue developing an even more successful business as we expand our operations, advance innovative customer-centric technologies, and integrate new construction processes. Our outstanding 2020 results in combination with continued strength in housing demand also has Pulte Group entering 21 with tremendous momentum. We begin the year with our largest backlog in well over a decade, along with great operating metrics and a strong balance sheet that gives us the flexibility to capitalize on market opportunities. These opportunities include the expansion of our offsite manufacturing capabilities that I spoke about earlier, as well as the geographic expansion of our home building operations. I'm sure that most of you saw last week's press release that Pulte Group has established new operations in the greater Denver area. At the same time, our Raleigh division is extending its reach and establishing a presence in the triad area of North Carolina, which includes the cities of Greensboro, Winston-Salem, and Burlington. We have our initial land positions in place, and we're working quickly to increase our lot pipeline in these new areas. We are excited about the opportunities we see in both markets, as well as several other cities we are currently evaluating. With our goal to increase closings by more than 20% this year, along with investing $3.7 billion in land and our expansion into new markets, we believe we are well-positioned to grow our operations while continuing to deliver high returns. In closing, I'm extremely proud of what our organization accomplished in 2020. And I want to thank all of our employees for their efforts toward delivering an outstanding home buying experience and homes of exceptional quality. I also want to thank our suppliers and trade partners who are working tirelessly to provide the resources needed to successfully run our business. We entered 2021 with high expectations, but I know the pandemic continues to rage. And so we will continue to operate our business thoughtfully and safely. Let me turn the call back to Jim. Great.

Thanks, Ryan. We're now prepared to open the call to questions so we can get as many questions completed as possible during the remaining time of this call. We ask that you limit yourself to one question and one follow-up. Thank you. And now let me ask Andrew to again explain the process and open the call for questions.

Thank you. We will now begin the question and answer session. To ask a question, you may press star then 1 on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star then two. Again, participants are limited to one question and one follow-up. At this time, we will pause momentarily to assemble our roster. The first question comes from Mike Dahl of RBC Capital Markets. Please go ahead.

Hi, thanks for taking my questions and nice results. Brian or Bob, his first question really is around land investment and, in a way, capital allocation as well, and not to turn our nose up at an $800 million increase in land spend this year. It does seem like you guys are maintaining your typical balance when you're thinking about the debt uh pay down the potential for share repurchases a lot of your peers have started to more significantly ramp up uh land investment just given the strength and demand and potentially some um you know some shortfalls and community accounts coming how do you think about this current environment and your allocation to land investment relative to your your more balanced kind of through cycle mentality

Yeah, Mike, good morning. Thanks for the question. You know, a couple things that I would share with you. Number one, I would orient you to the fact that we've maintained for, you know, the better part of a decade that we're running a balanced business through cycle where we want to invest in land first and foremost and grow our business, but there are other parts of capital allocation that we believe create long-term value. You know, we are taking a pretty big step up in our land spend this year, as I think we've highlighted this morning, going to $3.7 billion. It's a big bump from where we were at in 2020. Certainly, there were some delays in 20 that have, you know, rolled into 21. But even adjusting for that, you know, we think it's a pretty big step up. We are going to continue to be very thoughtful and responsible in making sure that we're driving the types of returns that we know create long-term value. We just don't believe that now is the appropriate time to get into, you know, back into the mentality where all available cash is funneled into land. You know, the last thing, Mike, I'd tell you is that, you know, we do, you know, while we don't peg our land investment specific to this number, we do think about land spend as a percentage of revenue. And, you know, we think the numbers that we have allocated and projected for 2021 are an appropriate step up reflective of what is a very strong market.

Okay, thanks, Ryan. My second question goes to the margin side, and you clearly had success in terms of utilizing price and controlling costs to drive margin expansion. I think you alluded to margins potentially being slightly lower than the 4Q levels and mostly being able to offset the increase in house costs. Could you just elaborate more on kind of magnitude of the increase in costs, maybe on a per square foot basis, or wherever you want to quantify that, that you're expecting to come through the P&L. And also, you know, if you could share, you know, some sort of kind of price per square foot that you've been able to achieve, just help us understand that balance between price costs a little bit better.

Yeah, Mike, it's Bob. I think it's important to remember we're starting from a very strong margin position, and certainly in the fourth quarter we got the benefit of some spec sales, and we don't have a ton of spec on the ground today. So as we're looking forward into the year, what we're trying to project is where are the sales prices that we've contracted today, But we recognize that our house costs are going up. We are projecting them to be up in the neighborhood of 5% next year in fiscal 21. So that's inclusive of commodity input cost and labor. So a little bit richer increase than we've seen for the past couple of years. Obviously, the market is strong. We think we can get most of that price back. The other thing we are conscious of is affordability, and we want to make sure that we've got pricing that people can actually afford to close on. So, you know, our teams are doing a nice job of managing that price equation as we're out in market, you know. So the guide for the year at 24.5, again, reflective of a very, very strong environment. But we do recognize, especially with lumber companies, having risen so rapidly, that there'll be a little bit of pressure on margins with that.

The next question comes from I.D. Zellman of Zellman & Associates. Please go ahead.

Thank you, and congrats on a strong year in the fourth quarter. Maybe, Ryan, you can help us better understand when you think about the $3.7 billion of acquisition land, acquisition development spend. Even excluding COVID, we hear a lot from municipalities or builders complaining, you know, we want affordable housing, just not in our backyard. And just thinking about some of the constraints on getting lots developed, is there anything that can change with maybe whether it's a some type of tax incentive to developers. There's a lot of focus on the demand side of the Biden administration. But do you think that it's not a constraint that appears to be and you're overcoming that? Or is there something that has to change to continue to build more shelter for this country with municipalities being a bottleneck?

Yeah, Ivy, good morning and thanks for the question. I think you've touched on an item that, you know, frankly, we've been talking about as an industry and as a company for a while. And, you know, you hit the nail on the head. I think all municipalities want more affordable housing and shelter as they work to grow their job base and grow their own local municipalities and economies. But, you know, you nailed it. They want it as long as it's not next door to existing residents or, you know, other folks that are already there. So, you know, I believe that's more a local issue than it is a national issue. But that being said, I do think a tone from the top, from the administration, can certainly, you know, help to influence what local municipalities do. So, look, there are challenges out there, but one of the things that I think we highlighted is our size. And I think the talented team that we have, we're working through, you know, what is a challenging environment out there. And we are able to get our land entitled. We are able to get it developed. We are able to get investment done. If things were a little easier, you know, I think you could do even more, but we feel, you know, we feel very comfortable about the numbers that we put forth for 2021.

The next question comes from Matthew Bully of Barclays. Please go ahead.

Hey, good morning. Thanks for taking the questions. Wanted to follow up on the margin side. So, you know, guiding gross margins up 20 basis points in 21, despite this pricing environment. I'm just wondering if there's any, I guess, other margin headwinds that we should be aware of beyond that increase in house costs you just mentioned, Bob. So I'm thinking, you know, whether it's the mix of option land that's come up and maybe now coming through, you know, or perhaps more first-time closings expected. Just what else might be sort of

um playing into the the puts and takes there on that guide thank you yeah matt i don't think there's anything really dramatic obviously land is more expensive you know each successive lot you know as the vintage gets um kind of worked through you know you're bringing more expensive land on as the market has appreciated through the years so that's a contributor um Other than that, I mean, we've got a very large backlog. We've got pretty good visibility into what our margins are going to be. And in candor, we contracted these houses three months ago, and so the pricing environment isn't fully reflected in our sales right now. So you see that kind of on a little bit of a lag with us. We actually like that because it puts us in a position where we can understand our house costs going into it when we're contracting. But, you know, we do have a little bit of a lag in terms of where the pricing environment is right now versus what is closing for us, for instance, in the first quarter.

Okay, understood. That's helpful. Second one, just around selling pace, you know, I think I heard you say that December ended up even stronger than November. And correct me if I misheard you, of course. But just, you know, obviously, Pulte, like many others, ending the year running faster than usual. Last quarter, you guys talked about sort of intentional slowing of pace. Do you think you have the capacity at this point to see, you know, further uptick on selling pace into Q1? as normal. And I guess, you know, I think you mentioned January sort of continued unabated. I guess any additional color there would be helpful as well. Thank you.

Matt, good morning. It's Ryan. We did have a very strong fourth quarter, and you heard correctly. December sign-ups were up over november and equal to what we did in october and you know i think for for those of you that have been following the industry for as long as you have um you know that's that's atypical normally you see a seasonally downturn you know october to november november to december so um you know i think it's reflective of how how strong the demand is and then um you know january is is off to a very good start so We did, in the majority of our divisions, manage the number of sales that we were allowing to be sold either via lot releases or price increases or some combination of both. And that's really about making sure that we're matching our sales rate to our ability to produce homes. We've significantly increased the production capacity that we have. So I think we're doing a nice job working through that. And then the other factor that you've got to think about is lot availability. So we factor all of those things into our sales release and our pricing strategy. And all of those elements are reflected in, you know, the guide that we've given for the full year. So, you know, as I highlighted in some of my prepared remarks, it's a great time to be in the home building business. And I think there are a number of, you know, really strong demographic and economic trends that are going to continue to help support this industry.

The next question comes from Stephen Kim of Evercore ISI. Please go ahead.

Yeah, thanks very much, guys. Good quarter. I was really intrigued by some of the things that give a glimpse into what could be coming. One of the interesting things I think that you pointed out is that you have a bill-to-order model, which suggests that what we saw in the fourth quarter doesn't really fully reflect the environment, which sounds like it was pretty enormously strong in the fourth quarter. So it looks like that's still yet to come. And so in that vein, I wanted to ask you about your outlook for pricing and therefore implicitly margins. You know, we couldn't help but notice that your order price this quarter was extremely strong. And relative to the price that you are forecasting or your outlook for price for the full year next year, I just did a quick analysis of that going back through time. And we have never seen anything like the kind of decline that you're calling for in your full year 21 year. closing price relative to the order price that you took this quarter. And in your commentary, everything seemed to suggest that there is actual momentum building in price. And so I just wanted to talk to you about what is embedded in that. Is there a significant mix shift of more entry-level communities that you are embedding in that assumption? And are you not seeing what other builders seem to be seeing which is consumers actually paying up for more options and upgrades, which your BTO model would capture, and even a preference for larger homes, because your guidance would seem to suggest that's not happening nearly to the degree that you're going to have a negative net shift. It's kind of curious, so I was wondering if you could address that.

Good morning, Stephen. It's Ryan. Thanks for the question. There was a lot in there to unpack, and I'll try and touch on the key elements. And if I miss anything, we'll come back and grab it in a follow-up. But we are seeing a robust pricing environment, as I think we've highlighted, as it relates to the pricing, the ASP guidance that we've given for the full year. It is being largely influenced by the increasing amount of first-time business that we have coming through our business, along with geographic mix. So, you know, as you know, we build in kind of coastal locations like Northern California, Southern California, et cetera. The load of closings that come out of those divisions relative to other places in the country can certainly have an influence on ASP. As it relates to the pricing and our ability to take price, I think, Stephen, you know that we've long – talked about our strategic pricing methodology and how that has been a large contributor of the company's outperformance in margin relative to the competition. So certainly we feel that'll continue to be a real strength for the company. We're operating in the same market that I think everyone else is, and so there's not really any reason to believe that we wouldn't benefit from the uptake in demand and the ability to push price.

Yeah, I certainly would agree with that. It's just that maybe we haven't seen it as quickly in your numbers just because you've built an order model, but that should also allow you to capture, I would think, if anything, a little bit more price because you give your customers the ability to option. in that regard um we've seen a couple of other builders report so far that are you know spec builders and um in both cases we've uh well so far we've seen margins for the spec builders you know surprised to the upside even versus what they had thought you know a couple of months ago and when we dig into that some of it obviously is pricing but but some of it is also that cost per square foot seems like it didn't go up as much as they might have thought and part of the reason for that is because they found that they're building somewhat larger homes and that the somewhat larger homes have an actual lower cost per square foot because there's only one kitchen and only one roof and all that kind of stuff. So you get more efficiency when you build a slightly larger box. I was curious if you're seeing any of that and if you have incorporated any of that into your thinking about what cost per square foot will be over the next six to 12 months.

Yeah, Stephen, so we've certainly factored in into the guide that we've given what we believe the product mix will be. But within a given community, the offering that you could have could easily range from, just as an example, 2,000 feet to 3,300 feet. Within that, there might be four or five floor plans, and you don't know what plan the customer is going to choose until they come into the sales office. We have made some assumptions. I think as we highlighted in our prepared remarks, we're seeing customers do different things based on their current living situation, their work-from-home situation, the need for more space, more space for school, more space for home gyms, etc. I think there certainly is a story to be told that there are some bigger homes being built. To your point, I'd agree with you. Bigger homes are a little bit more efficient. So time will tell. We've factored in what we think are our best assumptions at this point in time, and we'll continue to keep everyone updated as the year progresses.

The next question comes from Michael Rehout of JP Morgan. Please go ahead.

Thanks, Zach. Good morning, everyone, and congrats on the results. I wanted to circle back to gross margins, and I apologize that this is beating a dead horse a little bit, but just wanted to try and get a better sense of the levers here. And you hit on price. you know, but you know, when you look at the 25% margin in the fourth quarter, you know, it was up a little bit, uh, versus the guidance of 24 and a half. And now you're also looking for 24 and a half in the first quarter and, uh, 21 in the full year of 21. So I was just curious, number one, what drove that differential and if it was more temporary or mixed driven per se, and number two, um, When you think about price versus cost inflation, I think a lot of builders have been looking towards some decent level of gross margin expansion in 21 versus 20. Given your margins being so much higher historically over the last few years than most of the other builders, I'm wondering if there's any upward limitations on taking price from an affordability perspective or a competitive perspective, if that's why perhaps we're not seeing as much expansion in 21 versus 20, just getting a higher starting point.

Yeah, I think it's... You know, it's apples to oranges to a certain degree in terms of us versus others, so I can't comment on their relative margin performance. And, Mike, there's clearly nothing that prevents us from accelerating price if it's available in the market, and if that's expansive to margin, we're going to do it. You know, I think we've demonstrated it, and you saw it actually in fiscal 20 versus the prior year. You know, we were up That 25% was up 220 basis points over the prior year. So we're paying attention to market, and we're looking to get every dollar of price that we can. You know, I think in terms of the forward guide, you know, we've got 15,000-plus homes in backlog. We kind of have pretty good visibility into what our margin profile is going to look like next year. There is nothing, and I want to be clear about this, nothing that will stop us from trying to expand that margin. But based on what we see today, we want to give you the best estimate we've got. And as I said in answer to an earlier question, we do see vertical construction costs escalating. Lumber, I think everybody is aware of. It's a busy market out there. There's a lot of people selling a lot of houses. We think there will be some price on the labor side that will be asked to contribute for that. um so you know at the end of the day we are you know pretty we're pleased with our margin profile we'll seek to try and push it to the extent that we can get more price going forward and if that more than covers the increasing costs including land i think um you know you can see us um do that and and you know there's no there's no message here but you know we outperformed in this most recent quarter you know, if the opportunity is there, we'll seek to do the same going forward.

And, Mike, on the Q4 outperformance, I just, you know, you asked where did that come from. We mixed in, you know, more spec inventory in Q4 than we, you know, had anticipated. And so, you know, there's a good example of we were able to get kind of current market pricing that helped, you know, help provide some outperformance in Q4.

Thanks for that, Ryan and Bob. That was very helpful. I guess secondly, I just wanted to focus a little bit on community count and sales case. And, you know, your community count in the second quarter just down a touch year over year, you know, which was a relative positive, I think, versus some of your peers having much greater declines. You know, At the same time, you know, you've made comments, I believe, around, you know, and correct me if I'm wrong here, but to a degree perhaps managing sales pace to make sure you're not getting too far ahead of your backlog and, you know, allowing your business to operate at a relatively consistent cadence. Yeah. you know, how should we think about 21 on those, um, metrics and specifically, you know, community count, if you could give any directional guidance for, you know, the first quarter and where we should expect a year end to, uh, wind up. And to the extent that you've kind of limited or managed your sales pace, uh, could we expect, you know, um, sales case in 21 to be more, you know, kind of consistent, even off of these levels. You know, obviously, again, you're not seeing in your numbers, maybe the dramatic year over year growth on some of your peers. And I'm just wondering if, you know, that could actually work towards your benefit as you get through the next few quarters.

Yeah, so I think the question sort of is what's the community count for next year and how are we thinking about sales against that? And the way I think we ask you to think about community count is, you know, we obviously had a slowdown in development spend this year, even some delayed act. You know, we've highlighted that we're going to be investing at a more aggressive rate next year. Ryan walked through that. Where we see it is community count in Q1 of 21 versus Q1 of 20 is down about 5%. And then if you fast forward to your question at the end of the year, where do we think we'll be? We think we'll be down about 5%, you know, kind of end of year 21 versus end of year 20. We'll have some variability in that during the year. And it will be dependent on, you know, what's the sales environment like, how quickly are we closing out of communities, and, you know, what's the weather like, how does development go. You know, we'll obviously be looking to accelerate communities as much as we can. But the sales environment is going to drive some of that number, too. And we are looking at, you know, a pretty big step up in acquisition spend in next year, which would obviously contribute to years beyond that.

The next question with apologies to Ms. Zellman, a follow-up or second question for her from Zellman and Associates. Please go ahead.

Hey, guys. Thank you.

I thought I scared you away with my last answer.

Yeah. No, I appreciate the follow-up.

It was Zuber's fault.

It was Zuber, right? Yeah, there you go. Just digging in a little bit on the land spend, you know, you think about, you know, spending $3.7 billion. Are you spending, are you fully set up for 22? Or are you still buying for 22? And how far out are you buying? And just give us just the perspective between the margin differential on the option loss versus on the own loss, if there is a differential. from a price perspective or margin perspective?

Yeah, Ivy, both good questions. We're pretty well set up for most of 22 at this point. You know, some of the spend that will happen in 21 will, you know, influence the back half of 22, but we're mostly set up. So, you know, given the difficulties that you highlighted in your first question with entitlements and approvals and things like that, you know, we're largely into 2023 at this point in time. um and and and we've we've factored that into kind of everything everything that we're doing um in terms of uh and the second part of your question i lost my train of thought on on that one the option option oh the option thank you um yeah margin and or price differential yeah so ivy um return i know you focus on return did i recognize that

And I see a faster return with the option or a better return. But just thinking about the pricing in the market, the land grab right now is pretty heated. So what are you seeing if there's a differential when you're optioning lots and what that may be from an impact to a gross margin, even if it's a better return?

Yeah, so I don't want this to come across as a non-answer, Ivy, but you highlighted the most important point, which is we underwrite the return. Every single deal we do has got very different characteristics depending on who the seller is. As a general rule of thumb, though, there is a cost to doing options. They're not free. You know, and we factor that into what the ultimate return is and the overall kind of risk-reward balance that we think we're getting for the option. So, Bob, anything else you'd highlight on that?

The one thing I'd add is that in terms of the optionality, you know, there's a couple of ways that that manifests itself, right? You know, are you doing a finished lot option transaction, or are you tying up a bigger parcel where you're saying, all right, I want a third of the lots today, a third of the lots two or three years from now, and a third of the lots two or three years after that? Remember, we're trying to manage against market risk as much as anything else. And so... You know, I don't think that the kind of the step-up is as impactful on margin because of that as opposed to just doing a straight finish lot option deal. So if you're in a master plan, because they're getting real-time retail pricing. for taking all that risk for you to take just in time lot delivery. So I don't know, you know, if you look at the book, a lot of our transactions are more what I've described as having, you know, these are larger lot positions that's just more than we need right now. And so we're paying a little bit for people to carry the land, but then we might even be developing the land. It might not even be an option of finished lots. So I don't think it's as deleterious from a margin perspective as, you know, some people think sometimes when they're looking at it exactly the way you just did.

The next question comes from Ken Zahner of KeyBank. Please go ahead.

Good morning, everybody. Hello, Ken. Good morning, Ken. I want to make sure I was connected. Good. Great quarter. I mean, your leverage is flat. Your returns on capital, or as I look at it, returns on inventory are very high. So you should be investing in your company like you're doing. So I have two questions. First, you know, go over your logic for this 50% owned option target. How much does Dell Web Legacy Land play into that? And then my second question is you're a build-to-order builder. yet your start capacity is limiting your orders perhaps. So what does that mean for your kind of start capacity? I mean, you started about 7,500 homes. You know, we can calculate your starts basically. So what does, you know, your 30,000 guidance reflect in terms of where your quarterly capacity is going? Thank you.

Good morning, Ken. So I'll maybe take the start capacity question first. And, you know, we feel good about how our production machine is running. We have ramped it up almost every single quarter, and we continue to do so. And that's, you know, the guide that we've given for full-year deliveries are reflective of You know, the pace that we believe our production capacity is on. Certainly, if we can do more, we'll work to do that, and we think the demand environment is there that would allow us. But, you know, there's a lot of moving parts in that, labor capacity, supplier capacity, et cetera. So in addition to that, Ken, and I think everybody knows, we've long believed that the built-to-order model is better for a number of reasons, and it's the one that we've chosen to largely employ. But specs are a big part of kind of what we do as well, especially with our entry-level, lower-priced product. And so in addition to building our sold-out started backlog, we're also increasing the number of specs that we have in the system. I don't believe that the built-to-order model is limiting our ability for success because at some point in time, you've got to make a decision about how much you can build. Whether you build that as a sold or you build that as a spec, you've still got to put the start in the ground at some point in time. You know, we're in a great time right now. We're excited about the prospects for 2021. And, you know, if we can keep some of the wins at our sails here, I think we're going to have a great year.

Andrew, are you still there? That is next in the queue.

It's 9.30. Could they have timed it?

Go ahead.

Andrew.

Um,

I think we're still live on the call, but I don't know that we can get anybody up for the next Q&A. Operator, are you there? Anybody wants to text me or email me a question, we can try answering it that way.

Yeah, Jim, I got confirmation from a couple of folks that the audience can still hear, so it sounds like it's an operator challenge.

So if anybody wants to... We're still here. So if anybody wants to text me a call or text me a question, we'll do our best to take it that way because I'm not sure where our operator disappeared to. I'm not sure at this point in time in terms of technical difficulty how we're going to solve this. But again, we'll give it another couple minutes. If anybody wants to email me a question or text me a question, I'm happy to answer it. And I apologize for this confusion. I guess it's just a... Pardon me.

This is the conference operator. It looks like we're experiencing some technical difficulties. I'm going to go ahead and take over the call for now. It seems we are in the middle of our Q&A session. Is that correct?

That's correct.

Okay. Our next question comes from Jack Masenko with SIG. Please go ahead.

It's always numerous, though, isn't it?

You know, Jack, I think this one we can actually let Zimmer off the hook. I'm not sure he had anything to do with it.

He was running around with wire cutters, but I don't know what happened.

Because he knew you were next in the queue, Jack. Probably, probably. All right, so we've got a huge backlog. We've got great visibility into it. The industry, you know, has seen backlog conversion rates come down, not surprisingly, coming out of some of the unique things we've dealt with in 2020. It looks like the 1Q guide is calling for continued pressure on backlog conversion historically, which tells me there's a ramp in the back half of this year to get that 20% growth. Can we unpack some of the drivers that I think Bob talked about increasing spec? in the prepared commentary, but what gives you confidence you can sort of build back some of that backlog conversion in the back half of the year while maintaining margin?

Yeah, Jack, good morning. It's Ryan. You know, we tend to look at our conversion of work and process inventory as opposed to backlog. So we do have a larger backlog than we ordinarily carry, which, you know, is reflective of the strong sales environment. From a production standpoint, we're running, you know, very comparable to what we've historically run in terms of work and process conversion. And, you know, what I can tell you without giving you specific numbers is, you know, the daily, weekly, monthly start rates are increasing working through that sold not started backlog and the spec inventory such that, you know, we feel like, you know, the guide that we've given for the full year is very achievable. So it's not necessarily a huge bet on a bunch of incremental spec inventories. which I think you may have been alluding to a little bit. Certainly, we want to put more in there, but it's really reflective of getting through the sold-not-started backlog, you know, in addition to putting some more spec in the ground. Our cycle times are a little elongated, given some of the disruptions in the supply chain. You know, I think... The, you know, the areas where there's some, you know, a little bit of sand in the gears from a product standpoint are probably fairly widely known. You know, I'd highlight that the relationships we have, the size of our company, the talented procurement team that we have, you know, we've done a really nice job working through that. But, you know, it is a challenge that is out there for sure.

And then you've got the one plant down in Jacksonville. You're bringing another one online, I think, or at least. online early 22. Ryan, how should we think of where will that show up in the numbers? Is that going to be, you know, at a company level? Is that going to be gross margin? Is it going to be GMA ratio? Maybe lower warranty reserves over time? Where can guys like us outside looking in kind of expect to see the benefit of that in the model?

Yeah, Jack, I'll let Bob take that one. Maybe what I'll do is I'll highlight the benefits that we think we're going to get out of these plants and the reason that we bought the first one, the reason that we're expanding to the second one. We're getting huge increases in our cycle time efficiency, which is a big deal, and the labor efficiencies that we're picking up are tremendous as well. You combine those things with the added cost benefits that we're getting, and we're very pleased with how these offsite manufacturing facilities are performing. As I highlighted in my prepared remarks, Jacksonville has exceeded our expectations. We're on to plant number two. We're in the final stages of site selection and just working through some contract things. You know, we're excited about the prospect of what the future of this holds. And then I'll let Bob touch on where you can see the numbers.

Yeah, Jack, it's in home building, obviously. And so, you know, you'll see, I think, a couple of impacts. One is the contribution from the business itself. It's, you know, on the margin line, it's consistent with not a little bit better than our building or home building operation. And then you obviously have the benefit, we believe, in terms of both the cycle time that Ryan talked about, but even some cost benefit to the builder side of the business, so the actual division is contracting with them. And then, you know, there is a cost to doing this, but it's not out of line with the rest of our business. So, Yeah, I think it, for all intents and purposes, you won't see it impact things materially other than that we get the improved operations that Ryan was talking about.

Operator, I think we have time for one more call if you're still there. One more question if you're still there.

No problem. Our next question comes from Susan McClary with Goldman Sachs. Please go ahead.

Thanks for taking my question. My first question is really around the active adult business. You know, you saw another nice lift there this quarter. You know, I think, Ryan, in your comments you kind of mentioned the fact that it feels like that buyer is definitely out there. Can you just give us a little bit of color on, you know, what you're seeing in terms of the demand trends there, how you're thinking about that? coming through. And, you know, how much of this do you think is really being driven by the fact that maybe the existing market and in some areas in the country, like maybe the Northeast and other parts that weren't as strong prior to COVID have really kind of picked up and allow these people to kind of get out of their homes and make that transition?

Yes, Susan, good morning, and thanks for the question. I think there's a number of things that are benefiting the active adult buyer right now. One is they were first to kind of go to the sidelines. They've certainly got more comfortable figuring out how to buy and figuring out how to make the decisions that they want to make as it relates to their retirement. The strong stock market behavior, I think, certainly plays a factor in that as retirement accounts are are flush. And then finally, you know, the strong resale market has made it a seller's market and so very easy for that active adult buyer to sell their existing home and move into one of our new communities. So our expectation is that, you know, the web brand will continue to be a big part of our business and that buyer will continue to perform very well.

Okay. And my follow-up question is around capital allocation. You know, you started to buy back some stock in the fourth quarter. Can you just talk a little bit to how you're thinking about that for 21 and any kind of color you can give there?

Yeah, Susan, you know, the stance that we've taken on stock buybacks is that we'll report the news. What we have highlighted is it is going to continue to be part of our capital allocation process. We paused for the second and the third quarter given the pandemic. But, you know, as you saw in the fourth quarter, we reinitiated at a $75 million level. So we will be active throughout 2021. We're not going to provide forward guidance on the amount of the spend. Rather, at the end of each quarter, we'll share with you what we've done.

And I think we've now kind of run out of time. And I apologize for the technical difficulties for it. We'll certainly look forward to getting back to everybody over the course of the day. We appreciate your time, and we look forward to talking to you on our next earnings call.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.