普爾特房屋 (PHM) 2015 Q2 法說會逐字稿

Good morning.

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

At this time I would like to welcome everyone to the PulteGroup Incorporated second-quarter 2015 financial results conference call.

(Operator Instructions)

Mr. James Zeumer, you may begin your conference.

Great.

Thank you, Steve, and good morning everyone participating today.

I want to welcome you PulteGroup's conference call to discuss our second quarter financial results for the three months ended June 30, 2015.

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

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

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

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

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

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

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

That said, let me turn the call over to Richard Dugas.

Richard?

Thank you, Jim, and good morning, everyone.

For those of you who have been following PulteGroup for the past few years you have repeatedly heard us use terms such as balance, discipline and return driven, which are all supportive of the value creation strategy we have been pursuing since 2011.

Consistent with this focus, let me highlight a few numbers.

We have purposefully increased our land spend over the past 24 plus months allowing us to grow our community count and land pipeline over the period, while actually owning fewer lots but controlling more positions via options.

We've remained disciplined in our pursuit of land, yet our land acquisition and development spend for the first six months grew by 30% or roughly $200 million over the prior year.

The increased investments we make now are intended to support an expanded business in the future.

We have focused on investing in superior land positions which coupled with a slow but steady housing recovery, helped drive an 11% increase in our second quarter order value, our highest quarterly value in eight years.

We have also been consistent in our emphasis on maximizing margin opportunity on the homes we sell as demonstrated by our second quarter gross margin of 23.3%, an increase of 60 basis points from the first quarter.

Our gross margins continues to rank among the highest in the industry which is a dramatic improvement from just a few years ago.

And finally, we paid down $238 million of debt in the second quarter while also returning almost $0.25 billion to shareholders through dividends and stepped up share repurchase activity in the quarter.

I know we have made this point before, but in the past we likely would have driven every dollar back into new land even if it meant reaching for deals or potentially taking on additional risk.

Under today's more disciplined approach, we look first to invest appropriately in the business and then to return excess funds to our shareholders.

When we started our value creation journey in 2011 we talked a lot about being more disciplined in how we ran the business and including share repurchases and an increase in dividend in our allocation of capital.

We also talked about the need to focus on key operating and financial metrics such as gross margin, overhead leverage, inventory turns and return on invested capital.

I am very pleased to say that the numbers I highlighted and others that Bob will discuss shortly demonstrate the ongoing success of our efforts and that we remain clearly on track with our value creation strategy.

The final numbers I want to highlight relate to our backlog, which at almost 9000 homes valued at $3.1 billion, is our highest in the past eight years.

Such a large pipeline of sold homes affords us a lot of production visibility and stability as we look to the second half of 2015.

Picking up on comments that I made on our last earnings call, broadly speaking I would say the improvement in housing demand that we noted in the fourth quarter of 2014 continued through the entire spring selling season of 2015.

Our experience aligns with government data that, while always subject to revision, shows that new home sales on a non-seasonally adjusted basis are up every month of 2015 over the comparable prior year period.

While dynamics ranging from potential federal reserve actions to uncertainty around global events are helping to create significant volatility in the financial markets, the key underpinnings of the housing recovery remain very supportive of future strength.

First, the US economy continues to expand at a modest rate enabling the country to generate in excess of 200,000 jobs per month without triggering inflation fears.

Second, interest rates are still historically low, and while they have started to move higher, they are still very supportive of home buying especially as compared to ever increasing rental rates.

And finally demographics are aligned to support sustained housing demand with the large boomer population at one end and the even larger millennial segment at the other.

Recent data suggests that millenials are getting more active in the market.

According to the National Association of Realtors, the percentage of first time buyers rose to 30% in June.

In contrast a year ago, first time represented 28% of all buyers.

While still below the 40% to 45% expected in a typical recovery, first time demand is showing more consistent signs of improvement.

Overall we continue to see positive market trends and believe we are still in the early to mid stages of a sustained recovery of US housing.

In addition we believe PulteGroup is extremely well positioned to capitalize on the market conditions.

Our goals remain consistent to deliver exceptional operating and financial results, return funds routinely and systematically to shareholders and to deliver an unmatched experience to our home buyers.

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

Bob?

Thanks, Richard, and good morning.

PulteGroup's homebuilding revenue for the second quarter totalled $1.2 billion which is comparable with prior year results.

Second quarter revenues reflect a 1% or $3800 increase in average selling price at $332,000 which was essentially offset by a 1% decrease in closing to 3744 homes.

The 1% increase in average selling price in the quarter was driven by a 6% increase in our average Centex price of $214,000 along with a 2% increase in Del Webb to $332,000.

The average selling price for our Pulte brand was down 1% to $391,000.

The decrease in second quarter ASP for Pulte primarily reflects a mix shift driven in part by last year's acquisition of certain home building assets of Dominion Homes in Columbus and Louisville.

In the second quarter the closing percentages by brand were as follows.

24% were Centex; 48% were Pulte and 28% were Del Webb.

This compares with 23%, 45% and 32% respectively in the second quarter of last year.

As we've discussed over the past two years, two-thirds or more of our land investment has been going toward Pulte communities because that's where we're seeing the best returns on invested capital.

The overweighting to Pulte communities continues to drive a shift in the mix in the homes we deliver.

Gross margin for our second quarter was 23.3% which is a sequential increase of 60 basis points from Q1 of this year and is down 30 basis points from the second quarter of 2014.

Allowing for typical quarter-to-quarter variability we expect our third and fourth quarter gross margins to be comparable to the 23.3% delivered in Q2.

Based on these expectations we anticipate that our full year gross margin will exceed our previous guidance of 23%.

The Q2 trends and option revenues and locked premiums were comparable to what we experienced in Q1 of this year.

For the second quarter, option revenues per closing increased 9% or $4400 over last year, while locked premiums gained 5% or $600.

Sales discounts in the quarter totaled 2.2% per home which is up about 50 basis points from last year but consistent with our preceding two quarters.

As a result of changes to certain accounting estimates recorded in the second quarter of 2015 and 2014, SG&A for the periods was not directly comparable.

Reported SG&A in the second quarter of 2015 was $130 million or 10.5% of home sale revenues.

SG&A in Q2 2015 included a $27 million benefit resulting from a legal settlement.

Excluding the impact of this settlement, SG&A was consistent with our guidance for quarterly expenditures in the range of $160 million to $165 million.

Reported SG&A in the second quarter of last year was $230 million which included an $88 million in charges for insurance reserves and office relocation cost.

Financial services second quarter pretax income was $10 million up slightly from $9 million the prior year.

Our mortgage capture rate for the quarter increased to 83% up from 80% last year.

Closing out our review of the income statement, the effective tax rate was 38%, which is consistent with our previous guidance resulting in second quarter net income of $103 million or $0.28 per share.

EPS for the quarter was calculated on approximately 364 million outstanding which is down 4% from last year resulting largely from share repurchase activities.

Moving on to our home building operations, at the end of the second quarter, the Company had 6779 homes under construction of which 17% were spec.

Our finished spec inventory at quarter end was only 314 homes which remains well below one finished spec per community.

We continue to emphasize a build to order model for our operations, but we may elect to put a limited number of spec homes into production in certain communities to help reduce seasonality in our production in the future.

While the number of spec units involved will be modest, we believe a more even production cadence has the potential to yield construction efficiencies and can help reduce some of the volatility in quarter-to-quarter closing volumes.

On the land side we approved approximately 4800 lots for purchase and ended Q2 with 136,000 lots under control.

In total, 40,000 or 30% of our lot positions are controlled through options which compares to 10% at the end of 2010 when we launched our value create initiative and reflects the progress we have made in our effort to manage our land risk and drive higher returns on invested capital.

Of our controlled lots approximately 23% are developed.

In the second quarter, we spent $444 million on land and related development of which 58% was for development of existing positions and 42% was for acquisition.

For the first six months of this year, our total land spend was $929 million.

We are anticipating that our land investment activities will accelerate in the second half of 2015, although we are likely to slightly underspend the $2.4 billion full-year authorization we noted at the beginning of the year.

A competitive land market, development delays and longer entitlement timelines on a number of projects mean some deals have slipped and some may have been postponed or can be delayed indefinitely.

As we have said previously, we won't force investment into the system.

While our $2.4 billion authorization remains in place, we now expect that our 2015 land investments will be closer to $2.3 billion.

This would represent an increase of almost 30% over last year's land spend and is consistent with our view that the housing recovery will continue for at least several more years.

In addition to investing in the business during the quarter, we also repurchased 10.7 million shares of PulteGroup stock for $213 million or $19.90 per share.

This level of activity is roughly double recent quarters and is consistent with our commitment to the return of capital to our shareholders.

We also used available capital to retire $238 million of senior notes that matured in the second quarter.

Given the reduction in both our debt and equity positions, we ended the quarter with a debt to capital ratio of 26% and a cash position of $478 million.

Second quarter sign-ups totaled 5118 homes an increase of 7% over the prior year.

As Richard noted in his comments on a dollar basis, sign-ups increase 11% to $1.8 billion, our highest quarterly value in 8 years.

By brand unit sign-ups increased 27% at Pulte and decreased 13% and 7% at Centex and Del Webb respectively.

Adjusting for community counts, absorption paces increased 6% at Pulte and 4% at Del Webb while declining 7% at Centex.

Lower reported Centex paces were deliver in part by acquired communities in Columbus and Louisville which are still transitioning to new product and [prosecute].

During the second quarter, we operated from 630 communities which is up 7% from the comparable prior year period.

Plans still call for us to open approximately 200 new communities during 2015.

Depending upon the ultimate timing of community openings and closing, we expect to operate from approximately 610 to 625 communities in both Q3 and Q4.

And finally, we ended Q2 with a backlog of 8998 homes valued at $3.1 billion which is up from 8179 homes valued at $2.8 billion last year.

Now, let we turn the call back to Richard.

Thanks, Bob.

You just heard Bob provide a break-down of our business by brand, but we have had discussions internally about whether this data provides a complete picture of our home-building business.

Why do we say this?

As we have talked about on our prior calls, in 2014, we undertook a comprehensive study of active adult consumers.

Then this year we launched a comparable study of first-time home buyers to identify underserved market opportunities.

Last year's research has already led to our developing smaller active adult communities, and, while the first-time buyer study is still wrapping up, it shows distinct differences across the spectrum of first-time buyers from traditional entry level to millennials.

While externally we discussed buyer activity along brand lines for the sake of simplicity, investors who have follow PulteGroup for a while, know that we actually design communities to serve 11 targeted consumer groups or TCGs.

From the community location and lot lay-out to the specific floor plans and options we offer, we develop each community to address distinct buyer wants and needs.

Our TCG process and brands usually align, but not always.

For example, some of our newer, smaller active adult communities are marketed under the Pulte Homes brand to differentiate them from large, highly ammenitized Del Webb offerings that may be also in the market.

At the same time within our array of communities are those developed to serve a subset of first-time buyers who prioritize proximity to downtown over schools and single-family design.

Based on experience and consistent with this year's market research work, the buyers for these communities are very much today's millenials who are moving out of shared living arrangements and into their first homes.

While geared for first-time home buyers, these communities typically sell under a Pulte Homes brand.

The active adult communities under the Pulte brand are just ramping up in number.

But communities serving first-time millennial buyers under the Pulte brand accounted for roughly 10% of our communities and 500 sign-ups in the second quarter.

And based on our project pipeline, our investment is growing consistent with increased first time buyer demand.

Our future calls will look for ways to efficiently bridge the gaps between our brand information and the more fundamental TCG data to provide clearer insights into our consumer focused approach to the market.

Before we open the call to questions, let me close out my comments with a quick overview of market conditions.

Consistent with comments made earlier in this call, overall demand in the second quarter was solid with strong buyer traffic to our communities and sign-up gains in both units and dollars.

Generally, demand trends at the market level have remained fairly constant over the past several quarters.

At a high level, conditions in the quarter were as follows.

Starting on the east coast, we experienced strong demand pretty much across the board from Massachusetts to Florida.

As we have highlighted in the past, Georgia, Florida, and the Carolinas continue to demonstrate notable strength.

We have also seen improvements further up the coast, particularly in the northeast.

Working our way toward the central third of the country, the midwest generally experienced a favorable demand environment although we saw volatility between markets and periods.

I would like to make a comment about our Columbus and Kentucky markets which we entered last year through the purchase of certain Dominion assets.

The team there has done a great job repositioning select communities and building the business while getting integrated into our system and adopting our common plan processes and related strategic pricing programs.

Both markets are very healthy, and we are pleased to have a business presence there.

Dropping down into Texas, demands softness at higher price points in Houston which we have commented on previously is being exacerbated by shortfalls in lot availability in certain communities across the state resulting from rain-induced development delays.

Traffic to our communities across the Texas markets indicate that buyer interest remains high, but consumers have more product from which to chose as additional supplies in the market.

Demand conditions out west remain strong from Arizona, Nevada, and New Mexico, and into California.

If there is a market or submarket where we have experienced any softness in sales, the issue is more likely product availability than buyer interest.

We are certainly encouraged by the demand conditions we saw in the quarter and over the spring selling season.

I will say, however, that market, submarket, and community locations matter with better, closer in positions generally still fairing better in the quarter and through the first few weeks in July.

For PulteGroup's perspective, we would say the spring selling season was a successful one for the Company and one that leaves us well-positioned for the coming quarters.

We experienced strong sign ups allowing us to end the quarter with a backlog of almost 9000 homes, our highest backlog in years.

At the same time, we have a robust land pipeline that we continue to expand through our disciplined investment process.

And our operations continue to deliver superior gross margins with the potential for significant overhead leverage as delivery volumes climb in the last two quarters of the year.

Finally, we maintain what might be the strongest balance sheet and financial position in the industry.

We view the flexibility this provides us as an important competitive advantage as we continue to move through the housing cycle.

The strength of our market and financial positions are a direct reflection of the hard work of our 4000 employees, and I want to recognize and thank them for their efforts.

Now let me turn the call back to Jim Zeumer.

Jim?

Thank you, Richard.

I'll now open the call for questions.

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

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

(Operator Instructions)

Our first question comes from the line of Alan Ratner with Zelman & Associates.

Good morning.

Nice quarter, and congrats on the buy-back activity.

I think that is going to be well-received.

First question on the backlog conversion and the closings.

I think last quarter you highlighted that you really expect to see most of the catch up from the weather issues more into Q3, Q4.

Was hoping you could give us an update there on how you think closings are going to play out over the course of the remainder of the year.

And with the new spec strategy or I guess little bit higher spec total, is that something we that should factor into closing and order estimates this year, or is that more in anticipation of the 2016 selling season?

This is Richard.

A couple of things.

We don't really use conversion rate as something that we track a lot internally, but weather in the second quarter did impact our delivery schedule, and I would just say this.

With regard to the balance of the year, we expect that conversion rates to trend back toward historical norms through Q3 and Q4.

Relative to the spec comments Bob made, one thought there.

We are not dramatically changing our spec position, but we are going to introduce selected spec deliveries to help even out production cadence, and that is more of a 2016 impact than anything you could expect this year.

Got it, thank you.

And then one follow-up.

On the pricing environment you mentioned margins should be pretty flat with Q2.

I was curious what you are seeing on the pricing side.

Is pricing power accelerating in any of your markets, and if so, how do you think about the margin outlook maybe beyond the next couple of quarters?

Do you feel like the bias is more to the upside from current levels, or are you still striving for maintaining a current 23% level on a go forward basis.

First of all -- this is Richard again.

And I'll say that we are very pleased with our margin trajectory, and we are happy with the guidance that we provided which is up slightly from what we said before.

From a pricing perspective I think we believe there's more upside than downside to pricing.

We're going to have to watch what happens with the economy and with rates overall.

But we wouldn't want to provide, Alan, any commentary beyond the guidance that Bob gave.

And so nothing really at this point for 2016.

Our backlog visibility is not quite that far yet.

Thank you.

Our next question comes from the line of Stephen Kim with Barclays.

Your line is open.

Thanks very much, guys.

Good results.

Let me ask you a question if I could about the orders.

I think you mentioned about Centex down 7%.

You were talking about some acquisition-related affects?

Can you guys give a little more granularity about that?

What you meant by that and what we are seeing on the ground which is driving that negative impact?

Yes.

Stephen, this is Bob.

What we were highlighting was that the paces out of the Columbus and Kentucky are slower, so if you would exclude that from our Centex results, our Centex basis would have been flat quarter-over-quarter.

Got it.

Okay, that's great.

Second question relates to a comment -- I think a thread of conversation that you and I had a month or so ago where you were talking about some consumer research, I think, that you were conducting regarding the entry level, and I think one of the take-aways was that we were -- you were starting to see that millennials or entry level buyers are willing to trade size for proximity.

They're not willing to drive til they qualify kind of thing.

They kind of want to live closer to the job centers and were willing to take a smaller footprint home to do that.

I wanted to follow up with you and see whether or not that is, in fact, what your research has concluded.

And if so, do you have any availability in your existing communities or ones that you keyed up here over the next year or two to accommodate maybe some smaller more entry-level product into existing land positions, or -- because that would seem to suggest you would have to rezone them -- or not?

If you could just talk about the research and how you would deal with the conclusions when you're on the ground.

Yes.

Stephen, it's Bob again.

We have not concluded that research.

We're making progress, and so certainly before the end of this year.

But for everybody's benefit essentially what it would suggest is that there is a group of first-time buyers in that millennial age group that, and you said it, that are willing to trade sizes for proximity, and I think essentially what Richard talked about in his prepared remarks about that millennial buyer and what it was trying to tell you was that it is already a pretty significant part of our portfolio of, again, not entry level but first-time buyers in that millennial age group.

And so we do have communities open today.

Certainly you have heard us talk about three quarters of our spend is Pulte branded.

It includes that buyer group.

So, yes, we are actively serving them today.

And, Stephen, Richard with a little additional commentary.

That is what we call our TCG3 category which is part of that first-time buyer group that is served under the Pulte brand.

That was a clarification we are providing at the end.

In addition to it being a big piece, as Bob indicated, we also indicated in our prepared remarks it's a growing piece.

And then lastly, we would not anticipate being able to rezone existing communities to take advantage of it, but that's not to discount the ramp-up in investment activity geared toward that category which will play out over the coming years.

Thank you.

Your next question comes from the line of Stephen East with Evercore ISI.

Your line is open.

Thank you.

Good morning, Richard.

You made two comments during your prepared remarks that I thought were interesting.

One you talked about investing appropriately as you move forward and the other better located still performing well.

Could you talk some about what that means to you, investing appropriately as you go through this cycle?

And maybe you can put it in context versus this year.

I don't know.

Whatever works best.

But then also the better located is still performing well and through July and all that.

Talk about what that means -- better located if you will.

Sure, Stephen, good morning.

I would say from an investing appropriately standpoint, what we really mean by that is tied to our discipline philosophy where number one, we invest in the business in our land positions.

And the other investment choices come after that including an increase in dividend, selective M&A and then residual cash being used for routine systematic buy-back purchases.

And I think you saw us execute against all of those this quarter.

We view that as very consistent.

To put a little more granularity in it, we're very proud of the fact that we stuck to the appropriate investment philosophy which leads to your second comment around better locations.

What we are trying to say is that is one of the reasons our margins are holding up well.

We continue to believe we're buying the best dirt out there.

We're not reaching for things.

Overall, our land trajectory, our spend trajectory has been up, so we would expect a bigger business in the future.

And that is why we continue to invest where we are while keeping all the other parameters in check.

I hope that helps.

It does, thanks.

And then along those lines, your orders grew pretty much in line with your community count.

I know you focused a lot more on margins over the last three years and have not been as focused on the absorption pace if you will.

As you look out, call it over the next four quarters, six quarters, whatever time frame you're comfortable putting on it, how do you view that dynamic?

Are you out of a point in a cycle where you think your absorptions should be greater, or you still are that's just secondary to what you are doing on the gross profit line?

Yes, Stephen.

Our overall goal we said it repeatedly is return on invested capital, and the blend between pace and price is a tricky one in every single community, and frankly, it depends on the community overall.

I would be hard-pressed to say whether we had more opportunity in margin or pace going forward, but I will tell you this, we made a lot of progress on margin over the past few years.

We haven't provided any guidance beyond that, but we're looking to balance both and for us, everything from compensation to the way we talk about the business is really ROIC.

We've emphasized margins a lot these past few years, because our margins needed a lot of improvement overall.

And at this stage, we're really talking about returns.

I apologize for not being able to give you more specificity there, but that is the way we're looking at it.

Our next question comes from the line of Mike Dahl with Credit Suisse.

Your line is open.

Hi.

Thanks for taking my questions and the helpful color here.

I wanted to you just ask a question maybe a little bit more granularly on the margin guidance.

It seems like if you are holding these levels for the next couple of quarters, it nets out to slightly above 23%.

The previous guide was approximately.

Are we talking was the previous guide really like a 22.8%, and now it's a 23.2%?

Just any sense of magnitude on what the increase is.

Yes, Mike, it's Bob.

We have -- just trying to clarify.

We have been speaking to 23% certainly in the last quarter.

Since we delivered in excess of that and have suggested that we'll continue to -- and with the seasonality of the business, the production being more geared toward the back half of the year.

We would blend to a higher rate than 23%.

Just wanted to point that out.

Got it.

Okay.

And then shifting to some of the color around Texas.

Obviously some challenges conditions as you noted with the weather.

But were some of those comments also around just being the high end pricing issues being issues exacerbated by shortages, but then there was also a comment about more competition.

Was that also still isolated at the high end, or was that a broader issue that you're seeing on the market -- on the ground in Houston.

Mike, this is Richard.

Raining throughout Texas hampered results across the state for the quarter, particularly with regard to production.

The comment we made regarding the high end was specific to Houston.

But the comment we made regarding a little bit more inventory in the market is statewide.

Our overall view on Texas.

We like Texas.

We like the market environment.

It's a little more competitive than it was.

We are trying to say it as matter of factly as we can.

Thank you.

Your next question comes from the line of Bob Wetenhall with RBC Capital Markets.

Good morning.

Congrats on a very nice quarter.

I have gotten a lot of very positive feedback on your share buyback activity.

And I think speaking to have some of Richard's comments about land prices being inflated.

If you don't find what you need in terms of land supply to your expectations, what is the priority for that excess cash?

Does it go to share buybacks, or what do you want to do with that?

Hey, Bob.

This is Bob.

I think the answer is we've looked at that every year.

Certainly, we have been more active in the share repurchase arena.

That is largely not a call on the equity.

It's actually just the capital structuring.

We're below our targeted range of 30% to 40% leverage at 26%.

So we feel we have significant capacity to do that.

But again first and foremost, we want to invest in the business.

You can see that in the investment level.

Going forward we will look at that with a forward view based on out best estimates of what the business can do.

Certainly, you heard Richard talk about the priorities investing the business, paying an increasing dividend, so we'll look at dividends.

M&A activity if it is out there, we would opportunistically look at.

And the rest would be share repurchases.

Okay.

That's very helpful.

So, my other question is on that theme of reinvesting back into the business.

Today when you are looking at the incremental dollar spend that you are going to put in, which of your three brands is most likely to get that dollar?

And geographically, where are you trying to invest in those?

Thanks and good luck.

Thanks, Bob.

Richard here.

Thus far in housing recovery, and we have been pretty consistent in this, we have been putting most of our dollars into the Pulte brand to serve that move-up category.

I would say there's an increasing focus on the entry level for us, and again, we are trying to highlight in our commentary that we have been actually putting quite a bit of capital to the first-time buyer, that millennial category to serve that growing category.

We'll have more to say about that in the future as our study continues.

And then I would say some selective Del Webb investments in smaller positions across the system.

Overall, I would say Pulte is the priority, and probably the other two categories with a fairly balanced approach.

But always trying to seek the highest return so it can vary from quarter to quarter.

Thank you.

Your next question comes from the line of Michael Rehaut with JPMorgan.

Your line is open.

Good morning, everyone.

The first question just on the segments.

You mentioned that the Pulte brand in a sense is bleeding into the other, if I could use that term.

Bleeding into the other categories in terms of serving some of the Del Webb demands as well as some of the entry level or millennial demand.

And I'm just curious when you think about, if you were to report ASPs and particularly closings is what I am getting at, not by the brand, but by, broader, let's say entry-level move-up, entry level/move-up for Centex, active adult instead of Del Webb which would include perhaps some of that Pulte branded offerings.

At this point, would the Centex and Del Webb percentages, be up by a couple percent?

And given the morphing or brand extension of Pulte, is this perhaps how you might report the segments from a demographic perspective going forward?

Sorry, I hate to be technical.

Our segments are geographic, Mike.

We present this information for simplicity for when we are talking to Wall Street.

But I think the answer is, and what Richard highlighted, we are seeing a -- we are seeing a future pipeline of that active adult that is Pulte branded.

We are -- we have an existing book of business that is first-time buyer that is Pulte branded, and he highlighted the amount of that.

So I think what it would show you if you looked at it in the way that you just asked, the -- that entry level first-time buyer group would be bigger than our Centex brand.

You wouldn't see much of a change out of Pulte into the active adults, so that wouldn't change much.

So, I think we're looking at is how to make that information digestible without confusing people with too much data.

Right.

I think that the continuation of thinking about that would certainly be helpful.

And maybe again broadening -- instead of Centex, Del Webb, maybe just broadening the definition so to speak.

Secondly, you mentioned Texas and also California in your regional review.

I was hoping to get a little bit more possible market by market review of California.

How the different markets are going as well as when you talk about Texas being slightly more competitive is that just in the form of perhaps discounts coming up a little bit by a percentage or two or if you are seeing any price reductions?

Hey, Mike, it's Richard.

With regard to California, what we are seeing is the better located assets are doing extremely well, some of the outer lying positions not quite as well.

But where you have very, very well-located communities, we're seeing a lot of strength.

With regard to Texas, overall, the Dallas market is the strongest of the markets.

But our commentary overall is not really related to discounts.

It's a little bit more inventory in the market across the state.

Not a dramatic shift, but something we have noticed a couple of quarters overall.

Again still a good housing market, one that we are pleased to be in, but a little bit more competitive than it was.

Thank you.

Your next question comes from the line of Megan McGrath from MKM Partners.

Your line is open.

Good morning.

I think you mentioned either in your slides or your press release that's out an increase in the amount of land that is optioned.

Was that a change over the last couple of quarters?

Are you seeing any kind of change and increase in options available, or could you maybe give more detail on what's going on there?

Yes, Megan.

It's Bob.

We have been seeking to do more option transactions and I would say it goes back over years.

It's not quarters.

You have seen a gradual increase in the data we have presented.

It showed 10% up to now 30% and the answer is to the second question is it more available?

Really not.

So what we are seeing is a lot more raw transaction so historically with a healthier developer base in the community, you might have seen more opportunity to do finished lot option take-downs.

We are really talking about is if there is a position, I'll make -- that will make up a fact pattern that has 600 lots in it.

We have a current need for 200 of them, a medium term need for 200 more and then a longer term need for 200 more.

What we are trying to do is structure transactions that would allow us to take the first third, control the second and the third third over time.

But we would be the developer typically, and so it comes down to a parcel by parcel negotiation.

Megan, Richard here.

One of the reasons we highlighted is just when you look at it over the few years as Bob indicated, it's a pretty dramatic improvement and very consistent with our overall focus on a much more balanced approach with regard to capital.

In addition to the priorities for capital even within the land priority, we are very proud of the fact that we are controlling a lot more lots while not taking near as much risk as we have in the past.

All right.

Thanks.

And just a little more clarification on the first-time buyer discussion.

I think you're trying to answer this, but let me just clarify And you mentioned in your initial comments that there is evidence in the market that the first-time buyer is coming back.

You mentioned some statistics from the NAR.

And you also mentioned the new stuff -- that your Centex is flat.

And you are saying that you are actually seeing it?

It's just in these Pulte branded communities, or you are saying there is some evidence but you are not actually seeing it yet in your order growth?

Actually, Megan, if you go back over the last year or two, we've had pretty strong comps in terms of the Centex brand and not just in Texas.

We have highlighted other parts of the country, but those -- Texas is a big part of our Centex business.

So I think we have seen flat although absorptions this quarter, ex Louisville and Columbus, we have seen pretty good results over time.

And to your question in terms of what is in the Pulte brand, I don't have the data right now to tell you what that first-time buyer component that we flagged Pulte is.

But obviously the Pulte same store comps were up 6% so you can certainly conclude that it was a portion of that.

Thank.

You your next question comes from the line of Jack Micenko from SIG.

Another question on the first time buyer and how it relates to the Pulte brand expansion.

What I think I am hearing is the strategy on the first time for Pulte is hey, look, we're going to keep focusing on that higher income, first-time buyer, maybe the larger house, in part to preserve margin.

More so than a lower margin, lesser location Centex type product.

Is that the fair interpretation of where we are on the first-time strategy.

Jack, I don't think it is either, candidly.

What we are trying to highlight is that under the Pulte brand as I think everyone is aware we have been serving this millennial buyer and the traditional view of an entry-level consumer buying a home in their mid 20s and trading up, et cetera, over time, is changing.

In fact, we're seeing a lot of people actually skip the Centex true entry level product, say at $200,000 and buy a Pulte branded home at $300,000 in their early to mid 30s, typically consistent with when they either get married or begin living together, and their housing needs change from rental to ownership.

We have been doing quite a bit of that business with the Pulte brand, and it's in an urban sort of in-fill location clearly targeted to that upwardly mobile millennial buyer.

And as we started peeling through the data and in response to lots of questions from investors, we wanted to just provide a little more clarity, that that was a significant portion of our business, and we were not ignoring the growing interest in what is happening with the millennial category overall.

We have been doing a lot of that business through the Pulte brand with town home product, a little bit of condominium product, and it's not an insignificant amount of our business.

As we indicated about 500 closings in the recent quarter.

We are simply just trying to introduce this concept that our brand strategy was not always perfectly consistent with first-time move of an active adult.

Going forward, we are looking for ways to clarify that a little bit more.

Okay, thank you.

And then I think, Richard, in your prepared comments, you had mentioned land heating up.

Any way you can give us a magnitude of rate of change, and then curious if the step-up in buyback is in any way related to that higher, more expensive land picture that you mentioned.

I'll start, and Bob may want to add something here, Jack.

First of all, the land environment has been competitive for the last several quarters, and we haven't noted anything unique this particular quarter overall, and as it related to our buyback activity, starting last fall, we told investors very clearly that we had a priority for investment, first in land, second in increasing dividend, third in opportunity M&A and fourth, residual cash for systemic and routine buybacks.

And we have been executing exactly against that.

As Bob indicated, our leverage is a little bit lower than we like it.

We had free cash flow.

And I think we are extremely pleased with the flexibility we have.

It's not an either or for us.

We were able to step up our land purchases fairly significantly in the range of the guidance we provided while still paying down debt and repurchasing shares at a higher rate than we had.

So it wasn't particularly related to a spike in land prices this quarter, but more of an execution on our strategy that we think over time provides the best returns for shareholders.

Jack, The only thing I would add to that on the land piece is it is important to remember -- and you heard Richard talk about that we are seeking better located assets, and the reality is those are always competitive.

Thank you.

Your next question comes from the line of Will Randow from Citigroup.

Your line is open.

Good morning and congrats on the quarter.

In terms of your two years of developed supply, is that skewed towards controls -- I wouldn't expect it to.

And do you think that is enough developed lot supply if we see demand pick-up incrementally?

I'm not sure that I understand the question.

When you say our two-year supply?

Maybe you could repeat it, Will, if you don't mind.

Sure.

Sorry about that.

Your two years of developed lots, in terms of supply.

Do you think that's skewed -- is that skewed towards control in any way?

And do you feel like that's enough lot supply if we were to see demand pick-up?

Yes.

I think the answer is it's going to be market by market.

There are certain markets where we have ample supply of lots in front of us.

There are others we are working through and developing lots as we go.

I think we've got 27% of our lots are finished owned.

26% are under development.

We feel pretty good.

What you heard Richard talk about in Texas when we get weather it can slow you down, so it's always a work in process.

Thanks for that.

And in terms of as a follow-up as the $27 million legal settlement.

Do you expect any further reoccurrence of that, and what is the cash flow hit from that?

Well, actually this is a reversal of an accrual so it means we won't spend the cash, and it's really just another step in the process of settling construction issues, one that has been working its way through the courts for a number of years.

Thanks, guys.

Thank you.

Your next question is from Susan Maklari with UBS.

Your line is open.

Good morning.

Your Centex ASP rose 6% during the quarter despite some of the sort of issues around the acquisitions and things in that segment?

Can you just talk a little bit about what drove that and how we should be thinking about it going forward?

Susan, it's actually a mixed issue.

It's because of the production issues in Texas which has our lowest Centex price product, so the mix is just different.

Okay.

And then looking long, bigger picture, with the potential rise in rates coming this year, are you hearing from any of your buyers that that's factoring into their decision process yet, or maybe how that will eventually factor into their thoughts and getting them maybe to pull trigger and make that purchase decision?

Susan, it's Richard.

I would say it's a little early yet for that to have played out.

Rates just did begin rising here over the last month or six weeks primarily.

Historically, I would say that does drive purchase behavior as people fear the loss of low-rate environment, so we certainly don't fear that occurring provided that it continues with the economy continuing to strengthen.

Are we are hearing a lot of anecdotal information on the ground about that?

I would say not yet.

Thank you.

Your next question comes from the line of Buck Horne with Raymond James.

Your line is open.

Hey, thanks, guys.

I'm just trying to interpret some of the comments and maybe read between the lines here.

But based on the land investment strategies and the talk about the first-time millennial buyer which may be acting and behaving differently than previous generations.

I am kind wondering is there a sense that the core Centex, that entry-level suburban, sub-$200,000 price point, is that really going to have a recovery in this cycle, and I am guessing what are your thoughts about do we really need to maintain the Centex land positions at this point?

Or do we -- is there a need to continue reinvesting in that product.

Buck this is Richard.

We absolutely want to continue reinvesting in that area when returns make sense.

Nothing in our commentary would suggest that we don't believe that is an important part of the housing recovery.

I would say, however, consistent with what we've said in the past, making the returns work for those more suburban, lower priced product is more challenging still today.

And we would expect that as the housing continues that, that will be a little easier as pace continues to come back into that segment.

That's a little bit disconnected candidly from our comments about the millennials.

We were simply trying to highlight with regard to the millennials that there is a growing appetite for a fairly affluent in-town urban buyer that wants this attached product that we have been delivering and will continue to.

With regard to Centex proper, if you will, the kind of traditional entry level $200,000 price point as an example, that is an important part of the business, particularly in Texas and particularly some of the southeast markets that we want to continue to innovates in.

It just hasn't warranted the ramp-up in investment that some of the other categories have yet.

But we're watching it closely, and we candidly expect it to at some point in the housing recovery.

Okay.

And just because it was brought up earlier in a quick comment.

There was a mention about you'd potentially look at M&A transactions if they would make sense, I guess.

I am wondering what criteria and under what circumstance you guys would think about M&A.

Is that mainly looking at other private players or potentially another public to public transaction.

What was maybe behind that comment or thought process?

Nothing new there.

We highlighted that it would be one of the priorities for our utilization of capital.

I wouldn't want to speculate as to whether it would be a private or public builder.

We would typically look at these as land transactions, though.

We use the same basic underwriting criteria for a transaction for a group of assets from a builder as we would for a single community.

So it is really a land play for us.

Thank you.

Your next question comes from the line of Nishu Sood with Deutsche Bank.

Your line is open.

So, on the interest rate question, we have seen rates rising through most of this year, particularly in the second quarter.

So is there anything that you have seen on your month by month trends or maybe through your mortgage operation that could give us some sense of whether the rising rate environment has spurred people on or caused people to back away from purchases?

I don't know that there is anything that you would be able to know what would have happened if rates had been different.

One thing you can see is that people are locking a little bit earlier.

People are not choosing ARMs.

So from the financing perspective, it influences their behavior in terms of how much risk they want to take coming up to the closing.

But I haven't heard any detailed commentary about I am not buying because of interest rates, or I bought today because interest rates might go up.

Got it.

And on the -- you have talked a good bit about the weather.

You address Texas mainly as I understand it your comment so far.

So in the midwest and the northeast, there were also some pretty significant rains towards the end of the second quarter, particularly June.

You folks obviously have a decent-sized operations in those regions.

Any effect on those regions either from a demand perspective or from a deferral of closings, construction schedules perspective?

Nishu, it' s Richard.

I would say, and what we have seen in the rest of the country, you typically see somewhere in the country with regard to weather.

We haven't called it out uniquely.

Clearly weather always plays a factor in production.

It's not as big of a factor with regard to sales unless it prevents you from opening communities which the reason we called out Texas at this time as it was so unique.

It caused some community delays which impacted our sales environments some but more importantly helped to cause the production shortfall that we have seen through the first couple of quarters of the year.

So beyond that, nothing that we would note particularly.

Thank you.

Your next question comes from the line of Mark Weintraub with Buckingham Research.

Your line is open.

Thank you.

On the capital structure, I wanted to get a sense as to where you think you are today.

Is your cash position about where you would want it to be, and do you feel that you are still under levered?

What might be the key metrics that we should be thinking about to understand what you view as an optimal capital structure.

Yes, what we have highlighted is that we would like to have leverage, it sort of hinges off of leverage somewhere between 30% and 40%.

We're obviously a little bit below that today.

We have just under $500 million of cash at the end of the quarter.

We have several hundred million dollars of availability under our credit facility above and beyond that.

So we feel like we have a really strong liquidity position.

Obviously we chose to pay down our debt instead of refinancing it with the maturity in the second quarter.

So going forward, I think as we look at it, a lot of it will depend on our expectations for investment in the business, and obviously, we reforecast that periodically, coupled with our expectation for cash generation out of the business.

And so in looking at it I think it's fair to assume we have got a pretty big maturity coming up next year, so we'll be looking at our leverage over the next two or three quarters to figure out what makes sense.

We pay attention to capital markets activity all the time to see if there are attractive entry points.

So I think we are very comfortable running with this much cash and even a little bit less candidly, because we have so much availability under the revolver.

And then we think we have access to the capital markets on terms that would be attractive, so when we need to we have a way to fill any cash shortfalls that we might want to deal with.

So, again, leverage being between 30% and 40% is what is driving most of our decision making.

So is it fair to say -- because I guess you haven't made that decision whether to go refinance or not.

I see that you might have decided, yes, go and refinance and yet you chose not to.

Is that because you want to have a greater degree of line of sight on terms of the investments in land and development opportunities that would have justified putting more debt on the balance sheet?

Well, we feel like we do have a pretty good line of sight into our projected spend certainly over the next 6 to 12 months.

So what it tells you is we have obviously a business that is cash accretive.

We're not paying cash taxes.

We have a lot of production coming at the back of this year which will be generating a lot of cash.

We're also going to be investing a lot, but we didn't feel any pressure that says -- oh, gosh, we should go refinance this debt.

So really, it's just an evaluation as time goes on.

Thank you.

And your next question comes from the line of Jay McCanless with Sterne Agee.

I wanted to ask in terms of the ROIC focus.

Could you talk about the returns of potentially selling some of the land that you may have earmarked for some of these entry level and maybe a little more spec heavy communities.

Because it looks like in the first half of year, you guys have run a land gross margin of about 22%.

Last year I think it was roughly 31%.

I think there is a case to be made that you might make more from selling that land.

Especially with the appreciation you discussed rather than trying to put maybe some gross margin dilutive homes out there.

Yes, Jay, this is Richard.

Several years ago, about three years ago, we undertook a really deep [dive] look at every single position on our balance sheet.

And we were pretty clear with investors that we did intend to sell a portion of land, and we've done most of that.

I don't know what the exact numbers are, but somewhere around $300 million of land over the past few quarters have been sold.

So, it's always a portion of our portfolio, and from time to time, there'll be a position that gets sold.

I would say a lot of that heavy lifting is done.

It's also hard to predict the timing on it so we couldn't give you any good projections.

But there's not a concerted effort to wipe off a portion of the balance sheet there.

We would rather develop that into home sites and capture the margin on the land as well as the home.

We have gotten pretty efficient at capturing margin on the home in addition to built-in land appreciation.

We prefer to capture it that way.

Given the fact that our prudence with regard to our capital structure has been what it's been, we're pretty happy about that decision.

I wouldn't look for any big land sales.

Okay.

And then I want to follow on, on the debt question with the 2016s and the 2017s coming due.

Could you talk a little bit more of that.

Could you refinance both transactions at one shot, or do you think you have a better shot of paying it off?

Just a little more color on the 2016s and the 2017s.

I don't want to comment on 2016s and 2017s other to say we obviously look at them as we think about our leverage.

I don't think it makes sense to take everything out.

We will probably start to want to develop a leverage ladder again.

So you see us putting different things in place but not trying to take care of all our current maturities.

But you never know.

Time will tell.

Thank you.

Your next question comes from the line of Haendel St.

Juste with Morgan Stanley.

Your line is open.

Hey there.

Good morning.

Thanks for taking my question.

Good morning.

So I guess the first question is to follow up on some other comments you made on spec.

I guess specifically your appetite for raising spec count levels.

As you look across your platform are there regions today where increasing spec count makes sense.

Is it across the board, and how do margins on your spec compare to margins on build to order?

Our comments -- this is Richard.

Our comments on spec are related to help us with regard to managing production cadence overall.

And it would be on a very limited amount.

We have gotten very, very comfortable and happy with our build to order model, so we're not trying to signal any kind of shift in priority.

We just wanted to let you know we may feather in some additional spec in select communities to give us an opportunity to help even out our production cadence.

I would suggest the margin impact of that would be very minimal.

We are not talking about any significant real change in spec policy.

Got you.

Appreciate that.

The second question is another margin-related question.

Curious to what extent mix playing a factor in driving gross margin higher sequentially and whether specific areas were able to contain costs versus the first quarter?

Yes, so on a sequential basis, actually, our margins are up across all three of our brands as well as a little bit of a benefit from interest.

So no concentrated issue there, just better performance across the entire spectrum.

Thank you.

And your next question comes from the line of Ken Zener with KeyBanc.

Your line is open.

Yes.

Hi Ken.

I wonder -- I have two questions.

One, is your success in gross margins which is adjusted for commissions industry leading?

Is that actually trapping you into a narrower opportunity in terms of how you are looking to invest, perhaps?

Ken, this is Richard.

I would say absolutely not.

We've tried to be as clear as we can that we run the business based on returns.

Frankly, whether margins go up from here or go down, if we get excellent returns on it, that's the name of the game for us.

Our land priorities are not margin specific.

They are return specific as we look at the 200 communities-plus we are going to open this year, it's all based on return.

I don't think gross margins have trapped us into anything.

We are happy with our gross margins.

We have done a good job with our gross margins.

We are proud of them.

I don't think it limits what we do going forward at all.

Good.

And I ask that obviously doing that respectfully, because you do have very high gross margins.

And I was thinking about a another builder that also focuses on returns, but in that investment process pursued, a lower price point, got higher absorption and I agree with that approach.

Obviously, there is a wider view perhaps from investments in terms of interpreting if that is good to have the gross margin to go down as they are not as focused investors on the returns on capital.

Could you perhaps highlight concerns or thoughts you have had on how others enacted their return on capital with relation to that gross margin.

And I think you have to appreciate it for returns on what the Company's overall philosophy is.

For us it's related to our overall capital approach.

If we were as focused on land investment exclusively as we were 5 or10 years ago, we might have a little bit of a different to posture here.

But given the fact that we want to be involved in all aspects of capital allocation which we are very convinced over the housing cycle is going to be the best total shareholder return for shareholders has dictated our philosophy.

So, I wouldn't want to comment on what anyone else is doing.

I would just say that we think we are doing a good job quarter in and quarter out in balancing it, and over time we are very confident, it's going to yield the right result.

We have learned our lesson in the past of trying to overdo it on the land side, and we are really pleased with our balanced and prudent approach today.

So I hope that helps.

Just to close that out, Ken, it's Jim.

We have talked for a while now about not being so focused on just driving unit volumes and driving volumes for volumes sake and really being more focused on, to Richard's point, about the returns.

And the consequence of the investments and everything to line up accordingly.

Thank you.

There are no further questions at this time.

I will turn the call back over to you, Mr. Zeumer.

Thanks, everybody, for your time this morning.

We'll certainly be around for the remainder of the day.

If you have got any additional questions, we'll look forward to speaking with you on our next call.

This concludes today's conference call.

You may now disconnect.