PulteGroup, Inc. (PHM) Q4 2020 Earnings Report, Transcript and Summary

Good morning, and welcome to the Fourth Quarter 2020 Pultegroup, Inc. Earnings Conference Call. [Operator Instructions]. Please note, this event is being recorded. I would now like to turn the conference over to James Zeumer, Vice President of Investor Relations and Corporate Communications. Please go ahead.

Thank you, Andrew, and good morning. I'm pleased to welcome you to PulteGroup's Fourth Quarter Earnings Call. For the period ended December 31, 2020. We appreciate your time this morning and offer belated best wishes for the new Year. I'm joined on today's call by Ryan Marshall, President and CEO; Bob O’Shaughnessy, Executive Vice President and CFO; and Jim Ossowski, Senior VP of Finance. A copy of this morning's earnings release and the presentation slides that accompany today's call have been posted to our corporate website at pultegroup.com. We'll also post an audio replay of this call later today. I want to highlight that we will be discussing our reported fourth quarter numbers as well as our results adjusted to exclude the impact of certain reserve adjustments and tax benefits recorded in the period. A reconciliation of our adjusted results to our 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. Also, 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?

Thanks, Jim, and good morning. I appreciate everyone joining today's call. I hope that your New Year has started well and that you are -- and that you remain healthy and safe. It goes without saying that COVID-19 and the resulting challenges made 2020 a year, unlike any that we've experienced before. Let me just say right up front that I'm extremely proud of how our entire team responded and how our organization remain engaged and focused during some very difficult times. Thanks to the sustained efforts of our dedicated team, we successfully navigated through a year that started strong, slam to a halt and then accelerated into the strongest demand environment this industry has experienced in more than a decade. As you read in this morning's press release, PulteGroup completed an exceptional year by delivering outstanding fourth quarter results that included a 24% increase in orders, a 220 point increase in gross margin and a 31% increase in adjusted earnings per share. We also ended the quarter with $2.6 billion of cash and a net debt-to-capital ratio below 2%. Reflecting a lot of hard work by an amazing team PulteGroup realized a 6% increase in full year closings to 24,624 homes and a corresponding 7% increase in full year home sale revenues to $10.6 billion. Benefiting from our ability to expand homebuilding gross and operating margins, along with dramatic gains in our financial services business, we converted the 7% top line growth into a 29% increase in pretax income of $1.7 billion. Our outstanding results extend beyond our income statement as we generated $1.8 billion in operating cash flow in 2020, after investing $2.9 billion in land and development during the year. Beyond investing in land, we increased our dividend by 17%, effective with the payment we made this month and repurchased $171 million of our common shares in 2020, despite having suspended the program for 6 months because of the pandemic. I'm also extraordinarily proud to note that consistent with our focus on generating high returns over the housing cycle we realized a 23.7% return on equity for the year. With 2020 complete, we enter 2021 in a strong financial position and with numerous opportunities to drive further business gains. Obviously, we can't control how the pandemic plays out, but we are optimistic that the multiple vaccines getting distributed mean that we can see a light at the end of this long tunnel. Bob will provide specific guidance as part of his comments, but let me offer a view of how we are looking at the business and how we plan to operate in the year ahead. We expect a strong demand environment, which the housing industry experienced for much of 2020 and in reality, for many quarters prior to COVID, can continue well into 2021. We said for years that we thought housing starts needed to be around 1.5 million to meet the natural demand created by growth in population and household formations. We finally reached 1.5 million starts in 2020, but we have underbuilt relative to this number for years. Given this unmet need and the potential mix shift in demand toward more single-family and away from apartment living, we believe demand can remain strong going forward for our business. Beyond the demographic tailwind, we also believe that the pandemic has caused a permanent increase in the number of people who will be working from home full or at least part time. Such a shift has profound implications in terms of what people need from their homes as well as where their homes can be located. For example, we believe a remote working dynamic expands the buyer pool because it can allow people to purchase more affordable homes in further out locations. At the same time, working from home has the potential to increase the intent to buy new homes, which offer floor plans and technology features that better meet the needs of today's homebuyers. With such a strong demand environment, it works to our advantage to be among the nation's largest builders with access to land, labor and material resources. We enter 2021 with more than 15,000 houses in backlog 180,000 lots under control of which half are controlled via option and long-standing relationships with suppliers and trade partners. The combination of these factors should allow us to increase 2021 deliveries by more than 20% over last year. As we've demonstrated over the years, I am confident in our organization's ability to operate the business successfully and to get homes built. But I do think it's fair to acknowledge that there are points of friction in the system. Labor remains tight, although the change in administration may allow for some relief, assuming immigration policies are eased. At the same time, product manufacturers are battling supply chain issues and the occasional COVID-related disruption within their plants. Although I must say our suppliers have been tremendous partners, going above and beyond in many instances to provide the materials we need. Given high expectations for the company's operating performance and our balance sheet strain at year-end, I believe we are exceptionally well positioned to execute on all of our capital allocation priorities. More specifically, we are targeting land acquisition and development spend of $3.7 billion in 2021. This is an increase of roughly $800 million over our 2020 investment, but we think appropriate given the growth in our operations. Beyond our expected land investment, we have made great progress in planning for and selecting the location of our next off-site manufacturing plant. We still have a few details to work out with the owners of the sites under consideration but we hope to finalize a plant agreement within the next couple of months and then begin installing the requisite production equipment later this year. Our ICG operation in Jacksonville has exceeded our expectations so we are excited to get this new plant up and running sometime during the first quarter of next year. Along with investing in the business and continuing to fund our dividend, as you read in this morning's press release, we will be using available cash to pay down $726 million of our outstanding debt in the first quarter. And finally, we will continue to return excess funds to shareholders through our share repurchase program. In response to the uncertainties caused by the pandemic, we had suspended share repurchase activities during the second and third quarters of last year. As detailed in our press release, we resumed the program and repurchased $75 million of stock in the fourth quarter, bringing our full year total to $171 million. We have repurchased more than 1/3 of the company's shares since initiating the program, and we expect to remain an active buyer of our shares going forward. Housing demand was outstanding in the back half of 2020, with strength across all geographies and buyer segments. And I'm certainly pleased to report that this strength has continued unabated through the first few weeks of January. The housing industry has been extremely fortunate in being an economic engine, but we do not take this for granted, nor will we forget how devastating COVID-19 has been for thousands of businesses and millions of people. It is certainly our hope that we are rapidly approaching the end of this pandemic. Let me now turn the call over to Bob. Robert O’Shaughnessy: Thanks, Ryan. Good morning, everyone, and let me add my best wishes and express my hope that we can all navigate the coming year in health and safety. As indicated in our press release, our fourth quarter financial results were impacted by the following items: a $16 million net pretax benefit from adjustments to insurance-related reserves; a $22 million pretax charge from adjustments to financial services reserves; and a tax benefit of $38 million resulting from energy tax credits and deferred tax valuation allowance adjustments. Where appropriate, I'll reference the impact of these items during my review of the quarter. For our fourth quarter, home sale revenues increased 5% over last year to $3.1 billion. The increase in revenues for the period was driven primarily by a 4% increase in average sales price to $446,000 and as closings were up 1% to 6,860 homes. The increase in average sales price for the period reflects a strong pricing environment for all buyer groups. We're pleased to report that on a year-over-year basis, our average sales price was higher for our first time move-up and active adult buyer groups. The demographic mix of our closings moved slightly in the quarter and reflects changes caused both by the pandemic and by our strategic investment to serve more first-time buyers. Consistent with these dynamics, our fourth quarter closings in 2020 consisted of 32% first time, 46% move up and 22% active adult. In the fourth quarter of 2019, closings were comprised of 31% first time, 45% move up and 24% active adult. Our net new orders for the fourth quarter increased 24% over last year to 7,056 homes, while our average community count for the period was down 2% from last year to 846. The decrease in community count reflects the slowing of our land activities earlier this year in response to the pandemic as well as the faster close out of communities due to the strong demand environment and related elevated absorption paces. Demand was strong across the entire period and actually accelerated toward quarter end as December orders were higher than November and essentially flat with October. Given the strength of ongoing demand, our divisions are taking specific actions, manage sales pace and production, so our backlog does not get overextended. We are also being thoughtful about adjusting price to help cover rising house costs especially the cost of lumber, which moved significantly higher in the quarter. Consistent with what we experienced during the third quarter, demand was strong across all of our brands, including the ongoing acceleration in demand among active adult buyers. In the fourth quarter, first time orders increased 27% to 2,084 homes, move up orders increased 17% to 2,994 homes, while active adult orders increased 33% and to 1,978 homes. In fact, our Q4 active adult orders were less than 100 units below the all-time quarterly high we reported in the third quarter of this year. After a pause in the first half of 2020, active adult buyers have clearly gotten off the fence. Our fourth quarter cancellation rate was 12%, which is down from 14% last year. Based on the strength of our sales, our year-end backlog increased 44% over last year to 15,158 homes. Backlog value at year-end was $6.8 billion compared with $4.5 billion last year. We believe our large backlog and continued strong demand for new homes has the company extremely well positioned to realize significant year-over-year growth in closings in 2021. At the end of the fourth quarter, we had a total of 12,370 homes under construction, of which 1,949 or 16% were spec. In the fourth quarter, we focused on closing sold inventory, but we're actively working to increase production of sold and spec homes throughout our markets. Our large backlog makes this process a little easier, and we're working closely with our trades and product suppliers to ensure the needed capacity to deliver more homes going forward. With 12,000 -- 12,370 homes under construction at year-end, we expect deliveries in the first quarter of 2021 to be between 6,300 and 6,600 homes. At the midpoint, this would be a 20% increase in closings over last year. This growth rate is in line with what we expect for the full year as we are targeting deliveries to increase approximately 22% to 30,000 homes for all of 2021. Given the strength of our move-up in active adult sales, along with price increases realized across all buyer groups, our average sales price in backlog was up 4% over last year to $448,000. Based on the prices and backlog, we expect our average sales price on closings to be in the range of $430,000 to $435,000, both for the first quarter and for the full year 2021. As we've said in the past, the final mix of deliveries can influence the average sales price we deliver in any given quarter. Reflecting the benefits of the favorable pricing environment and our ongoing work to run a more efficient homebuilding operation, our fourth quarter gross margin of 25% was up 220 basis points over last year and 50 basis points from the third quarter of this year. Driven primarily by increases in lumber and labor, our house costs will be higher in 2021. However, given strong demand conditions, we expect to pass-through most of these costs through increased sales prices. As a result, we expect gross margins to remain high and be approximately 24.5% for both the first quarter and the full year. Our reported SG&A expense for the fourth quarter was $280 million or 9.1% of home sale revenues. Excluding the $16 million net pretax benefit from adjustments to insurance-related reserves recorded in the fourth quarter, our adjusted SG&A expense was $296 million or 9.7% of home sale revenues. Last year, our reported fourth quarter SG&A expense was $262 million or 8.9% of home sale revenues, excluding an insurance reserve adjustment of $31 million last year, our adjusted SG&A expense was $293 million or 10% of home sale revenues. At the outside of the pandemic, we took action to adjust our overheads in anticipation of a more difficult operating environment. Although nearly all furloughed employees have rejoined the company, and we have hired back many of the employees we released, we still expect to realize improved overhead leverage in 2021. At present, we expect SG&A expense in the first quarter of 2021 to be in the range of 10.5% to 10.9%, which is down from 11.9% last year. For the full year, we are targeting an SG&A expense of 10% of home sale revenues, down from 10.2% on an adjusted basis last year. Our financial services operations continued to deliver strong results as we reported fourth quarter pretax income of $43 million, which is up from $34 million last year. It's worth noting that our fourth quarter 2020 results include the $22 million pretax charge from adjustments to our mortgage origination reserves as we settled claims tied to mortgages issued prior to the housing collapse. The increase in pretax income in the quarter from our financial services business reflects continued favorable rate and competitive market conditions, along with higher loan volumes resulting from an increase in mortgage capture rate. Our mortgage capture rate for the quarter was 86%, up from 84% last year. Our reported tax expense for the fourth quarter was $86 million, which represents an effective tax rate of 16.4%, and which reflects the tax benefit of $38 million, resulting from energy tax credits and deferred tax valuation allowance adjustments recorded in the period. In 2021, we expect our tax rate to be approximately 23.5%, including the benefit of energy tax credits we expect to realize this year. Finishing out my review of the income statement, we reported net income for the fourth quarter of $438 million or $1.62 per share. Our adjusted net income for the period was $404 million or $1.49 per share. In the comparable prior year period, the company reported net income of $336 million or $1.22 per share and adjusted net income of $312 million or $1.14 per share. Benefiting from the outstanding financial performance and resulting cash flows generated by our homebuilding and financial services operations, we ended the quarter with $2.6 billion of cash. In addition, at the end of the year, our gross debt-to-capital ratio was 29.5%, which is down from 33.6% last year, and our net debt-to-capital ratio was 1.8%. In the fourth quarter, we repurchased 1.7 million common shares at a cost of $75 million or an average price of $43.69 per share. For the full year, the company returned $171 million to shareholders through the repurchase of 4.5 million common shares at a cost of $37.58 per share. As noted in our earnings release, we expect to pay down $726 million of our outstanding senior notes in 2 separate transactions during the first quarter of this year. First, we'll exercise the early redemption feature effective February 1 on $426 million of senior notes originally scheduled to mature on March 1 this year. In addition, we initiated a tender offer this morning for $300 million of our 2026 and 2027 senior notes, which we expect to complete on February 26. Assuming full execution of the tender, the retirement of the $726 million will save the company approximately $34 million in annual interest charges and on a pro forma basis, lower our gross debt-to-capital ratio to 23.7%. In the fourth quarter, we invested $942 million in land acquisition and development which brings our full year 2020 spend to $2.9 billion. As Ryan mentioned, given our positive view of the market and the expected strong cash flow generation of the business, we currently expect to increase our investment in land acquisition and development to $3.7 billion in 2021. And finally, we ended the year with slightly more than 180,000 lots under control, of which 91,000 were owned and 89,000 were controlled through options. I want to highlight that based on these numbers, we've effectively reached our stated goals of having 50% of our land pipeline controlled through options. And given our guidance targeting 30,000 closings '21 we've also reached our goal of having 3 years of owned lots. Land acquisition can be lumpy, so the numbers could move around, but we remain disciplined in our investment practices and focused on enhancing returns and reducing risks through the use of options. Now let me turn the call back to Ryan.

Thanks, Bob. When I took over as CEO in 2016, there were several areas where I saw an opportunity to enhance our long-term business performance. Among the targets we put in place were to expand first time to be 1/3 of our business, to lower our lot position to 3 years of owned lots, to control 50% of our land pipeline via option, and increase our growth rates while continuing to deliver high returns for our shareholders. Given our 2020 performance and our expectations for 2021, it is gratifying to say that we've achieved these initial goals with this foundational work in place, we can now continue developing an even more successful business as we expand our operations, advancing innovative customer-centric technologies and integrate new construction processes. Our outstanding 2020 results in combination with continued strength in housing demand, also has PulteGroup entering '21 with tremendous momentum. We begin the year with our largest backlog in well over a decade, along with great operating metrics and a strong balance sheet that gives us the flexibility to capitalize on market opportunities. These opportunities include the expansion of our off-site manufacturing capabilities that I spoke about earlier as well as the geographic expansion of our homebuilding operations. I'm sure that most of you saw last week's press release that PulteGroup has established new operations in the Greater Denver area. At the same time, our Raleigh division is extending its reach and establishing a presence in the TRID area of North Carolina, which includes the cities of Greensboro, Winston Salem and Burlington. We have our initial land positions in place, and we're working quickly to increase our lot pipeline in these new areas. We are excited about the opportunities we see in both markets as well as several other cities we are currently evaluating. With our goal to increase closings by more than 20% this year, along with investing $3.7 billion in land and our expansion into new markets, we believe we are well positioned to grow our operations while continuing to deliver high returns. In closing, I'm extremely proud of what our organization accomplished in 2020. The and I want to thank all of our employees for their efforts toward delivering an outstanding homebuying experience and homes of exceptional quality. I also want to thank our suppliers and trade who are working tirelessly to provide the resources needed to successfully run our business. We entered 2021 with high expectations, but I know the pandemic continues to rage and so we will continue to operate our business thoughtfully and safely. Let me turn the call back to Jim.

Great. Thanks, Ryan. We're now prepared to open the call to questions. So we can get as many questions completed as possible during the remaining time of this call. [Operator Instructions]. And now let me ask Andrew to again explain the process and open the call for questions.

[Operator Instructions]. The first question comes from Mike Dahl of RBC Capital Markets.

Nice results. Brian or Bob, I guess first question really is around land investment and in away capital allocation as well. Not to turn our nose up at an $800 million increase in land spend this year, it does seem like you guys are maintaining your typical balance when you're thinking about the debt paydown, the potential for share repurchases. A lot of your peers have started to more significantly ramp up land investment, just given the strength in demand and potentially some shortfalls in community counts coming. How do you think about this current environment and your allocation to land investment relative to your more balanced kind of through-cycle mentality?

Yes, Mike, thanks for the question. A couple of things that I would share with you. Number one, I would orient you to the fact that we've maintained for the better part of the decade that we're running a balanced business through cycle, where we want to invest in land, first and foremost, and grow our business, but there are other parts of capital allocation that we believe create long-term value. We are taking a pretty big step-up in our land spend this year, as I think we've highlighted this morning, going to $3.7 million. It's a big bump from where we were at in 2020. Certainly, there were some delays in '20 that have rolled into '21. But even adjusting for that, we think it's a pretty big step-up. We are going to continue to be very thoughtful and responsible in making sure that we're driving the types of returns that we know create long-term value. We just don't believe that now is the appropriate time to get into -- back into the mentality where all available cash is funneled into land. The last thing, Mike, I'd tell you is that we do -- while we don't peg our land investment specific to this number, we do think about land spend as a percentage of revenue. And we think the numbers that we have allocated and projected for 2021 are an appropriate step up, reflective of what is a very strong market.

Okay. My second question goes to the margin side, and you clearly had success in terms of utilizing price and controlling costs to drive margin expansion. I think you alluded to margins potentially being slightly lower than the 4Q levels and mostly being able to offset the increase in-house costs. Could you just elaborate more on kind of magnitude of the increase in costs, maybe on a per square foot basis or however you want to quantify that, that you're expecting to come through the P&L? And also, if you could share some sort of kind of price per square foot that you've been able to achieve, just help us understand that balance between price cost a little bit better? Robert O’Shaughnessy: Yes, Mike, it's Bob. I think important to remember, we're starting from a very strong margin position and certainly, in the fourth quarter, we got the benefit of some spec sales, and we don't have a ton of spec on the ground today. So as we're looking forward into the year, what we're trying to project is where are the sales prices that we've contracted. But we recognize that our house costs are going up. We are projecting them to be up in the neighborhood of 5% next year in fiscal '21. So that's inclusive of commodity input cost and labor. So a little bit richer increase than we've seen for the past couple of years. Obviously, the market is strong. We think we can get most of that price back. The other thing we are cautious of is affordability, and we want to make sure that we've got pricing that people can actually afford to close on. So our teams are doing a nice job of managing that price equation as we're out in market. So the guide for the year at 24.5% again, reflective of a very, very strong environment. And -- but we do recognize, especially with lumber, having risen so rapidly that there'll be a little bit of pressure on margins with that.

The next question comes from Ivy Zelman of Zelman & Associates.

And congrats on a strong year in the fourth quarter. Maybe, Ryan, you can help us better understand when you think about the $3.7 billion of acquisition land acquisition development, spend, even excluding COVID, we hear a lot from municipality or builders complaining, we want affordable housing, just not in our backyard. And just thinking about some of the constraints on getting lots developed is there anything that can change with maybe whether it's some type of tax incentive to developers? There's a lot of focus on the demand side by the Biden administration. But do you think that it's not a constraint that appears to be and you're overcoming that? Or is there something that has to change to continue to build more shelter for this country with municipalities being a bottleneck?

Yes, Ivy, and thanks for the question. I think you've touched on an item that, frankly, we've been talking about as an industry and as a company for a while, and you hit the nail on the head. I think all municipalities want more affordable housing and shelter as they work to grow their job base and grow their own local municipalities and economies. But you nailed that they want it as long as it's not next door or 2 existing residents or other folks that are already there. So I believe that's more a local issue than it is a national issue and -- but that being said, I do think a tone from the top, from the administration can certainly help to influence what local municipalities do. So look, there are challenges out there, but one of the things that I think we highlighted is our size. And I think the talented team that we have, we're working through what is a challenging environment out there, and we are able to get our land entitled. We are able to get it developed, we are able to get investment. If things were a little easier, I think you could do even more. But we feel very comfortable about the numbers that we've put forward for 2021.

The next question comes from Matthew Bouley of Barclays.

I wanted to follow-up on the margin side. So guiding gross margins up 20 basis points in '21 despite this pricing environment. I'm just wondering if there's any, I guess, other margin headwinds that we should be aware of beyond that increase in-house cost, you just mentioned, Bob. So I'm thinking whether it's the mix of option lands that's come up and maybe now coming through? Or perhaps more first time closings expected? Just what else might be sort of playing into the puts and takes there on that guide? Robert O’Shaughnessy: Yes, Matt, I don't think there's anything really dramatic. Obviously, land is more expensive, each successive lot as the vintage gets kind of worked through, you're bringing more expensive land on as the market has appreciated through the years. So that's a contributor. Other than that, I mean, we've got a very large backlog. We've got pretty good visibility into what our margins are going to be. And in candor, we contracted these houses 3 months ago and so the pricing environment isn't fully reflected in our sales right now. So you see that kind of on a little bit of a lag with us. We actually like that because it puts us in a position where we can understand our house cost going into it when we're contracting. But we do have a little bit of a lag in terms of where the pricing environment is right now versus what is closing for us, for instance, in the first quarter.

Okay. Understood. That's helpful. Second one, just around selling pace. I think I heard you say that December ended up even stronger than November. And correct me if I misheard you, of course. But just obviously, Pulte, like many others, ending the year running faster than usual. Last quarter, you guys talked about sort of intentional slowing of pace. Do you think you have the capacity at this point to see further uptick on selling pace into Q1 as normal? And I guess, I think you mentioned January sort of continued unabated. I guess any additional color there would be helpful as well.

Matt, it's Ryan. We did have a very strong fourth quarter. And you heard correctly, December sign-ups were up over November and equal to what we did in October. And I think for those of you that have been following the industry for as long as you have, that's atypical. Normally, you see a seasonally downturn October to November, November to December. So I think it's reflective of how strong the demand is. And then January is off to a very good start. So we did, in the majority of our divisions manage the number of sales that we were allowing to be sold either via lot releases or price increases or some combination of both. And that's really about making sure that we're matching our sales rate to our ability to produce homes. We've significantly increased the production capacity that we have. So I think we're doing a nice job working through that. And then the other factor that you've got to think about is lot availability. So we factor all of those things into our sales release and our pricing strategy. And all of those elements are reflected in the guide that we've given for the full year. So it's -- look, as I highlighted in some of my prepared remarks, it's a great time to be in the homebuilding business. And I think there are a number of really strong demographic and economic trends that are going to continue to help support this industry.

The next question comes from Stephen Kim of Evercore ISI.

Yes. Good quarter. I was really intrigued by some of the things that give a glimpse into what could be coming. One of the interesting things, I think that you pointed out is that you have a build-to-order model, which suggests that what we saw in the fourth quarter doesn't really fully reflect the environment, which it sounds like it was pretty enormously strong in the fourth quarter. So it looks like that's still yet to come. And so in that vein, I wanted to ask you about your outlook for pricing and, therefore, implicitly margins. We couldn't help but notice that your order price this quarter was extremely strong. And relative to the price that you are forecasting or your outlook for price for the full year next year. I just did a quick analysis of that going back through time. And we have never seen anything like the kind of decline that you're calling for in your full year '21 closing price relative to the order price that you took this quarter. And in your commentary, everything seemed to suggest that there is actual momentum building in price. And so I just wanted to talk to you about what is embedded in that? Is there a significant mix shift of more entry-level communities that you are embedding in that assumption? And are you not seeing what other builders seem to be seeing, which is consumers actually paying up for more options and upgrades, which your BPO model would capture and even a preference for larger homes. Because your guidance would seem to suggest that's not happening nearly to the degree that you're going to have a negative mix shift. It's kind of curious. So I was wondering if you could address that.

Stephen, it's Ryan. Thanks for the question. There was a lot in there to unpack, and I'll try and touch on the key elements. And if I miss anything, we'll come back and grab it in a follow-up. But we are seeing a robust pricing environment, as I think we've highlighted, as it relates to the pricing, the ASP guidance that we've given for the full year, it is being largely influenced by the increasing amount of first-time business that we have coming through our business, along with geographic mix. So as you know, we build in kind of coastal locations like Northern California, Southern California, et cetera. And so the load of closings that come out of those divisions relative to other places in the country can certainly have an influence on ASP. As it relates to pricing and our ability to take price I think, Stephen, you know that we've long talked about our strategic pricing methodology and how that has been a large contributor of the company's outperformance in margin relative to the competition. So certainly, we feel that will continue to be a real strength for the company. We're operating in the same market that I think everyone else is and so there's not really any reason to believe that we wouldn't benefit from the uptake in demand and the ability to push price.

Yes. I certainly would agree with that. It's just that maybe we haven't seen it as quickly in your numbers just because you have a build-to-order model, but that should also allow you to capture, I would think, if anything, a little bit more price. Because you give your comes the ability to option. In that regard, we've seen a couple of other builders report so far that our spec builders and in both cases, we -- well, so far, we've seen margins for the spec builders surprise to the upside even versus what they had thought a couple of months ago. And when we dig into that, some of it, obviously, is pricing, but some of it is also that cost per square foot seems like it didn't go up as much as they might have thought. And part of the reason for that is because they found that they're building somewhat larger homes. And that the somewhat larger homes have an actual lower cost per square foot because there's only 1 kitchen and only 1 roof and all that kind of stuff. So you get more efficiency when you build a slightly larger box. I was curious if you're seeing any of that and if you have incorporated any of that into your thinking about what cost per square foot will be over the next 6 to 12 months?

Yes, Stephen. So we've certainly factored into the guide that we've given what we believe the product mix will be. But within a given community, the offering that you could have -- could easily range from -- just as an example, 2,000 feet to 3,300 feet. Within that, there might be 4 or 5 floor plans, and you don't know what plan the customer is going to choose until they come into the sales office. So we have made some assumptions. I think as we highlighted in our prepared remarks, we're seeing customers do different things based on their current their current living situation, their work from home situation, the need for more space, more space for school, more space for home gyms, et cetera. So there's -- I think there certainly is a story to be told that there are some bigger homes being built. To your point, I'd agree with you, bigger homes are a little bit more efficient. So time will tell. We've factored in what we think are our best assumptions at this point in time, and we'll continue to keep everyone updated as the year progresses.

The next question comes from Michael Rehaut of Jpmorgan.

And congrats on the results. I wanted to circle back to gross margins, and I apologize that this is beating a dead horse a little bit. But just wanted to try to get a better sense of the levers here. And you hit on price. But when you look at the 25% margin in the fourth quarter, it was up a little bit versus the guidance of 24.5%. And now you're also looking for 24.5% in the first quarter and -- of '21 and the full year of '21. So I was just curious, number one, what drove that differential? And if it was more temporary or mix driven per se? And number two, when you think about price versus cost inflation, I think a lot of builders have been looking towards some decent level of gross margin expansion in '21 versus '20. Given your margins being so much higher historically over the last few years than most of the other builders, I'm wondering if there's any upward limitations on taking price from an affordability perspective or a competitive perspective, if that's why perhaps we're not seeing as much expansion in '21 versus '20, just given the higher starting point? Robert O’Shaughnessy: Yes. I think it's apples-to-oranges to a certain degree, in terms of us versus others. So I can't comment on their relative margin performance. And Mike, there's clearly nothing that prevents us from accelerating price if it's available in the market. And if that's expansive to margin, we're going to do it. I think we've demonstrated, and you saw it actually in fiscal '20 versus the prior year, we were up that 25% was up 220 basis points over the prior year. So we're paying attention to market, and we're looking to get every dollar of price that we can. I think in terms of the forward guide, we've got 15,000-plus homes in backlog, right? We kind of have pretty good visibility into what our margin profile is going to look like next year. There is nothing, and I want to be clear about this, nothing that will stop us from trying to expand that margin. But based on what we see today, we want to give you the best estimate we've got. And as I said in answer to an earlier question, we do see vertical construction costs escalating. Lumber, I think everybody is aware of. It's a busy market out there. There's a lot of people selling a lot of houses. We think there'll be some price on the labor side that we'll be asked to contribute for that. So at the end of the day, we are pretty -- we're pleased with our margin profile. We'll seek to try and push it to the extent that we can get more price going forward. And if that more than covers the increase in costs, including land, I think you can see us do that. And there's no message here, but we outperformed in this most recent quarter. If the opportunity is there, we'll seek to do the same going forward.

And Mike, on the Q4 outperformance, I just -- you asked where did that come from, we mixed in more spec inventory in Q4 than we had anticipated. And so there's a good example of we were able to get kind of current market pricing that help provide some outperformance in Q4.

Thanks for that, Ryan and Bob, that was very helpful. I guess, secondly, I just wanted to focus a little bit on community count and sales pace. And your community count in the second quarter, just down a touch year-over-year. Which was relatively positive, I think, versus some of your peers having much greater declines. At the same time, you've made comments, I believe, around -- and correct me if I'm wrong here. But to a degree, perhaps managing sales pace to make sure you're not getting too far ahead of your backlog and allowing your business to operate at a relatively consistent cadence. How should we think about '21 on those metrics? And specifically, community count, if you could give any directional guidance for the first quarter and where we should expect year-end to wind up. And to the extent that you've kind of limited or managed your sales pace, could we expect sales pace in '21 to be more kind of consistent even off of these levels? Obviously, again, you're not seeing in your numbers, maybe the dramatic year-over-year growth on some of your peers. And I'm just wondering if that could actually work towards your benefit as you get through the next few quarters? Robert O’Shaughnessy: Yes. So I think the question sort of is what's the community count for next year? And how are we thinking about sales against that? And the way I think we ask you to think about community count, we obviously had a slowdown in development spend this year, even some delayed AC. We've highlighted that we're going to be investing at a more aggressive rate next year, Ryan walked through that. Where we see it is community count in Q1 of '21 versus Q1 of '20 is down about 5%. And then if you fast forward to your question at the end of the year where do we think we'll be? We'll be down about 5% kind of end of year '21 versus end of year '20 will have some variability in that during the year, and it will be dependent on what's the sales environment like? How quickly are we closing out of communities? And what's the weather like, how does development go? We'll obviously be looking to accelerate communities as much as we can. But the sales environment is going to drive some of that number too. And we are looking at a pretty big step-up in acquisition spend next year, which would obviously contribute to years beyond that.

The next question with apologies to Ms. Zelman, a follow-up or second question for her from Zelman & Associates.

Maybe I thought we hit I scared you away with my last answer.

Yes. No, a follow-up.

It was Zeumer's fault, right?

Yes, Zeumer, right. It was Zeumer's fault, there you go. Just digging in a little bit on the land spend. You think about spending $3.7 billion. Are you spending -- are you fully set up for '22? Or are you still buying for '22? And how far out are you buying? And just give us just the perspective between the margin differential on the option lot versus on the own lot? If there is a differential from a price perspective and margin perspective?

Yes, Ivy, both good questions. We're pretty well set up for most of '22 at this point. Some of the spend that will happen in '21 will influence the back half of '22, but we're mostly set up. So given the difficulties that you highlighted in your first question with entitlements and approvals and things like that, we're largely into 2023 at this point in time. And we've factored that into kind of everything that we're doing. In terms of -- and the second part of your question, I lost my train of thought on that one.

The option -- the option margin or price differential?

Yes. So Ivy -- the thing I or --

I know you focus on returns, and I recognize that. And I see it a faster return, we'd be the option or a better return. But just thinking about the pricing in the market, the land grab right now is pretty heated. So what are you seeing if there's a differential when you're optioning lots and what that may be from an impact to gross margin, even if it's a better return?

Yes. So I don't want this to come across as the nonanswer, Ivy, but you highlighted the most important point, which is we underwrite the return every single deal we do has got very different characteristics depending on who the seller is. As a general rule of thumb though, there is a cost to doing options. They're not free. And we factor that into what the ultimate return is and the overall kind of risk reward balance that we think we're getting for the option. So Bob, anything else you'd highlight on that. Robert O’Shaughnessy: The 1 thing I'd add is that in terms of the optionality, there's a couple of ways that, that manifests self, right? Are you doing a finished lot option transaction or are you tying up a bigger parcel where you're saying, all right, I want 1/3 of the lots today, 1/3 of lot 2 or 3 years from now and 1/3 of lots, 2 or 3 years after that. Remember, we're trying to manage against market risk as much as anything else. And so I don't think that the kind of the step-up is as impactful on margin because of that as opposed to just doing a straight finished lot option deal. So if you're in a master plan because they're getting real-time retail pricing for taking all that risk for you to take just-in-time lot delivery. So I don't know -- if you look at the book, a lot of our transactions are more what I've described as having these are larger lot positions that's just more than we need right now. And so we're paying a little bit for people to carry the land but then we might even be developing the land. It might not even be an option of finished lots. So I don't think it's a deleterious from a margin perspective as some people think sometimes when they're looking at it is exactly the way you just did.

The next question comes from Ken Zener of KeyBanc.

To make sure I was connected. Great quarter. I mean, your leverage is flat. Your returns on capital, or as I look at our returns on inventory, are very high. So you should be investing in your company like you're doing. So I have 2 questions. First, go over your logic for this 50% owned option target and how much does del web legacy land play into that? And then my second question, is you're a build-to-order builder, yet your start capacity is limiting your orders. Perhaps. So what does that mean for your kind of start capacity? I mean, you started about 7,500 homes. We can calculate your starts basically. So what is your 30,000 guidance reflect in terms of where your quarterly capacity is going?

Ken, so I'll maybe take the start capacity question first. And we feel good about how our production machine is running. We have ramped it up almost every single quarter, and we continue to do so. And that's the guide that we've given for full year deliveries are reflective of the pace that we believe our production capacity is on certainly, if we can do more, we'll work to do that, and we think the demand environment is there that would allow us. But there's a lot of moving parts in that, labor capacity, supplier capacity, et cetera. So in addition to that, Ken, and I think everybody knows, we've long believed that the build-to-order model is better for a number of reasons, and it's the 1 that we've chosen to largely employ but specs are a big part of kind of what we do as well, especially with our entry level, lower priced product. And so in addition to building our sold not started backlog, we're also in increasing the number of specs that we have in the system. I don't believe that the build-to-order model is limiting our ability for success because at some point in time, you've got to make a decision about how much you can build. Whether you build that as a sold or you build that as a spec, you still got -- you've got to put the start on the ground at some point in time. So we're in a great time right now. We're excited about the prospects for 2021. And if we can keep some of the wins at our sales here, I think we're going to have a great year. Andrew, are you still there? Who is next in the queue? Robert O’Shaughnessy: The . Is 9:30. Could they have timed it.

Andrew? [Technical Difficulty]. Yes. Jim, I got a confirmation from a couple of folks that the audience can still hear. So it sounds like it's an operator challenge.

So if anybody wants to -- we're still here. So if anybody wants to text me a call or text me a question, we'll do our best to take it that way because I'm not sure where our operator disappear to. I'm not sure at this point in time in terms of technical difficulty, how we're going to solve this. But again, we'll give it another couple of minutes if anybody wants to e-mail me a question or text me a question, I'm happy -- we're happy to answer it. And I apologize for this confusion.

I guess it's just a are this is the conference operator. It looks like we're experiencing some technical difficulties. I'm going to go ahead and take over the call for now. It seems we were in the middle of our Q&A session. Is that correct?

That's correct.

Okay. Our next question comes from Jack Micenko with SIG.

It's always Zeumer's fault, isn't it?

Jack, I think this one, we can actually let Zeumer off the hook. I'm not sure he had anything to do with this. Robert O’Shaughnessy: He was running around with wire cutters, but I don't know what that so now your next in the Q? Jack?

Probably, probably. All right. So we got a huge backlog. You've got great visibility into it. The industry has seen backlog conversion rate come down, not surprisingly coming out of some of the unique things we dealt with in 2020. It looks like the 1Q guide is calling for continued pressure on backlog conversion historically, which tells me there's a ramp in the back half of this year to hit that 20% growth. Can we unpack some of the drivers that I think Bob talked about increasing spec in the prepared commentary but kind of what gives you confidence you can sort of build back some of that backlog conversion in the back half of the year while maintaining margin?

Yes, Jack, it's Ryan. We tend to look at our conversion of work and process inventory as opposed to backlog. So we do have a larger backlog than we ordinarily carry, which is reflective of the strong sales environment. From a production standpoint, we're running very comparable to what we've historically run in terms of work and process conversion. And what I can tell you without giving you specific numbers is the daily, weekly, monthly start rates are increasing, working through that sold not started backlog and the spec inventory such that we feel like the guide that we've given for the full year is very achievable. So it's not necessarily a huge bet on a bunch of incremental spec inventory, which I think you may have been alluding to a little bit. Certainly, we want to put more in there, but it's really reflective of getting through the sold not started backlog in addition to putting some more spec in the ground. Our cycle times are a little elongated, given some of the disruptions in the supply chain. I think the areas where there's some -- a little bit of sand in the gears from a product standpoint or probably fairly widely known. I'd highlight that the relationships we have, the size of our company, the talented procurement team that we have. We've done a really nice job working through that, but it is a challenge that is out there for sure.

And then you've got you've got the 1 plant down in Jacksonville. You're bringing another 1 online, I think early online early '22, right? How should we think of -- where will that show up in the numbers? Is that going to be at a company level, is that going to be gross margin? Is it going to be G&A ratio? Maybe lower warranty reserves over time. Where can guys like outside looking and kind of expect to see the benefit of that in the model?

Yes. Jack, I'll let Bob take that one. And maybe what I'll do is I'll highlight the benefits that we think we're going to get out of these plants. And the reason that we bought the first one, the reason that we're expanding to the second one, we're getting huge increases in our cycle time efficiency, which is a big deal and the labor efficiencies that we're picking up are tremendous as well. You combine those things with the added cost benefits that we're getting, and we're very pleased with how these off-site manufacturing facilities are performing. So as I highlighted in my prepared remarks, Jacksonville's exceeded our expectations. We're on the plant number two. We're in the final stages of site selection and just working through some contract things. So we're excited about the prospect of what the future of this holds, and then I'll let Bob touch on where you can see the numbers. Robert O’Shaughnessy: Yes, Jack, it's in homebuilding. Obviously. And so you'll see, I think, a couple of impacts. One is the contribution from the business itself. It's on the margin line, it's consistent with not a little bit better than our building our homebuilding operation. And then you obviously have the benefit, we believe, in terms of both the cycle time that Ryan talked about. But even some cost benefit to the builder side of the business, so the actual divisions contracting with them. And then there is a cost to do in this, but it's not out of line with the rest of our business. So I think it -- for all intents and purposes, you won't see it impact things materially other than that we get the improved operations that Ryan was talking about.

Operator, I think we have time for 1 more call, if you're still there. One more question if you're still there.

Our next question comes from Susan Maklari with Goldman Sachs.

My first question is really around the active adult business. You saw another nice lift there. Quarter. I think, Ryan, in your comments, you kind of mentioned the fact that it feels like that buyer is definitely out there. Can you just give us a little bit of color on what you're seeing in terms of the demand trends there? How you're thinking about that coming through? And how much of this do you think is really being driven by the fact that maybe the existing market in some areas in the country, like maybe the Northeast and other parts that weren't as strong prior to COVID have really kind of picked up and allow these people to kind of get out of their homes and make that transition?

Yes. Susan, and take the question. I think there's a number of things that are benefiting the active adult buyer right now. One is they were first to kind of go to the sidelines they've certainly got more comfortable figuring out how to buy and figuring out how to make the decisions that they want to make as it relates to the retirement. The strong stock market behavior, I think, certainly plays a factor in that as retirement accounts are our flush. And then finally, the strong resale market has made it a seller's market, and so very easy for that active adult buyer to sell their existing home and move into 1 of our new communities. So our expectation is that the Webb brand will continue to be a big part of our business, and that buyer will continue to perform very well.

Okay. And my follow-up question is around capital allocation. You started to buy back some stock in the fourth quarter. Can you just talk a little bit to how you're thinking about that for '21? And any kind of color you can give there?

Yes, Susan, the stance that we've taken on stock buybacks is that we'll report the news. What we have highlighted is it is going to continue to be part of our capital allocation. We paused for the second and the third quarter given the pandemic. But as you saw in the fourth quarter, we reinitiated a $75 million level. So we will be active throughout 2021. We're not going to provide forward guidance on the amount of the spend rather at the end of each quarter, we'll share with you what we've done.

I think we've now kind of run out of time, and I apologize for the technical difficulties for it. We'll certainly look forward to getting back to everybody over the course of the day. We appreciate your time, and we look forward to talking to you on our next earnings call.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.