PulteGroup (PHM) Q3 2022 earnings call transcript

Jim Zumer, Vice President of Investor Relations and Corporate Communications. You may begin. Great. Thank you, Chris, and good morning. I want to welcome everyone to PulteGroup's earnings call for our third quarter ended September 30, 2022. Joining me to discuss PulteGroup's third quarter results are Ryan Marshall, President and CEO, Bob O'Shaughnessy, Executive Vice President and CFO, and Jim Osowski, Senior Vice President and Finance. A copy of this morning's earnings release and the webcast slides that accompany this call have been posted to our corporate website at PulteGroup. com. We'll also post a replay of today's call later today. As always, I want to alert everyone that today's presentation includes forward-looking statements about the company's expected future performance.

Actual results could differ materially from those suggested by the comments we make today. The most significant risk factors that could affect future results are summarized as part of today's earnings release and within the accompanying webcast 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 suspect that throughout this morning's call, we will find ourselves delineating between the favorable demand environment that existed earlier this year, which drove PulteGroup's third quarter earnings versus the more challenging market conditions we're encountering today. Stating the obvious, the primary difference between the two periods is that mortgage rates have more than doubled since the start of the year to upwards of 7%. Our Q3 earnings reflect the benefits of the strong demand and pricing conditions that existed at the end of 2021 and into the first few months of 2022.

The favorable demand and pricing dynamics which existed at the time are reflected in the 15% or $71,000 increase in the average sales price of closed homes that we reported for our third quarter. Further, even with tight labor and a difficult supply chain, we were able to leverage this pricing gain into a 360 basis point expansion of gross margin and an almost 50% increase in earnings to $2.69 per share. Bob will provide more details on our third quarter results in a few minutes, but it is important to acknowledge the success and recognize the efforts of the entire PulteGroup organization in delivering these great results. If our income statement demonstrates prior demand strength, third quarter order and cancellation rates show the more challenging market dynamics we are operating under today.

As we move throughout the quarter, you could almost see demand ebb and flow with the movement of interest rates. Softness in July home buying demand eased as mortgage rates fell in August The positive trend in demand was short however as interest rates surged higher in September in response to Federal Reserve actions and hawkish commentary from Chairman Powell The pullback in demand was widespread across geographies and consumer groups as potential homebuyers moved to the sidelines, some because they could no longer afford a home, and others because they were unsure if now was truly the best time to buy a home. The impact of consumers dealing with issues of financing or fear also extended to our backlog as cancellation rates increased to 24% in the quarter.

While there are a number of factors influencing housing demand, the rise in mortgage rates has likely had the most significant impact on today's consumers. Based on their commentary, expectations are that the Federal Reserve will continue to aggressively raise rates to control inflation for at least the remainder of 2022 and then likely hold rates higher for longer. Given these market dynamics, we continue to meaningfully adjust our operating practices as we adapt to today's more challenging market conditions. On the sales side, we are working closely with our divisions on a market-by-market and even community-by-community basis to find pricing where buyers are able and are willing to transact.

When demand first began to slow in response to higher rates, incentives in most of our markets were focused on mortgage rate locks and buy-downs. As mortgage rates have moved even higher, incentives have extended to other areas, including more aggressive discounting of standing inventory and price reductions. As we move through the third quarter, absorption paces were choppy, but on average slowed as the quarter progressed. This trend continued into October, although ongoing adjustments to incentives and pricing are gaining some traction with consumers.

We've told our divisions to be strategic in their decision-making, but we need to intelligently find the market and turn our inventory. The reality is that we can't be margin-proud, but rather we need to protect our share of sales within the markets. Housing is front and center in the Federal Reserve's battle against inflation. As the Fed clearly desires, new home sales rates and selling prices are in the process of adjusting lower in response to higher interest rates. With home sales slowing, we are adjusting how we approach ongoing land investment. At the end of the second quarter, we controlled 130,000 lots under options. Given the more challenging demand conditions we face today, we are re-underwriting our land deals using price, pace, and cost assumptions based on current market conditions with a view towards assessing whether expected returns still achieve or exceed our required hurdle As a consequence of these reviews, in the third quarter we canceled agreements accounting for approximately 19,000 lots, or 14% of the lots we held via option at the end of the second quarter.

In taking these actions, we walked away from almost $800 million of future land acquisition spend. No one wants to write off $24 million of deposits and pre-acquisition spend, but the flexibility to exit these transactions reaffirms the strategic importance of building more optionality into our land pipeline. Homebuyer demand clearly moved lower as the third quarter progressed, with the dramatic and ongoing rise in interest rates likely being the biggest concern for most consumers. However, there are certainly other factors at play, including inflation, fear of recession, or increasing concerns about job loss.

Given all of these considerations, it is easy to understand why consumers have moved to the sidelines. Having said that, people still desire homeownership and are prepared to buy when they find a compelling offer. However, operationally, we are appropriately taking a more defensive posture for at least the near term as we work to navigate today's more turbulent conditions. We believe this approach is appropriate today and appreciate that stability, whether talking about mortgage rates, the stock market, or inflation may be what people will need to move off the sidelines and become homebuyers again.

Let me now turn the call over to Bob for a more detailed review of our Q3 operating and financial results.

Thanks, Ryan, and good morning. There's a lot to review this quarter, so I'll dive right in. Home sale revenues for our third quarter totaled $3.8 billion, which represents an increase of 16% over the same period last year. Higher revenues for the quarter were driven primarily by a 15% increase in our average sales price to $545,000. The year-over-year increase in average sales price of $71,000 was driven by improved pricing across all buyer groups, as first time was up 20%, move-up gained 16%, and active adult was up 15%. Unit closings in the quarter increased by 1% over last year to 7,047 homes. It's worth noting that approximately 200 closings that were slated for the third quarter were delayed due to Hurricane Ian as we shut down or slowed operations across a number of our Florida and Carolina markets ahead of the storm.

On a year-over-year basis, the mix of homes delivered in the third quarter changed slightly as 36% were first-time buyers, 38% were move-up buyers, and 26% were active adult buyers. In the prior year, 31% of homes delivered were first-time, 44% were move-up, and 25% were active adult. The shift in mix to more first-time is in alignment with our strategy of having approximately one-third of our business in the first-time buyer space.

Net new orders in the third quarter totaled 4,924 homes, which is a decrease of 28% from last year. The year-over-year decline in orders reflects softer demand, resulting primarily from higher interest rates, as our absorption pace fell to 2.0 homes per month, down from 3 homes per month for the same period last year. Along with the slower pace of sales, our reported net new orders in the third quarter were impacted by a significant increase in cancellations. Our cancellation rate for the third quarter was 24%, which compares with 10% in the third quarter of last year and 15% in the second quarter of this year.

In the quarter, orders among first-time buyers increased 3% over the prior year as sales benefited from a double-digit increase in community count and the availability of quick-move-in homes as the majority of our spec production is in our Centex communities. Orders from move-up buyers were lower by 45% than the prior year, while active adult orders decreased by 31%. Changes in community count did not materially impact order rates among either of these buyer groups.

During the quarter, we operated from an average of 823 communities, which is up 7% from last year. The increase in community count is consistent with our previous guidance and reflects both new store openings and the slower closeout of existing communities. Average community count for the fourth quarter should increase slightly to 840.

At quarter end, our backlog totaled 17,053 homes, which is down 14% for the same period last year. While unit backlog is lower, the dollar value of our backlog increased 3% over the prior year to $10.6 billion due to the rise in our average sales prices.

We ended the third quarter with a total of 23,010 homes under construction, which is up 22% over last year. Of the units under construction, 65% were sold and 35% were spec. Consistent with comments made on prior earnings calls, we have been working to increase our inventory of spec homes, primarily in our Centex communities, to better serve first-time buyers. We continued starting specs in the third quarter as we have continued to see buyer preference for homes that can close in 30 to 90 days across all buyer groups. At quarter end, we were still well below our commonly used metric of one finished spec per community. However, with 8,000 specs in production, we believe we are well positioned to meet demand and to compete effectively in our markets.

Having achieved our targeted level of spec within our production universe, we have now lowered our spec starts and will manage our production to maintain the balance of our spec and dirt inventories with an emphasis on build-to-order production for move-up and active adult consumers. Based on the homes we have in production and current sales rates, we now expect closings in the fourth quarter to be approximately 8,000 homes.

The decrease in expected deliveries relative to our prior guide reflects the challenging sales environment, higher cancellation rates, and the ongoing impact of Hurricane Ian on our Florida operations. To the last point, while damage to PulteG communities in Florida and the Carolinas was limited, municipal resources are appropriately being diverted to the repair and restoration of services at the expense of getting power to new homes and communities.

Based on the mix of homes we expect to deliver in the fourth quarter, we anticipate the average sales price on closings to be in the range of $560,000 to $570,000. At the midpoint of our range, this would be up 15% over last year. Please note that all of the guidance we provide on this call, including ASP, reflects our current best estimate, but cancellation rates and pricing dynamics as we move through the quarter could impact our actual results. For the third quarter, our home building gross margin was 30.1 percent, which represents an increase of 360 basis points over the third quarter last year. Referring back to Ryan's opening comments, our third quarter gross margins benefited from the strong demand and pricing conditions that existed at the end of 2021 and into the first half of 2022.

These conditions supported the double-digit price increases we show in the quarter and allowed us to cover higher material and labor costs, including elevated lumber prices. The strength of demand in that period can also be seen in our sales discounts, which were only 1% for homes closed in the third quarter. By contrast, discounts on new orders taken in the quarter increased 180 basis points over last year to 2.5 percent.

It's worth noting that this increase in discounts is in addition to the higher financing incentives we discussed during our Q2 earnings call.

Financing incentives on new orders in the third quarter were 1.9 percent, which is approximately 80 basis points above last year and our historic average. Given the demand and pricing dynamics we are currently experiencing in the market, in addition to the increase in incentives needed to attract sales, we currently expect our fourth quarter home building gross margin to be approximately 28%. This would represent an increase of 120 basis points over last year, but would be lower sequentially and is down from our previous guide. Given the changing market dynamics, our procurement teams are already having discussions with suppliers and trade partners in an effort to identify opportunities to reduce our land development and house construction costs. However, at this point, any savings we were able to realize would benefit our business in 2023.

In the third quarter, our SG&A expense was $350 million, or 9.1% of home sale revenues. This compares with prior year SG&A expense of $321 million, or 9.6% of home sale revenues. The company remains on track for full year SG&A to be in the range of 9.2% to 9.5%. Given the pullback in buyer demand and expectations that market dynamics will remain challenging for some or all of 2023, We are taking needed actions to better align overheads with current demand.

For the third quarter, higher gross margin and greater overhead leverage helped PulteGroup generate an operating margin of 21%, which represents an increase of 410 basis points over the prior year.

Turning to financial services, our operations continue to face extremely challenging market conditions. In the third quarter, our reported pre-tax income totaled $28 million, which is down from $49 million last year. In the quarter, lower loan origination volumes, driven in part by a lower capture rate, and decreased profitability per loan were the primary drivers of the decline in pre-tax income.

Capture rate for the quarter was 77% compared with 85% last year, as our mortgage business seeks to be competitive but not to chase unprofitable business. Our tax expense for the third quarter was $183 million, which represents an effective tax rate of 22.6%. Our taxes in the third quarter include federal energy-efficient home credits, which were extended as part of the Inflation Reduction Act that was enacted into law in August of this year. In total, PulteGroup's reported net income for the third quarter increased to $628 million, or $2.69 per share. The company's prior year net income was $476 million, or $1.82 per share. In the third quarter, we continued our share repurchase activity, buying 4.4 million shares, or another 2% of our outstanding common shares, for $180 million, for an average price of $41.20 per share.

Through the first nine months of the year, we have repurchased approximately 9% of the shares we had outstanding at the beginning of the year, for $975 million. Along with buying back stock, we invested $1.3 billion in land acquisition and development in the quarter, of which 56% was for the development of existing land assets. As Ryan discussed, in response to changing market conditions, we are re-underwriting every land transaction based on current price, pace, and cost dynamics. We ended the third quarter with approximately 232,000 lots under control, which is down 11,600 lots from the end of the second quarter of this year, due in large part to the deals we elected to terminate. At quarter end, 50% of our total land pipeline was controlled via option, and we continue to work toward our long-term goal of getting 65 to 70%.

While we have terminated a number of transactions, there are land positions that we have under control that we still project to achieve or exceed our required rates of return. As a result, we currently expect to close on such transactions and expect our result in full year land investment to be approximately $4.8 billion, which is in line with our prior guide. Given the change in buyer demand and the resulting impact on the turning of our own land inventory, we currently expect that our land spend will drop materially next year. While we are still in the planning process, our preliminary estimate is that land acquisition and development spend in 2023 will drop by $1.5 billion to approximately $3.3 billion.

Of this spend, we expect that upwards of two-thirds will be for the development of existing land assets. We will provide more details on next year's planned land acquisition and development spend during our Q4 earnings call. We ended the quarter with $291 million in cash and had $319 million drawn on our revolving credit facility. Our drawings under the revolving credit facility were driven primarily by our land acquisition and development spend, an increase in our house inventories as we moved homes through production and the delay in closings related to Hurricane Ian. Our debt to capital ratio at quarter end was 22.5%. Wrapping up, the higher interest rates being orchestrated by the Federal Reserve are achieving the Fed's objective in terms of slowing demand and negatively impacting price appreciation in the market.

While conditions have gotten tougher, I am confident in PulteGroup's competitive position and in our ability to successfully work through this phase of the housing cycle. Now, let me turn the call back to Ryan.

Looking at the tables in this morning's press release, you can see that on a year-over-year basis, our net new orders were lower across the country, although we continue to see relative outperformance in Florida, Texas, and the Southeast. Generally, we are faring better in markets where buyers can still find affordability. In contrast, conditions in our Western markets are clearly more difficult as price appreciation, generally higher selling prices, and the spike in mortgage rates have forced buyers to pause their buying plans.

The softer demand conditions that we experienced in the third quarter continued into October and have likely gotten even more challenging with mortgage rates now pushing 7%. Running a home building company during this part of an economic cycle is complicated, but we are fortunate to have an experienced leadership team that knows how to operate the business. We are taking action to impact the critical areas of the business, including finding price at a community level where we can sell homes. We will do the best we can to protect backlog, but we won't sit on inventory. With the right level of home inventory to meet demand and to compete effectively, Collectively, we are aligning starts with the ongoing pace of sales and remain committed to our bill-to-order model.

We remain disciplined in our approach to land acquisition. It's hard to cancel a land deal that you've worked on for months or even years, but if the return's no longer pencil, then we will walk away. We will work intelligently with our suppliers and trade partners to adjust costs given the new market pricing dynamics. And we will continue to evaluate and adjust our overhead spending and changes in current and expected construction volumes. For all the defensive actions we're implementing, I remain constructive on long-term housing demand. While we expect the coming quarters will be difficult for the industry, long-term dynamics for housing remain positive. If the Federal Reserve just pauses, or if the stock market doesn't swing 5% in a single day, or if inflation starts to ease, that might go a long way toward giving consumers enough confidence to get back into the market.

While we wait for conditions to stabilize, we will be aggressive in managing our day-to-day business to sell homes, efficiently run our operations, intelligently manage land investment, and work to deliver high returns. I want to recognize our employees for their tremendous work in delivering a great third quarter. I also want to call out our teams impacted by Hurricane Ian.

You have done tremendous work taking care of each other and the communities you serve. Before opening the call to questions, I want to provide a quick comment on the second press release we issued this morning. After a 30-plus year career with our company, John Chadwick, PulteGroup Executive Vice President and Chief Operating Officer, has announced his plans to retire in 2023.

John has had an amazing career with our organization and has been instrumental in its success over the years. I know I speak for our board and our entire company in wishing John all the best in retirement. Brandon Jones Senior Vice President Field Operations has been named to replace John effective January 1 2023 as Chief Operating Officer Brandon began his PulteG career 18 years ago as the Director of Operations in Arizona as a senior vice president of the City of Arizona and had a great pleasure to have heard up for the City of Arizona Brandon began his PulteGreer 18 years ago as the director of operations in Arizona, and has held a series of field positions of increasing responsibility, including division President and several markets and area President of our Southeast Area.

John will remain with the company through April of next year to assist with the changeover. We are fortunate to have a deep and talented bench within PulteGroup, and I look forward to advancing the great partnership Brandon and I have built over the years.

Now let me turn the call back to Jim.

Great. Thanks, Ryan. We're 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. And now, Chris, if you will explain once again how to ask questions, we'll get started with Q&A.

Yeah, Carl, I appreciate the question this morning. As I mentioned in my prepared remarks, we've worked through the changing market conditions over the last three to four months. Early on, our incentives were largely financing-related incentives, things aimed at buying the rate down, extended rate locks, things of that nature. We felt early on that we were getting traction with consumers, especially when you could provide interest rates that were sub-5%. In some cases, we were able to even get sub-4% with the incentives.

As rates have pushed up into the 7% range, we're finding those things to be less effective. And so we've really focused the majority of our energy on pricing to what we believe current market conditions are. So, you know, price rollbacks and price drops. We have been strategic in those, Carl, as I've talked about. We've worked to protect backlog as best we can. But, you know, we really feel it's important to continue to move inventory and to maintain the market share that we've worked so hard to get in the market.

It's really those price rollbacks that we've seen get some traction over the last two to three weeks. And so, you know, we do feel, you know, while it's tough, we are encouraged with the activity that we're seeing.

Yeah, we typically don't give that little detail, Carl. You know, what we have seen with CANs is a little bit of a change versus where we were three months ago. So we were seeing churn in the 30 to 60 day. What we have seen is a little bit more cancellation for folks that have been in backlog a little bit longer, and it's that rapid and substantial rate increase from when they signed. So at the end of the day, you know, I think I don't think we're surprised by that, but we have seen a little bit movement from people that have been in backlog a little bit longer. The one comment I would offer to that, Carl, is we have historically seen the lowest can rate out of our active adult consumer.

That's a buyer that's not as heavily dependent on financing. That's been consistent over the years, and the trends that we're seeing today continue to support that.

Well, Steven, let me maybe just start with saying we've got a really outstanding sales and marketing team that has always focused on the basics of working our entire lead funnel.

And that hasn't changed in good market times or even these more challenging market times. So our ability to get relevant and timely messages out to our sales funnel, I'm very confident in our ability to do that. So, you know, we're so fortunate to see rates drop. I know that we can get the right messaging out to let folks know. So, you know, we really emphasize and push with our local sales professionals as well to maintain the relationships with our lead banks and with our interested buyers at a very local and personal level. So, you know, I think there's multiple ways using kind of the big bullhorn of the corporate marketing platform, but you've also got the grassroots local relationships with our sales professionals.

You know, maybe just the last thing is I think the market itself, if we were so fortunate to see rates come back, I think will probably be the greatest marketing machine of any of them.

Steven, Jim will give you the sticks and bricks, and then I'll take the second piece of the question.

Under production, we've got $3,164,000,000, and then we have another $328,000,000 in models for sticks and bricks.

And then, Stephen, as to your question on our level of spec inventory, we've been talking for the better part of the last two to three quarters about our desire to have more spec inventory in the system. Over the last three to four months, as the market has slowed, we've seen a real preference for homes that are able to deliver in the next 30 to 90 days. And that continues to this very moment.

In terms of the inventory we have in our system, 35% of our WIP is spec, and that is right where we want to be. So we feel very comfortable with respect to that. Looking at the finished inventory, we continue to have less than one finished home per active community, which has always been our historical kind of benchmark. So, you know, we also feel comfortable that we're not under any pressure with finished inventory. We continue to see good flow through of our sales rate of specs that are being sold and that are delivering in the near term, which is real positive for us.

And then maybe just the last thing, Stephen, and, you know, you've seen this transition over the last couple of years. As we've moved more of our business to the first-time entry-level product, we've intentionally put more spec inventory into those first-time entry-level communities. And certainly that's where the higher percentage of our spec inventory resides. So, you know, we feel comfortable with that. The last thing, and I highlighted in my prepared remarks, as it relates to forward starts of new inventory, we've significantly slowed that and we're matching that to what our sales rate is. So, you know, we think we've done exactly what we said we were going to do, and we've made additional kind of adjustments based on how we see market conditions at the moment.

Yeah, so in the most recently printed quarter today, you know, third quarter, our incentive load was 1%. On closings. On closings, right. And that, you know, that is a little bit better than last year, 30 basis points better than closings during the third quarter of last year. What we did highlight was on the sales in this quarter, so not the closings, but the sales, that rate ran up to about 2.5%, so running higher. And also that financing incentives, and we talked about this in the second quarter, were up over sales in the third quarter of last year, so that the total load of incentive is up on current sales, you know, by a couple of hundred basis points versus the closings that we had in this quarter.

So then that will influence our business, you know, over the next couple of quarters as those homes close.

Mike, in addition to Bob's comments, I just highlight that as we make price adjustments, those adjustments are made to base price, and so those adjustments aren't going to necessarily show up in the incentives that Bob just described. But we've talked about it for the last several quarters as well. As we're opening new communities, which there are a fair number of those, we've been very intentional in pricing to the current market such that you have what we believe is a more normal incentive load.

Yeah, Mike, there's so much detail behind that, you know, where, what the price points are. You can see, though, our sign-up average price for sign-ups is down by about 6%. That certainly reflects some of the current pricing. You know, you have to be a little bit careful because our signups were a little bit more skewed towards first time, and so mix matters in that.

So I wouldn't want to put a number on X percent down because it really varies by market, by community. But, again, you can see that ASP is likely to come down, and there will be, you know, some margin consequence, and you can see it in the guide that we gave where we're at 28 percent.

And then, Mike, to your margin question, yeah, a lot of that will certainly be next year for homes that are on a built-to-order model. If it was a spec home, then those will show up more likely than not in the fourth quarter, and that is incorporated into the margin guide that Bob gave for the fourth quarter. You know, depending on kind of the nature of the adjustments we've made, you know, some of those incentives also have flown into backlog as we work to protect the backlog and get those homes closed as well. That's also incorporated into the guide for the fourth quarter.

Yeah, without getting into the detail of month by month, I think you heard it in Ryan's prepared comments. The demand equation followed the rate movements, and so you saw a little bit of a dip in rates in August. We saw some activity around that where people came off the fence. As rates progressed higher after that, we saw a relative decrease in demand.

What we're expected to go down next year is because it's getting harder to make stuff work, especially in things that were negotiated more recently. So as that stuff comes to the table, I think we're going to have some questions to answer internally as to whether it still meets our return requirements. You know, the good news is, and, you know, again, it was in Ryan's prepared remarks, you know, the 11,600 lots that we walked away from had a land act spend of $800 million. And if we had bought all that land at a point in time, that might have been, you know, some tough markets that we would have had to work through. So we feel, you know, and Ryan said it, we don't feel good about a $24 million charge.

Having said that, having to work through $800 million of land with, oh, by the way, a lot of development spend on top of that. So we feel like it's actually operating the way we are. As we look at the market, we're trying to get more of that optionality into our book. You know, we've targeted 65 to 70 percent. Again, we're pushing our teams to look for optionality, whether it be in time or takedown.

So I think I don't want to guess at what the market's going to bring to us. We'll work through each transaction as we go.

Yeah, Matt, it was really wrapped up, and I think the prior answer that I gave, you know, as we looked at what will close in the fourth quarter, you know, it incorporates specs that have been sold, some specs that still need to be sold, as well as some adjustments that flowed through to backlog based on pricing adjustments that we made in active communities. You know, those are the big drivers that are influencing the Q4 guide.

You know, the only other kind of piece that I would add is there's a little bit of, you know, continued labor pressure with back-end trades, you know, specifically the finished trades for, you know, what is still a pretty heavy load of inventory that's moving not only through our production machine, I will now turn the call over to management for the PulteGraph You know and it given us you know better ability to have productive conversations with front trades as we work to pull costs back that are responsive to the dynamic environment that we seeing Got it.

Yeah, Anthony, it's a fair question, and I'll go back to what I think we've talked about for years. We really look to maximize return, and so we're focused on both the pace and the price kind of levers. You know, I would tell you we'd like to see more volume than what we're currently seeing, you know, but as I highlighted in our prepared remarks, we're trying to be strategic and take a long-term view that's really underpinned by, you know, what we still see as a very positive housing market. You know, unfortunately, we've had a doubling of interest rates in 10 months, which we've never seen in this country, at least not in the last 40 years.

And, you know, that coming on the heels of an unprecedented global pandemic, it's created, you know, certainly some dynamics that we're being responsive to, but we're not going to overreact.

Anthony, as I highlighted in maybe my previous question, we're continuing to see some back-end labor pressure with the finish trades. And at the current environment, we haven't seen a bunch of progress with cycle times. We're still running right around six months, which is kind of unchanged from where we were in the prior quarter. I wouldn't expect to see any improvement in Q4. There's just too much production still on the machine. I am very focused with our production teams to claw back cycle time in 2023.

So my hope would be by the time we hit Q2, Q3, Q4 of next year, we're starting to see some meaningful quarter-over-quarter improvement as we get back to more typical cycle times. So I'm confident, you know, based on the drop in volume, but also just the healing of the supply chain, which continues to get better and better, you know, that that can become a reality in 2023 and beyond.

Yeah, Ivy, thanks for the questions. Appreciate it. You know, in terms of the cancellations that we're seeing, it's both. We're absolutely seeing buyers that can no longer afford. We're also seeing buyers that still can't afford, but they've gotten cold feet for whatever reasons. And in many cases, they're walking away from pretty sizable earnest money deposits that economically don't make a ton of sense. But that's where you really kind of get into the psychology of they're just not confident in making a purchase. I tell you, as we look at the trends over the last couple of quarters, we haven't seen a noticeable or a significant change in the mix of reasons why folks are canceling. That's been pretty consistent.

In terms of the buyer pool, Ivy, you know, it's understandably less, and I'll specifically focus on who can afford. As the industry is going through some pricing adjustments, I think we are working to get more people into that pool. The pool that's harder to quantify, and I'm not even going to attempt to guess, is how many people are on the sideline because of psychological fear.

Those folks just aren't engaging with us. They're waiting. And as I highlighted in some of my prepared remarks, I think the only way we get that buyer back into the market is through stability.

And, you know, those are unfortunately things that we don't directly control. So, and we've highlighted kind of what we think they are.

Yeah, Ivy, what I'd highlight is we underwrite return. We've never underwritten the margin. And so the screen that we're using in the current environment is we're using current pace and price against the historical return on invested capital screen and risk grid that we've always used. And we have not compromised on that. So the deals that we've elected to walk away from simply don't meet that screen. You know, the ones that we've elected to move forward with, by and large, continue to meet our return-based screen, and that includes margins that are, you know, kind of, you know, all over the board in terms of the historical range that we've typically operated in.

Bob, anything you'd add in terms of kind of underwriting?

So, hopefully, Ivy, that helps in terms of your question.

Yeah, we'll go through the same exact exercise we always have. You know, it's interesting. We highlighted in this call we are out on our revolver, which is, you know, we started borrowing a little bit last quarter. We're actually out on the line today. First and foremost, we'll pay that off. You know, our expectation is that we'll be able to do that in short order. Then what we always do is look at what the next several years, so it's not a point in time capital generation and usages, and we'll consider, you know, investment in land. We've highlighted that we think spend is going to be down. We'll be building and monetizing our backlog, so we think we're going to be cash flow positive.

And so we'll look at the capital base that we've got and what to do. And, you know, we'll have choices. You know, we can, we can, we will obviously continue our dividend. We can look at share repurchases. We will also be looking at our leverage. You know, obviously the run-up in rates makes our debt a little more attractive on a pricing basis. I'm not suggesting we're going to do anything, but we look at these things consistently through time, and we'll consider all those things. But I think you can and should expect to see us in market for equity, and we'll look at any other use of cash at the same time.

Not at all. We're continuing to move forward with it and open those communities. And in fact, some of the communities that we've recently opened have been some of our brightest and best performers, which is really encouraging. I think there's two reasons for that, John. One, these are good communities and good locations that have got great interest lists that we've been working for a long time, referencing back to the marketing comment that was asked a little bit ago. We've also been very deliberate in making sure that we're pricing the current market. Now, we do that all the time when we open up new communities, but especially in light of the current environment, when we're opening, we're making sure that we're opening at a value, and we've seen traction there.

So, you know, communities that are opening today have been in our pipeline for a long time. They were bought right. They were arguably developed at a pretty attractive cost basis as well. And so we can continue to deliver nice margins and, more importantly, good returns out of those communities.

Yeah, I'm looking. We're going to have to get back to you on that. You know, what I can tell you is that it is, again, running at a consistent percentage. We haven't seen a run up in the percentage of people who just don't outright qualify or rejections. So, but what the relative percentage of that is, I don't know off the top of my head.

No, Mike, we actually feel really good about our geographic footprint. You know, we've entered into several new markets over the last three to four years, and we're as confident in those today as we were when we made the decision to go there. You know, a lot of the places that we've entered into in recent years have been places that have had really attractive job growth, and really nothing's changed along those lines. There are also places that are attractive climates. They generally tend to be more affordable places, and they're in locations that are predominantly kind of in the sunbelt. So we think our new market expansion strategy still makes a ton of sense. In terms of our existing markets, we're really happy with them.

I don't know that I have any real additional color to add in terms of the geographies that are doing well versus not, other than what I highlighted in my prepared remarks. The Western markets are the toughest, for sure. I think that's been widely reported from many sources. We are also seeing relative softness in the Northeast, some of the more expensive locales. The Southeast, Florida, Texas, relatively are performing better for a lot of the reasons that I just touched on with my comments on expansion markets.

Kevin, you know, the view that we've had on realtor commissions kind of through time is to be balanced with it. You know, we certainly appreciate when realtors are the procuring cause or, you know, truly bring kind of a buyer into our sales office and help with that process. You know, we've paid, I think, a market competitive broker commission. We're still in the same position today. So, you know, there's certainly, you know, cases here and there where you may have a above average broker commission as an incentive to move a particular property that's got a unique set of circumstances. But broadly, you won't see us as a strategy employ above average broker commissions.

I think it depends. It depends on the market and it depends on the builder. I think there are certain builders that part of their strategy, their marketing strategy, is largely directed toward outsized or above-average broker commissions. So, you know, as the market gets tougher, you're seeing certain competitors that use that as maybe their primary marketing tool. You're starting to see those bigger numbers come into play.

Yeah, Truman, it's really the, you know, we've been talking with all of our trades, but I would tell you the more kind of recent and impactful conversations have been with the front-end trades. You know, so underground plumbing foundation, you know, up through shell, exterior shell, those conversations have been, you know, frequent and helpful. You know, those are the trades that are feeling the slowdown in the industry right now. And so as they evaluate their kind of business situation and kind of the volume that they would like to be doing and what efficiencies look like, you know, we're engaged in what I would tell you are productive conversations.

We need to pull cost out of housing generally. You know, that's our organization and that's our trades as well. I think we can all appreciate that we've seen unprecedented inflation, both in materials and labor, and those costs are real. And so, you know, I think we're trying to take a pragmatic but very intentful approach in, you know, how we try to pull costs out of the system.

Thank you, Truman.

I will turn it over to Jim Zoomer for any closing remarks. I appreciate everybody's time today. Sorry we could not get through all the questions, but we will be available over the remainder of the day. Certainly feel free to call or email. Outside of that, we will look forward to speaking with you on our next call. Thank you.