普爾特房屋 (PHM) 2014 Q2 法說會逐字稿

Good morning.

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

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

second quarter 2014 financial results conference call.

(Operator Instructions)

Thank you.

Jim Zeumer, you may begin your conference.

Great, thank you, operator.

This is Jim Zeumer, Vice President of Investor Relations for PulteGroup.

I wanted welcome everyone to our call this morning to discuss our second quarter financial results for the three months ended June 30, 2014.

On the call today to discuss our results are Richard Dugas, Chairman, President and CEO; Bob O'Shaughnessy, Executive Vice President and CFO; Jim Ossowski, Vice President Finance and Controller.

Before we begin, I want to remind everyone that copies of this morning's earnings release along with the presentation that accompanies today's call have been posted to our corporate website at www.PulteGroupInc.com.

Further, an audio replay of today's call will be available on the site later today.

Please note that today's presentation may include forward-looking statements about Pulte Group's future performance.

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

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

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

Now let me turn the call over to Richard Dugas.

Richard?

Thanks, Jim, and good morning, everyone.

I'm extremely pleased with Pulte Group's second-quarter results which show a continuation of the positive company and industry dynamics we discussed as part of our first-quarter conference call and more broadly over the past 12 to 18 months.

Within a US housing market that remains on a steady recovery path, we are benefiting from company-specific initiatives that continue to generate gains in key financial metrics consistent with our value creation strategy.

Reflective of an ongoing recovery in demand and overall favorable pricing environment, the value of our second-quarter signups increased by 5% as we once again realized improved absorption paces over last year.

We see these as positive signs for our business going forward.

As Bob will detail, among the promising aspects of these gains is the meaningful increase in the performance of our Centex communities and the implications for potential future demand among entry-level buyers.

It has been widely reported that the first-time buyer has been under represented in this housing cycle, so improving demand at Centex communities is a very encouraging sign.

We also realized a solid increase in sales pace within our Del Webb communities.

As we have talked about before, there is tremendous operating leverage to be realized with volume, so continued gains in Webb's absorption pace is important.

Within this demand environment, we continue to focus on maximizing profitability on each home we sell.

Consistent with this strategy, we realized a 12% increase in average selling price over last year.

Along with favorable market conditions and our ongoing mix shift, price gains were generated through specific pricing strategies that address everything from base house and option pricing to lot premiums and discounts.

Each is a dial we can adjust to accommodate different buyer groups and local market conditions to help us achieve our goal of higher returns on invested capital in each community we operate.

Through better price realization and initiatives to drive more efficient homebuilding operations, we were again successful in raising reported gross margins.

On a year-over-year basis, gross margin for the second quarter increased by 480 basis points to 23.6%.

In fact, you have to look in the history books all the way back to 2005 for these type of margins from PulteGroup.

We are of course pleased with the improvement in gross margin that we have generated in 2014 as well as over the past several years and see opportunities to continue this trend going forward.

Through a combination of pricing strategies, gains in operating efficiency and savings associated with lower interest cost, we see the potential for incremental gross margin improvement from here.

An insurance related charge taken in the quarter makes the year-over-year gains in our homebuilding operations a little harder to appreciate when you see earnings of $0.11 per share up from $0.09 per share last year.

However, when you adjust for the charges taken in both periods, and the more normal tax rate in 2014, the meaningful and sustained improvement in our homebuilding operations is clear.

Given the gains we have realized in operating and financial performance, we are comfortable increasing our level of investment into the business, confident that will be able to generate better returns on invested capital than we were delivering in the past.

The roughly $400 million of land spend for the quarter and $720 million for the first half of 2014 is the most we have invested in a number of years.

The increased investment is possible given our more efficient homebuilding operations and strong balance sheet and is consistent with our view of an ongoing recovery in housing demand.

There are headwinds facing the housing industry, including tight credit availability, but in our view, the negatives are outweighed by the positives such as the monthly jobs report showing an economy generating more jobs than it had in the recent past, interest rates remaining low even while the Fed continues to withdraw support from the system, and inventories of new and existing homes remaining in balance with reports about an undersupply of product in some areas of the country.

These conditions in concert with the good pricing environment and continued increases in apartment lease rates support our expectation for a continued, albeit measured, recovery in housing demand.

Now let me turn the call over to Bob for more details on the quarter.

Bob?

Thank you, Richard, and good morning.

Pulte Group's second quarter results demonstrate further success operating against our value creation strategies and driving improved operational performance and financial results.

As I will detail, these improvements are evident in our Q2 numbers.

Looking at our income statement, home sale revenues in the second quarter were $1.2 billion, which is an increase of 2% over the comparable prior-year period.

The higher revenues for the quarter were driven by a 12% increase in our average selling price to $328,000, partially offset by a 9% decrease in our closings to 3798 homes.

Consistent with recent quarters, we realized price increases in many of our communities and within each of our brands.

For the second quarter, the 12% average increase in selling prices included a 13% increase to $396,000 in our Pulte communities, a 9% increase to $325,000 in our Del Webb communities and a 3% increase to $202,000 in our Centex communities.

We continue to experience a shift in the mix of homes closed to move up and active adult product.

For the second quarter, 45% of closings were from Pulte communities, 32% were from Del Webb and 23% were from Centex.

In Q2 of 2013, the mix of closings was 46% Pulte, 27% Del Webb and 27% Centex.

Our reported gross margin for the quarter was 23.6% which represents a gain of 480 basis points compared with last year.

Our margins benefited from the higher prices and mix shift I noted as well as lower interest cost.

I think it's important to highlight that we believe our margins are being enhanced by our strategic pricing model which seeks to maximize lot premiums and option dollars within the final selling price of the home.

We continue to realize gains through this initiative as lot premiums and option revenues per closing in the second quarter increased by 23% and 14%, respectively, to $12,000 and $47,000 per unit.

Also supporting the expansion of margins was a reduction in sales discounts, which dropped 90 basis points from last year to 1.7%.

In dollar terms, discounts were only $5700 per home, down from $7900 last year.

We've highlighted that we don't expect discounts to decline significantly from these levels.

Along with capturing pricing opportunities, we continue to expand our use of commonly managed plans to help ensure that we are building the best home for the lowest price.

In the second quarter, 39% of our deliveries were from commonly managed plans.

This is an increase from the 30% we reported in the first quarter.

We're extremely pleased with our progress on this metric as we have grown this percentage from just 13% one year ago.

We are clearly on track to meet or exceed our goal of 40% of our closings from commonly managed plans by the end of 2014.

Given the benefits of commonly managed plans, the favorable pricing dynamics we're experiencing in the market and the impact of our deleveraging of the balance sheet over the last few years, we continue to see opportunity for further margin expansion from here although there will be volatility from quarter to quarter.

Based on our current backlog we expect margins for the balance of the year to be consistent with to slightly higher than our margin this quarter.

SG&A costs for the second quarter were $230 million or 18.4% of home sale revenues, compared with $151 million or 12.3% last year.

The year-over-year increase in SG&A was primarily driven by a charge of $84 million recorded in the quarter for increased insurance reserves.

The adjustment to our reserves was driven by cost associated with siding repairs in certain previously completed communities in the West.

Beyond the direct cost of the repairs, the negative development in the period to use the insurance parlance impacted our actuarial estimates for incurred but not reported or potential future claims.

The combination of higher cost incurred and the resulting increase in estimates for future expenses drove the second quarter charge.

Repairs are in process in the impacted communities, and we're working with homeowners and contractors to ensure the work is completed efficiently and with minimal disruption to the residents.

Excluding this charge, SG&A costs in the period were consistent with expenditures in Q1 of this year and with previous guidance.

Financial services reported pretax income of $9 million for the quarter compared with $16 million in Q2 of last year.

The reduction in pretax income for the period was the result of lower origination volumes and the more competitive operating conditions that continue to exist within the mortgage industry.

Capture rate for the period was unchanged from last year, and consistent with Q1 of this year, mortgage put back request remained at very low levels.

Inclusive of the $88 million of charges for insurance and office relocation costs, pretax income for the second quarter of 2014 was $68 million.

Prior year pretax income of $38 million included charges totaling $67 million for contractual dispute, debt repurchases and corporate relocation.

As you can see, our operating performance excluding these items was significantly improved.

Income tax expense for the period was $26 million or an effective tax rate of 38%.

This is consistent with our previous guidance that taxes in 2014 would be approximately 39%.

Prior year tax expense was only $2 million for an effective tax rate of only 5% as the company had yet to reverse its deferred tax asset valuation allowance.

Net income for the second quarter was $42 million or $0.11 per share, including $0.14 per share of charges recorded during the period.

For the second quarter of 2013, net income was $36 million or $0.09 per share including charges of $0.17 per share.

Again this year's net income reflects the 38% tax rate compared with the 5% rate last year.

Looking at other operating metrics, we had 6321 homes under construction of which 15% were spec at the end of the quarter.

Spec production is consistent with prior year and prior quarter.

Of particular importance, however, finished specs totaled less than 300 houses or well below one per community.

During the quarter, we put 6700 lots under control and invested $395 million in land acquisition and development.

We approved more deals in the quarter than we have in any quarter since 2006 including the approval of three new communities to serve future active adult buyers.

Continuing recent trends, about three quarters of the deals are raw, meaning that land development is required so these transactions will support production in 2016 and beyond.

We had 126,000 lots under control at the end of the quarter of which 26% were controlled via option.

24% of the lots under control are finished, and we have another 18% under development.

At $395 million for the quarter, our land spend is clearly increasing.

For the year to date period, we have spent approximately $720 million.

We continue to target a full-year land spend of $2 billion for 2014 but recognize it will be a challenge to spend an additional $1.3 billion over the next six months.

As we've highlighted before, we are comfortable with this.

We continue to invest in a disciplined manner with a focus on better located positions and acceptable risk adjusted returns.

It's important to note that we continue to see good opportunities as evidenced by the level of spend we approved during the second quarter.

Along with our higher land investment, we also increased our share repurchase activity in Q2.

In total, we acquired 2.8 million shares for $53 million or $19.12 per share.

As of June 30, 2014, we had $137 million in capacity remaining under our share repurchase authorization.

We ended the quarter with $1.3 billion of cash on the balance sheet.

I would also highlight that we entered into a new three-year $500 million unsecured revolving credit facility yesterday.

The revolver, which includes an uncommitted accordion feature that could increase the facility to $1 billion, replaces a letter of credit facility that is set to expire later this year and provides added financial flexibility for the Company.

Moving past our financial statement, the dollar value of signups in the quarter increased 5% over last year to $1.6 billion.

On a unit basis, net new orders totaled 4778 homes which is down just 2% from last year despite a 6% decrease in community count.

As Richard highlighted, this is the second quarter in a row we experienced higher absorption paces.

Looking at this by brand, net sign ups decreased 1% at Pulte, 5% at Centex and 2% for Del Webb.

Q2 absorption paces were down 8% at Pulte but up 11% at Del Webb and 26% at Centex.

The 26% increase at Centex follows a 29% improvement in year-over-year absorptions in the first quarter of this year.

Certainly part of the increase is driven by the overall strength of demand in Texas, but the trend at Centex warrants close monitoring as there may be a growing opportunity with the entry level buyer.

We ended the quarter with 589 communities, which is a decrease of 6% from the end of last year.

Q2 community count was flat with the first quarter of this year and in line with guidance that we expected to operate from approximately 560 to 580 communities throughout 2014.

The stability across the quarters hides the fact that this is a very active year as we plan to open approximately 190 new communities over the full year.

Our quarter end backlog was 8179 homes valued at $2.8 billion which compares with prior year backlog units and dollars of 8558 and $2.7 billion, respectively.

The average price of our homes in backlog is up 7% over last year to $339,000 and up from $336,000 in Q1 of this year.

Overall I'm extremely pleased with our results for the quarter, even more encouraging are improving absorption paces with better pricing, growing margin and increased investment put us in a very strong position moving forward.

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

Thanks Bob.

As Bob just detailed, we continue to experience strong buyer demand in the quarter which generated increased absorptions and allowed us to realize higher selling prices.

While we appreciate the housing data can be volatile from month to month, we remain optimistic about overall conditions and very encouraged with demand through the first six months of the year.

Looking at conditions in the second quarter on a more regional basis, on the East Coast, conditions didn't change all that much from the first quarter this year in that activity was stronger as you move from the North to the South.

Buyer activity remains particularly strong in the Carolinas and throughout the state of Florida.

Market conditions in Washington DC however were still challenging in the quarter.

Conditions in the middle third of the country were positive in the second quarter.

Similar to our experience on the East Coast, demand strengthened as you move from North to South.

Texas remains one of the strongest areas of the country with exceptional demand across all markets of Dallas, Houston, Austin and San Antonio.

Relative to the first quarter of the year, demand conditions got better as we moved past the tough winter.

Finally, moving to our Western markets, the patterns of the past several quarters continued as we experienced strong demand in northern California and the Pacific Northwest while our markets in the Southwestern states of Arizona, New Mexico and Nevada are good but not as strong as this time last year.

As the US economy continues to improve, we would anticipate that these markets will benefit.

In terms of demand for the first few weeks of July, we have seen a typical summer slowdown, but the market specific trends we experienced through the first six months of the year are generally unchanged.

In closing, my thanks to all of our employees who are working extremely hard to help us drive our improved operating results and who are doing an amazing job opening 190 new communities this year.

Thanks for your time this morning and I will now turn the call back to Jim Zeumer.

Jim?

Thank you, Richard.

At this time we will open the call for questions.

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

Anastasia, if you will explain the process, we will get started.

(Operator Instructions)

Michael Rehaut, JPMorgan.

Thank you.

Good morning, everyone.

Nice quarter.

First question I had was, your comments on Centex and the continued positive sales pace.

You mentioned part of it was driven by Texas.

And I just wanted to get a sense of if sales pace was up in the other regions where Centex is more dominant or how much really Texas was responsible for this and if part of this is just a reformulation or mix benefit from some newer communities as well?

Mike, this is Richard.

It's a combination of Texas and other markets.

To be clear, the entry level does appear to be improving in other markets as well.

We happen to have the biggest percentage of Centex communities in Texas.

And as everyone knows, the job growth in Texas is strong; so that is why we highlight it.

It appears to be a broadening improvement for the entry level category.

Just secondly, the gross margins continue to be great; and you've shown a lot of improvement there.

One of the competitors this morning mention that they've maybe taken some actions to improve sales pace in the market, which might suggest a modest negative impact on gross margins.

Is this something you think might continue going forward and spread through the industry, or have you seen this from a competitive standpoint by other builders or in certain other markets?

Mike, we are definitely running the Company for the highest returns on invested capital.

And we are not pushing discounts.

As a matter of fact, as Bob indicated, discounts dropped year over year to an incredibly low level, while lot premiums and option revenue increased.

I can't speak to what competitors are doing.

I'm not seeing broad-based discounting across the board.

I think inventory levels, candidly, are too low.

And I would point out that the very strong quality land that we have been buying the last several years along with our return strategy is supporting our higher margins.

And as Bob indicates, we expect them to continue.

Ivy Zelman, Zelman and Associates.

Congratulations on another strong quarter.

If you can please talk to a little bit with the charge reserves on the $90 million for the siding.

This is completely separate from the construction defects that you reserved for a few years ago.

Just understanding, making sure that's separate.

And my follow up is, as you think about the competitive mortgage environment, what are you seeing more in terms of lenders' willingness to remove some of the credit overlays?

As you deliver loans to Fannie and Freddie, is the consumer actually seeing a better price as a result of the competitive pressures?

And maybe more specifics within the credit buckets recognizing that you're typically dealing with a better quality borrower?

But you're also indicated the Centex business is picking up.

So is that a function of also lending improving to that bucket?

Thank you.

Bob do you want to take the first part?

Sure.

The charge, Ivy, is for siding issues; and it is construction defect work.

So we are repairing siding issues that we have identified.

And the mechanics of this are, we've got certain communities, where we have costs.

And then looking at the actuarial analysis, when we saw that activity, the actuaries look at that and say -- Okay, if we see it today, we have to extrapolate across the universe of reduction.

So it is actually both specific to certain communities' siding issues and then an extrapolation for incurred but not reported claims.

Ivy, with regard to the mortgage environment, I would say credit appears to be easing just on the margin or on the edges if you will.

I do believe that is some of the improvement in the entry level.

I do think, however, the majority of the improvement in entry level is job-growth related.

I don't think credit has moved much, but it appears to be easing just on the edges.

We've seen a very slight increase in credit availability as measured by MBA in their statistics.

David Goldberg, UBS.

My first question, I wanted to follow up on one of Bob's comments earlier about being aware of what's happening in the Centex business segment and the higher absorption rate and the trend and keeping an eye on the trend.

What I'm trying to get an idea of is, what is the trigger point for you to start focusing more land acquisition on Centex communities?

Is it you hit a certain absorption pace?

Is it a certain confidence in the economy?

What are you looking for when you are examining that trend in the improvements you're seeing to get more confident in your land acquisition in that segment?

The simple answer is -- and you heard Rich say it -- it's return.

As we look at land transactions in the market, the teams are agnostic to brand.

So they've got opportunities to invest in any one of our brands.

So I think what would drive increased investment in Centex is a continuation of the pace increases that you're seeing here because it still has lower ASPs, still has lower margin; and so we need higher paces.

So it would the that improving environment for the buyer.

And Texas is a great example.

The job market there is really strong.

Richard highlighted this.

Strong jobs are driving consumer confidence.

And that buyer is therefore buying in more volume.

So you would see would see us invest more in that land when we see that activity.

That's great color.

My second question was on the three new active adult communities that were put under contract, you mentioned earlier in the commentary.

Can you give us a high level?

Are these replacement communities for things that are rolling off?

Are these incrementally -- and what might be different or maybe the same about those communities relative to the existing Del Webb communities as you look at the rolling off and rolling off pattern?

Great question.

These are largely replacement communities.

There is one that is a fresh community.

What I think you'd see different from the historical Del Webb presentation is they are smaller.

They range in size from 600 to 1200 units.

We think we'll be in and out of them in, say, five years.

It will have a slightly smaller amenity package to what you've probably heard me refer to as the Cruise Ship Del Webb.

If it's a continuation on an existing community, it may have a shared amenity.

But typically, it will have a clubhouse.

It might not have a golf course anymore; it will have walking trails -- so, again, a little bit smaller.

And I think we've talked about this for a couple of years.

Those 5,000-unit communities are likely not in our future.

David, everything Bob mentioned is all driven around return.

It's all part of the Pulte story.

Eli Hackel, Goldman Sachs.

Just wanted to go back to the first time buyer and credit for a minute or so.

Richard, you talked about maybe things easing on the margin.

Is there anything else you can see over this next six/nine months, whether it's conversations in the industry with your mortgage friends, with people in DC, or maybe that would change more incrementally?

Also on the first time buyer, do think there is any holdback of them buying due to lack of available supply in the markets?

Or it's really much more back to your first point, which is really job growth accelerating within that core buyer?

I will answer in reverse, Eli.

I think that the majority of the problem is a combination of tight credit and jobs, the combination there overall.

I don't think there's a lack of supply for that category.

I think the industry can ramp up to build for that category.

There are certainly some supply shortages.

But the majority of the issues, I believe, are tight credit and jobs.

With regard to credit potentially easing from here, mortgage finance reform legislatively is likely dead for this year.

As I think everyone knows, the Johnson-Crapo bill didn't make it too far through Congress.

So we are working as a group of collective large builders to push the administration particularly to work on administrative solutions to the credit box, which we do believe can have some impact.

That would be things like changing FHA fees, things like that.

Unfortunately, that sometimes tough to get done.

And I do believe that will take time.

But by clarifying putback rules, by ensuring that the definition of qualified mortgages and qualified residential mortgages is very clear, by focusing on FHA fees -- things like that --we do believe there are some administrative actions that Mel Watt could take, as he heads up FHFA, that would be outside of the legislative arena.

We are working on that.

We're not holding our breath that anything is going to happen dramatically to help that.

It is going to take some time for credit to ease, in my view.

Stephen East, ISI Group.

Richard, you talked a little bit about July being pretty normal seasonally.

And we've heard from various places that June absorptions were down like 15% across the industry, et cetera.

Could you talk about how your order progression was during the quarter, and whether you saw that type of absorption drop in the quarter?

Yes, Steve, we saw a fairly seasonal, typical trend.

And April and May were stronger than June.

We didn't see a dramatic falloff in June.

It was very typical summer seasonal, which has continued into July.

We've also heard over the last three or four months that generally traffic has been much better than the conversion into orders.

I was wondering if you all were seeing that?

And then if I could just ask one question back on the gross margins.

Can you reconcile a little bit?

The commonly-managed floor plans jumped from 30% to almost 40%, but the gross margin stayed about flat.

How do we reconcile those two, and is that going to be an ongoing thing there?

I will take a crack at both, and then maybe Bob might want to add any color.

On traffic versus conversion, we are continuing to see good traffic.

And conversion is respectable, I would just again say, within the bounds of a typical summer slowdown.

So not a lot of movement, Steve, either way on either metric.

So I would say we still had good traffic and respectable conversion, both marginally down given the summer season.

On gross margin performance, the commonly managed plans are better margin product; and we're excited about the 39%.

But many things going to the margin performance, including specifically mix for the quarter.

And we have indicated that we would have quarter-to-quarter volatility.

Our margins, even though they were sequentially down I think about 20 basis points, they continue to be at a very high range.

And as Bob indicated based on our backlog, we see opportunities the next couple quarters for them to be in this range or slightly higher from here.

Were pleased with our overall margins, and mix influences things from quarter to quarter.

Bob, any other color?

The only thing I would add is one of the things that we've highlighted about these commonly-managed plans that we think is the hidden gem is that our absorption paces are higher with them.

And I think it's contributing to the absorption pace increases you're seeing from us, which is equally as important to return for us as the margin is.

Nishu Sood, Deutsche Bank.

First question I wanted to ask was about the profile of land spend.

You mentioned that you approved the most number of deals since maybe going back to the housing boom.

But at the same time, you also said that $2 billion land authorization -- it will be tough to get there.

I was just trying to reconcile those two.

Does that imply that you've shifted your land purchases towards much longer deals where the cash flows are more backend weighted?

Or is that just a reflection of the fact that the trajectory of housing this year has probably turned out to be a little bit slower than most of us originally expected?

I would actually characterize it as a change to a certain degree in what we are buying.

There isn't much finished lot availability out there, so we're buying raw land.

While our dollar is out the door today, it will be a challenge to get the $2 billion.

We've actually committed a fairly significant amount in terms of what will develop in 2015 and 2016.

You will see spending increasing in out years because of what we've done this year.

We think will get close to the $2 billion; we're just not sure we will get all the way there.

And it is because we've continued to tell our folks, don't chase deals.

You've got authorization to go spend money, but don't do it foolishly.

The discipline that they are exhibiting is going to make it a little bit of a challenge to get to $2 billion.

But you will still see a significant increase over FY13, and we like the land that we're buying.

Nishu, this is Richard.

I want to add two things to what Bob said.

Number one, we are seeing some delays in entitlement and municipal issues which, candidly, are somewhat out of our control, just based on processing times to get things to the cycle.

And that is causing some of the delay.

Secondly, I want to be crystal clear.

We are not lengthening the land supply and the profile of the deals we're doing.

As a matter of fact, we're doing our best to make them strong returners, which generally means a little bit shorter positions clearly than the Company was buying in the past.

There's no change in our profile over the last two or three years that we've been indicating -- ROIC first.

Got it.

Following up on that, 190 new communities,, I think you mentioned, that you will be opening this year -- so a significant amount of turnover, as well as this accelerated pace of taking land under control.

Do we begin to see then a more significant pace of [community count] expansion looking into 2015?

Nishu, we haven't commented on that yet.

And we are sticking with our guidance of 560 to 580 for this year.

As we get closer into either late Q3 or Q4, we will provide some guidance for 2015.

But it's too early for us to speculate on those numbers.

Stephen Kim, Barclays.

Thanks very much for the color.

Interesting about the entry level.

We will just have to see how that goes.

I wanted to ask you a question about labor and the ability to construct homes.

We all know that labor shortages have been something the builders have talked about for a while, and obviously there are cycle reasons associate with the severity of the downturn that have made labor in particularly short supply.

My question is, is it more difficult or easier to get labor to build your entry-level product versus some of your higher end product?

And specifically what I'm getting (technical difficulties), do you see a recovery in the entry level demand?

Do you anticipate that labor shortages will constrict your ability to meet that demand with product?

Or could it be that because entry-level homes don't maybe require the same amount of finished skills, not as much trim and so forth, that actually you can take some lesser-skilled labor and still get those homes built at the entry level?

Steve, we are not seen any difference in labor availability for entry-level versus a more luxury focused product for us.

I will say labor is tight in the industry, particularly for unskilled trades -- drywall, roofing, things like that.

And clearly there's some constraint on ability to close backlog in the near term.

It's just a timing issue, so you may have units move from one month or one quarter to another.

So I don't think it's a big problem for the industry.

But it could cause some minor disruptions, frankly not unusual from past recoveries.

But, no, not a lot of change in segment availability of labor.

That's encouraging, great.

You made a comment in your prepared remarks about land; and I just want to make sure I got the numbers.

You mentioned I think that 24% of your lots were finished.

I wanted to make sure I understood.

Was that 24% of owned lots or 24% of your controlled lots?

I want to know how many owned, finished lots you have.

It was controlled, Stephen; and we will see if we can get that number for you.

We have 24,683 finished owned lots, which would be 27% of all owned lots we have.

Ken Zener, KeyBanc.

Richard, you commented on approval process impacting your land spend.

Could you comment on what the discipline side -- i.e., your return -- says about what land prices are in various markets is my first question.

Yes, Ken, we've certainly seen a significant escalation over the past 12 to 18 months in land prices.

They do appear to be moderating to some degree.

However, I would tell you that the discipline that we're exhibiting with a very capital-constrained focus internally to drive higher returns continues to lead us toward challenges to meet the overall land spend goals that we have.

As Bob indicated, we hope to get to the $2 billion level; but we're not going to force it.

Overall we are pleased with our discipline.

We think it's served us well, and we think it's one of the reasons that our margins have held up as well as they have and frankly one of the reasons our paces are doing well -- simply because of the quality of land we're buying.

So continued more of the same I would say is in our future.

My second question, broadly related to how you're running the capital structure, could you give us a sense of what you think the Company will do?

If your revenues are growing, let's say 10% or X percent, what does the cash flow cycle imply about your yield or your free cash flow as it relates to potential to buy back stock as you did in the quarter, given that you got going to be as cyclical on the capital investment cycle?

That's a great question, Ken.

And as a Company, we continue to, we think, exhibit balance with our capital allocation strategy.

And I think you can expect more of the same from the Company.

We reintroduced the dividend last year to a reasonably nice level, and we stepped up our share repurchases in Q2.

So I would expect the Company to continue to exhibit balance.

Now that our returns are as strong as they are, our first priority would be to put it in the business.

But, candidly, we don't want to dilute our return; so we want to make sure that we're buying the right land.

I think it's fair to say were going to have plenty of cash available to do a multitude of things.

And I would suggest that continuing to return funds to shareholders through dividend and buyback is likely in our future as part of our balance process.

Right, and I guess if you think about invest in the business, like you said, and you're going to be holding land to let's say a two-year, how do you gauge your discipline relative to what you want to invest today based upon where you think the market's going to be because that's the real thing, right?

If you have two years but you're assuming 50% growth, that's different than a steady 10% or 15% growth, which would yield a different element of cash flow.

I think it's tough to predict out in the future too far, Ken.

I would suggest for the near to medium term, we like the conservative posture that we've taken.

And we realize the large cash balance is a non-earnings asset, and we would like to deploy it.

We just don't want to do anything dramatic or sudden to try to time the market, if you will.

Stay tuned for further clarity and commentary on that as the picture becomes a little clearer in the future for us.

Robert Wetenhall, RBC Capital Markets.

Nice quarter.

How much upside do you think there is in gross margin?

The standardized floor plans have been fantastic, very positive impact.

Do you still see opportunity for upside?

Bob, we indicated for the next couple of quarters, we see things in this range or slightly improved.

Beyond that, long-term we don't want to provide a lot of guidance.

We certainly like the benefit from commonly-managed plans.

We like our discipline.

But I will highlight something that Bob indicated.

It's certainly a nice margin story, and we want to keep it going; but it's about return for the Company.

We're going to continue to make good decisions based on return overall.

So we like where margins are headed for the foreseeable future.

That's helpful.

You've been in the homebuilding industry for a long time.

Do you think we're transitioning from early cycle to the mid cycle of the recovery?

And if you could give us your view, where we are in terms of the evolution of that process, that would be great.

I think housing has several good years ahead.

I don't think we're mid-cycle yet, frankly, in my view.

But I do think it's a slow and steady path upward from here.

I tell our folks internally my best projection is that I don't see anything causing a sharp increase in overall demand, nor do I see anything causing a sharp decrease in demand.

I think a slow and steady recovery is the most likely one, which is kind of what we have seen.

There are a couple of headwinds that we historically might not have had in housing recovery, such as job growth, that is good but not great in tight credit.

By the same token, those things appear to be getting better slowly but surely.

So that would be what I would expect.

One other thing, Bob, just to mention, is that the recovery now appears to be taking on regional and local geographic characteristics, which is very typical of a normal housing recovery.

I think we transitioned probably late last year or early this year from this macro view, where housing was horrible for several years and then we had a couple of years where housing was really good everywhere.

Now it's becoming much more about local economies of local geographies, and that is normal.

As we indicated, Texas has got great job growth; and it is strong.

And DC has got so-so job growth, and it is not as strong.

That feels normal to us.

Again, to summarize, slow steady from here is my best guess for many years.

Adam Rudiger, Wells Fargo.

Richard, in the last couple questions, you've mentioned returns a lot.

In one in particular, you said returns are strong now.

So I was wondering if you could be a little more specific and talk about what you're referring to and whether it's simply margins or if it's ROEs or ROICs and where you are versus where your targets and what might be achievable.

We are clearly focused internally on our invested capital, so it is ROIC that I am referring to.

All of our folks in the field have been running the business.

This is the fourth year in a row with the focus on a combination of margins, SG&A leverage and asset turns.

If you put that in a triangle, right in the middle of it we'd stamp ROIC.

We feel like our returns are very strong today, and we feel like we can keep them in this range or higher from here.

We don't think that our balance sheet is completely being utilized.

In other words, we still have a number of lots that are long positions.

And as we cycle through those that we replace them with more term-friendly deals, I think that can help the denominator; and obviously we're working on the numerator as well.

It's hard to predict where returns can go, but we intend to be a high-returning builder through the cycle.

Certainly not as high returns in a down cycle as in an up cycle, but we want to be focused on returns from here on out because we do believe that that metric is the most important metric to drive shareholder return over the long run.

Will Randow, Citigroup.

In regards to your land spend, are you guys augmenting that towards Texas and Georgia?

Because those are some of the stronger markets I think we're seeing, and I don't know if you are as well.

We actually focus our investment on a couple of things.

One is to maintain relative market share in the markets where we operate.

The other is, obviously, where we see the opportunity for increased investment.

So it will be a function of how well they're investing today.

We don't say -- Okay, if we're going to invest 100 in total, X percent goes here, here, here and here; it's static.

It actually moves over time.

So certainly the improved operating environment in Texas is one that has us interested in investing more.

So they have a fair amount of capital.

But we are trying to maintain relative market share in all of the markets where we operate.

In terms of the balance sheet, given your solid credit metrics, do you intend to refinance your 2015 and 2016 maturities from Centex?

I guess overall, is your goal being investment grade?

Or is it just more of returns on capital?

I wouldn't want to comment on individual debt offerings.

What I will tell you is that they are very expensive.

So as we've looked at all of our debt over time, if we were to make an investment to buy it back, it would be because we can get some positive yield out of it.

And that's a challenge with some of the pricing that we're seeing on our paper.

Sorry, I forgot the second question.

We will come back to you, Will.

Jay McCanless, Sterne Agee.

First question, what was the can rate in the quarter?

14.1%, so flat with last year.

My second question and a little different take on the land spend.

Can you comment on the valuations you're seeing in private builders who are willing to sell?

And are those valuations in line with what you're looking for with the ROIC strategy?

And could you potentially go out and do some deals and buy some of these private builders to accelerate that land growth that you're talking about and hit that $2 billion target this year?

Certainly we see all the transactions that are coming out, the stuff that gets announced.

We see these.

And I would say the answer is, yes, we could potentially be doing transactions.

But we look at them as typically just a land transaction.

So we are putting the same return requirements on them as we are on any particular land transaction in a market.

Oftentimes when people come to market, they've got fairly lofty expectations for price.

We haven't seen anything that was compelling to us to chase, but that doesn't mean we wouldn't.

We look at them and we're interested.

We're a buyer and seller of land; it's part of the equation here.

Jim Krapfel, Morningstar.

Given your risk-weighted focus on ROICs, ultimately where do you see options as percent of total land under control long term?

And how long do you think it would get there?

Jim, we'd like to drive options as high as we possibly can.

We've been real pleased with our ability to do so, given our focus on returns.

To some extent that's going to be dictated by the seller.

In some instances, it's not available.

Bob, if you have any more color?

The only thing I'd add to that is options can take on different looks and feels.

If you've got a finished lot option transaction, it's different than one where you've got raw land where you're optioning parcels of it as you go forward.

And for us the mechanics turn into what generates the best return risk weighted.

So if we're buying raw land, the option, we want the option to have risk transfer elements to it.

Whereas if you buy finished lots, it's a little bit simpler to work through.

What we've been doing now, we are increasing our percentage of option transactions.

But again, they are typically raw, where you may have a 600-lot community and we take the first 200 down and option the second 200.

On the finished land side, the option for finish land, when do think you could start to do that to a greater extent?

When will the developers regain their financial health to do those kind of deals?

That is a great question, and I do not know.

Haven't seen it to a large extent at all today.

Dan Oppenheim, Credit Suisse.

It's great to hear the confidence that you talked about in terms of the gross margin in the back half of the year, either flat or slightly up.

Just wondering about that.

How much that is the view that what you're doing internally in terms of the common plans and the price optimization is offsetting what's a slower home price appreciation and some higher land costs?

Dan, I think it is all of the above.

I will tell you, I'm very pleased with our internal focus on commonly-managed plans.

And don't rule out the stats Bob keeps giving every quarter around lot premiums and options.

Those are end discounts.

Our internal focus on isolating each of those metrics and trying to optimize them helps.

So it's clearly a combination of all of the above.

When you have as many moving parts as we do going in, it is hard to isolate it to any one; but collectively, that's where we get.

The second question.

You talked about the strong absorption on the Centex side.

But in terms of pricing with Centex, it was up less.

Should we assume that's to say a regional issue in terms of more in Texas at a low price points as opposed to pushing price less in Centex than any other brands?

Certainly our operators are trying to get price wherever they can.

They're also trying to get return, so paces get you there.

It's interesting.

We were talking earlier.

The Texas market had outsized first time absorption increases, but the non-Texas markets were up 13%.

So of that 20%-plus pace increase, it's not just Texas.

The return characteristics are not so much in that business about generating higher prices because that buyer is somewhat limited to the down payment they can come up with.

So pace is what actually replaces it, and we've seen that across all of our markets this quarter.

Stephen East, ISI Group.

Just wanted to follow up, Richard and Bob, a little bit on the cash generation, et cetera.

As you sit here and look, this year and next year, before your debt paydown and your repos, given the big land spend, what do you expect should flow through on the cash generation side for this year and next?

We haven't given any color on next year.

Obviously, we've been -- absent debt transactions, dividends and share repurchases, we're going to be cash flow generative this year and substantially so.

A lot of it will depend on how much of the land spend we actually get done and then how much we allocate to share repurchases.

If Richard's scenario were sort of a slow and steady, is it rational for us to think $215 million cash generation before those other issues would be on a similar track?

Steve, we'd hesitate to give a number.

I think in general we are focused internally on positive cash flow generation given where we are, so that's clearly among the things we are focused on.

Certainly we will not be a taxpayer next year; so our earnings stream is cash, consistent with this year.

Buck Horne, Raymond James & Associates.

I wanted to ask a strategic question because you've got good presence with the entry level brand; you've got the move up brand; you've got the active adult segment.

Have you given consideration to moving further upstream, whether it's the second time move up or making a full bigger push into the luxury market?

Have you considered expanding your brand options?

Buck, we have talked about it.

This is Richard.

We've talked about it internally, and we think the Pulte brand allows us to expand up nicely.

As a matter of fact, we have several communities operating in the sixes, sevens and even a couple over one million with that brand just fine.

One of the things we recognize is that even though the margin and return characteristics in that segment are very strong and good, they typically represent about 10% of the total housing market, plus or minus.

So we think we can serve that very effectively with the Pulte brand.

So you wouldn't think you would need to make an acquisition outside of the Company to try to establish a different presence or a different brand?

That is correct.

We have enough experience with the Pulte brand and with the construction techniques, design, et cetera, that we believe we can stretch that name into that category.

But again, we want to be selective.

We like the fact that we are diversified with our portfolio.

I apologize, Will, I remembered your second question; and it was about the rating agencies and investment period.

The business that we're running we think certainly warrants consideration for investment period.

We've shared our thoughts on that with the rating agencies.

The one thing I would say is it's not the overarching reason we do things.

Again, we think we actually warrant consideration for investment period today.

And we're running the business in a way, I think, that is supportive of that type of rating.

But it doesn't mean we would've look at doing things differently if we thought it was better for shareholders.

There are no further questions at this time.

I turn the call back over to Jim Zeumer.

Thank you, Operator.

I know you have a lot of other calls to deal with today.

So we will be available if you have any follow up questions.

Thanks very much for your time, and we'll look forward to speaking with you in the next quarter.

This concludes today's conference call.

You may now disconnect.