PulteGroup, Inc.

Good morning. My name is Julie and I will be your conference operator today. At this time, I would like to welcome everyone to the Q3 2021 Pulte Group, Inc. Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you'd like to ask a question during this time, press star followed by the number one on your telephone keypad. If you'd like to withdraw your question, press star one again. Thank you. Jim Sumer, you may begin your conference.

Great. Thank you, Julie, and good morning. I want to welcome you to Pulte Group's earnings call for our third quarter ended September 30th, 2021. Joining me to discuss Pulte Group's strong third quarter results are Ryan Marshall, President and CEO, Bob O'Shaughnessy, Executive Vice President and CFO, Jim Osowski, Senior VP 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 PulteGroup.com. We'll also post an audio replay of this call later today. As always, 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 within the accompanying presentation slides. These risk factors and other key information are detailed in our SEC filings, including our annual and quarterly reports. Now let me turn the call over to Ryan. Ryan?

Thanks, Jim, and good morning. I look forward to speaking with you today about Pulte Group's third quarter operating and financial results. In this morning's press release, you read that our home sale revenues in the third quarter increased by 18% over last year to $3.3 billion, while our gross margin expanded 200 basis points to 26.5%. In combination, top-line growth and margin expansion helped drive higher earnings per share of $1.82. This is an increase of 36% over the prior year's third quarter adjusted earnings of $1.34 per share. Inclusive of these strong third quarter numbers through the first nine months of 2021, our home sale revenues are up 22% to $9.2 billion, while our reported earnings per share are up 36% to $4.85. The resulting strong cash flow being generated by our operations continues to put our company in an enviable position in which we can invest in our business, return funds to shareholders, and still maintain outstanding balance sheet strength and overall liquidity. More specifically, consistent with our constructive view on the housing market, we have invested $2.9 billion in land acquisition and development so far this year. Our $2.9 billion of land spend is comparable to what we invested for the full year in both 2020 and in the pre-pandemic year of 2019, and we remain fully on track to invest approximately $4 billion in total for the full year of 2021. I would highlight that while we were investing more into the business, we remained disciplined and focused on building a more efficient and lower-risk land pipeline. At the end of the third quarter, our lots under option had grown to 54% of our total controlled lot position. Compared to when I set the initial 50% option target, we have over 65,000 more lots under option and now view 50% as the floor rather than the ceiling in terms of how we control our land assets. Consistent with our capital allocation priorities, along with investing $948 million more in land acquisition and development, through the first nine months of 2021 compared with last year. We have also returned $726 million to shareholders through share repurchases and dividends and have paid off nearly $800 million in debt this year, leaving us with a net debt-to-capital ratio of only 5.7%. Finally, consistent with our strategic focus, our operating and financial performance has helped drive a return on equity of 26% for the trailing 12 months. Just like the broader economy, our operations continue to be impacted by the pandemic. On one hand, we are managing through the disruptions COVID-19 and the Delta variant have inflicted on our workforce, our trade partners, and the global supply chain. On the other hand, our results have certainly benefited from the remarkable demand and pricing environment the home building industry has experienced over the past 18 months. Either way, to deliver our third quarter numbers during a global pandemic and with a supply chain that is clearly struggling reflects the commitment and tireless efforts of the entire Pulte Group team. Since we updated our production guidance in early September, broader industry comments have validated the challenges within the construction supply chain are significant and don't have any quick fixes. Based on a myriad of calls and questions we have received, I think it's hard for everyone to appreciate the full magnitude of the issues we're facing when you're not dealing with them on a day-to-day basis. For some products, it's simply the materials aren't available. Sometimes you can switch to an alternative, but when you can't, you wait. For others, it's changing lead times where order fulfillment has gone from six weeks to 16 weeks, back to 11 weeks, and then back to 16 weeks. And for others, it's seeing allocations being imposed as manufacturers and distributors do their best to keep their major customers, which I would note we are one, at least partially satisfied. Our local divisions may not get much advance notice of the shortage and resulting allocations, so we have to adjust on the fly. In other cases, it's logistics. When you're forced to ship materials to solve near-term issues, this might be shipping siding from the southeast to the southwest or our trades driving across the state for paint. In one form or another, these issues impacted our third quarter results, and as Bob will detail, we'll put additional pressure on our deliveries and margins in the fourth quarter. As difficult and frustrating as this is, I can say that our suppliers have been outstanding partners and routinely bend over backwards to get us the materials we need to solve our issues. I can say that we've been clear with our teams that we have to over-communicate with customers to keep them informed of any schedule changes. We also have to be flexible and creative in sourcing materials, even if this means spending additional dollars to acquire needed resources. And finally, we must maintain our standards on the quality and completeness of each home that we deliver. Given the varied problems impacting the supply chain, we would expect that solutions will be found over different timelines depending on the supplier's underlying issue. In the interim, we will adjust our production estimates for the fourth quarter and work to position the business for more consistent cadence in the year ahead. We will also continue to work in close partnership with our suppliers to manage through the supply chain issues as quickly and as intelligently as possible. Now let me turn the call over to Bob for a detailed review of our third quarter results.

Thanks, Ryan, and good morning. Our teams have done an outstanding job navigating through the challenging production environment, which can be seen in the exceptional operating and financial results we delivered in the quarter. Starting with our income statement, our home sale revenues for the third quarter increased 18% over last year to $3.3 billion. The increase in revenues was driven by a 9% increase in closings to 7,007 homes in combination with an 8% increase for $37,000 increase in average sales price to $474,000. The higher average sales price realized in the third quarter reflects meaningful price increases we've realized across all buyer groups, with first-time up 8%, move-up up 10%, and active adult up 8%. The mix of homes we've delivered in the third quarter included 32% from first-time buyers, 44% from move-up buyers, and 24% from active adult buyers. In last year's third quarter, 30% of homes delivered for first time, 45% were move-up, and 25% were active adult. Our net new orders for the third quarter were 6,796 homes, which represents a 17% decrease from last year that was driven primarily by a 14% decline in year-over-year community count. In addition to fewer open communities, orders for the period were impacted by ongoing actions to manage sales paces to better align with current production volumes. The actions to manage sales pace and outright restrict sales were more frequently targeted toward our first-time buyer communities as we strategically worked to build up spec inventory within our Centex-branded communities. Looking at our third quarter orders in a little more detail, our orders from first-time buyers decreased 20% compared with last year. This decrease was driven primarily by our actions to restrict sales, as our first-time community count was only down 6% compared with last year. In contrast, our orders from move-up and active adult buyers decreased 22% and 4%, respectively, which was driven by comparable 22% and 5% decreases in community count, respectively. In the third quarter, we operated from an average of 768 communities. Consistent with the guide in our recent market update, this is down 14% from last year's average of 892 communities. Our Q3 community count should be the low watermark for the year, as we expect our fourth quarter community count to increase to approximately 775 active communities. Further, our existing land pipeline should allow us to realize a meaningful ramp-up in community count as we move through 2022. As is our practice, we will provide more specifics on 2022 community count as part of our fourth quarter earnings call. Our unit backlog at the end of the third quarter was up 33% over last year to 19,845 homes. The dollar value of our backlog increased an even greater 56% to $10.3 billion as we benefited from robust price increases realized over the course of this year. At the end of the third quarter, we had 18,802 homes under construction, of which 83% were sold and 17% were spec. We have almost 900 more spec homes in production than we did in the second quarter as we've been working to increase spec availability, particularly in our Centex communities. In many instances, this has meant tightly controlling current period order rates, but we feel this is the appropriate action as we seek to better align our sales with the current pace of production. Given that 90% of our specs are early in the construction cycle and that we have only 109 finished specs, these units are about helping to position the company for 2022 rather than providing closings in 2021. We face similar dynamics within our production of sold units as two-thirds of these homes are in the earlier stages of construction and we can see gaps in the supply of key building products needed to complete these homes. Given these conditions, we believe it appropriate to update our fourth quarter guide for expected fourth quarter deliveries and currently expect to deliver approximately 8,500 homes in the fourth quarter, which would represent an increase of 24% over the fourth quarter of last year. It's difficult to say there are positives to be gleaned from a challenging production environment, but one of the outcomes is that the limited supply of homes, coupled with ongoing strong demand, has supported higher prices across the market. Reflective of these conditions, our average price and backlog increased 18% for $78,000 over last year to $519,000. Although more than half of our quarter-end backlog is expected to deliver in 2022, we will continue to see the benefit of rising prices in our fourth quarter as our average closing price is expected to be $485,000 to $490,000. At the midpoint, this would represent an increase of approximately 10% over last year. Our reported home building gross margin in the third quarter increased 200 basis points over last year to 26.5%. Given that our third quarter closings absorbed the elevated lumber prices from earlier this year, expanding our gross margin by 200 basis points attests to the strong pricing environment the industry experienced over the past year. It's worth noting that the strong market conditions also contributed to another step down in incentives in the period as discounts fell to 1.3%. This is down from 3% last year and down 60 basis points from the second quarter of this year. As our margin increase demonstrates, strong buyer demand has allowed the company to pass through the higher labor and material costs we've experienced. That said, and as Ryan discussed, we are knowingly incurring additional expenses to get houses built within today's challenged operating environment. In addition to the incremental build costs we are absorbing over the short term to get homes completed, our reported gross margins are being influenced by the mix of homes closed. As we also highlighted in our recent market update, certain of the homes that we expected to close in Q3 slipped into Q4, and others have been pushed out of the fourth quarter into 2022. These conditions are impacting our reported gross margins in the third and fourth quarters of 2021, but set us up to realize gross margin expansion as we head into 2022. That said, with the changing mix of homes we currently expect to close in the fourth quarter, coupled with the added material, labor, and logistics costs we're paying to get homes closed, we currently expect our fourth quarter gross margin to be 26.6% or 26.7%. This would represent an increase of 160 to 170 basis points over last year's fourth quarter and an increase of 10 to 20 basis points over the third quarter of this year. We see the opportunity to build on this momentum as the strong pricing conditions we've experienced, coupled with the lower lumber costs we expect in next year's closings, should result in further gross margin expansion in 2022. Our SG&A expense for the third quarter was $321 million for 9.6% of home sale revenues. Prior year SG&A expense for the period was $271 million for a comparable 9.6% of home sale revenues. Given the sequential increase in closings we expect to deliver in the fourth quarter, we should realize improved overhead leverage with SG&A expense in the upcoming quarter expected to fall to a range of 8.9% to 9.2% of home sale revenues. Looking at our financial services operations, our third quarter pre-tax income was $49 million compared with $64 million last year. As has been the case for much of this year, higher origination volumes have been offset by lower profitability per loan given more competitive market conditions. The company's reported tax expense in the third quarter was $145 million for an effective tax rate of 23.3%. In the comparable prior year period, our effective rate was 14% as we realized the tax benefit of $53 million associated with energy tax credits recognized in the period. For the third quarter, our reported net income was $476 million for $1.82 per share. This compares with prior year adjusted net income excluding the impact of the energy tax credits of $363 million for $1.34 per share. Moving over to the balance sheet, our business continues to generate strong cash flow, which allowed us to end the quarter with $1.6 billion of cash after significant investment in the business and continued shareholder distributions in the quarter. In the quarter, we repurchased 5.1 million shares, or about 2% of our outstanding common shares, for $261 million at an average price of $51.07 per share. The $261 million in stock repurchases is a sequential increase of $61 million from the second quarter of this year. As stated previously, we are fully prepared to allocate more capital to shareholders as conditions warrant. We also invested $1.1 billion in land acquisition and development in the third quarter. This brings our total land-related spend in 2021 to $2.9 billion and keeps us on track to invest approximately $4 billion in land acquisition and development for the year, which would be an increase of almost 40% over last year. We ended the third quarter with a debt-to-capital ratio of 22.4%, which is down from 29.5% at the end of last year. Adjusting for our cash position, our net debt-to-capital ratio at the end of the quarter was 5.7%. We ended the third quarter with approximately 223,000 lots under control, of which 54% were controlled through options. Our divisions, and particularly our land teams, have done an outstanding job building a more efficient land bank while helping to reduce market risk. We're extremely proud of their efforts and the success that they've realized. Now let me turn the call back to Ryan.

Bookending the front of this call where I talked about supply, let me finish the call by providing a few comments about third quarter demand, which is a very positive picture. We continue to experience strong demand in the quarter with very consistent traffic and sign-up numbers across the period. I would also add that strong demand has continued through the first few weeks of October. While sign-ups in the quarter were lower compared with last year, the primary driver of the decline was the decrease in community count. Beyond the impact community count had on order rates in the quarter, our divisions continue to manage or outright restrict sales pace to better match sales with our current production. As Bob indicated, this most recent quarter should be the low point of our community count this year as we expect our community count to move higher on a sequential basis as we move through 2022. Reflecting the strong demand conditions and relatively limited supply of new and existing homes, we were able to raise prices in the quarter across most of our communities. The most typical increase in the quarter was in the range of 1% to 3%, although some of our divisions were able to push pricing in select communities a little more aggressively. That being said, we continue to keep a close eye on affordability metrics within our local markets, especially given the recent rise in mortgage rates. Between an improving economy, a strong jobs market, wage inflation, and government stimulus checks, consumers are in a very strong financial position and have proven they are prepared to pay today's higher prices for everything from food to autos to homes. We continue to see a very strong financial profile among our homebuyers, with the average FICO score remaining above 750 and loan-to-value of 83% based on users of our mortgage company. Looking at demand across the country, I would tell you that generally where we have product available, we can sell it and at a higher price than earlier in the year. Although frustrated at times because of limited supply, higher prices, and longer build cycles, consumers remain engaged in the home buying process and are anxious to get into a new home. Just to wrap up, While there are certainly challenges in the business, Pulte Group remains in an excellent position, both operationally and financially. We have a strong and improving land pipeline that we continue to make more efficient through the use of lot options. We have an opportunity to further expand margins based on limited supply, strong buyer demand, resulting favorable pricing dynamics, and lower lumber costs in 2022. We have an outstanding home building operation that is generating tremendous cash flow. And we have an exceptional balance sheet strength and liquidity that can support our operations and gives us tremendous flexibility to capitalize on market opportunities. Let me close by again thanking our employees for their tireless efforts to serve our home buyers and deliver outstanding business performance. Now let me turn the call back to Jim.

Great. Thanks, Ryan. We're now prepared to open the call for questions so that we can get to as many questions as possible during the remaining time of the call. We ask that you limit yourself to one question and one follow-up. Julie, I'll now open the queue for questions and answers.

Thank you. At this time, I would like to remind everyone, in order to ask a question, press star, then the number one on your telephone keypad. Your first question comes from Truman Patterson with Wolf Research. Please go ahead.

Hey, good morning, everyone, and thanks for taking my questions. First, I wanted to touch on gross margin. Is there any way you could just quantify the elevated costs you've incurred that'll impact the fourth quarter? And then in the prepared remarks, you mentioned 22 gross margin likely moving higher, which I think there's been a lot of investor uncertainty on that. So you know, with prices moving up, lumber coming down, other costs accelerating, can you just help us think through, you know, the gross margin and backlog or kind of the incoming orders?

Yeah, I'll start with the fourth quarter, Truman. You know, we obviously have taken down our margin expectation for Q4, depending on which, you know, where you've Peg the margin, call it 60 or 70 basis points from what we had originally guided. And I would suggest the way to think about that is we've got mixed changes, very consistent with what we had in the third quarter as stuff has moved out of the fourth quarter into 22. That's probably 30 basis points of it. And then incremental costs, and you heard us talk about them in the prepared remarks, To get things done today is about $2,000 a house for us, which is about 40 basis points. And so that's sort of the magnitude of what we're seeing in the fourth quarter. We didn't provide a guide for 22 gross margins. um but but you know we obviously did highlight the significant pricing that we're seeing in our backlog um you know it's up 78 000 a unit or 18 percent um plus we'll have lower lumber costs now lumber's variable you know it's moved down it moved up a little bit we'll see where that lands um But we'll see on a sequential basis as we get into 22 some decreases. So certainly the structure is there for lower margins. We'll give you an estimate of what that is as we release our fourth quarter. Higher margins. Did I say lower? My apologies, higher margins in 2022. Okay, that's important. Jim had a horrified look on his face. I apologize for that. And we'll give you some visibility to that as we release our fourth quarter earnings, and we'll have obviously better visibility into the year at that point.

Okay, okay. And then on the supply chain constraints, I realize it's kind of a moving target, and it varies by the metro, but I'm just hoping you could run through where the most common pressure points are in the supply chain and, you know, on the material side.

Any highlights on the vendors?

Are they giving you a timeline as to when they expect their internal capacity, you know, begins improving and actually increasing product in 2022? Yeah, Truman, it's Ryan. Good morning. It really depends on the region, Truman. So, you know, in like the Florida regions, there are challenges of block. You know, most of our homes are built out of concrete block as opposed to lumber. So we've been on allocation there for a number of months. Windows, I would tell you, generally across the entire United States are a pressure point. Paint is a pressure point. and appliances would be some things that I think are common across the entire enterprise. And then when you get into certain regions, things like siting become a pain point depending on how much of that we use in the construction of our homes in those regions. In terms of kind of when things are solved, Truman, as I tried to highlight in my prepared remarks, we think that the timeline of fixing things will be varied. and it really depends on what the underlying issue is for that particular distributor or manufacturer. You know, there are some things that are obviously reliant on microchips like appliances, and I think that Those challenges are well detailed. In some cases, it's chemicals and things like resin. I think the paint suppliers, paint manufacturers have kind of highlighted some of the things they've done. You know, in particular, Sherwin-Williams recently purchased their own resin plants in order to help solidify some of the challenges that they'd had in obtaining resin. And then, you know, in some cases it's logistics. And so there's just simply not enough, you know, transportation capacity to move things from the ports to the distribution centers or from the factories to our job sites. And so I think what we're going to end up with is a mixed bag of results and recovery timelines as we move through 2022. um the relationships that we have with our suppliers are outstanding uh we're communicating actively with them and collaboratively solving problems i think we're being treated very well with our suppliers and they're bending over backwards to um you know take care of us and and the significant volume that we do uh of of new homes so you know i'm i'm going to remain optimistic But there's no doubt there are some headwinds out there that we're fighting through each and every day. You know, as Bob highlighted, we'll talk more about 2022 as we get to the end of the fourth quarter, which is when we customarily provide our guidance. But there are some favorable things with community account growth. opportunity for margin expansion etc that you know i think leave uh leave reason to continue to be optimistic and your next question comes from alan ratner with salmon please go ahead hey guys good morning uh thanks for taking my questions um so first question you know i'd love to dig in a little bit to the pricing environment um

I believe you indicated kind of the typical price increases were about 1% to 3% in the quarter. Your average order price was up way more than that, up 9%. So I'm guessing the delta there is mixed, but I'm curious if you could just talk a little bit about what you're seeing in terms of pricing power now versus three months ago, six months ago. For you, a few other builders kind of suggested maybe pricing power is moderating a bit. It doesn't sound like you're seeing that in your communities, but any color you can give there would be great.

Yeah, Alan, I would just – good morning, by the way. You know, I'd highlight that the demand environment continues to be very strong, and in most communities we continue to have pricing power. You know, we're exercising that through price increases, obviously, and in some cases we're, you know, outright restricting sales, which, you know, I think is in the same kind of family of actions that we take to manage the demand that we have. You know, what I would tell you, you know, we highlighted on average most communities were 1% to 3%. There were certainly some communities that were well in excess of that. Those kind of outlier communities combined with the fact that you do have some mix in there as well as I think contributes to the, you know, the incremental increase that you highlighted in your question. In terms of kind of where things are at today pricing power-wise relative to a quarter ago, two quarters ago, I'd suggest it's pretty comparable to where we were at in Q2, a little weaker than where we were at in Q1 in terms of kind of month-over-month or week-over-week pricing changes today. We are keeping an eye on affordability. We highlighted that in our prepared remarks. I think it's something that while the consumer continues to be strong financially, you know, they don't have unlimited financial means and resources. And so, you know, we need to be mindful of that, not only as a company, but as an industry.

Great. I appreciate that, Ryan. Second, maybe more for Bob, but the $2,000 per house incremental cost you talked about, I'm just curious when you kind of qualitatively talk about the 22 margin outlook in terms of improvement, what's the assumption on that piece? Are you assuming that that's a temporary headwind that goes away as the supply chain normalizes? Do you think that it even goes higher if builders are kind of cramming to try to get more specs on the ground? What's the assumption embedded within the outlook for margin improvement next year?

Well, to be clear, we haven't given a margin expectation for next year. And part of the reason for that, Alan, is because, you know, we want to give ourselves the opportunity to really evaluate that question more fully. You know, certainly the supply chain is not going to cure itself in the next three months, probably not the next six. You know, anybody's guess as to how long beyond that. And so there will be continued constraints. You also have kind of working in the other direction that most builders are kind of pushing towards their year-end in Q3 and Q4, so there's more kind of demand for service and materials, and that will mitigate to a degree in the first half of next year. So, you know, I think a lot of it will depend on how the supply chain kind of moves forward from here, and, again, it's one of the reasons why that we are waiting until the fourth quarter not just convention but also we think we'll get better information as we get into you know december january and can answer that question more fully and your next question comes from the line of michael rehaut with jp morgan please go ahead thanks uh good morning everyone uh thanks for taking my question um

First, I just wanted to talk a little bit about capital allocation. Obviously, not just in terms of share repurchase, but maybe just to shift the question a little bit on lot optioning and lot owning. A lot of progress on lot optioning, but actually, if you look at the years owned It's staying around, you know, 3.8, 3.9 in terms of, you know, 3.8, 3.7 in terms of year zone supply. Any thoughts around trying to get that metric down over the next two or three years? And, you know, as a result, you know, I'd presume that it would free up even more cash to perhaps return to shareholders or invest in the company in other ways.

Hey, Mike. Good morning. It's Ryan. Yeah, in terms of capital allocation, I'm really proud of what we were able to do in the quarter. You know, the health and the quality of the home building operations continues to generate outstanding cash flows. And so we were able to do a lot in the quarter. You know, we were very pleased with the total amount of land that we've been able to invest in in the year. We sit right at $3 billion year-to-date and are on track for four, which will be a big year for the company. We had an outstanding quarter of returning funds to shareholders, and that's something that is very consistent with and right in line with our capital allocation philosophy of investing in the business and returning funds to shareholders. So I think, you know, two kind of very solid check marks there. As it relates to, Mike, your question on land pipeline, you know, the thing that I'd highlight is that we've got 54% of our controlled pipeline under option, right? You know, we'd set a target of 50%. We've passed that number, and it's something that we really are pleased with what our teams have been able to do to continue to maintain success. optionality, you know, optionality with the overall land supply. In terms of your question on three, you know, three-seven-a-year supply, Mike, you know, that number would be calculated using the trailing 12-month closings. You know, I think that's certainly an acceptable convention in terms of how you would look at what the own pipeline is. That number is less if you look forward, and I realize we haven't given visibility to what that forward number is, but I think we've very clearly highlighted our desire to grow, and you've seen the early end of that with the amount of capital that we've been investing into the business. You know, the other thing that I'd also, you know, just mention, and we've been consistent in stating that we haven't changed our land underwriting guidelines, and we continue to do, you know, approve land deals that are right in line with our target of three years on land.

Okay. That's helpful, Ryan. I appreciate it. I guess secondly, and I apologize here for this question in advance because I know it's a little bit of beating a dead horse, but we are getting some inbound client questions around it. The understanding that you're not quantifying gross margins for next year, you did say that you expect improvement, and I believe you're talking about improvement off of 4Q levels. So it's just trying to get a sense of, you know, is that all kind of on the lumber benefit, maybe exceeding other areas of cost inflation? Or are there other drivers to, you know, that initial at least directional guidance, so to speak?

Yeah, Mike, it's a fair question, and I realize that there's a lot of interest in this area from investors, and we're anticipating getting to the end of the fourth quarter when we can kind of give you more of a guide. You know, the biggest driver is price, Mike, and I think you've seen that over the course of the year. You see what's happened in our backlog. And so, you know, that ought to give you, you know, a reasonable, you know, reasonable information to use and how much is there. We've highlighted the fact that our highest lumber loads are coming in Q3 and Q4, and we start to get benefits as we move into Q1 and Q2 of next year. So, you know, there's a lot of benefit there on the lumber side, you know, as we're experiencing today, not only in Q3 but also Q4. We've got some incremental costs that we're paying today. And, you know, as Bob, you know, suggested to one of the prior questions, You know, we've got to see what the next three to four months look like in terms of how much of that we'll continue, you know, to have to pay. And they're essentially bounties, you know, where we're spending money above and beyond what we've contracted for in order to get the homes across the finish line at the quality standard that we expect. You know, I know it's less than a fulsome answer, but we're going to leave it as we currently see room for margin expansion next year, and I'm going to probably leave it at that.

Your next question comes from Anthony Pitinari with Citi. Please go ahead.

Good morning.

Good morning. You've been building a second off-site manufacturing facility in South Carolina. I'm wondering if you could talk about the progress there, and then just from a big-picture perspective, when you think about the kind of extreme supply chain pressure that you're seeing, does that sort of validate the off-site manufacturing approach and increase the urgency there, or does it present new challenges for that model where you might have to dial things back a bit? Yeah, Anthony, thanks for the question. We are in the process of fitting out that space in South Carolina. We'd expect to be delivering product out of there in mid 2022. So that's on track at this point in time. You know, in terms of kind of broader supply chain, you know, implications. I would tell you that the primary reason that we continue to roll out and expand our offsite manufacturing capability is related to labor availability. um and and we we really believe that the automated nature of those off-site facilities will help to um you know help us weather what will be a a prolonged labor uh headwind within the space over the next you know eight to ten years as the current labor force continues to age out so The current supply chain challenges, I think, are more around raw materials and more around logistics and truck drivers, candidly. So while certainly having your own facilities, you're in a bit more control of your destiny. You know, those factories need raw materials as well, and clearly those are in short supply. So, you know, we remain very optimistic and bullish about what the off-site facilities can do for our business and, you know, remain on the path of building six to eight of these facilities, you know, over the next number of years. Okay, that's very helpful. And then is it possible to say what percentage of your communities are still restricting sales? And other than the lower community count impacting some of the early traffic in October, is there any other trend that you call out between buyer type or geography that you might see as driving some sort of cooling or normalization of demand?

Yeah, we are still restricting sales in more than half of our communities today. And even in the ones where we're not, we're seeing strong traffic such that when we bring lots to market, we're able to sell them. I don't think I'm looking at, Ryan and Jim, any other trends. Nothing of note, no.

The only other trend I'd highlight is that, you know, we've actually seen continued strength as we've moved out of Q3 and into October. You know, I think normally you would see some seasonality in sales, paces, and trends. And, you know, we're quite pleased with the activity that we've seen so far, you know, sitting here in the third week of October. Okay, that's very helpful. I'll turn it over.

And your next question comes from Matthew Blank with Barclays. Please go ahead.

Good morning. Thanks for taking the questions. So on the active adult business, obviously kind of a less severe community decline, and it sounds like less sales restrictions in those communities, perhaps given the depth of available product and lots you've got there. Is it fair to assume that the mix of active adult deliveries should therefore be higher in 22?

And I'm curious if you could remind us how the margin and return profile on that product might look compared to the rest of the business.

Thank you. You know, in terms of forward mix, you know, it varies by quarter. Candidly, you know, in the current quarter, It was about 29% of our signups. Prior year, it was about 25%. So you may see a 1% or 2% or 3% kind of mixed shift. Interestingly, given the way the market has behaved, there isn't a significant difference today in the margin profile of that business versus the move-up or entry level. So I don't think it causes any significant change and hasn't really for the last couple of years. You know, the market is pretty strong across the board. You saw, you know, 8% price increase first time, 10% move-up, 8%. active adults. So we're seeing kind of that rising tide lift all boats.

Got it. Okay. Now, that's very helpful there, Bob. Thank you for that. Second one, just on the topic of the sales restrictions and supply chain, obviously the reduction to delivery guidance for Q4.

I'm curious how we should think about the kind of balance of, you know, these production bottlenecks, which is kind of unpredictable how long this will last, versus the

the rebuilding of spec inventory that you've now been doing for quite some time. Is it realistic that as we get into the spring, you might see a normal or even greater than normal uptick in both spec sales and deliveries associated with that, just as you've worked so hard on kind of rebuilding inventory homes?

Thank you.

Yeah, Matt, it's Ryan. We have, you know, we have worked hard to get more, you know, stuck into the pipeline. I think we've been highlighting for the last two or three quarters that ideal for us is to be 25 to 30 percent of our total inventory of our of our total inventory stock. You know, we've got 1,000 more specs in the pipeline today than we did, you know, a year ago. So we're very happy about that. It's still only 17% of our total production. So, you know, we're a full – you know, 10 to kind of 13% below where we'd optimally like to be. So it's better. You know, we highlighted the fact that, you know, that... where we've restricted sales more is in our first-time communities. That also happens to be where we're rebuilding that spec pipeline. So, you know, look, if we can continue to have some success there, we can move those units along, we can get them closer to being ready for delivery, you know, that's when you put those on the market for that buyer group. And, you know, certainly, you know, our hope would be that we've got more available to sell as we move through Q4 and into Q1 next year.

And your next question comes from Mike Dahl with RVC Capital Markets. Please go ahead.

Morning. Thanks for taking my questions. Mike. I wanted to follow up first with a question around pricing power because it does seem like your comments and your results suggest a little more positive tone around pricing than I think some peers, as alluded to earlier, have talked about. more recently, and that's consistent in the work that we've tracked as well. So I guess the question is, when you look at kind of the sales restrictions, when you look at your balance of price versus pace, do you think that you're acting in a way that's different than peers right now and still pushing a little more price and layering on a little more in terms of restrictions than some of your peers are?

Yeah, Mike, I'm probably not in a position to make a great comparison there with specific data other than anecdotally. You know, the one thing I would highlight is I think it's the benefit of our built-to-order model. In our build-to-order model, I think we continue to give customers the ability to choose their lot, their floor plan, and to personalize the home in the way that they see the most value. And so I do think that our strategic pricing model, which we probably haven't talked about as much over the last couple of quarters because um things have been so frenzied i think that does continue to give us some pricing power that's a competitive advantage relative to our peers would be probably the you know the biggest thing that i would i would highlight um related to that model a big component of it is the is the option and the lot premiums And that's up 7% year over year. So we've seen, you know, some nice growth, you know, from those two things, which are, you know, as I think you all appreciate, big contributors to our overall margin of profitability.

Got it, got it. Okay, that's helpful. And my follow-up is somewhat related, slight variation, but, you know, when we look at the pace, it's sitting at a little below three a month in terms of, orders and I think closings right around three months. Even some peers at kind of the middle to higher end of the price spectrum right now I think are putting up pace and construction starts a little bit north of that. So it does seem like you're going outside the lines in terms of paying up to get what you can across the finish line. But I guess I'm wondering where you're just saying, you know, that just doesn't make sense. We're going to, you know, we've paid up to $2,000, but this extra piece, just we can't justify it. So we'll either keep the restrictions or we're going to push out the deliveries, depending on whether you're looking at orders or closing. So I guess, you know, without talking specifically about any of your competitors, are there certain areas in the market that you're just – choosing not to be as aggressive to get things closed today versus what you theoretically could.

Yeah, Mike, there was a lot in that question. So let me unpack a few pieces, and I'm going to start with absorptions per community. What I'd start with is I'd reiterate the continued strong demand that we've seen from consumers, not only in the quarter, but what's continued into October. If in our orders and absorptions in the quarter while maybe lower than what we would have liked, I want to highlight a couple things. Number one, except for entry level, the absorptions that we had in the quarter were consistent with what we had in the prior year. So Bob highlighted that in his prepared remarks. You know, the change there was completely driven by the community count decline. The exception to that is entry level, where we had more, We had lower absorptions and lower signups relative to the drop that we saw on community count. You know, the area that I'd probably highlight is Texas. You know, Texas is a state where we have a lot of entry-level Centex communities, and that happens to be, you know, a place where we've significantly restricted lot sales as we rebuild that spec pipeline. All in all, we feel really good about the way that homes are selling and the underlying demand that continues to be there. In terms of cost, You know, Mike, I would tell you, I think we're doing things where we believe we can make a difference. So, you know, if we can get the material, if we can put it on a truck, if we can send somebody to the other side of the state to pick it up and get it, we're going to do it. And I don't, you know, I think the added costs are to simply compensate for people for the extra time and effort that's going into getting it done. So I don't feel that we're doing anything unreasonable or being held hostage to do anything. We're also really thinking about our customer. That's something that we put um first and foremost in everything we do we're really proud of the quality of the homes that we build and so um you know we're not going to deliver incomplete homes or rush things across the finish line um that we don't believe meet our quality standards and you know we're we're kind of unwavering on that so in terms of kind of how much we're paying relative to what our competitors are paying i think You know, my sense is we're very competitive there. I don't think we're doing anything, you know, that would be out of line relative to the competition. So, you know, we feel pretty good about what we've been able to do given the operating conditions that not only this industry is in, the whole world is in. Okay. Thanks, Ryan.

And your next question comes from Steven Kim with Evercar. Please go ahead.

Yeah, thanks a lot, guys. I wanted to drill in on the 4Q gross margin guide. You talked about, I think, 70 basis points, guiding about 70 basis points lower than what you had done previously.

And you had indicated, I think, that 40 basis points of that was sort of these extra costs. Maybe 30 basis points was mixed. So within the extra cost, I wanted to clarify that this is actually what I guess you could call scrambling costs, you know, like just scrambling around to try to get these homes closed and whatnot, not generalized, you know, general input cost inflation, you know.

um because of that you would expect to sort of persist but sort of this scrambling around kind of cost you would expect to dissipate so i just wanted to clarify that 40 basis points of extra cost is in fact not just generalized input cost inflation and if you could provide maybe some additional color around what kind of uh

you know, these unusual costs you're doing. Like, are you warehousing products, you know, just to make sure that you have them on hand when you need them? If you could give some color around that, that would be helpful.

Yes, David, you summarized it correctly. I wouldn't have thought of scrambling costs, but it's not a bad descriptor. You know, we in our more recent commentary told folks that we saw kind of 9% to 11% inflationary growth And we're still there, and this is just the things we're doing above and beyond that to get stuff done. And, you know, you heard Ryan talk about some of those in his prepared remarks. You know, literally, you know, paint suppliers don't have paint, so we're asking people to drive to go buy paint in retail stores. That's not normal. It's not the way we do business. We are shipping trusses from market A to market B, again, because there was a truss factory fire in market B that limited the production capability there. And there are myriad examples of that. And they're different for different types of construction. They are different in different markets for us. You know, you kind of mash it all together, and that's the $2,000 a unit. So, you know, on some units it might not be much at all. On others it might be $8,000, depending on the circumstance. It kind of blends to that $2,000. I might steal scrambling costs, so thank you for that.

Yeah, Stephen, and I would highlight, you mentioned it, we're warehousing things like windows. You know, if we can get them, we're ordering them earlier than we need them. You're putting them in. a storage unit or a warehouse and we're pulling uh you know those windows when we need it so you know that's part of those incremental costs as well great and then just to make sure that i'm crystal clear on it this two thousand dollars um is that the total amount of these sort of unusual costs or is that simply the increment from what you would previously thought you might have you know to absorb of these kind of special costs you know three months ago

These are incremental costs as we've kind of, you know, we're three months smarter, Stephen, so what we're seeing in the field in real time. Right, so that's just the change from three months ago.

That's not necessarily the total. If I imagine three months ago you anticipated something, okay, got it, just to make sure. And then the 30 basis points that relates, I think you indicated mixed.

And I just wanted to make sure I understood what that mix was, because you've indicated that margins are pretty similar across the three product types. Maybe there's some regional differences, but I just want to understand what that mix was.

And then also, one thing you didn't really specifically mention in the 30 and the 40 basis points was lumber. Is lumber going to hit 4Q early? worse than you would have expected three months ago? And is it going to be a heavier sort of drag on your margins than it was in 3Q?

Yes, Stephen, the mixed commentary is not on product. It's on geography. And, you know, we had highlighted that in the market update in our conversations then. Essentially what has happened is the market the margins on some of the units that got pushed from Q3 into Q4 were higher margin units. And similarly, the ones that got pushed from Q4 into next year are higher margin units. Part of that is just where they are in the production cycle. Part of it's geography in terms of where they are. You know, we always highlight that mix matters. we will get that margin. It's just a little bit later than we thought. And in terms of lumber, no, you know, we have pretty good visibility into our lumber pricing. We know what the lumber packs are going to be on our – we knew what they were on Q3. We know what they are on Q4. You know, we have pretty good visibility into what they're going to be next year. And so that wasn't – you know, the lumber component – hasn't changed in what we thought and what we're guiding.

But there is more in Q4 than there was in Q3, which I think we've also highlighted for a number of quarters, Stephen, that the highest load was coming in Q4. And that's incorporated and has been incorporated into the guides that we've given.

And your final question comes from Eric Bushart with Cleveland Research. Please go ahead.

Thank you. Two things. First of all, the change in 4Q on gross margin, that's helpful to clarify. I think the delivery number is different in 4Q relative to what you said 45 days ago. Can you just explain what changed in regards to that relative to 45 days ago?

Yeah, Eric, thanks for the question. It is different than what we highlighted 45 days ago, and I think it's just the continued disruption that is going on in the supply chain world. So every day as we move things down the production line, We're making an assessment as to whether or not it will deliver in the quarter. There were homes that were in production where we were anticipating getting certain supplies that we needed in order to meet a Q4 delivery. And once you cross kind of certain kind of critical path dates, you start to run out of days, you know, where you can compress schedules. And so, you know, candidly, things slide. You know, our run rate at this point in time is – you know, 100 to 150 homes a day. So, you know, you lose two, three, four days of time due to delays and, you know, the numbers have been adjusted as we've indicated today.

Okay, that's helpful. And then secondly, the conviction and community count growth, 3Q being the bottom, the improvement from here, Just a little bit of color for why you have the conviction in the progress and the magnitude of the progress.

Yeah, so, you know, we've got great visibility into the land that we own and, you know, specifically which communities that land is allocated to. We've got good visibility into how those communities are moving through the entitlement and the development process. You know, certainly those are subject to or run the risk of delays just like the vertical side is. But given what we see in our pipeline and adjusting for what we think will be headwinds next year, we are very confident that we'll see community growth and expansion in the next year. So, you know, we'll give you the specific numbers at the end of Q4, Eric, but, you know, we're confident enough that we've hit the low point that we're you know, we can give you at least a preview that we'll see expansion in Q4 and nice expansion in the next year as well. Great. Thank you.

Thank you. This is all the time we have for questions today. I will turn the call back over to the presenters for closing remarks.

Great. Thank you, Julie. Appreciate everybody's time this morning. Certainly be available over the course of the day to answer any follow-up questions, and we look forward to speaking with you on the next call.

This concludes today's conference call. You may now disconnect.