PulteGroup [PHM] Conference call transcript for 2022 q1
2022-04-28 13:36:05
Fiscal: 2022 q1
Operator: Good morning. My name is Abby, and I will be your conference operator today. At this time, I would like to welcome everyone to the PulteGroup Q1 2022 Earnings Conference Call. Today’s conference is being recorded and all lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. Thank you. And Jim Zeumer, you may begin your conference.
Jim Zeumer: Great. Thank you, Abby. Good morning. Thanks, everyone, for participating in today’s call to discuss PulteGroup’s first quarter earnings for the period ended May 31, 2022. Q1 represents another quarter of strong financial results and has gotten the year off to a great start for us. I am joined on today’s call by Ryan Marshall, President and CEO; Bob O'Shaughnessy, Executive Vice President and CFO; and Jim Ossowski, Senior VP 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 will also post an audio replay of this call later today. Please note that as part of this morning’s call, we will review our prior year results as reported and as adjusted to exclude the impact of a $61 million pretax charge associated with the bond tender and a $10 million pretax insurance benefit recorded in the period. A reconciliation of prior year adjusted results and reported financial results is included in this morning’s release and within today’s webcast slides. We encourage you to review these tables to assist in your analysis of our business performance. I also 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: Thanks, Jim, and good morning. As Bob will detail shortly, PulteGroup delivered outstanding first quarter financial results with year-over-year growth of 18% home sale revenues and 43% in adjusted earnings per share. The significant increase in our Q1 earnings per share reflects gains in a number of areas, including higher selling prices, expanded gross margins, increased overhead leverage and our active share repurchase program. PulteGroup’s first quarter financial results are just the most recent in a string of strong quarters that have raised our return on equity to 29.4% for the trailing 12 months. There is a lot for investors to be excited about in terms of the company’s operating and financial performance. Taking a step back from the specifics of our Q1 financial results, I think, it’s fair to say that, the supply/demand dynamics of the first quarter were consistent with the trends the industry has been experiencing for the past year or more. In short, demand was strong, available inventory was scarce and the incoming supply is limited. Let me take a minute to expand on these thoughts. On the demand side, consumer interest in purchasing a new home remained high throughout the quarter. With few exceptions, demand was strong across all the price points, buyer groups and markets that we serve. The U.S. housing market continues to benefit from favorable demographics, a strong economy, an outstanding job market and a rising wage environment. New home sales are also benefiting from ongoing and significant increases in rental rates for single and multifamily dwellings. According to John Burns Real Estate Consulting, their numbers indicate that rental prices for single-family homes increased by upwards of 5% in 2021, while multifamily lease rates were up by approximately 13% over the prior year. Forecast point to further increases in 2022. Even with today’s higher prices and rising rates, owning a home can still make clear economic sense for many consumers. Not only can homebuyers get a comparable or even lower monthly payment, but that payment is more stable over time. Given this demand strength in the first quarter, we were able to raise prices in effectively all of our communities with sequential price increases in the range of 1% to 5% common across the country. In addition to the fundamental strength in homebuyer demand, home price appreciation is benefiting from a lack of available inventory in both new and resale. Similar to buying a new car these days, people who are shopping for a home understand how competitive the market is. This brings me to the supply side of the equation. As demonstrated by our first quarter results, our teams did an outstanding job advancing our homes through the construction process and even surpassed the high end of our closing guidance. I want to recognize the efforts of our homebuilding operations to manage through the constraints and the availability of people and materials that are impacting everything from land entitlement and development to home construction. Depending on the specific market, the availability of labor and materials has at best remain the same, but in certain areas conditions have gotten a little worse and build cycles have gotten longer. Given these challenging conditions, our production time lines extended by about one week in the first quarter and now stand at 145 days to 150 days in most of our divisions. With only a couple of days remaining in April, unless dynamics change dramatically in the next couple of weeks, which does not look likely any improvement in the supply chain would provide a more meaningful benefit to 2023 production. Bob’s comments will include us reaffirming our guide for expected 2022 deliveries of 31,000 homes and I would highlight that this guidance assumes that the availability of labor and materials does not change for better or worse. With our production cycles remaining extended, we continue to tightly control sales in most of our communities across the country. We appreciate these restrictions can be frustrating for consumers, but it is the right strategic decisions given overall conditions. From both the customer experience and a business risk perspective, it doesn’t make sense to extend our backlog out a year or more just to record another sign up. Even with all of these challenges, I want to highlight that we started almost 9,000 homes in the first quarter and that we now have approximately 5,200 spec homes in production. The majority of these homes are in the initial start and framing stages, but we would expect these houses to deliver in the back half of 2022. As we have noted on prior calls, our spec production is largely focused in our entry level communities. In sum, I think it’s fair to say that housing demand remains strong, home prices continue to rise and the supply of new construction homes coming to market is constrained. That being said, the Federal Reserve has been very clear in signaling that interest rates are going higher as they seek to control inflation that has hit 40-year highs. There are a lot of favorable market dynamics that can support ongoing buyer demand in the face of higher rates, but the Fed is intent on slowing down the economy and this certainly has the potential to impact the housing industry. Given this dynamic, it makes sense for us to take actions to position our business for continued success. For now, this means focusing on our land acquisition practices. Internally, we are committed to increasing our option lot position and have set a goal of having 65% to 70% of our future land pipeline controlled under option. Our disciplined land investment process helped us to place some great land positions under control over the past several years and we will be closing on -- that we will be closing on in 2022. Going forward, we will continue our thoughtful approach to investing in the business and we will be prepared to make adjustments in response to changing market conditions. We certainly expect that our land teams can continue to identify tremendous land opportunities, but we want to make sure that only the best projects ultimately get approved. Now let me turn over to Bob for additional comments on our first quarter. Bob?
Bob O'Shaughnessy: Thanks, Ryan, and good morning. As Ryan highlighted, the year has gotten off to an excellent start as home sale revenues in the first quarter were up 18% over last year to $3.1 billion. Higher revenues for the quarter were driven by an 18% increase in average sales price to $508,000, while closings of 6,039 homes were consistent with last year. The higher ASP for the period was driven by double-digit gains in pricing within our first-time move-up and active adult fire groups. By buyer group, our mix of closings for the first quarter was also consistent with last year, as we made -- we remain well balanced across the primary buyer groups. In the quarter, 35% of buyers were first time, 40% were move-up and 25% were active adult. In the comparable prior year period, the breakdown was 33% first-time, 44%, move-up and 23%, active adult. In the first quarter, we recorded net new orders of 7,971 homes, which is down 19% from last year. Lower orders for the quarter were primarily the 7% decrease in community count, combined with the impact of aggressively controlling sales paces, given ongoing disruptions in the supply chain. As has been the case for the past several quarters, we continue to restrict sales in many communities in order to align sales with current production pace. Looking more closely at our order activity, orders to first-time buyers decreased 13% to 2,710 homes, while orders to move up buyers were lower by 22% to 3,341 homes and active adult orders declined 23% to 1,920 homes. The relative outperformance among first-time buyers is due to the availability of the spec production we started in the back half of 2021 that supported some incremental orders. Between delays in municipal approvals and extended land development time lines, it is taking longer for some communities to open for sale. As a result, in addition to being down from the prior year, our first quarter average community count of 777 was slightly below our previous guidance. We expect the modest drag in the community openings that we experienced in the first quarter to continue for the remainder of the year. As such, we now expect that our average community count in the second quarter will be 780, with growth to 800 in the third quarter and 830 in the fourth quarter. Reflective of the strength -- strong demand conditions we experienced in the quarter, our cancellation rate remained exceptionally low at 9%. In total, we ended the first quarter with a unit backlog of 19,935 homes, which is an increase of 5% over last year. The dollar value of our backlog increased 31% to $11.5 billion, which reflects the 5% unit growth combined with a significant year-over-year increase in our ASP and backlog. As Ryan noted, our teams are doing a great job moving homes through the production cycle in light of the challenges the industry is facing and the availability of labor and materials. As a result, we ended the first quarter with 21,269 homes under construction, which is an increase of 44% over last year. This production number includes 5,181 spec homes that are currently in the pipeline, which is almost triple our spec units at this time last year. At quarter end, specs were 24% of units under production as we continue to make steady progress toward our goal of 25% to 30%. Our overall production pipeline is still early in the construction process as 28% of these homes are at the initial start stage with 43% of the homes at the framing stage. We ended the quarter with only 64 finished specs, which is consistent with our comments that homes made available for sale sell quickly. Based on the universe of homes in production, as well as their stage of construction, we currently expect to deliver between 7,200 and 7,600 homes in the second quarter. Again, assuming no significant improvement or erosion in the availability of labor and/or materials, we still expect to deliver 31,000 homes for the year, which would be an increase of 7% over last year. On our prior earnings call, we noted that, given supply constraints and limited opportunity to meaningfully increase construction pace, we would rely on price as the bigger lever to maximize return. Looking at the dollar value of our backlog and new orders, you can see that this is what has occurred. Based on the average price in backlog and the mix of homes we expect to deliver, we expect our second quarter closings to have an ASP in the range of $525,000 to $535,000. Inclusive of the $508,000 average sales price realized in Q1 and the first-time spec homes we expect to deliver in the back half of the year, we now expect our average sales price for the full year to also be in the range of $525,000 to $535,000. As we always highlight, the final mix of deliveries can influence the average sales price we realized in any given quarter. Given the ongoing strong demand conditions, we have been able to increase sales prices sufficiently to offset rising costs and to further expand our gross margin. In the first quarter, homebuilding gross margin was 29%, which is an increase of 350 basis points over the first quarter of last year and is up 220 basis points sequentially. In addition to the strong demand and pricing environment, our Q1 deliveries also benefited from the flow-through of lower cost lumber, as prices for wood products rolled over in the back half of last year. Until a recent pullback, lumber prices had moved significantly higher since the beginning of the year, which will impact our closings in the back half of this year. Beyond lumber, we are continuing to see meaningful inflation in most materials and labor costs. As such, even with the recent pullback in lumber, we expect house cost inflation exclusive of land cost to be in the range of 10% to 12% for the full year. Based on the strength of recent selling conditions and despite the volatility in the materials and labor market, we now expect our gross margin to be in the range of 29.5% to 30% for each of the remaining three quarters of the year. Given the timing and impact of lumber and other input costs, we expect to be towards the higher end of this range in Q2, but likely toward the end -- lower end of the range in the third and fourth quarters. As always, there are a lot of moving pieces, so we will update you on our gross margin guidance if needed as we move through the year. Our SG&A expense in the first quarter was $329 million or 10.7% of home sale revenues, which is in line with our earlier guidance. In the comparable prior year period, our reported SG&A expense of $272 million or 10.5% of home sale revenues included a pretax insurance benefit of $10 million. Exclusive of that benefit, our adjusted SG&A expense was $282 million or 10.9% of home sale revenues. Given expected homebuilding revenues for the coming quarters, we currently expect SG&A expense in the second quarter to be in the range of 9.4% to 9.6%, which would be a 30-basis-point improvement over the prior year at the midpoint. For the full year, we now expect SG&A expense to be in the range of 9.2% to 9.5% of home sale revenues. First quarter pretax income for our financial services operations was $41 million, compared with prior year pretax income of $66 million. Lower pretax income for the current period is reflective of a much more competitive market conditions which negatively impacted our capture rate and overall profitability per loan. Mortgage capture rate for the quarter was 81%, down from 88% last year. Our reported tax expense for the first quarter was $145 million for an effective tax rate of 24.2%. Our effective tax rate in the period was lower than our recent guidance. We recorded benefits related to equity compensation in the quarter. Looking ahead, we estimate our tax rate to be approximately 25% in each quarter over the balance of the year. Our reported net income for the first quarter was $454 million or $1.83 per share. In the comparable prior year period, our reported net income was $304 million or $1.13 per share, while adjusted net income was $343 million or $1.28 per share. In the first quarter, the company repurchased 10.3 million common shares or approximately 4% of the shares outstanding at the end of 2021 at an average price of $48.59. Relative to the first quarter of last year, our share count is down by almost 10%. In addition to allocating $500 million to share repurchases in the first quarter, we invested $1.1 billion of land acquisition and development. This keeps us on track to achieve our prior guidance of $4.5 billion to $5 billion of land spend for the full year, with more than 50% of that spend being for development of existing land assets. Inclusive of our first quarter spend, we ended the quarter with approximately 235,000 lots under control, of which 52% were held under option. Our strong land pipeline provides us with the lot need to grow our business, while allowing us to focus future investment on projects that meet our underwriting standards. Even after allocating approximately $1.6 billion to investment in the business and share repurchases, we ended the quarter with $1.2 billion of cash and a gross debt-to-capital ratio of 21.5%. It’s worth mentioning here that as highlighted in this morning’s earnings release, Moody’s Investors Service recently noted the strength of our operations and overall financial position when they upgraded PulteGroup’s senior unsecured ratings from Baa2 -- to Baa2 from Baa3. As Ryan discussed, given the Federal Reserve comments that we were in for a period of rising rates, we are acutely focused on ways to mitigate land related risk. In recent years, we have established a land pipeline that can support the ongoing growth of our operations, but provides optionality should demand conditions change in the future. Going forward, we will continue to emphasize the use of lot options or comparable structures to control rather than own positions and we are actively working to increase our percentage of option lots within our land portfolio. Now let me turn the call back to Ryan.
Ryan Marshall: Thanks, Bob. We realized continued strong buyer demand in the first quarter and buyer interest has remained high through April. That being said, a 200-basis-point increase in mortgage rates since the start of the year is likely to have an impact on consumers. Even with the potential for changes in demand, I think the limited supply of available homes means prices can remain high and puts the construction industry in an advantageous position to weather future demand volatility. As we sit here today, the bigger challenge by far isn’t getting houses sold, but rather getting them built. That said, it is important that we take actions now to put PulteGroup in the best possible position for continued success. Based on recent field visits and walking numerous job sites, I can personally tell you that our teams are doing an amazing job getting our homes constructed. I want to thank our entire organization for their efforts and I have to highlight the work of our corporate and field-based procurement teams, sourcing even the most basic materials can change from week-to-week, but this group has learned to adapt and find solutions to the most challenging situations. Before opening the call to questions, I would also like to highlight that PulteGroup was again ranked among the 100 Best Companies to Work for by Great Place to Work and Fortune Magazine. We didn’t just rank again this year but jumped up 32 positions to number 43 on the list. Being ranked is certainly a nice acknowledgment, but much more important is actually having an amazing and supportive culture that makes PulteGroup a place where people want to be. This is an important competitive advantage when working to attract and retain the most talented individuals. Now let me turn the call back to Jim.
Jim Zeumer: Great. Thanks, Ryan. We are now prepared to open the call for questions. So we can get to as many questions as possible during the remaining time of this call. We ask that you limit yourself to one question and one follow-up. Thank you. Abby, if you will explain the process, we will get started.
Operator: Thank you. And we will take our first question from Matthew Bouley with Barclays.
Ashley Kim: Hi. This is Ashley Kim on for Matt today. Thanks for all the colors. So, just my first question, understanding that you kind of saw order strength across the business, but just wondering if there’s any reason to think that those communities are specifically thinking entry level buyers may begin to see greater challenges given where rates are going?
Ryan Marshall: Well, actually, I think, it’s a fair question. As we highlighted in our prepared remarks, the demand that we saw in the first quarter was exceptionally strong and that’s continued into April. To your point, if there is a buyer group that will be more impacted by rising rates, it’s certainly the first-time buyer. For -- it’s for that reason, among others that we have maintained the importance of our diversified and balanced consumer strategy. We have about 35% of our business that’s specifically targeted to entry level. We do tend to play at the higher price points within the entry-level consumer group. So I think it gives us some room to move around. The other piece that we have done here to help with the kind of buying process is most of those homes were starting to specs and we are not releasing them for sale until they are closer to the delivery window, which I think shortens the amount of time that a buyer will be waiting to take delivery of their home in our backlog.
Ashley Kim: Thanks for that. And then have you done any recent stress tests on your backlog to kind of see what the potential risk there as your buyers kind of sit in backlog for a while to lock in rates?
Ryan Marshall: We have -- actually, Bob, will give you a little color on that.
Bob O'Shaughnessy: Yeah. I think we are always obviously in close contact with our backlog. We have seen people taking a longer rate lock position and so we have highlighted that an increase in rates is a single-digit -- 100-basis-point rate increases a single-digit, perhaps, impact on our backlog. It’s interesting, most of the folks that are there have significant equity built up in their house and so they have expressed that they want to close. And so we have lots of different ways that we can help people get there, whether it’s to source additional income, if they have some additional down payment different programs. So the backlog is pretty solid, and obviously, people have changed in circumstances we work with them as best we can to try to get them to closing table.
Ashley Kim: Thanks for that and good luck on the quarter.
Operator: We will take our next question from Alan Ratner with Zelman & Associates.
Alan Ratner: Hey, guys. Good morning. Thanks for taking my questions and nice quarter.
Ryan Marshall: Thank you.
Alan Ratner: So, I guess, a lot we could drill on it. Maybe first just kind of talk a little bit about the land portfolio. Obviously you guys are making an effort there option share higher. If I look at your lot count today, about 235,000 lots, that’s up about 50,000, 60,000 from the end of 2020, and I guess, you have delivered probably 30,000, 35,000 lots over that timeframe or homes over that timeframe as well. So is the right way to think about it that agnostic to the option and own split that roughly 90,000, 100,000, so maybe 40% of your portfolio has been kind of contracted or tied up for over the last 18 months -- 15 months, 18 months or I know there’s a lot of moving pieces there. So I am trying to figure out maybe if you can provide some color on the vintage of your portfolio of land and how much actually has been tied up as of late?
Bob O'Shaughnessy: Yeah. Alan, it’s -- I think a way to think about it is pre- and post-pandemic, just to be simple and we would tell you that half of it is pre and half of its post. Obviously, we put things under control, oftentimes a fair amount of time in advance of when we actually take the lots down and so owned versus option plays into that. On balance, it’s usually taken us 12 months to 24 months to get from contract to getting communities open. So I don’t know if that gets you there, but roughly 50% is pre-pandemic or two years to three years ago.
Ryan Marshall: Bob O'Shaughnessy: Yeah.
Alan Ratner: Got it. Okay. That’s helpful. And that was, I guess, pretty close to the numbers I was getting to there. So I guess when you think about the land market today and the move towards off-balance sheet and what’s going on in the industry in general. Have you seen any led up over the last few months and the competitiveness of the land market? What’s the inflation rate running at across your portfolio right now? And what’s the outlook going forward, I mean, do you think that some of these deals might get re-traded if things do soften a little bit or is there just so much embedded kind of margin profit in them right now that kind of what’s spoken for is likely going to move forward?
Ryan Marshall: Yeah. Alan, it’s Ryan. I would tell you the land market remains competitive. Certainly, we have other new homebuilders that are buying for the prime parcels and there’s other options as well, might it be apartments or other types of users for the land. So I think if you have got a well-located parcel of land, it’s competitive, always has been, I think, always likely will be. In terms of kind of what we have seen with more recent optionality. We have pushed from two years ago or three years ago where we were kind of in the 30%s, 30% range in terms of amount of options. Today, we sit at 52%. As you have heard, we are going to push that higher, we have kind of set a goal and a target for ourselves to be in the 65% to 70% range. In terms of your question about, is there potential for things to be re-traded. We are purchasing this year, Alan, I would tell you there’s likely no need for that. To your point, there’s a lot of embedded value. These are parcels that were put under contract or under control 18 months to 24 months ago and so, they are great deals and we are going to close on them. We are going to be really thoughtful and judicious around what we are underwriting. What we are putting under control now that will be closings in 2023 and 2024. Those are the parcels that, I think, are more susceptible to being tighter in terms of economics that meet our standards and it’s part of the reason that we think it’s so important that you have got optionality in your land portfolio because it gives you the flexibility to maneuver.
Alan Ratner: That’s great. I appreciate the color there. And if I could sneak in one just housekeeping question, do you have the share of your orders this quarter that be considered kind of non-primary buyers thinking single-family rental, investors/like homeowners. I am not sure if you track that, but any disclosure you can give there and the trend would be great?
Bob O'Shaughnessy: Yeah. It’s pretty consistent with history at about 3% to 5%, Alan.
Alan Ratner: Great. All right. And that includes the SFR business that you have been involved with?
Bob O'Shaughnessy: We don’t have much of that at this point. Those closings are coming next year.
Alan Ratner: Okay. Perfect. Thanks guys. Appreciate it.
Bob O'Shaughnessy: Yeah.
Operator: We will take our next question from Mike Dahl with RBC Capital Markets.
Mike Dahl: Good morning. Thanks for taking my question. Ryan, thanks for the balanced commentary. I wanted to press on the strategy of restricting sales a little bit, because I think we are all synthetic to the supply chain issues, and obviously, recent quarters, been very clear that, that’s the right thing to do, but this is a pretty dynamic and rapidly evolving market, especially with rates. You seem to be acknowledging being a little bit more guarded around what may or may not happen with demand at least in the near-term. And so why is it still the strategy to be so restrictive on sales versus, say, you get the buyers signed up, get them into backlog and then be able to work with them on extended rate locks or things like that could give a little bit more certainty and visibility?
Ryan Marshall: Yeah. Mike, it’s a great question. I think the biggest reason is inflation. We are in a hyperinflationary environment for all things in the world. And as we had -- as we mentioned in some of our prepared remarks to go out and put another buyer in backlog that’s not going to be able to close on their home for another year, I don’t think it’s a great experience for anybody. The consumer doesn’t want to wait that long. They are susceptible to all kinds of potential fluctuations in interest rates, which they may or may not be able to handle. And then we have locked in our economics in terms of what we are charging the consumer at the point that we sign the contract. And then we are exposed to a year plus of potential moves in commodity inflation and we just don’t think that makes sense for our customer and their experience and it certainly doesn’t make sense for economics. So we really like the way the production environment moving. We started almost 9,000 homes in the quarter, which I think demonstrates that we are getting units in the ground. We were able to close homes that were at the high end of our guide, which I think also demonstrates the fact that we are -- we have got pretty good control and predictability around what’s in production and so we are actively moving through bringing our backlog down to a level where we can start to release more things for sale and we are certainly looking forward to that.
Mike Dahl: Got it. And just as a follow-up to the last one. As you make that progress, I mean, how do you envision the year playing out in terms of the restrictions and your ability to lift those. And then as kind of follow-on to the first one, but if I could add a second different question. Just anything you are seeing around upgrades, options, things that might be more leading edge in terms of highlighting some new buyer sensitivities?
Ryan Marshall: Yeah. Mike, we don’t -- I think as you are aware, we don’t guide to new orders. So we will stop short of doing that on this call. We are seeing some minor wins in the supply chain and we are having pretty good luck getting homes in the ground. The first quarter is still a quarter where you deal with a fair amount of weather. So to get 9,000 new starts, I think, demonstrates that the supply -- that our production pipeline has moved. So I think it’s fair to assume if we can continue at that rate, that you will start to see some restrictions lifted on the way we are releasing lots and releasing homes for potential sale over the balance of the year. We are reaffirming our guide or we did reaffirm our guide of 31,000 closings for the year and that assumes that the kind of supply chain environment kind of stays about like it is right now.
Bob O'Shaughnessy: Yeah. And to your question on option and lot premium spend. It was almost $100,000 a unit in the most -- in this print. That’s up 23%, which I think reflects the strength of the market. And you can -- we don’t provide that level of detail on our -- on the orders we have taken, but you can see from the average sales prices being up, we are not seeing much change on that at all.
Mike Dahl: Okay. Great. Thanks, Ryan. Thanks, Bob.
Ryan Marshall: Yeah.
Operator: We will take our next question from Mike Rehaut with JPMorgan.
Mike Rehaut: Thanks. Good morning, everyone. Thanks for taking my question. First, I just wanted to and I apologize if I missed this earlier, but wanted to dial in a little bit in terms of intra-quarter trends and I know sometimes you are reticent to get into month to month. But as you have seen, obviously, a tremendous move in rates during the quarter, I was curious if you witnessed any change in terms of either cancellation rates month-to-month or any change in the marketplace, let’s say, not just you, but with regards to incentives or discounts or even rate of price increases that have occurred?
Ryan Marshall: Hey, Mike. Good morning. This is Ryan. Good question. And the sales pace throughout the quarter was incredibly consistent, because we were controlling it. So we set a rate that we were willing to sell at and so you saw a very similar performance January to February, February to March. Ordinarily, you would actually, I think, in a -- given it’s the spring selling season, you would see sales orders build through the quarter and we just didn’t let that this year. Discounts are non-existent. We were less than 1% in the quarter, which is down from where it was in the same quarter last year. And price increases remained on a fairly consistent predictable cadence with what we have been over the past six months to nine months. So I think the short answer is, the market is still healthy, demand is still strong, there are more buyers out there than we are able to build homes for right now.
Mike Rehaut: Great. Great. Thanks for that. Secondly, just a question on the planned increase to lot option, I was wondering whether or not that’s going to be driven by predominantly just by simply an increase in option lots going forward and perhaps keeping the owned lots flat. You did see your own lots go up, looks like about, I want to say, roughly 15% or so over the last few quarters, wondering if that might reverse even. And with a significantly higher level of lot optioning, if the, with the cash flow generation or reduced cash requirements of running a business like that, how that might change your repurchase or other uses of capital?
Bob O'Shaughnessy: Yeah. Mike, I wouldn’t want to speculate on actual owned lots at any one point in time. I think we are trying to grow the business to do that. You have to have lots on the ground. You have to develop them. Some of it will depend on whether we are buying raw that we are self-developing or if we have arrangements that provide us finished lots. So there’s a lot of things that will influence that. In terms of what that does ultimately to our capital allocation, I think, you have seen us, as we have driven that option percentage higher, we have been generating a significant amount of cash and we have been using that cash to continue to invest in the business and to buy back stock. You saw that we obviously bought back a lot of stock this quarter. Our lens on that doesn’t change, right? So, if we have excess capital and if that’s being generated by a more efficient balance sheet, we will evaluate the needs for that capital and one of those is going to be share repurchases. So I think at the end of the day, it does a couple of things for us. One, it provides us some flexibility and protection from market risk. It yields higher returns and it yields higher free cash that we would use, again, consistently with what we have done over the past 10 years.
Mike Rehaut: Great. Thanks so much guys. Appreciate it.
Ryan Marshall: Thanks, Mike.
Operator: We will take our next question from Rafe Jadrosich with Bank of America.
Rafe Jadrosich: Hi. Good morning. Thanks for taking my question. First I just wanted to ask, compared to prior periods of rising mortgage rates, how quickly would you have seen an impact and then how does that compare to how homebuyers have responded with this most recent spike in rates?
Ryan Marshall: Well, I think, it’s difficult to compare periods of rising rates, because of the factors that are driving those rising rates are so different. And we happen to be in an inflationary environment with an economy that is continuing to run pretty hot. We are seeing real wage growth. We are seeing a low unemployment environment and there’s a real shortage of supply. So there -- the other thing that I think its work highlighting, in this rate environment is the impact of the pandemic and so I think trying to compare to rising rate environment, well, I am sure, you can do it. I think the conclusion will drop will likely not be terrible informative.
Rafe Jadrosich: Okay. That makes sense. And then, can you just give a little more color on the serve initiatives there shift more towards lot of option, do you have sort of time line for the shift to the 65% to 70%? And then, can you just talk about willingness and ability to work with land developers and bankers to shift more towards option contract?
Ryan Marshall: Yeah. So it will take some time. It will be probably the next two plus years that you will see us progressively move there. But history is guide, I think, when we have laid targets like this out for our operating team. And frankly, we shared it with the investment community we have executive against it. We certainly think that we do that here as well, which give us the reason that gives us that we have got confidence to kind of put that target out there. I think it’s very doable. There are number of ways in which will effectuate moving from where we sit today to higher level of optionality, some of that will done with directly with the land sellers. We think that’s arguably the best way to do it. Sometimes we will work with development partners that are actually putting finished lots on the ground for us and there are some other alternative arrangements that you can use to get optionality in the land book as well. So I think you should expect us to probably use a mix of all of those things as we move to more optionality. We think it’s got a lot of benefits in terms of managing risk. But certainly very capital efficient, it helps to drive returns to a better place and we will use that in cash flow for some of the things that Bob highlighted a minute ago, including share repurchases.
Rafe Jadrosich: Okay. Great. Thank you.
Operator: We will take our next question from Truman Patterson with Wolfe Research.
Truman Patterson: Hey. Good morning, everyone. Just wanted to follow-up on that prior question with you all targeting more option land over the next couple of years, I am just hoping, if you look at today maybe versus six months ago, regarding land bankers or landowners, developers that you are optioning from. Have you seen any change in terms of the deals, deposits, interest costs, et cetera or even any sort of change in their appetite to continue doing deals?
Bob O'Shaughnessy: Yeah. Truman, I don’t -- not really, right? I mean, the market, I think, is pretty efficient. We have not seen a reduction in desire. So if we are talking to folks, there is money available. The question for us has always been, can we make the economics make sense and you have seen things tighten a little bit, which is good. For us, again, the goal is to try and create a transaction that yields us an acceptable return and gives us some flexibility and I don’t think that the market has changed appreciably. We are trying to broaden relationships. We are talking to different folks. We still probably start at if it’s a land seller trying to work out a deal with them first. What we are really doing now is saying, okay, if they are not willing to do some sort of option, does it make sense to put a third party between us and the dirt before we close. More to come on that to Ryan’s point. It will take some time. But we are working through it.
Truman Patterson: Okay. Thanks for that. And then, Bob, I believe earlier you mentioned that there’s been some increase in buyer interest and extended rate locks. I am just hoping to understand, have you all proactively gone to the buyers in your back and encourage them to lock, are you introducing rate lock programs? And in a similar light, are you all increasing either deposit escrow requirements given the current market strength in the face of rising rates?
Bob O'Shaughnessy: Yeah. To the latter one, we always seek a fair deposit and we are continuing to do that today. In terms of working with our consumers, we still enjoy a very robust capture rate. We do offer. We think attractive rate lock programs. We have seen people go out a little bit longer. They are locking a little bit earlier. And we are encouraging them to do that, because the rate environment is going to move, it seems and has moved against them. So we have seen, in particular, the sort of the 60-day rate lock environment, which is when people are getting closing dates typically. We have seen a lot of people participating in that.
Truman Patterson: Okay. Got you. But not too much longer than 60 days?
Bob O'Shaughnessy: Yeah. That goes to the individual, candidly. We offer it. We have got long rate locks. But it gets expensive, Truman. So they are…
Truman Patterson: Okay.
Bob O'Shaughnessy: … great for the consumer.
Truman Patterson: All right. Thank you and good luck in the upcoming year.
Bob O'Shaughnessy: Thanks, Truman.
Operator: We will take our next question from John Lovallo with UBS.
John Lovallo: Good morning, guys. Thank you for taking my question. The first one, it sounds like with your community count expectations over the next few quarters and in your current spec production we could see a nice reacceleration in orders in the back half, so just curious your thoughts on that? And then along the lines, the outlook doesn’t seem to include or incorporate any improvement in labor room materials. But if we take a step back, just curious what your view is on that, I mean, how do you assess the probability that we could see some improvement in those areas in the back half and if we could see some potential ramp in production?
Ryan Marshall: Yeah. John, good morning. Thanks for the question. On the community count side, we are dragging a little bit from where we would optimally have liked to have been and it’s mostly around entitlement delays with municipalities. It’s always been hard and it’s taken a long time to get through the entitlement process. I would tell you, cities and city councils and planning and zoning boards, while I think most are back and working, it’s just simply taking longer. So really nothing there that I would highlight other than it’s taken us a few months longer than ideal. In terms of kind of the supply environment, we are operating under the assumption that things are going to continue to remain hard for the balance of 2022, which means we are -- that’s why we have reaffirmed the guide that we gave. I will take you back to the commentary that we gave at the end of Q4, our assumption was that 2022 is going to remain a very difficult supply chain year and we are still there. As I highlighted in my prepared remarks, John, if we are to see some improvement and I’d like optimistically, I think, we have got to start turning the corner soon. That’s mostly going to benefit our 2023 production. We are clearly not there yet in terms of kind of giving guidance. And then, finally, in terms of kind of new orders and more communities and less sales restrictions. I think that all can be interpreted as a positive for the future. But we don’t give forward guidance in terms of orders. So we will -- while we are optimistic, we will report the news when we get there.
John Lovallo: Okay. That’s helpful, Ryan. And then just lastly, on the sequential price increases of 1% to 5%, can you just remind us, how does that compare to the last couple of quarters?
Ryan Marshall: It’s very similar. Not a lot of change. It was a strong quarter and pretty similar to what we saw in Q3 and Q4 of last year.
John Lovallo: Great. Thank you, guys.
Operator: We will take our next question from Stephen Kim with Evercore ISI.
Stephen Kim: Yeah. Thanks a lot, guys. My observation is that investors are just really struggling to understand how in the face of such higher rates, the demand is still holding up. And Ryan, I thought you did a good job of clarifying that, it’s really just that the supply is so constrained that the demand can come down, but it will still be greater demand than supply. So just to push on that a little bit more and to clarify, when you talk about rate locks, which is something that we have been hearing builders talk a lot more about in recent days, I just want to confirm that the orders that you are taking and that you have taken, let’s say, over the last month, forgetting about the closings, but the orders, those buyers are -- but today’s buyers are qualifying at today’s rate and if they are locking, they are basically at today’s rate. So there’s nothing about the orders today that reflects an obsolete rate environment. I just wanted to have you confirm that for us?
Ryan Marshall: Yeah. Stephen, that’s exactly right. Buyers that are purchasing today or purchased in the first quarter, we qualified them at the rate when they applied for a mortgage. It’s part of the reason that Bob touched on, the comment that we made about stress testing our backlog, those buyers would have qualified at whatever rate was there in a prior period. And largely, those buyers are still able to qualify and for the ones that are maybe a little tighter. We have got programs and things that we can do to help get them over the hump. But to your question, Stephen, and I think the most important thing is, yeah, the buyers that are signing up today are qualifying in today’s rate environment. And the reason that they are locking or doing longer rate locks is because they are making the trade between the cost of that forward longer term rate lock against the volatility that they think might play out in the interest rate environment.
Stephen Kim: Yeah. I totally get that and I think that’s super important, because we have been getting some people some conversation, where I think people got a little confused about that. So thanks for clarifying. The second question relates also on the rate situation in incentives. So one of the things that I have been wondering about is that, as you have seen the rates move up and you have seen cycle times extended. In many cases, you might have a situation over the next, let’s say, a couple of quarters where you have buyers who rate lock expired or they didn’t rate lock and the home is closing later than it ordinarily would have exposing them to a higher rate when they close. And so I am wondering, does your -- it sounds like today, rate locks and things like that are being borne by the buyer. But when it comes to the closing table, does your gross margin guidance assume that there may be some increase in sort of last minute incentives, like maybe a rate buy down or something due to this sort of unusual circumstance or is that -- and is that something you envisioned? Just trying to get a sense for how that might be factored or might be an issue as we go forward and to what degree it’s been contemplated in your gross margin guidance?
Ryan Marshall: Yeah. Stephen, there are certainly kind of one-off scenarios where we have to work through some kind of a challenging situation with the consumer. We pride ourselves on outstanding customer experience and doing the right thing for the consumer, which by and large, I think, we do always. The buyers that are in backlog have got tremendous backlog -- tremendous equity built up based on when they purchased. They are excited to close and so there’s not really a need for a lot of negotiation at the closing table. They want to be in their homes. They have got tremendous value built up. They are closing. So the -- the gross margin guide that we have given incorporates all of the information that we have, and kind of what we would expect to play out over the coming quarters and the balance of the year and it’s a healthy gross margin, as I think, you can probably appreciate.
Stephen Kim: Oh! Yeah. Absolutely. Well, great. Thanks for the help. Just one observation, your comment when you said about half of your land is pre-pandemic. If -- just making sure that, that’s half of your controlled land, which means that basically all of your owned lots, the effective equivalent of all of your owned lots are pre-pandemic. It’s because about -- you have about half of your lots controlled, which are also owned, right, actually a little less than that, right?
Ryan Marshall: Yeah. Stephen, that’s fair.
Stephen Kim: Okay. Thank you, guys.
Operator: We will take our next question from Deepa Raghavan with Wells Fargo Securities.
Deepa Raghavan: Hi. Good morning, everyone. Thanks for taking my question. There’s a lot of talk on supply chain constrain, how it’s getting better, in fact, a week elongated. But even with all of this, your closings came in above your high end of guide. I am curious was there anything that particularly drove the beat, like did you find additional resources quicker than expected, maybe had better work around or was just maybe things like Omicron or weather were just not as bad as you anticipated when you originally guided?
Ryan Marshall: Well, look, we are slightly on the high end and so high end of our guide, which we are thrilled with. I think it’s more a testament to the strength of our operations team, our construction team that really work incredibly hard to deliver homes in a tough environment and it’s hard out there. I think we have done a better job based on being in this environment now for a year, probably, going on almost two years that we have probably got better forecasting methodologies and assuming how and how quickly things are going to move through the cycle. But it continues to be tough out there, but that’s not taking anything away from our construction team that I think really knocked it out of the park.
Deepa Raghavan: No. That’s fair. So, yeah, it was good execution. No doubt. But I was just curious if the guide was set a little conservatively to begin with. Anyways, my follow-up is on, again, supply chain issues, but more categories based. Is any of your categories like active levels versus first-time buyer experiencing any tougher supply chain issues versus the other, just given that some products maybe perhaps unique to some categories or is it similar level of constraints? And also, should we -- if and when we go into a market slowdown near-term, can you talk through which of these categories you think you can take the most share in? Thank you.
Ryan Marshall: And to your first question on are there particular supplies? No. I think it’s consistent across buyer groups and it’s kind of the same commodities, the same items that continue to see constrained things that involve microchips are hard to come by. There are some commodities, some lumber components that are difficult for sure. So, but in terms of differences between buyer groups, I wouldn’t highlight anything. As for kind of are there consumer segments where we could take share. I would tell you, we are looking to grow our company across the Board. Our mix of business today is exactly where we want it positioned and so as we look to grow the company, we will look to do it equally across all consumer segments. I’d highlight that our Del Webb brand remains the most recognized and powerful brand within the active Adult Consumer Group. And so we like what we are able to do there. Similarly, we like the gains that we have made in the entry level consumer space with our Centex product, which that product is mostly being sold or started as a spec home and sold just prior to the home being finished.
Deepa Raghavan: Thanks very much. Good luck. I will pass it on.
Operator: We will take our next question from Carl Reichardt with BTIG.
Carl Reichardt: Thanks. Good morning, guys. Deepa actually asked one of my questions, so I just have one. I wanted to ask how traffic trended during the quarter and into April. And then how much does it matter? If interest lists are heavy relative to what you can use and you are using best and final offer pricing more frequently and more Internet marketing, is traffic still the leading indicator of sales that we have all used to think it has been. I am just interested in your perspective on that and that’s all I got. Thanks, guys.
Ryan Marshall: Yeah. Carl, I think, to your point, traffic is not as good an indicator of the strength of the market as maybe what it used to be. Most of our communities don’t have available inventory that you can buy off the lot, so to speak. So some of the things that we are really paying attention to today is the traffic to our website, virtual visits, in addition to the customers that actually come into the stores or the model parks physically. So it’s important, trust me, we pay attention to it, it’s something that I watch on a weekly basis, what’s going on with our traffic. But it is a little bit different right now compared to how it used to be. The difference maybe between now and pre-pandemic is the virtual traffic, which is ridiculously strong compared to maybe a prior cycle.
Carl Reichardt: And how was walk-in over the course of the quarter, Ryan, and into April?
Ryan Marshall: I don’t have those numbers. Does that walk-in, Carl, you were asking...
Carl Reichardt: Walk-in. Walk-in. Just what we consider old school traffic, let’s say.
Bob O'Shaughnessy: Yeah. It’s interesting, because of everything Ryan just said, that is relative to pre-pandemic good, but declining a little bit and mostly because I think people know there’s no inventory to look at. So they are not coming into the stores often but they are still searching for homes and literally and figuratively. Many places have such limited lot releases that there’s not anything to go look at.
Carl Reichardt: Okay. Thank you, Bob. Appreciate it. Thanks, Ryan.
Ryan Marshall: Yeah.
Operator: And ladies and gentlemen, this concludes our question-and-answer session for today. Mr. Zeumer, I will turn the call back over to you.
Jim Zeumer: Great. Appreciate it. Thank you, Abby. Appreciate everybody’s time today. We are certainly available for questions as we go through the remainder of the day and we will look forward to speaking with you on our next call. Thank you.
Operator: This concludes today’s conference call. You may now disconnect.
