普爾特房屋 (PHM) 2016 Q2 法說會逐字稿

Good morning.

My name is Scott and I will be your conference operator today.

At this time, I would like to welcome everyone to the Q2 2016 PulteGroup, Inc.

earnings conference call.

(Operator Instructions)

Jim Zeumer, you may begin your conference.

Great.

Thank you, Scott, and good morning to everyone participating in today's call.

I want to welcome you to PulteGroup's conference call to discuss our second quarter financial results for the three months ended June 30, 2016.

Joining me for today's call are Richard Dugas, Chairman and CEO; Ryan Marshall, President; Bob O'Shaughnessy, Executive Vice President and CFO; and Jim Ossowski, Vice President, Finance and Controller.

A copy of this morning's earnings release and the presentation slides that accompany today's call have been posted to our corporate website, at PulteGroupInc.com.

We'll also post an audio replay of today's call to our website a little later.

Before we begin the discussion, I want to alert all participants that today's presentation may include forward-looking statements about PulteGroup's future performance.

Actual results could differ materially from those suggested by our comments made today.

The most significant risk factors that could affect future results are summarized as part of today's earnings release and within the accompanying presentation slides.

These risk factors and other key information are detailed in our SEC filings, including our annual and quarterly reports.

Now let me turn the call over to Richard Dugas.

Richard?

Thank you, Jim, and good morning, everyone.

Over the five-plus years we have been operating under our Value Creation strategy, the Company has moved through several different stages as our operating and financial results progressed.

When we started back in 2011, our initial focus was on fixing our fundamental business performance along with strengthening our balance sheet and enhancing overall returns on invested capital.

Having made significant progress toward achieving these initial operating and financial objectives, in 2013 we were in a position to begin materially increasing investment in the business.

Our land acquisition spend on an annual basis the last few years doubled from $600 million, or 11% of revenue in 2013, to $1.2 billion, or 21% of revenue in 2015.

While the dollars grew, our underlying discipline has not wavered.

We have continued to invest in higher returning, shorter duration projects that are closer to city centers, allowing the Company to maintain high margins and returns through this time frame.

As we have talked about on recent calls, 2016 is the year this increased investment begins to pay off, as we have now reached an inflection point toward higher growth in the business.

The earnings release we issued this morning demonstrates this point, as our second quarter results show another quarter of strong year-over-year growth across a variety of important business metrics, including sign-ups, which increased 11% in units and 21% in value; closings, which increased by 27%; revenues, which increased 41% to $1.8 billion; earnings per share, which gained 21% on a reported basis and was significantly higher when you adjust for the charges and benefits in the respective reporting periods; and with our backlog value up 21% to $3.7 billion, our highest since 2007, we are in an excellent position to realize further growth over the remainder of 2016.

It is clear that after three years of increased investment in the business, we are driving meaningful growth across the operations.

While our increased land investments should bring growth for several years to come, we have not forgotten that homebuilding is a cyclical business, which is why we are already planning for the future.

Value Creation was designed over five years ago to help maximize shareholder value through an entire housing cycle.

With this in mind, in addition to announcing our strong second quarter financial results, this morning's earnings release highlighted additional actions we are now taking as we move through the housing cycle.

After four years during which our investment in new land grew significantly, we plan to slow the rate of growth in our new investment in 2017 and beyond.

With 143,000 lots currently under control, we maintain a very strong land pipeline on which to operate over the next few years.

Our stated capital allocation priorities of first investing in high returning land and then returning excess funds to shareholders have not changed.

As such, given a moderated level of land spend in future years, we expect to have sufficient liquidity to allow us to increase our share repurchase activities.

As stated in the release, our Board has approved an incremental $1 billion share repurchase authorization, bringing our total authorization to $1.5 billion.

As also stated, we expect to utilize that authority over the next 18 months through repurchases of $250 million in each of the third and fourth quarters of 2016 and an additional $1 billion in 2017.

Along with looking to create value through our allocation of capital over time, we are also taking action to create value through maximizing efficiencies within our operations.

Over the past several years, we have worked extremely hard to raise our operating margin from the bottom quartile of the homebuilding peers to among the industry leaders.

We want to maintain and, as possible, enhance our relative position.

To help realize this objective, we plan to lower our SG&A spend from an estimated 10% of revenues in 2016 to 9% of revenues or lower in 2017.

While we expect to realize a portion of this leverage benefit from increased revenues, we are also working to take unnecessary overhead out of the business.

The fact is that after five years, many of the core homebuilding disciplines put in place at the outset of Value Creation are now part of the Company's standard operating practices and are embedded in our muscle memory.

As such, there are opportunities to remove some of these costs.

As I wrap up my initial comments, let me say that I'm very proud of the excellent second quarter results and pleased with how well we are positioned for the future.

Furthermore, I believe the additional actions we are announcing today with regard to future capital allocation and overheads will help ensure we continue building value for shareholders going forward.

Now let me turn over the call to Bob for a detailed review of the quarter.

Bob?

Thank you, Richard, and good morning.

Building on our strong Q1 results, PulteGroup's second quarter financials are highlighted by significant growth and performance gains in the business.

Looking at the second quarter's homebuilding operations, home sale revenues were at $1.8 billion, which represents an increase of 41% over last year.

This significant increase in revenue was driven by a 27% increase in closings of 4,772 homes, combined with an 11%, or $35,000, increase in average selling price to $367,000.

The 27% increase in closings was due to the strong orders we've reported in recent quarters, coupled with our previously discussed actions to put additional homes into production at the end of last year and the beginning of this year.

As a result, our conversion rate for the quarter was 55%, which is up roughly 600 basis points over last year.

I'd like to point out that although our conversion rate improved on a year-over-year basis in the second quarter, tight labor resources, elongated build cycles, and development and permitting delays remain meaningful challenges across many markets.

As such, we continue to target conversion rate improvement versus last year, but don't expect we will return to the rates of several years ago in the short term.

As a result, we currently project a conversion rate of between 51% and 54% in the third quarter this year.

This compares to the 48% conversion rate in Q3 of last year.

The 11% increase in average selling price for the quarter reflects the ongoing shift in the mix of our business toward move-up product.

In addition to the shift in our mix, we also realized higher prices in each buyer group, including a 5% increase among first-time buyers to $270,000, an 11% increase in the price of move-up homes to $438,000, and a 4% increase in the average price of homes among our active adult buyers, $357,000.

During the quarter, closing percentages by buyer group were as follows, 29% first-time, 44% move-up, and 27% active adults.

In Q2 of last year, closings by buyer group were 34% first-time, 35% move-up, and 31% active adult.

Given that our backlog ASP of $387,000 is up 13% over last year and up 5% from Q2 deliveries, we expect ASPs will continue to gradually move higher over the coming quarters.

Our second quarter gross margin of 21.5%, which includes approximately 70 basis points of drag associated with our first quarter acquisition of the Wieland assets, was in line with previous guidance.

Adjusting for the impact of the Wieland closings, gross margins were down approximately 110 basis points from last year, primarily as a result of mix, higher land and labor costs.

The Company remains on track to deliver full-year margins of approximately 21.5% and we expect margins over the remaining two quarters to be in the range of 21.2% to 21.7%, which is down slightly from prior guidance of 21.5% to 22%.

Based on our current backlog, we see higher labor and material costs continuing to put slight pressure on margins.

Offsetting some of the margin pressure, we continue to have success with our strategic pricing programs.

In Q2, our total option revenues and lot premiums increased 5% over last year to approximately $67,000 per closing.

In addition, sales discounts totaled 2.7%, which is up about 50 basis points from last year but consistent with our first quarter of this year's results.

Second quarter SG&A was $192 million, or 11% of home sale revenues.

Prior year SG&A spend of $130 million, or 10.5% of revenues, included a $27 million benefit, or approximately 210 basis points, resulting from a legal settlement.

Increased SG&A spend in the quarter reflects ongoing growth in support of the Company's 26% increase in units under production, combined with costs associated with higher health care insurance and professional fees incurred in the period.

Although the absolute dollar spend is higher than forecast, we still expect full-year SG&A will be approximately 10% of revenues, allowing PulteGroup to maintain its operating margins among the industry leaders.

At 10% of revenue, SG&A expenses are certainly within historical ranges, but, as Richard discussed, we believe there are opportunities to drive greater overhead leverage.

Based on our current targets, we expect to drive SG&A spend lower by at least 100 basis points in 2017, to 9% or lower of home sale revenues.

Continuing down the income statement, we reported other expenses net of $13 million.

This includes approximately $7 million of deposits and other pre acquisition charges associated with determination of several pending land transactions, as well as the final $7 million of costs associated with the relocation of our corporate office.

Turning to financial services, we reported pretax income of $17 million, which is up from $10 million last year.

These results benefited from the higher closing volumes in our homebuilding operations, as well as a favorable interest rate environment, given the decline in rates experienced during the quarter.

Our mortgage capture rate for the period was 81%, down from 83% in the second quarter of 2015.

Consistent with Company guidance, our effective tax rate for the quarter was 38%, yielding Q2 net income of $118 million, or $0.34 per share.

EPS for the quarter was calculated on approximately 348 million shares, which is down 4% from last year, resulting largely from share repurchase activities.

Moving past our income statement and looking at our home building operations, we had 8,687 homes under construction at the end of the second quarter, of which 23% were spec.

Consistent with our Q1 comments, after increasing spec home production in the back half of 2015 and into the first quarter of 2016 to help ensure a more consistent construction cadence, we have slowed spec starts somewhat as we build the backlog for the selling season.

With an average of less than one finished spec per community, we remain in a very favorable inventory position.

In the second quarter, we approved approximately 5,800 lots for purchase and ended the period with 143,000 lots under control.

Consistent with recent quarters, about 29% of our lot position is controlled through options, as we work to manage our land risk and drive higher returns on invested capital.

Of our controlled lots, approximately 25% are developed.

During the quarter, we spent $379 million on land acquisition and generally remain on track with 2016 plans to invest approximately $1.6 billion, including the purchase of the Wieland assets, in new land positions.

Consistent with Richard's comments and after several years of significant growth, we expect the rate of growth of our land acquisition spend to slow as we head into 2017.

Recognizing that the current housing cycle is maturing, we are decreasing our land investment as a percentage of revenues and could ultimately reduce the absolute dollars we spend, depending upon our assessment of economic conditions and their potential impact on the housing industry here in the US.

Looking at share repurchase activity during the quarter, we repurchased 2.6 million shares for $48 million, or $18.51 per share.

This brings our total repurchase activity for the first half of the year to $98 million.

Expanding on Richard's earlier comments about capital allocation, we've invested significantly in land related development over the last few years and we expect those investments to drive volume growth and strong cash flows for the next few years.

We have also indicated that the growth in our investment is expected to moderate going forward.

As a result, we feel we are well-positioned to increase the return of funds to shareholders, consistent with our stated allocation priorities, through the expanded share buyback program Richard outlined.

We expect to take on a certain amount of incremental debt in connection with the outlined share repurchase activities, but we expect to be able to maintain a responsible and certainly very manageable debt to cap level throughout this process.

As a reminder, our target debt to cap range remains unchanged at 30% to 40%.

While we may have leverage rates outside this range at points in time, we continue to believe our targeted range is appropriate and will strive to operate in that range over the long term.

I'll just provide a couple more data points before turning over the call.

Sign-ups for the second quarter were 5,697, which represents an increase of 11% over the prior year.

On a dollar basis, sign-ups increased an even greater 21%, $2.1 billion.

Sign-ups by buyer group break down as follows.

First time increased 12%, move-up increased 21%, and active adult declined 3%.

Adjusting for changes in community counts, absorption paces increased 23% and 5% for first time and active adult buyers, respectively, but were lower by 8% among move-up buyers.

As we talked about on our prior call, given the higher price points among Wieland communities, absorption paces are slower than traditional Pulte communities, which impacted the move-up buyer results.

During the second quarter, we operated from 700 communities, which is up 11% over last year.

The 11% increase is in line with prior Company guidance for year-over-year growth and community count of 8% to 10% in the first half the year, expanding to 10% to 15% in the second half of 2016.

Now let me turn the call over to Ryan Marshall for some comments on market conditions.

Ryan?

Thank you, Bob.

While there's been a lot of volatility in the global economic and financial markets, US housing continues to move along the slow recovery path it has been following for the past five years.

Government data as of May showing new home sales of 550,000 puts US housing on track to deliver another year of roughly 10% growth.

The trend is certainly positive, but after five years of recovery, we still remain well below the 50-year average, which is why we believe the recovery has a few years left.

And while there's a lot of noise in the surrounding environment, there are certainly positives to be seen in the underlying economy, the job market, consumer confidence, and the low mortgage rate conditions that are important drivers of ongoing demand.

The demand conditions we realized in Q2 are consistent with those suggested by some of the broader housing stats which point to a sustained recovery, but with pockets of stronger and weaker demand depending on geography and buyer segment.

On a regional basis, demand conditions in the quarter were as follows.

Consistent with comments made on many of our prior calls, demand on the East Coast generally gets stronger as you move from North to South.

Florida, Georgia, and parts of the Carolinas continue to experience solid buyer demand as we benefited from strong local economies.

Getting homes sold in some of our mid-Atlantic and Northeast markets, however, is a little more challenging, as demand appears to be softer than at the start of the year.

The middle third of the country, covering our Midwest and Texas operations, continue to experience strong demand conditions.

All of our Midwest markets have been performing well, with notable gains in our Ohio and Kentucky operations, as we continue to build on the Dominion positions we acquired in 2014.

Our Texas markets are generally performing well.

Dallas continues to experience exceptional strength, although maintaining the needed pace of land development in the market is challenging.

Houston is still showing great resilience, as demand continues to exceed expectations.

Excessive rains earlier in the year have us behind on land development for Houston and Austin, but our teams are working hard to catch up on some of the delays.

And finally, looking out West, demand remains solid throughout the area, with good traffic and sign-up paces in Arizona, Nevada and California.

Although it is among our smaller markets, Seattle has realized a nice jump in buyer demand as we get new communities opened and new product on the ground.

Overall, we are certainly pleased with the selling season for PulteGroup, as we realize good absorption paces and built a sizable backlog of sold homes.

Our Q2 backlog is the highest in almost a decade, which sets us up well for the remainder of 2016.

Having a large backlog allows us to provide a consistent flow of production, which is helpful when it comes to working with a trade base that we expect will be stretched for the foreseeable future.

In closing, I want to recognize the entire PulteGroup organization, with special thanks to the sales and construction teams, which are doing an outstanding job capitalizing on the market opportunities and managing the challenges that develop.

Thanks to your efforts, we have tremendous momentum heading into the second half of the year.

Let me now turn the call back to Richard for a few final comments.

Richard?

Thank you, Ryan.

Before we open the call to questions, I want to take just a couple of minutes to comment on the other press release we issued this morning regarding the addition of three very talented executives to serve as independent directors on PulteGroup's Board.

For those of you who have followed homebuilding over the years, you will likely know the name John Peshkin.

John spent much of his 30-year homebuilding career with Taylor Woodrow, including serving as the company's CEO for six years.

John has also served on the boards of Standard Pacific and WCI Communities.

I am also pleased to welcome Josh Gotbaum to the PulteGroup Board.

After spending more than a decade in investment banking at Lazard, Josh held senior-level positions in the US government and has recently served as acting Chief Operating Officer of the Pension Benefit Guarantee Corporation.

Josh's extensive Wall Street and government experience will be a great add to the collective experiences of our Board.

Also joining our Board will be Scott Powers, a financial services executive with over 30 years of experience.

Scott, who was most recently President and CEO of State Street Global Advisors, has a long track record of success with some of the industry's premier asset managers, including Old Mutual, Mellon Financial and Boston Company.

We look forward to having the experiences of three such proven executives added to our Board.

I would also note that in addition to joining the Board, John and Josh have both been added to the search committee which was recently established to identify PulteGroup's next CEO.

The committee's work is well underway as they evaluate internal and external candidates.

John and Josh will go to work immediately to get actively engaged in the process.

And finally, I want to confirm that over the past several weeks, we have had conversations about broad business strategies and practices with Elliott Management, one of the Company's shareholders.

We certainly appreciate their perspectives about PulteGroup and ideas for creating long-term value for shareholders.

I would also tell you that from our very first conversation, we were in agreement with many of their thoughts because we had already been evaluating these same opportunities to enhance the business and potential returns for our shareholders.

As an example, PulteGroup's efforts to supplement its Board with direct homebuilding and additional Wall Street experience were already underway.

The final candidate selection was the result of a fruitful collaboration and discussion with Elliott.

In short, all our discussions with Elliott were constructive and productive.

Beyond just speaking with Elliott, we have an extensive conversations with many other large shareholders over the past several weeks and months.

The feedback has been very consistent in terms of investor support for our value creation strategy and the tactics we have been implementing.

We view the planned actions we announced today on capital allocation, land spend, SG&A, and corporate governance as appropriate next steps in our value creation work, as we work hard to drive even greater shareholder value from here.

Now let me turn the call back to Jim Zeumer.

Jim?

Thank you, Richard.

We'll open the call for questions.

So that we can speak with as many participants as possible during the remaining time of this call, we ask that you limit yourselves to one question and one follow-up.

Scott, if you'll explain the process, we'll get started.

(Operator Instructions)

Jack Micenko, SIG.

Good morning, guys.

Busy morning today.

The first question, Richard, on the land spend versus the buyback, 143,000 lots.

Should we think about your lot inventory declining?

Should we think about the pipeline of land moving under the eight-year number as you redeploy that cash into buybacks?

Jack, we've definitely discussed before, we would like to get the land, total land number lower, for sure.

We have been, over the last five years, buying much shorter positions.

But as we moderate the rate of growth in our land spend, we will have quite a bit of free cash flow and we intend, just as we allocated -- or excuse me, outlined -- as part of our Value Creation strategy that any dollars not going into land will be returned to shareholders.

So that's why we're upping the buyback today.

Okay.

On the cadence, I think you'd said $250 million a quarter.

Is that a pretty reliable number we can work with on the model and looking at the new earnings run rate and book value numbers?

It is, Jack.

Okay.

Thank you.

Alan Ratner, Zelman & Associates.

Hello, guys.

Good morning and nice job in the quarter.

I appreciate also the disclosures or the guidance on backlog conversion and some of the extra guidance there.

So thank you for that.

First question, just on the expected cash flow from operations.

And you mentioned, it sounds like you're not expected to cut the amount you're going to be spending on land, the rate of growth will slow.

Is there any land sales contemplated over the next several quarters that's going to be a source of cash?

Alan, we have sold about $400 million worth of land over the last several years and we are continually looking to prune unproductive assets.

So that will continue, probably not in any great rate, not a big slug at any one time, but slowly over time you will see that number continue to flow through a little bit.

But to be clear, with all the investment we put in over the past four years, which as you know has been in the 30% to 40% annual range in terms of increases year-over-year, we'll have substantial cash coming off the business just from that investment for at least the next few years.

So as we begin to moderate the rate of growth, we're still going to have substantial growth over the next few years, but the rate of cash coming in vis-a-vis the incremental cash going out for land will free up quite a bit of capital for repurchases.

So to be clear, we're not intending on huge land sales to fund the buyback.

Understood.

Thank you for that.

And second question.

You made the comment that even with the slowing growth of land spend, you still think there's several years of growth in the business.

Was hoping you might be able to frame that for us.

And within the context of your comments about the cycle and where we are, it sounds like you used some different language this quarter, as far as maybe coming a little bit closer to the end of the cycle or at least shifting the strategy a little bit.

I think there's this view that the market's in a pretty steady growth phase, call it 10%, plus or minus, and there's several large builders that expect that type of growth to continue for the next several years.

So A, would you agree with that as far as the market is concerned, and B, within the Pulte specific camp, how do you see you trending versus the market as you move out beyond 2017?

Alan, Richard here again.

A couple thing.

We do agree with that statement, this slow and steady path for the next several years overall.

The fact is, we've been stepping on the gas pretty hard the last few years with regard to land spend, and we're just going to moderate that a bit, which will free up quite a bit of cash from operations.

But that's our view collectively on the market.

The second piece is we realize that we have a large land base that we need to monetize, and we're going to work really hard to have that continue to drive business for us.

Bob Wetenhall, RBC Capital Markets.

Good morning.

A lot of stuff to digest today.

Just wanted to start, Richard, when you're thinking about 2017, and maybe to Alan's question, is the right way to think about how you're planning for the business that 2017 is going to be the peak year for deliveries relative to the fact that land spend is going down, so deliveries peak out in 2017 but you have a lower capital base and a more efficient balance sheet?

Is that the strategy, or am I missing something here?

Bob, I wouldn't necessarily say that 2017 will be the peak year for deliveries.

The reality is that land that we put in place today, it's 24-plus months before it comes online.

So when we began increasing investment back in 2013, we knew that 2016 would be a big year and we're expecting growth from here.

So I can't comment on exactly when that growth peaks.

And I'll point out that we're talking about only moderating the growth rate of land, not necessarily cutting the rate of land.

So we're still projecting solid growth for the next several years and I want to be clear about that.

I wouldn't call for 2017 to be the peak.

The reality is, though, we should be getting more and more efficient as we monetize this large land base we already have.

That's an important distinction and a helpful one.

Thanks for clarifying that.

Can you walk me through, and maybe the ball goes to Bob's court, you're slowing the pace in land.

It's partially calling the cycle, it's partially an effort to get better financial performance through the balance sheet.

But what's the logic behind levering up to buy back stock, given the fact that the stock's now trading at close to 2 times book, and obviously that's a positive thing which shows the Value Creation plan has worked.

So from my standpoint, I'm trying to understand, if the cycle's further along than we'd anticipated, does it make sense to run to 40% to 50%?

Why do you want to reinvest back on a systematic buyback program, given the fact that the underlying land in your existing balance sheet's already appreciated and the market recognizes the good work?

Yes, Bob.

It's worth remembering, if you go back to, call it December of 2014, I think, when we had our Investor Day and laid out what our uses of capital were going to be, this is really the execution of that.

So we highlighted we want to invest in high growth or high return opportunities, and when that, as we've talked about, is moderated.

Not stopping, to Richard's point, but moderating the growth of it.

So we'll still be investing a fair amount of money, using that excess cash flow to return to shareholders.

And the important thing, and you've asked the question, is around that it hinges on debt to cap between 30% and 40%.

Today we're at 35%.

We're talking about incremental leverage over that next 18 months that isn't really terribly significant.

Again, we highlight that we might go a little bit above 40%, but not a lot.

And again, what we've indicated is that we would seek to get back down under 40% as time goes by, because that's what we've outlined in terms of our priorities.

So we've not tried to make a determination of market.

So when we've been buying back equity over the last two or three years, we have been -- we have a view about market values, but typically we're buying on a relatively consistent basis with the cash we have available, and other than trading what we think is intelligently as the market price changes, we're not saying we think the stock is expensive or inexpensive, we're just returning shareholder funds.

Michael Rehaut, JPMorgan.

Thank you.

Good morning, everyone.

And also a lot to digest and I think a lot of good stuff.

Just wanted to try and get a little bit more clarity as we think about 2017.

And I know that it appears that you're not going to give too much in terms of guidance, but maybe just some rough ways to think about the upcoming year.

I think a lot of people are trying to figure out, and I think you've given some talking points to it in terms of when you talk about slowing growth in land spend, what does that mean for closings growth next year.

Certainly you've reiterated your community count guidance for the back half of the year.

How should we think about community count in 2017?

And it seemed that you should still be able to do some amount of closings growth, but maybe sub 10%.

Is that fair?

Mike, this is Richard.

I want to be crystal clear for everyone on the call.

What we're doing today will not impact our 2017 volumes.

When we buy land in this space, it's for at least 24 months out.

No one should model or change their view on what our growth should be relative to 2017 here at all.

That's why we commented extensively in our release that we will be growing for the next several years.

And I also want to point out, we're talking about moderating the rate of growth in our land spend.

And we've been growing substantially.

So there's lots of growth to come.

The reality is we have a large balance sheet and we're just going to monetize that to a better degree, I believe, than we have in the past and use the cash flow to help buy back equity.

And to a comment that was asked on the previous question, no one is talking about leverage anywhere near 50% here.

Bob stated very clearly we want to stay within that 30% to 40% range.

And we if we get outside of it, we'll work hard to bring it back in.

So just wanted to clarify there.

I appreciate that.

And again, how it affects your 2017, notwithstanding what you're saying it won't, I think if there's any ability to give any sense of how you're thinking about closing volume growth for next year, that would be helpful.

And also, moving on to the second question, again, incremental clarity, when I just ran some very quick numbers on some more share buyback and a little more leverage, or a little more debt, and it does appear that at worst being perhaps a 40% to 45% range, and again that would be for a brief amount of time, is that the right way to think about that, Bob?

Let me just -- I'll address both.

Typically, to your first question on 2017, we would give color on 2017 later this year and we would expect to do that, not today.

In terms of the leverage rates, like anything else in life, it depends on when we go to market, how the business cash flows are generated over time.

But again, I would tell you that our expectation is at the end of 2017, with the buyback levels that we're talking about, we don't think we get much outside of 40%, to Richard's earlier comment.

Stephen East, Wells Fargo.

Thank you.

Richard, you talked early on about overhead leverage, generating debt.

Could you talk about what specific actions you all have planned and how we should expect this to trend as we go through the next 18 months?

Yes, Steve, that is still underway internally, so I don't want to get too detailed here.

But we are looking at reducing overhead costs throughout the operation collectively.

And I would expect that the actions we take there will be taken in third quarter and that our newly established run rate will be in place for Q4.

So we'll have more to say on our Q3 call, clearly, about the detail there.

But we expect to reduce our overhead costs in Q3.

Okay.

And then I'm just going to jam in two questions here, if I could.

One, some of the organic metrics excluding Wieland, what the orders were or what the community count was?

And then do you have any type of timing on the CEO search?

I'll answer the first and then maybe Bob or Ryan could comment on the business excluding Wieland.

I'm not involved in the search, Stephen, but I do know the committee is underway.

They've engaged an outside firm and they intend to get the two new directors up to speed immediately, and I know there's plans to do that literally immediately.

So I can't speak for the committee, but I would hope that over the next couple of months they would be able to wrap up their work.

So not specificity there, but sometime in the not too distant future, I would think.

And then on the other comment?

Stephen, on Wieland, we're not going to give detail on Wieland versus the rest of the business.

What I'll offer is our absorption pace, as we highlighted, we're up 23% in first time, down 8% in move-up, up 5% in active adult.

Again, Wieland sits in that move-up space.

And absent the Wieland business, that would've been flat year-over-year.

So in total, our absorption paces were flat Q2 versus Q2 last yea.

They would've been up somewhat instead if we hadn't had the Wieland business.

And we did highlight 70 basis points of margin.

Eric Bosshard, Cleveland Research.

Good morning.

Curious as you look at the business now from a segment standpoint where the demand is or for land costs or where land costs are or where selling prices are and what you're seeing in the business that has you evaluating where we are in the cycle is what I'm trying to figure out.

Yes, Eric, I think it's fair to say we feel like we're somewhere in the middle of the cycle.

We're not in the early stages of the cycle.

It is maturing and land costs are up.

I'll echo something that Bob put in his script, we're proud of our operating margin performance and we are taking some SG&A action to help keep that, as land prices and labor prices are not allowing quite as much pricing power as we've had in the past on the gross margin side.

So it's a very healthy housing market.

We're really pleased with our absorption paces.

And we project the next few years are going to bring more of the same.

Just to follow up.

That's helpful.

I can understand the land and labor influence on the cost side of the gross margin equation.

On the selling price side of that, where within the markets are there segments of the market where, or segments of demand where it's harder to raise price to earn a really attractive gross margin that makes you feel a little bit different about volume?

Eric, this is Ryan.

What I would tell you is that the first few weeks of July have continued to show typical seasonal selling patterns.

And we continue to see local economies drive pockets of strength and/or weakness as we move across the country.

One great example that I'll give you is our Dallas market.

That's a market where the local economy continues to do very well and we're seeing nice pricing power throughout all of the segments.

And the other thing that I would point out to you, Eric, is we continue to say through our value creation strategy that our focus is on driving high returns.

Margins are certainly a component of driving high returns, but it's not the only thing that we focus on.

Will Randow, Citigroup.

Good morning, guys, and thanks for taking my questions.

In terms of, you gave some regional color on Florida and the Northeast, which I found interesting, because markets like the Mid-Atlantic for resale were quite strong.

Can you talk about where you saw the pockets of softness in the Northeast, as well as the pockets of strength in Florida?

Yes, Will.

Where we've seen pockets of relative weakness over prior year were in the Northeast markets, specifically New Jersey and our Boston area markets.

We saw nice strength in DC and throughout Florida was very strong.

Thanks for that.

And then I hate to beat a dead horse, but in terms of reduced land spend, should we anticipate that's mainly targeted at, I'll call it, non-Pulte Homes brands, specifically more like Centex?

And as a side note, in terms of cash flows, does this mean that you're not necessarily pursuing an investment-grade rating over the next, I'll call it, year and a half?

Will, this is Richard.

We're not giving color on where exactly our moderation in land spend will affect it.

As Bob indicated, as we get closer to the end of the year, we'll provide additional color going forward.

But I want to be clear, that won't be affecting the next couple of years worth of volume.

And then with regard to investment grade, I'll just make one opening comment and then turn it to Bob.

We are intending to maintain our investment discipline and our debt to capital discipline, which we've outlined five years ago as part of Value Creation was our target range.

So with that, Bob, you want to talk about the rating?

I would just make two comments.

One, on the capital, to your question, I don't think it would change our perspective.

Our land teams have -- we are agnostic to what land they're buying.

So we're not going to say we're not going to spend as much and we, in particular, don't want you to buy entry-level or something like that.

So the teams have the capacity to make the investment decisions.

And then with respect to the agencies, and I think Richard said it all, we will maintain the discipline we have.

We think we've got a business that is supportive of an investment-grade, whether they get there or not.

This will introduce some more leverage, but certainly within the guidelines that we outlined.

And if not, we'd seek to get back inside.

Ken Zener, Keybanc.

Good morning, gentlemen.

In regards to the gross margin for the back half, I wonder if you could explore that a little bit.

I see the order pace is going along with how we would expect, but I wonder, because you've had this really strong growth in closings, especially in the first half in general.

What was the factor or region that is causing that modest trim down, realizing you're obviously taking cost actions on the G&A side to offset that structurally.

But could you go into that a little bit?

Is it labor?

Is it the land?

Is it the pricing wasn't as strong?

And within regions.

Thank you.

Ken, I think the answer is all of the above, to some extent.

Certainly Wieland is impacting our margins, consistent with the way we thought they would.

Mix matters.

You look at our second quarter of this year versus second quarter of last year, Del Webb -- or active adult, I should say -- is less of a contributor and it is our highest margin business.

So that, on a mix adjusted basis, takes our margins down.

And to be clear, and we've said this over time, land prices have gone up over time and that more expensive land cycles into our mix.

Labor costs are up.

We have a generally positive or favorable commodity market, so the input cost there, but labor is expensive.

We've suggested or we've guided that 1.5% to 2% growth in our house cost, and again, a lot of that is labor.

So all those things factor in as we look at what we've had occur in this quarter and what's going to happen over the next couple of quarters.

And Ken, this is Richard.

I'll just add one thing.

We are committed to operating margin excellence, regardless of what gross margins are doing.

And we're pleased with where our gross margins are.

They're still, on a relative basis, quite strong.

But we just want to be clear that we want to maintain our lead in operating margins.

No, I understand that.

And obviously, you're taking the SG&A actions.

In regards to your comments, since you're not talking about 2017 in terms of operational metrics, like closings or community count, and your land actions this year are not impacting 2017, could you talk about the volume assumptions?

How are you getting to that 9%?

Is it just on cost reductions, efficiency, or how much leverage is occurring due to variables you're not commenting on?

How would you describe that?

Thank you very much.

It's a bit of both.

We are counting on revenue growth and volume growth, and we're counting on dollars, actual dollars coming out of the business, as well.

We're not providing any more color than that at this stage.

As Bob indicated, we'll have more to say a little bit later in the year.

But we're pleased with the fact that we'll be getting incremental leverage on the business next year.

And the other thing I'll just say about it is our 2017 volumes will be driven by what we invested in 2014, 2015 timeframe, primarily.

So that's why we know we'll have growth.

John Lovallo, Bank of America.

Hello, guys.

Thanks for taking my call.

Not to beat a dead horse here, but the 9% SG&A target, I just want to be clear that you guys think that you can achieve that kind of leverage on volume and also some structural cost reductions and it's not really coming at the expense of community count growth, is that correct?

That's 100% correct.

Yes.

Okay.

And if I missed this, I apologize.

But in the press release, you talked about a $0.03 charge from pending land transactions and also a corporate relocation.

Maybe if you can give a little bit more detail on that, particularly on the corporate relocation, which I thought would've been well behind us at this point.

Yes.

As we highlighted, that's actually what we think are the final costs associated with that.

And really we vacated the last space we had in Michigan.

So it just was dependent on when we actually got folks consolidated in one spot.

So we think that one is completely behind us now.

As it relates to the pending land transactions, essentially it's one fairly significant and complex transaction that we've been working on for a number of years.

The entitlements were challenging.

And as we moved forward, because of some of the cost elements of it, candidly, the deal just didn't make a lot of sense.

And rather than push it forward because we had a lot of money invested in it, we decided to walk away rather than make it a long-term problem for us.

So kind of a unique circumstance in that one.

Susan Maklari, UBS.

Good morning.

In the last call, you guys went through and you gave some really good information around your impaired land and how to think about the margin impact as those lots come back.

And as we're one quarter further and we hear about this newer land strategy or this updated land strategy that's coming together, is there any change in the thought around those impaired assets and perhaps the timing or the pace at which they may come and you start closing more homes on them?

Yes, Susan, just want to be clear, we haven't changed our strategy with respect to land.

All we've said is we're not going to grow our investment in land at the 30-plus % rate that we have for the last three or four years.

Our strategies remain the same.

In terms of our ability to monetize those assets, you heard Richard say, we've sold probably $400-ish million over the last four or five years of non-core assets, and so we will continue to seek to do that.

Those will be kind of lumpy as things become marketable, if they're out there and there are a ton of them, candidly.

We've got, as an example, less than $100 million on the balance sheet today of land held for sale, which is stuff that we would think would transact in the relatively short term.

And obviously, with respect to some of our other longer dated positions, we've talked about those pretty consistently over time where we're just seeking to drive the best return we can off of forward investment.

And so as demand is there, we will sell those.

Okay.

Thank you.

And then in terms of Texas, I know that you noted in your comments that you are a bit behind on the operations there just because of the rain that was experienced earlier in the year, but you had some good closings and you had some order growth there, actually.

Can you just give us a bit more color on that?

Yes, Susan, this is Ryan.

We're very pleased with what's happening out of our Texas operations, including the demand.

Certainly, the weather has been a factor.

I'll tell you that the weather's probably most greatly impacted our ability to develop land, as the dirt has just become so saturated we have to wait for it to dry out.

We don't anticipate it having a significant effect on our operations and ability to deliver future closings out of our Texas markets.

And Susan, the conversion improvement that we had in the quarter, which Bob noted, we expect continued improvement vis-a-vis last year, that's a result of the better pace of inventory management that we put in place over the past six to nine months.

And I think Ryan detailed that quite a bit on the last call and we're pleased.

We got more inventory in the ground that is helping.

Mike Dahl, Credit Suisse.

Good morning.

I was hoping to ask one more question about framing the margin environment.

And on the 9% SG&A, how much of getting from 10% to 9% in FY16 to FY17, how much of that is incremental to your prior, what you would've planned prior to this?

And should we think of this as you talked about some of the gross margin pressures, you're obviously focused on holding operating margin, so is it fair to characterize that as we look ahead, your current gross margin basis is roughly that 50 to 100 basis points lower that you're now looking to offset on the SG&A side?

Yes, Mike, we're not giving guidance beyond what we have in terms of margin.

I think what we're trying to communicate on the expense side is we're looking to maintain the efficiency of our operations.

We think we have an opportunity to run the business with a little bit less cost.

And so I don't think there's any correlation necessarily between the margin conversation and the expense conversation.

The margins will be what they are, depending on market conditions and our ability to control costs.

We are going to try and drive better efficiency in our operations through reduced expenses.

Got it.

And then secondly, since there's the new buyback out there and the bulk of it is coming at a point when there's a leadership transition.

And so if we think about the search that's going on and the candidates being evaluated, is the Board committed to finding someone who is entirely aligned with this current strategy or is there a chance that someone will come in and we'll see another shift in strategy next year?

Any comments around if there's a tie between the two right now.

Mike, this is Richard.

The Board is very aligned, as the leadership team is, around this Value Creation strategy.

I wouldn't want to comment specifically on what the next CEO would do, but I can tell you that our Board members who have spoken with investors have been very clear that they are committed to Value Creation.

So that certainly will influence the next CEO's thinking around this.

And it's been successful strategy for the Company.

So we're pleased with it.

Megan McGrath, MKM Partners.

Thank you.

Just a couple of follow-ups.

It sounds as if you're reevaluating where we are in the cycle and shifting your strategy a little bit.

I'm curious if that has changed any of the specifics around your land buying strategy.

At this stage in the cycle, do you place more emphasis on some of your risk factors in your model than others?

Does your view on growth in the different segments of the market change how, not necessarily amount of land that you're spending, but how you might spend that land, or do those risk factors and priorities stay the same no matter where we are in the cycle?

Megan, this is Richard.

I think I can help with that.

We view everything we are announcing today as a continuation and perhaps an enhancement of what we've already been doing, which is shortening the overall length of positions that we're taking on the land side.

We gave some good disclosure before that the last several years, we've been buying much shorter positions.

So that continues.

What we're also saying is that with 143,000 lots, we have a lot of dry powder to monetize from here and that we don't need to grow our rate of land spend at 30% or 40% a year, as Bob indicated, going forward.

But the care with which we underwrite deals, the focus on closer to the city properties, the discipline to stay away from those tertiary B and C locations, the idea to not take on 10, 15 years worth of land risk on anyone deal, that all stays the same going forward.

And to be clear, we do think the market's got several years of growth ahead of it.

We are just trying to be prudent with regard to recognizing the large land book that we have.

Okay.

Thanks.

And there had been some concern in recent weeks about perhaps the market slowing at the tail end of the quarter.

Can you talk a little about cadence throughout the second quarter?

Megan, this is Ryan.

What I would tell you is that the first few weeks of July have proven to be very similar to previous seasonal patterns that we've seen in prior years, and it's very normal.

The cadence has proven out to be very normal seasonal type patterns.

Buck Horne, Raymond James.

Thank you.

Good morning.

I want to maybe follow-up on Megan's question in a slightly different way, going back to the recognition that the cycle is maturing and that maybe you're dialing back the land investments.

You still have a fairly broad range of product categories.

Does it change how you think about the mix of the brands you have?

Does it make you think that would it make more sense to be a more streamlined builder around the move-up categories, or do you want to continue to have a line in the water on all the different price segments right now?

Buck, this is Richard.

That will continue to be driven by what our local operators are seeing with regard to demand in their business.

And that's, candidly, fluid all the time.

As an example, if you operate in Southwest Florida, we're doing a lot of active adult business, because that's the business there, whereas in Texas, the entry-level is quite strong.

So our local operations and what they're seeing will continue to let that land seek its natural place of highest return.

So we're not trying to make a macro call on the segment.

Okay.

And just quickly as a follow-up, the 23% increase in first-time buyer absorption, or those communities for first-time buyers, how much of that is a function of the shift of putting more spec into production?

Did that disproportionately affect those types of communities, or is it more of a true market shift in demand?

Can you help us add some context to that number?

Buck, this is Ryan.

What we're seeing is it's a true shift in demand in the marketplace, doesn't really have anything to do with our spec strategy.

Mark Weintraub, Buckingham Research.

Thank you.

On the Wieland acquisition, I think you mentioned, it had about a 70-basis point impact in the quarter.

Is that a similar amount is expected in the current quarter and when might you see that unwinding, do you think?

Yes, we had said that it would be 70-ish basis points this year as we work through the acquired inventory.

So I think you'll see it for the balance of this year, but not into next year.

Okay.

And then in terms of any financing that you might do for the repurchase program, et cetera, are you leaning to short term or would you be potentially going some more longer term debt, or how should we think about that?

Well, I think market conditions will help us to make that decision.

Over time, this business, I think, is best served by longer term capital markets activity, as opposed to short term for something of this nature, I think that's still consistent.

We'll look at the markets as we get to a point where we're going to issue debt.

They're attractive today.

So that would be a at market time decision.

And just lastly, doing quick, back-of-the-envelope math, it seems to me that the majority of the share repurchase program would be financed by free cash flow.

You did mention there would be some debt financing.

But if you're going to stay in the 40%, maybe a little bit above that, it seems that the majority would be from free cash flow.

Is that a fair conclusion?

Yes, I think we have indicated where we think leverage goes.

And again, within the six quarter period, when we borrow matters, when we earn money matters.

And so you'll see some volatility or variability, better choice of words, but we don't see it getting us much outside of our targeted leverage rate by the time all is said and done.

This concludes today's conference call.

You may now disconnect.