普爾特房屋 (PHM) 2017 Q4 法說會逐字稿

Good day, and welcome to the PulteGroup's Q4 2017 Quarterly Earnings Call.

Today's conference is being recorded.

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

Please go ahead, sir.

Great.

Thank you, Michelle, and good morning.

I want to welcome all participants to PulteGroup's fourth quarter earnings call.

Joining me today are Ryan Marshall, President and CEO; Bob O'Shaughnessy, Executive Vice President and CFO; and Jim Ossowski, Senior VP of Finance.

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

We'll also post an audio replay of the call later today.

I want to highlight that as part of today's call, we'll be discussing our reported results as well as our results adjusted to exclude the impact of certain significant items.

A reconciliation of these adjusted results to our reported results is included in this morning's release and within the webcast slides accompanying this call.

We encourage you to review these tables to assist in your analysis of our results.

Also, I want to alert all participants that today's presentation includes 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.

With that said, let me turn over the call to Ryan Marshall.

Ryan?

Thanks, Jim, and good morning.

I'm extremely pleased to report that PulteGroup's strong fourth quarter results completed a year in which we realized significant gains across a number of key operating and financial metrics.

Gains that I would note were realized despite the significant challenges created by 2 massive hurricanes and one multifamily building fire in the Northeast.

From double-digit growth on top and bottom lines to significant improvement in the company's return on equity, we clearly continue to make meaningful progress against our strategic goals.

Before I hand the call over to Bob for a review of our fourth quarter results, let me make a few comments about where we want to take this company going forward.

I believe that our decision to focus on returns of the outset of this recovery has driven better operating discipline and financial performance, while helping to lower the risk profile of our business.

As such, we will directionally continue along the same strategic path but with clear acknowledgment that we want to continue growing our business while driving greater efficiency in support of the strong cash flows and high returns.

Consistent with our favorable view of overall housing demand, we have begun investing to expand our business at a measured pace.

Our 2017 results, again, demonstrate that success of our approach, as we grew home sale revenues by almost $900 million or approximately 12%.

As we remain positive on the housing cycle, we are continuing to invest in our business with a view toward growing volumes while delivering high returns.

Embedded within this approach is a sustained focus on growing volumes, as we work to expand local share across all appropriate buyer groups.

We, and the entire industry, continue to see strong demand gains among entry-level and first-time buyers.

That being said, consumer demand and associated opportunities can, and frankly do, vary by market.

In some markets, yes, our biggest growth can be realized in first-time.

In other areas, however, local supply, demand and competitor dynamics might dictate that share gains are more readily achievable among move-up or active adult buyers.

We continue to make choices that we believe will drive the optimal business results and create value for our shareholders.

We have a brand portfolio that is unmatched in the industry today.

Our national brands, including Centex, and Del Webb along with our strong regional DiVosta and John Wieland brands, have decades of experience on which to build.

We will continue to use this to our competitive advantage, as we serve the entire spectrum of homebuyers from entry-level and first-time to move-up, luxury and active adults.

This has been, and will continue to be, a point of competitive differentiation for PulteGroup.

At 12.1%, our full year 2017 adjusted operating margin was absolutely among the industry's highest, and we continue working on our gross margin and overheads to help ensure that we keep it there.

We can do this by expanding share within our operating footprint, where we have the best opportunity to drive greater construction on overhead efficiencies.

In today's operating environment, cost pressures are real, but we can always do more to maximize our gross margin opportunity.

For example, while we achieved our initial targets on commonly managed plans, we must work to squeeze out additional costs as we refine the process and redesign floor plans.

Along these lines, we are currently redesigning our library of active adult floor plans.

As part of this effort we'll use our comprehensive 12-step design process in creating these new floor plans, including consumer validation, value engineering and related should costing.

We will then use this work to help drive the next round of efficiency gains.

By deploying these next-generation plans within our active adult communities, we can be in a stronger position to negotiate with trades and suppliers, giving us a better opportunity to maximize our margin performance.

We are obviously aware of our changing competitive dynamics in this industry.

But we are confident that our construction volume of more than 20,000 homes per year, built within a well-defined geographic footprint, provides a strong platform from which to compete.

I fundamentally believe that systemically growing the business can provide opportunities to realize incremental operating and financial gains as well as create career growth inside our organization.

By growing within our existing footprint, we also give ourselves the greatest chance to drive additional overhead leverage.

In 2017, our adjusted SG&A fell by 200 basis points to 11.5% of home sale revenues, but I believe we can do better as our business continues to grow.

Bob will share our expectations for 2018, but know that this is an area for focus for our entire organization.

If we can put more revenue through a more -- through more efficient operations, we will be in a position to routinely generate strong cash flow.

In 2018 alone, we expect this number to be in the range of $600 million to $800 million.

We have been clear on our allocation priorities, so we can put these dollars to work in high-returning projects, use them to reduce leverage or return them to shareholders through dividends and share repurchases.

From where we started with value creation, I think this next phase and its development is almost intuitive.

Within a cyclical business, we want to drive appropriate revenue growth that can be maintained without getting too far over our skis or forcing us to take on too much risk.

We are extremely pleased with the operating and financial performance we delivered in 2017 and would tell you that we still have a lot of runway in front of us to get even better.

Now let me turn the call over to Bob for a review of our Q4 results.

Bob?

Thanks, Ryan, and good morning.

As noted in this morning's earnings release, PulteGroup's fourth quarter results were impacted by several significant items.

While we have provided non-GAAP reconciliation tables as part of the release and in our webcast slides, I thought it would make sense to start my comments by providing a little more detail on these items.

First, we recorded a land charge of $57 million as home sale cost to revenues.

This charge relates primarily to one project, where we realized significant increases in our estimates for future land development and house construction costs.

The project is in an area where competitive conditions limit our ability to offset our cost increases through higher sales prices.

I would note that this action is different from the charge we took in Q2 this year, when we made the strategic decision to exit and sell select noncore land positions.

As a quick update, we have already disposed of more than half of the 5,000 lots included among those assets at prices consistent with our expectations.

Offsetting this land charge, we recorded a $66 million benefit in SG&A that is primarily associated with a reversal of construction-related reserves.

This benefit was largely driven by continued favorable trends in the development of our construction claims compared to actuarial estimates.

I would note that we recorded a similar benefit in the fourth quarter last year.

And finally, our fourth quarter tax provision includes $181 million of charges, primarily relating to the revaluation of our deferred tax assets, resulting from the Tax cuts and Jobs Act enacted in December.

Clearly, the dramatically lower corporate tax rate included in the new law will lower our future tax expense.

More importantly, given that we expect to be a cash taxpayer in 2018 and beyond, the new tax law will allow for lower cash tax payments.

I'll address our perspective tax rate later in this call as part of my comments on 2018.

Now let me move on to a review of our fourth quarter operating results.

Our net new orders for the period increased 14% over the prior year to 4,805 homes.

We realized growth in all of our buyer groups, as orders among first-time buyers increased 23% to 1,401 homes.

Orders among move-up buyers increased 13% to 2,208, and orders among active adult buyers increased 9% to 1,196 homes.

Adjusting for changes in community count, our absorption pace for Q4 increased 5% over last year.

For the quarter, first-time and active adult paces increased by 18% and 9%, respectively, while our absorption pace among move-up buyers was down 1%.

It's worth highlighting that the 14% increase in orders and 5% increase in paces represent our highest quarterly gains of 2017.

We believe this demonstrates that housing demand continues to improve, as it benefits from a number of positive dynamics, including a strong economic, employment and consumer confidence trends being experienced across the country.

Looking at our income statement, home sale revenues for the quarter were up 12% over last year to $2.7 billion.

Our higher revenues resulted from a 7% increase in closing volumes to 6,632 homes, coupled with a 5% or $19,000 increase in average sales price to $410,000.

Analyzing closings by buyer group shows 31% were first-time, 44% were move-up and 25% were active adult.

In the prior year fourth quarter, 30% were first-time, 43% were move-up and 27% were active adult.

The higher average sales price for the quarter of $410,000 reflects a modest mix shift toward more move-up homes combined with an increase in selling prices realized across all buyer groups.

In fact, during Q4, our average sales price to first-time homebuyers increased 9% to $326,000, move-up gained 2% to $478,000, and active adult was up 4% to $391,000.

With the average price and backlog up an additional 12% to $442,000, we expect closing ASPs will continue to move higher.

As we have discussed in prior quarters, geographic mix matters, as our numbers reflect increased investment in California, particularly Northern California, where sale prices are routinely much higher.

Moving down the income statement.

Our fourth quarter adjusted gross margin, which excludes the land charge I discussed earlier, was 23.8%, which is in line with our previous guidance.

Our strategic pricing programs continue to enhance our margin performance, as our option revenues and lot premiums in the quarter increased 6% or approximately $4,200 over last year to $77,000 per home.

We also continue to control our use of sale incentives, which, at 3.2% of revenues, were in line with Q4 last year and Q3 of this year.

Turning to overheads.

Our fourth quarter adjusted SG&A, excluding the insurance benefit I discussed earlier, was $268 million or 9.8% of home sale revenues.

This compares with adjusted SG&A of $263 million or 10.8% of home sale revenues in Q4 of last year.

We are pleased with the overhead gains we realized in the quarter, as we drove a 100 basis points of leverage compared with the prior year.

Even more impressive is the fact that for the full year, we realized 200 basis points of improvement in our adjusted SG&A spend, which fell to 11.5% of home sale revenues in 2017.

We continue to look for opportunities to capture additional efficiencies in 2018 and beyond.

Looking at financial services for the quarter.

We reported pretax income of $23 million, which compares to $25 million in the prior year.

The decrease was primarily driven by the more competitive pricing environment for mortgage originations we've experienced throughout much of 2017, as our capture rate in the fourth quarter was 81%, which compares to 82% last year.

In total, our reported pretax income was $409 million in the quarter.

On an adjusted basis, our pretax income was $400 million, which represents an 11% increase over our adjusted pretax income in the prior year.

Turning to taxes.

Our fourth quarter adjusted income tax expense, excluding the tax items I mentioned earlier, was $147 million.

This represents an effective tax rate of 36.8%, which is generally consistent with our previously issued guidance.

Our reported earnings for the quarter were $0.26 per share, which compares to reported earnings per share of $0.83 per share in the fourth quarter of last year.

On an adjusted basis, our Q4 earnings were $0.85 per share, which represents a 27% increase over our adjusted earnings per share last year.

Our earnings per share for Q4 was calculated using approximately 293 million shares outstanding, which is down from 328 million shares last year.

The share count decrease of approximately 34 million or 10% of outstanding, resulted primarily from our share repurchase activities.

Looking at our balance sheet.

We ended the fourth quarter with $306 million of cash after having retired $123 million of senior debt that matured in October and repurchasing $251 million of our stock during the quarter.

In total, we repurchased 7.6 million common shares in the quarter on an average price of $33.09 per share.

As of the end of the year, we had approximately $94 million of share repurchase authorization remaining.

For the full year, we've repurchased $910 million worth of stock, above just shy of the expected $1 billion of share repurchases, we expect repurchase activity continue in 2018.

To that end, today, we announced that our Board of Directors approved an incremental $500 million of share repurchase authorization.

We ended the year with a debt-to-capital ratio of 42%.

As expected, this is just outside our targeted debt-to-cap range of 30% to 40%, but we anticipate that normal business operations will move us back inside the range by the end of 2018.

Now switching over to operations.

At the end of the year, we had 8,856 homes under construction, which is an increase of approximately 1,400 homes compared with last year.

The increase primarily reflects higher sold backlog, as we remain disciplined with regards to the production of spec inventory.

In fact, we ended the quarter with only 300 -- with only 637 finished spec homes, which is essentially unchanged from last year.

For the quarter, we operated out of 790 communities, which is an increase of 9% over the prior year and is in line with our guidance.

In the fourth quarter, we spent $311 million on new land acquisition, bringing our land acquisition spend for the year to $1.1 billion, which is consistent with our guidance.

Reflective of our favorable view of the housing market, we expect land acquisition spend to grow by approximately 10% in 2018.

I would highlight that our claimed investment for 2018 did not change as a result of the new tax legislation.

In the fourth quarter, we approved 50 new deals, totaling approximately 8,650 lots, including land for 2 new Del Webb communities.

These transactions bring our year-end controlled land position to approximately 141,000 lots, of which, 89,000 lots are owned and 52,000 lots are controlled under option.

Consistent with our efforts to improve overall asset efficiency and reduce land risks by auctioning lots, we have successfully reduced our owned land to just 4.2 years, down from 5.6 years just 24 months ago.

At the same time, we have increased our lots controlled under option to 37%.

We are pleased with the progress we continue to make on both fronts.

Before turning the call back to Ryan, let me provide our outlook on expected business performance in 2018.

On a year-over-year basis, we expect home closings in 2018 to grow by between 5% and 10%, as we anticipate delivering between 22,000 and 23,000 homes at average prices in the range of $400,000 to $415,000 throughout the year.

Consistent with typical seasonal patterns, this would include closing between 4,250 and 4,500 homes in the first quarter.

Looking at our margins for next year.

We currently expect gross margin for each of the quarters, and for the year, to be in a range between 23% and 23.5%.

Margins for the year reflect the impact of higher land, labor and material costs, particularly lumber and concrete, partially offset by higher selling prices.

Consistent with comments we have made previously, we see opportunities to realize additional overhead leverage as our volume grows.

As a result, we expect 2018 SG&A to be in the range of 11% to 11.5% of home sale revenues compared with 2017's adjusted SG&A of 11.5% of revenues.

The resulting operating margin range of 11.5% to 12.5% compares with 2017's adjusted operating margin of 12.1%.

Although we are still analyzing the Tax Act and awaiting further interpretive guidance to complete the accounting for the act.

We believe our 2018 tax rate will be approximately 25.5% absent any discrete items.

As Ryan indicated, given the expected growth of our business and projected strong operating performance, we expect to generate between $600 million and $800 million of cash flow in 2018 before dividend and share repurchase activities.

Consistent with our capital allocation priorities, this capital would be available to invest in the business, reduce leverage and/or be returned to shareholders.

Clearly, our fourth quarter results capped a very strong year for the company and has helped us put it -- and has helped put us in an excellent position for continued success in 2018.

Now let me call -- turn the call back to Ryan for some final comments.

Ryan?

Thanks, Bob.

Before opening the call to questions, I'll provide some comments on market conditions and broadly, what we're seeing in the marketplace.

With a 14% increase in orders supported by a 5% increase in absorption paces for the quarter, I am sure you can appreciate why we are positive on the demand conditions we saw across the industry.

Even though interest rates have started to creep up and the tax plan has thrown a few wrinkles across the landscape, there remain many positive forces continuing to push demand higher.

The underlying economy looks to be gaining speed and the tax cut has the potential to add fuel to this engine.

Employment trends are certainly favorable and wages are showing some signs of growth, which would also be a positive.

Given these strong underpinnings, the potential for demand to expand further, particularly among the big book and demographics of millennials and boomers, is certainly very real.

Specific to our business in the fourth quarter, demand trends in the East were generally strong from Massachusetts down through Florida.

There was some uncertainty as to how the Southeast and particularly Florida, would recover following the hurricane season, but it's clear that demand has rebounded very quickly.

Looking out to our Midwest and Texas markets, we're very pleased with the traffic and demand conditions we experienced in the quarter.

Again, post-hurricane in Texas, we saw a quick return of buyers to our communities.

In the Midwest, we experience stronger buyer trends and are working to balance sales paces against lengthening backlogs.

And finally, the demand out West remained very strong over the quarter, with Northern California, Arizona and Nevada continuing to show exceptional results.

Through the first few weeks of January, traffic to our communities and buyer interest has generally been positive.

As is always the case, it'll be another week or so until we're really into the spring selling season and have a better read on demand in 2018.

Before handing the call back to Jim, I want to thank all of our employees for their efforts over the fourth quarter and the entire year.

Your hard work is reflected in our financial results, but more importantly in the quality of our homes, and the service we delivered to our homebuyers.

Now let me turn the call back to Jim Zeumer.

Jim?

Great, thanks, Ryan.

(Operator Instructions) Michelle, if you'll explain the process we'll get started.

(Operator Instructions) And our first question, we'll hear from Nishu Sood with Deutsche Bank.

First, I wanted to ask about the buyback.

Obviously, very strong indication of confidence, the $500 million for fiscal '18.

I wanted to ask about the thought process behind that.

Clearly, it reflects confidence in the business.

How much did the tax reform windfall affect the thinking of that?

Were you planning on $500 million already in the tax reform windfall just -- to support that thinking?

Or did the tax reform windfall enable, let's say, a larger share buyback than you might have otherwise planned?

Nishu, it's Bob.

I would tell you, it did not influence our thinking.

It certainly will influence our capital planning over the next few years, because, to your point, it will yield fairly significant cash savings when we're a cash taxpayer.

But we were -- the dialogue we have been having with the board around this didn't really change as a result of that action in December by the government.

Got it.

And second, I wanted to ask about the closings' guidance.

The 5% to 10% anticipated closings growth in '18.

Obviously, it's in line, I think, with what a lot of folks in the industry are expecting.

But in your case in particular, obviously, you had a very nice end to the year in terms of orders, the 14% order growth.

Also, your closings in '17 were depressed to some extent by hurricanes, et cetera.

And you would normally expect some rebound from that, and especially since you wouldn't anticipate those types of events to happen again.

So how do I reconcile that, the 5% to 10% versus the year-end and maybe some catch up on the deferrals?

Nishu, it's Ryan.

Yes, great question.

I appreciate the question.

What I would tell you is, we did have a very strong end to the fourth quarter.

We're very pleased with it.

I think the fact that we delivered 14% year-over-year growth, some of that coming from community count growth and a big chunk of that coming from true absorption growth was something that we were very pleased with.

We like where our backlog is at, at the end of the year, and it's really reflective of a couple of things.

One, we've had a heavy emphasis on increasing the size of our sold-not-started backlog.

We believe that helps us with our overall production models, number one.

Number two, we're not building a lot of spec inventory.

And so with the strong fourth quarter we had, a lot of those sales came in November and December, but given our built-to-order model, those deliveries will not be in the fourth -- in the first quarter of 2018.

So we like how our production pipeline is moving.

We like where demand is at.

And frankly, we think the 5% to 10% growth is very competitive and is demonstrative of the great year that we had in 2017.

And next we move on to Michael Rehaut with JPMorgan.

First question I had is, kind of, regarding more strategic, I guess, or over the next 2 to 3 years, one area of work that we've done recently is on return on equity and, kind of, in a recent report, looked at the DuPont approach and analyzing margins, leverage and asset turnover.

And I think for yourselves, along with a lot of other larger cap names, you're clearly, from a margin standpoint, at a pretty high level.

Your leverage, you're at the -- a little bit above the higher end, and I -- wanting it to decline or decrease over the next year or 2, and I think a lot of builders are, in general, trying to maintain a pretty conservative balance sheet.

And so as a result, asset turnover really becomes the focus, I think, in the next couple of years, in terms of driving higher returns.

So with that said, how are you thinking about, in particular there -- 2 areas I think that could drive that.

And if you have additional thoughts, love to hear it.

Specifically, the lot option, the lot -- the land position and also the sales pace.

Two areas where you can really driving improved asset turnover.

So how do you guys think about that?

Are you thinking about that over the next couple of years to drive high returns, and if there are any goals that you might share, particularly around, again, like the lot option or the sales pace, to achieve even higher returns than you're already, kind of, at the top of the heap already.

Mike, it's Ryan.

I'll take a stab at the first couple of pieces of your question, and then I'll let Bob fill in a few of the other components of it.

So first, let me talk about land strategy and where we're going there.

We've made tremendous improvement.

As Bob highlighted in the script, we're down to 4.2 years of owned land.

That is down substantially from where we were just 24 months ago, and it's reflective of the hard work that we've done on the asset portfolio, specifically the land portfolio.

We've -- I've been very clear in articulating our views about our land goals.

We want to be at 3 years of owned, and we're taking clear steps to get there.

As we've analyzed the assets that we've bought over the last 5 years, those new purchases have averaged right around 2.7 years of owned land, which is very much in line with where we want to go.

The difference being some of our longer-dated Del Webb positions, which we've talked about in prior calls.

We like the return profile we're getting out of those communities.

They're just -- they're a little bit longer in life.

So we are very focused in improving the land turnover and the asset efficiency.

As far as your question on sales paces, certainly that's part of the mix.

We look at it on a community by community basis, and we're making the decisions with price and pace that we believe are going to drive the best return on invested capital, which we've long stated is our #1 focus.

So that's how I'd answer the first 2 pieces, and Bob, anything you want to fill in on there?

The only thing I'd add is, if you look, I mentioned in the remarks, our optioned portfolio is now 37% of our total land portfolio.

And if you just look year-over-year, our owned position is down 11% to 89,000 lots.

Our optioned position is up 18% to 52,000 lots.

And so while our lot position is only down 1% at 141,000, the -- on balance, we've changed the flavor of that, such that our position is down, we highlighted from 5.6% to 4.2% over the last 2 years.

And the only other thing I'd add to that is, there is a higher cost structure that typically comes with optioned lots.

So just, I offer that, that people remember when we do this, there is some margin pressure that comes with that.

I appreciate that.

I guess, secondly, you threw out Ryan in your opening remarks, $600 million to $800 million free cash flow, I guess, operating cash flow number for '18, and also the $500 million share repurchase, the $1 billion, or the 10% growth in land spend.

Over the next, again, kind of, bigger picture over the next 2 to 3 years.

Is this kind of the playbook that (inaudible) made in terms of a 5% to 10%-ish type of unit volume growth, continued little bit of growth on the land spend and remain -- having the share repurchase continuing to be in the mix, obviously, not as prominent as the last 18 months or so but still, all of those pieces, kind of, that moderate growth, continued moderate return to shareholders, positive operating cash flow.

I mean, is this going to be the playbook for the next 2 or 3 years?

Well, Mike, it's certainly our playbook for the next year.

The next 2 to 3 years, I think, we're going to have to see what the market brings, and we're going to make the appropriate decisions that we think are going to give the best result to our shareholders.

We like the playbook that we're running right now.

We think it's resulting in a very favorable outcome for our shareholders.

We're driving good return on equity, it's good return, it's great return on invested capital.

We're demonstrating excellent earnings per share growth.

There are a lot of positive things that we're doing.

As I highlighted in some of my opening comments, I think that one of our opportunities is to continue to grow our volumes and continue to leverage the infrastructure that we've built to drive even higher operating margin and push earnings growth through not only increased efficiency but also increased topline growth as well.

So we know that we're getting later into the cycle, but we remain constructive on it.

And thus, that view is reflected in what we've laid out for 2018.

And Mike, just to -- I'm sorry, go ahead.

Mike, the only thing I was going to add to that is, part of it's going to depend on what we do with the cash, obviously.

We highlighted that we can invest in the business.

We can delever to a certain extent or at least store net cash, or we can return it to shareholders.

All of those choices will influence the kind of medium-term outcome.

So everything -- I agree with everything Ryan said.

And again, part of it's going to depends on what we decide to do.

And next, we are going to take -- next we'll move on to Ken Zener with KeyBanc.

Solid finish to the year.

My first question is on speculative units.

Can you comment on the spread between spec and nonspec margins?

And my second question is going to be, what would change your impact, your view, of how you use specs to enable a higher land turn?

Because, obviously, whatever you do to cash relative to taxes, that's going to be a choice you have.

But in terms of operations, higher spec tends to lead a higher land utilizations, which seems to be one of the elements you're pursuing.

Yes, Ken, I'll start.

Certainly, we see a margin differential, typically in the 200 to 300 basis point range spec versus nonspec and in particular, we see it become more pronounced if we have spec final on the ground.

We've been working to trying and improve the production capabilities of the company and what we call even flow.

So we've been trying to build sold-not-started backlog, which we've been successful at.

Doesn't mean we don't build spec.

Our spec production is up about 11% in terms of units year-over-year.

But our spec final is down 2%.

I gave the number in the release, in the prepared remarks.

637 units out of 790 communities.

So what we're really focused on is making sure we don't have a bunch of houses on the ground that people come in and feel like, let's make a deal.

It is worth remembering that spec feels great until it doesn't.

And if you get to a point where you have too many units on the ground and the market gets soft, that's when you really have pain.

So we're trying to be disciplined.

We start, obviously, our tax often has it -- spec in it.

We will start spec units in communities to be able to serve the buyers that have a shorter timeline.

But we can build a house typically quickly enough to get somebody in it in the current mortgage timelines.

So I'll let Ryan answer the question more strategically.

But I think in general, we're going to be pretty disciplined around this.

Yes, I -- the only thing that I would add to what Bob shared with you, Ken, is, we're not afraid to use spec, and we're using it in a way that I think smooths out our production pipeline.

Beyond that our view is, our profitability on build-to-order units is quite a bit higher, and we eliminate the risk of potentially having a unit that we've got to hold onto and discount to sell or pay the carrying costs associated with carrying a finished house.

So it's all worked into our model of driving the highest returns possible.

There's certainly multiple strategies out there in terms of how speculative units are used.

We happen to be partial to the one that we use, which is working for us.

And next, we move on to Mike Dahl with Barclays.

I wanted to start with a question around sales pace, and I think, Ryan and Bob, just given the focus on asset efficiency, if we look at absorption trends over the past couple of years, it seems like that's been an area where there's still clear opportunity, as we move forward through the cycle.

I think you've articulated in the past that there's been some mix effects that are depressing, what we're seeing a bit.

But you saw nice return to growth in 4Q.

Based on the closings' guide for 2018, it doesn't seem clear that you expect that growth and absorption to necessarily persist through '18.

So I was hoping you could give us a little more color on how to be thinking about absorption for this year?

And then also, if you have any color on community count growth expectations?

Well, the community count growth, we've often suggested that it's not the best measure of volume.

And since we've introduced both annual and quarterly guidance, we weren't going to provide any commentary around that.

In terms of our expectations for pace, I don't think we're expecting significant increases in pace in fiscal '18 relative to '17.

We did enjoy a pretty solid fourth quarter.

As Ryan has said, the first quarter has started off pretty well, but it's still early going, we haven't yet really got into the selling season.

Yes, and the only other thing I would point out on the absorption pace side is mix and buyer mix certainly matters.

I think it's no secret how we're positioned relative to the 3 buyer groups that we serve.

We saw a nice increase in absorptions in the entry level, which I think the entire industry continues to enjoy.

We're pleased with the performance there.

We saw nice increase in absorptions in our active adult segment, we were slightly down in the move-up.

So in totality, across our entire platform, we saw an increase of 5% in the quarter, which is very robust, and we're happy with it.

And then I think when you look at the absolute number of our absorptions, they're very respectable.

They're near the top.

And so just see outsized percentage gains, given where we're operating, I don't know that I would necessarily expect that to happen unless the market was to significantly change.

And then my second question is just around the impairment tick and in the quarter on land.

You mentioned that it was related to one project and increase in development and construction cost.

Could you give us some more detail on what exactly or where that land was, and what was driving that uptick that makes it one-off versus a potentially broader issue?

Yes, Mike, it's a fair question.

Certainly, this is an asset, it's in the Southeast.

It's a big asset, it's got more than 2,000 lots.

We're going to be there for a while.

And what we've seen is, the market around us in -- it is in Georgia, specifically, has been very active.

So the Georgia construction market is really working pretty hard right now.

We're bringing trades down to that particular site.

And so what we've seen is, because of the strength of the market, our land development costs are going up, our house construction costs have gone up.

And interestingly, this happens to be a community where it's positioned against some pretty inexpensive product, where price -- it's really price sensitive.

So we haven't seen much opportunity to increase prices.

And in fact, we've seen prices actually move backwards a little bit in 2017.

So all those things contributed to -- over the last couple of years, as the market has improved, our costs have gone up, and we just haven't seen the price opportunity.

And next, we move on to Alan Ratner with Zelman & Associates.

So first one, I apologize for, kind of, beating this topic further, but just on the closings' guidance.

So I guess, where I'm coming out a little bit confused.

Your backlog is up over 20% entering the year.

So you kind of spoke to the first quarter on why the closings' growth might not be that strong there.

And there, just based on, kind of, the stage of construction that those homes are in.

But you obviously have a really strong tailwind for closings growth in the first 0.5 or 0.75 of the year, based on where your backlog is.

So if I make an assumption on the, kind of, where your order growth has to be in the spring selling season to get to that full year number, it implies a pretty significant slowdown in order growth from where you've been tracking the last 3 quarters.

And I know you're not giving community count guidance, but I was hoping you could just help us a little bit better understand your expectations for the spring, because you kind of need to see order growth in the, call it mid-single digits, I would say, just to, kind of, hit that high end of the range, based on where your backlog is entering the year.

Yes, Alan.

I'll do the best I can to, maybe, answer that question again.

We -- a couple of things are driving the increase of backlog, as I mentioned in the earlier question.

We've had a heavy focus on growing the size of our sold-not-started backlog.

And deliberately lengthening this -- lengthening the duration of our backlog if you will, because we believe that puts us in a better position to run a more efficient construction operation.

It's been a work in process over the last 2 years, and we still got some ground left to cover, but we like the position that we're in.

We had a very strong November and December, which is, I think, reflective in the bullish comments that we've given, as we've talked about the fourth quarter.

We like what we're seeing, thus far, in the first 3 weeks of January, we're typically not into the official spring selling season until Super Bowl time.

And of course, that officially starts, kind of, next week.

So we're not giving -- closing our community count guidance because we've always said, I don't think it's a great proxy for providing expectations about what 2018 or the forward year is going to look like.

This is the first year that we've given annual closing guidance in quite some time.

In addition, we've given the first quarter closing guide, which we think is reflective of our current production pipeline.

And the only thing I just probably summarize all that with Alan is, overall, the demand environment is strong.

And so our expectations for 2018, from an order growth standpoint, are still very positive.

Okay, got it.

And then the second question on, so you're increasing your land acquisition 10% this year.

Obviously, tax reform is going to put a few more dollars in your pocket to spend, and sounds like that wasn't even contemplated in that number.

But the concern that we hear from people is that with a lot of builders, including yourself, focusing on an after-tax return metric, when they think about underwriting, that, ultimately, that excess cash is going to get competed away.

Because you're going to be able to effectively spend more on land to hit the same type of return threshold, given the lower tax rate.

So I was curious if you could give a little bit of insight into how you think about underwriting land, whether it's an after-tax metric you focus on, a hybrid of pretax, after-tax and ultimately, how you expect those dynamics to unfold in the industry in 2018 and beyond?

Yes, Alan, we've been asked that question off and on, since the prospect of tax reform has been raised.

We do not look at returns after-tax, when we underwrite transactions, we are looking at pretax returns.

I don't expect that we will compete that away, I'm not aware of anybody that would look at this after-tax.

Time will tell, but certainly it hasn't been part of the dialogue with sellers at this point, which is where you would probably expect the first year.

So not thinking that's an issue at all, honestly.

And next, we move to Susan Maklari with Crédit Suisse.

Obviously, you've made a lot of progress on the SG&A front over the last year or so.

As you, sort of, look out and think about the next, kind of, course of this cycle, and Ryan, you kind of talked to sort of thinking about the next round of efficiencies that can come through.

How should we think about where you can get SG&A, and maybe, what are the some of the levers that can come in there?

Yes, Susan, great question.

We're so proud of what our organization is done in getting more efficient.

We think we still have some room to grow.

But as Bob highlighted in some of his comments, we're 200 basis points more efficient today than what we've been in a long, long time.

And we wouldn't have been able to do that without the really hard work and diligence that our field teams have put in to make in our homebuilding operations more efficient.

So a lot of good work behind us.

As far as where we going in the future, it's really going to be around the volume growth.

And so part of what you heard from me in my prepared remarks was around our opportunity to increase revenue and to grow foot -- near to grow market share within the footprints that we currently operate in.

That's where I think we can probably get some of our biggest gains.

Certainly, we're always looking for opportunities to do things faster, better, smarter, and we'll do that.

But I think the majority of your (inaudible) comes from revenue growth.

Okay.

And just, kind of, building on that a little bit, how do you think about technology, I guess?

And maybe some of the changes that are coming through across lots of different areas of homebuilding, from mortgages to, maybe, some of the supply chains and differences that can happen there.

How can that, maybe, over time and not necessarily in the near term, but thinking further out, sort of help and maybe take some costs out, as we think further out?

I think the opportunity is huge.

And some of that we have already taken advantage of.

The efficiency that we have gotten on the marketing spend side has been extraordinary.

We haven't talked about it as explicitly as probably what we could have or should have, but the improvement in what we spend as a percentage of revenue on our marketing dollar from just 5 years ago versus today is a night and day -- it's night and day difference.

We've spent significant amount of money on our websites, and the way that we communicate with and market to consumers, it's helping us spend less, drive more targeted traffic that converts at a higher rate and not all works into a lead-to-prospect and prospect-to-sale conversion ratios that are significantly improved and more efficient.

Our marketing teams have done an extraordinary job in making that happen.

On the system side, we continue to invest a lot of money to make our systems more efficient, helping us understand our costs better, communicate with our trades in a more efficient way and to really pull waste, if you will, out of the production system.

There's a number of new technology platforms that we're dabbling with that interface with and disintermediate with the sale side that I think have the opportunity to take some cost out.

We're certainly -- those technologies are early in their development.

We're testing some of them, and we'll see where that ultimately goes.

And then we're doing a lot of testing right now with virtual reality, which is another thing that is showing early, strong early returns in our ability to help the customer ultimately envision what their end product is going to look like.

So I think the industry is ripe for innovation.

It's something that we're focused on.

We're putting investments into, and we'll see where it goes.

And we'll move on to John Lovallo with Bank of America.

It's actually Pete Galbo on for John.

Bob, I was wondering if you would be able to give any color around the cadence for the share reposed in 2018, or whether or not that's just going to remain opportunistic.

That will remain opportunistic.

We will not -- we'll be reporting the news, as opposed to previewing it for you.

Got it.

Got it.

And any update, guys, on the Boston community that had the fire from last quarter, just where you guys are in the steps of remediating that?

Yes, it's -- we're in the process of rebuilding that building.

It's already well underway.

The build time on that building is about a year or so.

It'll be -- that building will be rebuilt and delivered towards the end of this year, early 2019.

And we'll move on to Jack Micenko with Susquehanna.

No, this is actually Soham for Jack.

Can I -- I actually want to start with an ROE target.

I mean, do you guys have an ROE target you guys could speak to and maybe just talk through some of the levers to get there?

Yes, we've not historically provided a target.

We've talked about it.

I think, given the size of the repurchase efforts over the last couple of years, it didn't make sense to set targets because of the magnitude, and we didn't know where the equity price was going to be.

As we've said before, we'll think about that and probably give you some color.

My guess is that later this year.

Okay.

And then the second question was on gross margin.

It looks like you guys are guiding to flat to slightly down gross margin on an adjusted basis, if I heard that correctly.

Could you just maybe talk through some of your assumptions that are embedded in there?

And is there an assumption of any greater shift to the first-time buyer in that guidance?

Yes, this is Ryan.

I'll take that one.

And I think that -- where I'd want to start with this is, first, we highlighted that our margins are expected to be 23% to 23.5% for all of 2018.

That margin is likely still among the highest in the space, and I don't think we should gloss over that fact.

So it is slightly lower than where we operated in 2017.

Mix changes certainly can drive that.

But the biggest thing that's driving the change is, we're continuing to incur a lot labor and material costs, where we're seeing increases.

Not all of that are we able to pass on to the consumer.

So we're going to continue to focus on it.

Our expectation is that we're going to continue to enjoy a fairly attractive margin profile in 2018.

We need to keep an eye on where lumber and concrete specifically go, given that they're at very high rates at the current time.

And next we move to Stephen Kim with Evercore ISI.

Ryan, I had -- I heard 2 things in the call thus far that surprised me.

It didn't contrast to what I'm hearing from the heads of the -- your 2 largest competitors.

First was, your desire to manage down spec, when Arun Horton have been really pushing towards and extolling the virtues of standardization in their go-to-market strategy.

And I believe in respect to that you mentioned -- I mean, I think, Bob mentioned the danger of having too many specs when the cycle turns down, but even there, I got the lesson learned from the last down cycle was that the builders did best who were able to blow through their land inventory quickly by building out their communities.

So I actually didn't think the lesson learned from the last down cycle is that having too many specs was the problem.

Rather I thought the problem was builders who has tried toe the line on price, and maximize margin, and that resulted in a lot of bad landholdings through the down cycle.

The second thing I heard that was different, was leverage, both the heads of the other 2 companies have expressed a serious desire to operate with leverage, significantly below historical net debt to cap level.

And so I was curious if you could sort of talk a little bit about leverage, specifically, and why you don't think maybe delevering your operating with a significantly lower level of leverage and historically, it's a good idea?

Stephen, thanks for the questions.

I'll take the first one on specs, I'll let Bob handle the leverage question, other than I'll reiterate the range that we've said, we believe, is most attractive for us to operate within.

But let me start with the spec question and specific to standardization.

I'd ask or at least submit that we not confuse standardization and the ability to be more standard and efficient in the operating production cycle with the use of spec.

Part of our work with our commonly managed plans, with our zone operations, with a lot of the work that we did to drive value engineering and should-cost in gains, all of those gains and part of the reason that our margins are where they're at is because of the fact that we are standardized.

Certainly, we have room to go and room to improve, but we don't believe that we have to use speculative inventory to take advantages of those gains.

As far as the debt-to-cap range, we've said for the last 3-plus years that our optimal rage is to operate within a 30% to 40% band.

We have talked fairly, openly that because of the very large share repurchase in, really, 2016 and '17 combined that we are going to naturally accrete slightly higher than 40%.

But we would give guidance as to when we would come back within that range, which we expect to do in 2018 through the normal course of operation.

So I'll let Bob take it up from here and share a little bit more.

Yes, certainly, as we've talked about, we target a range that we're very comfortable with.

If you look at our capital structure on top of that, we've got $3 billion in debt right now, $1 billion of it has a tenure longer than 14 years.

The other $2 billion, only $700 million is in 3 years, the rest is 8, 9 years out.

So we have a very long-dated capital structure at very attractive financing rates.

So to think through that, our interest coverage is very strong.

To sit on cash and think about net debt, to me, we've got an unproductive asset on the balance sheet, and we've talked about this, we're going to use that either to invest in the business or to return to shareholders.

Doesn't mean we would never hold cash, doesn't mean we wouldn't think about our leverage structure.

But where we sit today we feel really good about.

And Ryan said exactly right, if not for the reach share repurchase activity, we have a very, very low net debt-to-cap and a low debt-to-cap.

So we feel good about our balance sheet.

And the business is generating $600 million, $800 million of cash flow this year, we've talked about it earlier and even in the prepared remarks highlighted, we can think about leverage as part of that because we're going to have a lot of choices to make with the cash flow we're generating.

So I don't like to comment on what other folks are saying, but I can tell you, we've been pretty consistent.

And our capital structure is pretty sound right now.

And we'll move on to Stephen East with Wells Fargo.

Ryan, you gave some -- a lot of good information in your prepared remarks.

And a couple of things stood out that I was hoping you could talk a bit more about.

Both on product side, one, the active adult, the second, the entry level.

You're talking about, really going through a big process, it sounds like, with your active adult repositioning product, et cetera.

Could you talk a little bit about how much of this is driven by the efficiency side of the world?

And how much is driven by the demand side where your acknowledgment that the competitive landscape is definitely changing as everybody or a lot of builders are trying to pivot toward active adults?

So just trying to understand, what's really driving it.

And what you think the outcome is on where you want to get to on the active adult?

And then on entry level, maybe I missed it, but when do you see -- entry level was obviously your better performer, just on a year-over-year performance.

When does that start to grow meaningfully versus the rest of your business?

I know '17 and '18 weren't the targets, but I didn't know if '19, we should see that as a percentage of total accelerate?

Yes, Stephen, this is Ryan.

Let me start with your first question around the active adult floor plans.

And where I would take you back is to the beginnings of some of the work that we did around our 12-step process back in 2012.

One of the very first product lines that we attacked through our 12-step process in our consumer validation and all of the research that we did was with that active adult floor plan line up.

It also happens to be the lineup that we get the most leverage out of throughout the entire country, because we're able to use those floor plans in a very high percentage of our active adult communities.

One of the things that we said with our focus on the consumer and getting feedback from consumers as they change what they want and how they live is that we would update those product lines, very similar to the way, I think, you see the auto manufacturers do.

There are changes to designs and the features as technology improves, as the consumers' desires change.

And that's exactly what you're seeing us do with this active adult floor plan.

We're really excited about it.

And we have the communities that we can readily deploy these new and improved floor plans into.

So I think it's part of our process as opposed to saying, it's demand or there's something else that's driving it or the competitive environment.

It's part of the strategy that we've laid out.

And we think that we're going to like the results that we get from it.

And then as far as part 2 of the question.

Entry-level.

Entry-level, sorry I was -- I drew a blank there Stephen.

As far as entry-level goes, we're running the playbook and the strategy that I laid out about 18 months ago that we would start to see a shift of some of our investment in move-up, go into entry level.

As we sit in land committee and we see the transactions that are coming through, we're seeing it.

We've said that it wasn't going to be a dramatic overnight shift, but you would see it slowly start to filter into our business as we appropriately index to what the market demand was in the individual markets that we operate within.

So we like where we're going.

I think we're already seeing even more of that business in 2018.

And I think by 2019 and beyond, you would see us, be it for the most part, rightsize to where we want to be.

And that will conclude today's question-and-answer session at this time, I would like to turn the call back over to Mr. Jim Zeumer for any additional or closing remarks.

Thank you, operator.

We appreciate everybody's time this morning.

We're certainly available for questions throughout the day.

And we'll look forward to speaking with you on the next conference call.

And that will conclude today's call.

We thank you for your participation.