普爾特房屋 (PHM) 2004 Q2 法說會逐字稿

Please stand by for the realtime conference call.

The Pulte Homes realtime conference call will begin momentarily.

Good morning and welcome to Pulte homes 2004 earnings release.

If you should require assistance at any time during the call, please press star and zero and an operator will assist you.

I would like to turn the program over to Mr. Jim Zeumer.

Go ahead please.

Good morning.

I appreciate your time in joining us for today's call to discuss Pulte Homes financial results for second quarter ended June. 30, 2004.

I'm Jim Zeumer, Vice President of Investor and Corporate Communications.

Pulte's release on the second quarter earnings contain some powerful numbers.

From earnings per diluted share up 48%, to a backlog valued at $6.3 billion.

Clearly Pulte operations had another very strong quarter of performance.

On the call to discuss Pulte's results are Richard Dugas, President and Chief Executive Officer, Steve Petruska, Executive VP and COO, Roger Cregg, Executive.

VP and Chief Financial Officer.

And Vinnie Frees, VP and Controller.

For those of you who have access to the Internet, a slide presentation will accompany this discussion.

The presentation will be archived on the site for those who want to review at a later time.

As with prior conference calls, I want to alert everyone listening on the call and via the Internet that certain statements and comments made during the course of this call must be considered forward-looking statements and as such are subject to risk and uncertainties that could cause actual results to deliver materially from those discussed during this call.

At this time let me turn the call over to Richard.

Thanks, Jim, and good morning.

You've heard the refrain about how this time it's different.

We along with the industries other large builders have talked about how balance sheets are stronger, about consolidation and how big builders are taking market share and our returns on equity and invested capital are being pushed to significantly higher levels.

Over the course of hundreds of investor meetings and countless media interviews, we have discussed important differences between the home building industry today versus a decade ago.

There is another important change that maybe hasn't gotten the attention it deserves, maybe because it is so basic or maybe because not many builders can demonstrate it.

And that's the impact geographic and customer diversification can have on a home builder's ability to deliver stronger and more consistent financial performance.

Home building is unique in that when you build a house, at least if you build it correctly, you can't move it.

The old adage about location, location, location stems from the fact that unlike cars, appliances, and furniture, you can't move an acre of land.

As a consequence, home building becomes a very local business that is heavily influenced by local economic conditions, and that typically results in a varied demand characteristics from one market to the next.

At times, the business can be so local that you can find meaningful differences between counties or submarkets within the same city.

It's all a matter of local supply and demand dynamics.

I think the benefits of geographic and customer segment diversification, became evident early in the quarter when you saw select financial reports being issued.

That showed meaningful swings in orders, closings, and/or margins.

It was reported that these swings were based on demand changes in just a couple of markets and/or customer segments within those markets.

It wasn't very long ago that Pulte was more of a regional builder with concentrations in a handful of areas, such as Denver, Virginia, and Detroit.

As they used to say, when General Motors sneezed, our Detroit operations caught a cold.

Having lived through a few local market cycles, we started to focus on the opportunities diversification could offer.

Both as a source of growth and longer term as a source of stability.

Which is why in the early 90s, we embarked on a significant geographic expansion, effectively doubling the number of markets in which we operated to over 40.

In addition as we've ofter discussed, Pulte serves the broadest range of buyer groups with sizable businesses in all major categories, including an industry-leading position with active adult buyers through our Dell Webb brand.

A few years ago when slowdowns in technology and telecom created head winds for northern California, Austin and Denver.

These markets found they could draft behind Atlanta, Phoenix, Detroit and a number of other markets.

Now Las Vegas, southern and northern California and Washington, D.C. are taking their turn at the front of the pack.

Which markets will be next to charge to the front?

It is impossible to say with 100% certainty, but looking at conditions and our land pipeline, I can point to several areas, including, Florida, Arizona, and Illinois as likely candidates.

In any given period, even in the exuberant 90s, not all the markets shared equally in the economies strength.

As rates now climb higher in step with the expanding economy, we fully expect that an overwhelming majority of our communities will continue to deliver solid results, while a handful probably will not meet expectations.

Success and failure in this business is achieved at the local level.

Driven first by location.

And next by the quality of the home and home buying experience.

In fact I believe these are the two most critical areas, where builders differentiate themselves with the customer.

While our hit rate with communities won't be 100%.

There is no question that managing a broad portfolio that is very well positioned based on local supply and demand, is a winning strategy.

In addition to providing more stable business performance, our geographic and customer segment diversity provide another important benefit.

We can take advantage of the earnings power in our strongest markets to adjust the operating strategies and tactics in those markets that may be facing changing market conditions.

Or where we just haven't been executing as well as we could have.

This is what we are doing today in our Texas and southeast operations.

As we have discussed before, we run our operations with a focus on project specific returns on invested capital In certain markets, we have historically achieved targeted return levels, operating under a higher turn, lower margin model.

That in truth may not have maximized the earnings opportunity that existed in these markets.

In other words we are leaving money on the table.

To a degree, limiting our flexibility to adjust, should market conditions require changes in operating tactics..

After a lot of analysis, including extensive research on the different buyer segments that exist in each area, we have been migrating our high return operations toward the higher margin model as a way to drive improvements in our overall financial results.

It is why our margins in Texas have actually improved for the quarter and year-to-date and why currently we have been willing to forego unit growth across Georgia and the Carolinas, in exchange for expanding gross margins.

Of course, it also helps that we are unique in our customer segmentation strategy, of serving all the major buyer groups, and that we can deliver products on a variety at price points.

Only by having this capability can we adjust our position within the markets once we've identified the best overall opportunity that offers the greatest financial benefit.

While we have excellent intelligence about local market conditions, we can't always know which markets will be the strongest tomorrow or two years from now.

So we decided over a decade ago to plant our flag in the largest and most critical markets, and then grow our business in those markets where local supply and demand gaps are the largest.

Pulte's flexibility is unmatched in terms of responding to any economic environment we may face.

And we will continue capitalizing on this strength community by community.

Now, as interest rates start to rise and local market economies strengthen at different rates, and as different buyer segment's respond accordingly, Pulte's diversified market portfolio should enable us to run a more successful business and to deliver results like the record-setting second quarter we just completed.

Now, let me turn the call to Roger who will provide details about our recently completed quarter.

Thank you, Richard, and good morning.

I'm once again pleased to report for Pulte homes an outstanding second quarter of operating and financial performance.

The second quarter order rate posted approximately a 17% increase over the second quarter last year.

For the second quarter of 2004, revenues from home settlements for Pulte Homes domestic homebuilding operations, increased approximately 30% over the prior year quarter to approximately $2.4 billion.

Higher revenues for the period were driven by an increase in unit closings of approximately 19%.

The average sales price increased approximately 9% versus the prior year quarter to an average of 282,000.

Resulting primarily from increased product prices and an overall volume driven improvement in and product mix and market mix.

In the second quarter, land sales generated approximately $56 million in total revenue, which is an increase compared with the previous year's quarter of approximately $24 million.

Domestic home building gross profits from home settlements, including home building interest expense for the quarter increased approximately 38% to $529 million.

Second quarter domestic home building margins from home settlements as a percentage of sales were 22.1% compared to 20.8% in the second quarter of 2003.

This increased margin conversion of approximately 130 basis points versus the prior year quarter is mainly attributed to product price increases in market and product mix shifts.

We continue to see strong pricing power in most markets.

But especially in the west to include Nevada, Arizona, northern and southern California and also in the northeast and Florida markets.

Home building interest expense increased during the quarter to approximately $30 million versus approximately $17 million in the prior year as a result of the continued growth of the business.

The gross profit contribution from land sales was approximately $14 million for the second quarter.

Versus approximately $9 million in the prior year quarter.

The profit on land sales may vary significantly from period to period based on the timing of land sales.

SG&A costs as a percentage of home sales for the quarter was approximately 9.3%.

Improving approximately 100 basis points over the prior year quarter.

The conversion improvement versus the prior year quarter was a result of increased selling prices and better overhead leverage with the increased volume over the prior year.

In the other income and expense category for the quarter, the expense of approximately $1 million is primarily the net result of joint venture income generated during the quarter of approximately $8 million.

Offset by expenses that include the amortization of intangible assets, insurance expenses and all other miscellaneous expenses.

Domestic home building pre-tax income for the quarter increased 61% to approximately $318 million.

With pre-tax margins at 13% on total domestic home building revenues.

This represents an increase of approximately 250 basis points In conversion over the prior year quarter.

At the end of the second quarter, our domestic home building operations had a backlog of just under 20,000 homes valued at approximately $6.3 billion, compared to approximately 15,200 homes in the prior year quarter.

Second quarter pre-tax income from our financial services operations was approximately $8 million.

A decrease of approximately 60% or approximately $12 million below the prior year quarter.

Despite the increased origination unit in dollar volume for the quarter versus the same period last year, the decrease in pre-tax income performance was attributed to the continuing changes in the marketplace to sell loans versus the prior year.

The shift in product mix toward the adjustable rate mortgage products during second quarter 2004, increased from 18% of origination dollars funded from our warehouse line last year to 42% this quarter.

Which has led to a decrease in profitability per loan compared to the prior year quarter.

In addition, operating expenses were incurred in the quarter in anticipation of the continued growth of the business projected for the balance of this year, mainly in the area of staffing, training and facility costs.

Pulte Mortgage's capture rate increased to 88% from 83% in the same period last year.

Mortgage origination dollars increased in the quarter approximately $335 million or 29% when compared to the same period last year.

The increase in originations is a result of higher production volumes and the higher capture rate.

Mortgage refinancing represented approximately 3% of total unit originations.

Compared to about 11% for the same period last year.

International operations posted retax income of approximately $150,000 for the second quarter compared to a pre-tax income of approximately $400,000 in the prior year quarter.

Increased operating performance in Mexico and Puerto Rico which posted increased volumes were partially offset by lower unit volumes in Argentina.

Also to be noted, as we have previously announced, we continue to explore and work through various long-term strategic alternatives with regard to our international operations.

At this time we have no further update to provide to you.

Total corporate expenses for the second quarter were approximately $24 million or an increase of approximately $2 million versus the prior year.

The increase is associated with higher net interest expenses in the current year quarter as a result of increase in debt funding.

Net income from continuing operations in the second quarter increased approximately 54% to approximately $188 million, Or $1.45 per diluted share, as compared to approximately $122 million or 98 cents per diluted share for the same period last year.

Fully diluted shares were approximately $129.4 million for the quarter.

Moving over to the balance sheet for the second quarter, the major changes versus the year end of 2003 continued to be in support of the company's growth initiatives as planned for the year and into the future.

We ended the second quarter with a cash balance of approximately $90 million.

Inventory increased to $6.8 billion in support of the 2004 and beyond planned growth opportunities.

The increase in the outstanding debt for the second quarter of approximately $550 million over the fourth quarter of 2003 is associated with the issuance of the $500 million, 5.25% unsecured senior ten-year note completed in the first quarter, offset by the redemption of the final remaining Dell Webb 10.25% Senior subordinated notes, plus the utilization of short-term borrowings under our bank revolver of $127 million.

Included in the other asset category of approximately $1.1 billion for the second quarter are major items such as land held for sale of approximately $223 million.

And receivables, prepaid expenses and deposits of approximately $300 million.

The category also includes investments and joint ventures for $168 million.

Net fixed assets and all other miscellaneous assets for the remaining $375 million for the corporate, home building, international and financial services operations.

At the end of the second quarter, the company's debt to total capitalization ratio was approximately 41.5%. and on a net basis was 40.7%.

This was in line with our expectations and our continued commitment to maintain a disciplined, conservative and flexible balance sheet. while investing for the future growth of the business and delivering increasingly greater shareholder value.

Subsequently, on July 6, the company issued $400 million of 4 7/8 unsecured senior 5-year notes.

The proceeds will be used for the repayment of expiring notes coming due on August 15th of approximately $112 million.

The reduction of short-term borrowings under our revolver agreement and for the continued investment in the business.

Pulte homes shareholder equity for the quarter increased to approximately $3.8 billion.

With a return on average shareholder equity for the latest 12 months of approximately 22%.

This is an improvement of approximately 320 basis points over the same period last year.

Pulte homes return on invested capital for the latest 12 months increased to approximately 14.3%.

An improvement of approximately 250 basis points over the same period last year.

In addition, under the company's authorized $100 million share repurchase program, no shares were repurchased during the second quarter.

Under the authorization to date, we have repurchased a total of approximately 990,000 shares for a total of approximately $23 million.

Looking ahead as permissible under the SEC Regulation FD guidelines, we are providing the following guidance on our current expectations for the third quarter of 2004.

Unit settlements in the third quarter of 2004 are likely to increase approximately 20 to 21% over the same period last year.

Driven primarily by the growth of additional volume across most of our major markets.

Average selling prices for the foreclosings in the third quarter are projected to be above the second quarter of 2004 by approximately 3%.

This projection is primarily being driven by price increases in addition to product and geographical mix for homes anticipated to be delivered during the third quarter.

Gross margin performance from home settlements as a percent of sales for the third quarter is anticipated to be 100 to 110 basis points above the second quarter of 2004.

This is dependent upon the product and geographical mix of the homes delivered.

Despite the higher material costs beginning to show up in the third quarter, our price increases established in the fourth quarter of 2003 and through the second quarter of 2004 will allow us to exceed the cost increases and continue to expand margins in the third quarter.

We are projecting land sale gains in the third quarter to be approximately $16 million to $18 million.

As mentioned in the past, land sales gains may vary significantly from period to period based on the timing of land sales.

As a percentage of sales, SG&A is expected to improve over the third quarter of last year by approximately 10 to 20 basis points.

Resulting from our ability to increase sales prices and the additional leverage associated with the increased volumes.

In the other income and expense category for the third quarter, we are projecting approximately a $3 million to $4 million in income.

Given no material change from the current interest rate environment. pretax income in our financial services operations is expected to be approximately 10 to 15% below the third quarter of 2003.

The increased income generated from higher volumes is being offset by a shift in product mix and related market pricing resulting in lower profitability per loan.

Additionally, increased operating expenses are anticipated with the volume growth in the coming quarters and into 2005.

For the third quarter of 2004, we anticipate interest rates to remain in a relative range as we're experiencing today as compared to a rising, then declining interest rate environment than the previous years quarter. which led to the highest interest rates for a 30-year mortgage in 2003.

In the third quarter, international operations are anticipated to be $1 million to $2 million above the previous year's quarter.

Total corporate expenses are projected to be $2 million to $3 million over the second quarter of 2004.

This increase is primarily driven by higher interest expenses associated with higher debt levels in the third quarter in support of greater unit volume growth.

We are projecting the effective income tax rate to remain at 38% for the third quarter of 2004.

Third quarter earnings per share from continuing operations are estimated to be in the range of $2.00 to $2.10 per fully diluted share.

This earnings per share number is calculated based on approximately 131.3 million fully diluted shares.

As we highlighted in our press release today, we are again increasing our outlook for 2004.

We offer the following comments regarding our expectations for the full year of 2004.

Given the current operating environment for the home building industry, these comments are based on the assumption that the overall macro economic conditions remain in a modest range comparable on what we are experiencing today.

Based on the strength of our second quarter sales orders, backlog and financial performance, we are revising our earnings target for the full year of 2004 earnings per share from continuing operations to be between $7.80 and $8.00 per share.

Estimates are based on 130.7 million fully diluted shares.

This represents an increase of approximately $410 million to $440 million in net income from continuing operations over our full year 2003 actual performance.

Or approximately in the range of a 70% increase.

Now, for some of the line-item guidance.

We are projecting that unit settlements for the full year of 2004 are likely to increase approximately 22% over the full year 2003.

Driven primarily by additional volume across most major markets,as a result of our focus and strategy on serving all buyer segments within our existing markets.

Average selling price for closings are now projected to be above the average 2003 selling price by approximately 10%.

This projection is primarily being driven by increased product prices, product mix, and geographical mix that we experienced year-to-date and project through the remainder of third and fourth quarters of 2004.

Gross margin performance from home settlements as a percent of sales for 2004, is now anticipated to increase in the approximate range of 240 to 250 basis points over the actual performance of 2003.

The margin expansion represents excess price realization over the expected material cost increases for the year.

The actual margin realized will be dependent upon the product and geographical mix of the final homes delivered.

We are expecting land sale gains for the year to be approximately $45 million to $50 million.

As we've mentioned before, land sales are an important component of our home building operations.

May vary significantly from period to period based on the timing of the land sales.

As a percentage of sales, SG&A is expected to be below 2003 conversion rate by approximately 80 to 90 basis points, reflecting the increased selling prices, and greater leverage as we expand our volume penetration over the course of the year in existing markets.

In the homebuilder other income and expense category for the year, we are projecting income of approximately $11 million to $13 million for the full year.

Given the current environment in the mortgage markets and the mix of product preferences from consumers our pre-tax income and financial services operation is expected to be below the full year of 2003 by approximately 22 to 25%.

Despite the increased volume, our drive to increase our capture rate and our efforts to improve customer service levels, the product mix shift has been moving towards less profitable loans versus what we delivered in 2003.

International operations are anticipated post a pre-tax profit of approximately $5 to $7 million for the full year.

In the corporate category, other corporate expenses are projected to increase by approximately $10 to $12 million over 2003 as a result of increased corporate overhead expenses and no anticipated corporate commercial land sale gains in 2004.

As we experienced in 2003.

Net corporate interest expense will increase to $14 to $15 million over 2003 associated with the increase in debt levels to support the continued growth opportunities in 2004.

We are projecting the effective income tax rate to be 38% for the full year.

Once again, for the full year 2004 earnings per share from continuing operations is estimated to be in the range of $7.80 to $8.00 per share, representing an increase of between 59 to 63% over our 2003 actual performance of $4.91 per share.

The 2004 earnings per share performance is calculated based on approximately 130.7 million fully diluted shares.

With that, I will now turn the call over to Steve Petruska for a few comments.

Steve?

Thanks Roger and good morning everyone.

Over the past six to eight weeks is there have been a lot of comments and data thrown into the general discussion about how different markets are performing and how demand is holding up in the changing interest rate environment.

Given the breadth of the markets and customers we serve, hopefully you'll find a overview of market conditions to be of value.

The second quarter we operated out of 554 communities, which is up from 510 last year.

And 541 in the first quarter of 2004.

We are now opening new communities throughout the country and continue to target an increase in our err and community count of 15 to 20% over the 2003 number of 535.

So you can see we plan to open a number of new communities over the remaining two quarters.

Now, for some more specific commentary on what our markets are experiencing.

While net new orders for the Northeast were down 6% the market overall is excellent with solid traffic patterns, good conversion and stable cancellation rates.

The reality is that the approval process in the northeast is among the toughest in the country which can impact the timing of community openings.

The result is that our community count for the area is down about 5% for the quarter versus last year.

As we've said many times, the northeast is one of the most supply constrained regions in the country, which means new communities, when you can get them approved and developed, can typically expect to be met with strong demand.

Year over year, net new orders for the Southeast were essentially flat.

As stated earlier, we're focusing on driving more margin versus unit growth in Georgia and the Carolinas.

In Florida, we've seen strength across the entire geography.

With notable order growth in Orlando and Fort Myers.

As reported in the press release, net new orders from the midwest were up 2% during the quarter.

For the record our midwest operations encompassed the greater metro areas of Detroit, Grand Rapids, Chicago, Indianapolis, Minneapolis, Cleveland and Kansas City.

Our orders for the period were up.

But it would certainly be fair to say that we're having to fight a little harder for each sale.

And having to throw in the occasional countertop or sprinkler package, but no significant changes in our incentive programs.

Once again our central region posted another good quarter with net new orders year over year growth of about 22%.

Orders were down slightly in Texas, although we did see some shift in mix with more orders coming from San Antonio and Austin and including our Sun City community offsetting reduced shift volume in Texas.

We're not trying to change volume in Texas.

In fact we're implementing the strategy to migrate our operations towards a higher margin model.

Beyond Texas the quarter benefited from solid growth in Colorado.

And the impact of the [Civage] Thomas acquisition which as competed as of July 1, 2003.

Finally we continue to benefit from the strength of demand out west. where signups increased by 43% for the second quarter in a row.

This even while we've been raising prices to slow down the sales price.

We fully expect the demand will remain strong out west.

There are lots of people and too few lots.

We expected such a frenzied pace won't remain forever.

We entered the second quarter with about 4400 specs, which is 26% of total homes under construction.

Improving from 29% in the second quarter of last year.

Following up on some earlier comments over the short term, we've been able to pass along increases in material cost through higher house prices.

While we continue to pursue initiatives in the areas of purchasing, supply chain and construction efficiency to lower cost and help drive future margin expansion.

Right now we're implementing a more focused initiative around reducing the number of plans we build, engineering these plans for greater structural and material efficiencies, standardizing specifications within those plans based on targeted consumer groups.

Vertically integrating certain construction tasks in select markets, and implementing more planned production to reduce cycle times to gain labor efficiency and overall reduce our house inventories.

Our strategy is to simplify our business in order to maximize the cost savings opportunity and capture the efficiencies associated with higher volume.

Redundant and inefficient house plans along with unnecessary variation and specification levels are being eliminated.

Aligning a supply chain with our more streamlined operation.

Gives us the best opportunity to push costs out of the entire process.

We will continue to keep you posted as we progress through this.

With almost 20,000 homes in backlog, we're well-positioned heading into the second haft of the year.

Our operations remain focused on delivering quality homes and getting new communities opened as these are the drivers for tomorrow's sales.

Let me turn the call back to Jim.

Thank you, Steve.

I want to thank everyone for your time and attention on the call this morning.

As appropriate, we are prepared to answer questions now about the quarter and our guidance for the remainder of 2004.

At this time we will open the call for questions.

Nate?

Let's get started.

Thank you Mr. Zeumer.

At this time, if you would like to ask a question, please press the star and 1 on your touch tone phone.

If you are using a speakerphone, please pick up your handset before you press star 1.

If your question is answered or you would like to withdraw it at any time, press the pound sign.

To ask a question, please press star and one on your touch-tone phone.

We will take our first question from Greg Greber, A.G. Edwards.

Morning, gentlemen.

Nice set of numbers.

I wonder if you've given to your community counts and your results in perhaps just segment, between what is happening in your basic Pulte home and that with Dell Webb.

I believe with Dell Webb, you said you were planning to have upward of 100 community openings during the coming year.

I wonder if you could update us there.

Yeah, Greg, this is Steve Petruska.

We're still on track, actually we're tracking now north of 100 communities, either open or under development that will open up over the next few years.

But our Webb business continues to be north of 36, 37% of our closing volume.

That's where we continue to target -- it is our most important consumer segment we see.

The greatest opportunity for growth.

We'll continue to aggressively pursue that.

Okay.

I wonder if I could ask about the shift you're making, where you're going to lower turn/ higher margin.

Have you quantified or have any attempts to quantify what the impact on your return on invested capital would be were you've done it or What you might expect going forward.

This is Roger.

Typically you could wind up with the same returns in each case like that.

Again, go to slower return higher margin.

As a high turn low margin business.

Our approach is really to try to continue to focus on driving more profitability with that to increase that.

Right now we're not anticipating a significant increase on return on capital just because of that change in the model.

Anticipation would be in the future as we make this shift we should expect to see something like that.

One last question.

If you could talk about what sort of changes you've seen in the market over the past few months in your sales velocity.

I wonder if you have any attempt.

Are you seeing any sort of changes among your different market segments?

As with geography, some segments are weakening, others strengthening.

Anything similar among your 7 marketing segments?

Greg, this is Richard.

Actually.

We have 11 specific targeted customer groups.

I would say no we haven't seen a shift in demand for all.

I would highlight the Webb active adult business continuing to be strong.

We believe that is driven by the supply/demand imbalance that exists there.

But overall, in reply to your question, demand has been solid throughout most of the segments.

Okay.

Thank you very much.

We'll take our next question from Margaret Whelan, UBS.

Good morning, guys.

Tough quarter.

I'm a little confused about the conversion ratio of your backlog into delivery.

Versus the guidance for the back half of the year..

I'm just wondering why it came down so much and how you're going to get it back up by the fourth quarter.

You didn't talk about specific weather delays or anything.

I'm not sure exactly what you're talking about on the conversion, but the units we're targeting roughly around 40,000 units for the year.

I'm looking at the backlog.

The deliver versus the backlog dropped to about 48% of the conversion ratio of the backlog in sales. vs. 54% last year.

Yeah, part of that is also we're driving lower specs coming directly out of sales.

With that we're driving in the southeast market as well as in our Texas market to shift that back into less specs.

That's part of it.

Less inventory.

Yes.

What% would that account for?

I don't have that.

I'm just trying to figure out how you'll get the back half numbers based on the trend the last three quarters.

Different build cycles around the country.

And I don't think -- I'm not sure that is indicative of what is going to drive the deliveries in a particular quarter.

We're seeing a pretty significant mix shift around the county from various areas.

Again, from moving from trying to drive it from a volume or velocity standpoint to also drive more margin.

We are seeing a mix shift in there as well.

I think that would represent part of that as well.

So the ratio would be lower, because the mix is towards more expensive homes that take longer to build.

Yeah, that's part of it.

Again we're seeing more of that in the west.

Again, we'll take a look at that.

Do you see any delays for the weather or anything like that?

Margaret, this is Steve.

We've experienced a little bit of slowdown.

I think it was back in early May, late April, where we lost some starts in both Florida and some of our California markets.

But we've significantly made up for that now.

It was more of a short term supply constrain.

Then once we got that figured out, which we did very quickly, we were able to get back on schedule.

I would tell you if we reduced closings, it was insignificant.

It was very small.

Because we got it so early.

We got it in May.

The second question I had is for Richard.

It's been 12 months now since you took over the helm.

Can you give us an idea of what you see as the biggest opportunity versus challenges now. versus 12 month ago?

Margaret, I think the answer would that would be executing our strategy.

I think we spent a lot of time initially crystallizing the strategy and really putting aggressive plans in place to pursue it.

Now it is about execution.

I wouldn't look for us to radically alter or strategy one way or another.

We're very happy with our major focus areas of segmentation. operational excellence and people development.

So we're going to continue pursuing those.

I think it is about execution.

I've been spending a lot of time getting that message out to our people.

And making sure everybody is on the same page.

And we think that execution is going to continue to drive our success in the future.

So I think that's the biggest challenge.

I would also highlight the challenge of people as we're growing our operations.

People are clearly a big component of our strategy.

And we need to continue to have industry leading ways to attract people, As well as retain them and keep them motivated.

How is that program going at the universities?

It is going great.

Year-to-date we're well on our track.

We've hired I know over 800 college graduates year-to-date on our way to our goal of 1500 for the year.

We're extremely pleased.

And the final question I have -- I know you haven't been there that long.

Can why you talk about the opportunities on the procurement side?

Where you think you are in the process and some examples?

This is Steve again.

As I highlighted, where we are right now is we're in the process of streamlining the products that we build and the specifications that we put into the homes to drive us back to a high velocity model of integration from the standpoint of logistics and volume purchasing.

Until we simplify that process and because we have 11 consumer groups we can do that across the nation.

Simplify that across the breadth of houses that we build, 40,000 this year.

And the guidance is 50,000 for next year.

We can't get to where we want to be from a volume purchasing standpoint.

So I would tell you as percentage of completion, we're probably 15 to 20% of the way along that.

The best yet to come.

How long does it take to get to 80%, 100%, whatever the target is?

If is going to be tough to say.

It is definitely within the next 12 to 15 months we'll be well on our way to that 75, 80%.

Margaret, this is Richard.

We can't realize the full benefits of what he can do for us until we uncomplicate our model.

And we're getting that done first, which is the right approach.

As opposed to shooting at a lot smaller target if we continue to keep our business more complex.

And quality over quantity across the nation with all your models.

That's right.

Absolutely.

Thanks very much.

Good luck.

Thank you.

We'll take our next question from Ivy Zelman.

Can you tell us what your cancellation rate was for the quarter versus a year ago second quarter?

This is Vinnie.

And I would be happy to refer some of the statistics for you.

Cancellation rate in the second quarter of '04 was 15%.

And second quarter of '03 was 16%.

Any change from the first quarter of pretty much the same?

Pretty much the same, within the 13-14% range in the first quarter.

With respect to your comments on arms, I'm interested in you have any statistics given the rapid increase.

Has it actually gone up or down?

Qualitative comments across board, or in in particular group?

It seems to be across more of the higher end as well.

Than the typical one you'd expect at the lower end.

Although, again, times are changing where people are definitely solving for that equation of the house cost or their monthly mortgage payment.

We've not seen it specifically concentrated in one area.

With respect to the further elaborate on that.

Within the arms -- I think you said 41%.

Do you know how much of that IOs?

The interest only component, and this is in unit in which we fund our mortgages, was about 25% of our arm units were interest only.

What is your average LTV today.

78%.

Does that include second mortgages at the time of origination.

When we go to measure the second mortgage component, we call it a combined LTV.

And our score there is 80.6%.

So including the combined.

How would those LTV's compare to a year ago?

The LTV 78% in the second quarter '04 compares to 79% in 2Q 2003. and the CLTV of 80.6 compares to 80.9 in the second quarter '03

On the finance side, The credit scores, and change overall?

Credit scores in the second quarter '04 were 738.

That's the average FICO score during the quarter.

That would compare to 725 in the second quarter of '03.

First quarter of '04 was at 735.

Moving away from that line of questioning.

One of the hot buttons recently, Journal and other trade magazines has been the significant increase in speculative buyers in the marketplace, predominantly out west and in Nevada.

Richard, are you right now incorporating any clauses in your accounts to try to mitigate flippers and any of those hot markets we see this as an issue?

We are.

We are implementing that policy.

And have it in all of our markets to some degree now.

And we've gotten more aggressive with that as we've seen the increase in speculative buyers.

Can you give us an idea of how big of an issue it may be in a market like Nevada to you and whether or not it is problematic or is it something that -- how big do you estimate it is in the market like Nevada and Las Vegas.

It is very difficult to pinpoint exactly what the number is.

You have a certain percentage of buyers who are buying second homes.

And that tends to be a bigger piece in destination locations such as in Nevada or Phoenix.

So it is tough to get a handle on it.

I would say as a general comment we don't want a lot of speculative buyers on our homes.

We don't think it's good for our business.

We want to make sure we keep it limited.

I can't give you an exact number.

We don't have any specific data on that.

We're looking in to quantify that.

When people apply for their loans, it is tough to get them to admit exactly what their intention is.

Lastly, going sort of big picture to your intro comments, Richard, your confidence and conviction with respect to your growth and portfolio diversity, diversification, obviously you're diversity within the price points that you're servicing.

That you've outlined, can you tell us what you incorporate in those assumptions and targets in terms of what happens with interest rates.

One of the things we clearly see, you've got the supply side set up on the balance sheet, you've clearly grown your land position.

And continue to do so.

I wonder where you get the conviction for the demand side when that's something that's hard to imagine any of us can really predict.

Most of that is driven by the knowledge we have on the supply/demand imbalances, in the particular pieces of land that we have put under contract.

And we've been pretty aggressive in stating that we don't think all land purchases are created equal.

I'll point as an example, Webb.

It is hard for us to overemphasize the degree to which we see tremendous demand for our Webb communities.

Simply based on the fact that there is not a lot of competition.

And a huge overwhelming population of active adult buyers.

As we look to 2005 and '06, we're going to be opening Webb communities in Detroit where we don't have that and in Tampa where we don't have them and Atlanta and Charlotte and markets like that where we don't have them.

We have extreme confidence that we're going to be able to hit those.

Not only do you have a nice demand number for all of those buyer groups but you have virtually no competition, particularly for a Webb type amenitized active adult community.

And you can take that same line of thinking to our other buyer groups as well .

When you have 35, almost 40% of your business in one sector there, we believe is the sweet spot, that gets us a lot of our information.

Recording interest rates, we predicted a modestly rising rate environment over the time frame.

We didn't predict that it would be spiking up radically to 9, 10% fixed rates.

We also do not predict it staying as low as it was.

So, modestly increasing, we put together when we put those numbers together.

So I think a combination of what we believe to be a strengthening economy.

More jobs.

Modest rate increases.

Really supply-and dynamics.

I would just continue to highlight that our strategy, we want to insure we have the segmentation nailed to where we make good investments.

That's what we think we're doing.

Thank you very much guys.

Thank you.

Our next question comes from Stephen Kim, Smith Barney.

Go ahead please

Thanks.

Again, Congratulations on a strong quarter.

Roger, I was wondering if you can comment on the concentration of your profit across your strongest either, markets or strongest communities.

If you were to take the top 10% of your markets or top 10% of your communities, roughly what % of your homebuilding pretax profit would come from that top ten percent.

And how has that changed from where it was five or ten years ago?

Maybe I'll approach it a different way.

If you look at the five ways we break it up into the five geographical areas today.

As we've talked about in the past is where our concentration of capital is.

I would tell you in the western part of the United States today represents roughly 40% of our capital.

And if you look at where we were maybe so far this year, probably 55% or maybe a little bit more of our income is coming from that area.

Certainly the opportunity so far this year has been in Las Vegas and Phoenix and in the California markets where we've seen rapid price rises and been able to capitalize on that.

With that as well I would tell you the investments in some of the other areas in the country are a little slower.

But the investment rates were coming along evenly across the country.

We've seen the rapid rise in pricing.

So I think we're going to see from an investment standpoint some of the other markets beginning to catch up to making that a little bit less going forward.

Today it is a bigger portion.

And I'll tell you, ten years ago we certainly weren't hardly in California.

We've made an effort over the last three years to increase our investments there.

So if you really look at where we were a decade ago, quite frankly we didn't have the diversification and breadth we have today.

Maybe even just looking at risk mitigation as you look at that, as Richard had mentioned there's opportunities where some markets cool off and other markets pick up.

So we saw that in 2000, 2001 in the California markets after the dotcom bust.

Other markets picked up.

There's an ebb and flow here, as the markets get hot, cool, and warm. at various times.

Hopefully that answered that.

I think to clarify.

You're saying 40% of your capital is in the west.

The rate which your currently investing probably across the country is at a rate less than 40% in the west?

Yeah.

I would say certainly the biggest piece of that was Dell Webb, when we acquired them.

And continued investment there for the next communities.

To clarify that, we are not chasing where the hot market is today.

For instance because Las Vegas is a very hot market, we are not chasing investment there.

For instance we bid on a piece of property, a project out there recently, that we ended up losing over $500 million.

Another group ended up getting it.

We don't feel compelled to drive our investment strategy against where the hot markets are today.

I think our knowledge of what goes up comes down.

So we're not pushing it that way.

We've got a strategy from the segmentation.

And it doesn't entail factoring in where the hot pricing markets are at this point.

So we are not doing that.

Where would you say, Roger, are the regions where you're seeing the biggest delta in terms of the share of capital investment right now?

I would say pretty much we're still seeing just where we've been.

As Richard mentioned, we see opportunities going forward in the Florida market.

We felt that we haven't been as heavily invested there.

Northeast market as well.

And so we're pretty much putting it in markets where the populations are.

Steve, it is Richard.

Just to add a little color commentary.

We're funding all of our areas, and we're funding them at what we feel is the appropriate rate given the population.

The housing activity, et cetera.

To Roger's point, we're not chasing a particular market because it's strong today.

Okay.

Second question related to outlook for margins going forward.

We have just conservatively, for example, looked for margins to decline over the next several quarters.

And just really conservatively, and was curious as to whether or not you believe that there is the potential, realistic potential in the next five quarters, lets say, to see something on the order of, you know, 200, 300 basis point drop in margins.

At your business or whether you feel that that is -- is somewhat unreasonable to expect.

And I guess you've indicated your margins will be up 110 basis points, roughly sequentially in the third quarter.

So I guess ill be referring to a 300 base point drop from there.

I'll tell you, right now, visibility for the balance of this year we laid out in the guidance, we expect it go up.

That has been our ability to raise prices over the cost increases.

Going forward into 2005 typically when we do a projection, we don't expect margins to be expanding because of price.

We relatively keep that neutral.

What we've tried to do in our February conference is just address the things we manage as a management team in our business.

For instance, a supply chain management side and those types of things in SG&A that we can actually leverage.

It's where we're focusing our attention.

We're not relying on the movement of the market price.

Given that, certainly, I don't see a 300 basis point movement downward.

If, for instance, the west part of the United States were to come crumbling down again, something specific in one geographical area, not all geographical areas of the US.

I don't see 300 basis points coming out of margin at this point.

Again, unless there is some type of a national crisis that shocks it or some significant change in the U.S. economic situation.

Would I even consider something of that large nature.

But again there are markets that could come down because of certain situations.

The growth and pricing in certain markets could cool off and could slide back a little bit.

But nothing to the tune of 300 basis points for the total corporation.

Got it.

I guess lastly -- this is a general question maybe for Richard.

I actually agree with you with respect to the advantages of diversification.

And that there are differences among the builders out there.

Although it doesn't look like people over the last couple of years have really been paying a whole lot of attention to those.

One of the things that has come to the fore, I think over the last year or so, is the way in which Pulte has become somewhat more -- I guess the word might be aggressive.

In terms of its deployment of capital, the willingness you've had to step up and increase your land positions in certain markets.

I was wondering whether or not you would agree the the characterization that Pulte is becoming a little bit more aggressive at this point in order to capitalize on what you think is going to be a continuing favorable supply/demand imbalance.

If you agree -- do you agree with that general statement?

And I guess another way to put it is, if the market remains strong, do you think you're poised to outperform your peers?

But perhaps if the market performs worse than you expect, perhaps might you be poised to slightly underperform your peers.

Would you agree with that characterization or not?

I think we would be characterized as aggressive in the way we're approaching maximizing our opportunity we have today.

We're trying to run a better business.

With regard to our land portfolio, the balance sheet doesn't lie.

We have put capital into land.

We're pleased with that.

We're very pleased with that.

And in terms of how we'll perform relative to competition and what have you.

Time will tell.

We have said we believe over time, one, two, maybe three folks will likely emerge from the group of builders as potentially the better performers in the industry.

I think part of that is natural given the fact you've had consolidation take place to this point that it has.

It is unlikely that everyone will move forward at the exact same pace.

And we are not bashful about the fact that we have sort of made our bet on what we feel like the market is going to do.

I will tell you, for us, that has nothing to do with wanting to be the largest or anything like that.

It has everything to do with wanting to be the best builder.

We happen to believe that we can drive the best value for shareholders overall and run the best business.

By in fact really understanding this land situation.

And I would tell you I think we do believe we are on the edge, maybe the leading edge of understanding how the supply-demand characteristics exist out there.

Hopefully that gives you a little color commentary on that.

In terms of, are we the most aggressive.

That's hard to say.

You've got other people out there putting a lot of capital out as well and pushing on different things.

Again, one of the big reasons that I think you might even be asking a question, for us, it is in on our balance sheet.

That's not part of our portfolio as we've documented before.

So putting all of that together, I would tell you we're proud of the execution we've had.

We wanted to improve our return on invested capital.

We wanted to drive our margins up.

We're well on our way to achieving the kind of things we have.

Time will tell whether it is the right strategy or not.

We certainly think it is.

Fair enough.

Thanks very much.

Thank you.

Our next question comes from Kevin Tynan, Argus Research.

Go ahead please.

Good morning.

Most of my questions have been answered.

I'm here with our economist, so maybe I'll ask a question on his behalf.

You alluded to the modest range of growth for the larger economic picture.

Could you just provide a little more color maybe what you're looking for in the second half.

Or split between the third and fourth quarter regarding, GDP and payroll numbers.

And also do you have initiatives or incentive programs in place should interest rates have a greater effect on demand than I guess is forecasted assuming that the Fed moves in an orderly fashion.

This is Roger.

Just a couple of comments for projecting GDP growth and that type of thing And how it relates to our business.

That's way too close on a short term basis.

We've managed our business on a long term.

To radically slam on the brakes or slam on the gas, given any change in those, our outlook, is not how we run the business.

Really looking at a long term basis for that.

Even as it goes to interest rates, we don't modify the approach that we take to any given market or our business in general or holistically.

So from an incentive standpoint, we're looking at returns and project based versus more economic.

If there is a change in the economy that is significant, and what we look at is where we've been over the last couple of quarters all the time.

So that will give us an indication, is it any better?

Is it any worse?

Not just to plow ahead very blindly to the effect that the economy falls off.

Interest rates might go up by 500-600 basis points, we're trying to do the same thing.

We certainly try to modify that all along the way, but to over-react at any given time to data that comes out is not how we can run this business.

I was not meaning that we would shift capital out of markets and chase hot markets so to speak.

But smaller like incentive plans like you had said earlier about sprinkler systems or sort of accessories to that level.

Kevin this is Steve.

You know, if interest rates move up, if we tend to get a slow quarter, we're always -- that's why I said, we're always in the business of using certain incentives to move certain inventory.

Over the totality, we don't see that as a significant increase, regardless of what happens with the interest rate.

We will adjust the business model in that particular market to those particular consumers that get impacted by that increase in interest rate.

Our active adult buyers, they are more interested in what is happening with their investment portfolio.

And we can make an argument that so many of them on fixed income that increased interest rate is actually a good thing for their portfolio.

It doesn't affect 37% of our buyers at all.

Right.

Okay, Thank you.

Our last question is from Carl Reichart.

Go ahead please.

Hi Guys.

I don't know if I missed this, did you give us a land under control owned and options?

Carl, we didn't.

We'll be happy to do that for you.

The total lots controlled as of of June 30, '04 is 312,700 of which 43% are owned.

Great.

Thanks a lot.

Very good.

At this time I would like to turn the call back over to management.

Thank you.

If there are no more questions.

We will be around the remainder of day should you have follow-up questions.

Very much appreciate your time this morning and look forward to talking to you in the future.