PulteGroup - Q4 2023

Transcript

Operator (participant)

Thank you for standing by, and welcome to the PulteGroup, Inc. Q4 2023 earnings conference call. I would now like to welcome Jim Zeumer, Vice President of Investor Relations, to begin the call. Jim, over to you.

Jim Zeumer (VP of Investor Relations)

Thanks, Mandeep. Good morning, and let me welcome participants to today's call. We look forward to discussing PulteGroup's strong fourth quarter and full-year financial results, the period ended December 31, 2023. I'm joined on today's call by Ryan Marshall, President and CEO; Bob O'Shaughnessy, Executive Vice President and CFO; and Jim Ossowski, Senior Vice President of Finance. A copy of our earnings release and this morning's presentation slides have been posted to our corporate website at pultegroup.com. We'll post an audio replay of this call later today. Please note that consistent with this morning's earnings release, we will be discussing our debt ratio on both a gross and net basis. A reconciliation of our adjusted results to our reported financials is included in this morning's release and within today's webcast slides.

Finally, I want to alert everyone that today's presentation includes forward-looking statements about the company's expected future performance. Actual results could differ materially from those suggested by our comments made today. The most significant risk factors that could affect future results are summarized as part of today's earnings release and within the accompanying presentation slides. These risk factors and other key information are detailed in our SEC filings, including our annual and quarterly reports. Now, let me turn the call over to Ryan. Ryan?

Ryan Marshall (President and CEO)

Thanks, Jim, and good morning. I'm excited to speak with you today about PulteGroup's outstanding fourth quarter and full-year financial results. Over the past few years, we have faced macro challenges ranging from COVID, to supply chain disruptions, to skyrocketing mortgage rates. Through it all, we've remained disciplined and consistent in running our operations, but when needed, have quickly adjusted key business practices to position PulteGroup for ongoing success. The benefits of this approach can be seen in the strength of our reported results. Bob will detail our Q4 performance, so let me highlight several of our key operating and financial achievements for the full year of 2023. By strategically increasing our spec production, we had more inventory available to meet the demand of first-time homebuyers and those consumers worried about mortgage rate volatility.

Increased house inventory was a critical support to PulteGroup, delivering 28,600 homes in 2023 and record home sale revenues of $15.6 billion. In the face of increased costs for land, labor, and materials, we carefully managed product offerings, pricing, incentives, and absorption paces to maintain high profitability while ensuring we continue to turn our assets. The result, we reported outstanding full-year gross margins of 29.3%, which helped drive a 6% increase in earnings per share to a record $11.72 per share, and a 27% return on equity. We also continued to efficiently increase our land pipeline as we completed transactions to put approximately 40,000 new lots under control.

Inclusive of these lots, 53% of our total land pipeline is under option, either with the land sellers or through our expanding land banking structures. Since making the decision to expand our use of land banking starting 15 months ago, we have placed approximately 25 communities, representing $1.5 billion worth of future land and development spend into such structures. Finally, consistent with our stated capital allocation priorities, we invested $4.3 billion in the business through land acquisition and development spend in 2023, and returned $1.2 billion to investors through share repurchases, dividends, and debt paydown. Inclusive of our 2023 spend, we have repurchased almost half of the 2013 shares outstanding since initiating the program over a decade ago.

By remaining consistent in our business practices and making market-responsive adjustments where needed, we reported another year of exceptional financial results. I want to thank the entire PulteGroup team for their tireless efforts in support of delivering superior homes and experiences to our homebuyers while providing outstanding financial returns to our investors. Consistent with the broader housing market, we saw home buying demand being negatively impacted during the early part of the fourth quarter, as 30-year mortgage rates increased toward their 2023 peak of 8%. We then saw buyer sentiment and demand improved as mortgage rates finally rolled over, ultimately dropping more than 100 basis points as we moved through November and December. The decline in rates helped drive our December net new orders and absorption pace to be the highest month in the quarter.

The increased home buying activity in December was an important driver of the 57% increase in our Q4 net new orders and demonstrates the desire for homeownership remains high across all buyer groups. It remains our view that the long-term outlook for new home construction is extremely positive. A structural shortage of housing caused by years of underbuilding has only been exacerbated by a lack of supply, lack of resale inventory, as owners are financially and/or emotionally locked into their low-rate mortgages. While the lack of existing home inventory will resolve itself over time, we believe that land entitlement and labor availability challenges mean it will be difficult to correct for the many years of underbuilding in this country. Given our constructive views on the outlook for housing demand...

We are investing in our operations with the goal of growing unit volumes by 5%-10% annually. Our decision to walk away from option lots as interest rates increased in 2022, will impact our community openings in 2024, leading to our growth this year being closer to the lower end of this range, as we expect closings of approximately 30,000 homes in 2024. For those of you who have followed PulteGroup's story for the past few years, you know it's never been about growth for growth's sake. Our focus is always on investing in our business to build shareholder value. So our objective is to grow our volumes while maintaining high returns on equity.

To accomplish this, we must continue to intelligently invest in high quality and high-returning projects, while continuing to invest in our own assets through the ongoing repurchase of our stock. As we have demonstrated for much of the past decade, we expect to continue to generate strong cash flows that will allow us to fund our business investment, pay our dividend, and return excess capital to our shareholders, all while maintaining our balance sheet strength and flexibility. Our expectation of continued financial success is reflected in this morning's announcement that our board approved a $1.5 billion increase to our share repurchase authorization. With many forecasting interest rates to fall, the economy to stay relatively healthy, and conditions in the job market to remain favorable, there are certainly reasons to be optimistic about housing demand in the coming years.

Let me now turn over the call to Bob for a review of our fourth quarter results. Bob?

Bob O'Shaughnessy (EVP and CFO)

Thanks, Ryan, and good morning. As Ryan mentioned in his comments, market conditions changed meaningfully as the fourth quarter progressed and as mortgage rates began to fall. Our reported financial results for the period were influenced by these evolving market dynamics, so I'll note any important areas of impact in my prepared remarks. Home sale revenues in the fourth quarter were $4.2 billion, compared with $5 billion in the prior year. Our lower home sale revenues for the period primarily reflect a 14% decrease in closings to 7,615 homes, along with a 2% decrease in our average sales price to $547,000.

I would highlight that our fourth quarter closings came in about 5% below our previous guide, as sales early in the quarter were negatively impacted by higher mortgage rates and the general softening and overall buyer demand. As Ryan noted, home buying demand accelerated the back half of the quarter, but sales, particularly sales of finished spec homes that would close in the quarter, finished below our assumptions. We could have captured incremental sales and closing value by offering higher incentives, but we didn't see that as a worthwhile trade-off. Given that buyer trends have remained positive in January, I think we made the right choices as we have inventory available to meet the stronger demand.

Our mix of closings in the quarter were comprised of 40% first time, 36% move-up, and 24% active adult, which is in alignment with our stated goal for the buyer mix for our business. In the fourth quarter of 2022, closings were 36% first time, 39% move-up, and 25% active adult. Our average community count for the fourth quarter was 919, which represents an 8% increase over last year's fourth quarter average of 850 communities and was in line with our prior guidance. Looking at order activity in the quarter, our net new orders increased 57% over last year to 6,214 homes. The large increase over last year reflects both improved demand in 2023, as well as the extremely difficult operating environment in the fourth quarter of 2022.

As discussed previously, demand conditions grew increasingly difficult early in the fourth quarter this year as mortgage rates climbed to 8%. But we experienced a notable improvement in buying activity as rates decreased over the back half of the quarter. On a sequential basis, our absorption pace improved from November to December, and we would attribute much of this improvement to the decline in interest rates. Along with stronger demand conditions, the year-over-year increase in fourth quarter net new orders benefited from a decrease in cancellation rate. In the most recent quarter, cancellations as a percentage of beginning period backlog fell to 9%, down from 11% in the comparable prior year period. Looking at our order activity by buyer, fourth quarter net new orders increased 70% for first-time buyers, 78% for move-up buyers, and 15% for active adult buyers.

Our order numbers indicate that demand improved across all buyer groups, which is a very positive dynamic when assessing potential housing demand in 2024. As a result of our sales and closings activity, our quarter-end backlog was 12,146 homes, which is effectively flat with last year. Reflective of the increased mix of first-time buyers and their lower average sales prices, our ending backlog value declined slightly to $7.3 billion. Inclusive of the seven thousand one hundred and twenty-eight homes we started in the fourth quarter, we ended the year with 16,889 homes in production. 44% of our production is spec, including 1,263 finished specs, which puts us in a strong position to meet buyer demand as we head into the spring selling season.

By the end of the fourth quarter, our construction cycle time was down to 130 days, which is a sequential improvement of about two weeks from the end of the third quarter. Going forward, we continue to target getting our cycle time down to 100 days or below by the end of the year. Based on our production pipeline, we expect closings in the first quarter of 2024 to be between 6,200 and 6,600 homes. And given our units under production, we expect full-year deliveries to grow by 5% to 30,000 homes. We currently expect the average sales price of closings to remain in the range of $540,000-$550,000 for the first quarter and the full year of 2024, which is consistent with our fourth quarter pricing.

At the midpoint, this would imply price stability over the course of the year. Our fourth quarter gross margin was 28.9%, which is down approximately 50 basis points from both the fourth quarter of last year and the third quarter of this year, but likely remains the industry leader among the big builders. As with the entire year, our fourth-quarter margins reflect higher incentive and input costs. Incentives, which primarily impact revenues, increased 50 basis points sequentially from the third quarter to 6.5%. On the cost side, lower lumber prices offset inflation and other material and labor, but higher land and land development costs impacted margins in the period.

Given my prior comments that we expect pricing to be flat in 2024, we anticipate that land and house cost inflation will result in gross margins to be in the range of 28%-28.5% for each quarter during the year. We reported fourth-quarter SG&A expense of $308 million, or 7.4% of home sale revenues, compared with prior-year SG&A expense of $351 million, or 7.1%. The 30-basis-point drop in overhead leverage can be attributed to the lower closings and revenues realized in the quarter versus the prior year. It should be noted that we recorded $65 billion of pre-tax insurance benefits in the fourth quarters of both 2023 and 2022.

Based on anticipated closing volumes, we expect SG&A expenses for the full year of 2024 to be in the range of 9.2%-9.5% of home sale revenues. Given our typical seasonality of closings, we expect ex-SG&A expense in the first quarter to be approximately 10% of home sale revenues, with overhead leverage improving as we move through the remaining quarters of the year. For the fourth quarter, our financial services operations reported pre-tax income of $44 million, which is up from $24 million last year. The improvement in pre-tax income reflects more favorable market conditions across our financial services platform, coupled with higher capture rates, including an increase to 85%, up from 75% last year in our mortgage operations.

Our reported pre-tax income for the most recent quarter was $947 million, compared with prior-year pre-tax income of $1.2 billion. In the period, we recorded tax expense of $236 million, for an effective tax rate of 24.9%. Projecting ahead to 2024, we expect our full-year tax rate to be in the range of 24%-24.5%. Looking at the bottom line, our reported fourth-quarter results showed a net income of $711 million, or $3.28 per share. In the comparable prior year period, we reported net income of $882 million, or $3.85 per share.

For the full year of 2023, we reported net income of $2.6 billion and a record earnings of $11.72 per share. Reflective of our strong operating results, in 2023, we generated cash flows from operations of $2.2 billion. Given our current expectations for operating and financial results, along with our plans to increase land investment to $5 billion in the coming year, we expect 2024 cash flows from operations to be approximately $1.8 billion. Turning to our investment and capital allocation activities, we invested $1.3 billion in land acquisition and development in the fourth quarter, of which 59% was for development of our existing land assets. For the year, our land investment totaled $4.3 billion, of which 59% was for development.

Given our constructive views on near and longer-term housing dynamics, as noted, our plan is to increase our land spend to approximately $5 billion in 2024. We would again anticipate a roughly 60/40 split between development and land acquisition. This increase in investment is consistent with Ryan's earlier comments regarding positioning the business to routinely grow future delivery volumes by 5%-10% per year. Inclusive of our fourth-quarter investments, we ended 2023 with 223,000 lots under control, which is an increase of 5% over the prior year. I would highlight that on a year-over-year basis, we lowered our own lot count by 4,000 lots, while increasing our lots under option by roughly 16,000 lots. As a result, our percentage of lots under option increased to 53%, up from 48% last year.

There's still a lot of runway ahead of us to achieve our goal of 70% optioned lots, but we're moving in the right direction. Based on the investments we've made and our anticipated community openings and closings in 2024, we expect our average community count in 2024 to be up 3%-5% in each quarter as compared to the comparable prior year period. Consistent with our stated our stated capital allocation priorities, we continued to return capital to shareholders in 2023. To that end, we paid out $142 million in dividends and have increased our dividend per share by 25% starting in the first quarter of 2024.

We also repurchased 13.8 billion common shares at a cost of $1 billion, for an average price of $72.50 per share, which included $300 million of repurchases at an average price of $83.03 per share in the fourth quarter. With the 13.8 billion shares acquired in 2023, we have repurchased approximately half of the shares outstanding at the time we initiated the program back in 2013. Having repurchased these shares at an average cost of $32.16 per share, we believe it's been a great investment for our shareholders. In addition to buying our stock, in the fourth quarter, we took advantage of market conditions by using $35 billion of cash on hand to pay down a portion of our debt.

For all of 2023, we retired $101 billion of our 2026 and 2027 senior notes through open market transactions, helping to lower our quarter-end debt to capital ratio to 15.9%, down 280 basis points from last year. Adjusting for the $1.8 billion of cash on our balance sheet, we ended the year with a net debt to capital ratio of 1.1%. Now let me turn the call back to Ryan for some final comments.

Ryan Marshall (President and CEO)

Thanks, Bob. Successfully navigating our business through the past 12 months of rising interest rates has been challenging. The same could be said about the past 24-, 36-, and 48-month periods as we battled through COVID and the global collapse in supply chains. I am extremely proud of how our entire team responded to these events and the exceptional operating and financial results PulteGroup has delivered over an unprecedented period. Looking back over the 5-year period of 2019 to the just recently completed 2023, we grew volumes 5% annually and delivered just under 135,000 homes. To support our growth during this period and for future years, we invested almost $19 billion in cumulative land acquisition and development spend.

Through our disciplined land investment, operational focus, and organizational expertise, we capitalized on market conditions to grow earnings per share over this period at a compounded annual growth rate of 34%, while delivering an average annual return on equity of just over 26%. It's this type of strong financial performance during an extended period of market volatility that has prompted increased discussion about the need to reconsider how the large home builders are valued. I think that if you want to be valued differently, you must demonstrate a fundamental change in how you operate the business and the results you deliver, not just for a year or two, but over an extended period of time.

What's different about the past 5 years is that while investing $19 billion into our operation, we also generated almost $7 billion in net cash flow from operations during this sustained period of growth. In fact, we recorded only 1 year of negative cash flow from operations since shifting our focus in 2012 from just top-line growth to driving high returns over the housing cycle. We paid off $1.1 billion of debt while cutting our leverage by more than half to end 2023 with a debt-to-capital ratio of 15.9% and a net debt-to-capital ratio of 1.1%. And we returned $4 billion to shareholders through stock repurchases and dividends. I'd add that the reality is we've been operating our business in just this way for really the past 10 years.

I know stocks reflect performance, so I believe that if we can continue to both grow our business and deliver ROE that remains among the industry leaders while generating positive cash flow and maintaining a low-risk profile, that our stock price and shareholders will ultimately be rewarded. Let me now turn the call back to Jim Zeumer.

Jim Zeumer (VP of Investor Relations)

Great. Thanks, Ryan. We're now prepared to open the call for questions. So Mandeep, if you would, explain the process, we'll get started.

Operator (participant)

The floor is now open for your questions. To ask a question at this time, simply press the star followed by the number one on your telephone keypad. We ask that you please limit yourself to one question and one follow-up question. We'll now take a moment to compile our roster. Our first question comes from the line of Carl Reichardt with BTIG. Please go ahead.

Carl Reichardt (Managing Director, Senior Equity Research Analyst, Homebuilding & Building Products)

Thanks. Morning, guys. Hope you're doing well. Ryan, I wanted-

Bob O'Shaughnessy (EVP and CFO)

We're doing well.

Carl Reichardt (Managing Director, Senior Equity Research Analyst, Homebuilding & Building Products)

Good. I wanted to ask a little bit more about January. Could you maybe expand on how business has been? And what I'm really interested in is, have you seen enough traffic or sales rates to start to think about more broadly, pulling incentives down or even starting to raise base across the footprint?

Ryan Marshall (President and CEO)

Carl, you know, so Bob highlighted in the prepared remarks that, you know, we, and specifically the Q4, October, November, were really below expectations, and it was driven by high rates. We had a great December, highest month in the quarter in terms of absolute sales and absorption per community. So, that was certainly an anomaly for typical December seasonal patterns. And the strength has really continued into January, Carl. So we're feeling, you know, pretty good about how the year is starting. In terms of kind of where it sets us up for reduced discounts, increased prices, you know, we're going to watch it closely, and I think we've demonstrated through past behavior that we're always looking to find the sweet spot between pace and price.

It won't come as a surprise to you, Carl, that affordability with the buyers remains a challenge. And so I think we're gonna have to, you know, be thoughtful about what we do on both the incentive and the price increase front. But, you know, we're feeling pretty good about how the year started.

Carl Reichardt (Managing Director, Senior Equity Research Analyst, Homebuilding & Building Products)

All right. Thanks for that, Ryan. And then, I'm gonna ask a couple of questions just on move-up. Obviously, the entry-level business has been strong for volumes. Move-up, a number of your peers have kind of shifted some of their investments more towards the low end. That's been going on for quite some time. Can you talk a little bit about how you look at that business this year? Is there any alteration in mix in terms of communities, and whether or not maybe your cancel rate in that business is improving faster than the other businesses? We're trying to see if the existing housing market's unlocking enough that you can start to see, you know, even more strength in that particular segment. Thanks.

Ryan Marshall (President and CEO)

Yeah, you know, Carl, our move-up business performed incredibly well in the quarter. We had on a year-over-year basis, the growth was north of seventy percent. So, you know, I think that segment performed very well. The margins out of our move-up, as well as our Del Webb business, continue to be some of our best gross margins, so we're seeing real financial strength there also. And then in terms of kind of community mix, Carl, we're kind of right in line with where our long-term strategic targets are, in terms of kind of that part of our business being about thirty-five percent of our overall mix. So we feel, you know, we feel pretty good about where that business is positioned.

Bob O'Shaughnessy (EVP and CFO)

Yeah, just maybe another point of clarification, that not only were the sales strong, it was our strongest absorptions on a same-store basis. So that consumer actually has performed well. To Ryan's point, strong margins and absorptions.

Carl Reichardt (Managing Director, Senior Equity Research Analyst, Homebuilding & Building Products)

Thank you, Bob. Thanks, Ryan.

Operator (participant)

Our next question comes from the line of Matthew Bouley with Barclays. Please go ahead.

Matthew Bouley (Director, Senior Equity Research Analyst, U.S. Homebuilding & Building Products)

Good morning, everyone. Thanks for all the details and for taking the questions. Question on the high-level growth algorithm that you gave, Ryan, around the kind of 5%-10% growth annually. You know, you're talking the low end of that this year because you walked away from some deals in 2022. So my question is, is this kind of a, you know, sort of a one-year poll, so to speak? And, you know, do you have the lands that you need today to kind of get back to your algorithm by 2025? Or how should we think about getting to that level of growth going forward? Thank you.

Ryan Marshall (President and CEO)

Yeah, Matt, thanks for the question. We feel really good about how we've positioned the land pipeline. We've been investing for growth for a number of years, and we've been trying to do it in a very responsible way, specific to having less owned and more optioned land. You know, the fact that over the last 15 months we've made significant headway with our land banking platform has helped with that. So we really like the number of lots that we have under control at 225,000 plus or minus, and we like the ownership structure, or the way that we've controlled those lands. We think it's a really capital-efficient structure. Specific to your growth target number, yeah, we're gonna be at the lower end for 2024.

Beyond that, we feel that, you know, we've got, you know, we've got the, you know, the right structure to kind of be in that range for future periods.

Bob O'Shaughnessy (EVP and CFO)

Yeah, maybe I'd add to that. You know, the land for 2025 is under contract and probably in development right now, and so the... You know, we have line of sight to 2024, 2025. You get out to 2026, you know, we're still working through some of that, but, you know, you can see from the approvals that we did in this most recent quarter or for the year, 40,000 lots. No, no issues from our perspective in terms of lining up that type of growth rate.

Matthew Bouley (Director, Senior Equity Research Analyst, U.S. Homebuilding & Building Products)

Got it. Okay, that, that's super helpful. Thanks, guys. Second one, back to the gross margin question. Yeah, I think you're guiding 2024 margins to be down at roughly 70 basis points from where you exited the fourth quarter. I think I heard you say, Bob, that it's you know, kind of flat pricing, and then you've got some headwinds in land, labor, and materials. I'm just curious if you kind of unpack that a little bit and maybe specifically focus on the land side. How are you kind of thinking about those headwinds to the margin, and how does that kind of you know, play into that guide in 2024? Thank you.

Ryan Marshall (President and CEO)

Yeah, fair, fair question. You know, and, and I think we laid it out this way. To try and answer that question, I'll give you a little more color. You know, we see pricing flat during the year. Now, you might see different pricing at different consumer groups. You know, the first time is the most affordability challenge, and that's where we saw actually the biggest decline in the current quarter. But we think pricing is relatively flat through 2024. We see modest, call it 2%-4%, house construction cost increases, kind of mid- to upper single-digit land increases, which is what we've experienced this year. And so when you kind of mix that all together, we...

And the one other point I guess I'd offer to clarify is, we're assuming incentive loads stay about the same at the 6.5% that we saw in this quarter. So when you marry that all up together, a little bit of a decline year-over-year, but still 28%-28.5%. Pretty, pretty strong margin performance.

Matthew Bouley (Director, Senior Equity Research Analyst, U.S. Homebuilding & Building Products)

Perfect. All right. Thanks, Bob. Thanks, Ryan. Good luck, guys.

Bob O'Shaughnessy (EVP and CFO)

Thanks, Matt.

Operator (participant)

Our next question comes from the line of John Lovallo with UBS. Please go ahead.

John Lovallo (Managing Director, Senior Equity Research Analyst)

... Hey, guys. Thank you for taking my questions. The first one, just maybe talking about January again, curious how orders looked, you know, versus, you know, normal seasonality, if you will. I think, you know, first quarter absorptions typically rise, you know, call it 40%-45% sequentially. Is there anything that would, you know, preclude that from happening, in your opinion, outside of rates, maybe in the first quarter of this year?

Ryan Marshall (President and CEO)

Yeah, John, we didn't, we didn't give a specific increase out of December. You know, we kept more of our commentary around the qualitative side of things, which, you know, I'd reiterate, we're very pleased with how things are performing in January, and we'd expect that strength to continue. So, you know, we, we continue to be in, you know, a situation where there's, there's low supply. Affordability has definitely gotten better. You heard Bob's comment about kind of what we've assumed with our incentive load. So yeah, I'd, I'd expect us to have a, a strong Q1. The one other thing I'd offer that's probably of note is we're starting to see some real signs of life in our western markets. You know, those have been...

That's been a part of the country that was slow for the majority of kind of 2022 and most all of 2023. But, you know, in the last 30-45 days, we're really starting to see those markets pick up, which is, you know, a welcomed outcome.

John Lovallo (Managing Director, Senior Equity Research Analyst)

Makes sense. And then on the share buyback, that was encouraging to see, I think could be a good driver of returns as we move forward here. Over the past few years, I think you guys have done about $1 billion per year. You know, the authorization now is closer to $1.8. How are you thinking about 2024 buybacks relative to the past few years? I mean, should we expect north of $1 billion?

Bob O'Shaughnessy (EVP and CFO)

You know, honestly, I'm gonna defer. We typically do. We report the news on that. I think, you know, you highlight we've done about $1 billion a year in the last couple of years. We have $1.8 billion in cash. We have offered that we project about $1.8 billion of cash flow from operations in the current year. So our capital allocation priorities don't change. You know, we've said we're going to increase our land investment to $5 billion. That's up about 16% year-over-year. We increased our dividend 25%. You know, that's not a huge cash element, but still, I think, reflective of our confidence in the business. You know, we do have $1.8 billion of authorization. And like I said, we'll report the news.

You know, you saw this year we bought back $100 billion of our notes because it was attractive. You know, the rate environment has made that a little less attractive, but we always look at liability management as part of the equation. So really, no change to our capital allocation priorities.

John Lovallo (Managing Director, Senior Equity Research Analyst)

Okay. Thank you, guys.

Bob O'Shaughnessy (EVP and CFO)

Sure.

Operator (participant)

Our next question comes from the line of Stephen Kim with Evercore ISI. Please go ahead.

Stephen Kim (Senior Managing Director, Housing Research)

Yeah, thanks very much, guys. First question relates to your, your land, on the balance sheet. It, I think that your cash flow guide seems to suggest, at least for my modeling, a modest rise in your own lot count, while you keep a year's supply of owned lots, fairly stable. I was wondering if that's right, and if there's any opportunity or desire to actually reduce your, land holdings in years, further.

Ryan Marshall (President and CEO)

Yeah, Steven. So, a couple of things there. We are increasing our land spend in 2024 from $4.3 billion-$5 billion. You know, our mix of developed spend versus land acquisition spend will continue to probably be about 60% development, 40% land acq. And then, you know, our long-term desire is to have 70% of our land controlled via option. You know, we highlighted in the prepared remarks this year, we moved that from 48% option to 53% controlled via option. So we're you know, I think both in we demonstrated through results over the past number of years as well as kind of articulated long-term goals, we want to be land lighter.

We're gonna continue to do it the right way, all with an eye toward delivering, you know, a lower risk model that's very capital efficient as well.

Stephen Kim (Senior Managing Director, Housing Research)

Well, I guess, Ryan, I mean, you gave most of that information in your opening remarks, so I appreciate that. But I guess my, the gist of my question, trying to incrementally, you know, understand what your plans are a little bit more, is to try to understand the actual amount of owned lots. Are you looking to get to your 70%, you know, optioned versus owned mix, by keeping your owned lot count kind of flat or your supply flat with where you are? Or are you actually looking to reduce that in addition to increasing your option lot exposure to kind of get to that 70% eventually?

Ryan Marshall (President and CEO)

Yeah, Steven, in terms of years owned, we'd expect to probably keep that right around the level that we're at, maybe a slight decrease. And then ultimately, we would start to flip from a years owned to years option. You'll see a little bit of a trade in that mix.

Stephen Kim (Senior Managing Director, Housing Research)

Okay, that helps. And then when you talked about land banking, and continuing to increase that, could you describe for us the... you know, when you think generally about what you're seeing in the market in terms of pricing, in terms of, you know, the way these negotiations are going with your land bankers, what kind of anticipated, you know, haircut to gross margin do you typically get when you go from just sort of buying versus, you know, doing a land option? And what's the benefit to your inventory turns that you typically think about? So what's the trade-off basically in your mind, some rules of thumb for us?

Ryan Marshall (President and CEO)

... Yeah, I don't know that there's a kind of a hard and fast answer to that, Steven. It, it depends on the mix of the business that we've got. You know, in terms of margin, you know, it can be a couple of hundred basis points on a relative basis. And in terms of inventory turns, you know, certainly it's going to be more efficient than a bulk raw transaction. But it depends on the life of the asset. So, you know, it, you know, in Del Webb, it's going to be very different than it is in the, in the Centex business for us. So I wouldn't want to, you know, paint that with too broad a brush.

Stephen Kim (Senior Managing Director, Housing Research)

Okay. That's fine. I appreciate it. Okay, thanks, guys.

Ryan Marshall (President and CEO)

You too.

Operator (participant)

Our next question comes from a line of Joe Ahlersmeyer with Deutsche Bank. Please go ahead.

Joe Ahlersmeyer (Equity Research Analyst)

Yeah, thanks very much. Good morning, everybody. Just a question on the assumption on the incentive load in the gross margin guidance. I'm wondering if that represents more, just a state of conservatism right now, waiting to see what happens with rates further, or if it's more about your philosophy as rates fall, that you might, you know, allow that to flow through to affordability and drive volume, versus letting it be a big margin benefit. If you could just talk about that trade-off.

Bob O'Shaughnessy (EVP and CFO)

Yeah, Joe, you know, I think the reason we've assumed that the incentive load stays about where it is is just because affordability continues to be challenged. So we've got low supply, but interest rates are relatively higher. And because of low supply, I think there's, you know, there's still some pressure on, you know, prices being elevated, you know, historically. So, you know, we've talked a lot in 2023 about how successful we were in helping to solve some of the affordability challenges with the incentive dollars that we put toward the forward mortgage commitments. We'll continue to use that as a tool in 2024. Now, as rates fall, we think, you know, the cost of those forward mortgage rate commitments will become less.

We've made an assumption that we reallocate some of those incentive dollars to other things that, you know, help to, you know, solve the affordability challenge and get a buyer into their home. So, you know, is it conservative? Time will tell. I think what you've seen from us historically is, you know, we're not afraid to raise price, we're not afraid to cut discounts, and, you know, we're always looking to optimize pace and price. You've also heard me talk the last several quarters. We're not going to be margin proud. So we're doing things to be responsive to what the market is, to derive an outcome that yields the best return for our shareholders. You know, you'll see us actively managing all things, pace, price, incentives, forward mortgage commitments, et cetera.

Joe Ahlersmeyer (Equity Research Analyst)

Understood. Thanks. Thanks a lot for that. And I appreciate your comments about the valuation. Sounds like you think that cash flow is a bigger part of that, potentially even than just, you know, percentage of ups and lots or any, any metric on the land side. It's about the cash flow. I tend to agree. And so just wondering if you are internally starting to think about your leverage in the context of cash flow or profits, and not so much on, you know, what it makes up relative to your inventory balances. Kind of thinking almost more like a manufacturer or distributor, because right now your net debt's at about 13 days of operating profit. So just thinking about the potential for using more debt going forward. Thanks.

Ryan Marshall (President and CEO)

Yes, that's an interesting question. You know, I'm not sure we can think like a manufacturing company completely. The risk profiles are different. But having said that, I think there are, you know, based on the strength of the operation, based on the cash flow that we've consistently shown despite growth, which historically is not the way this industry has behaved, you know, we believe there is an opportunity for people to think a little bit differently about the equity. In terms of how we manage the leverage on the balance sheet, a lot of that will have to do with our opportunities to invest in the business and what we do on the share repurchases.

Bob O'Shaughnessy (EVP and CFO)

But you know, even you know, you look at the rating agencies. They've been slow, but they've been responsive to kind of, I think, seeing the value in the business model and also the way the debt gets looked at. So would we use more debt for something? Without question, if it were for the right thing.

Joe Ahlersmeyer (Equity Research Analyst)

That's helpful, Bob. Thanks so much. Take care.

Operator (participant)

Our next question comes from a line of Michael Rehaut with JP Morgan. Please go ahead.

Michael Rehaut (Managing Director, Senior Equity Analyst, Homebuilding and Building Products)

Thanks, appreciate it. You know, wanted to circle back just on incentives and, you know, where we are today and, you know, to the extent that there's the potential for those to decline, how we should think about the impact on 2024. So when you talk about, I think assuming in 2024, 6.5% of a load rate for incentives, and I believe you said that was similar to the fourth quarter. Can you just remind us where you were in the fourth quarter versus the third and earlier in the year? And to the extent that, you know, perhaps incentives tick down a little bit in the first quarter of 2024, should we be thinking that there would be a 3Q or a 4Q impact? Just trying to get the sense there of the lag.

Ryan Marshall (President and CEO)

... Yeah, Mike, I'll take the first part of that, and then I'll have Bob do the last piece. So we're up 50 basis points from Q3. We were 6% in Q3, 6.5% in Q4. You know, in terms of what that means for 2024, you know, I think I addressed it on a prior call. We're gonna actively be managing our incentive load, but we've shared with you what our assumption is in, in kinda current form. If there's an opportunity to peel those back, we'll do it, and we'll certainly share that with you. In terms of kind of the quarter that it would impact, right now, about 50%, somewhere around 50% of our sales are spec. So those are closing in kind of the following quarter.

You know, spec sales now would either be late Q1 closings or early Q2 closings. If it's a dirt sale, Q1 closings typically end up being Q3 or early Q4 closings. So, you know, we've factored all of those assumptions into the margin guide that we gave for the year, which is, you know, 28%-28.5%, just to repeat that. And then, Bob, I don't know if you have the incentive load for Q1, Q2. I think that's the only piece I didn't answer.

Bob O'Shaughnessy (EVP and CFO)

It was about 6% in each of the first, second, and third quarters. It was 4.3% in the fourth quarter of last year.

Michael Rehaut (Managing Director, Senior Equity Analyst, Homebuilding and Building Products)

Great. No, that's helpful. Thank you for that. You know, I guess secondly, I'd love to kind of shift a little bit to the SG&A side. I think you gave guidance for the first quarter, but you know, you've been running last couple of years, you know, plus or minus around 9%, low 9%. Obviously, we've heard a little bit about you know, higher commission rates coming back, maybe in a more choppy market at points in the past year or so. You know, overall solid market, but still, we've heard a little bit about commissions maybe coming up a little bit.

How should we think about, you know, SG&A and the potential for further leverage over the next couple of years against a, you know, the growth algorithm that you talked about, and, if commissions, let's say, are stable from here, you know, could we see an 8% at some point or getting closer to an 8% number? Just love your thoughts on that.

Ryan Marshall (President and CEO)

Yeah, Mike, we've... You know, I think we've always been thoughtful in how we spend SG&A dollars. We have historically made some extra investments in the quality of the homes that we build and deliver, and the customer experience that we provide for our homeowners. And then we invest incremental dollars in the culture of our, you know, our workforce. So we've tried to maintain balance within the SG&A structure as well. We're not trying to run kind of the leanest and, you know, the lean on the lean end. We're also, you know, not trying to overspend. I think we're trying to be very balanced.

In terms of the leverage for 2024 specifically, you know, we've kind of given the guide, which will put us kind of in the low, you know, low 9s. And that's really reflective of kind of what Bob guided to on the average sales price, which we're expecting to be flat. And against that, you've still got, wage inflation for kind of our internal employees running close to, you know, 3.5%-4%. So, you know, there's some, you know, pressure, there's pressure on the SG&A front that we're not necessarily getting the benefit of on the ASP increase side. So in terms of kind of where it goes into the future, time will tell, but, you know, we've given the best visibility that we can for 2024.

Bob, I don't know if you anything you'd add on to SG&A? You know, Bob, Bob keeps us honest, I'll tell you that. We're not, we're not overspending anywhere, at least not under, under Bob's watch.

Michael Rehaut (Managing Director, Senior Equity Analyst, Homebuilding and Building Products)

Great. Thank you.

Operator (participant)

Our next question comes from the line of Sam Reid with Wells Fargo. Please go ahead.

Sam Reid (Senior Equity Research Analyst, U.S. Homebuilders & Building Products)

Hey, thanks so much, guys, for taking my question here. Wanted to drill down a little bit on the first-time buyer. You guys have given a lot of good color on pricing. It does sound like price did move lower for this buyer group a bit again during the quarter. Maybe help us unpack the relative split, perhaps between, you know, higher incentives for this buyer group as you try to make these, you know, homes more affordable, versus perhaps some of the other affordability levers that you might be pulling, like smaller floor plans, et cetera. Kind of any color here would be appreciated.

Bob O'Shaughnessy (EVP and CFO)

Yeah, I would tell you, you know, if you look, you know, year over year, pricing at $422 to that buyer is down 6%. Year over year, it was down about 1% versus the trailing quarter, so the third quarter of this year. And I would tell you, it is largely incentive related. And, you know, so we haven't, in the last 3 months or the last 12 months, had a radical redesign of the product that we're offering to people. You know, communities, when they get entitled, you have product approvals. You know, so to a degree, you can see people saying, "I want the smaller floor plan." I would tell you, that's not the driver of the price change. It is the incentive load that we've introduced.

So it's that, you know, 220 basis points, which for that buyer is about, call it $8,000. That's the price decline.

Sam Reid (Senior Equity Research Analyst, U.S. Homebuilders & Building Products)

... No, that's helpful. And maybe one more on pricing here, just from a slightly different vantage point. You guys have given good color in the past on option and lot premiums and the impact on ASP. I want to say it's been around $100K or north of $100K across your entire mix throughout 2023. Curious as to where that trended in Q4, and maybe give us a sense as to your outlook for that piece of the price component into 2024.

Bob O'Shaughnessy (EVP and CFO)

Yeah, in the fourth quarter, it was $105,000 per unit, so it's down about $4,000 versus the prior year. And so I think that speaks to the sales team, and I give them a lot of credit. You know, where we've needed incentive has been less around options and lot premiums and more oriented towards financing. So we didn't see a big change there, which I think is a real positive. It also, you know, is interestingly, you know, for that move-up and active adult buyer, and we've highlighted the relative strength from them in this quarter and the relative pricing strength there.

So, you know, just like our first-time was down about 6%, our move-up pricing was actually flat quarter-over-quarter, and our active adult was actually up 3%. And I think it's reflective of the way we go to market, the way we sell the lots that we've got, the options that people put in houses. So, you know, our teams are still doing a really good job of, you know, providing value for that which people desire.

Sam Reid (Senior Equity Research Analyst, U.S. Homebuilders & Building Products)

Helpful color all around. I'll pass it on, guys. Thanks.

Operator (participant)

Our next question comes from a line of Ken Zener with Seaport Research Partners. Please go ahead.

Ken Zener (Senior Analyst, Homebuilders & Building Products)

Morning, everybody.

Bob O'Shaughnessy (EVP and CFO)

Hey, Ken.

Ken Zener (Senior Analyst, Homebuilders & Building Products)

I've got two very simple questions. First is on land banking. What percent of closings do you expect to be from finished lots once you reach your 70%, you know, option-owned scenario, generally?

Bob O'Shaughnessy (EVP and CFO)

That's an interesting question. You know, certainly the land banking would be finished lots, but for the optionality that we have with, with individual sellers, many of those were self-developing, and so I don't, I don't have that in mind. Jim, do you-

Ryan Marshall (President and CEO)

Yeah, my and this is a little bit of a guess. Ken, roughly 20%-25% of our total closings, once we get to 70/30, will be finished lots. You know, the rest will... There'll be a lot of optionality in there, but to Bob's point, a lot of our options we take down as, you know, raw land chunks, and then we self-develop those. They're, you know, still highly efficient. It's just a different form of, you know, an option structure.

Ken Zener (Senior Analyst, Homebuilders & Building Products)

Right. I assume that's kind of reflecting your entry-level exposure as well. Second question is, talk to options. Again, could you update us, what % of your ASP is coming from options? And then comment on the margin benefit you get from that, if you could, so we could discern, you know, your operating construction costs versus your strategy of bringing in these options. Thank you.

Bob O'Shaughnessy (EVP and CFO)

Sorry, I want to make sure I understand the $4,000, the $105,000 that you just gave. How much of it is options? No, I think-

Ken Zener (Senior Analyst, Homebuilders & Building Products)

Right. Yeah, right. Your A, you know, your total ASP, you have a certain option exposure, more at move-up and adult, active adult.

Bob O'Shaughnessy (EVP and CFO)

Yeah, so-

Ken Zener (Senior Analyst, Homebuilders & Building Products)

But could you talk to the margin impact of that as well? Thank you.

Bob O'Shaughnessy (EVP and CFO)

Yeah. So of the $105,000 of option and lot premium, $80,000 is options, $25,000, that's lot premium. You know, I could say, for instance, lot premiums are pure margin. I'm not sure that that's fair, right? You know, pricing doesn't really work that way. But in terms of the option spend, typically, it's going to have a relatively rich margin mix, call it 50%. And so it'll, you know, it is accretive to the overall margin. And, you know, the way we try and go to market, Ken, and I don't know if this answers it better. You know, we put a base price house that we think is kind of market standard and what people can and should expect to pay for that house.

Then, we start talking about, "Okay, which lot do you want? What are you willing to pay for that lot?" That's what generates the $25,000. And then, okay, now, in the house, if we're offering optionality, and we don't for everyone, right? So for the Centex buyer, we may have curated packages or no choices at all. But for the folks that can do structural options for fit and finish, that's what's driving that $80,000 in incremental revenue.

Ken Zener (Senior Analyst, Homebuilders & Building Products)

Thank you very much.

Operator (participant)

Our next question comes from a line of Alan Ratner with Zelman and Associates. Please go ahead.

Alan Ratner (Managing Director)

Hey, guys. Good morning. Thanks for all the-

Bob O'Shaughnessy (EVP and CFO)

Good morning

Alan Ratner (Managing Director)

... the details so far. Question on cycle times. So, congrats on the improvement there. Sounds like, you know, you expect to see further improvement in 2024. Curious, you know, to get to the 100-day target from 130, where you're at right now, you know, you guys are targeting 5% growth. We've heard some other builders may be a little bit higher than that. Is there a level from a labor perspective where, you know, if builders try to push starts more significantly, that you think cycle time improvement might stall a bit? You know, are there any constraints that you could foresee, or is the unleashing of kind of the normalization of the supply chain just kind of independent of whatever the start pace might look like in 2024?

Ryan Marshall (President and CEO)

... Yeah, and it's a fair question. You know, based on the total amount of production that's happening, you know, I don't see the industry stressing the labor availability. Now, I'm not suggesting there's a whole bunch of excess labor running around out there, but at least for the big builders, I think we've got great, you know, trade relationships. And, you know, I think we'll continue to get, not only schedule performance, but, you know, but the labor on our job sites. I think, the pressure likely comes on dollars before or more so than time. You know, if we're running into labor pinches because of a volume increase, I think it's probably dollars more than time.

A lot of the, you know, the decreases it will take, it'll be because we're getting things on a predictable schedule like we used to pre-COVID. So, that's working better, which allows us to take some kind of dead days out of our schedule that we had, you know, we built in for things to go wrong or for, you know, time, and we were just literally waiting for material to show up. So it's a little bit of that, a little bit of, you know, we're just getting back to the cycle times that we had pre-COVID. So, we trimmed out about 30 or so days in 2024. We'll get or in 2023, rather.

You know, we think we can get another 30 or so days by the end of 2024, and we'll be back, largely in line with pre-COVID, cycle times.

Alan Ratner (Managing Director)

Great. Appreciate those added thoughts, Ryan. And then, I guess in a similar vein, was curious if you could just give an update on the, the ICG, growth plans there and kind of how that's been trending and what your current thinking is as far as, additional market expansion, if there is any?

Bob O'Shaughnessy (EVP and CFO)

Yeah, Alan, it's it continues to go well. We have 2 plants today. You know, both are focused in the southeast part of the U.S. Our growth plans are, you know, still largely on target to have approximately 8 factories. So we haven't announced anything new. You know, we'll similar to our share buybacks, we'll probably report the news on that as opposed to give you know, forward-looking forecasts.

Alan Ratner (Managing Director)

And I guess if I could sneak one in on that. I mean, you know, it's hard for us to conceptualize what impact that has on your business, and obviously, it's concentrated in a handful of markets right now. But are there certain kind of metrics that you can share with us, whether it's cycle times or costs, margin, et cetera, that, you know, you can kind of demonstrate on a case study basis how that's contributing to your business right now?

Bob O'Shaughnessy (EVP and CFO)

Yeah, Alan, so that's... We haven't given a bunch of guidance on that just because it is concentrated into a couple of markets, and we don't, we don't feel it's appropriate to extrapolate to the entire enterprise yet. As we get further down the path, we'll share more. Conceptually, it's exactly what you highlighted. We're getting cycle time improvements, we're getting better quality, and there are some raw material cost savings that we believe we're getting as well.

Alan Ratner (Managing Director)

I appreciate that. Thanks a lot.

Operator (participant)

Our next question comes from the line of Susan Maklari with Goldman Sachs. Please go ahead.

Susan Maklari (Senior Equity Research Analyst)

Thank you. Good morning, everyone, and thanks for fitting me in. My first question is just around the specs. You know, you mentioned that you had about 44%, I think, of your production, that's in spec. As you think about the year and the way that the demand may come together, any thoughts on where that may move or, or how you're thinking about it longer term?

Bob O'Shaughnessy (EVP and CFO)

Yeah, Susan, I wouldn't anticipate a massive change from the percentage. We're probably on the higher end of the range that, you know, we'll have in spec right now. Specific to the fourth quarter, we put more spec starts in the ground than what we sold, and that was intentional. We wanted to have some additional inventory going into the spring selling season, which we have. So, you know, as we move throughout the year, probably right in line with where we're at or a tad lower.

Susan Maklari (Senior Equity Research Analyst)

Okay, that's helpful. And then when we think generally about the potential for rates to come down this year and that possibly driving some increase on the existing home side of the market, any thoughts on what the implications of that could be, especially perhaps on the move up and the active adult parts of the businesses and any initiatives you have relative to that?

Bob O'Shaughnessy (EVP and CFO)

Yeah, Susan, you know, with the rate cuts that are forecasted, I don't see it being at a level that's going to unleash a tidal wave of resale inventory. So, you know, is it better than where we're at today? Certainly. Will that start to free up some resale inventory? I think so, and I think that's probably helpful against the backdrop of we continue to be undersupplied in the country. So on balance, I don't think it has much impact at all on what we're projecting for our business in 2024.

Susan Maklari (Senior Equity Research Analyst)

Okay. Thanks for the color, and good luck.

Operator (participant)

Our final question comes from the line of Rafe Jadrosich with Bank of America, where we've reached the time allotment for this morning's call. Please go ahead.

Rafe Jadrosich (Director, Senior Equity Research Analyst, U.S. Homebuilders & Building Products)

Great, great. Thank you, and thanks for taking my questions. Can you—in terms of the additional 30 days of build cycle improvement you're expecting for 2024, can you talk about what the build cycles are in homes that you're starting today? Like, are you already at that 100-day level? And is that improvement embedded in your cash flow guide?

Ryan Marshall (President and CEO)

... Yeah, Rafe, it's a fair question. Homes that we're starting today will deliver in kind of late. You know, it will, the homes we're starting today will deliver in Q2, basically. So, no, we're not at 100 days yet. Now, that being said, there are some markets and some communities where we are at the 100 days, and in fact, we were at the 100 days last year. When you blend it all together, you know, we think it'll be Q4 before we're at the 100 days that we've highlighted as our goal. And Rafe, our guide does factor in what we see in terms of cycle times during the year, the cash flow guide, to your question.

Rafe Jadrosich (Director, Senior Equity Research Analyst, U.S. Homebuilders & Building Products)

Got it. Thank you. That, that's helpful. And then, you gave really helpful color in terms of the, the land inflation you're expecting in your, your, gross margin for 2024. And you have the land that you need through 2025. On the land that you're, contracting today, what are you seeing in terms of inflation? Is it, is it at a similar level, or are you actually seeing that come down? And then, can you kind of help us understand the difference between development cost inflation relative to what you're seeing for, for raw land?

Bob O'Shaughnessy (EVP and CFO)

Yeah. So... Sorry, I forgot the first part of the question.

Rafe Jadrosich (Director, Senior Equity Research Analyst, U.S. Homebuilders & Building Products)

You spoke about the land inflation in the-

Bob O'Shaughnessy (EVP and CFO)

Yeah, I got it.

Rafe Jadrosich (Director, Senior Equity Research Analyst, U.S. Homebuilders & Building Products)

Yeah.

Bob O'Shaughnessy (EVP and CFO)

I'm sorry. Yeah, we, you know, listen, it's interesting. Land prices don't come down very often. You know, they're sticky. And we've seen, and we've highlighted, you know, sort of sequential increases in lot costs. I would tell you that the land we're seeing today is consistent with that. You know, prices are pretty robust, and it's a pretty competitive landscape out there. You know, we underwrite to return, and so it's we look to see can we get return out of that. So I think, you know, no change, honestly, in the land market. In terms of the inflationary aspect, you know, what we are seeing is that labor constraint influences the development of land, just like it does building of houses.

And with general cost inflation that we were seeing last year in particular, it was influencing the cost of pipe. Everything that we do to do the development of the communities was running pretty hot, too. So again, you know, we've highlighted, we think it's gonna be a little bit more expensive in terms of our lot increase this year for 2024. And again, I think that just reflects all the activity that was going on and some of the cost inflation that we saw in 2023 feeding into our lots this year in 2024. Good news is, you know, the vertical, we're seeing a pretty benign input market, whereas that had been running pretty hot last year, obviously. So the slowdown in inflation, we feel it now in the house.

Hopefully, we'll feel that a little bit later in land. It would be an opportunity for us, for sure.

Rafe Jadrosich (Director, Senior Equity Research Analyst, U.S. Homebuilders & Building Products)

Great, great. Thank you. Appreciate all the color.

Bob O'Shaughnessy (EVP and CFO)

Thanks, Rafe.

Operator (participant)

I would now like to turn the call over to Jim Zeumer for closing remarks.

Jim Zeumer (VP of Investor Relations)

Well, appreciate everybody's time this morning. We'll certainly be available over the rest of the day, if you have any additional questions. Otherwise, we'll look forward to speaking with you on our next earnings call.

Operator (participant)

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