Earnings Call Transcript - TPH Q1 2021

Operator, Operator

Greetings. Welcome to the Tri Pointe Homes First Quarter 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. Please note this conference is being recorded. I will now turn the conference over to your host, David Lee, General Counsel. Thank you. You may begin.

David Lee, General Counsel

Good morning and welcome to Tri Pointe Homes Earnings Conference Call. Earlier this morning, the company released its financial results for the first quarter of 2021. Documents detailing these results, including a slide deck, are available at www.tripointehomes.com through the Investors link and under the Events and Presentations tab. Before the call begins, I would like to remind everyone that certain statements made on this call, which are not historical facts, including statements concerning future financial and operating performance are forward-looking statements that involve risks and uncertainties. The discussion of risks and uncertainties and other factors that could cause actual results to differ materially are detailed in the company's SEC filings. Except as required by law, the company undertakes no duty to update these forward-looking statements. Additionally, reconciliations of non-GAAP financial measures discussed on this call to the most comparable GAAP measures can be accessed through Tri Pointe's website and in its SEC filings. Hosting the call today are Doug Bauer, the company's Chief Executive Officer; Glenn Keeler, the company's Chief Financial Officer; Tom Mitchell, the company's Chief Operating Officer and President; and Linda Mamet, the company's Chief Marketing Officer. With that, I will now turn the call over to Doug.

Doug Bauer, Chief Executive Officer (CEO)

Thanks, David, and good morning to everyone joining us on the call today. This day is a celebratory one for TRI Pointe as we commemorate Earth Day like we do every year through our proprietary LivingSmart program. LivingSmart is our company-wide walk-the-walk commitment to our customers' well-being and the well-being of our planet. We've been a leader in green building since 2001 and our commitment is always expanding, incorporating the latest innovative design, materials, and technologies into LivingSmart for homes and communities. More of Tri Pointe ESG highlights are available on our website and we will be publishing our 2020 ESG Report in May as we strive to improve everyday life for all of our stakeholders. With that, 2021 is off to a great start for Tri Pointe Homes with the record-breaking sales momentum we experienced last year carrying into the new year. Net new orders for the first quarter increased 20% year-over-year, thanks to a 49% improvement in our absorption pace. This order activity we experienced was broad based, both from a geographic and product standpoint, which is a testament to the appeal of our homes at a number of different price points, as well as to the strength of the housing market across the country. The combination of powerful millennial demographic forces, low existing inventory levels, favorable mortgage rates, and years of under-building has led to a real supply-demand imbalance that has taken the nation's need for new housing supply to new heights. The intensified demand for new homes brought about by the pandemic continues unabated as we see life beginning to normalize. Simply put, we are in the midst of one of the strongest housing markets in my career. We continue to take advantage of the robust demand with ongoing price increases and reduced incentives, allowing us to stay ahead of the cost inflation we are experiencing on a number of fronts. Gross margin from home deliveries for the first quarter came in at 23.9%, a 340 basis point expansion over the last year. We have also been successful in improving our operating leverage by keeping our costs in check, while growing revenues, lowering our SG&A as a percent of revenue by 250 basis points year-over-year to 11.4% for the quarter. And another positive note for our industry at large, mortgage interest rates have stabilized in recent weeks after the upward trend in the latter half of the quarter. The rising rates have not impacted demand and based on the sensitivity analysis we perform, we are confident in the quality of our backlog should mortgage rates continue to rise. As a premium lifestyle builder, Tri Pointe Homes attracts a very well-qualified buyer. Tri Pointe Connect, our affiliated mortgage company, is a significant asset to our operations and captures over 80% of our deliveries. The average homebuyer financing with Tri Pointe Connect has a FICO score of 748, debt-to-income of 36%, and loan-to-value ratio of 82%. While we continue to see new home demand far outstripping supply, today's environment is not without its operational challenges. Cycle times are being extended in all of our markets due to material shortages, labor availability, and municipality delays. Suppliers are pushing for price increases of their own in an effort to offset raw material cost inflation, as well as labor cost increases. New phase releases at communities are being weighed against existing backlog constraints. To be sure, these are good problems to have and are indicative of a strong housing market. Fortunately, our leadership teams throughout our organization are made up of seasoned industry veterans who know how to navigate this landscape and keep Tri Pointe in a position to be successful. At Tri Pointe, our goal is to grow our operations in a profitable manner, achieving top 10 market share in each of our geographic segments and improving returns, while maintaining a strong capital position. We made progress on all these fronts during the first quarter of 2021, including a return on average tangible equity of 15.8% for the trailing 12-month period. We posted an 18% increase in new home deliveries in the quarter and are poised to record a significant year-over-year increase in deliveries for the full year, based on our existing backlog. As we noted on the last call, we opened 22 new communities during the first quarter and remain confident in our ability to open roughly 70 new communities for the full year. In California, we continue to reap the rewards from our long-dated California assets, thanks to their low basis and excellent market positioning as we experienced robust order activity at both our coastal and inland communities. For instance, four of our five top-selling communities in the first quarter are in California and range from premium, entry-level attached homes in San Diego to detached homes in Southern California's Inland Empire, as well as Northern California's East Bay. The investments we have made in our early-stage markets of Austin, Dallas, the Carolinas and Sacramento are generating excellent results. In the first quarter, these markets contributed 157 deliveries on a combined basis, with an average sales price of $445,000 and gross margins of 21%. While these markets are contributing to the bottom line now, they still have a considerable runway for growth. Combined, these early-stage divisions currently own or control approximately 8,300 lots and are anticipated to deliver over 2,000 homes annually by 2023. We also made further strides in our efforts to acquire land in a more capital-efficient manner. We increased our lots controlled via option agreement to 38% at the end of the quarter, representing the highest option lot percentage in our company's history. We believe partnering with intermediaries to help facilitate the purchase and development of some of our lots is a prudent, risk-averse way to acquire land and will also lead to better returns on our capital in the long run. Overall, we are in a fortunate land position, considering the demand environment we're in. Page 14 of the earnings call slide deck shows the details of our lot position. With nearly 37,000 lots owned or controlled, we do not need to be aggressive in the current land market. We continue to be disciplined in our underwriting approach knowing that we own or control 100% of our forecasted deliveries in 2021, 2022, and over 95% in 2023. In addition, most of these lots were controlled one to three years ago, or even longer in the case of the long-term California assets. This should prove favorable to the company considering the rate at which both home prices and input costs have increased over the past 12 months. Tri Pointe Homes remains in an excellent position from a capital standpoint with over $1 billion in total liquidity, including cash and cash equivalents of $585 million. We put some of our cash to work during the first quarter in the form of share repurchases, buying back 3.7 million shares at a weighted average price of $17.88. The number of shares outstanding was 9% lower on a year-over-year basis and we plan on reducing our outstanding shares even further as the year progresses. With an increasingly diverse and growing homebuilding operation, a rapidly improving return profile, and a strong balance sheet, Tri Pointe Homes is poised to take advantage of the strong housing fundamentals in the market today and create value for our shareholders over the long term. We think that the current housing cycle will have long-term momentum, given the powerful demographic forces at play and the supply issues facing most of our markets. We believe Tri Pointe Homes has the right team, strategy, and leadership in place to achieve our goals. With that, I'd like to turn it over to Glenn for more detail on the first quarter and our outlook for the rest of the year. Glenn?

Glenn Keeler, Chief Financial Officer (CFO)

Thanks, Doug, and good morning, everyone. I'm going to highlight some of our results and key financial metrics for the first quarter and then finish my remarks with our expectations and outlook for the second quarter and full year of 2021. At times, I will be referring to certain information from our slide deck that is posted on our website. I wanted to start by discussing our new reporting segments, which we have reorganized in connection with the recent implementation of our one brand platform to Tri Pointe Homes. Slide 4 of the earnings call deck shows the map of the US and the markets we currently operate in. Our Arizona, California, Nevada, and Washington markets will now be reported in the West segment, with Colorado and Texas in the Central, and finally the Carolinas and the DC Metro markets in the East. Slide 5 of the earnings call deck provides some of our financial and operational highlights from our first quarter. As Doug mentioned earlier, demand continued to be robust in the first quarter with orders up 20% compared to the prior year and an absorption rate of 5.8 homes per community per month, representing a 49% increase compared to the prior year. Demand was strong across all geographies with the West reporting an absorption rate of 6 homes per community per month, a 39% increase compared to the prior year; the Central had an absorption rate of 6.1, which was a 118% increase compared to the prior year; and finally, the East had an absorption pace of 4.3, which was a 4% increase. Demand continues to be strong in April with 340 orders through this past Sunday, April 18th. We continue to focus on our new community pipeline, opening 22 new communities in the first quarter. For the full year, we expect to open approximately 70 communities and end the year between 120 and 130 active selling communities. For 2022, we continue to expect to open approximately 90 new communities and end the year between 150 and 160 active selling communities. We reported a strong performance on all key metrics this quarter. We delivered 1,126 homes, which was an 18% increase year-over-year. Home sales revenue was $717 million, an increase of 20%, and our average sales price was $636,000, a 2% increase compared to the first quarter of 2020. Our homebuilding gross margin percentage for the quarter exceeded the high end of our guidance range at 23.9%, a 340 basis point improvement year-over-year. SG&A expense as a percentage of home sales revenue of 11.4% improved 250 basis points compared to the prior year. Our focus on leveraging technology and operational excellence is evident in our reduced sales and marketing expense of 5.6% of home sales revenue in the first quarter compared to 7.2% for the prior-year period. The evolution of our digital marketing and home shopping tools, less reliance on outside brokers, and our employment-driven sales approach enables our sales and marketing operations to be more efficient. For instance, we generated 8.5 orders per sales employee in the first quarter of 2021 versus 5.8 orders in the same quarter of 2020. We reduced our broker attachment rate from 71% of deliveries in Q1 2020, down to 69% of deliveries this quarter, with an average broker commission representing 1.7% of our total home sales revenue. Looking at the balance sheet, at quarter-end, we had approximately $3 billion of real estate inventory. Our total outstanding debt was $1.3 billion, resulting in a ratio of debt-to-capital of 37.5% and a ratio of net debt-to-net capital of 25.3%. We ended the quarter with $1.1 billion of liquidity, consisting of $585 million of cash on hand and $543 million available under our unsecured revolving credit facility. Now, I'd like to summarize our outlook for the second quarter and full year. For the second quarter of 2021, the company anticipates delivering between 1,500 and 1,600 homes at an average sales price of $630,000 to $640,000. Homebuilding gross margin is expected to be in the range of 22% to 23% and our SG&A expense as a percentage of home sales revenue is expected to be in the range of 10% to 10.5% for the second quarter. Lastly, the company anticipates its effective tax rate for the second quarter to be approximately 25%. For the full year, we are raising our anticipated delivery guidance to between 6,000 and 6,300 homes and increasing our expected average sales price to $620,000 to $630,000. We are also increasing our homebuilding gross margin range to between 22% and 23% for the full year, while lowering our SG&A expense as a percentage of home sales revenue, which we expect to be in the range of 9.8% to 10.3%. Finally, the company is forecasting its effective tax rate for the full year to be approximately 25%. I will now turn the call back over to Doug for some closing remarks.

Doug Bauer, Chief Executive Officer (CEO)

Thanks, Glenn. To sum up, the housing market and Tri Pointe Homes are hitting on all cylinders. Our absorption pace of 5.8 in the first quarter was the best in our company's history and the same is true of our home sales gross margins of 23.9%. And when price and pace can both be achieved at such a high level, it is clear we are experiencing an exceptionally strong market. And while we expect demand to remain elevated for the near term, we also expect there will be a leveling off to a more normal demand environment at some point. This would enable the industry to be in a better balance with the supply chain as it moves more in line with demand. Until then, we will continue to take advantage of the strong housing fundamentals and grow our operations, while adhering to our underwriting discipline, a strong balance sheet, and continuing to improve our returns. Finally, I would like to thank our team members for their contributions in producing a record-breaking quarter. Results we posted in the first quarter are a testament to your hard work and entrepreneurial spirit and I'm extremely proud of what we have built together. That concludes our prepared remarks and now we'd like to open it up for questions. Thank you.

Operator, Operator

Our first question is from Alan Ratner with Zelman & Associates. Please proceed.

Alan Ratner, Analyst - Zelman & Associates

Hey guys, good morning and congrats on the great results and glad to hear you're all doing well. Doug, I'd love to start off with kind of the comment you just closed with and talking a little bit about an eventual normalization of demand and kind of some of the supply side challenges that the industry is facing today, and I was poking around on your website and I couldn't help but notice there were quite a few communities that you guys have labeled as temporarily sold out and I'm guessing that that somewhat ties into your commentary there. We've been hearing a lot of builders intentionally slowing the sales pace just to allow the production machine to catch up a little bit. So I'm curious if you could talk a little bit about if you guys are doing that and to what extent and have those limitations we've been seeing of late helped at all to allow the supply side to catch up, or are those problems still intensifying?

Doug Bauer, Chief Executive Officer (CEO)

Yes, good question. Out of our community universe—and Linda, I think you may have the number more exact—but if I recall, it's about 20 to 30 communities that are in that mode and we haven't really seen that improve the supply chain. I think the supply chain is going to be a challenge for the rest of the year as all homebuilders and other industries are affected by a lot of global factors—from chip manufacturing to the Suez Canal, extreme weather events to everything else that's been going on since the pandemic—and there's just been such a rapid increase in demand that didn't correspond with an increase in the supply chain. It's going to take a little bit to catch up, but I don't think it's going to all happen in a short-term manner. I think it's going to be a challenge for the rest of the year as we continue to see strong demand across all our marketplaces.

Alan Ratner, Analyst - Zelman & Associates

That makes sense and I appreciate the candidness there. Maybe this is related, maybe it's not, but the gross margin guidance does imply a little bit of sequential pressure from the very strong results you just put up in the first quarter. So I'm curious if you could talk a little bit about the moving pieces there, is that mix, is that cycle times extending that's putting some pressure on that? Any color you can give there would be great.

Glenn Keeler, Chief Financial Officer (CFO)

Hey, Alan, it's Glenn. It is a bit of mix. We had some higher-end communities close out in the first quarter, so that contributed to that higher margin, but it also is reflective of some of the cost increases that happened in the back half of last year that are delivering as a bigger part of the mix in Q2 and Q3. But overall, as you saw from our guidance, we raised the margin guidance at the high end by 100 basis points for the full year. So it shows that we have been able to raise prices above costs compared to where we were on our last call.

Alan Ratner, Analyst - Zelman & Associates

Yes, absolutely. Didn't mean to imply that it wasn't impressive, just curious what the drivers were there, so I appreciate that Glenn. Thanks a lot guys. Good luck.

Doug Bauer, Chief Executive Officer (CEO)

Thanks, Alan.

Operator, Operator

Our next question is from Jay McCanless with Wedbush Securities. Please proceed.

Jay McCanless, Analyst - Wedbush Securities

Hey, good morning and thanks for taking my questions. First question I had, any impact from the February weather in Texas in terms of delivery, timing, etc.?

Doug Bauer, Chief Executive Officer (CEO)

Yes, Jay, this is Doug. It did affect about 20 to 30 deliveries in the first quarter and it's probably why we were just a few units below consensus for the quarter, but we picked it up from there and expect more deliveries as part of our overall guidance for the year out of Texas.

Jay McCanless, Analyst - Wedbush Securities

And then in terms of the community count guidance for this year, I know you all took that down a little bit, is there any geographic bent to where that came from, or are you just having to deal with some municipal issues pretty much countrywide?

Glenn Keeler, Chief Financial Officer (CFO)

No, the lower community count guidance for the full year is just reflective of selling out a little bit quicker than we originally planned based on the high absorption pace we saw in the first quarter. We're still opening the same amount of communities that we guided to previously. So from an opening perspective, we're right on where we thought we were going to be. We're just going to close out a few more communities before year-end quicker than we thought. That's all it is.

Doug Bauer, Chief Executive Officer (CEO)

Jay, that obviously implies a healthy backlog going into the second half of the year.

Jay McCanless, Analyst - Wedbush Securities

Yes, absolutely. And then the other question I had just on cycle times, could you talk about where they are now versus last year? Last year of course was COVID, but where do you think they are now and where they should be?

Tom Mitchell, Chief Operating Officer & President (COO)

Hey, Jay, good question. This is Tom, and obviously we still are dealing with COVID impacts this year, although it is different. But in general, on average, I would say our cycle times have increased 10% to 20% year-over-year. We are battling a significant supply and labor constraint and we're doing our best to overcome that. Translated into working days, that's about a 10 to 20 day increase on average for our average construction cycle time. We're setting appropriate expectations with our customers and delivering their homes in a time frame that meets their expectations. So far, so good. We don't anticipate that it will have any impact on our ability to deliver year-end units that we're planning on.

Jay McCanless, Analyst - Wedbush Securities

Sounds great. Thanks for taking my question.

Operator, Operator

Our next question is from Stephen Kim with Evercore ISI. Please proceed.

Stephen Kim, Analyst - Evercore ISI

Yes, thanks a lot, guys. Great job obviously in the quarter. Doug, you made a mention about how you ran an analysis on your backlog to determine how secure it was in the event of a rate rise. I was curious how broad that analysis was, if you could shed a little more light on it. In particular, I was wondering if it was analyzing your buyers' credit quality and stress testing it for higher rates and then you kind of concluded it wouldn't have a negative impact if rates rose. At what point of mortgage rate would it have had an impact in your view?

Doug Bauer, Chief Executive Officer (CEO)

I'll let Tom and Linda chime in on that.

Tom Mitchell, Chief Operating Officer & President (COO)

Yes, Stephen, great question. We did do a stress test on our backlog as you mentioned and it was on all fronts as you indicated, including buyer quality. Being a premium lifestyle brand, we have significant buyer quality and that's demonstrated with an average FICO score of about 748, our average loan-to-value is 82% and our debt-to-income ratio is around 36%, as Doug said in the prepared remarks as well. What we did was go into our backlog and focus primarily on stressing interest rates by a half point and then a full point and looking at debt-to-income and seeing where the tipping point was. In both those scenarios, very little of our qualified buyers drop off their ability to purchase. So, the answer would be somewhere over a point in interest rate increase would begin to have any effect on our buyer pool.

Stephen Kim, Analyst - Evercore ISI

And can you translate that into a number? I assume it's north of 4%, obviously.

Doug Bauer, Chief Executive Officer (CEO)

Correct.

Tom Mitchell, Chief Operating Officer & President (COO)

North of 4%, yes.

Doug Bauer, Chief Executive Officer (CEO)

And that was about 75% to 80% of our backlog.

Stephen Kim, Analyst - Evercore ISI

Right, okay. Great, well, that's really interesting. I appreciate that. And then I guess another question is about the gross margin guide and I know you mentioned that there were some unusually high gross margin communities that closed in 1Q, but you beat your 1Q guide pretty handily. So I'm just curious, is it right to think that you're using pretty much the same methodology for guiding your margins in 2Q as you did for 1Q?

Tom Mitchell, Chief Operating Officer & President (COO)

It's a similar methodology in that we're guiding based on where prices and costs are today and some of that was, like I said, a mix shift. There were some communities that pulled into Q1 that are higher margin that we thought were going to go into Q2. So that mix definitely plays a part into it, but yes, we're basing that on what's in backlog right now, what we know the margins to be. Obviously, there are still houses to sell throughout the year. So if we can continue to raise price above the cost increases, there could be margin upside to the full year guide, but there's still a lot of time left in the year.

Stephen Kim, Analyst - Evercore ISI

Yes, sure. Great, I appreciate that. I think you guys know which side my bet's going on. But that's great, good job and good luck with the rest of the year.

Tom Mitchell, Chief Operating Officer & President (COO)

Thanks, Stephen.

Operator, Operator

Our next question is from Mike Dahl with RBC Capital Markets. Please proceed.

Mike Dahl, Analyst - RBC Capital Markets

Hi, thanks for taking my questions. I wanted to ask a more detailed question around pricing. I think based on the work that we've been doing it seems like for a lot of the past six months or so you had good pricing power, but potentially slightly lagging the peer group in terms of breadth and magnitude and more recently you've kind of fully caught up and maybe even exceeded, which certainly seems to be reflected in the margin guide. But I'm wondering if A, you think that's a fair characterization and B, how much of that is really kind of the market strength continuing to broaden out and give the higher-end stronger pricing power versus more company-specific actions that you're taking, whether it's the lot allocations or just a more aggressive approach to pricing given how strong the sales base has been?

Tom Mitchell, Chief Operating Officer & President (COO)

Hey, Mike, good question. The pricing environment is very fluid right now and we continue to see strength and elasticity in our ability to continue to raise prices in all markets and at all price points, so we see it being pretty broad based. Obviously affordability is a general concern out there. As I said with Stephen, our stress testing of our backlog appears that we've got room to move there and we're going to try to take advantage of that where we can. Linda, do you have anything else to add on pricing?

Linda Mamet, Chief Marketing Officer (CMO)

No. Again, as you said, it has been very broad based and as there becomes less supply of home sites remaining in a community, we have more opportunity to continue to push prices.

Glenn Keeler, Chief Financial Officer (CFO)

And one thing I will add, Mike, I wouldn't say we lagged the rest of the group from a pricing power perspective if you look at pure percentages, because we have higher average sales prices that may appear the case, but when you look at total dollars that I think we're definitely getting our fair share of price increases. As you mentioned, that's reflected in the margin guidance. So yes, I think we've been able to raise prices throughout the entire run-up in the homebuilding market just as everybody else has.

Mike Dahl, Analyst - RBC Capital Markets

Okay, that's helpful and good point there, Glenn, thanks. My second question just on the April commentary and sales pace in general. I understand it's only halfway through or two and a half weeks through the month, but it seems like that number would suggest maybe pace closer to five a month versus the six-plus in Feb and March, and clearly articulated that six is the right number for you guys. But just curious to get your take on given the actions that you've taken around communities, given the pricing, given the demand you're seeing when you're thinking through the balance of the year and the guidance, what are you guys assuming in terms of sales pace right now?

Glenn Keeler, Chief Financial Officer (CFO)

I think it's similar to what we talked about before. We had a really strong Q1 and your math is correct: it was around five for the first couple of weeks of April. Part of that is us limiting some of the releases to allow construction to catch up to the sales pace. We're not seeing any real drop off in demand. Demand is still really strong out there. What we do think is that it will get back to a little bit more of a seasonal norm and slow down in the back half of the year from an order pace perspective; that is our assumption in the plan. We could be surprised with upside on that, but that is how we built the plan.

Tom Mitchell, Chief Operating Officer & President (COO)

I think the other thing to think about is as we are limiting releases, you'll see continued choppiness and potential spikes in absorption rates as we hit new releases. There is strong pent-up demand, so we have a strong absorption pace on those releases. We're bringing a lot of new communities to market as well and there is significant pent-up demand at those new communities. As we bring those releases on, I think we'll have accelerated absorptions as well.

Doug Bauer, Chief Executive Officer (CEO)

I'll add to Glenn's comment, Mike. With society hopefully getting back to normal and seeing travel start up again, we do see a seasonal pattern that we forecasted in our plan for the last three quarters. Typically we see some seasonal slowdown in the summer months and a little pickup before the fall. So that's our thinking, but we could be surprised with upside.

Mike Dahl, Analyst - RBC Capital Markets

Right. Okay, great, that's very helpful. Thanks.

Operator, Operator

Our next question is from Tyler Batory with Janney Capital Markets. Please proceed.

Tyler Batory, Analyst - Janney Capital Markets

Hey, good morning. Thanks for taking my question. Just a few from me and I wanted to start on the land side of things, just curious what you guys are seeing out there in terms of land prices generally, interested if there are other instances perhaps where prices might have expanded in terms of what some of your peers or competitors might be seeing.

Doug Bauer, Chief Executive Officer (CEO)

Yes, good question. As we pointed out, we're in a very strong position. We were active in the land market one to three years ago. So we've got a great book going into 2023, 100% for 2022 covered and 95% for 2023. We're in the land market every day and continue to underwrite the current market conditions. Are there examples of land deals getting bid up beyond reasonable terms? There are a few, but generally speaking, the builders we work with and joint venture with are still being disciplined in their underwriting. Land values are a function of your land residual and if home prices go up, land prices will go up. But input costs have also gone up. You have to factor all that into the equation and that's how we look at the land business. Tom, do you want to add anything to that?

Tom Mitchell, Chief Operating Officer & President (COO)

Well said. We are really positive on our existing land pipeline in all our markets and we continue to look for the right pieces to add. As Doug said in the prepared remarks, we're in a great position and we're really looking for land to finish off that last 5% in 2023, but for 2024 and beyond our focus is on adding land.

Tyler Batory, Analyst - Janney Capital Markets

Okay, great, that's very helpful. And then just as a follow-up, wondering if you can elaborate a little bit more on what you're seeing in some of your early-stage divisions, just curious how those are progressing versus your expectation. I think you cited 21% margin for those overall. So interested how that's comparing to what you originally expected, and then I think you talked about the 2,000 annual sales by 2023. Just wondering if you could talk a little bit more in terms of progression and timeline over the next year or two moving towards that target in some of these earlier-stage locations.

Doug Bauer, Chief Executive Officer (CEO)

We are very bullish on our early-stage divisions and that's why we shared the information. Twenty-one percent margins are very strong for early-stage divisions, but more importantly, we own and control over 8,300 lots that will generate 2,000 homes annually by 2023. That's within the two- to three-year timeframe. We're very pleased with the Carolinas, Dallas, Austin, and Sacramento. Teams have done an excellent job of sourcing land and again, that land was sourced one to three years ago. With the rapid increase in prices and input costs, we're in a very good position to deliver those 2,000 homes annually in 2023 and ideally deliver a consistent margin profile with that.

Tyler Batory, Analyst - Janney Capital Markets

Okay, great. That's all from me. I'll leave it there. Thank you very much for the detail.

Operator, Operator

Our next question is from Truman Patterson with Wolfe Research. Please proceed.

Truman Patterson, Analyst - Wolfe Research

Hey, good morning, guys. Thanks for taking my question. First, just wanted to touch back on your 2021 gross margin guide. Even though you beat pretty materially in 1Q, 2Q through 4Q, it seems like you still lifted your guidance for the remainder of the year as well. So could you discuss that a little bit more in depth? Are you expecting more higher-margin California mix in there, or are you just seeing a general lift across the country where pricing is outstripping costs? And then finally, what sort of cost inflation are you all really expecting in the back part of the year?

Glenn Keeler, Chief Financial Officer (CFO)

Hey Truman, it's Glenn. I'll take the first part. It was really the latter part of your comment. It reflects us being able to raise prices above costs, which gave us the ability to raise that gross margin guidance based on what we see in backlog currently. I'll let Tom take the cost inflation question.

Tom Mitchell, Chief Operating Officer & President (COO)

Hey Truman, good question. We're not dissimilar to what you're hearing elsewhere relative to cost; there is significant pressure in that arena right now. So far, we're expecting costs to increase on our direct side of the business in the range of 5% to 15% in the magnitude of what we've been experiencing lately.

Truman Patterson, Analyst - Wolfe Research

Okay, Tom, and in that 5% to 15%, I imagine that's labor and materials blended, but on the lumber side, is that really one of the largest swing factors in that number? Over the past month, lumber is up 50% plus. Big picture on the lumber side, how do you think that plays out over the next nine months? Is this level of lumber pricing here to stay, will we see relief, or will it continue accelerating upwards? Just your big-picture thoughts on that.

Doug Bauer, Chief Executive Officer (CEO)

This is Doug. We are not in the business of forecasting these swings. Lumber is a major component of cost increases. As I mentioned earlier to Alan, we are anticipating a continued supply chain challenge for the rest of this year as builders work to deliver housing for consumers. I don't know where lumber will go; a year ago it was much lower. Your guess is as good as ours. As Tom mentioned, our divisional cost inflation ranges 5% to 15% and pricing has also increased 5% to 20%. That's a big component of what's going on and is why we provided an increase in our gross margin guidance for the year. In the first quarter, some of it was mix, and as it stretches out for the year, we're looking to increase our margins about 100 basis points as we indicated. We still think prices will be able to cover those cost increases.

Truman Patterson, Analyst - Wolfe Research

For clarity, that divisional cost inflation range of 5% to 15% is what you experienced in the first quarter, correct?

Doug Bauer, Chief Executive Officer (CEO)

Yes, that's what we experienced in the first quarter.

Truman Patterson, Analyst - Wolfe Research

Got you. If Tom, do you have the metric of what you're baking into guidance for Q3/Q4, or is that within the same 5% to 15% range?

Tom Mitchell, Chief Operating Officer & President (COO)

Yes, it's within that same range.

Truman Patterson, Analyst - Wolfe Research

Okay. All right, thank you, guys. Good luck on the upcoming quarter.

Doug Bauer, Chief Executive Officer (CEO)

Thanks.

Tom Mitchell, Chief Operating Officer & President (COO)

Thanks, Truman.

Operator, Operator

Our next question is from Deepa Raghavan with Wells Fargo. Please proceed.

Deepa Raghavan, Analyst - Wells Fargo

Hi, good morning. My first question is on pricing. I know you provided good color earlier. The pricing within the orders—you mentioned that given all the inflation out there, you're increasing prices for inflation and then some more, which means you are capturing some amount of profit. You mentioned pricing increases 5% to 20%, cost increases 5% to 15%, so there is a spread there. Just curious, is that spread actually been increasing of late, given that demand is so strong and your absorption is pacing strongly? That means you do have pricing power, and that additional spread should give you the power to offset some of the volatility in the second half you alluded to. Are you seeing that spread increase in your order level and do you anticipate it will go higher?

Doug Bauer, Chief Executive Officer (CEO)

This is Doug. The pricing band of 5% to 20% and cost band of 5% to 15% reflects what we experienced in the first quarter. We don't forecast revenue increases in our base business planning; we do have current cost inputs in our plan. If revenues were to sustain at current levels, there could be, as Glenn mentioned earlier, some margin expansion in the latter half of the year.

Deepa Raghavan, Analyst - Wells Fargo

Is there a delta between your order pricing and your closing pricing—like is the pricing delta between your order pricing and your closing pricing strong enough to capture additional support as well?

Glenn Keeler, Chief Financial Officer (CFO)

Yes. Based on raising the gross margin guidance for the year, it shows that the spread was positive. In the first quarter, is the spread increasing? I wouldn't necessarily say it's increasing; I think it's been there. We've been able to raise prices above cost throughout the last nine months. I wouldn't expect the spread to continuously increase because costs are rising pretty rapidly. We're thankful that we can raise prices to cover costs right now; that's a good position to be in. It varies widely on a community-by-community basis: in some communities the spread is increasing because there's a limited supply of houses, and in other communities it's less so. It's a tough question to answer on a macro basis.

Deepa Raghavan, Analyst - Wells Fargo

All right. That's helpful. My follow-up is, looking at your Q1 performance across regions, I see some ASP decreases in the Central and East. What's driving those year-on-year decreases, especially since those markets are strong? Any color there?

Glenn Keeler, Chief Financial Officer (CFO)

All that is pure mix. Our percentage of attached homes in our mix is higher this year than it was last year. We're targeting the right price points for the buyer pool in each market. It's not reflective of pricing declines, it's just pure mix of types of homes we're selling.

Deepa Raghavan, Analyst - Wells Fargo

That's helpful, thanks so much. I'll pass it on.

Glenn Keeler, Chief Financial Officer (CFO)

Thanks, Deepa.

Operator, Operator

Our next question is from Carl Reichardt with BTIG. Please proceed.

Carl Reichardt, Analyst - BTIG

Thanks. Good morning, guys. I wanted to ask about SG&A and I'm sorry if I missed it. SG&A was quite better than your guidance. The dollars were actually down, but the delivery volume was sort of at the low end of the guidance. I'm curious why the leverage was so strong or even why the dollars were down. Is that in part a function of the cost cuts from last year rolling through?

Glenn Keeler, Chief Financial Officer (CFO)

Yes Carl, it's Glenn. Good questions. That's part of it for sure. We haven't had to hire back as many staff as we might have thought, considering the volume increases because we are more efficient as we discussed in our prepared remarks. In addition, because of the strong demand we saw in the first quarter, we spent a bit less on advertising than we originally thought we would have to, because when demand is that strong you don't need to spend as much on advertising. Between sales per employee and advertising spend, that's where we saw meaningful savings.

Carl Reichardt, Analyst - BTIG

Thanks, Glenn. And then a bigger picture one for Doug. Doug, you mentioned the broader goal of wanting to be in the top 10 in all the geographic markets Tri Pointe's in. I'm curious why that specific target—why not top 15 or top 5? What's the driver behind that long-term goal? What are the economics behind it?

Doug Bauer, Chief Executive Officer (CEO)

We are never looking to be the biggest; we want to be the best. To be the best and to generate the revenues and profits we target, when you back into the various markets we're in, you need to be in the top 10. Our focus is on generating higher profits and higher returns and being more efficient in turning inventory. We believe our expansion east of California into efficient markets will allow us to hit those targets. Those are macro goals to keep our competitive position. Again, it's not about being the biggest, it's about being the best.

Tom Mitchell, Chief Operating Officer & President (COO)

Carl, we've had several conversations about this. Scale provides leverage, and there is an economic benefit to having scale in certain markets. We believe that and have seen it prove out. In our early-stage divisions, we're looking to reach an optimization level that is within that top 10 and provides the volume to produce leverage.

Carl Reichardt, Analyst - BTIG

Thank you, Tom. Thanks, fellows.

Doug Bauer, Chief Executive Officer (CEO)

Thanks, Carl.

Operator, Operator

And our final question is from Alex Barron with the Housing Research Center. Please proceed.

Alex Barron, Analyst - Housing Research Center

Yes, thanks, gentlemen, and good job on the quarter. I think you had previously indicated you expected that company ASPs tend to be heading down, but obviously pricing power is going the other way. Can you walk me through your expectations on that going forward?

Doug Bauer, Chief Executive Officer (CEO)

Hi Alex, this is Doug. I don't think we indicated pricing power was going down. We don't forecast significant price increases in our base planning, but the market is very strong right now and we experienced significant pricing power in the first quarter. The housing business is as good as I've seen in my 30-plus years and I think it will continue to be very strong this year. I'll let Tom and Glenn add color.

Tom Mitchell, Chief Operating Officer & President (COO)

I'll chime in. If you're asking relative to guiding to a lower company ASP over the next couple of years, that is correct. As we bring on new products through our early-stage divisions, those ASPs are lower. Overall that's going to reduce company ASP, even though we've experienced pricing power that has recently increased our ASP overall. The projection of ASP reduction is due to the mix of new units coming into our portfolio.

Alex Barron, Analyst - Housing Research Center

Okay. In terms of that mix, is it geographic exposure driving that trend, or is it more because you're introducing smaller floor plans, more entry-level housing, that type of thing?

Doug Bauer, Chief Executive Officer (CEO)

It's primarily due to expansion east of California, although even in California we're expanding more affordable price points, especially in the Inland Empire and San Diego. But generally speaking, it's expansion east of California and a slight reduction in average square footage for the company.

Glenn Keeler, Chief Financial Officer (CFO)

Alex, I can give a specific example. In the Carolinas, we only have three communities open right now and those price points are in the $350,000 to $450,000 range. In a couple of years, we're going to have over 10 to 15 communities open there. So it's part of that geographic mix of early-stage divisions.

Alex Barron, Analyst - Housing Research Center

Okay. And I think I also heard you say you're indicating more emphasis on share buybacks. Is that something you expect to be a percentage of profits, opportunistic, or more programmatic? How are you thinking about that?

Glenn Keeler, Chief Financial Officer (CFO)

We're looking to be a little more programmatic. You've seen us be more consistent over the last couple of quarters and we're forecasting in the near term that continuing to be the case.

Alex Barron, Analyst - Housing Research Center

Got it. Okay, well, best of luck for the year. Thanks.

Glenn Keeler, Chief Financial Officer (CFO)

Thanks, Alex.

Doug Bauer, Chief Executive Officer (CEO)

Thanks, Alex.

Operator, Operator

We have reached the end of our question-and-answer session. I would like to turn the conference back over to Doug Bauer for closing comments.

Doug Bauer, Chief Executive Officer (CEO)

Well, thanks, everyone, for attending our Q1 call and we look forward to meeting all of you next quarter. I hope you all have a great weekend. Thank you.

Operator, Operator

Thank you. This does conclude today's conference. You may disconnect your lines at this time and thank you for your participation.