普爾特房屋 (PHM) 2016 Q3 法說會逐字稿

Good day and welcome to the Q3 2016 PulteGroup, Inc.

earnings conference call.

Today's conference is being recorded.

At this time, I would like to turn the call over to Jim Zeumer.

Please go ahead, sir.

Okay.

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

We want to welcome you to PulteGroup's conference call to discuss our third-quarter financial results for the three months ended September 30, 2016.

Joining me for today's call are Ryan Marshall, President and CEO; 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 slide -- excuse me, slides that accompany today's call have been posted to our corporate website at pultegroupinc.com.

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

Before we begin the discussion, I want to alert all the 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 Ryan Marshall.

Ryan?

Thanks, Jim.

As this morning's press release detailed, our Q3 results showed the Company delivered another quarter of double-digit growth on both the top and bottom lines.

And consistent with positive demand trends in US housing, we realized one of our largest increases in sign-ups in recent years, up 17% in units and 25% in dollar value as our business continues to benefit from the increased land investments we made in recent years.

Particularly encouraging is that we realized higher sales across all buyer groups, which is a great sign on the overall health of the market.

Along with showing strong demand on the front end, we realized a 16% increase in deliveries for the quarter, which drove a 29% gain in topline revenues to $1.9 billion.

The topline growth in business carried through to the bottom line as the Company generated a significant expansion in earnings for the third quarter.

Overall, I am very pleased with the Company's very strong third-quarter.

Before I turn over the call, however, there are a few other thoughts I would like to offer before we get into discussing our operating results.

Since being named CEO in September, I've had the opportunity to speak with a number of shareholders, including meeting more than 60 investors during my attendance at one of the industry's larger homebuilding conferences several weeks ago.

These conversations gave me the chance to exchange questions and comments with investors about PulteGroup, our strategy, about management and Board changes, and most importantly, about the fundamentals of the housing market.

The conversations were wide ranging.

There were, however, a handful of questions, which routinely came up regarding how we plan to run the business and what, if any, changes we plan to make.

Given the consistent level of investor interest, I thought it appropriate to share a few of my answers with this larger group.

First, I've been with the PulteGroup for more than 15 years.

Most of that time was spent in our operations running some of our largest businesses, and more recently, as a senior officer managing many of our corporate staff functions.

In other words, I've been deeply involved in and worked closely with Richard on the development and implementation of the Company's value creation strategy.

I've seen firsthand the significant operating and financial benefits we've realized from value creation since its launch over five years ago.

I certainly remain an advocate of value creation and plan to continue operating against this strategy going forward.

That being said, I think it's appropriate to state that my background and my career experiences are unique and different from Richard's, so over time, you could see us emphasize certain things more strongly than we have in the past.

For example, having spent most of my career in the operations, I can tell you that operations is an area of particular focus, even passion, for me.

I am and will continue investing a lot of my time with my staff and our field leaders on finding opportunities to drive greater construction efficiencies and squeeze additional costs from our building processes.

Programs such as common plan management, value engineering, and strategic pricing have been very successful and we will be working hard to build on these programs going forward.

Over the last five years, we have raised PulteGroup's gross margins to be arguably the best in the industry and we certainly want to keep it that way.

Beyond the operations, we've also made progress adjusting our land portfolio to match our value creation goals of generating higher returns while managing our risk.

I believe, however, there is more for us to accomplish.

For example, based on our trailing 12 months of deliveries, we own approximately 5.2 years of lots, which is down from 7.7 years in 2011.

Over time, I would like to see this number continue to move lower and ultimately get below four years, even approaching three years of ownership.

While this will take years to accomplish, there are actions we have implemented which should allow our owned land position to decline gradually over time.

First, we are focusing our investments on shorter, faster turning communities.

Second, we're working through our larger legacy web positions, which will allow us to reduce to 7.4 years of active adult lots we own today.

And third, we are well-positioned to continue to grow our unit volume, which effectively reduces our years of owned supply.

By focusing on shortening the duration of our land assets, we can accelerate inventory turns, improve returns on invested capital, and reduce some of the risks inherent in the business.

This will take time to accomplish, but I wanted you to understand the long-term direction for the Company.

And finally, also relating to our investment practices, I think the potential exists for us to be a little more balanced in our market position.

We've clearly capitalized on the strong demand within the move-up category but I see opportunities for us to realize a better balance across the buyer groups we serve.

Today, approximately 45% of our deliveries are to move-up buyers but at a division level, this percentage can be higher.

Going forward, I believe we can diversify and expand our business among first-time buyers where market demand appears to be accelerating.

We will seek to replicate the success certain PulteGroup markets have achieved by building our first time business in more markets across the country.

On this front, I would note that approximately 40% of our land approvals in the Q3 -- in the third quarter were for first-time buyer communities, which is higher than recent quarters.

Obviously, these are very high level thoughts, but I wanted to provide some insights into how I view the business.

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

Thanks, Ryan, and good morning everybody.

As we've discussed on recent calls, 2016 reflects the growth we've expected, given our increasing land spend over the last several years.

Q3 clearly continues that trend as home sale revenues grew by 29% to $1.9 billion, driven by a 16% increase in closing to 5,037 homes, combined with an 11% or $37,000 increase in average selling price to $374,000.

Consistent with our prior guidance, our deliveries of 5,037 homes represented a conversion rate of 52% in the quarter, which represents a roughly 400 basis point improvement over the third quarter of last year.

Our conversion rates have improved but labor resources in many markets remain stretched and will likely continue to be so during this housing recovery.

Based on feedback from our division presidents, it's clear that labor availability has gotten even tighter relative to last year and continues to impact production timelines.

Our decision last year to put a few more spec homes into production has turned out to be the right one given these market dynamics.

Looking at the fourth quarter, we currently project our conversion rate to be in the range between 62% and 64%.

This represents a meaningful increase over the third quarter and is comparable with the fourth quarter of last year.

We are pleased with the improvements we have made to our production cadence, especially in light of the challenging trade environments.

One item to note, however, is the potential impact from Hurricane Matthew on our operations.

We were fortunate that none of our employees were injured and our communities weathered the storm extremely well so our recovery time should be quick.

This is likely not true for the local power companies, which have a lot of work in front of them restoring power and rebuilding infrastructure.

As that activity will take priority over installing meters or even bringing power to our new subdivisions, it's possible that we maybe -- may face production and delivery delays in affected areas.

Looking at our closings by buyer group during the quarter, 29% were first-time; 44% were move-up; and 27% were active adult.

In the comparable prior-year period, the breakdown was: 33% first-time; 35% move-up; and 32% active adult.

The 11% gain in average sales price for the quarter reflects the higher percentage of move-up closings as well as higher prices realized in each buyer group.

In fact, our average sales price has increased 8% to $283,000 among our first-time buyers, 11% to $441,000 among our move-up buyers, and 4% to $358,000 among our active adult buyers.

With our backlog ASP showing increase of 11% to $393,000 compared to last year, which was also up 5% from our Q3 deliveries, we expect our average selling prices to continue moving gradually higher in the coming quarters.

The Company's recorded gross margin for Q3 was 21.1%, which was 10 basis points below our guidance range.

Beyond margin pressure from higher absolute land costs as we cycle through our land pipeline, we continue to experience labor rate inflation as it relates to both land development and house construction costs.

We had anticipated house costs to rise 1.5% to 2% this year, but labor costs are running outside of that band in many of our markets.

While we expected costs to rise at this stage of the housing cycle, market dynamics are not allowing these costs to be passed through to homebuyers at the same rates we experienced over the past few years.

Assuming these conditions continue in Q4 and into 2017, we now expect Q4 margins to be in the range of 20.5% to 21%.

Further, we expect this range will likely carry through for the full year 2017.

As is our practice, we will update you as the year progresses.

While our margin trend has been lower, I think it's important to highlight that we are still generating the highest margins among the big builders.

As a reminder, our convention is to include sales commissions in cost of sales, while most of the industry reports commissions in SG&A.

As a result, on a comparative basis, our reported gross margins present lower than our peers.

On average, our commissions are approximately 350 basis points of revenue so on a comparable basis, our reported Q3 gross margin of 21.1% would equate to 24.6%.

We believe part of the reason for our strong relative margins is our strategy to maximize the amount of lot premiums and option revenues we generate, as these are our highest-margin revenue streams.

In the third quarter, our total option revenues and lot premiums increased 9% over last year to approximately $71,000 per closing.

Sales discounts in the third quarter were 2.7% of sales, which is flat with Q2 this year and up about 70 basis points from last year, but at roughly $10,000 per home certainly remained modest.

SG&A spend in the third quarter was $183 million, or 9.7% of home sale revenue.

Included in this total are $8 million of severance costs associated with actions taken in the quarter to reduce overhead expenses.

Among the actions we took was a reduction in our workforce of approximately 350 people.

The majority of those reductions took place in our corporate corporate or area structures.

Many of those roles had been established at the outset of our value creation effort but could be cut back as related initiatives are now part of standard operating procedures.

In implementing these actions, we were obviously very careful to ensure we didn't hinder the ability of our field operations to manage what we expect to be a growing volume business in 2017 and beyond.

Also included in this quarter's SG&A were approximately $4 million of costs with shareholder's activities.

Having successfully reached agreements with two of our larger shareholders, we expect these costs to drop materially going forward.

As a reminder, on our last call, we discussed plans to cut SG&A costs from an expected 10% of revenues in 2016 to a target of 9% in 2017.

All significant activity related to the actions to achieve our targeted spend level in 2017 were completed during the quarter.

Last year's third-quarter SG&A spend of $159 million, or 10.9% of revenues included, a $6 million benefit associated with the reserve adjustment taken in the period.

In the third quarter of this year, we also reported $20 million of charges within other expenses net.

This includes a $15 million charge due to the settlement of a dispute over a land transaction that we terminated a decade ago with the collapse of the housing market, in addition to $5 million of lease exit and related costs taken in connection with our SG&A reduction efforts.

Financial services during the quarter generated pre-tax income of $21 million, up from $14 million last year, as this benefited primarily from higher construction volumes in our homebuilding operations.

Mortgage capture rate for the quarter was 81% compared to 83% last year.

Our tax rate in the quarter was 39.5%, which compares to our prior guidance of 38%.

The increase related to adjustments to our deferred tax assets resulted from changes in certain state tax rates which impacted our reported earnings by $0.01 per share.

Reported net income for the quarter was $128 million, or $0.37 per share, which includes the $31 million pre-tax charges I detailed that reduced our reported earnings per share by $0.06 per share.

Earnings per share for the quarter was calculated using approximately 342 million shares outstanding, which is down 3% from last year, resulting largely from share repurchase activities.

Looking at our homebuilding operations, we had 9,235 homes under construction at the end of the third quarter, which is up 18% over last year.

Consistent with our strategy to increase spec but at a controlled rate, specs were 24% of Q3 homes under construction, which is up from 17% in Q3 of last year but effectively flat on a sequential basis from the second quarter of this year.

We ended the quarter with 600 finished specs, or less than one per community, which is up only slightly from the second quarter of this year.

We recorded 4,775 sign-ups during the third quarter, which represents an increase of 17% over the prior year.

On a dollar basis, sign-ups increased an even greater 25%, to $1.8 billion.

Looking at our sign-ups by buyer group, first-time increased 8%; move-up increased 30%; and active adult increased 9%.

Adjusting for changes in community count, our absorption pace has increased 4% for the first-time buyers and 14% among active adult buyers but were lower by 4% among move-up buyers.

Beyond the impact from our Wieland communities, which has lower absorption paces given their higher prices, some divisions have noted move-up buyers are taking longer to sign contracts.

During the third quarter, we operated from 709 communities, which is up 16% over last year.

The year-over-year increase is consistent with prior guidance for community count growth over the prior year in the range of 10% to 15%.

We remain active in the land acquisition arena.

During the third quarter, we approved approximately 3,100 lots for purchase.

At the end of September, we owned approximately 102,000 lots and controlled an additional 43,000 lots via option.

In total, we spent $266 million on land acquisition during the quarter, which brings our nine months' spend to approximately $910 million, excluding our purchase of the Wieland assets.

During the quarter, we also repurchased 12 million of our shares, representing just over 3% of our outstanding flow for $250 million, or $20.77 per share.

This brings our total repurchase activity during 2016 to approximately 18 million shares for $350 million.

As we discussed on our Q2 call, we plan to continue to return excess funds to shareholders subject to market conditions through the repurchase of an additional $250 million of shares in Q4, and $1 billion in 2017.

In July, we raised $1 billion of 5- and 10-year debt at very attractive rates.

Proceeds from the transaction were used to repay approximately $500 million of outstanding debt as well as to help fund our operations and our share repurchase activities.

We ended the quarter with a debt to cap ratio of 40%, which is within the 30% to 40% range we seek to operate in.

Depending upon the timing of future share repurchases, we may move above 40% but expect that future earnings should work to quickly delever our overall capital structure.

We ended the quarter with $461 million of cash, which resulted in net debt to cap ratio of 36%.

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

Ryan?

Thanks, Bob.

While there can be conflicting signals from period to period across the variety of metrics people track, I think most feel that economic conditions are improving, albeit at a slower pace than most would like.

Recent moves higher by 10-year treasury rates further suggests that the economy continues to get stronger.

Certainly, the sizable gains seen in recent US new homes sales data supports the position that housing remains on a sustained path of recovery.

As has been the case for the past several years, demand is being aided by low unemployment, job formations, a low interest rate environment, and generally favorable supply dynamics.

With a 17% increase in units and a 25% increase in dollars, PulteGroup's third-quarter sign-up data tracks the move higher in the broader housing market and anecdotal comments from our field reinforce the view that while there can be volatility from point-to-point, the overall trend is for modestly higher volume.

For example, looking at the demand conditions in the quarter on a regional basis, we saw the following.

Strong demand in Florida and much of the Southeast, although Charlotte and Raleigh were a little bit choppy during the quarter at some of the higher price points.

We didn't see much change in the Mid-Atlantic and Northeast markets, where we are having to compete for each new sign-up.

We have our eyes open for any possible acceleration in DC once we get through the election cycle.

Our Midwest and Texas operations continue to see strong demand conditions across the markets and throughout the quarter.

As we've said before, Houston has held up much better than expected, and given the recent rise in oil prices, it could be that the worst is already past.

Finally, in the Western third of the country, demand was solid throughout the quarter as we continued to experience good sign-up paces in our major markets of Phoenix, Las Vegas, and Northern and Southern California.

Through the first few weeks of October, demand appears to be on its normal seasonal track.

Overall, we are very pleased with Q3, and more broadly, the first nine months of the year, as we were able to get new communities opened and they were met with strong buyer interest.

With over 9,400 homes in backlog, we are well-positioned to complete a very strong 2016.

Let me close by saying it's a positive to have reached a resolution with two of our major shareholders and to have removed any uncertainties related to Company leadership as we have successfully completed our announced CEO transition.

Now we can focus conversations on talking about the business.

As you read this morning and you heard in our comments, there are a lot of positives to discuss.

And finally, I want to say thank you to the employees of PulteGroup.

You have done an amazing job staying focused on serving our customers and delivering great quality homes.

Now, let me turn the call back to Jim Zeumer.

Jim?

Great.

Thank you, Ryan.

We will open the call for questions.

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

Audra, if you would explain the process, we'll get started?

Certainly.

(Operator Instructions)

Nishu Sood, Deutsche Bank.

This is actually Tim Daly on for Nishu.

Thank you for taking my call.

So my first question is regarding kind of the absorption pace that you guys saw this quarter.

So there's a bit of concern out there that pushing volumes via absorptions rather than community count could accelerate some gross margin slippage but that was -- didn't seem to be the case this quarter with most of the order growth coming from community count.

So obviously, you said the gross margin -- a bit of the pressure mainly came from the labor but as you move forward, do you have the communities in the pipeline ready to go?

Or do you expect some gains to come from absorptions going forward?

Well, Tim, I think if you are asking about over the next 12 to 18 months, certainly, we own all the land that we have.

We've got production slated for both land development and opening of communities.

So I think what you've seen, at least in our quarter, is that absorptions held pretty firm.

There were up 4% in the first-time space.

Ours were down 3% in the move-up, which includes Wieland and a little bit of stickiness and nice pace in the active adult space, being up 14%, 15%.

So the market, there's some supply out there so I think at the end of the day, I can't speak to what others are going to do, but I think you can expect to see the same from us, trying to realize return.

We're going to keep selling in communities.

Tim, this is Ryan.

The other thing that I would just point out on the community count guidance, we had provided guidance in the back half of the year to show 10% to 15% growth year over year, and as you can see from our reported quarter in the third quarter, we reported 16% growth year over year, which demonstrates that we've gotten our new communities opened.

All right.

That's great.

Just to follow-up quickly, so you touched on the 40% of land approvals in 3Q being the first-time versus I think you mentioned about 29% of closings for 3Q.

So with this low -- the shorter land profile that you guys have on the investment, were these similar to the two- to three-year investment horizon that you've been talking about recently?

And how does that gross margin compare and when should it mix in?

Tim, this is Ryan.

It does fall in terms of the tenure of land, the averages that we have been running have been just shy of three years with recent approvals.

And this quarter is consistent with that.

Like everything else, Tim, we don't underwrite to margin.

We underwrite to return and so every one of them is unique.

How many of them are optioned, how many of them are raw with development work, but we haven't seen a significant change actually in the margins that we're seeing in the underwriting process.

Michael Rehaut, JPMorgan.

Thanks.

Good morning, everyone.

First question I had was on also around the first-time and the margins and Ryan, some of your comments regarding recognizing some of the stronger demand seen for that segment, so how should we think about, given that you are increasing proportion of your land spend, I would presume that, that's baked into your gross margin guidance for next year?

I'm just trying to get a sense of what you're on track to do in terms of first-time percent of deliveries for 2016 and if the 2017 guidance bakes in any incremental exposure as maybe you do a soft shift increasing towards that segment?

Hi, Mike.

It's Ryan.

I'll take the first piece of that and then I'll have Bob give you a few more comments but in terms of our first -- or the acquisitions that we have made that are targeted toward the first-time buyer, there won't be any impact on our 2017 margins.

Exactly, so if we are putting land under contract today, it's going to be 2018 production and beyond.

So in terms of mix shift, you won't see anything until then.

And Mike, the only other thing I would add to that is I would reiterate what Bob's comment was a minute ago.

We don't underwrite to margin.

We underwrite the return.

Margin is certainly an important component of the equation but it's not the only thing that we look at.

That's helpful.

And it's good to clarify because obviously, sometimes the first-time parcels are faster turning and get into the system a little quicker so thanks for that.

Secondly, the community count, going back to that for a moment, obviously, solid results this year.

How should we think about 2017 in terms of, obviously, you know what you have in the pipeline and kind of your plans?

Should we expect a similar type of 10% to 15% rate or perhaps, like some of your peers, slowing down a little bit to high single digits?

Yes, Mike, it's Bob.

We haven't given any color on 2017 yet.

We will give that when we release our fourth-quarter earnings.

Okay.

Directionally, do you want to make a pass or just wait until next quarter?

We'll talk to you when we release fourth-quarter earnings.

All right.

Fair enough.

Thanks.

Thank you.

Ken Zener, KeyBanc.

Good morning, gentlemen.

Hi, Ken.

How are you?

Doing well.

Ryan, thank you very much and -- for your comments.

It sounds like you're going to have a little different communication approach in terms of your comments specifically around gross margins, which is what I want to explore.

It did sound like you're taking those down near term.

You haven't given guidance on FY17 but the implication seems to be that fourth quarter would have some insight into FY17.

Now, unlike, past cycles you're not able to recover the land or the labor components.

Can you talk if that -- how much that's playing a part of it as opposed to perhaps kind of the regional mix that your -- or pressure that you're seeing?

For example, I believe Florida is still your highest margin segments but that one is down even though demand is good.

Just talk about how the regional EBIT is impacting that comment around gross margins coming down?

Yes, Ken, here's what I'd tell you.

We're certainly cycling through newer land that is more expensive and that's a drag on our margins.

On top of that, it's widely known that the labor is increasing, both on the material and specifically, on the labor side.

We gave you a little bit of color commentary around what we're anticipating in terms of cost increases so I think those are the things that are impacting our forward margins, not regional differences.

Ken (multiple speakers) -- sorry.

Just to clarify, we did give a view towards 2017, which is consistent with that fourth-quarter 20.5% to 21% margin.

Again, what we'll do is we'll give you color as we go quarter by quarter, depending on how the year plays out, but based on what we're seeing today, that fourth-quarter projection actually is through 2017 as well.

Okay.

I think that's -- gentlemen, I think that's obviously a very good approach that you're taking and obviously, there's implications I think to the extent you want to flesh that out more by region because they're such different regional components.

That will be useful over time but thank you for giving us that guidance.

Ivy Zelman, Ivy Zelman & Associates.

Good morning, guys.

Thanks for taking my question.

With respect to the --

Hi, Ivy.

Broad-based growth -- hi.

The Broad-based growth that you experienced in the strong orders across your price segment was impressive and it's obviously very good and shows the health of the market.

Could you just help us walk through each of the segments on where -- maybe you're seeing an increase in selling incentives within your markets as you move up price point, if at all?

Maybe just differing the various level of concessions in the markets that you're contending with?

And what your strategy around margin versus volume -- or volume at the expense of margin, if you give us your thoughts around that?

Thank you.

Yes, Ivy.

It's Ryan.

I think the easiest way to look at it, frankly, is that discounts remain relatively flat with where they were in the prior quarter.

We did not see a material change.

As Bob mentioned in some of his comments, they are running right around $10,000 a unit, which we think is very reasonable.

Certainly, in some of the move-up price points, things have gotten to be a little bit more difficult and we've seen accelerating demand on the first-time buyer, which I think is reflective of some of the comments that I gave to you about where a lot of our land investment went in the third quarter.

And Ivy, what we'll -- one other thing I would add to that is as we look at the business and we don't necessarily look at it regionally or by segment the way you talked about it, but we've invested a fair amount of money over the last couple years and we are focused on getting a return out of that investment, so our absorption paces, we were pleased with them.

They were consistent with what we have seen over the last year or so and the margins are still really strong on it.

We're guiding down a little bit, to Ryan's point, it's a little bit harder to get price margins, a little bit harder to come by but at these margins, you will see us continue to sell to actually realize the return on an investment.

It's really important to remember it's not just margin, it's margin and pace.

How quickly can we work through it?

We've made good investments; we like the margins we're getting from them and we like the return we can get if we can continue to sell against that.

And so we are playing in the market.

So you can see year over year, we've got a little bit of creep in our discounts.

That's almost community by community, though.

What's open nearby?

What are our competitors up to?

But what we want to make sure we do is take all the money that we have invested and get the return out of it.

No, Bob, that's extremely helpful.

So it's really a focus on return and getting that pace and getting your money back basically, which is different than other builders so I think it's important that people understand that strategy and I appreciate the follow-up on that.

Thanks, guys.

Good luck.

Ivy, the only other thing that I'd add to your last comment there is that's really what's at the heart of the value creation strategy, from the very beginning, was a focus on return on investment.

Great.

Thanks, Ryan.

Good luck with everything.

Stephen East, Wells Fargo.

Thank you.

Ryan, first of all, congratulations on the CEO role, and just -- could you expand a bit as you prepared in your prepared comments, you talked about the vision for the Company, the operational changes, your land bank, et cetera?

Could you give us maybe a little bit more detail on how you're thinking about it?

And how long do maybe some of your plans take to implement, et cetera?

Just whatever things you've been grinding through since you've taken over?

Yes, Stephen, we haven't provided any details and I probably wouldn't want to get into it today in terms of specifics around implementation.

What I will elaborate on, as I did in some of my prepared remarks, is that I'm a very big supporter of our value creation strategy.

The Company has realized great financial benefits from that strategy and we will continue -- we're going to continue to run that playbook.

My experiences in the operations of our organization over the last 15 years are certainly a little bit different and unique from Richard's and you will see heavy emphasis and focus from me as the leader of our organization on driving the efficiencies out of our homebuilding operations.

That's where we made substantial and sizable gains over the last four or five years in becoming a more efficient builder.

I believe that we can continue to drive that well into the future.

The other piece that I talked about is just being more balanced in terms of where we are investing our land.

We are brand agnostic and we've talked about that quite a bit.

We have an entry-level first-time business today and we'll continue to have that business well into the future with our Centex, Pulte, and Del Web brand construct.

I'm quite encouraged by the fact that we are becoming more balanced than what we've been, as represented by the 40% of our land acquisitions in the third quarter going to the first-time buyer.

Okay.

Great.

Just a quick compound question, if you will.

Bob, could you tell us the way you all define returns, tells where you are now?

And maybe what type of longer-term targets you all have out there?

And then as you look at buying back shares, I guess a couple quick message -- a couple of mixed messages.

You want to get to investment grade but you have added significant debt, and with the equity trading at 1.5 times book, how do you reconcile that versus land opportunities, et cetera?

I guess, Stephen, to the second question, investment grade, what we've said is that we think we are behaving like an investment-grade credit.

We have over time.

We have strong credit metrics.

The offering that we did in July, I think are directly supportive of that view.

What we have said is we won't jump through hoops to try and get somebody to say that we are investment-grade.

So I think we're running a very, I think, disciplined and healthy capital structure, so if -- and within that, we've laid out for the last couple of years, what we're going to do with our capital, including the buyback shares.

And I apologize, I forgot the first question.

Returns.

Sure, well, if you look at our returns over the last couple of years, what they've been is relatively flat as we have grown the income statement but we're growing our investment at the same time.

Going forward, I think we've highlighted that we would be not growing at the same rate in terms of investment but that we can and do expect to be able to yield return off of the investments which we're making so I think you'll see improvement there and what I think you can expect from us is later this year, to lay out what we think the target might be over time.

John Lovallo, Bank of America.

Hi, guys.

Thanks for taking my call as well.

Hi John.

Hi, good morning.

First question would be, Bob, you guys laid out 20.5% to 21% gross margin and you talked about SG&A as a percentage of sales at around 9%.

It would seem to imply that there's a decent chance that operating margin could be flattish to actually down next year.

I know you're not giving explicit guidance but directionally, am I thinking about that correctly?

Well, I think the -- I don't want to be pithy, but the math is the math.

Again, we think the margins are strong.

We think the operating margin will be strong.

And what we're trying to do is manage, just like Ryan talked about, we're managing against return.

It's the total return of our income stream that's really important to us and we certainly seek to maximize gross margin.

We are trying to be as efficient as we possibly can, all with a goal towards driving strong operating margin, and again, not trying to be cute.

That -- if you use 21%, or 20.5%, and 9%, that's still a strong relative operating margin compared to historical norms.

Okay.

That's helpful.

And then just thinking about the cycle here, growth is arguably -- him or the rate of growth, I should say, is arguably decelerating on an industrywide basis.

Your first-time community seemed like they won't be up and running until 2018.

I guess what is it that gives you guys confidence that the buyers are going to be there and that the market is still going to hold in?

John, I think a couple things here.

Don't lose sight of the fact that we've got a very healthy first-time business today and we have for a number of years.

This isn't a new focus for us.

We certainly are seeing additional opportunities as of late and we have allocated some incremental capital toward that space and we'll continue to realize the benefits from the business that we've always had there in addition to the more recent investments.

So that would be the first piece of it.

The other piece, in terms of overall demand, we like where the housing market is quite a bit.

When you look at overall new home sales this year, somewhere in the $575,000 to $600,000 range, we believe we are still under historical norms and historical equilibriums and with an economy that is healthy and low interest rates, low supply, we see demand still being quite favorable and we like how that shapes up for our business.

Okay.

Thank you, guys.

Thank you.

Stephen Kim, Evercore ISI.

Thanks very much, guys and let me also say I really appreciate the detail you guys have given.

I agree with you also, Bob, about your operating margin being pretty good where it is already.

In that vein, I wanted to ask you for a little bit of clarity about your land spend.

First of all, I don't think I got the development numbers, if you can just give a -- the specific, what the land spend was in the quarter?

And then with respect to this 40% of the spend that was on first-time buyers in the quarter, can you help us understand, how much of this stuff is the land that you're buying, is what you might consider a stereotypical -- stereotypically located first-time community more out in the outer fringe and versus maybe some of the stuff that's a little closer in, maybe different kind of first-time buyer community?

Yes, Stephen, again, a couple of questions there, but LD in the quarter was $374 million and total spend was $640 million, when you add in the $266 million of land acquisition.

That brings us to -- for the year, to about $1.9 billion, and that excludes Wieland.

So pretty much right on track with the $1 billion to $1.2 billion that we had projected for full year 2016.

Then to your question on that first-time buyer, we've been pretty clear that we're not out in the exurbs chasing volume in that space.

We're typically going to be a little closer in.

We're typically going to be a little higher price point, that more affluent millennial first-time buyer who's a little bit older, partnered, might have two incomes.

So I don't think we have changed at all what we have expressed that first-time business means to us.

It's just that with the acceleration of that business, we are seeing more opportunities to invest and so of the approvals and that's not necessarily a cash flow, that's just approvals.

So the cash will be spent at some point in the future.

You're seeing more of it in that first-time space.

Got it, okay.

That's helpful clarification.

Thanks for that.

And then the second question I had related to your gross margin commentary.

Obviously, a lot of things embedded in your outlook for 2017.

I'm sure some of the other folks have touched on some of those, I wanted to see if you could comment a little bit specifically on two, however.

One is what you're seeing in lumber?

We've seen the random lengths have moved up pretty noticeably here.

I was wondering if that is factored into your thinking?

Also, the Fair Labor Standards Act seems to have the potential to raise labor costs for lesser skilled laborers who have to put in more than 40 hours in a given week and then you had alluded to Hurricane Matthew possible delays.

Is any of that embedded in your outlook in 4Q 2016?

Thanks.

Well, Stephen, for the fourth quarter and even for next year, it is our best estimate today and so yes, it encompasses everything we know.

I think the reality is that Matthew is more likely a production than cost issue.

Time will tell about on the labor side but the folks that are working on the power lines aren't the folks that are building our homes.

So it's not an absolute labor issue; it's just will we be able to get power turned on --

Stephen, the other thing that I -- this is Ryan.

The other thing that I'd mention about Hurricane Matthew.

We actually -- we feel quite fortunate that there wasn't a huge human factor -- human damage as a result of the storm.

Our employees are safe.

The majority of the residents that live in the affected areas came through the storm safely.

Our properties, in particular, fared quite well.

We had minimal damage; it's mostly some landscape-type clean-up that we're going to be dealing with.

Bob mentioned the power companies.

There's a lot of work that they've got to do to restore the existing infrastructure and what we'll see likely happen based on past experience, and I lived in Florida for a long time.

I'm quite familiar with what happens post-hurricane storms.

As they rebuild infrastructure, new meter sets, and getting new communities energized will take last priority.

We do believe that we've factored the best information into our Q4 estimates that we can but as you can certainly appreciate, we don't have total visibility into what the backlog is for the power companies.

Susan Maklari, UBS.

Good morning.

Hi, Susan.

Good morning.

First off, you talked a lot about the longer-term trends in terms of SG&A and getting to that targeted 9% level next year but it seems like you also made a bit of progress this quarter relative to where we were.

Can you just talk a little bit about the benefits maybe that you're already starting to see from some of the changes that you've made?

Yes, Susan, this is Ryan.

When we -- at the end of our Q2 call, we talked about -- we've got a targeted run rate of 10% in 2016.

We were going to reduce that by 100% -- or 100 basis points going to a targeted run rate of 9% in 2017 and any of the actions that we plan to take toward that target would be taken in the third quarter.

Bob laid out some of the details of how we've effected that and how we've effectuated that, rather.

We are already seeing the benefits of that and feel that we're very much on track toward that target of 9% for 2017.

But to be -- put a finer point on it, yes, we are already benefiting from the actions that we've taken.

Okay.

And then perhaps slightly bigger picture, recognizing that it's a perhaps a -- or is a very different election cycle than what we've seen historically, but can you talk a little bit to any impact that has on consumer psyche or demand as we get closer to the election and perhaps maybe the DC market, specifically, but even just broader thoughts?

Yes, Susan, my experience from spending a number of years in the field in our operations is anytime we're this close to the end of an election cycle, I think the general public is trying to calculate and figure out what the impact will be of a change in power, moving from one side of the political power grid to the other, what that will do to their earning power potential, what that will do to job growth, what that will do to the stock market, et cetera.

My general sense is that folks maybe pause, and wait and see.

We actually, as you saw from our sign-up growth and our absorption paces, we are quite happy, very happy, in fact, with what we saw in the third quarter.

So I don't know that we saw any kind of noticeable impacts.

I think I'd probably speak for the collective country in saying that I think it will be nice once this election cycle is over in a few short weeks.

Megan McGrath, MKM Partners.

Good morning.

I guess my first question is a chicken versus egg question.

You mentioned a little bit in one of your answers before about being generally product agnostic, although it's certainly -- although you talked about going to 40% and it sounds like you're, Ryan, excited about that.

So I guess, are you starting to talk about getting more diversified because you saw that your underwriting was pushing these first-time buyers or was there something proactive you did in your underwriting to shift towards the first-time buyer in the last couple of months?

Yes, Susan, the way that I would answer that is we don't necessarily want to be over-indexed toward any one specific buyer.

I think what you heard in my prepared remarks is that we would like to run a balanced business.

We feel that we have that today.

We would like to continue to ensure that we have it and what you will see over time is that as there are opportunities with a particular buyer group, you may see our spend flex ever so slightly toward that particular buyer group.

And as we've seen a recovery with that first-time buyer, paces have been accelerating.

I think that you have seen us spend a little bit more money toward that opportunity.

On the whole, though, when we look at the entire enterprise, the goal is going to be maintain balance.

So you didn't really shift anything in your underwriting criteria in the quarter to purposely go after more first-time buyers?

No, we did not.

Our underwriting criteria has stayed the same.

Okay, that's helpful.

Thanks.

Just a quick follow-up on the SG&A.

Are you done with the bulk of the low hanging fruit there or is there still more to come?

We are done.

We will always work to be as efficient as we possibly can but all of the actions that we plan to take, we have taken and we are done.

Great.

Thanks very much.

Jack Micenko, SIG.

Good morning, everybody.

Bob, I wanted to talk about the G&A number versus the percentage.

You took about 350 FTEs out of the mix.

You did a 183 number so I backed out the 12 in one-time items, we're back to sort of like a 165 number.

I think in the past, you've talked about $160 million, $165 million run rate.

I guess the question is, does that number come down from here going forward or how do we think about the dollar level of G&A?

Yes, Jack, there is variability based on volume, right?

So I don't want to start hanging targets on dollar levels.

What we've indicated is 9% of revenues for next year will be -- our projection is 10% for this year and we think we will get there.

So rather than turning it into an X dollars per quarter because there are -- while many of our costs are relatively fixed over time, because sales commissions aren't in SG&A, there are model and start-up costs that come through the SG&A line, in connection with opening new communities, and so it really does flex and I don't want to put unrealistic or bad targets out.

So the 9% is where we'd like you to think about it.

Okay.

And then in the financial services business, the capture rate looks in line but it looks like you did a much better margin there.

Is there anything different about the mortgage business over the last quarter that would have driven that?

No, it's, candidly, it's mostly volume driven.

We are operating in an environment where we have pretty strong margins today and have with little fits and starts over the last few years, been operating in a pretty strong margin environment.

Our team does a great job, I's a captive lender so they're working with our customers.

We seek to be competitive on price and so we are out there battling against all the other originators.

They do a fantastic job and the margin environment has been pretty good.

Buck Horne, Raymond James.

Good morning, guys.

A little bit of color on the geographic mix of where you're making new land investments right now in terms of just where you are thinking you would want to allocate more dollars regionally or by state?

It's Bob.

We go through a process annually that we update, candidly, quarterly, where we look at the capital allocation, and we give our field teams three years of visibility in terms of what their expectation can be for capital availability and candidly, we are a buyer everywhere.

We certainly look to demand and demographic considerations when we think about it.

We think about the team's historical ability to get money invested, where they are indexed, so to Ryan's point about a balanced business, obviously, if you look at Texas and Dallas, in particular, we've committed a lot of capital there because the market is so strong.

But on the whole, there are no markets where we're saying you don't get capital and there's none where we've said you're getting twice as much as you used to.

Okay.

Thanks.

That's helpful.

I'm curious about John Wieland as well.

Just -- maybe how you would evaluate that segment's performance so far?

Maybe you gave this earlier, I was curious about what the change in the move-up segment absorption pace was without the effect of Wieland?

Buck, it's Ryan.

And I would tell you thus far, we are very pleased with the John Wieland acquisition and the related integration efforts.

Our team, frankly, has done a phenomenal job in bringing the Wieland platform onto our platform and we're quite happy with the results that we're getting there and it's in line with our underwriting criteria.

One of the things that we really look to with that particular acquisition was margin opportunity by becoming more efficient on the cost side.

And we are continuing to work through that.

When -- as to your absorption comment, ex-Wieland, our move-up absorptions were flat.

Jay McCanless, Wedbush.

Hi.

My questions have been answered.

Thank you.

Thanks, Jay.

Will Randow, Citigroup.

Good morning.

Thanks for taking my questions.

In terms of the price increases and absorption paces you've mentioned for the three segments first-time, move-up, and active adult, can you talk about the absolute price increases as opposed to -- I'm not -- I don't believe you excluded out mix or I don't know if you can quantify that or qualify that?

Sorry, those are the absolute increases, Will, not sure I understand your question.

Okay.

I wanted to make sure that was the case and then my follow-up was, if you're seeing that type of strength in move-up relative to the two other segments, what is driving your emphasis towards the first-time buyer?

I know you highlighted a few different comments there but I would love to hear a little bit more detail in terms of --

Yes, Will, I just -- I probably just want to clarify the comment.

We're -- the focus is on running a balanced business and we're not going to get over-indexed toward any one particular buyer group.

We like the recovery that we're seeing in the first-time buyer.

They were noticeably absent in this recovery, as this recovery was predominantly led by the move-up buyer.

And I think as the economy and, frankly, the housing recovery cycle has continued to progress, we're seeing strength from the first-time buyers and thus, additional opportunities for us to put capital to work.

As Bob highlighted and detailed, our strategy has been to stay closer to the job core, closer to the city center.

We're not going into the exurbs and chasing volume for volume's sake.

So while we like what we're seeing and we're seeing opportunities to be a little bit more balanced in how we are allocating capital, you won't see us become over-indexed toward any one buyer group.

Mark Weintraub, Buckingham Research.

Thank you.

It's actually just a clarification.

There had been a question earlier on operating margins given what you have indicated on SG&A and preliminarily on gross margin.

I just want to make sure that I understand because I believe given your 4Q guidance in gross margin, that your gross margin in 2016 is going to be about 21.2% or 21.3%.

And if that's right, then I believe if you're going to be reducing SG&A by 100 basis points, then if you're going to be in that 20.5% to 21% range for gross margin preliminarily for 2017, that actually indicates a modest increase in operating margin.

I just want to make sure I wasn't missing something.

You are not.

That is the math, Mark.

Thank you.

Michael Rehaut, JPMorgan.

Thanks for taking my follow-up.

I just wanted a point of clarification and also just a little bit more color perhaps on the gross margin.

First off, there was an earlier question that talked to the potential, with the guidance for 2017 operating margins to be down year over year, and I don't quite see that math per se, if you're doing -- if you're guiding to 20.5% to 21% growth and 9% SG&A.

That kind of gets you in the high 11%s on an operating margin basis.

I just want to make sure that I'm not missing anything there.

Yes, Mike, your math is correct.

Okay.

And then just secondly, when thinking about the 2017 gross margin and certainly, appreciate the guidance there of course.

I was just wondering if you give a little more granularity in terms of how to think about interest expense amortization, Bob?

And aside from that, when you think about the -- it looks like you're going to do in the low 21%s for full-year 2016, what would be the bigger drivers of the incremental contraction labor versus land?

Yes, so on interest, Mike, we obviously have borrowed an incremental roughly $1 billion during the year so our interest cost is up.

We don't think it will have a significant impact on the gross margin percentage because it's going to be against the bigger base of business so we think it's relatively neutral 2016 to 2017.

In terms of the color commentary, we are in the midst of doing our planning right now and so we can give you a little more color on that when we provide a fresh update for our, candidly, our real estimate -- not real, sorry, our budget-based estimate for 2017.

Alex Barron, Housing Research Center.

Yes, thank you.

I know you guys indicated an interest in lowering the number of years' exposure to active adults.

But I'm wondering if you guys are changing anything to do that such as -- I don't know, increasing the number of actually active adult communities or lowering your size of homes or something to increase absorptions.

Can you just elaborate your thoughts on the active adult space?

Yes, Alex, this is Ryan.

We're just not as -- we're not investing at the same rate that we were previously in the active adult space, as you're also seeing the overall size of the communities come down and be a little more smaller.

If you look at -- if you look historically, some of our Del Webb communities were 2,000 and 3,000 and 4,000 homes per community and that's simply gotten smaller over time so that would be the primary driver of bringing the average years of supply down.

They are just simply smaller communities.

We are very big believers in the active adult space.

It's a huge consumer group.

We have an unbelievably strong brand with the Del Webb brand and we're continuing -- we're going to continue to play in that space with that particular consumer.

Okay.

Great.

Thanks.

Thank you.

That concludes today's question-and-answer session.

At this time, I will turn the conference back over to Mr. Zeumer for any closing remarks.

I want to thank everybody for your time this morning.

We will be around all day if you have any follow-up questions and we look forward to speaking with you on our next call.

That does conclude today's conference.

Again, thank you for your participation.