Pultegroup Inc

NYSE:PHM

Earnings Call Transcript 2021-Q2

[Operator]

Good morning everyone and welcome to the Q2 2021 PulteGroup Incorporated earnings conference call.

All participants will be in a listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today’s presentation, there will be an opportunity to ask questions. At that time, in order to ask a question, you may press star and then one. To withdraw your question, you may press star and two. Please also note today’s event is being recorded.

At this time, I’d like to turn the conference call over to Jim Zeumer. Sir, please go ahead.

[Jim Zeumer]

Great, thank you Jamie, and good morning. I appreciate everyone joining today’s call to review PulteGroup’s operating and financial results for the second quarter ended June 30, 2021.

Joining me today to discuss PulteGroup’s strong second quarter are Ryan Marshall, President and CEO, Bob O’Shaughnessy, Executive Vice President and CFO, and Jim Ossowski, Senior Vice President, Finance.

A copy of this morning’s earnings release and the presentation slides that accompany today’s call have been posted to our corporate website at pultegroup.com. We will also post an audio replay of the call later today.

Let me note that in addition to reviewing our reported Q2 results, we will also be reviewing adjusted results which exclude a $46 million pre-tax insurance benefit and a tax benefit of $12 million resulting from a change in valuation allowances associated with state net operating loss carry forwards. A reconciliation of our adjusted results to our reported financials is included in this morning’s release and within today’s webcast slides. We encourage you to review these tables to assist in your analysis of our business performance.

As always, I want to alert everyone that today’s presentation includes forward-looking statements about the company’s expected future performance. Actual results could differ materially from those suggested by our comments made today. The most significant risk factors that could affect future results are summarized as part of today’s earnings release 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 Marshall. Ryan?

[Ryan Marshall, President, Chief Executive Officer]

Thanks Jim. Good morning. On today’s call, we will be covering PulteGroup’s financial results as well as updating you on several important initiatives we continue to advance. As Bob will detail in a few minutes, PulteGroup delivered another quarter of strong financial results.

Looking at the business, along with a 28% increase in net new orders, we generated significant top line revenue growth, outstanding gross and operating margins, and a 50% increase in adjusted earnings per share. Clearly there is a lot to be excited about in our results.

Clearly financial results are important, but I believe that running a successful homebuilding business means thinking about the long term and focusing on the key drivers that we believe create shareholder value. These include attracting and retaining a highly engaged workforce that strives to provide a world-class buying experience for our customers, following a disciplined capital allocation strategy, running an efficient homebuilding operation, and realizing higher returns and intelligently manning risks through time. I’m proud to say that consistently executing against these key drivers has been critical to the quality of the operating results we have realized and the outstanding financial position we had established.

Consistent with our constructive view of the housing market, we previously announced our intention to increase land investment in 2021. In fact, through the first six months of this year, we’ve invested $1.8 billion in land acquisition and development. This is up from $1.1 billion last year and $1.5 billion in 2019, with the latter number including the acquisition of the American West assets. Given our increasing land spend, I want to emphasize that we continue to make these investments using the same disciplined approach and underwriting practices against which we have operated for most of the past decade.

In overlay to our investment process, we also continue to execute against our strategy of controlling more land via option. I’m happy to report that 53% of our land was optioned at quarter end, which is approaching all-time highs, and we will of course seek to raise this percentage as market conditions permit.

Although on a smaller scale compared with land, I would highlight that we continue to invest in our offsite manufacturing strategy. I’m pleased to report that we recently leased a facility in Florence, South Carolina that will expand our offsite manufacturing capabilities. We expect to begin delivering product from this facility to parts of our southeastern operation in the first half of 2022.

The Florence facility is our second offsite manufacturing plant and follows our earlier acquisition of ICG at the beginning of 2020. These two plants are part of our long-term strategy to address labor and related production challenges that we expect will continue impacting the future of homebuilding.

As part of our disciplined capital allocation policies, we are also continuing to return capital to shareholders. Through the first six months of this year, we have returned just shy of $430 million through share repurchases and dividends. You will recall our Q1 announcement of a $1 billion increase to our repurchase authorization. You can see that we are already putting this authorization to use.

Having capital available to allocate comes from strong cash flows being generated from well run operations. Bob will provide the details, but I would like to highlight that our reported operating margins in the second quarter exceeded 18% with adjusted operating margins approaching 17%. With an industry that historically achieved operating margins of approximately 10%, our performance over the last several years is clearly breaking with this old paradigm. More broadly, I think it’s important to acknowledge that our entire industry is working to raise this performance bar.

Finally, we believe creating long term value for our shareholders comes from generating high returns over the housing cycle. For the trailing 12 months, PulteGroup has delivered an outstanding return of 25.7% on our equity. Driving higher returns is something we’ve been talking about for the past decade, so we are proud to be delivering on that objective.

The returns we generate are an outcome that reflects the myriad of day-to-day decisions we make as we allocate capital and run our business. As I noted, we are making these decisions today based up on a favorable long term view of the U.S. housing market, although we appreciate recent questions about near-term conditions. As a general statement, I will tell you that housing demand was strong in the second quarter and that these trends have continued into the first few weeks of July. From Google website searches to community visits, we continue to see a very high level of consumer interest in buying new homes. Given the unusual demand dynamics created by the pandemic, we are careful when comparing 2021 to 2020, so we also look back to prior years for additional perspective.

To that end, we monitor an array of traffic, conversion and sign-up trends and our local operations provide insights on what is happening on the ground in their respective markets. Based on all the metrics we monitor and consistent with our business performance, we would say that the second quarter demand in the overwhelming majority of our markets was as strong or stronger than the first 90 days of this year.

I would also tell you that buyer interest in the period was stronger than the second quarter of 2019, in other words, prior to the pandemic. Buyer demand has been strong but customer feedback also hints at a sense of frustration with the lack of homes available for purchase and the rate of price appreciation they’ve seen in the market.

With this as a backdrop, I would also tell you that we purposely restricted sales through lot releases or similar actions in roughly 75% of our communities across the country. These actions were taken to better align our sales efforts with our current production capacity and to begin rebuilding spec homes closer to our historic level of 25%. Said simply, we likely could have sold a lot more homes in the quarter above the 28% increase in net new orders and 40% increase in absorption pace that we reported.

When we thread all these data points together, we continue to see a strong demand environment with a very high level of interest in buying a new home. As has been the case for multiple years, the ongoing strength in demand reflects powerful macro forces, including favorable demographics, an under-supply of new and resale homes, an improving economy and a supportive interest rate environment. While meaningful constraints on home availability and price increases are likely influencing short term conditions, we remain very optimistic about the long term demand trends.

Now let me turn the call over to Bob for a review of our second quarter results.

[Bob O’Shaughnessy]

Thanks Ryan, and good morning. I’m pleased to have the opportunity to review PulteGroup’s second quarter results, which show our ongoing gains in key operating and financial metrics.

Starting with the income statement, wholesale revenues for the second quarter increased 31% over the comparable prior year period to $3.2 billion. Higher revenues for the period were driven by a 22% increase in closings to 7,232 homes, along with a 7% increase in average sales price to $447,000. While our second quarter deliveries showed nice gains over last year, they did come in below our prior guidance due directly to an incremental increase of roughly two weeks in our build cycle times in the majority of our markets. The increase in build cycle times primarily reflects ongoing disruptions in the supply chain.

Consistent with comments made on recent calls, the 7% or $31,000 increase in average sales price in the second quarter reflects price increases realized in all markets and across all buyer groups. Our mix of deliveries in the quarter included 32% from first-time buyers, 41% from move-up buyers, and 27% from active adult buyers, which compares to 31% first-time buyers, 44% move-up buyers, and 25% active adult buyers in the second quarter of last year.

The company’s net new orders for the second quarter totaled 8,322 homes, which is an increase of 28% over the second quarter of last year. In the quarter, we saw continuations of the trends we reported in the first quarter of this year, which included strong demand across all geographies and buyer groups with clear outperformance among our active adult home buyers.

In the quarter, first-time orders increased 12% to 2,637 homes, move-up orders increased 15% to 3,273 homes, and active adult orders increased 81% to 2,412 homes. It’s worth noting that the significant year-over-year increase in active adult orders reflects a dramatic pandemic-induced slowdown in 2020, but I would also highlight that the absolute order rate for these buyers is actually near 15-year highs.

Beyond any impact the pandemic has had on our year-over-year comparisons, I refer back to Ryan’s comments that our divisions were actively restricting sales in upwards of three quarters of our available communities during the second quarter. By design, these limitations had the most significant impact in our first-time and move-up communities.

During the quarter, we operated from an average of 808 communities, which is a decrease of 9% from an average of 887 communities last year and is consistent with our previous guidance. The cancellation rate for the second quarter was 8%, which is down significantly from last year and consistent with the first quarter of this year.

Benefiting from our strong Q2 orders, our year-over-year backlog increased by 52% to 20,056 homes. Given the strong pricing environment, the value of our backlog increased an even greater 70% to $9.8 billion.

Consistent with comments made during our first quarter earnings call, we started construction on 9,800 homes in the period. This is more than double what we started in Q2 of last year and represents a sequential increase of 17% over the number of homes started in the first quarter. As a result of the increase in our starts, we ended the second quarter with 17,344 homes under construction, which represents an increase of 58% compared to last year. Of the homes under construction, 2,233 or 13% were spec units. This percentage is up slightly from the first quarter but remains below our longer term target of 25%.

Based on the fact that many of our units under construction are still early in the build cycle coupled with existing supply chain challenges, we expect deliveries in the third quarter to be in the range of 7,300 to 7,600 homes. These same forces will also impact our total deliveries for the full year. At this time, we expect full year closings of 30,500 homes, which would be an increase of 24% over full year 2020 results.

As has been well reported, favorable supply-demand dynamics have supported price increases in new and existing homes across the country. Positive conditions can be seen in our average price in our backlog, which is higher by 12% over Q2 of last year to $491,000. Given higher backlog prices and the anticipated mix of home deliveries going forward, we expect our average closing price in the third quarter to be between $470,000 and $475,000.

For the second quarter, we reported a home building gross margin of 26.6% compared with 23.9% last year. The 270 basis point increase, which exceeded our guidance, reflects the exceptional pricing environment we have been experiencing for a number of quarters as well as the mix of homes closed in the period. Beyond the 7% increase in the average price of homes closed, discounts in the period fell to 1.9%. This is down from 3.5% last year and represents a sequential decrease of 60 basis points from the first quarter of this year.

Our second quarter margins also reflect a legal settlement of $5 million, which benefited gross margin by approximately 20 basis points.

As reflected in the increases in our sales prices and gross margin, we have been able to pass on the meaningful cost inflation we have incurred over the course of the year. At this point, we now expect house costs to be up between 9% and 11% for the full year with the peak of certain costs, driven by lumber, flowing through in the third and fourth quarters. Even with the ongoing rise in build costs, we still see opportunity for gross margins to move higher over the remaining two quarters of the year. As a result, we expect our third quarter gross margins to be 26.8% with our fourth quarter gross margin expected to be 27.3%.

Our reported SG&A expense for the second quarter was $272 million or 8.4% of home sale revenues, which includes a $46 million pre-tax insurance benefit recorded in the period. Excluding this benefit, our adjusted SG&A expense was $319 million or 9.8% of home sale revenues. For the second quarter of last year, our reported SG&A expense was $197 million or 8% of home sale revenues, and excluding the impact of a $61 million pre-tax insurance benefit and $10 million of pre-tax charges from actions taken in response to the pandemic, adjusted SG&A was $247 million or 10% of home sale revenues.

Based on projected closings over the remainder of the year, we expect SG&A expense in the third quarter to be in the range of 9% to 9.5% of home sale revenues and now expect our full year adjusted SG&A to be 9.6% of home sale revenues, which represents a 20 basis point improvement compared to our previous guidance for the year.

For the second quarter, our financial services operation reported pre-tax income of $51 million compared with $60 million last year. The decrease in profitability relative to recent quarters reflects the increasingly competitive market conditions that developed during the first half of the year.

In the second quarter, our reported tax expense was $136 million, representing an effective tax rate of 21.3%. In the quarter, we realized a tax benefit of $12 million resulting from a change in valuation allowance associated with projected utilization of certain state net operating loss carry forwards.

Our reported net income for the second quarter was $503 million or $1.90 per share, and our adjusted net income for the period was $456 million or $1.72 per share. The company’s reported net income in last year’s second quarter was $349 million or $1.29 per share, and our adjusted net income was $311 million or $1.15 per share.

Looking at the balance sheet, we ended the quarter with $1.7 billion of cash and a debt to capital ratio of 22.7%, which is down from 23.3% at the end of Q1 and 32.1% a year ago. Given our large cash position, our net debt to capital ratio at the end of June was 4.5%.

As a reminder, our board of directors authorized a billion dollar increase to our share repurchase plan in April of this year. In the second quarter, we used $200 million of our authorization to repurchase 3.6 million shares, which represents a 1.4% reduction in our outstanding shares at an average price of $55.84 per share.

In the second quarter, we also invested $986 million in land acquisition and development, bringing our year-to-date spend to $1.8 billion. As we remain constructive on the opportunities for long term housing demand, we continue to invest in our business through the same disciplined processes we’ve used to build our existing land pipeline. Given our positive stance on the market, we are targeting full year investment this year of approximately $4 billion in land acquisition and development, which represents an 8% increase over our prior guidance.

Inclusive of the investments made in the second quarter, we ended the period with approximately 207,000 lots owned and controlled. Of these lots, 53% are controlled through options, which is approaching all-time highs for the company. While the owned-option split can shift a little from quarter to quarter, we continue to make steady progress against our strategy to increase land option to enhance returns and/or reduce market-related risks. I would highlight that our percentage of lots controlled via option has increased from 31% at the end of 2016 and we will continue to seek optionality in an increasing percentage of our controlled lots.

Overall, we are pleased with the performance of the business during the quarter and believe that we are extremely well positioned heading into the second half of the year.

Now let me turn the call back to Ryan.

[Ryan Marshall, President, Chief Executive Officer]

Before we open the call to questions, I want to briefly touch on an exciting relationship that we just announced with Invitation Homes.

As most of you know, we have been evaluating different ways for PulteGroup to get involved in the rapidly expanding long-term single family rental business. We were looking for an approach that leveraged our expertise in land acquisition and home construction with an acceptable level of risk and that generated sufficient margins and returns. I believe that we have accomplished this through our collaboration with Invitation Homes, the leader in single family rental.

As outlined in the release, beginning in 2022, PulteGroup expects to design and build approximately 7,500 new homes over a five-year period for sale to Invitation Homes for inclusion in their single family rental leasing portfolio. We have already agreed to projects in the state of Florida, Georgia, California and Texas, representing an initial 1,000 homes. Under the program structure, we are effectively a preferred provider of new construction homes to Invitation.

Along with providing a strong margin and return opportunity, this relationship offers a number of other benefits. The increased construction volume allows us to further expand local market scale within the areas we currently serve. The increased inventory turn resulting from these sales can enhance overall project returns. The increased volume could allow the company to potentially pursue larger land pieces in select locations, and the relationship could also support PulteGroup’s entry into select new markets we have been assessing.

We have been diligent in our efforts to find the right entry point into single family rentals and we are excited about this opportunity and the chance to work with an industry leader like Invitation Homes.

Before turning this back to Jim, let me thank all of our employees for their work in delivering these exceptional financial results and, more importantly, an outstanding home buying experience for our customers. I also want to applaud our entire organization on PulteGroup being ranked among the 2021 Best Workplaces for Millennials by Fortune and Great Place to Work. Following our being named to the prestigious Fortune 100 Best Companies for Work For earlier this year, this newest ranking further builds our position as an employer of choice for all generations. As the CEO of PulteGroup, I appreciate what you do every day for our customers and for each other.

Now let me turn the call back to Jim.

[Jim Zeumer]

Great, thanks Ryan. We are now prepared to open the call to questions. So we can get to as many questions as possible during the remaining time on this call, we ask that you limit yourself to one question and one follow-up. Thank you, and I’ll now ask Jamie to explain the process and open the call for questions.

[Operator]

[Operator instructions]

Our first question today comes from Mike Dahl from RBC. Please go ahead with your question.

[Mike Dahl, RBC Capital Markets]

Good morning, thanks for taking my questions. Ryan, really helpful commentary just now. I wanted to start with your comment about how demand feels at least as strong in the majority of your markets over the course of 2Q as 1Q, and just as you go across maybe from a buyer segmentation standpoint, to what extent, if any, have you started to see the demand pool get a little bit thinned out by affordability as you’ve continue to push price fairly aggressively?

[Ryan Marshall, President, Chief Executive Officer]

Yes Mike, thanks for the question. As we highlighted in our prepared remarks, we really haven’t. To your point, we have raised prices quite aggressively. We’ve effectively limited sales through restricting lot releases and other processes we used in over 75% of our communities, so we just have not seen demand wane throughout the quarter.

As I characterized it in my prepared remarks, we think demand was at least equal to what we saw in Q1 and in some communities and some locales, even better.

[Mike Dahl, RBC Capital Markets]

Okay, thanks. Just to follow up on that as my second question, to your point, you’ve got multiple prongs in terms of the ways that you’ve kind of restricted and managed sales, one being phased lot releases, but I think you’ve also employed, I believe you term it the easy offer process, so basically accepting bids on the lots once they’re released. I was wondering if you could comment a little bit more on to what extent you’ve employed that practice, is that across all those 75% of the communities that you’re restricting, and any additional details you can give us on how that has trended as one of your--one of the tools and whether that’s being used more or less now versus a couple months ago.

[Ryan Marshall, President, Chief Executive Officer]

Yes Mike, it is one of the tools that we use. We find that for certain buyer groups in certain communities, it works well, Mike. I’d tell you that we don’t use it in every division in every community, so it’s one of the tools, and to give you an exact number of how many times we used that versus other mechanisms, I’m not sure that I’ve got that information at my fingertips, but a pretty high number of our divisions do use it.

[Operator]

Our next question comes from Alan Ratner from Zelman & Associates. Please go ahead with your question.

[Alan Ratner, Zelman & Associates]

Hey guys, good morning. Thanks for taking my questions and for all of the detail and commentary so far.

Ryan, I’d love to first touch on the supply-demand environment right now. I think you mentioned 75% of communities limiting sales, which I think is pretty consistent with what we’ve heard from a lot of other builders. I’m curious where you see that going over the next several months - on one hand, it looks like your start pace improved quite a bit, which is great; on the other hand, it seems like cycle times continue to get extended. You trimmed the closing guide for the full year a little bit, so it feels like a lot of those challenges, if anything, are not getting better, maybe getting worse a little bit.

Is there an opportunity to kind of pull back on some of those limitations, or do you actually maybe anticipate them accelerating or getting more aggressive here over the next few months to allow the supply chain to catch its breath a little bit?

[Ryan Marshall, President, Chief Executive Officer]

Yes Alan, good morning. Thanks for the questions.

As I think Bob highlighted in some of his commentary, we’d characterize the supply chain as about the same. There are different challenges that are popping up - one gets solved and then you’ve got another one to deal with. It certainly has elongated our cycle time, and that’s what’s contributed to us adjusting our full year closing guide for the total year.

With what we see today, we’re not anticipating it getting any worse than what we’re currently experiencing, and our hope would be as the world continues to reopen, more and more folks are vaccinated, more employers are going back to work in full capacity, that some of those supply chain related challenges would get solved or would maybe get slightly improved. That’s what I would share with you on the supply side.

As far as demand goes, Alan, time will tell. I would continue to reiterate what we experienced in the quarter and well into the third week of July - demand is strong, and we continue to be impressed with the appetite of the consumer and the buyer for homes in general, but specifically new homes. Keep in mind, I think all of this is being done against the backdrop of summer time, maybe the first kind of normal or semi-normal summer that we’ve had in the better part of two years, so suffice to say I think there’s been other distractions out there that potentially capture the attention of the consumer, and we haven’t seen it have an impact on demand at this point.

[Alan Ratner, Zelman & Associates]

That’s great to hear and very helpful.

Second, I’d love to spend a second or two hearing a bit more about the partnership with Invitation Homes, and what I’m curious about from your perspective is 7,500 homes over five years, should we think about that as being additive to your for-sale business, or is some of that going to maybe come out of the for-sale business, recognizing it’s competing for the same land, the same labor, the same materials, and it doesn’t seem like those constraints are getting better anytime soon. Is the capacity there to fully make this a one plus one equals two, or should we think about this as maybe a little bit more of a hedge and maybe the business grows a bit, but not fully at that 1,500 home per year level?

[Ryan Marshall, President, Chief Executive Officer]

Yes Alan, it’s a fair question, and I’m going to give you a little bit of a, it’s a bit of both, answer. We do believe that a fair number of these homes will truly be incremental to our existing for-sale business, and that would certainly be the intent. We think that this partnership will give us access to larger land parcels and allow us to build everything that we normally would have built for sale, and then incrementally do some rental units as well. Certainly I think there will be some projects where it becomes a little fungible and some of the units will come out of what historically would have been our for-sale portfolio. We’ll see how the partnership plays out and what opportunities are there, but we do believe that this will become part of our growth story and we’re excited about that.

I’d highlight, Alan as I think you know, the price points of the homes that are typically going to the rental pools are slightly smaller, more on the entry level price point, the cycle times are a little faster, the construction’s a little easier, so we certainly think that aspect will help on the construction side of things.

[Operator]

Our next question comes from Ken Zener from Keybanc. Please go ahead with your questions.

[Ken Zener, Keybanc]

Good morning everybody.

[Ryan Marshall, President, Chief Executive Officer]

Hi Ken.

[Ken Zener, Keybanc]

Obviously we’ve had new home sales yesterday - I think it slowed sequentially and there’s been some downward revisions on the government data, but you’re still doing about 3.4 orders this last quarter, a bit down but above your 2.5-plus range in the past. The question is, can you talk to how the higher pace is changing the industry, the norms for you guys perhaps, and specific to that, how we should think about how you’re thinking, how you’re buying your land when you run your models relative to communities rising, relative to the order pace as we see it today, because you’re talking about larger communities which obviously could have higher pace, but I’m just trying to understand how you’re thinking is evolving, even how the industry is shifting, because there obviously was that pivot away from higher communities given last cycle’s experience.

[Bob O’Shaughnessy]

Yes Ken, it’s a fair question. I think, and this is going to perhaps be a boring answer, we haven’t changed our thought process in terms of how we’re seeking to access the land market, and more importantly what our return expectations are. Now, obviously when we look at potential transactions, the current market influences our thinking, but as we highlighted in the prepared remarks, we’re mindful that the market is moving at a pretty fast pace today, and so we always think what happens if it goes back to what had been the norm before that, what does it do to our return expectations. On balance, our community sizes have gotten a little bit bigger but not much, honestly - they’re still three years on average, our return screen is the same.

One of the nice things, and Ryan highlighted it about the relationship with Invitation Homes, is because they are going to have a need for and a desire for delivery of certain cadence of homes, coupled with the homes that we’re going to build for sale, it allows for an accelerated build and delivery rate that is return enhancing, so it actually lets us look at different communities.

Maybe a little bit further on the question that Ryan got asked a minute ago, it allows us to think about different land parcels, so it might be something that we would have passed on but for the relationship with Invitation Homes. All those things factor in, and so when our teams are out looking, stuff that they used to say no to, we now have a different kind of build and sell model that we can layer it into that might broaden the universe of assets that we’re looking at.

Again to be clear about this, our return expectations haven’t changed, and whether it’s looking at things that we’re going to build solely for sale or include a rental portion, we have the same return expectations around that.

[Ryan Marshall, President, Chief Executive Officer]

Yes, and Ken, I’d also add and just kind of emphasize, I think Bob touched on it, we haven’t changed our philosophy in terms of the number of years of land that we want to own. We’ve also, as we highlighted in this most recent quarter, we’ve gotten our land under option up to the highest that its arguably been in the last decade at 53% of our lots are controlled via option, so I think we’re sticking to the fundamentals and the principles that we laid out, that we believe, to the point that Bob made, really manage risk and drive the best returns that we can get.

[Ken Zener, Keybanc]

Right, right. I appreciate that.

Bob, just during your answer, I thought of a question which I didn’t think of, related to the Invitation Homes. I think your business is running very steadily, obviously, but when you look at these parcels of land, is there--I’m just thinking about joint ventures or any obligations, if the world changes, are you guys--is there some type of guarantee in terms of them purchasing if you’re buying the land, or is the land for these lots held differently?

Thank you very much.

[Ryan Marshall, President, Chief Executive Officer]

Yes Ken, we do not have a joint venture. As Bob and I highlighted in my prepared remarks, we have an arrangement with Invitation Homes that is on a--that’s struck on a project-by-project basis, so we underwrite every project individually, as do they. We have purchase and sale agreements that are, while bigger in size, pretty normal with what we typically do in purchase and sale type agreements. We think in terms of the risk on our side, risk on their side, we think we’ve effectively managed that and we’re doing it in a pretty responsible way.

[Operator]

Our next question comes from Matthew Bouley from Barclays. Please go ahead with your questions.

[Matthew Bouley, Barclays]

Good morning, thank you for taking the questions.

Just back on the sale restrictions in, it sounded like, three-quarters of your communities, I’m just curious if you could outline a little bit around what you’re looking for to loosen those restrictions, if there’s any targets you may have, something like specs per community or just knocking cycle time back down. Obviously it’s going to be different everywhere, but just looking for any kind of guideposts on how to think about that. Thank you.

[Ryan Marshall, President, Chief Executive Officer]

Yes Matt, thanks for the question. You highlighted a number of them. The other one that I would add to that is the number of months that a customer will be in backlog while their home is constructed, so we ideally like to target something in the six to seven month range. We occasionally will go outside of that, but we find you go much longer than seven months, it starts to have a negative impact on the customer experience, so we will look at that as well.

We also look at overall cycle time, which we’ve highlighted is slightly getting expanded, and then our lot availability and our lot development times, kind of what the runway is in front of us, we evaluate that. Then you’d add into that obviously production capabilities, trade availability, so do we have the opportunity to bring on more trades.

In some of our entry level communities, Matt, I would highlight that we’re building more specs in those communities, and so in those communities we actually don’t want to sell the home until it reaches a later stage of production, and so in those communities, we’re trying to catch up. We are certainly still selling and we’re open--it’s mostly in our Texas communities, we’re open and we’re selling but we’re intentionally really holding back as we put more homes into the spec pipeline.

[Matthew Bouley, Barclays]

Great, really helpful color there. Thanks for that, Ryan.

My follow-up, I wanted to ask about pricing power actually on the first-time buyer portfolio relative to, I guess, move-up and active adult communities. Obviously your first-time is not entirely the lowest end entry level, but I’m just curious if you’re seeing that first-time buyer perhaps getting stretched at all relative to those buyers that are selling an existing home and realizing the equity in that. Thank you.

[Bob O’Shaughnessy]

Yes, it’s a fair question. Interestingly, the average sales price for our first-time buyers is $338,000 in the most recent quarter - that’s up 6% over the prior year. That’s against the combined portfolio up 7%, and just for perspective, our move-up was up about 9%, our active adult was up about 8%, so it’s all. In the prepared remarks, we highlighted this - it’s kind of all markets, all buyers that pricing is pretty consistent.

[Operator]

Our next question comes from Stephen Kim from Evercore ISI. Please go ahead with your question.

[Stephen Kim, Evercore ISI]

Yes, thanks a lot, guys. You put out a pretty aggressive start outlook last quarter for this quarter, and you pretty much hit - 9,800 starts, I think you said is what you did in 2Q. I was curious as to whether this is a level of start activity that you intend to sustain or perhaps even increase over the next several quarters, if you could give us some visibility on that because obviously that’s a level of starts which is running considerably higher than your closings, and it seems like you’ve indicated that the lengthening of the cycle time has started to level out, basically, that you’re not seeing cycle times meaningfully increase still as we’re in the third quarter here. I just wanted to clarify what your outlook is for starts.

[Ryan Marshall, President, Chief Executive Officer]

Yes Stephen, thanks for the question. We did have a really good start quarter, and our field production and construction teams, I think did an amazing job getting the 9,800 homes in the ground in the quarter. We’d highlighted last quarter, and I’d highlight it again today, that’s not a rate that we would intend to run at through the balance of the year. The Q2 number was really meant to get some of our outsized backlog into the production pipeline, as well as to rebuild our spec inventory. We think we’ve made meaningful progress against that.

Our Q3 and our Q4 start rate will certainly be up over prior year, although we probably expect it to be below the 9,800 that we did in Q2. As we think about production capacity, we think we’ve got a lot of inherent ability and inherent capacity built into our system, and certainly as we look to grow the company, we look to grow in the future years, we’ll evaluate what that spec or that ultimate start rate should ultimately be over several cycles.

[Stephen Kim, Evercore ISI]

Got it, thanks very much for that. Then your gross margin was pretty strong, and you’ve given some guidance that you’re going to have peak lumber costs, basically, running through in 3Q and 4Q. I’m curious as to whether--you’ve helped us understand what the year-over-year headwind from lumber you’re expecting to be embedded within your 3Q and 4Q guidance, and in terms of basis points, is it a year-over-year headwind of, whatever, a couple hundred basis points, that kind of thing?

Then secondarily, if 3Q and 4Q is peak lumber, is it fair to think that given what we’ve seen in terms of the lumber prices recently, that 2022, the beginning of ’22 margins should benefit, kind of like the reverse of the headwind from higher lumber in 3Q and 4Q maybe getting the benefit in first half of 2022?

[Bob O’Shaughnessy]

Yes Stephen, fair question. We’re not going to give a guide on margins for next year. Fair to say that if lumber prices stay where they are, it will be a tailwind.

In terms of absolute impact on our margin, I think we had highlighted this in the most recent call, historically we would have thought the lumber pack ex-labor would have been 3% to 5% of the ASP. We had highlighted that had run up to probably 6% to 8%, so in real dollar terms on a $440,000 ASP, $25,000 to $30,000 in lumber cost in a house, so you can kind of think through if pricing falls, and depending on where you think lumber goes, random lags OSD falling at different rates, the benefit will be--you know, if we can get back to that 3% to 5% of ASP, pretty sizeable. Where pricing is, what lumber does, how that happens, again we’ve seen different rates of change for different components, but if things go as it appears they’re looking, it’ll be a little bit of a benefit in fiscal ’22.

[Stephen Kim, Evercore ISI]

For sure, thanks.

[Operator]

Our next question comes from Truman Patterson from Wolfe Research. Please go ahead with your question.

[Truman Patterson, Wolfe Research]

Hey, good morning everyone. Thanks for taking my question.

First, just wanted to touch on the offsite manufacturing facility you’re expanding to a second location. I know historically you haven’t necessarily given any quantitative measures on margin performance or anything like that. I was just hoping you could give us an update, either any quantitative on the margin side or just qualitatively what you’re seeing - better cycle times, lower warranty costs, and any update or metrics you can put around that would be helpful.

[Ryan Marshall, President, Chief Executive Officer]

Hey Truman, it’s Ryan - good morning. We’re really excited about the second location for our ICG operation. To your point, we have not provided margin guidance at this point. Even with this second facility, we think the amount of our business that it’s impacting is still pretty small. As we continue to scale, we get to a third plant, a fourth plant, and it’s starting to impact a bigger part of our business, I think that that insight will become more relevant and certainly more appropriate.

Qualitatively, I think the thing that I would expound and elaborate on, we’re really happy with what it’s doing for our operation. In terms of the quality of the product that’s coming out of the facilities, it is top notch. We’ve got a really talented team of designers and operators that are running that plant. The constructability of those components that are happening in the field are really exceeding our expectations, and it’s serving saving a significant cycle time on the frame shell components of the homes, depending on how many of the components are actually going in.

Talented group of folks that are running the ICG operation for us. We’re going to continue to grow it from here, and our hope would be in the coming six to nine months, we can have some type of an investor day or some type of an event where we can show you all firsthand what this factory does for us.

[Truman Patterson, Wolfe Research]

Okay, thanks for that. You know, Ryan, when I think about--you know, you all are accelerating your land investment quite a bit this year, and that’s going to impact how your company looks a couple years out. When I think back over the past handful of years, you seem like you’ve been a little bit more flexible as to which end markets you’re willing to go in, just purely based off of returns, whatever drives the highest return.

With that in mind, are there any areas, recognizing how large of an investment you’re making this year, entry level, move-up, active adult, is it in line with where you’ve been historically, or are there any product categories that you’re rotating towards, geographies, anything along those lines to help us out?

[Ryan Marshall, President, Chief Executive Officer]

In terms of consumer groups, Truman, very consistent with where we’ve been targeting historically. As a refresher, 35% of the business first-time entry level, 40% of the business with our Pulte branded move-up family communities, and 25% in active adult, so really no change to that focus.

In terms of markets, not a whole lot of change there either, other than we have highlighted that we’ve recently re-entered Denver. We are in the triad area of North Carolina, and we’ve started to kind of expand into some of the markets like Columbia and Greenville as well, leveraging some of our existing operations. You’re starting to see a little bit of incremental land spend in a few of those places, but other than that, it’s largely consistent with our current footprint.

[Truman Patterson, Wolfe Research]

All right, thanks for taking my questions, and good luck on the upcoming quarter.

[Ryan Marshall, President, Chief Executive Officer]

Thanks Truman.

[Operator]

Our next question comes from Michael Rehaut from JP Morgan. Please go ahead with your question.

[Michael Rehaut, JP Morgan]

Thanks, good morning everyone. First question I had was on the active adult business - obviously a really strong result from an order growth standpoint, and actually looking at it on a two-year stack, if I’m doing the math right, it looks like orders were up 40% versus 2019 second quarter, versus first-time up 30%. The question is, obviously you’ve had the first-time buyer really strong more broadly speaking over the last two, three years, I think that by and large continues to today, but the active adult obviously has historically allowed for great customer diversification. At the same time, you’ve had somewhat of a longer land position for that business, and over time you’ve shifted from kind of the bigger battleships to the more nimble positions, maybe 500,000 lot type communities.

Just curious how you see the business over the next two or three years. Is this stronger growth rate that I referred to allowing you guys to maybe cycle through land a little bit more quickly and allow that business to even result in an overall consolidated Pulte continuing to shift more towards that lot optioning and improve your overall financial profile?

[Ryan Marshall, President, Chief Executive Officer]

Yes Mike, we’re excited about what the Del Webb brand is doing for the company, and specifically the recent performance. We had a great quarter. On a year-over-year basis, the absorptions were up 76%. Now admittedly, that’s against a pretty soft quarter last year when that consumer wasn’t traveling, but on an absolute new order basis, we reached levels that we haven’t seen in a long, long time.

We like the way the brand’s performing, we think we’ve got some great assets. Our newer vintage Del Webb communities are even better located than what historical ones were, and some of those historical battleships, given that we’ve had them for a long time, they’re in pretty damn good locations as well, just as time has allowed them to mature and they’ve become closer in.

The other advantage that we have with some of those legacy communities is we do have land there. We’re able to develop that land and run those communities at a little faster rate in the current environment, which is certainly helping with return and overall inventory turn.

In terms of what the brand does for us over the next two to three years, as we’ve highlighted in some of our comments, we’re very constructive on the overall U.S. housing market. We believe with that market staying healthy, that will bode well for this active adult consumer as well as they’re typically selling their resale home and looking to move and do other things. We’re certainly bullish on the entire business, but I think maybe extra positive on the active adult component.

[Michael Rehaut, JP Morgan]

Okay, that’s helpful, appreciate it. Second question, perhaps just to think about sales pace in the back half of the year, you mentioned that you would expect 3Q, 4Q starts pace to be below the rate you did in the second quarter. Historically in the back half of the year, sales pace has moderated roughly 10% sequentially in the third quarter, another 15% off of that in the fourth quarter. At the same, obviously, you’ve talked about the fact that demand well exceeds your ability to--well exceeds supply as you’re limiting lot releases, etc. How should we think about sales pace in the back half with all that considered? Is a reversion towards that historical sequential decline, roughly speaking, how we should be thinking about things, or should we be considering a different dynamic given the strong, continued strong demand backdrop that you’ve described?

[Ryan Marshall, President, Chief Executive Officer]

Yes Mike, we’re not going to give any guidance on order rates for Q3 or Q4, but I would tell you that given the current environment and how strong demand is, and the fact that we are intentionally and purposefully restricting sales, I think it’s difficult to use historical models to predict the next couple of quarters. We like the way we’re operating, we are very optimistic and bullish on consumer demand. We’re going to continue to sell as many as we think we can produce and our land pipeline will--our developed land pipeline will allow for, but at this point that’s probably all I can give you in terms of future order growth.

[Operator]

Our next question comes from Susan Maklari from Goldman Sachs. Please go ahead with your question.

[Susan Maklari, Goldman Sachs]

Thank you, good morning everyone.

My first question is around the SG&A - you know, you’ve obviously done a good job of leveraging that, and the guidance is lower than where we were coming into the year. Can you talk about the key drivers of that and how we should be thinking about it going forward as you continue to expand the business?

[Bob O’Shaughnessy]

Yes, hey Susan, it’s Bob. I think very consistently, we’ve answered this question over time. As the business grows, we certainly expect that we will get leverage from that, and I think if you go back probably five years and look, with the exception of sort of the pothole that got created because of the basic elimination of spend during the pandemic, you’ve seen a very consistent inverse trend - as our revenues have increased, our SG&A as a percentage of those revenues has decreased in relative step order to the size. I think we’ve done a very nice job through time of managing against our expense--our expenses against our revenue stream. I think it’s a pretty good blueprint for what you can and should expect from us going forward.

We’ve said it before - we likely will never be the cheapest company in terms of SG&A spend. There are things that we invest in, whether it’s IT or marketing related things, that we think benefit the business and contribute to both the engagement of our workforce, the experience of our consumers, the gross margins that we generate, so we think we run a pretty tight ship. We think we’re leveraging as we grow, and I think that’s how you should think about it as we go forward.

[Susan Maklari, Goldman Sachs]

Okay, all right. That’s helpful. My next question is around capital allocation. I know you mentioned that you’re forecasting or estimating about $4 billion of land spend this year, which is up about 8%. Obviously you’ve got plenty of cash on the balance sheet, you’ve been buying back the stock. What else should we be kind of expecting in terms of capital allocation, anything else that’s changed in there?

[Bob O’Shaughnessy]

Yes, good news, Susan, is nothing’s changed. We still have a desire to invest in the business when we’re constructive, as we are today. I think you see that both in terms of the year-over-year growth and even the increase that we’ve highlighted for investment this year, up 8% versus what we thought at the beginning of the year, which is a pretty sizeable increase over the prior year. We’ve obviously demonstrated a willingness to work the dividend through time, the share repurchase authorization and the activity during this most recent quarter, and you should expect us to be doing, on some level, all of those things going forward.

[Operator]

Our next question comes from Deepa Raghavan from Wells Fargo. Please go ahead with your question.

[Deepa Raghavan, Wells Fargo]

Hi, good morning everyone. Thanks for taking my question. Ryan, I’ll start with a high level question.

The industry seems to be struggling to meet even this 1.5 million starts for this year, given the supply chain constraints. Do you think we will be ready for a higher number next year, say 1.8 million starts or so? Any high level thoughts on what needs to happen to get us to a higher number, and is it even realistic to expect a 1.8 next year?

[Ryan Marshall, President, Chief Executive Officer]

Yes, candidly I think the supply chain challenges are bigger than just housing. I think nearly every industry across the globe is dealing with shortages of various materials. Sometimes those are major parts and pieces and sometimes they’re microchips that cost less than a dollar. I think in terms of does the industry have capacity, I think we do. I think we have the land pipeline, I think we have the labor base, I think there’s just some sand in the gears related to certain materials.

The things that are having the biggest impact on us right now are windows, to a lesser degree certain lumber components and components needed to manufacture lumber-related pieces, and then candidly, I think in terms of the ability to increase start rate bigger than the current supply challenges, it’s going to be land, titled developed land, so we’ve all really worked to put more on the balance sheet to move things through the entitlement process, but over the long haul I think that’s the constraint that we should be focused on, as opposed to what I think are mostly short term supply chain issues.

[Deepa Raghavan, Wells Fargo]

Got it, but you think from a land perspective, 1.8 which is pretty much under control of the housing industry, not necessarily the [indiscernible] industry, within what is in your control with this land, 1.8 is still not necessarily off the table, it’s still on the table?

[Ryan Marshall, President, Chief Executive Officer]

Well, I only control what goes on inside of our shop. I know that we’ve got a healthy land pipeline, as indicated by the 207,000 lots we control. In terms of what the entire industry has and where that’s at in the overall entitlement development process, I’d probably leave that up to economists that are smarter than I am.

[Operator]

Ladies and gentlemen, with that we will be ending today’s question and answer session. I’d like to turn the floor back over to Mr. Zeumer for any closing comments.

[Jim Zeumer]

Jamie, thank you. Appreciate everybody’s time this morning. Certainly available for the remainder of the day to answer any other questions, and we will look forward to speaking with you on our next quarterly call.

[Operator]

Ladies and gentlemen, with that we’ll conclude today’s conference call. We do thank you for attending. You may now disconnect your lines.