PulteGroup FY 2023 Earnings Call Transcript

Participants

Corporate Executives

• James P. Zeumer, Vice President of Investor Relations and Corporate Communications
• Ryan R. Marshall, President and Chief Executive Officer
• Robert T. O'Shaughnessy, Executive Vice President and Chief Financial Officer

Analysts

• Carl Reichardt, BTIG Research
• Matthew Bouley, Barclays PLC
• Michael Rehaut, J.P. Morgan
• Joseph Ahlersmeyer, Deutsche Bank Aktiengesellschaft
• Stephen Kim, Evercore ISI
• Kenneth Zener, Seaport Research Partners
• John Lovallo, UBS Group AG
• Mike Dahl, RBC Capital Markets
• Alan Ratner, Zelman and Associates
• Truman Patterson, Wolfe Research

Presentation

[Operator]

Ladies and gentlemen, good morning. My name is Abbie, and I will be your conference operator today. At this time, I would like to welcome everyone to the PulteGroup Incorporated Third Quarter 2023 Earnings Conference Call. Today's conference is being recorded and all lines have been placed on mute to prevent any background noise. [Operator Instructions]

Thank you, and I will now turn the conference over to Mr. Jim Zeumer, Vice President of Investor Relations. Mr. Zeumer, you may begin.

[James P. Zeumer, Vice President of Investor Relations and Corporate Communications at PulteGroup]

Great. Thank you, Abbie. We appreciate everyone joining today's call to discuss PulteGroup's third quarter operating and financial results.

As detailed in this morning's earnings release, PulteGroup delivered another quarter of strong earnings as we continue to capitalize on our competitive strengths and balanced approach to the business.

Joining me on today's call to discuss our Q3 results are Ryan Marshall, President and CEO; Bob O'Shaughnessy, Executive Vice President and CFO; and Jim Ossowski, Senior Vice President, Finance.

A copy of our earnings release and this morning's presentation slides has been posted to our corporate website at pultegroup.com. We'll post an audio replay of this call later today.

We want to inform everyone that today's discussion includes forward-looking statements about the company's expected future performance. Actual results could differ materially from those suggested by our comments. 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 our SEC filings, including our annual and quarterly reports.

Now let me turn the call over to Ryan. Ryan?

[Ryan R. Marshall, President and Chief Executive Officer at PulteGroup]

Thanks, Jim, and good morning.

As we will discuss over the next several minutes, PulteGroup reported another quarter of outstanding and, for a number of key metrics, record financial results. Our financial performance demonstrates once again the importance of PulteGroup's balanced and differentiated operating model. Leveraging our broad geographic footprint and diversified product offering, we are working to maintain significant market share among all major buyer groups. At the same time, we are successfully executing both large scale spec and build-to-order homebuilding businesses. Our spec business allows us to more cost efficiently serve first-time buyers, while our build-to-order business caters to move-up and active adult buyers looking to personalize their home location and design features.

Specific to our financial results, I am extremely proud of our entire organization for their efforts in delivering third quarter results that include a 43% increase in orders, industry-leading gross margins of 29.5%, record third quarter earnings of $2.90 per share, and a return on equity that exceeded 30%.

In the quarter, I would highlight our active adult business as an important contributor to our sign-up growth and our gross margin performance. In an operating environment where rising mortgage rates are creating increasing affordability challenges, 47% of our Del Webb purchasers were cash buyers. This is up from 33% just two years ago. Along with largely being cash buyers, these were customers who can afford the premium lots and upgrades that make active adult our highest margin business.

Just to demonstrate the brand power of the Del Webb name, in June we opened Del Webb Kensington Ridge in Michigan, not a market you might consider a hotspot for retirees. In a community where base home prices range from $370,000 to north of $600,000, we have already sold 114 houses in just over 100 days. We fully appreciate that to some degree, all buyers are impacted by rising rates and macroeconomic concerns, but buyer groups can absolutely behave differently over the course of a housing cycle. For PulteGroup, we believe being diversified across all buyer groups can enhance both growth and stability.

Beyond our diversification across buyer groups, PulteGroup's strong third quarter financial performance also benefited from our ability to offer consumers both spec built and build-to-order homes. As we have discussed on prior calls over the past 24 months, we have transitioned our first-time buyer communities to a spec build model to better serve these customers.

Looking at our first time business, spec building allows us to maintain a more consistent cadence of starts in those communities, which drives construction efficiencies and is important in working with our trades. More directly to our quarter, having additional inventory available was important, given 49% of our sales in the period were spec sales. I would note that 49% spec sales in the quarter is down from 58% in Q1 of this year. I think the decrease in the relative percentage of spec sales in the quarter reflects two interesting dynamics. On one hand, the affordability challenges caused by higher interest rates are pushing some buyers, particularly first-time buyers, to the sidelines for now. On the other hand, more affluent buyers who are less fearful about rates are comfortable contracting for a home where they've selected the lot, the floor plan, and the design options.

On the construction side, I'm pleased to say that we continued to shorten our production cycle. Just to remind people, pre-COVID, our production cycle was approximately 90 work days. At its worst, this number ballooned to 170 days. By the end of the quarter, we had reduced this number to about 140 days. Our teams continue to shave days and weeks off our build cycle and we remain optimistic about our ability to get back below 100 days in 2024.

As you would expect, cutting more than a month off of our cycle time has positively impacted our cash flow, which we continue to allocate across our key business priorities. Through the first nine months of 2023, we have invested $3 billion in our business through land acquisition and development. Over this same period, we have returned over $800 million to shareholders through share repurchases and dividends. In this most recent quarter, we even took advantage of market conditions to retire $65 million of near term debt at prices just below par.

PulteGroup has delivered outstanding operating and financial performance in the quarter and throughout the first nine months of the year as we have leveraged our strong competitive position to capitalize on buyer demand. It grows increasingly clear that Federal Reserve actions to raise interest rates are having the desired effect of slowing the economy, although the speed of deceleration has been slower than expected given the unprecedented ramp in rates. While arguably not the most supportive economic backdrop, new home demand in 2023 has benefited from a robust jobs market and rising wages, financially resilient consumers, and a continuing dearth of supply from the existing home market. And finally as higher rates begin to bite, we have responded with adjustments in product, pricing and incentive programs that successfully address consumers' biggest pain point, affordability.

It's difficult to know if the Fed is done hiking rates for this economic cycle and trying to guess when they will move to cut rates is challenging, so we will remain disciplined in how we manage our business. We'll focus on serving our customers, supporting our employees, turning our assets and allocating capital appropriately, while maintaining a strong and highly flexible capital position.

Now let me turn the call over to Bob for a detailed analysis of our Q3 results. Bob?

[Robert T. O'Shaughnessy, Executive Vice President and Chief Financial Officer at PulteGroup]

Thanks, Ryan.

PulteGroup's third quarter results add to what has been an exceptional year for the company as we have grown revenues and earnings, generating significant cash flow from operations, lowered our debt, and generally strengthened our entire operating platform.

Specific to our third quarter, home sale revenues increased 3% over last year to $3.9 billion. Higher revenues for the quarter reflect a 2% increase in our average sales price to $549,000, in combination with a less than 1% increase in closings to 7,076 homes. The 2% gain in average sales price of homes closed in the quarter was driven by increases of 4% and 6% from move-up and active adult buyers respectively, partially offset by a 3% decrease among first-time buyers. The lower ASP among first-time buyer closings reflects our focus on remaining price competitive as interest rates have moved higher throughout the year.

The mix of homes delivered in the third quarter changed just slightly from the prior year as we continue to operate within the range of our stated mix of business. For the quarter, closings among first-time buyers represented 30% -- 38% of the business, move-up buyers totaled 37%, and active adult buyers represented 25% of the homes closed. In the third quarter of last year, 36% of homes delivered were first-time, 38% were move-up, and 26% were active adult.

Net new orders for the third quarter increased 43% over last year to 7.065 homes as we realized year-over-year gains in both units and absorption pace across all buyer groups. Orders among first-time buyers in the third quarter increased 53% over last year to 2,979 homes. The gain among move-up buyers was even greater as net new orders increased 56% to 2,524 homes. And finally on a comparable community count, we realized a double-digit gain in sales among active adult buyers as net new orders for the quarter increased to 1,562 homes.

In the third quarter, we operated from an average of 923 communities, which is up 12% over last year. Adjusting for community count, the monthly absorption pace in the third quarter averaged 2.5 homes, which is up from 2.0 homes per month in the third quarter of last year.

As a percentage of beginning backload, our cancellation rate in the third quarter was 9% compared with 8% in the prior year. To be clear, on a unit basis cancellations in the third quarter were down more than 20% from last year, but the relative size of our backlog in each period results in the cancellation rate staying comparable.

Our unit backlog at the end of the quarter was 13,547 homes compared with 17,053 homes at the end of last year's third quarter. On a dollar basis, the value of our ending backlog was $8.1 billion, down from $10.6 billion in the third quarter of last year.

At the end of the third quarter, we had a total of 17,376 homes under construction. This is down 24% from the same period last year as we strategically manage starts and realize the benefits of faster cycle times. Of the homes under construction, 61% were sold and 39% were spec units.

As we have stated previously, we are comfortable putting spec units into production, but we are thoughtful about aligning the pace of starts with the pace of sales to help reduce the risk of putting too much inventory on the ground. Consistent with this measured approach to production, of the 6,700 spec homes currently under construction, fewer than 1,000 were finished. Given our Q3 community count of 923, we continue to carry approximately one finished spec per community, which is in line with our operating targets.

Based on the homes we have in production and, as importantly, current sales trends, we expect closings in the fourth quarter to be approximately 8,000 homes. Delivering 8,000 homes in the fourth quarter would put us at 29,000 for the full year, which is down slightly from our previous guide for full-year closings to be 29,500 homes. The change in our guide reflects the more challenging affordability conditions resulting from higher rates as well as the slight shift in our mix toward build-to-order homes which won't deliver until 2024. Given the mix of homes we currently expect to deliver in the fourth quarter, we expect our average sales price on closing to be in the range of $540,000 to $550,000 in the period.

Our third quarter home sale gross margin of 29.5% continues to lead the industry as we successfully our turned our assets while still achieving high levels of profitability and driving higher returns on investment. PulteGroup's reported results benefited from strong margin performance across all buyer groups: first time, move-up, and active adult. Further, as we have talked about on prior calls, our diversified product portfolio is allowing us to capture higher gross margins that are typically available within our move-up and active adult communities.

As I would remind everyone, our primary focus is always on driving higher returns on invested capital, but we appreciate margins are an important contributor to achieving such returns. This is why we remain disciplined in where we locate and how we underwrite our communities and how we design and build our houses, and in how we strategically price our homes in the marketplace.

Given the ongoing strength of our margins, we continue to get questions regarding relative margin performance among the larger public builders. I want to quickly address the line of thought that our margins benefit from land positions within our older Del Webb legacy communities. The reality is that the margins for these communities are comparable to the rest of our active adult business, but they aren't inflating our aggregate numbers. That being said, I'm pleased to say that we expect to continue delivering high margins as we continue to expect home sale gross margins to be in the range of 29% to 29.5% in the fourth quarter. Given current interest rates, demand and cost dynamics, we would expect to be toward the lower end of this range.

SG&A expenses in the third quarter totaled $353 million or 9.1% of home sale of revenues. This compares with prior year SG&A expense of $350 million or 9.2% of home sale revenues. Based on anticipated closing volumes for the fourth quarter, we expect SG&A in the fourth quarter to be approximately 8.8%.

In the third quarter, pre-tax income from financial services was $29 million, up from $27.5 million last year. While market conditions remain highly competitive for our financial services operations, the business benefited from a higher capture rate of 84% compared with 77% last year. The large increase in capture rate relates to the expanded use of rate-based incentives, which are executed through our mortgage operations.

Looking at our taxes, consistent with our prior guide, our third quarter tax expense was $209 million or an effective tax rate of 24.6%. For the fourth quarter, we continue to guide to a tax rate of 24.5%.

PulteGroup's bottom line results show net income for the quarter of $639 million or $2.90 per share, which is up from prior year net income of $628 million or $2.69 per share.

Given the ongoing financial strength and cash flow generation of our business, we repurchased 3.8 million shares for $300 million in the quarter. This was up from $180 million last year and $250 million in the second quarter of this year.

In the third quarter, we also elected to allocate capital towards paying down a portion of our debt. In total, we retired $65 million of our 2026 and 2027 senior notes through open market transactions at prices slightly below par. Inclusive of these transactions, we've lowered our debt-to-capital ratio to 16.5%, which is down 220 basis points from the start of '23 and down 600 basis points from the third quarter of '22. Adjusting for the $1.9 billion of cash on our balance sheet at quarter end, our net debt-to-capital ratio was less than 1%.

Beyond buying back our equity and debt in the third quarter, we also invested $1.2 billion in the business through land acquisition and development, which keeps us on track to invest upwards of $4 billion for 2023. Almost two-thirds of our investment in the third quarter was for the development of our existing land assets.

Inclusive of our Q3 spend, we ended the quarter with approximately 223,000 lots under control, of which 53% are held via option. We continue to systematically rebuild the optionality of our land pipeline after having walked away from selective land positions in the back half of 2022. As part of this rebuilding process and consistent with our stated strategy of getting more land light, we are expanding our use of different land banking structures. To date, we have completed land banking transactions for approximately 5,000 lots. Going forward, we will look to use such land banking facilities in order to create optionality in situations where the underlying seller requires a bulk sale. It's a disciplined process as we work to balance land costs, returns and risk, but we are gaining momentum in our efforts.

We are also getting more questions on our land pipeline, so let me add that about one-third of the lots we have under control are developed and we continue to develop most of the lots that we acquire. As a large homebuilder, assuming you're confident in the third party's ability to consistently deliver developed lots on time, the decision to purchase finished lots versus raw dirt comes down to return. Finished lots cost more but can turn faster, whereas the lower cost of undeveloped lots can drive higher margins, but the land is on balance sheet for a little longer. In all of our land transactions, we assess how best to drive higher risk-adjusted returns and to find opportunities and deals for finished and/or undeveloped lots.

Now let me turn the call back to Ryan.

[Ryan R. Marshall, President and Chief Executive Officer at PulteGroup]

As you would anticipate, given our 43% increase in net new orders, we saw strong demand throughout the quarter. Q3 displayed more typical seasonality than we have experienced in the three years since COVID as absorption pace eased as we moved through the quarter. Demand has been a little choppier in the first few weeks of October, with more volatility in the day-to-day sales numbers. I'm sure for some buyers, higher rates have pushed affordability just that much further away, while others may be worried about their jobs. For other buyers, global unrest may simply have them thinking of other things. We are fortunate to have an experienced operating team that will make adjustments if and when needed.

On a year-over-year basis, for the first nine months of 2023, we have increased net income by $156 million and increased earnings by share by 17%. Over the same period, we've increased our cash position by approximately $1.6 billion while dropping our net debt-to-capital ratio effectively to 0% [Phonetic]. Based on guidance that we've given, we look forward to delivering exceptional full year results for 2023.

From population growth and demographics to supply dynamics and the tremendous opportunity for wealth creation through home ownership, we are bullish on long term housing demand. Over the near term, however, we fully appreciate the affordability challenges being created by higher mortgage rates and the potential impacts from an economic slowdown the Federal Reserve is hoping to bring about. As such, we remain disciplined in how we operate our business, particularly as it relates to investing in land, the pace of production, the allocation of capital, and the quality of homes and experience we deliver to our customers.

We have a clear and successful operating model against which we have been executing for over a decade. So decision making throughout the organization is consistent and actions are implemented quickly. This strong organizational foundation, along with tremendous financial strength, has PulteGroup well positioned for ongoing success.

In closing, I want to thank the entire team at PulteGroup for their tremendous efforts in delivering for our home buyers, our shareholders, and each other. I am so proud of what you accomplish every day.

Let me turn the call back to Jim so we can begin Q&A.

[James P. Zeumer, Vice President of Investor Relations and Corporate Communications at PulteGroup]

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

Abbie, we're ready to open for Q&A.

Questions and Answers

[Operator]

Thank you. [Operator instructions] We will take our first question from Carl Reichardt with BTIG. Your line is open.

[Carl Reichardt, Analyst at BTIG Research]

Thanks. Good morning, guys. I wanted to first just ask about the cycle time numbers you talked about 140, trying to get down below 100 next year. So that's more than a month off. What specifically, Ryan, needs to happen for those numbers to go down? Where are the best and most obvious lever points?

[Ryan R. Marshall, President and Chief Executive Officer at PulteGroup]

Yeah Carl, so a lot of the work has already been done and what we're seeing is some of the homes that are delivering now, and maybe better said, the homes that are starting now are on cycle times that will yield that overall cycle time of below 100 days. So it's really about getting the older stuff that's been in the pipeline, that's got longer cycle times, that as those numbers close out, I think we'll see our overall cycle times come in line with that target of 100 days.

[Carl Reichardt, Analyst at BTIG Research]

Right. Thanks, Ryan. Then you mentioned the choppiness in October, and I wonder if you could expand a little on that and talk a little bit, maybe about performance among the three segments in the month so far or particular markets? And then also from a cancellation perspective, if that's beginning to sort of impact you in October too? Thanks.

[Ryan R. Marshall, President and Chief Executive Officer at PulteGroup]

Yeah Carl, happy to talk on October. As I mentioned in the prepared remarks, we've seen sales in October, while good, they've been a little bit choppier than -- the day-to-day kind of numbers have been a little choppier. I think the biggest thing that I'd want you to hear is that similar to what we saw in the third quarter, we actually have seen a return to what we would consider seasonal type sign-up trends that we experienced pre-COVID, and we've seen that continue into October.

On an absorption rate, the numbers that we're seeing on absorptions per community are pretty similar to what we saw in 2018 and 2019 pre-COVID levels, which were pretty healthy. So all things considered, we feel pretty good about the continued ongoing desire for home ownership. And it's not lost on any of you out there listening, rates matter, and there has been a lot of rate movement over the last 30 days. And so I think the consumer, all things considered, has handled that really well.

[Carl Reichardt, Analyst at BTIG Research]

Great. I appreciate the color. Thanks both.

[Operator]

And we will take our next question from Matthew Bouley with Barclays. Your line is open.

[Matthew Bouley, Analyst at Barclays]

Hey. Good morning, guys. Thank you for taking the questions. Just a question around some of the comments you made at the top, Ryan, around addressing affordability and some of the challenges you're seeing, particularly with the first-time buyer. Any additional elaboration on what you're doing with incentives and rate buy-downs, and what's working and not working as we get into September and October, and sort of the margin implications of all that? Thank you.

[Ryan R. Marshall, President and Chief Executive Officer at PulteGroup]

Yeah. Matt, thanks for the question. We continue to use the permanent 30-year buy-down as probably our most powerful incentive. Right now, we've got national incentives that offer 5.75% on a 30-year fixed. So I think given rates today on the open market would be over 8%. To be able to get a new home in a great location of the quality and design features that we have at 5.75%, I think is pretty powerful. I'll remind everybody, what we've done is we've simply redistributed incentives that we've historically offered toward cabinets and countertops and things of that nature. We've redirected those to interest rate incentives. And I think that's the -- that's been the most powerful thing for that buyer group.

[Matthew Bouley, Analyst at Barclays]

Got it. Okay. That's really helpful. Then secondly, just one on stick and brick costs just as you're addressing these issues and presumably there is margin pressure out of that, and the housing market has evolved here. What are you guys doing around construction costs, labor, sort of ability to push back on all that? How should we think about that over these next few months? Thank you.

[Ryan R. Marshall, President and Chief Executive Officer at PulteGroup]

Yeah. Well, look inflation is real, and we've previously talked about something in the neighborhood of 8% to 9% year-over-year inflation, which I think is part of the reason we're in the rate environment that we're in as the Fed's trying to get a handle on that. What we've seen on our cost to build is on a year-over-year basis, we're actually flat. Now, that's a lot of commodity and material and labor increase in a number of categories that's been offset by lumber save. So headline is we're flat on a price per square foot to build year-over-year, but it's a lot of increases in material and labor offset by lumber.

[Matthew Bouley, Analyst at Barclays]

Got it. Thanks, Ryan. Good luck, guys.

[Operator]

We will take our next question from Michael Rehaut with J.P. Morgan. Your line is open.

[Michael Rehaut, Analyst at J.P. Morgan]

Thanks. Good morning, everyone.

[Ryan R. Marshall, President and Chief Executive Officer at PulteGroup]

Good morning, Mike.

[Michael Rehaut, Analyst at J.P. Morgan]

Just wanted to kind of take a step back and understand some of the dynamics. You talk about October being choppy, but at the same time it sounds like more in line with seasonality pre-COVID. And you also -- the flipside of that is with volume, you're putting out a gross margin guidance for the fourth quarter, maybe a touch down from 3Q. Can you just give us a sense of the level of incentives, if through your own offerings in October or maybe even more broadly in the marketplace? Have you feel like incentives have started to come up over the last couple of months because certainly, I guess in the near term, you're looking for a similar gross margin? And maybe, just more broadly, how you feel the market is reacting to September and October?

[Ryan R. Marshall, President and Chief Executive Officer at PulteGroup]

Yeah Mike, I'll take part of that, and then I'll have Bob talk about the incentive load. But as demonstrated by our orders in the quarter, we had 43% growth in new orders and it was a number of over 7,000. So I think we've clearly demonstrated that we've got the ability to sell homes. You've heard me talk about not being margin proud. But at the same time, we're not going to give away price and incentives that we don't have to. And I think we did exactly that in the third quarter and we'd continue to focus on making sure that we're turning the asset and we're getting the number of absorptions that we need in every single community to deliver the best return on invested capital that we can. So look, I think it was a great quarter. We're happy with how sign-ups performed in October. You heard me kind of talk about that on the question that Carl asked, so I won't repeat it.

Then Bob, if you can, maybe just talk a little bit about the incentive load.

[Robert T. O'Shaughnessy, Executive Vice President and Chief Financial Officer at PulteGroup]

Yeah Mike, you can see in our data we've got about a 6% incentive load. That's $35,000 a unit, rough math. That actually is down 10 basis points from Q2 of this year. It is certainly up. It was 2.2% last year. But the sales environment that led to the closings in Q3 of last year was dramatically different. So you can see kind of a normalization here at 6%. I think you can take from our margin guidance for Q3 that what we see closing in the fourth quarter, and we've got pretty good visibility into that at this moment, will not be significantly impactful. I would highlight that we've given a continuation of that same guide at 29% to 29.5% on margins. We have told you we're going to be at the lower end of that, so there is some cost to this interest rate environment.

[Michael Rehaut, Analyst at J.P. Morgan]

Right. No, appreciate that, Bob. I guess, secondly, maybe bigger picture conceptually, you talked about earlier in the call questions around your higher gross margin versus your peer group. When you think about the 6% today versus 2% a year ago, and I don't know if that 6%, I want to say it's a little bit above your longer term average maybe around 3%, how does that square with the level of gross margins you're generating today? And if you think about over the next couple years, we've heard different things from different builders about maybe increasing hurdle rates from underwriting about -- just thinking about higher cost land perhaps might flow through over the next couple years. If incentive levels stay where they are, would that suggest kind of a moderation a little bit from the current level of gross margins? Or how should we think conceptually about the next couple of years directionally for this metric?

[Ryan R. Marshall, President and Chief Executive Officer at PulteGroup]

Yeah Mike, our crystal ball at this point, a couple of years out, we're not there yet. We're still kind of focused on Q4. We've given a guide for that quarter, when we get to kind of the end of Q4, we'll certainly give a full year guide for the balance of 2024.

Bt maybe the thing I do want to address is the incentive load that we currently have, that is allowing us to offer incentives on the interest rate, that's been in our margin guide for the entire -- our margin guide and our results for the entire year. So you're seeing the impact of offering below-market interest rates as an incentive. It's been in Q2 results, it was in our Q3 results and it's in our Q4 guide. So no guidance about what margins direction will be beyond Q4 of this year. But that's all embedded in our -- to this point, everything that we've been doing. That's embedded in the results that we've delivered and the guide that we've given.

[Michael Rehaut, Analyst at J.P. Morgan]

Thanks. Appreciate it.

[Ryan R. Marshall, President and Chief Executive Officer at PulteGroup]

Thanks, Mike.

[Operator]

We will take our next question from Joe Ahlersmeyer from Deutsche Bank. Your line is open.

[Joseph Ahlersmeyer, Analyst at Deutsche Bank Aktiengesellschaft]

Hey. Good morning, everybody. Thanks for taking the questions. I appreciate the data point about the active adult community in Michigan. Hopefully, snow removal is included in that HOA fee.

[Ryan R. Marshall, President and Chief Executive Officer at PulteGroup]

In fact it is, Joe.

[Joseph Ahlersmeyer, Analyst at Deutsche Bank Aktiengesellschaft]

Good. Look, market conditions, that's what's going to determine the margin volume and price into next year. I think it's an under-appreciated element of your business. Of course, the composition of that can vary, right, within the definition of success. But you are obviously appropriately acknowledging the headwinds here. Maybe if you could just talk instead to the return headwind from this, instead of either the absorption headwind or the gross margin headwind, just how are you thinking about returns on capital, and then, similarly returns on inventory if interest rates remain high? You're basically at net zero debt now. Just how you're thinking about ROE relative to ROI?

[Ryan R. Marshall, President and Chief Executive Officer at PulteGroup]

Yeah Joe, thanks for the question, and I'll do my best to give you an answer. For the last decade, maybe even going on 12 years, the way that we've operated the business has been with a singular focus on delivering the best possible return on invested capital that we can. Given the capital intensive nature of this business, we -- for us, we think that's the best way to make decisions and to operationalize a -- operationalize our platform in a way that delivers high return on assets, high return on equity, whatever metric you want to look at. I think we've clearly done that.

I highlighted in my prepared remarks that, for the trailing 12 months, we delivered return on equity over 30%, and part of that derived from running a good business but also a very thoughtful and disciplined way in allocating capital, which includes things beyond just buying land and building homes. We are paying a dividend. We've bought back near 45% of the company over the last 10 to 12 years that we've had our share buyback program in place. And we just highlighted this quarter we opportunistically took advantage of the opportunity to buy some debt in -- near term debt in that was trading below par.

We will -- I think the -- maybe the best way I can describe it, Joe, we're going to continue to focus on buying assets in great spots, turning those in a way that delivers high return on invested capital. And one of the other kind of things that I think can also continue to give us flexibility and return-enhancing leverage is moving our land options to 70%. So we sit at 53% today. We've given you kind of a long term target of 70%. We've got things in place and work underway that will help us get there.

[Joseph Ahlersmeyer, Analyst at Deutsche Bank Aktiengesellschaft]

Appreciate all those thoughts, Ryan. Yeah, and as a follow-up, just maybe on the comment around matching starts to orders, should we interpret that as roughly 7,000 starts in the fourth quarter? Or is that more of a comment on what the fourth quarter orders look like, that's what your starts might look like?

[Ryan R. Marshall, President and Chief Executive Officer at PulteGroup]

Yeah, fourth quarter starts will be more reflective of order trends that we're seeing in the fourth quarter. We're starting more spec than we historically have. As -- we've highlighted that we've completely moved our first-time business to a spec business, so some of that's predetermined based on what we saw in the third quarter and what we would anticipate. But we're just not going to get into kind of a position where we've got a build-up of spec inventory that creates pressure to do things that are unnatural on the pricing front. But we are going to put some units in the ground to have those ready for Q1. You saw us do that last year -- in the back half of last year that set us up for a really strong Q1 of 2023, so. I'd want you to hear balanced approach, inventories going into the ground, we're going to have it ready for Q1, but we are going to be responsive to some of the headwinds that we've acknowledged are out there in this current rate environment.

[Joseph Ahlersmeyer, Analyst at Deutsche Bank Aktiengesellschaft]

Sounds good. Thanks a lot.

[Operator]

And we will take our next question from Stephen Kim with Evercore ISI. Your line is open.

[Stephen Kim, Analyst at Evercore ISI]

Yeah. Thanks very much, guys. Great job. Exciting times. Ryan, in your opening remarks, you sort of talked about some of the reasons why -- some of the ways in which buyers seem to be responding to the rates, and you sort of contrasted or laid out that there's a psychological component, maybe math versus mental. I'm curious -- and you talked about the role of buy-downs in that. So my first question relates to, how you think -- let's do it this way, what percent of your buyers are taking a rate buy-down? And when you're negotiating these buy-downs, you've talked about the 5.75% through the end oo this year, it looks like, where are you setting new locks? Because I imagine you're negotiating those now for the next batch. Where are you setting those locks from a contracted rate perspective?

[Robert T. O'Shaughnessy, Executive Vice President and Chief Financial Officer at PulteGroup]

Yeah. Hey Stephen, it's Bob. It's an evergreen process, honestly. We are buying contracts typically weekly, actually, and they are market-based. We set the pricing on that, and that determines the price to us to offer that value to the consumer. So the rate that Ryan talked about is a negotiated price and essentially we fill the cost of being able to provide that contract rate to our consumer. There is an upfront fee for purchasing the contract and then there is the rate buy-down as part of that.

And so it's a -- it's not like we're buying now for three and six months from now. These are contracts that we enter into that we expect to build, candidly, within 30 days, and typically we're filling them within a week. So it's a -- it's very market responsive. As rates go up, it's why you've seen what we've offered has moved up a little bit. We've increased our cost as part of that to a degree. So it's a process we've been working through for, gosh, 10 or 11 months now since we put it in place, and we've found it works pretty well.

[Stephen Kim, Analyst at Evercore ISI]

Just so I'm understanding that, it sounds like what you're talking about is you have a forward purchase commitment that you're doing on a relatively short term basis, but then you're also layering on top of that an individual rate buy-down, sort of ad hoc, if you will.

[Robert T. O'Shaughnessy, Executive Vice President and Chief Financial Officer at PulteGroup]

These are 30-year rate buy-downs for the consumer.

[Ryan R. Marshall, President and Chief Executive Officer at PulteGroup]

Stephen, the other thing that I'd maybe just add to your conversation is some buyers, they take the available incentives that we have that get them all the way to 5.75%. There are other buyers that decide that they don't need to go all the way to 5.75% and they'd like to have a little bit higher rate and use some of the other incentive money that we're offering for other things that they see value in. So we're seeing about 80% to 85% of our buyers are getting some form of incentive towards interest rates. That doesn't mean everybody will go to 5.75%. Just some fraction of our total sales end up in that very lowest category. The big headline is that we've got the tools out there and our sales team has got the tools out there to help individually solve what each and every buyer needs to make the transaction work for them.

[Robert T. O'Shaughnessy, Executive Vice President and Chief Financial Officer at PulteGroup]

Maybe to put a finer point on that, as Ryan said, 80% to 85% of the people have an incentive program. Only 25% of the business in the quarter was through that national campaign that you asked about. So those are targeted to specific inventory units typically, but we offer incentives to all of our consumers, we always have. And as Ryan has stated already today, the vast majority of those incentives now across all of our buyers is financing-oriented.

[Stephen Kim, Analyst at Evercore ISI]

Yeah. Okay. That was really helpful. Appreciate all the nuances there. My second question relates to getting back to sort of the seasonality. And it sounds like you've acknowledged that seasonality is sort of coming back into the business. Where -- as we in the -- in the fourth quarter, it's a little weird, right, because the housing market kind of generally slows, particularly in the last six weeks of the year, and I'm curious as to your posture as you assess the buyers. Are you anticipating -- do you generally think that there's relatively more inelasticity on the part of the buyer, or relatively less elasticity might be a better way of saying it? So that it causes you maybe not to push so aggressively on incentives to try to keep up sales momentum in the last six weeks of the year, kind of like pushing on a string. Is that a reasonable way to be thinking about how you're likely to approach the market over the next six weeks -- I'm sorry, in the last six weeks of the year?

Then lastly, regarding risk, you had talked about wanting to evaluate all of your land actions in terms of risk adjusted returns, but you're also running at a super low net debt to cap. And I'm curious if you move to lower risk through increased incentive -- increased land banking, would it be reasonable to think you'll also carry increased leverage than you currently are today?

[Ryan R. Marshall, President and Chief Executive Officer at PulteGroup]

Yes Stephen, we are at a very -- we're at a lower leverage rate than what we've historically run at. And I think that's really more than anything. It's a testament to the strength of the business. We've been operating really well and we have been generating a lot of cash. We've really been touching kind of all the critical parts of our capital allocation philosophy. We've invested a lot of money into land and land development. We've been paying our dividend. We've bought back the highest single quarter spend in shares this year in the third quarter at $300 million, and we bought back some debt. And with that, we still grew the cash balance. So I think it really demonstrates how strong the business is operating.

In terms of your question on pricing and discounts and elasticity or inelasticity, we're going to continue to price and set incentives at a level that we think is appropriate for the market. We're going to be responsive. We're not going to be margin proud. At the same time, I think we've got a good understanding of what value is. And you shouldn't expect to see kind of the national year-end blowout red tag kind of screaming baby sale from us. I don't think that helps the consumer. But I think you're seeing us put the appropriate incentive load such that we're turning the asset, we're turning the inventory, we're making sure that we're getting a minimum of two sales per active community, which is kind of the level that I think you need to be at in production homebuilding to deliver the types of return on assets, return on inventory, return on invested capital that we want.

[Stephen Kim, Analyst at Evercore ISI]

Perfect. Appreciate that. Thanks, guys.

[Ryan R. Marshall, President and Chief Executive Officer at PulteGroup]

Thank you, Stephen.

[Operator]

We will take our next question from Ken Zener from Seaport Research Partners. Your line is open.

[Kenneth Zener, Analyst at Seaport Research Partners]

Good morning, everybody.

[Ryan R. Marshall, President and Chief Executive Officer at PulteGroup]

Good morning, Ken.

[Kenneth Zener, Analyst at Seaport Research Partners]

Just want to delve into the option impact on your margins. So I think you've been saying options have been about 19% of your ASP. Is that still where we're at in terms of the options?

[Robert T. O'Shaughnessy, Executive Vice President and Chief Financial Officer at PulteGroup]

Yeah. We've talked about our options and lot premiums being a consistent driver of value. It's part of the way we go to market. We think it's one of the strengths of our sales process. In the most recent quarter, that was $107,000. It's up $3,000 sequentially and year-over-year, so that is still part of our sales operation. It's how we go to market. And yeah, 20% is roughly where we are. I wouldn't expect that to change as long as market dynamics stay where they are.

[Kenneth Zener, Analyst at Seaport Research Partners]

Right. And so I guess -- what we talked about since last quarter was options are obviously higher margin, one can imply that's accounting for historically, that 300 or 400 basis point lift of gross margins versus peers. So as that option mix, can you kind of relate what is the cost of -- or what was the drag specifically for all these mortgage rate buy-downs? So 5.75% versus the 8% now. What is the net impact on your gross margin? I realize it's part of incentives, but if you could quantify that.

Then what is the actual kind of the distribution of that? It seems like an active adult paying cash doesn't need it. So is that largely occurring in the first-time buyer? I heard the 80%, but I'm just trying to understand that spread of usage relative to these options, which are structurally a good tailwind for you. And then I guess that's one.

And then second, your mention of finished lots, very interesting because you're return focused. So I think the street's too focused on margin, not focused enough on turns. Did you have, or what percent of closings in the quarter came from finished lots, and what's the margin impact of that as well? I appreciate you answering those two sets of questions.

[Robert T. O'Shaughnessy, Executive Vice President and Chief Financial Officer at PulteGroup]

Right. So Ken, there's a lot there. Let me start with that. I highlighted this before, our incentive load is about 6%, $35,000. So that would tell you 6%, 6.3%, something like that. And again, I think we've highlighted the majority of that incentive is rate buy-down or financing support. So I think that's the answer to your first question.

And I apologize. Your second question was, I think what percentage of our...

[Kenneth Zener, Analyst at Seaport Research Partners]

Right. You were talking returns, right? Like you're a return-based company, even though the Street and you guys focus a lot on margins. So to the extent the first-time buyer, more spec, finished lots, so you get better turns. You guys mentioned finished lots, I believe, for the first-time. So what is the impact of the finished lots? Are you closing finished lots? What type of margin impact is that?

[Ryan R. Marshall, President and Chief Executive Officer at PulteGroup]

Ken, actually it's Ryan. I'll jump in on that. We haven't sliced the ballooning quite that thin. And I want to attempt to do it on this call. We are a return-focused company. There is no change there. We've -- I think we've been the purveyors of the message. We don't focus on margin. It's a component of the overall operating model. We're focused on return and depending on the number of units that we sell in a particular community and how quickly you turn the asset, if you do that fast enough, then it can offset and you can allow for lower gross margin. So if you're getting a lot just in time and somebody else is developing it and carrying it, and we can build in the kind of 100 days that we're talking about. It allows us to run a high returning business to a lower margin. So that's not a new concept. That's exactly what we do. And it is exactly what we'll continue to do.

[Operator]

[Operator Instructions] And we will take our next question from John Lovallo with UBS. Your line is open.

[John Lovallo, Analyst at UBS Group]

Good morning, guys. Thank you for taking my questions. The first one is, so your rates at 8% today, you guys are buying down to 5.5%. Can you just remind us last quarter when rates were, I guess, closer to 7%, what level you were buying down to?

[Ryan R. Marshall, President and Chief Executive Officer at PulteGroup]

Yeah, John, we were -- I think the lowest we were, was 5.25% at a national level. We had some specific markets that may have been sub-5% at 4.99%. But basically, as you've seen the headline rate move from 7.5% to 8%, you've seen our promotional rate move-up by that same 50 basis points.

[John Lovallo, Analyst at UBS Group]

Okay. And you would anticipate probably taking that same strategy as we move forward if rates were to move up?

[Ryan R. Marshall, President and Chief Executive Officer at PulteGroup]

I think generally, that's a good rule of thumb. I mean there is -- I think, practically speaking, there's a limit to how much money you can throw at the rate relative to what the headline number is.

[John Lovallo, Analyst at UBS Group]

Makes sense. And then the second question is just on community count, how you're thinking about that through the remainder of this year and maybe any initial thoughts as we move into next year?

[Robert T. O'Shaughnessy, Executive Vice President and Chief Financial Officer at PulteGroup]

Yeah. I think very consistent with what we've said, we think we'll be up 5% to 10% over fourth quarter of last year.

[Ryan R. Marshall, President and Chief Executive Officer at PulteGroup]

And then we haven't given anything for '24 yet, John. But as we've said in the past, you can see the capital that we've spent or the land that we've spent this year, a pretty good indicator of what community count will be in the future. Or you can use as a proxy for what community count can turn into in the future.

[John Lovallo, Analyst at UBS Group]

Got it. Thank you, guys.

[Ryan R. Marshall, President and Chief Executive Officer at PulteGroup]

Thanks, John.

[Operator]

And we will take our next question from Mike Dahl with RBC Capital Markets. Your line is open.

[Mike Dahl, Analyst at RBC Capital Markets]

Good morning. Thanks for taking my questions. Ryan, just to pick up on one of your last responses. In terms of the practical limit on how much you can throw at the rate buydown, I mean, we've heard different things from different builders depending on whether you're doing pure kind of buy downs versus the forward purchase commitments, which I think you alluded to earlier, and kind of what is and isn't considered seller contributions. Can you maybe elaborate a little bit more on the details of how you're executing -- in the case of going down to 5.75%, how you're executing that? Is it -- like how much is allocated towards the forward purchase commitment versus the pure points? And do you consider the purchase commitments and the cost of that as part of your seller contributions?

[Ryan R. Marshall, President and Chief Executive Officer at PulteGroup]

Yeah. So I don't want to give away all of our kind of trade secrets on that. But suffice to say there are different rules based on who is depending on which government agencies rules you're using for that mortgage program. For the upfront fees that we're paying on a forward commitment, because those are done prior to having a home under contract, those fees do not count towards seller contribution. But the -- there are additional incentives that have to be applied through the deal once the homes under contract. Those do certainly count towards the seller contribution. So to get to 5.75%, you've got some fees on the front end, you've got some fees on the back end. We do look at them in the aggregate, and those are the numbers that you're hearing, Bob talked about.

[Mike Dahl, Analyst at RBC Capital Markets]

Okay. That's helpful. And then, my follow-up is, if we think about the movement in rates, I don't know if you've looked at it this way, and I'll ask it in a historical context year-to-date. If you look at your year-to-date orders or closings -- maybe let's focus on closings. Have you run an analysis of how many of those buyers just wouldn't have qualified at today's rates versus the rates that you were able to get them year-to-date?

[Ryan R. Marshall, President and Chief Executive Officer at PulteGroup]

No. We haven't done that analysis. Now, whatever -- I would highlight that no matter the rate that we're offering we qualified the buyer on the 30-year rate. So a lot of the incentives that we've been doing have been 30-year fixed rate. So that is the rate we're qualifying. But in the case that you do a temporary buy-down, the buyer is qualified at what the permanent 30-year rate will be. So I think everybody knows that but I think it's worth highlighting because we don't -- none of us want to see the industry back in a situation that we were in, in 2008.

[Mike Dahl, Analyst at RBC Capital Markets]

Right.

[Operator]

And we'll take our next question from Alan Ratner of Zelman and Associates. Your line is open.

[Alan Ratner, Analyst at Zelman and Associates]

Hey, guys. Good morning. Thanks for the info so far. Switching gears a little bit. I guess what I'd like to hear your opinion on is maybe what opportunity you could potentially come about from this recent, I guess, softening or choppiness that you're describing. Your balance sheet is obviously in fantastic shape. So it's pretty much the rest of the public industry. But we are hearing anecdotes of ABMC Capital tightening up for private operators and land developers, and we hearing build for rent deals kind of potentially falling out of favor here. So have you started to see any increase in either distress or opportunities that you feel like you might be able to take advantage of if these current conditions persist for a handful of quarters?

[Ryan R. Marshall, President and Chief Executive Officer at PulteGroup]

Alan, I think we're hearing the same things that you are, particularly on maybe availability of capital or the cost of capital on the land development side. There's definitely, I think, some strain or tightness in that arena. I think that certainly might continue to create an opportunity the longer that we stay in a high-rate environment. I think it's also a great opportunity for us to take market share with our mortgage company, the size of our balance sheet, the ability to be active in the capital markets, I think it gives us an opportunity to do things that smaller local builders and maybe private builders can't.

So I think there's certainly a market share opportunity there as well. We've made a build to rent a small piece of our business. We've got good relationships with national partners that we're building some percentage of our annual deliveries for those operators. And I think we've talked extensively about that. That will continue to be an arrow in our operational quiver.

So I -- look, I'm really, really confident and pleased with the way we're operating, the health of the business, the volume that we're selling and kind of the core operations. And then when you go to the balance sheet, I think we're set up to do a lot of great things that will continue to set us up for success down the road.

[Alan Ratner, Analyst at Zelman and Associates]

That's helpful, Ryan. And then I guess just other builders have kind of put out an absorption target that they manage their business to, that tends to maybe more of the spec guys entry level, where volume is certainly more of a consideration. But I'm curious when you think about your price outlook and your margin profile and where your incentives are currently running at, right now your absorption pace this year is probably going to be in the mid-2s somewhere. Is there a level where if that pace dipped below that you would get much more aggressive on incentives and discounts and even adjust base prices again? What would that level look like?

[Ryan R. Marshall, President and Chief Executive Officer at PulteGroup]

Yeah, Alan, it's a good question. We're -- the thing that I talk about with our operators, and I spent a lot of time in the field in our communities and our division offices talking about exactly this. The mantra that we have inside the company is a minimum of two sales in every community. Now certainly, we have certain price points and communities that sell way more than two per community. But as a production homebuilder, it's hard to have an active store that does less than two. You just -- you can't make the returns work to the level of our expectations.

So below two per active community, that's where we start looking at, hey, we are positioned right, right? Do we have the right incentives? Do we have the right pricing? Do we have the right product? Are we going after the right consumer? There's a number of those levers that we pull. But it nets out for this quarter, we were 2.5, but that two per community is kind of the level that we look at.

[Operator]

And we will take our final question from Truman Patterson with Wolfe Research. Your line is open.

[Truman Patterson, Analyst at Wolfe Research]

Hey. Good morning, everyone. And Ryan, the screaming baby sale got me. I think that kids probably in high school or college by now. But...

[Ryan R. Marshall, President and Chief Executive Officer at PulteGroup]

We're going to the way back machine, Truman.

[Truman Patterson, Analyst at Wolfe Research]

Exactly. Exactly. You all -- I'm trying to understand your orders for entry-level were performing well in the third quarter. I think you said up like 53% year-over-year. But then, you mentioned some more cautious commentary about that buyer. I'm just hoping maybe big picture if you could help us think through the monthly incentives needed for that buyer cohort versus you mentioned active-adult maybe move-up more affluent, not needing quite as much. I'm just hoping you can help us just kind of understand these kind of bigger trends that you're seeing near term.

[Ryan R. Marshall, President and Chief Executive Officer at PulteGroup]

Yeah, Truman. Look, I think we're really pleased with what our first-time business is doing. We've invested in it. It's -- we've said our target was to get it to kind of 40% of our business, and we've done that. And I think you've seen not only growth in absorptions but growth in communities and the business is about where we'd like it to be. On one hand, that buyer doesn't have a home to sell, they're not locked into a low interest rate that are reluctant to get rid of. So I think that's the positive with that first-time buyer.

In terms of the headwinds, I think it's obvious, it's 8% interest rate. And that's a buyer that's got a down payment, hopefully, either they've saved it or that's been gifted to them by parents, and then they're going to get in a 30-year mortgage and they're working on what they can afford based on their wages. Good news is wages are going up, which is helping affordability. But beyond kind of rate, rate, rate, there's probably not a bunch more that I could add in terms of kind of the first-time buyer.

And maybe just last thing on the overall rate environment. Look, high rates aren't good for the consumer. They're not good for housing. They're not good for the broader economy. But we're all kind of playing in the same environment. And with the quality of the management team that we have and the way that we're operating this company, I think we've proven that we've got the tools and the operational flexibility to be successful in any environment in this most recent quarter is a great example of that.

[Truman Patterson, Analyst at Wolfe Research]

Okay. Perfect. And then Ryan, you mentioned adjusting product, given the higher rates. I'm hoping you could elaborate on what all that entails for Pulte specifically. And then if I'm kind of reading between the lines, spec sales were about 49% of your overall bucket this quarter. That's a pretty good run rate that you will expect going forward?

[Ryan R. Marshall, President and Chief Executive Officer at PulteGroup]

Yeah. So in terms of product, Truman, the one great thing about our product portfolio is that we offer a lot of flexibility to scale up, scale down. We offer structural options that allow a smaller floor plan with added square footage in the form of loft or additional flex space. So we've got the ability to take a base floor plan, scale it up or scale it down, and we're seeing buyers use that flexibility to help address some of the affordability challenges that are out there. In our -- the way that we sell options, we see buyers pick the things that they see value in. And we're also seeing buyers make trade-offs in terms of how they spend those dollars in terms of cabinets, countertops, upgrades, et cetera.

And then the last piece of your question, Truman. Remind me again.

[Truman Patterson, Analyst at Wolfe Research]

Your spec strategy, should we kind of assume that it's pretty much stable from here that you're targeting about half the business perhaps as...

[Ryan R. Marshall, President and Chief Executive Officer at PulteGroup]

Yeah, roughly. I think that's a good go-forward run rate. It's higher than what we experienced pre-COVID. That's mostly reflective of the size of our first-time business and entirely moving that spec. We did highlight this quarter 49%, that's down from about 60% earlier in the year. So we feel pretty good about the performance of the spec business.

[Operator]

Ladies and gentlemen, that is all the time we have for questions. I will now turn the call back to Mr. Jim Zeumer for closing remarks.

[James P. Zeumer, Vice President of Investor Relations and Corporate Communications at PulteGroup]

I appreciate everybody's time today. Sorry, we couldn't get through to all the questions but certainly available over the remainder of the day to follow-up. And we look forward to speaking with you next quarter.

[Operator]

[Operator Closing Remarks]