Good morning, everyone, and welcome to the Q3 2020 PulteGroup, Inc earnings conference call. All participants will be in a listen-only mode. Should you need assistance, please hail a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question you may press star then one. To withdraw your question you may press star and two. Please note, today's event is being recorded. At this time, I'd like to turn the conference call over to Jim Zeumer. Sir, please go ahead.
Great. Thank you, Jamie, and good morning. Pleased to welcome you to PulteGroup's third quarter earnings call. We appreciate your time and hope that you are doing well. 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 slide that accompanied 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. We want to highlight that we will be discussing our reported results as well as our results adjusted to exclude the impact of certain tax credits recorded in the period. A reconciliation of our adjusted results to our reported 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 results. 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 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 quarter report. Now, let me turn the call over to Ryan Marshall. Ryan?
Thanks, Jim, and good morning. Over the past six months, it has grown increasingly clear that new home construction is an economic bright spot and important contributor to sustaining some level of forward movement in the broader economy. We certainly do not take this for granted and appreciate that the daily lives of millions of people continue to be disrupted. As such, we sincerely hope that you and your families remain healthy and are successfully navigating these difficult times. We appreciate your time this morning and look forward to discussing PulteGroup's outstanding third quarter results.
As you read in this morning's press release, gains can be seen throughout our third quarter operating and financial results, including a 7% growth in home sale revenues, a 140- basis- point increase in reported gross margin to 24.5%, a 70- basis- point improvement in overhead leverage, and a 33% increase in adjusted earnings per share. Whether looking at national data or PulteGroup-specific numbers, housing demand remains strong throughout the third quarter. Reviewing our numbers for the period, year-over-year unit orders increased 36% and showed strength across all price points, buyer groups, and geographies. Along with the ongoing strength in our first-time buyer group, we saw a notable pickup among our move-up and, in particular, active adult businesses. Given the potentially higher risks associated with COVID-19, active adult buyers had been a softer part of the market at the onset of the pandemic.
In this most recent quarter, however, net new orders from our active adult communities exceeded over 2,000 signups for the quarter. This is the highest level for any quarter in over a decade. You've likely heard me say before that a robust housing market requires strong demand across all the consumer groups. I believe this is what we are experiencing now, as strength among entry-level and first-time buyers is enabling demand at the higher price points. Further, given limited housing supply and the ongoing price appreciation, existing homeowners can more easily sell their existing home and move to the next property. Given the positive supply and demand environment, we have taken the opportunity to raise prices across most of our communities.
In fact, more than half of our divisions increased prices across their entire portfolio with the typical increase realized in the quarter being in the range of 1%-3%. Based on recent conversations, it's clear that market pricing dynamics are an important topic of discussion for investors and analysts these days. PulteGroup is typically a price leader, but we are always looking for the right balance of price and pace. Affordability is still important as well, so it is important that we not become overly aggressive and move prices too fast or too high, particularly within first-time communities. Given market competition and normal affordability constraints among entry-level buyers, pushing prices a few thousand dollars too high can stall sales very quickly. The outstanding demand environment has in turn created a production environment that I believe favors the big builders.
Right now, builders who have an existing land pipeline, the ability to develop incremental lots, and can maintain access to trade resources have a competitive advantage in the market. I will tell you that our scale was instrumental in the company exceeding its closing guidance for the quarter, and as Bob will discuss, in enabling us to raise our closing guide for the full year. PulteGroup runs a highly efficient construction operation, but market dynamics are such that we must be focused and disciplined in how we are approaching the business in the current operating environment.
On the land side, we have geared up land acquisition and development activities after suspending much of this work earlier in the year when COVID-19 first hit. For example, our land acquisition spend of $463 million in Q3 was double that of this year's second quarter and almost 70% higher than the same period last year. While much of our land investment in the quarter was the completion of transactions we delayed at the outset of the pandemic, we are identifying opportunities to selectively increase land spend where appropriate. In addition to increasing our land spend, I would highlight that we continue to make our pipeline more efficient, with 47% of our lots are now controlled via option.
It is important to note that it takes longer to ramp up land production than it does to slow it down, especially in today's environment, but we have a solid land pipeline that will allow us to continue to run our business efficiently. Consistent with our return focus, we are intelligently manning our existing lot inventory to support ongoing sales and minimize gap outs while driving high returns on invested capital. On the house side, our construction and procurement teams are doing a great job keeping the production machine running, as demonstrated by our improved closing volumes. At the risk of sounding repetitive, this day-to-day work is also not without its challenges.
I would highlight that labor is tight across all markets and can be adversely impacted by pandemic-related absences, so we are working closely with our trades to help ensure resources are available in the near term and as we work to grow volumes in the future. That said, the building materials environment is even more dynamic these days. For example, our Q4 deliveries will feel the initial impact from this year's spike in lumber costs. While wood prices appear to have rolled over, we will be dealing with the effects of higher lumber costs for several quarters. Beyond wood, we have had to manage through sporadic disruptions on everything from appliances and cabinets to plumbing fixtures and windows. I can't compliment our procurement teams enough for their efforts to minimize construction delays.
In addition to having an outstanding organization to help us manage through today's market conditions, we are working from a position of operational and financial strength. We ended the quarter with a backlog of almost 15,000 homes and a cash balance of $2.1 billion. Given these numbers, we are clearly well-positioned to deliver strong fourth quarter results while having the financial strength and flexibility to pursue our strategic business objectives as we head into 2021. In conclusion, we are extremely pleased with our third quarter results and with how our business is positioned heading into Q4 and the year ahead. While we grow increasingly confident in the sustainability of housing demand, we are well aware that we are operating within a global pandemic that is not really under control. As such, we continue to adhere to the business strategies and disciplines which have guided our business for the past decade.
We remain focused on achieving high returns over the housing cycle while intelligently growing our business and allocating capital consistent with our stated priorities of investing in the business, paying our dividend, and returning capital through share repurchase. To that last point, we have reinstated our share repurchase program beginning in the fourth quarter. As is our practice, we will provide an update on our purchase activities when we report our fourth quarter earnings. Now let me turn the call over to Bob for a more detailed review of the quarter. Bob?
Thanks, Ryan, and good morning, everyone. In any market environment, our third quarter results were impressive, but given the backdrop and challenges of a global pandemic, I think the results were exceptional. As has been our practice this year, I'll be providing a high-level review of the quarter, along with color on any impact COVID-19 had on our operations and on our outlook for the business. Looking at the business, our home sale revenues in the third quarter were up 7% over last year to $2.8 billion. The higher revenues for the period reflect a 4% increase in closings to 6,454 homes, in combination with a 3% increase in average sales price to $438,000. I would highlight that closings for the quarter came in slightly higher than our prior guidance, as we were able to sell and close more spec units than we anticipated in the period.
Our higher average sales price in the third quarter was driven by higher prices within our move-up and active adult communities. First- time pricing was down slightly from last year, but this was driven by mix rather than an erosion in sales price. Demographic mix of third quarter closings was 30% first time, 45% move up, and 25% active adult. These numbers compare to last year's mix, which included 28% first time, 46% move up, and 26% active adult. In the third quarter, our net new orders increased 36% over last year to 8,202 homes. Our average community count for the period was 892, which is an increase of 3% over last year. Average community count for the quarter was higher than our prior guidance, since we were successful in accelerating community openings that had been anticipated to incur in the fourth quarter.
Looking at sales activity during the quarter, demand and our volumes were relatively consistent across all three months. However, our September orders were modestly impacted by the fact that the majority of our divisions took some level of action to manage signup pace. Those actions were taken to properly manage our projected production environment with a view towards meeting customer expectations and reducing the risk of input cost inflation. In addition to the absolute increase in orders, we are extremely pleased by the strength in demand across each of the buyer groups. For the quarter, first-time orders increased 39% to 2,443 homes. Move-up orders increased 39% to 3,697 homes, and active adult orders were up 28% to 2,062 homes. As Ryan mentioned, our active adult orders were the highest we've reported for any quarter in the past decade.
Our third quarter cancellation rate of 12% was down from last year's 15%, and our second quarter rate of 19%, and much more consistent with recent historic trends. As with our orders, the cancellation rate was stable over the quarter. Given the outstanding order activity in the period, we ended the third quarter with 14,962 homes in backlog. This is up 29% over last year. Our backlog value is up an even more significant 32% to $6.6 billion. It is our highest ending backlog value in more than 10 years. We ended the quarter with a total of 11,451 homes under construction. Of the homes currently under construction, 1,755 or 15% were specs.
Our spec inventory is down from last year and down sequentially from the second quarter due in large part to the pause in spec starts we put in place at the outset of the pandemic, coupled with the robust level of demand we've experienced during the last several months. It is certainly our intent to increase spec starts and rebuild our inventory over time, but our near-term focus remains on delivering our backlog of sold homes. Based on the 11,451 homes under construction at the end of the quarter, we expect to deliver between 6,600 and 6,900 homes in the fourth quarter. As a result of the improved outlook for fourth quarter deliveries, coupled with the strength of our third quarter deliveries, our guidance for full-year deliveries has also increased to a range of 24,350-24,650 homes.
Given the average $441,000 selling price of homes in backlog, we expect the average sales price on fourth quarter closings to be in the range of $440,000-$450,000. As always, the final mix of deliveries can influence the average sales price we ultimately realize in a quarter. Continuing down the income statement, we are extremely pleased to report that our third quarter gross margin was 24.5%. This is an increase of 110 basis points over last year's adjusted gross margin, and a sequential gain of 60 basis points from the second quarter of this year. Our margins continue to benefit from the strong demand environment, which has allowed us to raise prices and/or lower incentives in many of our markets. In the quarter, sales discounts decreased 70 basis points from last year to 3.1%, and fell 40 basis points from the second quarter of this year.
As Ryan mentioned, our future closings will begin feeling the impact of materially higher lumber costs, but we believe we're in a position to maintain gross margins at current levels over the balance of the year, and expect gross margin in the fourth quarter to be consistent with the 24.5% realized in Q3. On a dollar basis, SG&A expense in the third quarter was $271 million, which was comparable to last year. Given the increase in 2020 closings and revenues, we were able to improve SG&A expenses and percentage of home sale revenues by 70 basis points to 9.6%. Given our third quarter results, we now expect full-year adjusted SG&A to be in the range of 10.1%-10.3%, which indicates overhead leverage in the fourth quarter is expected to be consistent with our Q3 results on a percentage basis.
Gains in overhead leverage in the quarter and for the year are being driven in part by the actions we took earlier in 2020 to lower expenses in response to COVID-19. Based on the rebound in sales activity compared to our expectations at the time we took those actions, we have reinstated nearly all the employees we furloughed. We have also begun to selectively rehire personnel to maintain proper staffing levels within our sales, construction, and financial services operations. While we had always assumed furloughed employees would be retained, the costs associated with new or rehired personnel have also been included in our SG&A guidance for 2020. Moving over to financial services, third quarter pre-tax income effectively doubled over the prior year to $64 million.
As has been the case for the prior two quarters, the increase in profitability reflects a favorable margin environment, higher loan volumes resulting from growth in our home building operations, and higher capture rates. Our mortgage capture rate for the third quarter was 86%, compared with 84% last year. Looking at our taxes, income tax expense for the third quarter was $68 million. This represents an effective tax rate of 14%, which is down from an effective tax rate of 25.4% last year. Our rate for the quarter was lower than last year because of energy tax credits recognized in the current period. Going forward, we continue to expect our tax rate to be approximately 25%, excluding any discrete permanent differences like the energy tax credits that may arise.
Completing my comments on the income statement, our reported net income for the third quarter was $416 million, or $1.54 per share. Excluding the income tax benefit related to the energy credits, our adjusted net income was $363 million, or $1.34 per share. Our prior- year net income for the third quarter was $273 million, or $0.99 per share, with an adjusted net income of $280 million, or $1.01 per share. Switching to the balance sheet, our strong financial performance and resulting cash flows allowed us to end the quarter with $2.1 billion of cash and a net debt- to- capital ratio of 9.6%. On a gross basis, our debt-to-capital ratio was 30.8%, down from 33.6% at the end of 2019. As previously discussed, we slowed our business investment activities in the second quarter as we assessed the impacts of COVID-19.
Having become more comfortable with the long-term trends for housing demand, we increased our land acquisition and development spend in the third quarter to $843 million. Some of this investment represents spend that had been delayed, we remain confident that we'll achieve our plans to invest $2.7 billion in total land acquisition and development in 2020. We ended the quarter with 171,500 lots under control. As Ryan also mentioned, we are extremely pleased to report that 47% of these lots are controlled via option as we continue to make progress toward our goal of having 50% of our lots owned and 50% under option. Let me now turn the call back to Ryan.
Thanks, Bob. Let me offer a few final comments before opening the call for questions. The strong demand that we experienced throughout the third quarter has continued into the first few weeks of October. At a very high level, we see demand continuing to benefit from a number of factors, including exceptionally low interest rates, the ongoing movement of millennials into home ownership, some level of desire to move away from urban centers. With COVID-19 forcing houses to now serve as home, office, school, gym, entertainment center, and countless other functions, our ability to design homes that can meet the expanded needs of today's buyers gives us yet another competitive advantage in the marketplace. Before closing the call today, I want to make sure that we recognize and thank our employees for the tremendous work that they did in the quarter and throughout 2020 thus far.
This has been a year unlike any other we've experienced. As a group, our team has done an outstanding job adapting to changes in both their professional and personal lives while continuing to deliver a superior experience to our home buyers. It's their commitment to our customers and to each other which allowed PulteGroup to again be certified as a Great Place to Work and to be recognized as one of the 2020 Best Workplaces for Women by Fortune Magazine and Great Place to Work. In a world where the competition for the best talent is fierce, we view the strength of our culture as an important competitive advantage. Finally, many of you know and have spoken with Deb Still, the President and CEO of Pulte Financial Services. Deb is an acknowledged leader in the mortgage industry and was just named one of Denver's Most Admired CEOs of 2020.
We want to publicly congratulate Deb. We are truly fortunate to have her as a senior leader at PulteGroup. 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. Jamie, if you'll now open the queue, and we'll get started.
Ladies and gentlemen, we will now begin our question and answer session. Once again, to ask a question you may press star and the one using your touch-tone telephone. If you are using a speakerphone, we do ask that you please pick up your handset before pressing the keys. At any time that you would like to withdraw your question, you may press star and two. Once again, that is star and then one to join the question queue. Our first question today comes from Michael Rehaut from JP Morgan. Please go ahead with your question.
Thanks. Good morning, everyone, and congrats on the results. Hope everyone is safe and healthy out there. First question I had was, and I apologize if I missed this earlier, but just trying to get a sense of the monthly cadence of order trends in the quarter. Obviously positive that you were able to see that strength continue into the first few weeks of October. I was wondering if that was more close to what you're seeing perhaps in terms of the exit rate or what you were seeing in September. Also any color around the active adult segment, if you're seeing any acceleration there as you noted to a strong order book or interest in improvement.
Hey, Mike, it's Ryan. Good morning. Thanks for the question. I'll take the signup question first. As I think Bob shared in some of his prepared remarks, we saw a very consistent sales order pace throughout all three months of the quarter. September was the exception to that, where we started to see it slow down just a tad, but it was self-induced. Most of our divisions worked to restrict sales, either via price increases or lot releases or some combination of both. That was really an effort, Mike, in order for us to make sure that we're not getting overly exposed on future cost increases with an elongated backlog as well as managing customer expectations. I'd highlight the demand curve or the demand situation was quite consistent throughout all three months of the quarter.
We've seen things continue to be strong in the early weeks of October, both in the number of orders that we've recorded as well as the demand. Things are continuing into the fourth quarter. Finally, your question on active adult. We're really pleased with how that business has performed. We'd highlighted in Q2 that it had been a softer part of our business given the age demographic of that buyer group. They were, rightly so, being very cautious because of COVID-19. I think as everybody's gotten more comfortable with PPE and social distancing, that buyer has come back into our sales offices. The thing that I'd repeat is we booked over 2,000 new orders in the quarter from our active adult communities, which is the highest that we've had in over a decade.
Right. No, that's really helpful, and I appreciate you pointing that out. I guess maybe switching a little bit from the incoming order book to trying to get the units out the door. Your fourth quarter guide implies a backlog conversion rate in the mid-40s versus 59% a year ago. How should we think about the ability to deliver this obviously incredible backlog of homes over the next two or three quarters? Would you consider the year-over-year decline in backlog conversion as we see it in the fourth quarter as maybe being a low point in terms of the year-over-year differential, and that from here, we might be able to see that year-over-year decline narrow as production ramps? Any type of forward-looking thoughts around the ability to obviously produce this tremendous amount of homes. How do you see that playing out?
Yeah, Mike, we're really pleased with how the production environment is running right now. As I highlighted in some of my prepared remarks today, our production teams, both the construction and the procurement teams, have just done a real nice job of keeping things moving. We're quite pleased with how things are rolling off of the production line. You've probably heard me say before, Mike, we're not fans of backlog conversion. I think you can get some really goofy numbers, as is indicated by some of the percentages that you shared a minute ago. I'd really encourage you to look at conversion of units in production.
I think it's a much better indicator of how efficiently the assembly line is working, and I think what you'll find with the guide that we've given for Q4 is that the conversion of our production is very consistent with where it's been over the last couple of years. As it relates to 2021, Mike, we're not giving any guidance on that at this point in time. We'll certainly plan to do that as part of our Q4 call.
Our next question comes from John Lovallo from Bank of America Merrill Lynch. Please go ahead with your question.
Hey, guys. Thank you for taking my questions. The first one, maybe getting back to the September orders that were sort of deliberately slowed down given pricing and different actions along those lines. I'm curious, Ryan, what degree of pricing did it actually take to slow those orders? If it is the $1,000 or $2,000 that I think you may have mentioned during the call, given that labor costs are likely going up, lumber is still high, structural panels are still high. As we move into 2021, is it likely that we're going to see margin degradation across the industry?
Yeah, John, good morning. We haven't given any guide on 2021 at this point in time. You did hear us say, as it relates to lumber, that that will be a headwind for us over the next several quarters just because of the way we buy. We buy on a 13-week trailing Random Lengths average, which means just kind of now in the back half of the third quarter, and as we move into the fourth quarter, we'll start to see the higher lumber costs come into our margin profile. As it relates to your question about price increases and slowing sales, that's a tough thing to quantify in an answer on a call like this, John. What I'd tell you is that we have been very successful in pushing price, as evidenced by a very rich 24.5% margin print in this quarter.
We think we've done a nice job managing the pricing environment. We are sensitive, however, to that delicate balance of affordability. While I think we're maximizing what the opportunity is, I think we're being careful not to kind of break the affordability demand model. The last thing that I'd probably highlight is that it's not just price. In some cases, we're managing the sales pace with the number of lots that we're releasing. It's a combination of a number of factors that we can use to manage the number of sales that we want to take in an environment like this, given what we're doing on the production side.
Okay. That's helpful. Then maybe one for Deb. Deb, congratulations, first of all, on your recognition. The question is, recognizing here that FHA and VA is, I think, 20% of your business, so relatively small. Delinquencies at the FHA level are sort of mid-teens right now nationally, I believe. I think the average is sort of mid-single digits. What are your views on sort of what happens across the industry when the moratorium on foreclosures ends at the end of the year?
Yeah, John, Deb's not on the call. I'll try and answer that. It's Bob. It's a fair question. I think the answer is that we're hopeful that there will be some sort of continued relief. I don't know that there is a big appetite today to introduce that kind of consternation into the market. If that were not to be the case, I think you'd have some turbulence in the market. I don't know what that would translate into in terms of the current sales environment. Certainly it could create issues. Interestingly enough, most of the folks that own today have equity in their homes. Unlike the last downturn where people were upside down, one solution here is people can sell their house and pay off the mortgage.
I don't want to be pollyannaish about it, but I'm hopeful at least that this won't cause a lot of wreckage in the market.
Our next question comes from Alan Ratner from Zelman & Associates. Please go ahead with your question.
Hey, guys. Good morning. Congrats on the great quarter, and glad to hear you're all doing well. Ryan, I would love to drill in as well on the kind of the limiting lot releases or sales activity in September that you guys saw. I guess the first question on that is, what exactly has the trend been on your cycle times in terms of kind of what you're quoting buyers from contract to delivery time now versus, say, six months or so ago? The follow-on to that is, I'm a little surprised that you're taking such aggressive steps there, just given how strong your community count has held up here. You mentioned actually being able to pull forward some openings, which is impressive.
Recognizing you're not quantifying the monthly trends, is it still safe to assume that on a year-over-year basis, you're able to grow the order book, given your impressive land position?
Yeah. Good morning, Alan. There was a lot there. Let me see if I can kind of pick through some of that and give you some answers. As it relates to kind of the order trend over the quarter, the slight downtick in September was small. The year-over-year numbers in total for the quarter at 36%, they were fairly consistent as we moved July, August, September. I probably don't want to overplay that too much. The big takeaway that I think I'd want you to have is that demand is great. To your point, we were successful in getting some communities opened a little earlier. It's continued to kind of benefit our business, not only in the current quarter, but certainly in future quarters as well. As it relates to cycle time, Alan, we've been seeing things extend a little bit longer.
It's not anything that I would characterize as overly problematic, but we've seen the breaking ground to kind of finish delivery times expand just a tad. As far as when we're quoting deliveries, Alan, in most of our system, it's right in the six-month range, which has been very consistent with how we've operated the to-be-built order model for a long time. We're really not, other than maybe a few specific communities here or there, we're quoting delivery times that would be kind of in the March-April timeframe. That's all reflective of what's in our backlog and what our lot availability situation looks like. I may have missed a couple of the things you asked, Alan, but maybe you can hit them in a follow-up if I missed anything.
No, that was perfect, Ryan. I think you got everything there. Then, secondly, I'm imagining this is the time of the year where you start to think about your next year budget and plans and probably are having conversations with your trades involved in that as well. Looking at the landscape out there, it's pretty clear starts need to accelerate rather sharply over the next few months. Any color you can give us in terms of conversations you're having with the trades in terms of how they're equipped to deal with this spike in activity that's likely to occur, whether they're geared up for 2021 start activity. I guess in the context of that, any comments. I saw the Leading Builders of America kind of launched a new pilot program to try to improve some of the labor availability trends there as well.
Any color you can give on that front would be great.
Yeah. I'd probably just expound a little bit on the prepared comments that I made, Alan, where labor is tight. I believe that as a big builder, which we're certainly in that category, we've got an advantage. The fact that we've got a large backlog, we run a very sophisticated, orderly shop in terms of start rate and how things move through the production environment. What our trade partners tell us is they appreciate that. They appreciate the consistency. They can send the same crews to the same community every day. They know they've got a consistent level of production, which helps them be more efficient, more profitable. While things are tight, and I think we're going to continue to manage through things and absences related to COVID-19, as the proverbial curveball that you've got to be anticipating.
Things like that can certainly have a disruption on a trade partner shop. We think we're pretty well prepared for not only the fourth quarter, but for next year, and I give credit to our local teams that have built and managed and continue to foster the strong relationships that we have with our trade partners. We think as is evidenced by the guide that we've given for Q4 on the closing front, we think we're in a good spot to finish out the year strong.
Our next question comes from Ken Zener from KeyBanc. Please go ahead with your question.
Good morning, gentlemen.
Hello, Ken.
Hi, Ken.
What a year this is. I think a lot of people, including myself, the rubber meeting the road, so to speak, for the industry is that there's a lot of orders, which is a piece of paper that goes in the backlog, but your actual inventory is what constrains your earnings fourth quarter as well as next year. Can you talk to this constraint? Because your backlog- to- inventory ratio has never been lower at 3Q. It's about just under 80%, which is obviously leading to your fourth quarter guidance. I think the big issue here is your starts. What is the real constraint there? We hear constraints for appliances, I hear it for windows. Lately, I've been hearing it for garage doors.
Obviously, Ryan, you commented on labor, but it seems as though investors' optimism around where starts can go seems to be at a bit of a disconnect from where the industry is able to produce homes. If you see all this demand, what really keeps you from accelerating that process somehow? I know we have longer construction cycle times, but what keeps you from starting more specs? Is it your land constraints? I know some builders have run out of land, for example, to grow community counts, things like that. What's that conservative nature that keeps you there? Is it something that is industry-wide that you really can't get around, therefore, investors' growth optimism might be too high as we look forward?
Yeah.
Thank you.
Ken, I wish that I could tell you that it was isolated to one thing. The reality is it's a lot of things. Probably the first thing I'd highlight is permits. Municipalities and government agencies have arguably probably been the most conservative in terms of shutdown and slowdown. We can't start a home without a permit, that would be probably the thing that I would highlight as being the initial barrier that we've got to overcome. I think we're doing a nice job doing that. Then you go into the various production-related kind of delays. You highlighted a number of them. We highlighted a number of them in our prepared remarks, where it's been appliances, it's been windows, it's been interior doors, it's been cabinets. None of them have persisted, but different things come and go based on a myriad of factors.
Then you also highlighted lot availability. There are constraints around horizontal labor, land development labor as well. There's constraints around getting plat maps recorded and development plans approved through municipalities again. There's a little bit of sand in the gears everywhere. Nothing that has completely shut the machine down. Again, I think that's where the big builders are favored because of our size and our scale and the processes and the systems that we have. We're able to really deliver some nice results, as is evidenced by this most recent quarter. We're incredibly proud of what the business is doing. We're thrilled about kind of what we've got projected for Q4. As we finish up our planning for next year, we'll certainly provide some more guidance about 2021 as we get to the end of the fourth quarter.
I've been in this business a long time. It seems that no matter the business environment that we're operating in, there are challenges that we have to deal with. This current time, no different. I can tell you right now, though, and I mentioned to some of my team over the past week, I'd rather be dealing with these types of issues and small challenges than figuring out an environment where demand is lacking and you can't sell homes.
Right.
They're first-class problems, and I think we're well-equipped to deal with them.
Thank you.
Our next question comes from Truman Patterson from Wells Fargo. Please go ahead with your question.
Hey, good morning, guys. Great quarter, thanks for taking my questions. First, wanted to follow up on community count. Look, it actually increased sequentially, and it was up 3% year-over-year. This is at the high end of the range that you guys were guiding to at the beginning of the year. Pretty surprising given all the pause during COVID-19, how strong absorptions have been recently. Just can you elaborate a little bit more on what occurred internally and at the muni level? I know you mentioned that there's constraints at the muni level, this would kind of indicate otherwise. Hopefully, you can walk through some of those moving parts and then the sustainability of this 892 level as we look into 4Q or even first half of 2021.
Yeah, Truman, it's Bob. Obviously, we gave a guide coming into the third quarter, where we thought we'd be down a little bit. The teams are working really hard, as Ryan has shared with you. There was probably a degree of conservatism in that because people were just coming out of the pandemic, kind of real lockdown. When we were talking to you folks back in July. Really all we did was pull forward some community count out of what we thought would start in the fourth quarter into the third quarter.
I don't know that there's the ability to continue that through time. We've done a refreshed look, and we think actually our Q4 is going to be consistent with what we told you back in July. We had said, again, down 2%-4% in July for the third and fourth quarters. We're still there. We obviously working hard to get stuff open. We obviously haven't provided a guide beyond the fourth quarter. There's a limit to how much pull- forward you can do. Again, the team did a great job. We don't think it repeats in the fourth quarter, but we'll make every effort.
Okay. Thank you for that. Just jumping over to the land market today, with you all bumping up your land spend, how would you characterize the land market? Is it overheated? Is it just normal conditions that is generally pretty competitive? Are there any metros of concern that have specifically gotten overheated lately?
Truman, it's Ryan. I'd characterize the land market as competitive, which other than maybe in the depths of the great housing recession, the Great Recession.
Yeah.
I don't know that I've ever seen land go on sale. It just doesn't. There's a finite number of pieces that are within kind of the zones that are allowed to be kind of developed, entitled, et cetera. I think, we see competitive behavior there, whether it's from other home builders or you've got commercial and other uses for most good land parcels. I wouldn't characterize it as anything other than competitive. We're continuing to be smart. We're sticking to our underwriting fundamentals and the way that we have kind of approached land investment. Really no deviation from us on that front. I would tell you, I don't know that I would characterize any specific markets as being overheated and irrational at this point in time.
Our next question comes from Stephen Kim from Evercore ISI. Please go ahead with your question.
Thanks very much, guys. I think it's a pretty unusual market right now where it seems like your ability to sell is pretty much just limited by the available product to sell. In that regard, I'm curious as to how to think about what PulteGroup's max production capability is and how to sort of think about forecasting what that might be next year. One way that I could think about it is that you've given a guide of 6,900 deliveries in the fourth quarter. If I just sort of multiply that by four, would it be reasonable to think that that's your max production capacity right now?
Should I be looking at the orders you took in 3Q and say you probably wouldn't have taken those orders if you didn't think you'd be able to deliver them with good customer service, and so maybe 4x that number is kind of your max capacity. How should I be thinking about max capacity, and how much do you think it can grow in any given year for a builder of your size?
Yeah, Stephen, all of those are difficult questions to answer because they are essentially all 2021 guidance, which we're not given at this point in time. I'll do my best to give you a little bit. What I would tell you is that the business, both from a sales standpoint as well as a production standpoint, it's seasonal. We see seasonal fluctuations in demand. We see seasonal fluctuations in what our max capacity is, mostly driven by weather. You know that we've got a very big Midwest business, and it gets more difficult to build homes in the middle of winter in the Midwest. We certainly do it, of course, but it's not as good or as fast in the summer months. We really like the way that the production machine is running right now.
We'd certainly endeavor to increase that as much as we're able based on having available land and available trade resources. Rest assured, we're working on that every single day to get our start rate up. To your point, the demand environment is great. Like I mentioned on one of the earlier questions, we think the better way to evaluate the efficiency and the efficacy of the production machine is a conversion of what's in production. We think we're operating at a very consistent historical level as it relates to that. Look, we're going to do everything we can to put more into the machine. That's on both fronts, both the vertical side as well as on the horizontal land side.
I hear you on the Midwest and the northern parts of the country being a little bit more difficult to produce and seasonality, therefore. In the fourth quarter, that's one of those quarters where it gets pretty cold up there, and you've given a number there. I'm assuming you're pretty much going lights out now trying to build as much as you possibly can. I'm inclined to think that that number times four is probably not a bad guess as to what your max capacity is today. Correct me if I'm wrong. I'm really trying to get at what your ability is to grow capacity in any given year, and what are the things that actually are the limitations on that? I'm less interested in actually what they are. It's more like what the number might be.
Is it reasonable, for example, to think that a company of your size can grow capacity, production capacity, on a sustained basis by about 20% a year? Is that unreasonable? Just trying to understand it, because it's not something we've ever really thought about before, frankly. We always thought about it from the demand side.
Yeah, Stephen, I think the best thing that I can give you, is that we've given the guide that we've given for Q4, from a delivery standpoint. We're quite happy about that. We've given a community count guide that Bob just talked about in an earlier question for Q4 as well. I think you've got probably as good insight in the demand environment as probably we do, based on what we've talked about. I think you look at those things, you factor that into kind of your models for future years. What I'll tell you is that we'll give more robust guidance for 2021 at the end of the fourth quarter. As I mentioned a minute ago, we're really seeking to grow our starts. We think that this environment favors the big builders. We're going to endeavor to do that.
I think the limiting factors are the same that they've been, and probably consistent with what you've heard from us in the past. It's land and labor. Can we continue to grow the labor force? We're trying to do that, and you heard a comment from Alan. Leading Builders of America has got an effort underway where we've created a foundation that is solely focused on promoting the wonderful career opportunities that are available within the home building industry. We'd hope to get some traction with that to increase the labor side. Land, I think the biggest impediment there is, frankly, the municipalities and working through the development system. Lastly, and I think probably I'd rank it third on the list, is there's a little bit of stickiness in the supply chain.
Again, nothing that we haven't been able to manage through, but it does create a little bit of stickiness.
Our next question comes from Susan Maklari from Goldman Sachs. Please go ahead with your question.
Thank you. Good morning, everyone.
Hey, Sue.
My first question is, thinking about the active adult segment and the obvious improvement that you've seen there over the quarter, how much of that do you think is coming from what we're seeing in the existing market, the fact that some of these areas, like the Northeast, the Midwest, that were soft prior to this have really seen an improvement in there, and it's just become a lot easier for these people to sell their existing homes and get into these newer units? I guess with that, too, are you seeing geographic shift? Are you seeing a lot of people that are coming out of the northern half of the U.S. in the active adult segment and going into some of these southern markets?
Yeah, Susan, I think there's a couple things going on. We're seeing a continuing trend of folks leaving Northeastern and Midwest markets, and they're moving South. That's a trend that was going on pre-COVID. It's a trend that's continued post-COVID. We continue to see that benefiting our business, given that we've got a lot of properties in the South. As it relates to the active adult consumer, we think that there's a couple of things going on there. One, this buyer has gotten more comfortable in resuming normal daily activities over the last couple of months, and that includes figuring out what they're going to do in retirement. We think we've benefited from that buyer reengaging in the buying process.
Then the comment that I made in my prepared remarks, our view is that a healthy housing environment requires all consumer groups to be participating, and certainly we're seeing that right now. Given the increased desire of individuals to have a single-family home, it's created an inventory shortage, really in every price point of the market. It's created some pricing opportunities, not only for us, but also for the resale side. That's made it easier for individuals to sell their home. They've sold their homes at really great prices, which gives them a lot of options and a lot of choices in terms of what they do on the new side. I think what all that adds up to is a great operating environment for our company.
Got you. Okay. Thank you. My next question is around the buybacks. I think it was really encouraging to hear that you are reinstating that program in the fourth quarter. Can you talk a little bit about how we should be thinking about the cadence of the buybacks coming back? What's given you the confidence to do that, and how you're thinking overall about capital allocation, and especially maybe as we think about the accelerated pace of demand, the need to keep supplying those lots and supporting the growth, and just how you're balancing all those different factors looking out?
Yeah. It's a fair question. As Ryan mentioned on the call, we'll give you news on what we've done after we've done it, as opposed to giving you a guide in terms of what our expectations are for spend. The way we're looking at share repurchases is exactly the same as we were prior to the pandemic. Our capital allocation process starts with investing in the business, to your question. That will be our primary source or use of capital. Second, we want to fund our dividend. Third, if we have excess capital, we will use it to buy back shares. Again, all against the backdrop of leverage and cash capacity. With $2 billion in the bank and a business that has strong cash generating right now, we can kind of do all of those things.
I know we've talked about this in the past. Our expectation based on the guide we gave you is we'll spend $800 million-$900 million on land acquisition development in the fourth quarter. We'll pay our dividend. We think we're cash generative after that. The $2.1 billion in cash probably gets bigger. We've talked about the fact that we've got a maturity in the first quarter of next year that we are still likely to use cash to redeem, so $426 or $7 million. With all that said, we still have a lot of capacity to invest in the business, then we think actually buy back stock. We always use that lens. We always look out in time as we're thinking about the sources and uses of capital in the business.
We don't see it as a choice between, oh, do we want to invest in the business or buy back stock. We will be doing both.
Our next question comes from Mike Dahl from RBC. Please go ahead with your question.
Morning. Thanks for taking my question. Wanted to talk more about kind of the pricing power and dynamics you're seeing. I think you mentioned 1%-3% price increases. I understand it's widely varied, but wanted to get a sense on a relative basis. You talked about the constraints at the entry level from an affordability standpoint, but on average, is your entry-level pricing increases trending in line or above or below those numbers that you're quoting? I guess the second part of that question is, when you talked about the constraints, are we talking true hard bumping up against FHA, VA limits at this point, or is that more just a feel on moderating and metering out your price increases to avoid sticker shock?
To your second question, Mike, it is the latter. It's an affordability question, not a mortgage capability question. Interestingly, our business, and we've talked about this before, even in that first time space, we are typically a little bit at the higher end of the price range there. It was mentioned earlier on the call, FHA, VA for us is and has been pretty consistently about 20% of our origination. We don't have a lot of consumers at that lower FICO score where you might be getting up against capability to borrow. I think at the end of the day, as we look at it's just trying to make sure that we're pricing appropriately, but not pushing things so far that people have a choice. People always have a choice.
Whether it's rental or competition, you don't want to get the affordability equation for that more cost-conscious buyer out of whack.
Got it. Okay. The second question I had, you talk about lumber impacts starting to hit in the fourth quarter, but as you articulated, mostly kind of a first half issue. Could you just size up sequentially what's the margin headwind that you've got to absorb in 4Q versus 3Q? I know you don't want to give 2021 guidance, but based on that lag and your backlog, you do likely have a sense of the magnitude that's coming at the beginning of next year. Any color you can give us on kind of how that steps up from 4Q to 1Q in terms of just what you've got to absorb from a pricing standpoint to cover lumber?
Yeah, Mike, we haven't broken that out. What we have talked about is that lumber, about the sticks package is about 3%-5% of our cost. It's a meaningful percentage. 3%-5% of ASP is what the sticks package is. It's a decent chunk of money. I think what you saw in the fourth quarter is that we've had some nice price appreciation that we pushed through the system. We had a really nice margin print in the quarter. We've given kind of our margin guide for Q4, which we've said is going to be consistent with Q3. I think what you're seeing is that we've been able to offset the increases that are coming through the system because of lumber with prices.
As it relates to Q1 of next year, we haven't given any guidance on that yet, but we certainly will as part of our Q4 release.
Ladies and gentlemen, with that, we've reached the end of the allotted time for today's question- and- answer session. I'd like to turn the conference call back over to Jim Zeumer for any closing remarks.
Hey, we appreciate everybody's time today. If you've got any questions, certainly feel free to get back in touch with us via email or calls, and we will look forward to talking to you on our fourth quarter call. Thank you.
Ladies and gentlemen, with that, we'll conclude today's conference. We do thank you for attending today's presentation. You may now disconnect your lines.